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Markets cheer RBI repo cut; but move will take time to trickle down

The Reserve Bank of India took the equity markets by surprise announcing a reduction of 25 basis points in repo rate to 7.75% shortly before they opened for trading on Thursday. Equity players were taken aback by the RBI move which was a major deviation from its usual practice of announcing policy changes after the close of market hours.

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The Reserve Bank of India took the equity markets by surprise announcing a reduction of 25 basis points in repo rate to 7.75% shortly before they opened for trading on Thursday. Equity players were taken aback by the RBI move which was a major deviation from its usual practice of announcing policy changes after the close of market hours.

"The surprise move before market hours was well received by the markets and has given an incremental push to the sentiment. But this will not lead to an immediate increase in capex," said U R Bhat, managing director at Dalton Capital (India) Advisors, a foreign fund.

They said the markets have been displaying bearish trends since Tuesday and on Wednesday, Nifty was down by 46 points from Monday's close of 8323, following global cues where commodity prices like crude, copper continued to weaken hitting new lows on weak demand.

Most players said the rate cut was factored in by the bond markets which reacted a bit by slipping 8 bps largely on future hopes of rate cuts. The 10-year bonds ended at 7.69% from the previous day's close of 7.77%. The fact that rupee, after showing intra-day volatility of 61.50, closed 10 paise stronger at 62.08 to the dollar from its previous close of 62.18.

Not all agree that the markets could correct immediately after today's gain and come in sync with global developments. The trade data released by the government late evening has made many players optimistic of a sustained rally.

The country's trade deficit or current account deficit (CAD) hit a 10-month low at $9.43 billion in December as a result of dwindling global oil prices (currently at $48.61 from June's high of $115.06 a barrel) tumbled and lower demand for gold, both of which tilts highly in favour of trade balance and stemming the weakening rupee.

The deficit was much below the market expectations of $16 billion. Lower global crude, a renewed hope of sustainable inflation levels of less than 6% and now the repo rate cut, augurs well for the country's road map to growth.

"The rupee showed signs of gaining during intraday trades to 61.50 to the dollar, but closed slightly weaker above 62 following buying from importers and state-owned banks," said K Harihar, treasurer at FristRand Bank. "The encouraging trade data should help the rupee stabilise if not strengthen," he added.

Economists and bankers opine that the sentiment on the economy has changed for good. Though the quantum of 25 bps per se is insignificant to translate into immediate rate-cuts to the common man or push up investment cycles, but it certainly emits a strong signal that softer rates were in the offing.

"My personal view is that interest rates could come down by as much as 200 bps during the course of the year. Funding under repo is one source for banks, some liabilities of banks are of long term duration, therefore deposits would continue to be high. The signal that RBI has now given is that we are now entering a regime of low interest rates," said Keki Mistry, CEO and vice chairman of HDFC.

Equity markets ended with a 2.6% gain. The BSE Sensex ended 728.73 points higher at 28,075.55 translating into a gain of 2.66%, while the NSE Nifty closed 216.60 points up at 8494.15 or 2.62% higher.

"The unexpected timing of rate cut saw the Indian equities open up with a wide gap and the gains continued through the day, wiping out all shorts. The markets could become vulnerable on global cues in the days to come," said Arun Kejriwal of Kejriwal Research.

"The credit growth has remained in a limbo. It would take time for banks to lower rates as any move in that direction could impact profitability," said VK Vijayakumar, investment strategist and economist at Geojit BNP Paribas.

Most economists are of the view that one could expect further rate cuts but timing is something one cannot predict. According to Shubhada Rao, president and chief economist at YES Bank, "The disinflationary process remains incomplete, as the economy is yet to fully absorb the sharp deceleration in commodity prices led by oil. Inflation momentum is this expected to ease further. This along with government's policy support, should allow RBI to front-load the cuts in the repo rate, which we anticipate to the tune of another 50 bps in 2015."

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