There’s a coherent thesis that the most important character trait for a central bank governor is the ability to lie with a straight face. The idea is, if the banker's body language can be successfully decoded, the market knows what he's going to do. And, if the market knows what the central bank will do, much of the impact of its actions is lost.
At this instant, the market is fairly sure what the RBI will do. The question is, when and by how much, policy rates are likely to be cut. Most traders expect a 25 basis points (bps) cut in repo on January 29, perhaps with a CRR cut thrown in. The optimists expect 50 bps cuts.
Based on that consensus, I'd say the Bank Nifty and other sensitive non-banking financial stocks will not move all that much if there’s a 25 bps cut. Financials will zoom if there’s a 50 bps cut and will fall if there’s no cut. If RBI actually hikes rates, the Bank Nifty will sink like a stone and may drag the entire market down with it.
So let's see what the RBI is at. The Wholesale Price Index (WPI) has been flat for the past three months (until December 2012), which suggests inflation has indeed dropped. The point-to-point change in WPI in December 2012 over December 2011 is also at a multi-year low. “Core inflation”, which is the WPI stripped off volatile food and energy, is 200 basis points lower than WPI. The Index of Industrial Production (IIP) is also weak – November 2012 IIP was lower than Nov 2011.
Trends in both IIP and the WPI seem to have reached an inflection point where a rate cut could fuel a bounce in economic activity. It seems high time that the RBI did cut. Ideally, rates should fall through a two-or three-year time-horizon.
On the other hand, the Consumer Price Index (CPI) is running high. The prices of food, clothing and housing are all zooming. Since roti, kapda and makaan are politically sensitive, the prime minister recently said that inflation will be high priority. At the same time, it is true – and both Manmohan Singh and D Subbarao know it – that tight monetary controls do very little to control inflation in such items because the problems are supply-side.
That brings us to another supply-side cause of inflation - energy. Approximately three years late, the government has bitten the bullet and moved to a more sensible policy of gradually hiking diesel rates as well as capping the number of gas cylinders on subsidy. This eases some pressure on the subsidy front. But it will mean more explicit inflation. Coal, too, is more expensive now - India is increasingly a net coal importer.
There’s no way for monetary action to curb inflation fuelled by high energy costs. But a rising CPI adds to political pressure to not cut rates. Balanced against that, there is also some pressure to cut rates as articulated by Mr Chidambaram.
Despite its independent status, RBI has to weigh political pushes and pulls like any other institution. It also has the job of raising government debt via treasury auctions and of managing an orderly recapitalisation of state-owned banks. The market doesn't have enough information to second-guess these situations and assess what the RBI may decide to do.
The timing complicates matters. The policy is coming just after a long weekend and, within three sessions of settlement. This is a guarantee of high volatility. Unwinding any sort of leveraged position may be chaotic in the circumstances.
My instinct would be to stay long but that is also the generic market expectation and it may just be wrong. Whatever you do, assume that the Bank Nifty will swing through two sessions of 300-point moves this week, though the directionality is uncertain. If the trend moves against you, be prepared to exit in a hurry.
