Near decadal low repo rate may not revive economic growth, earnings yet

While experts laud the move as a step in the right direction, earnings growth may take a 3-6 quarters to recover

The Reserve Bank of India (RBI) governor surprised many with a 35 basis points (bps) repo rate cut, given that expectations were for a 25 bps cut. Yet, for the equity markets, it passed off as just another day. In fact, the Sensex and Nifty closed lower by 0.8 per cent on Wednesday. Though the rate cut was in the right direction, there are multiple reasons why markets had little to cheer for the monetary policy, starting with the lowering of GDP growth to a more cautious outlook on macro headwinds. In other words, the question is whether a near decadal low repo rate can revive economic growth and earnings (see chart).

Among others, there are two important factors to rev up growth – capital expansion or capex (public and private) and domestic consumption. Both these engines are currently on a weak note and that is well captured in India Inc’s June quarter results published so far. “Earnings were poor and management commentary across the board, including banks, was weak,” says Vineeta Sharma, head of research at Narnolia Financial Advisors. In this context, unless there is enough to revive consumer and industrial demand (led by government’s initiatives), there is little hope of a reasonable rebound in earnings. Whether a rate cut can engineer capital expenditure at least to boost corporate India’s demand for capital and appetite for expenditure needs to be seen. 

While the picture is gloomy as there are no signs of capex revival in traditional pockets such as metals, large infrastructure projects and power plants, there are some green shoots in smaller pockets such as cement, consumer staples and specialty chemicals. “Government capex may revive soon, and private capex may return in some pockets in the next 6-9 months,” says Pankaj Pandey, head of research, ICICI Securities. 

But is this adequate to revive growth? “There are reasonable triggers know, but if they get delayed, then earnings growth may also be pushed to next fiscal,” says Pandey. Meanwhile, even if the 110 bps repo rate cut in the current calendar may have effect on corporate demand for money, consumer demand is the weak link. Dhananjay Sinha, head of strategy research, IDFC Securities points out that there aren’t enough levers for consumption demand. “What we need is spending growth and just rate cuts will not revive that,” he explains. 

Therefore, with transmission of rate cuts remaining patchy and earnings outlook not materially improving soon, easing repo rates alone may not move the needle for equity markets. More importantly, as Sensex valuations at 26x FY21 earnings are far from affordable, the risk-reward hasn’t turned favourable yet.