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Although the current long-term bullish trend is intact, markets are awaiting clarity on the taper and the Assembly election results, says Devangshu Datta.
Traders, who cheered when Janet Yellen was appointed the US Federal Reserve Chairperson, cheered again when she lived up to her dovish reputation.
Despite a strong US recovery that was unaffected by the shutdown, Yellen assured the market that tapering wasn't going to happen immediately. Jittery global markets promptly soared again.
The best guess now seems to be tapering will start sometime between February and April. That is also when the Indian oil marketing (OMC) public sector undertakings (PSUs) start to reverse their dollar-rupee swaps with the Reserve Bank of India (RBI). Between August and November , the OMC PSUs such as Indian Oil, HPCL, and BPCL, have swapped about 15 billion worth of dollars.
The interest rates, if any, are unknown. The swap exchange rate of the USD/INR can only be guessed. It is possible the RBI will rollover the swaps if they coincide with the taper, and the forex market goes temporarily haywire.
One thing is certain. As and when the swaps are reversed, demand for dollars will spike and that will impact the USD/INR rate. The OMCs are now sourcing about one-third of their monthly requirements from the market, rather than using the swap window. That has pushed USD/INR up sharply anyhow.
Somebody or the other will lose from the swap unless the rates, when they reverse, are fairly close to the rates at which the swaps were agreed. Since we don't know the terms, it's hard to guess who will lose and how much. Trying to work this out should provide some entertainment for minority shareholders in the OMCs.
In other good news interpreted as bad news, Germany has declared a massive trade surplus. On second thoughts, this isn't unalloyed good news. Most of that surplus has come from exports to other Euro zone nations, which means external deficits for those countries. Since they cannot devalue currency, they have a problem trying to readjust the balance. Cynically speaking, Germany may have to help by carrying on with bailouts.
Of course, what the markets would like through 2014 is a continuing tale of US and global recovery coupled to a continuation of the Quantitative Easing (QE) 3 programme and the Japanese QE programme.
Between them, the two central banks of Japan and the US are pushing out the equivalent of $160 billion a month. Most of that money has gone straight into financial assets. There is a chance that Yellen will taper ever so gradually that she will, in effect, enable QE continuation plus higher gross domestic product (GDP) growth.
Perceptions about India, of course, are being increasingly driven by a focus on political shenanigans. GDP growth, it is generally accepted, will not accelerate much in 2014-15, and the best one can say about 2013-14 is that the current account deficit will fall substantially though it will still be over the red line at $55-60 billion.
What happens in the Assembly elections that are around the corner could have an impact on short-term valuations. Several major foreign institutional investors (FIIs) and almost all the minor players seem to be prepared to gamble on Narendra Modi coming to power and a subsequent business-friendly climate.
Goldman Sachs and Nomura have publicly stated this. If the Bharatiya Janata Party scores in the Assemblies, that sentiment will be reinforced and it may lead to higher India weight and inflows.
On the monetary front, the data make it very likely that the RBI will be looking at another rate hike fairly soon. So do Dr Rajan's public statements about the focus on inflation. The wholesale price index has spiked to nine-month highs and so has the consumer price index.
The rupee has weakened again, implying that there could be further inflationary pressure from higher imported fuel prices. Ergo, raise the policy rates, cross your fingers and pray.
Indian politicians are hypersensitive to inflation in election years so, the RBI could actually get tacit support from the government. Hiking rates probably won't work since food inflation is driving the indices up. Food is near 15 per cent despite a good monsoon and excellent agro performance.
Rate hikes won't do much to pull food prices down in the absence of structural reforms in the distribution and procurement structure. But Rajan might pull out the sledgehammer anyhow. Higher treasury yields and the recent rate hikes by the State Bank of India and other banks indicate market expectations.
More worrying is the lack of enthusiasm evinced by the Index of Industrial Production (IIP). The IIP is up 2 per cent on a low base of September 2012. However, the manufacturing component is up nominally at 0.6 per cent and consumer durables remain in the negative zone. The key growth area was "electricity" - this jumped by 13 per cent - and electricity has a 10 per cent weight in IIP.
The October IIP numbers will give us some inkling as to any possible boost from Diwali. Luckily, de-seasonalising for Diwali isn't such a problem since Diwali in 2012 and 2013 were in approximately the same period.
The taper-relationship with Indian equity values remains very obvious. Domestic FIIs have been steady sellers as Q2 corporate results were released. The FIIs bought through October and November, until they spooked at the possibility of an early taper. The stopped buying and the market dropped over 5 per cent in six sessions. Then the fear of early tapering receded and the FIIs started buying again.
Technically speaking, the broad indices bottomed out above their respective 200 Day Moving Average. This suggests that the long-term bullish trend remains intact. The financials dropped more than the broad market on fears of a likely rate hike.
On the upside, we'll have to see if the Nifty is capable of being pulled above 5,340, where it made its most recent peak. It's quite likely that the markets will mark time and range trade the zone between 5,950-6,350 until there's clarity on the taper and perhaps, until Assembly election results.
