The Reserve Bank of India has cut the repo rate by 50 basis points (bps) after three years. We believe this is the beginning of a reversal in interest rate cycle. The rise in repo rate by 375 bps since March 2010 (before the rate cut) was too aggressive and these are yet to play out in the manufacturing sector. The industrial sector has already lost pricing power because of these hikes.
On the crop front, record food grain production is expected this year, which can’t co-exist with rising food grain prices.
The base effect will also play out. What matters to the stock markets is the rate of change, rather than the absolute change in prices. Since the beginning of the tightening of interest rates in March 2010, the headline inflation base index has risen 17 per cent and the fuel & power index 24 per cent. Such a steep rise in overall inflation will play a vital role in moderating the rate of change in inflation, going forward.
The scope for a war among nuclear armed nations is limited. Therefore, we believe, in the short term, crude oil prices could moderate. Hence, we expect continued moderation in inflation and thereby, reversal in the interest rate cycle, subject to a good monsoon. This would trigger a sustained rally in the domestic equity market this calendar year.
While we expect 10% year-on-year (y-o-y) earnings growth in the January-March quarter for the corporate sector, we anticipate the banking sector to post a net profit growth of 25-30 per cent y-o-y.
Last year, despite a normal monsoon, we saw double-digit food inflation, due to structural shift in demand. Hence, the monsoon this year would be vital for reversal of the interest rate cycle.
A big trigger would be a 50-60 per cent y-o-y fall in import of gold in the January-March and April-June quarters. This will improve the current account balance of the balance of payments. A final trigger would be an improvement in GDP of the manufacturing sector beginning this quarter.
Though exports have grown 20 per cent y-o-y in FY12, the trade deficit stands at around $185 billion for FY12. Assuming $90 billion receipts from service exports, we still need to finance around $95 billion of current account deficit (CAD), largely through investment flows from foreign institutional investors (FIIs) and foreign direct investment (FDI), besides external borrowings and drawdowns from forex reserves. So, the government has no option but to encourage these inflows, failing which forex reserves could evaporate soon. Hence, we expect measures like allowing FDI in aviation and multi-brand retail, which would provide another major trigger to the market.
Considering these triggers, we expect about 25 per cent upside to the equity market this calendar year. The risk to our view would be any possible failure of the monsoon.
The author is Group CIO, Centrum Wealth Management
