The Reserve Bank of India’s (RBI) decision to keep policy rates unchanged is understandable, given the combination of high inflation and fears of a monsoon failure. However, as far as the market is concerned, it was a wrong decision. The statutory liquidity ratio (SLR) cut would do nothing for the market. Credit is freely available; it is just very expensive.
A look at results for the quarter ended June suggests on an average, interest costs stood at about 17 per cent of sales for about 570 companies that have announced their results so far. Few businesses can generate meaningful profits after paying that sort of interest. Most companies have put their expansion plans on hold and are just hoping to survive.
During the last 30 months of high interest rates, banks have delivered reasonable results. Any commercial lender suffers when rates start rising; the value of its portfolio of previous loans is eroded and the volume of future business is hit by weaker demand. The chances of defaults also rise. We’ve seen all this happen. But overall, banks have delivered reasonable returns with increased volumes, coupled with some rise in non-performing assets (NPAs) and rising requests for corporate debt restructuring (CDR). In the past three quarters, the tempo of NPAs and CDR requests has risen quite a lot.
There are a few interesting implications of the latest credit policy action, or rather, inaction. Core inflation (inflation in non-food and non-fuel items) is already fairly low. A weak index of industrial production and the flat trend in the first quarter results suggests core inflation will fall further. So, it isn’t core inflation RBI is afraid of.
If a monsoon failure is worrying RBI, it is now a given. The food basket is likely to remain expensive. If it’s fuel prices it is worried about, these should decline due to slow global growth. But trouble in Syria or Iran could force crude oil prices up again. Incidentally, high interest rates can do nothing to combat either food inflation or fuel inflation. We’ve seen that demonstrated over the past three years.
Anyhow, this probably means the rates would remain at their current levels for the second quarter. In that case, one can expect corporate sales and profitability trends to run along the same lines as in the first quarter, and the previous several quarters. That means reasonable sales growth, stable operating margins and lower net profits due to rising interest costs.
Changes in interest rates impact equity valuations. The lack of change means equity valuations don’t change. If risk-free rate returns are about nine per cent, equity fair value would be about PE 12-13. Growth in earnings would probably be in the 9-12 per cent range. Hence, the market is probably over-valued at a Nifty PE of 17.
The author is a technical and equity analyst
