Business | Markets
Rate rise to keep Sensex under pressure
A stiff increase in interest rates by India's central bank last week should keep shares under pressure over the near term, but hopes the government will hasten reforms to raise foreign holdings in insurance and pursue freer norms for investment in banks could underpin the market.
- By Geetha Bhaskaran, Special to Gulf News
- Published: 00:09 August 3, 2008
Mumbai: A stiff increase in interest rates by India's central bank last week should keep shares under pressure over the near term, but hopes the government will hasten reforms to raise foreign holdings in insurance and pursue freer norms for investment in banks could underpin the market.
The Reserve Bank of India (RBI) lifted its benchmark short-term lending rate by half a percentage point to nine per cent, its highest in more than seven years and above market expectations for a quarter point rise. The increase follows a hefty 75 basis points hike in June.
The RBI also pushed up the deposits that commercial banks must keep in reserve with it by a half point to nine per cent.
"We got socked with a double-whammy," said equity trader Arun Kumar. "This is going to be painful and I think we will have to pay a heavy price."
Rising borrowing costs will slash spending by consumers and hurt sales for companies. The big losers will be property developers and automobiles, all of which are mostly bought with loans.
Still, the top-30 Sensex rose 2.7 per cent last week to 14,656.69, stretching gains into a fourth week in a row and matching its best run of rises in 2008. Still, the index is down nearly 28 per cent this year.
"We saw a late rally on hopes for reforms in the fin-ancial sector," said investment consultant Martin Thomas. "But clearly the outlook is anything but subdued. The RBI is focused on curtailing inflation. If growth is damned, so be it."
Banks that make money from expanding their loan portfolio will be hit as demand for credit slows, while the risk for defaults on existing loans climb. They will also be knocked by rising yields that will cause heavy notional losses on their investment in bonds.
Annual inflation has been hovering around 12 per cent, the highest in more than 13 years and rising prices of food and other essential items will become a major issue with national elections due by May next year.
For the central bank, fighting inflation has always been its top priority though its earlier attempts were tempered by the government, which also wants to keep growth firmly on a robust upward trajectory.
"We are emphasising a lot on inflation but underplaying growth," RBI Governor Y.V. Reddy said after releasing the monetary policy on Tuesday.
A central bank survey of professional forecasters showed they expected inflation to remain in double digits for most of the year, with a 40 per cent chance of it easing to 9-9.9 per cent by March, higher than the RBI's upwardly revised estimate of seven per cent..
"Bringing down inflation from the current high levels and stabilising inflation expectations assumes the highest priority in the stance of monetary policy," the central bank said in its quarterly review.
The central bank lowered its growth forecast for 2008-09 to around eight per cent from its earlier projection of 8 to 8.5 per cent.
Probably fearing the iron-fisted monetary tightening would cause unease among investors and dent growth sharply, Reddy said: "Exaggerated bearishness is as dangerous as exaggerated bullishness."
"We're not expecting any pass through of global oil prices to domestic prices in the current financial year," Reddy said.
The RBI survey showed economists expected growth to slow to 7.9 per cent in 2008-09, a notch lower than the central bank's estimate. It forecast profit growth for the corporate sector will slow to 16 per cent, sharply lower than a quarter rise expected in a previous survey, due to the aggressive spate of monetary tightening in recent weeks by the central bank.
Rallies
Thomas said the market could see short bursts of rallies as falling oil prices ease concerns about inflation. But weak underlying sentiment will trigger quick bouts of profit-taking, keeping the market rangebound with a negative bias over the near term.
Many economists think the rising borrowing costs will balloon the government's debt, worsen its fin-ancial condition and trigger downgrades by agencies - a move that could hurt foreign portfolio inflows.
The government has waived $17 billion of farm debt, while oil subsidies are estimated to cost $42.5 billion. Both are challenges to monetary policy.
However, Finance Minister P Chidambaram sought to calm nerves. "These interest rates will not remain high forever," he said on Friday. "We will get out of this trough and we will go back to moderate and normal interest rates hopefully in about six months to a year."
- The writer is a journalist based in India.
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