Market volatility is here to stay

FPIs are unwilling to bear currency risks and are braced for a continued uptrend in rupee yields. That's not a good signal

Easing crude prices bring the prospect of relief. Policy makers can hope that the energy import bill will not be quite as severe as feared. However, there was no relief for consumers as retail petrol and diesel prices were not reduced. 

The GST Council may consider putting aviation turbine fuel (ATF) and natural gas under its purview at the next meeting. This may also be opposed by various states that earn serious revenue from the state excise imposed on these fuels. The states earned Rs 1.6 trillion in tax revenue from petroleum products in 2016-17 and petrol and diesel will continue to remain outside the GST, even if ATF and natural gas come under GST.

If Saudi Arabia and Russia ramp up production and the US shale industry goes into fourth gear, there's a ceiling on crude prices. However, there is also a floor. Much of the shale industry is not profitable below $55-60. Those operations will shut down if prices fall, causing a new supply crunch.  

All Brent monthly futures out till December 2024 are running at above $60/ barrel. Global shipping must switch to low-sulphur fuels by January 2020 and that could mean a big shakeout in the petroleum industry. Net-net, crude may become more expensive as shipping switches over to low-sulphurs.  

A recent sensitivity analysis from a research outfit indicated a possible current account deficit of 2.4 per cent of GDP if the Indian crude basket averaged out at $65/ barrel for 2018-19. The basket was $69 in April and moved over $75 in May. If the sensitivity analysis is accurate, the CAD could climb considerably higher. 

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The Q4, GDP numbers are due to be released this week. The RBI's Monetary Policy Committee will release its policy review next week. Obviously the MPC must consider the external deficits and the potential impact on the rupee. The RBI has expressed its reservations about the accuracy of methodology of GDP calculation and the frequent rebasing of macro-variables. But it will presumably use those numbers even if it assumes large error margins. it will be interesting if the RBI's projections for future inflation and growth vary from government numbers.

Given higher inflation across wholesale and consumer indices, and given the likelihood of elevated crude prices, the central bank is very unlikely to cut rates, or ease money supply. It may maintain status quo since a hike in rates seems unlikely until the monsoon status is clear.

The rupee is close to its lowest-ever level. Given continued FPI selling, there's a fair chance the  rupee will land lower. In that case, the RBI must take a call as to where it would like the rupee. It will have to manage currency volatility on a daily basis. 

The Q4 results are basically all about banking. Other sectors have done all right without doing well. Every one of the large public-sector banks has posted massive losses and hugely increased bad loan provisioning. Several of the large private sector banks have also seen similar results, though not on the same scale. The consensus is, “The worst is over”. Is it? 

Enhanced provisioning and better recognition is all very well. But banks will continue to bleed until due diligence and credit appraisal systems improve. For what it's worth, the RBI projected losses would peak in September 2018 and that estimate was made before the PNB scam broke. Recapitalisation of PSU banks is going to cost at least twice as much as the Rs 2.1 trillion the government has estimated. 

Several PSU banks are now under the PCA (Prompt Corrective Action) umbrella, which means that these institutions essentially cannot lend, except to the government. It's hard to recall instances from financial history, where GDP growth, and corporate expansion, have sustained at a fast clip while close to 10 per cent of GDP is stuck in bad loans, and lenders are unwilling, or unable, to expand credit disbursal. 

It's important to note that FPI selling of rupee debt has been much heavier than the FPI selling of equity. This indicates the FPIs are unwilling to bear currency risks and braced for a continued uptrend in rupee yields. That's not a good signal since it implies rate hikes or serious rupee weakness. 
 

The FPI selling of equity through April and May was comfortably exceeded by Domestic institutional buying in both months. However, retail sentiment seems to have weakened since there have been net losses. Small caps and midcaps have lost much more than large caps and retail sentiment is crucial for those market segments. 

Technically, the market seems to be holding on, with the Nifty bottoming out above its own 200 Day Moving Average and moving up again. But it's not been able to penetrate the 11,000 levels. The sharp correction and volatility after the hung verdict in Karnataka could be repeated again, and again, given the political situation.