Tough call for RBI

Most available data points suggest that GDP growth slowed further during July-September 2019. The State Bank of India (SBI) says that out of 26 indicators that it tracks, as many as 21 slowed down. For example, tax collections were down, automobile sales were down, the Index of Industrial Production was down, and imports and exports were down.

Most estimates for Q2 GDP growth range between 4.2-4.7 per cent with estimates for the full year 2019-20 also getting scaled down. The pessimistic forecasters include the SBI, the Reserve Bank of India (RBI), the International Monetary Fund, the Asian Development Bank, World Bank, etc. In addition, Moody’s has downgraded the sovereign credit rating outlook to “negative”.

However, major market indices remain up. The Nifty gained 4.7 per cent in the past month or so.  So, who’s doing the buying? Foreign portfolio investors (FPIs) have bought over Rs 35,000 crore in rupee assets in October and November (until November 14), with about Rs 27,000 crore in equities. Domestic institutions have been net equity sellers, to the tune of about Rs 900 crore in October and November.

Mutual funds have seen inflows of about Rs 6,200 crore into equity schemes in October. The bulk of that has come from retail investors. The positive inflows into equity mutual funds indicate strong retail sentiment. This is reinforced by gains in small cap and midcap indices in the past month. Those indices are also largely driven by retail attitude.

Is all the optimism justified? Corporate results have not been strong. Revenue growth has been low, though the cut in the corporate tax rate seems to have boosted profitability. Inflows are being driven to a large extent by liquidity, and the hopes of greater liquidity.

Global growth is in slowdown mode and central banks are expected to ease through the next year. America’s Federal Reserve has cut rates thrice in 2019 and the RBI has cut rates five times. Lower rates foster a risk-on attitude and create room for stocks to sustain higher valuations.

More liquidity is certainly on the cards. If the global economy does slow down, it’s quite possible the Fed will cut rates again. The European Central Bank could also ease, given impending Brexit and flat growth across the rest of the European Union. The People’s Bank of China (PBoC) has held its policy interest rate so far, despite a slowdown in China. But the PBoC could also cut if the trade war, and protests in Hong Kong continue, since both are dragging down growth.

The other major factor driving equities is the absence of attractive alternative investments for Indian investors. Debt and real estate are two “go-to” assets for Indian investors. A breakdown in those assets has meant cash flowing out of these, and into equities.

Normally rate cuts are good for debt instruments. But the continuing trend of defaults has made Indian investors wary of debt. The real estate market is down and even the recent Rs 25,000 crore support for real estate may not be enough to turn things around quickly.

Another traditional asset – precious metals – has done better. Gold and silver have both seen bull runs in the past six months to a year. But both metals have also corrected slightly in the past month. This does, to some extent, suggest there’s been slow demand during the festival season, when Indians traditionally buy gold. Ideally, however, November data will be required before we can de-seasonalise across the entire festive period from “Sradh” to Diwali.

Despite the strong FPI inflows, and a lower trade deficit, the rupee has declined. Moreover, inflation has risen, to 4.6 per cent year-on-year in October. This is largely due to higher food prices. However, core inflation (ex-food and ex-fuel) is running at 3.5 per cent.

This makes for an intriguing situation ahead of the RBI’s next policy review in early December. Growth is down – so there’s an argument in favour of yet another rate cut. But the repurchase (repo) rate is at 5.15 per cent with the CPI running at 4.6 per cent. Due to lower core inflation, there may be room for another cut. That would put the real repurchase rate (net of inflation) into zero territory. So, the RBI has a difficult decision.

Based on a recent compilation of Q2 results for 1,697 companies, net profits increased by 22.5 per cent, while revenue fell 0.2 per cent. (This set excludes Vodafone and Airtel.) If financials are excluded, net profit growth is 11.3 per cent and revenue is down 3.3 per cent. Sector-wise, IT, pharma, private banks, and FMCG are the best performers. Precious metals and forex assets continue to look like the best options.

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