Reddy-mix gives Sensex indigestion

MUMBAI: The Reserve Bank of India’s (RBI’s) determination to reduce money supply and credit growth roiled the markets on Monday, with the Bombay Stock Exchange Sensex recording its second-largest fall ever of 617 points. The index closed 4.7% down at 12.455.

What is spooking the markets is not what the RBI did last Friday - it raised banks’ cash reserve ratio by 50 basis points to 6.5% and the repurchase (repo) rate by 25 basis points to 7.75% - but what it may still be planning to do.

“The RBI’s aim is to reduce excess liquidity in the system (which is stoking inflation). With capital inflows from foreign investors continuing unabated, there seems to be no sign of a tempering of liquidity,” says Manish Sonthalia, vice-president of equity strategy at Motilal Oswal Securities.

The markets are thus not sure if the RBI is finished with its interest rate hikes or whether there’s worse to come. Given the inverse correlation between interest rates and stock prices, some market mavens believe that the indices have further to fall.

So will we see a repeat of May, 2006, when the markets fell 29% in 25 days? This year the markets have already fallen 15% from their peak of  February 8 in 35 days. So there could be more mayhem ahead.

Deepak Jasani, head of retail research at HDFC Securities, explains the parallels and differences between last year and now. “In May-June, 2006, the correction in the Indian stock markets was initiated by a global tightening of interest rates and funds flowing out of emerging market equity.” In June, 2006, the US Fed raised rates for the last time, ending 17 consecutive hikes of 25 basis points each that started two years earlier. “This time, however, the correction is the result of domestic policies that are trying to stem excess liquidity,” says Jasani.

“Clearly, if capital inflows slow down, they would address the RBI’s concerns to a great extent,” adds Jasani.  Net inflows from foreign institutional investors (FIIs) has topped Rs 7,000 crore this year. In March, 2007, it has been over Rs 1,400 crore.

Does this mean that FII inflows, which add to systemic liquidity, are bad for the markets? No, because demand for Indian paper by foreigners translates into higher stock prices, and better overall sentiment. But over the short term, if this demand is fuelling money supply and hence inflation, the RBI could take measures to curtail it, which could adversely impact market sentiment.

So, with interest rates moving up, is the stock market waiting for local interest rates to peak before finding its bottom?

Sonthalia of Motilal Oswal feels that with the base effect of last year kicking in, wholesale prices inflation should moderate soon. “Given this, at least in April, we may not see the RBI resorting to further hikes,” he says. “Since the markets have been subdued over the past couple of months, the prospects of a crash, as seen in May last year, look very unlikely.”

Monday saw interest rate-sensitive sectors like banking, autos and real estate stocks coming in for a sharp correction.

Considering that the Sensex is just 40 points above its recent bottom of 12,415, touched on March 5, 2007, technical analysts feel that the Sensex should find major support at these levels. “Purely on technicals, we went below the May, 2006, top on March 5, 2007. That level of 12,415 should act as a strong support,” says Prem Daga, a technical analyst who has been tracking the charts for 15 years now. “If that bottom holds, the correction may be getting over. If it doesn’t, then the Sensex would find its bottom at around 11,500, which is the 17-month moving average for the index,” he adds

So, keep your fingers crossed.