And this cheer could spread to the core sector too, though with a lagged effect.
Stock market prices are a leading indicator for the real economy. This was borne out between 2003 and 2008 in the last boom-bust cycle. The big bull market started in April 2003. That was deep in a slowdown, six months before earnings growth and GDP numbers suggested any recovery.
Even a year later, the NDA was voted out because the real economy hadn't recovered enough for voters to believe India was shining. The slide of 2008 started in late January. Again, that was six months before slowdown became apparent.
Similar lead times are noticeable throughout if you map the Nifty's historical movements quarter by quarter against its earnings growth. The lead times are different in every boom-bust cycle. But the stock market usually recovers significantly before the real economy does.
Interestingly, the stock market lags the bond market. That's because bond yields anticipate changes in commercial interest rates while the stock market responds (almost instantly) to commercial rate changes. And the real economy responds in lagged fashion to rate changes. So it is last in the progression of yields, commercial rates, equity prices, real economy.
More From This Section
The bond market is signalling a major trend reversal. This could be a false dawn but the move has lasted four months. The yield on the 364-DayT-Bill peaked in September at around 9.5 per cent. Since then, yields have slid. The cut off yield on the 364 T-Bill has hit 4.5 per cent. That's lower than anytime after 2004. The 10-Year GoI security is at an all-time low of 4.8 per cent.
Falling yields are backed by lower inflation numbers. Since May 2008, the WPI has been falling, suggesting deflationary trends for the past seven months. Even on an annual point-to-point basis, the WPI has dropped from over 12 per cent to below 6 per cent in the past four months.
A trend of falling inflation and falling T-Bill yields should translate into falling commercial rates. RBI has cut its policy rates and the CRR to encourage this. Unfortunately banks have been cautious in following the central bank's lead.
At one level, this reluctance on the part of banks to cut rates is hard to comprehend. Liquidity cannot be an issue at the current credit-deposit ratio of 75 per cent. T-Bill yields of sub-5 per cent and WPI at 6.5 per cent makes current PLRs of 12.75 per cent absurd.
At those yield and inflation levels in 2004-5, the prevailing PLRs were in the range of 9-9.5 per cent with floating home loan rates of 8 per cent. By that comparison, there's room for 250-300 basis points cut or more, if lenders wish to get aggressive. Instead, banks are talking about measly cuts of 50-75 bps in the current quarter.
Given the loud signals from RBI, the only reason why banks are so cautious must be fear. They must be terrified defaults will go out of control. This in turn, suggests NPAs have risen substantially in the past quarter. That is not unlikely. If it is indeed so, we'll get an inkling of the truth once the Q3 results come through.
The sooner rates are cut, the sooner the real economy is likely to recover. Given caution from banks, the recovery is likely to take longer. Gut feel suggests that RBI will not cut again until PLRs have dropped substantially.
Gut feel also suggests that mere rate cuts will not be enough to revive demand. Manufacturers will have to pass on falling raw material costs to bring consumers back. Again, given that prices of cement, steel, crude, rubber and other key commodities have dropped sharply, producers can well afford to slash. They will do so when they get desperate about evaporating toplines.
It's started to happen in aviation. Automobiles are another logical sector for price cuts. Real estate is also seeing downwards pressure building up. The process could take a couple of quarters to filter through the entire real economy and things may get worse in Q4 before they get better.
However, falling yields are a healthy leading indicator. If the trend is genuine, we could see commercial rates cut and a stock market revival by the middle of calendar 2009. That's a lot earlier than the average prognosis.