| Distress management | |
| MARKET INSIGHT | | Devangshu Datta / New Delhi November 30, 2008, 0:47 IST | |
 Another rate cut could happen, but lower forex inflows would dampen spirits.
In the Indian context, it is difficult to agree where inflation actually is and in which direction it is travelling. The Wholesale Price Index (WPI) is widely reported but the "rate of inflation" under focus is a point-to-point (P2P) comparison with the WPI levels of a year ago.
A P2P rate is a snapshot of prices on two specific days. This is misleading if there is a "base effect" and the period 12 months ago saw unusually low or high prices. Nor does the P2P tell you if prices spiked (or dropped) in between these two given days.
The other big problems are that about 100 out of the 435 commodities in the WPI basket are not relevant to current economic life, and the base year is 1993-94. Less than 2 million Indians flew in that financial year, there were less than 30 million phone subscribers and the dollar was at Rs 31.37. In 2007-08, over 55 million Indians flew, there were nearly 300 million phone subscribers and the dollar was in the range of Rs 38-42.
While the WPI is up 9 per cent P2P compared to November 2007, it is actually lower than it's been since end-May 2008. In the past three months, the WPI has fallen, suggesting inflation has moderated.
The WPI focus avoids highlighting the Consumer Price Index (CPI), which reflects the retail cost of living. At the September-end, when it was last computed, the CPI had risen 9.8 per cent in P2P terms. Again, this doesn't give a clear picture of the CPI time series' moves. The CPI data are also more confusing than the WPI since there are several CPI data series going through consolidation and reorganisation.
Based on what RBI thinks inflation is, and the prevailing trend, it may cut rates again. Partly, this is going to be driven by global rate cuts. However, the US, Japan and Europe, are running out of room. RBI still has manoeuvring space since real rates appear to be quite high. So it probably will cut, if it believes in apparent inflation moderation over the last three months. Common sense suggests inflation in 2008 has been caused by a combination of real estate and commodity bubbles, coupled with rising interest rates and oil price hikes. Rising real estate prices and rates forced home owners to cut back other consumption to service their mortgages.
Crude oil prices rose almost 200 per cent between June 2006 and June 2008. The government had to raise retail prices, albeit by a much smaller 60 per cent. That was, in itself, enough to cause inflation.
Crude oil prices have dramatically moderated and so have commodity prices, especially metals. Manufacturers would be willing to cut prices, given weak Q2 performances, lower cost of raw materials and anaemic post-Diwali sales. Real estate prices are down and likely to see further fall. The sector is over-leveraged and the number of home loans has drastically declined.
If rates are slashed as well, could we see a strong, V-shaped, consumer-driven rebound by the middle of 2009-10? It's unlikely. Domestic recovery also depends on forex inflows and a stronger export performance. Both seem very unlikely due to weak global conditions, although exports are likely to pick up, given the competitiveness at Rs 50/$.
But rate cuts will be a necessary if insufficient condition for any recovery to take place at all. The sooner those cuts take place, the better. As always, the banking and finance sectors would be disproportionately sensitive to monetary measures.
By the end of this quarter, the possible exposures of the financial sector to overseas junk and to rising local NPAs will have been discounted. Valuations are down more than the benchmark with the Bank Nifty down over 60 per cent versus the Nifty's 56 per cent.
Banking would remain a distressed industry until such time as the overall economy starts picking up again. But the distress may be somewhat be eased if rates are cut. That could create the conditions required for a stock price bounce. If you believe that you can second-guess RBI, you could even buy banks now (or take a long Bank Nifty position) on the assumption that a rate cut is imminent.
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