Facing a dilemma, RBI takes baby steps

Apr 20, 2010

In this issue:
» Now, sovereign funds set their eyes on India
» India's food problems to rise
» Will the rapid growth in 2-wheeler sales continue?
» Jim Rogers on the impact Goldman can have on stocks
» ...and more!

There was nothing against expected lines in RBI's monetary policy announcement today. But the central bank worded its policy (for FY11) very carefully. It had its eye on future inflation as it raised interest rates for the second time in almost a month. It also kept a close watch on the fledgling economic recovery, which justifies that the interest rate hike has been marginal at 0.25%.

As to what it means for markets and Indian banks, be rest assured that there is no bad news! The sufficient liquidity in the system gives banks enough headroom to lend despite some of it being sucked out. Also, proposals for new bank licenses, freedom of pricing loans (base rate) and the like have offered banks enough reasons to cheer. Markets in particular, have been enthused by the RBI once again referring to the foreign banks' entry roadmap that was put on the backburner last year.

Having said that, the RBI has a dilemma of its own! It needs to ensure that while absorbing excess liquidity, growth and borrowing are not impacted. But as before, the central bank is treading the path many would fear to tread. It will not only be very transparent in explaining the logic of its monetary stance but also discuss the same with analysts. The baby steps in ensuring financial stability that the RBI has taken so far are commendable.

 Chart of the day
Today's chart shows the rise in the number of FIIs registered with the SEBI. FIIs, or foreign institutional investors, have been the major movers of Indian markets in the past. And they continue to wield a heavy influence on Indian stock prices even today. One way we can reduce this dependence is by way of strengthening the domestic institutional and retail investor base. While reforms have been suggested for this to happen over the next few years, we still see a lot of time to pass before something meaningful is seen on ground.

Data Source: SEBI

Continuing with foreign investors, there is increasing interest from this set of investors in emerging markets like India. Investors of all hues seem to be queuing up to buy a piece of the future. As per a leading business daily, 'sovereign funds' are the latest entrants into the Indian markets. Recently the Oman Investment Fund has registered with SEBI. Earlier, heavyweights from China, Abu Dhabi, Australia, Ireland, Brunei, New Zealand and Canada have registered. Some of them of them are pension funds. These government-promoted funds are seeking the highest returns just like everyone else. Technically, they fall under the category of foreign institutional investors (FIIs). A set of investors we are not great fans of! But hopefully sovereign funds will operate under a long term investment horizon. Indian investors have often borne the brunt of FII fickleness who exit en masse during any crisis.

India's rise as an economic powerhouse has received wide praise worldwide. But there is one aspect of this growth that the western world doesn't seem to be liking. It's the impact of India's demand for more food on global food prices that have been rising. India herself hasn't been spared of this rise in food prices. The impact is clearly seen in the rising food inflation that stands at 17% currently.

But that's not all! Rising temperatures and inadequate rainfall are causing grain output to stagnate in India. This is likely to threaten food security in the country of a billion-plus population. As per reports, average temperatures have increased by 0.25 degree Celsius in the past decade, when the monsoon crops are sown in June. Temperatures have risen by 0.6 degrees when winter crops are planted in October! Call this the 'hottest' economic threat India faces over the next few years and decades!

Indian markets reacted positively to the RBI's move. The BSE-Sensex was trading with gains of around 70 points (0.4%) at the time of writing this. Stocks from realty and banking sectors were among the biggest gainers today. IT stocks however lost out. Gains were also seen in most other key Asian markets, except China and Japan.

Hero Honda, the two-wheeler industry bellwether announced its full year results yesterday. Everything that could go right with the company went right in FY10. Macro environment improved, tax rates were lower, cost pressures were muted and plants were humming at full capacities. Obviously, any company would benefit from such a trend. And Hero Honda was no different!

The company logged in record numbers and managed to grow its full year net profits by 74% YoY. This came on the back of a 28% growth in sales and strong improvement in operating margins. Besides, the company produced more vehicles from a tax free facility. This also helped the profits grow. All in all, a fantastic year for the company!

However, a favorable year on all fronts comes with a big drawback. There is nothing left to improve upon in the next year. And secondly, there is a high probability that a few favorable factors start moving against you. This is certainly what the company should guard against. Already, commodity prices have moved up. This should start pressuring margins as per the company's own admission.

Another key Indian company TCS, India's largest IT exporter declared its FY10 results yesterday. The company's management in the post-results analyst conference call was upbeat about the robust deal pipeline. As per it, growth appears to be promising in sectors like banking & financial services, retail and healthcare.

TCS' management also sees stability in demand for and pricing of 'running the business' kind of basic IT services. Large deals in discretionary IT spending space are still hard to come by. We believe Indian IT majors who invested in the business while maintaining the cost and pricing discipline are emerging stronger from the downturn. Currency volatility, Indian direct tax regime and SEZ policy, and the comeback of discretionary IT spending, will be a few key variables defining the future growth for these companies.

The scandal at Goldman may have shaken up world markets off late. But if investing veteran Jim Rogers is to be believed, there is still a lot more to go. Rogers opined recently that markets are overdue for a correction. "Any market that goes up this much, this fast, this steadily without correction - it's not normal. When that sort of things happens, the market could be setting itself up for a 15 to 20% correction," says Rogers.

Further, he feels that Goldman is surely not alone. There will be many, many more skeletons to come. His warnings may be dire. As far as India is concerned, while we do not find ourselves as pessimistic as Rogers, we certainly find stock prices to be on the higher side. Not a good time to be loading up on stocks for sure!

Now that's what you can call as the trade of this decade! This is for those who understand a bit of derivatives. "April 170 Goldman Sachs" puts, which would have expired worthless on Friday had the SEC not come out open on the Goldman Sachs fraud, rose 140,000% on that day.

So, as The Daily Reckoning says, "...anyone with an extra thousand bucks and some insider info on Friday morning could have made just shy of a million and a half by Friday afternoon." Anyways, as per reports, there was surprisingly large volume in these 'out of the money' puts the days before. This means someone knew what was coming. Maybe someone in the SEC should look into that, too!

 Today's investing mantra
"The best stock to buy may be the one you already own." - Peter Lynch

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4 Responses to "Facing a dilemma, RBI takes baby steps"

Anand Sankaran

Apr 21, 2010

that one is a good one



Apr 20, 2010

As rightly pointed out, Foreign Institutional Investors have been playing a major role in the movement of Indian Stock Markets. When they enter the fray in a big way, the market moves up steeply and when they opt to exit, all at the same time during a crisis, the market crashes. The sufferers are our unwary investors.

Oppressive summers and scanty rainfalls have certainly adversely affected food-grain production in the country to a very great extent. As a result, Indian economy is facing a major economic threat.


Burnt Investor

Apr 20, 2010

Your IPO advisory on Shree Ganesh Jewellery IPO was way off target


chandravadan ajmera

Apr 20, 2010

Dear sir;
First of let me admit frankly that i am a new reader of this 5 minuted wrap up. so first let me congratulate for such an excellent holistic coverage. it is much better than the professional writers writing the economic news papers of national coverage. the writer seems to be a great thinker.i have found it extrelely interesting and satisfying. i would like to congratulate the whole team of the equity master for such a professional excellnce.as such i am a practicing physician; but i am having good interest in economic matters. thanks again and god bless you.

Equitymaster requests your view! Post a comment on "Facing a dilemma, RBI takes baby steps". Click here!