Forget PSU Bank Mergers, Rising Interest Rates Are More Important for the Market - The 5 Minute WrapUp by Equitymaster
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Forget PSU Bank Mergers, Rising Interest Rates Are More Important for the Market

Sep 18, 2018

Kunal Thanvi, Research analyst

The big news of the day is the merger of Bank of Baroda, Vijaya Bank, and Dena Bank.

If you're not a shareholder in these banks, this event should not concern you. In fact, if you've been keeping up with what Tanushree's been saying, you would have stayed away from most PSU Banks if not all of them.

Having said that, if you're a shareholder in Vijaya Bank, or Dena Bank, congratulations! You may get something out of your investment.

If you're a shareholder in Bank of Baroda, I offer commiseration.

Now, dear reader, if you're not holding shares of any of these three banks, that's good. You can keep your mind away from these distractions. And focus on bigger issues...like the direction of interest rates.

Interest rates affect stock prices after all...and they're going up. The Reserve Bank of India (RBI) has started increasing rates. The market is expecting another hike next month.

The RBI is facing a peculiar situation. Here's a short story that highlights their predicament...

My friends' brother is applying for a job these days. He is frustrated. As we all know, the job market is dull...to say the least.

He told me... 'It is very difficult to get a job without experience. But I can't get experience unless I have a job. It's like a trap. A classic catch-22 situation.'

I tried to offer some kind words... 'Don't worry man. Be patient. Just keep trying and you will get it'.

The RBI is facing a similar situation.

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Which Way to Go?

You see, dear reader, the rupee has fallen around 12% this year. It hit 72 against the US dollar last week. The rupee is the worst-performing currency in Asia.

Usually, when the currency depreciates, the central bank increases interest rates.

Why?

Higher interest rates tend to attract foreign investment. This increases the demand for and value of the home country's currency.

The RBI has already hiked the repo rate twice in 2018 to 6.5%. No wonder, the market is expecting another hike in the RBI's October policy.

There is another argument to support rate hikes: Crude oil prices. In 2018, crude oil prices have increased by 15%.

This plays a significant role in determining the level of inflation in our country. Fuel is an important component in India's consumption basket. We import more than 80% of our requirement and it can't be easily substituted, despite the government's efforts to promote ethanol!

But wait...

The recent inflation data tells us another story.

Consumer price inflation fell to 3.7% for the first time in 2018. This is below the RBI's medium-term target of 4%.

The lower than expected inflation complicates the task for the RBI's Monetary Policy Committee (MPC).

Not to mention, a rate hike could complicate matters politically with the general election less than a year away. High interest rates could impact demand and thereby impact growth.

As Sarvajeet highlighted a few months back... 'Till now, the capex recovery is like a mirage in a desert. You go after it and it gets further and further away'.

With further rate hikes, a revival in investment and manufacturing could be halted and could disrupt growth prospects.

Really, it's a catch-22 situation that the RBI faces.

And with this, the MPC meeting in October becomes an interesting quandary.

So, will the RBI hike the interest rate?

We'll find out soon enough.

The MPC meeting is two weeks away. In this time period, the movement of the rupee and the crude oil could dictate whether the RBI will go ahead with the hike or maintain the status-quo.

It's really a delicate situation. It's best to stay cautious and not get too aggressive in this market.

Chart of the Day

As I mentioned earlier, the Indian rupee is the worst performer in Asia in 2018. It has fallen by around 12% against the US dollar this year.

Indian Rupee is the Worst Performing Currency in Asia

The rupee is under pressure due to a strong dollar and high oil prices. Similarly, the spill-over from the emerging-market turmoil in Argentina and Turkey is weighing on the rupee.

The falling rupee is also triggering sales of bonds and stocks, which in turn is further pressuring the rupee.

Nevertheless, last week, the government announced several measures. This includes cutting down non-necessary imports, removal of withholding tax on rupee-denominated bonds, and easing overseas borrowing norms.

That said, in the near term, the rupee being under pressure could benefit export-oriented businesses.

The recent Smart Money Secrets recommendation will benefit from the rupee depreciation.

The company derives around 65% of the revenue from exports. The icing on the cake is the company's focused entry into the B2C segment, which provides it a long runway for future growth.

If you're a Smart Money Secrets subscriber, read the detailed report here.

If not... you can get the report by signing up here.

Regards,

Kunal Thanvi
Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi, editor of Smart Money Secrets, is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stock recommendations that won't put your wealth at risk, subscribe to Kunal's Smart Money Secrets.

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1 Responses to "Forget PSU Bank Mergers, Rising Interest Rates Are More Important for the Market"

Bharat Shahane

Sep 18, 2018

We seem dead keen on following USA in so far as financial and monetary policy goes. Puzzling, considering how poorly this has helped USA inspite of its master puppeteer status controlling the global economy via the $ whereas we have no such lever.

That said, INR has on average depreciated around 5% against the $ annually, last 20 yrs. So an addl 7% dip seems understandable - given a specially strong $, not to mention we need to remain competitive vis-a-vis other Asian exporters. Let's not forget how powerful our IT industry lobby is; IT always wants a playing field tilted the other way (a cheaper INR) to ensure their ball keeps rolling...

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