Is the tide turning for the financial industry? A lot of bets are riding on the Reserve Bank of India (RBI) switching its credit policy stance and cutting rates, and on January 24. The central bank started raising rates in February 2010, in a tight policy that continued until December 2011, when it left rates unchanged.
A fall in food inflation, coupled with increasing signs of distress from India Inc, could lead to a rate cut. Easier credit would take a while to work through the real economy and, indeed, I think policy rates would need to drop 100-125 basis points before it makes a perceptible difference.
But any cut would have an instant, maybe short-lived, beneficial effect on share prices, especially in rate-sensitives like financials, auto and real estate. It would also have an influence on the rupee’s exchange rates.
Rate cuts may not happen. Inflation is politically sensitive and there are impending assembly elections. If the US-Iran argument gets more heated, crude oil prices will spike, guaranteeing more inflation. It’s a different matter that rate cuts (or increases) have zero influence on crude oil-driven inflation; it’s more a matter of being seen as doing something.
However, if there are rate cuts and some promises of more, the market will bid financials up. The rupee will probably harden, more because of Foreign Institutional Investor (FII) inflows than fundamentals. In anticipation, the market is already bidding financials and real estate shares up. We may see a ‘buy-on-rumour, sell-on-news’ effect playing out.
If there’s a minimal cut of 25 basis points, prices will stabilise. There will be a sell-off if there are no cuts, and a big sell-off if there is a rate increase. If there’s a larger-than-anticipated cut, of 50 basis points, rate-sensitives will shoot up.
The highest-risk, highest-return segment is that of listed real estate firms.
The major non-banking finance companies (NBFCs) are also high-risk, high-return. Both sectors have taken a battering, so a big return could occur even on a dead-cat bounce. On the other hand, if RBI disappoints, a huge sell-off may take place.
It’s also possible to go long in the futures of specific banks directly or to go long in Bank Nifty futures. Given that banks have good, high-beta correlation with the Nifty, it’s possible to hedge via the Nifty. Due to the hedging possibilities and also because banks are seen to have sounder balance sheets, they are less risky than real estate or NBFCs.
Keep that January 24 deadline in mind. Settlement comes up on January 25, and it could get chaotic if RBI pulls a rabbit out of its hat. There may be frantic volume action in these two sessions.
The author is a technical and equity analyst