Renewed speculation for an easier monetary policy by the Indian central bank should underpin equities in the coming weeks, after retail inflation dropped to a five-month low. Investor confidence would also be strengthened by receding chances for an increase in US interest rates when the Federal Reserve’s policy panel announces its decision on Wednesday.
The Reserve Bank of India (RBI) is scheduled to meet on October 4 and market pundits are betting that new Governor Urjit Patel would herald his term with a reduction in the repo rate. Consumer price inflation, the decisive factor that influences rate decisions, fell to 5.05 per cent in August from 6.07 per cent the month before, reversing a rising trend over the past few months to 23-month high.
Citigroup said a CPI reading of 5 per cent would open up the possibility of a quarter-point rate reduction in October.
The repo rate has remained at a five-year low of 6.5 per cent since April, after former Governor Raghuram Rajan, whose three-year term ended on September 4, made no changes in two subsequent policy meetings, citing inflation concerns. His exit was caused by the government’s lukewarm response for a second term.
“We expect Governor Patel to surprise the markets by being less hawkish than Governor Rajan, while staying focused toward meeting the stated flexible inflation targeting mandate,” Deutsche Bank economists Taimur Baig and Kaushik Das said in a report.
“If the RBI refrains from cutting in October,” then it will likely cut rates in December by 50 basis points, they wrote.
Slower retail inflation was helped by a drop in the prices of pulses, a major staple for the country’s 1.3 billion people. As a result, food inflation eased to 5.91 per cent from 8.35 per cent in July, and the trend should continue with bountiful rains increasing the prospects for higher farm output.
Economists believe that inflation has peaked and should now move to a declining trajectory. The central bank has a March 2017 target of 5 per cent, which looks achievable. Adding fuel to the clamour for lower rates was official data that showed industrial output in July contracted 2.4 per cent from a year earlier, dented by lower production of capital goods and consumer non-durables.
Overall economic growth in the June quarter grew at a lower-than-expected 7.1 per cent, the slowest pace in more than a year and well off 7.9 per cent expansion in January-March.
Given the situation on the ground a rate cut in early October, just ahead of the peak consumer spending season, would be a big booster for the markets. Many businesses in India pay their annual bonuses to their employees before “Diwali”, the festival of lights, which falls on October 29. A reduction in prices and stronger consumer demand would boost sales.
“There was heavy profit-taking at the start of the week, but buying came in strongly in the last three days,” said equity salesman Manish Shah. “There are many funds waiting to jump in, so I expect gains in the next week.”
Tepid US economic data is seen as pouring cold water on a rate increase by the Federal Reserve next week. Cash flows into emerging markets can take a hit when US rates rise, so a steady policy would help maintain the robust foreign demand for Indian equities and bonds.
Dwindling domestic demand pulled US retail sales down 0.3 per cent in August, more than expected, after edging up 0.1 per cent in July, indicating the soft underbelly of the economy. With manufacturing output also down last month, economists are cutting their growth estimates for the third quarter.
The Federal Open Market Committee (FOMC), the rate-setting panel, is scheduled to meet over Tuesday and Wednesday, and Goldman Sachs said the likelihood of a rate hike dropped to 25 per cent from 40 per cent earlier, pointing out that Fed officials have refrained from preparing markets for a tightening.
“The lack of a signal is meaningful because if action were likely, the committee would normally make an effort to nudge the market toward anticipating a hike,” the investment bank’s economists led by Jan Hatzius wrote in a note to clients.
“While participants’ recent arguments for and against further tightening mirror those made in the pre-lift-off debate, we find the generally in-line performance of the economy this year difficult to square with the policy path that the FOMC has chosen,” Goldman said.
Both the top-30 Sensex and the broader 50-share Nifty closed with weekly losses for the first time in three weeks, but they pared the fall as bargain hunters leapt in.
The decline was caused by profit-taking, led by foreign funds who sold about $160 million worth of stocks, after the benchmark index had climbed to an 18-month high. Overseas investors are still net buyers of more than $6.3 billion of stocks since the start of January.
The rupee came under pressure on cash outflows and talk about a devaluation, which was denied by the finance ministry. The currency, however, could feel some heat because of more than $20 billion that banks would have to shell out over four months for maturing foreign currency deposits collected from expatriate Indians in 2013. Still, with exchange reserves of more than $350 billion, there is enough cushion.
The currency could also draw comfort from a reduction in the trade deficit in August. The shortfall in the first five months of the current financial year has dropped more than 40 per cent to $34.7 billion, with the slide in imports outpacing a smaller drop in exports.
Merchandise exports contracted by 0.3 per cent to $21.5 billion in August, while imports plunged 14.09 per cent to $29.2 billion, helping the trade deficit to narrow to $7.7 billion from $7.8 billion in the previous month. Gold imports fell for a seventh straight month to $1.1 billion.
The rupee closed at 66.985 against the US dollar, down 0.5 per cent over the week, after slipping beyond 67 at one point on Thursday.
ICICI Prudential IPO
On the radar is an initial public offering by ICICI Prudential Life Insurance Co Ltd, a joint venture between ICICI Bank and UK’s Prudential Plc, which opens on Monday. It is the first share offering by an insurer in India and the price range for the sale is Rs330-334 per share.
At Rs60.5 billion, the IPO would be the biggest since Coal India’s sale in 2010. While ICICI Bank is selling 12.65 per cent from its 68 per cent holding, Prudential that owns 26 per cent is not selling any stock in the IPO.
Meanwhile, L&T Technology Services Ltd’s Rs8.94 billion IPO was subscribed 2.52 times when the sale closed on Thursday, exchange data showed. Its parent engineering and construction conglomerate Larsen & Toubro Ltd had offered about a tenth of its stake in the unit in a price range of Rs850-860 a share in the sale.
The response for the offering was tepid compared with software services company L&T Infotech Ltd’s IPO in July that attracted bids for more than 11 times the shares on offer.
The author is a journalist based in India.