 "Devangshu Datta: A bullish yet unpredictable situation")
As expected, the Reserve Bank of India (RBI) held status quo on money supply and interest rates at its bimonthly policy meet. In the statement, the central bank warned about the potential rise in inflation, which was "sharper than anticipated" in April.
RBI Governor Raghuram Rajan also gave advance warning about likely USD shortages in September when the RBI would start unwinding $34 billion of USD-INR swaps taken between September and December 2013. About $20 billion of that is due in September itself while the rest would be returned over the next few months. The governor was evasive about his reappointment prospects. If he doesn't get an extension by September, there may be some additional volatility.
Two events that affect forex market stability will also play out in the next fortnight. First, the US Federal Open Market Committee will release its policy review in the middle of this week. If the Fed does signal a rate hike soon, there will be some USD hardening.
The other event is an absolute one-off: The UK votes on Brexit on June 23. This is binary - it will either happen or not. If the UK does exit the European Union (EU), there will be huge swings in forex markets. The pound sterling is likely to take a hammering. The euro may also be under pressure. The economic outcomes will be major and so could be the political repercussions. It would, almost certainly mean a change of government in Britain. It may well mean copycat exits by other EU nations, including the big ones that use the currency.
But that is a big "if". Britain may also vote to stay in the EU. If it does, there will still be some currency readjustments, since traders who have shorted sterling and euro will cover positions. If the Fed does opt for a USD rate hike, or says it will soon hike rates, that will, one way or another, add to the pressure on pound sterling or euro.
In certain scenarios, where the Fed hikes rates and the Brexit causes severe volatility, the RBI may be forced to raise rupee interest rates or tighten money supply or take temporary action such as opening swaplines and asking oil importers to stay off the open market, as it did in September 2013. These are not very likely situations, but not absolutely impossible either.
The macroeconomic data continues to confound. The official gross domestic product (GDP) rate of growth rose to 7.9 per cent in January to March 2016. However, the Index of Industrial Production fell in March to a barely positive 0.1 per cent year-on-year and went into negative territory in April, at minus 0.8 per cent year-on-year. Manufacturing shrank, at minus 3.1 per cent year-on-year.
At the same time, corporate results do seem to indicate some sort of revival in the earnings cycle, if public sector undertaking banks are excluded. The revival is still patchy, there are still plenty of stalled projects and corporate demand for credit is low.
One possible shadow on the horizon is a firming up of crude prices. According to Minister of State for Finance Jayant Sinha, the fiscal arithmetic of the Budget would stay intact if the Indian crude basket does not rise about $60/barrel. It was $28 in January, it is now $50. But in this respect at least, slow global growth may be beneficial, as crude prices are unlikely to driven up by high demand. The World Bank has just cut its global GDP estimates for 2016, which should make the crude bears happy. Of course, slow global growth has also meant six quarters of falling exports.
The "one-eyed king" metaphor led to some controversy but the fact is, India is shining in comparison to the rest of the world without growth being spectacular. Higher growth has meant investment inflows and portfolio investors mostly seem to be overweight on India. Predictions of a strong and well-distributed monsoon have meant that investment houses have also raised targets in terms of Indian index returns in the past fortnight.
Foreign institutional investors (FII) have hiked their equity exposures in the last 10 sessions while domestic institutions have sold into the rising equity market. FIIs have sold rupee treasury debt however, which may indicate they are wary about non-hard-currency debt exposures at this instant.
Valuations are fairly stretched at the moment. At index private equities (PE) of 22-plus, Indian markets are close to historical danger levels. The 10-year average valuation of the Nifty is about 19.3 PE with a standard deviation of about 3. Current valuations are edging above the zone of average plus one standard deviation and historically, that is not an area which offers high returns.
However, in terms of momentum and technical trends, the market is clearly bullish. It has gained 20 per cent since the Budget and registered a continuous sequence of higher highs and higher lows. All bets are off if the Brexit and/or the Fed play(s) spoilsport. Otherwise, the markets could well head higher even if the valuations seem to be excessive. However, any trader would do well to note that many factors discussed above - monsoon, Brexit, crude prices, Fed attitude,
FII attitude - are entirely unpredictable and outside the ambit of policy control.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
