Market Rebounds and Growth Continues Unabated!

Ashish Advani (February 4, 2010)

Reserve Bank of India gets Aggressive

Issue #17

Dear Dalal Street Insider Subscriber,

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There has been some major action in India over the last week. So let’s roll the tape and take a gander!

The Reserve Bank of India (RBI) surprised the market on Thursday last week. Over the past few weeks I have been speaking to you about the potential of rising rates in India. This was becoming a real pressure point for the RBI when the food-related inflation hit 20% in the past few weeks. It was becoming apparent that the RBI would have to move sooner than it would have liked to start raising rates to control inflation.

But their action caught most of us by surprise. First, I expected them to move in April after squirming under high inflation for a couple more months. Next, I was wrong in my expectation of the quantum of increase that I expected in the rates.

How Cash Reserve Ratio (CRR) defeats Inflation:

The RBI raised its cash reserve ratio (CRR) by 75bps to 5.75% in two stages – my expectation was for a 50bps increase. For those new to the CRR – Let’s see how this works:

When we have inflation in the market, what is really happening? There is too much money (liquidity) chasing too few goods. Consequently, prices of goods go up.

The RBI raises Interest Rates to reduce liquidity in the markets. By reducing money supply (companies find it costly to borrow so they borrow less and slow down their production), the RBI is able to mop up excess liquidity in the market and stop the over-bidding for goods in the market.

Now the RBI reduces liquidity in several ways. There is the traditional way of raising the benchmark interest rates for interbank borrowing which translates into the higher borrowing costs for you and me. Then the alternative way is to raise the CRR.

CRR, in simple words, is the amount of cash that banks have to maintain in relation to the monies they lend to their customers. So if a bank lends me $100, it needs to keep $5.75 as a reserve. The cash has to be deposited with the RBI who pays them interest. By raising the CRR, the RBI has reduced the amount that the banks have available to lend to consumers and corporations.

The accompanying statement has heavily emphasized inflation as a policy concern. The concern was for inflation in the traditional sense (price inflation) as well as asset prices (Property prices).

I expect the next move to be on the traditional interest rate front. Expect a 25 bps increases at the next few subsequent policy meetings.

I am not expecting any further increase in the CRR for now. With this move, the RBI has effectively withdrawn roughly 45% of its Stimulus. While this may be painful in the short-term, it is an excellent move for the long run.

The economic assessment of the RBI indicates its more hawkish stance. On inflation, the RBI has both highlighted its concern over rising asset prices and once again revised its price inflation forecast to 8.5%.

On growth itself, the RBI now believes that agriculture production will be flat from the previous year rather than negative and on that basis and expects FY10 (fiscal year ending March 2010) GDP to be 7.5%. The previous estimate was 6%. Picking a quote from the policy statement, “As the recovery gains momentum, it is important that there is coordination in the fiscal and monetary exits.”

While the Stock Market will not like the reduced liquidity, it will adjust its opinions and soon get past this move. None of these events worry me.

Besides being good for the economy overall, it has already started working well for our portfolio’s Indian Rupee pick.

December Trade Numbers show further Upside

Merchandise imports rebounded sharply, growing 22.1% qoq. On a yearly basis, imports grew 27.2%, the first positive print since the crisis.

Merchandise exports continued to show a healthy up-tick of 6.8% qoq. On a yearly basis, exports growth was positive for a second consecutive month since the crisis.
The trade deficit widened fractionally to US$10 billion from US$9.7 billion in November as growth in imports was higher than that in exports.

Domestic demand has been rebounding quickly. The January Purchasing Manager’s Index (PMI) came in at 57.7, much higher than the 55.6 in December.

I expect the strong trend to continue—with GDP growth forecasts for FY11 and FY12 at 8.2% and 8.7% respectively.

On the stock market pricing front, I had alerted you to the slide in the market by about 7% in the past two weeks. I had indicated that it is a Blue Light Special on some of the stocks. As I had expected, Dalal Street has rebounded by 3% in the past two days! I do not rule out downturns in the next few days, so some of the “Strong Buys” have been listed as “Buys.”

I am ready with my next pick, but want to wait a week or so just to make sure I get a proper sense of the market’s direction. We do have a long-term focus in our portfolio and expect triple-digit wins on all of our trades; it does not hurt to be patient if we are expecting to buy the same stocks cheaper by buying a couple of weeks later.

Let’s review our positions:

Your Editor making sense of moves on Dalal Street,

Ashish Advani