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RBI and the bearish stock markets

Aug 8, 2000

The fall in the value of the Rupee is of prime concern to the domestic stock markets. And this is not just because of its effects on borrowing costs and cost of imports. The key concern is how and when (if at all) is the central bank going to step in for the second time to put a halt to this persistent depreciation. The first time Reserve Bank of India (RBI) opted to raise rates. Next it tried to talk up the Rupee. Now since both these measures have failed to calm the markets, there is a fear that the RBI could be forced to take even more severe measures. And the stiffest measure is to raise rates (again).

Higher interest rate, as we have time and again mentioned in our market analysis, will be detrimental to market sentiment. Higher rates mean lower corporate profitability, lower demand for goods/assets purchased using borrowed funds and above all a higher interest burden for the government (higher deficit). Higher rates will help in delivering a stronger Rupee and lower inflation.

The trade off currently is between a stable exchange rate and a buoyant economy (in the short term). Banks have already initiated measures to jack up prime lending rates. This is bound to affect investment activity, which in the manufacturing sector is anyway sluggish.

The stock markets, it seems, are more concerned with the RBI's response to the depreciation of the Rupee rather than the effect of such depreciation on corporate profitability and borrowing costs. Another confusion is whether a pull out by FIIs is contributing to this depreciation, or is it that the depreciation is keeping fresh portfolio investments from being made in India. The first surely is true to some extent. The possibility of the latter however cannot be ruled out.

All in all, the stock markets are faced with an uncertain short-term scenario. Only when the depreciation in the value of the Rupee halts and/or the RBI categorically lays out its plans for the same, will the stock markets get to focus on other developments. These other developments, speaking generally, are largely positive (be it export performance, corporate profitability, policy initiatives or central government finances). To repeat what we said the other day, the markets are bearish. But then there are reasons for investors to be bullish, atleast selectively.

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