If RBI's rate hike triggers a correction, then... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

If RBI's rate hike triggers a correction, then... 

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In this issue:
» Best performing markets since Lehman's demise
» US economy is in a great correction, says Bill Bonner
» Rating agencies gung-ho on India
» Greenspan's interesting blame game
» ...and more!!

Showing that it's getting increasingly worried about rising inflation, the RBI raised interest rates yesterday. The RBI raised both the repo and reverse repo* rates by 0.25% each to 5% and 3.5% respectively.

We see these rate hikes as insignificant to impact the economic recovery. But importantly, the RBI's action is a clear sign of things to come. With the central bank getting uneasy about rising food and non-food prices, we foresee more such hikes over the next few months. The next could well come on April 20, when the RBI will meet to review its annual monetary policy.

We see the RBI's intentions as positive because it shows its resolve to tackle the inflation problem in a timely manner. But how will the markets react in the short run is anybody's guess. Investors in auto and realty stocks, however, might not like the RBI's move. This is considering that companies from these sectors flourish in a low interest rate environment, and suffer when rates rise.

Whatever be the reaction of the markets on Monday, we advise you to not act in haste. Treat any correction in stock prices triggered by RBI's latest and future rate hikes as healthy. This is considering that these will bring valuations of good quality stocks at reasonable levels for you to buy into them.

* 'Reverse repo rate' is the rate at which the RBI absorbs money from the system. 'Repo rate' is the rate at which it lends short term funds to banks.

01:03  Chart of the day
Lehman Brothers' demise came as a shocker to the world financial markets. Credit markets went into a tizzy, Stock markets went crazy as investors liquidated their holdings. The impact was seen more in emerging markets like India, China and Brazil, which crashed like ninepins over the next 5-6 months. However, these very markets have been amongst the biggest gainers since the rally started in March 2009. Now, if one were to look at their returns point to point i.e., since the day Lehman went bust till today, these have far outperformed other world markets. As our chart of the day shows, Chinese stocks have gained around 54% since then, followed by Brazil with gains of 42%. Then comes the safe haven gold that has moved up 41% since then. And then the Indian markets that are up 30%.

Note: Country names represent their respective stock market indices;
Data Source: Yahoo Finance, Kitco, CNNfn

India is now the toast of the ratings agencies. Most of them are coming out with reports that highlight India's structural strengths. Moody's believes that the tendency of Indians to save for the rainy day will form the bedrock on which the country will post strong growth rates in the future. And with growth, government finances will improve. Standard and Poor's is also enthused about the growth prospects improving government finances. Especially when the Finance Minster has clearly stated in the Union Budget 2010 that he plans to decrease the fiscal deficit. Andrew Holland, chief executive officer of Ambit Capital believes the key lies in the rising spending patterns of Indian shoppers. While we are no big fans of rating agencies or brokers, we do agree that there is a strong case for India's growth story. And much of it is indeed driven by the savings and consumption pattern of Indians.

This isn't a recession. Recessions happen when there is a pause in economic activity and after the pause, the economy keeps growing. However, any such thing is unlikely to happen this time around. We are in a period of great correction where the economy is dead and one cannot revive a dead body.

Grim words, isn't it?

But do not worry! These do not pertain to India. These refer to the environment that the US finds itself in currently and this was described by none other than Bill Bonner, one of the most astute big picture guys in the world, in the recently held Equitymaster Investment Summit 2010.

However, this is not all. Bill also spoke at length about the demise of a deeply, flawed economic theory that has existed for fifty years now and a lot of other things that would surely excite and would be of great value to investors across all asset classes. Of the greatest value perhaps would be Bill's new trade of the decade. It should be noted that Bill was amongst the very few investment thinkers who had advocated way back in 1999 that investment in gold is likely to give the best returns over the next 10 years. And what a sound advice it has turned out to be. We are sure you do not want to miss his new trade of the coming decade.

If you missed out on The Equitymaster Investment Summit 2010, don't lose heart! We're bringing out a special Limited Edition Investment Summit twin CD pack. To get your copy, please click here.

Now, here's an interesting twist to the blame game as to who caused the global financial crisis. Alan Greenspan, the former US Federal Reserve Chairman, whose legacy has been tarnished by the global financial crisis, has blamed the fall of the Soviet Union that led to millions of workers entering the global marketplace, as the root cause of the crisis! He said to an international publication, "This new market-based workforce helped push up growth in the developing world. This in turn fueled a global savings glut that drove down long-term interest rates, leading to an unsustainable boom in house price."

It can't get interesting than this! This is given that Greenspan has himself, over the last two years, blamed Fed's policies for the crisis. "It is easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities," said a former President of the Bank of England. Greenspan can definitely vouch for this.

The knives are out on Chinese currency. And two world famous economists have lined up on each side of the argument. Nobel laureate Paul Krugman is in favour of a revaluation of Yuan. However, Stephen Roach of Morgan Stanley has called such an idea as totally absurd. "America does not have a China problem, it really has a savings problem. It is ludicrous to blame China for the financial crisis," Roach has said. Krugman though is not willing to buy this argument. He asserted that the demand for goods and services will come down if US increases its savings rate right now.

Interesting thoughts we should say. We are of the opinion that both the gentlemen seem to be correct in their own way. America's huge trade deficit and China's fixed currency peg and its huge trade surplus are the biggest imbalances in the global economy right now. And both need to correct if we were to have a stable world economic order in the long run. Thus, while the US certainly needs to lower its spending and increase savings, a stronger Yuan could lower China's trade surpluses and boost domestic consumption. However, in a complex world, such transformations are easier said than done. Expect more friction in the days to come!

India was among the biggest gainers in world markets this week. The BSE-Sensex closed with a weekly gain of 2.4%. It was followed by China and the US, which were up 1.8% and 1.1% respectively. Gains in India were led by stocks from the oil & gas and metals sectors. Realty stocks were among the worst performers during the week.
Note: Country names represent their respective stock market indices;
Data Source: Yahoo Finance, Kitco, CNNfn

04:58  Weekend investing mantra
"Keep it simple and remember what you set out to do." - Charlie Munger
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5 Responses to "If RBI's rate hike triggers a correction, then..."

akkiraju srinath

Jul 3, 2010

There will initially be a kneejerk reaction where the
market may come down by say 1 to 2 percent and then things
may pick up momentum on the upside again. Monday, will be
a negative day for the markets, more so due to the
uncertainty due to the fact that the US markets would
remain closed on July 5. The markets will close deep in
the red.


Selvaraj Kuppannan

Mar 21, 2010

Kishorkumar ,

Obviously it drains money from the system, for that matter inflation, interest rates, CRR, repo and reverse repo , and so will affect the total liquidity in the system. Increasing or decreasing any of these figures will bring cash surplus or deficient in peopleís hand. Consequently people might take money out of the stock market, delay their investment (incase of cash deficient) or invest in the stock market, (incase of cash surplus) or other investment like real estate.

I hope this will explain you.



Mar 20, 2010

The advice, 'not to act in haste', tendered by you to the investors, in the aftermath of the interest rates hike by the RBI, is quite sound and most welcome. It will be a boon to many.



Mar 20, 2010

When China hiked interest rate we reacted negatively and this negative surprise is also negative.


Kishorkumar Patel

Mar 20, 2010

How it effects the Indian share markets?

Kishorkumar Patel

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