Prof Amogh Notes # 2

Annus horribilis (year of horror) – is what most of us in financial markets would want to term year 2011. A year that started with lots of hopes eventually turned out to be one of the most turbulent periods for financial markets across the globe. So much so, that one was compelled to draw parallels to periods ranging from the ‘90s to the very recent 2008 financial crises.

Worst part was India – which never originated the crises, actually bore the maximum brunt, with an ailing currency as also deteriorating growth prospects. The INR depreciated -15.87% in 2011, while the Sensex eroded in value by -24.64%. Also, the combined fiscal deficit of the state and center is likely to be around 10% for FY 12. None of these frankly were so clearly envisaged at the beginning of the year.

So what really went wrong ?

If 2008 crises was US led, then time the lead role was played by the Euro zone. Money flocks to safe haven in times of turbulence and hence it was no surprise to see the dollar reign supremacy in 2011 with a gain of 1.58% in the dollar index (most currencies depreciated in this period).The US 10yr treasury also returned around 17%. It was therefore natural to see INR depreciate in line with other currencies. This continued happen at a time when crude prices also remained reasonably steady. Infact, brent crude (which is relevant for India) rose almost 15% in CY 11. India is a net importer of crude and the depreciating rupee only aggravated the oil bill, leading to a widening of the Current account deficit (CAD). To add fuel to the fire, India’s gold imports also remained robust. Further, for most part of the year inflation remained sticky (WPI averaged at around 9.59%) which led to monetary tightening by the RBI (interest rates hike by 225 bps in CY ’11). The yield curve bear flattened in response to rate hike as well as tight liquidity conditions

Have things changed since then?

Not entirely – but early signs of hope do linger. Globally, the Euro does not seem to break off the marriage in a hurry, though differences still exist. The recent measure by ECB to extend 3yr loans to banks is some indication towards that. There is less bad news from the US, indicating more stable conditions there. Closer home, the recent domestic macro economic data do have a story to tell. The IIP has shown a negative growth of 5% over the last year. Food inflation has cooled off from peak levels, as also the WPI. Early signs of slowdown in consumption also have been visible alongside some stalling in the investment cycle.

What to expect in 2012?

While the idea is not to do a crystal ball gazing or put down a list of predictions to prove our astrology skills, we are trying to make a knowledgeable conjecture of what we feel could be in store for 2012

- Policy rates to start easing from Q1 – FY 13 as the stance changes from “growth focus” to “inflation focus”. CRR cut may be effected earlier to allow the system to breathe easy on liquidity. Recall that the system has been in the deficit mode for over 5 quarters now.

- Inflation to ease off in the 1^st half due to base effect and softening impact of primary articles. 2^nd half could trend higher, albeit average for the year could still be lower

- The “China effect” which saw rally in commodities could temper off if talks of China slowdown were actually to materialize

- Gold to continue to display resilience in a market where uncertainties continue to exist. Headwinds may be faced from stronger dollar, but trend for 2012 remains higher.

- Currency to continue to remain under pressure in near term, range bound for most part of the year

- Some stocks have corrected more than the broader indices. Markets could remain range bound with attempts to seek valuation based buying this year. Remember current levels of index offer PE multiples at around the similar levels last seen in FY09.

- Fixed income to offer opportunities across the yield spectrum. Short duration funds to be beneficiaries of the anticipated steepening in the yield curve (currently flat/inverted)

- 10yr Gsec yield to hover in the band of 7.75% t0 8.25%. Intermittently, either end of bands could be breached in response to ad hoc news. OMOs by RBI and slow down in credit disbursements to anchor any sharp rise in yields

- Equity markets to move sideways before some stimulus (read rate cuts) could change sentiment. Expect a trading range of 14500 – 18000 for the Sensex

Moody's reaffirms India's sovereign rating; cautions growth

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·         Amogh Gothoskar

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·         brindaparikh@ymail.com

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Thursday, 22 December 2011 7:13 PM

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In what comes as a big boost to the waning confidence in the Indian economy, credit rating agency Moody's has reaffirmed India's sovereign rating at BAA3. However, it has said that India's growth downturn is expected to persist for two quarters.

