Has inflation warrior RBI doused stock market euphoria?

Are the big bulls of Dalal Street living in denial?

A day after inflation-spooked RBI went for the second straight interest rate hike, markets are showing greenshoots of worry.

While never-ending global concerns and effects of an anticipated global currency war are the favourite whipping boys these days whenever Indian stocks fall, the bellwether Sensex on Thursday falling 356 points has a local angle too, though few would admit it on-record. Truth be told, the central bank's monetary policy actions have kind of punctured the shallow rate-hike regime theory propagated by the pundits of share-bazaar when the first rate-hike happened in June.

With a national election less than a year away, the economic cost of fighting politically-sensitive inflation may come by sacrificing a little bit of growth --- this is the prism in which some participants are beginning to see the second successive hike, spoiling their usually effervescent mood.

The difference in the market's reaction to the same quantum of rate hike shows its distress. On June 6 when the RBI surprisingly hiked the interest rate by 25 basis points to 6.25%, bold markets surged with Sensex closing 276 points up to end above the 35000 mark. A day later on June 7, the index went up by a further 284 points, shrugging off any concern about growth. But the same market on August 1 slipped 85 points even though commentators said the second rate hike was on "expected lines". On August 2, the decline was larger as the Sensex fell by nearly 1% or 356.46 points to 37165.16.

Tasked with the unenviable job of running a tight ship, RBI Governor Urjit Patel has his hands full: inflation with lurking uncertainty about oil prices, possibility of a global trade war and fiscal slippages worries. "Price-rise ahead of a Lok Sabha election is a political hot potato the united Opposition will make chips from. We understand RBI's compulsions. But lower rates are critical for Indian economic recovery. If rates are hiked again, we will have to adjust expectations," said a portfolio manager, who manages long-term term money of foreign investors.

A sustained rise in interest rates is bad for corporates. Investors price a company's stock as the value of all its future cash flows discounted back to the present. So, if interest rates go up, those future cash flows are worth much less today.

"Over the last six to 12 months, borrowing costs for corporates, banks and other institutional borrowers have been rising with yields across the curve on instruments ranging from CPs, CDs, corporate bonds, T-bills and government bonds rising by 125 to 150 bps probably on account of reduced appetite for corporate lending by banks. RBI's action to hike the repo rate by another 25 bps today might result in a marginal increase in lending rates for corporate borrowers with a lag," said Dhaval Kapadia, director, portfolio specialist, Morningstar Investment Adviser India.

While some fund managers suggested that the RBI is at the end of its rate-hike cycle and that is reiterated by the Monetary Policy Committee's (MPC) neutral stance, not everybody is so optimistic. The RBI has forecasted a mildly rising inflation trajectory -- 4.8% in H2FY18 and 5% in Q1FY20. Upside risks to inflation remain on account of crude oil price rise, volatility in global financial markets, rise in households' inflation expectations, higher-than-average hike in MSPs for Kharif crops, and fiscal slippage both at Centre and state levels.

Many experts, especially economists at the US banks, have had to face the ignominy of having their RBI calls going wrong, twice. Among wealth managers, there is a consensus building about the timing of the next rate hike. They feel the RBI will be on hold if rains are normal, and if not then brace for a third hike in October.

"Equity markets will take the rate hike in stride pending additional data; generally, it takes at least three hikes in a rate-hike cycle for the impacts to start to be felt by consumers and businesses," points out Sunil Sharma, chief investment officer, Sanctum Wealth Management.

The RBI's 'neutral stance' is also under the spotlight. "Although underlying tone of RBI statement appeared balanced, inflationary risks and outlook highlighted by the central bank indicates hawkishness. We believe that RBI may be understating the inflation trajectory," wrote Dhananjay Sinha, head, institutional research, economist and strategist, Emkay Global Financial Services in a note to investors.

A repo rate of 7% is on the table, i.e. 50 bps more than 6.5% at present. Arvind Chari, head-fixed income & alternatives, Quantum Advisors, said if upside risks indeed pan out in the next 3-6 months, expect the repo rate to be hiked further to 7.0%.

With the Sensex already trading much above the December 2018 targets of 32000-35000 of most foreign and local brokerages, caution is clearly in the air.