Economy: Block the noise! - Views on News from Equitymaster

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Economy: Block the noise!

Dec 14, 2006

Information can be interpreted in more ways than one. This has been well accentuated in the market movements over the last three days. While <>monetary policies and economic analysis are not new to investors, they seem to be swiftly adapting the association of such data in their investment behaviour, as is observed from their US counterparts. Thus, while a 25 basis points (0.25%) hike in the CRR causes all hell to break loose, the FM's re-affirmation as also the Fed's inaction brings back sanity to the bourses. RBI - Leaving no stone unturned
Having exercised the reverse repo option thrice since last year to tighten the liquidity in the system, the central bank has now chosen a more lethal instrument to pull back the excesses. The CRR that was last raised two decades ago (in the 1980's) and left untouched since October 2004, was chosen as a more suited tool for curbing liquidity. For the uninitiated, the Cash Reserve Ratio (CRR) is the minimum cash balance required to be kept by banks with the RBI. By serving as an instrument of monetary policy, the CRR helps the central bank regulate the flow of liquidity in the system. Banks, hitherto, had to maintain CRR at 5% of their net demand and time liabilities (NDTL) and also earned interest on the funds parked in the form of CRR (in excess of 3%) with the Reserve Bank of India (RBI) until June 2006. Thus while the CRR is currently non-remunerative to banks, in a rising interest cost scenario, they are also instrumental in dampening the margins (NIMs) for the players in the sector. A hike in the CRR thus acts as a double-edged sword in curbing the incremental outflow of credit to the system.

Economy - The red signal
The RBI's intolerance of inflation levels above 5% has been cited as one of the prime causes for the pre-emptive move. The sustenance of high levels of growth in money supply (M3) and non-food credit growth were seen to be the triggers for the rise in the headline inflation (WPI). The lower than expected growth in industrial production also reared fears that the economy, projected to grow at 8.5% in FY07 (as per the CMIE), would slow down if the demand push inflation was not corrected.

Fed - Taking a breather
The US central bank, the Federal Reserve, which had been taking similar recourses so far (raising the short-term rate by 25 basis points each time) to reinstate its fears of economic slowdown, has sat on the fence for some time now (kept interest rates unchanged for the fourth meet in a row). While the same does not seem to have influenced the policy initiatives of the RBI, Indian investors certainly seem to be taking cues from it.

Markets - Victim of information overload
While it remains undisputed that the health of the economy and the stock markets are closely linked, every economic 'instance' does not deserve to be the reason for a market upheaval. In fact, investors while doing their research must be well aware of the prevalent macro-economic dynamics and take cues from the same. Also, besides economics, sectoral positioning, financials and valuations must enjoy an equal weightage in the investor's decision making. The point we wish to emphasis on here is that - while information at the disposal of investors is ample today, they need to cleverly examine the relevance of the same and prevent themselves from getting carried away by the noises.

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