But, Moody’s has said that if the fiscal deficit situation worsens, it may lead to a change in the credit ratings, reports CNBC-TV18’s Aakansha Sethi.

The important thing is that they have maintained India’s sovereign rating at BAA3 at a time when S&P downgraded the US from AAA to AA+ and its outlook from stable to negative in August

RBI paused after 13 rate hikes; indicated a reversal of cycle (rate cut) going forward on risk to growth

RBI finally hit the pause button, as expected, after hiking rate for 13 times since early 2010. RBI was also dovish as it mentioned about increasing downside risk to growth with inflation remaining on projected path. RBI’s growth forecast for FY12 was changed to 7.6% with significant downward risk. Inflation projection remained at 7% by March end. Most importantly, RBI indicated that, going forward, it might reverse the monetary-tightening cycle due to the risks to growth. RBI mentioned that it will intervene in forex market if warranted and conduct further OMOs as and when needed.

Pause in Policy Rates:
·        RBI kept Repo rate unchanged at 8.50%. As a result, Reverse Repo and MSF rate remained at 7.50% and 9.50% respectively. CRR remains at 6%.

Reasons given by RBI for pause:
·        The global economic outlook has worsened significantly.
·        In India, the growth momentum is clearly moderating due to the uncertain global environment, the cumulative impact of past monetary policy tightening and domestic policy uncertainties. The downside risks to the RBI’s growth projection have increased significantly.
·        Inflation remains above RBI’s comfort level but it is moderating with decline in food inflation. Inflation pressures are expected to abate on moderation in aggregate demand and lower food inflation despite high crude oil prices and rupee depreciation. The inflation projection for March 2012 is retained at 7%.

RBI hinted at reversal of tightening cycle going forward:
·        With inflation remaining on its projected trajectory and downside risks to growth significantly increasing, RBI feels further rate hikes might not be warranted. Going forward, RBI announced that the monetary policy actions are likely to reverse the cycle, responding to the risks to growth.
·        But risks from Inflation and Rupee depreciation remain. The timing and magnitude of future rate actions will depend on how these factors shape up in the months ahead.

Bottomline
·        RBI action was in line with expectation as it acknowledged significant risk to growth and softening in Inflation.
·        Most importantly, RBI explicitly mentioned that tightening cycle is over and RBI will reverse cycle (cut rate) if risk to growth increases.
·        RBI did not cut CRR or announce any OMO calendar as expected by market. RBI felt that liquidity is adequate currently. But RBI said that it will conduct further OMOs as and when needed.
·        RBI also said that it is closely monitoring the external sector and will intervene to support rupee.
·        Overall, it was dovish policy where growth was given more importance than inflation. Interest rate has peaked. Inflation will start moderating and that will provide room for RBI to cut rate.

Quick update on fall in gold prices

Last trading session has been very bad for global markets, including commodities. The EUR breached the 1.3 mark v/s the dollar, a level not seen in past 11 months. Clearly markets are indicating that the Euro zone crises is still not out of the way. The CRB commodity index was down 3%, gold is now trading at $1575 – sign of risk off sentiment. The key reason for the same is the $ rally which has got all commodities reeling under pressure, including gold….            

The good part for Indian investors is that in Rupee terms, gold is still holding on as depreciating rupee boosts the value of gold. Hence we haven’t seen as much carnage in gold when priced in INR. Last 1 month gold has fallen nearly 12% in $ terms, but less than 2% in INR terms

The outlook for gold in $ terms continues to be on the downward side as it technically poised for some more selling. This is the 1^st time since Jan 2009 gold has broken the 200 DMA (daily moving average). The attempt will be to pull up back to the 200 DMA levels, but near term momentum remains weak. However, the view is that INR would continue to remain under pressure, so to that extent the rupee value of gold is not likely to be as impacted despite the steep $ price correction in gold (as I write INR has breached the 54 mark !!!!).Overall, near term remains cautious, but given the spectacular performance of gold as an asset class, some period of correction / consolidation was warranted –and this is one such phase we are witnessing

Good days for gold are not over – just taken a breather.