Fundamental triggers missing

The Reserve Bank of India (RBI) announced its monetary policy on May 3, and reduced the repo rate by 25 basis points to 7.25 per cent. This is the rate at which banks can borrow from RBI. Since October 2011, RBI has cut the repo rate by 125 basis points (bps) and the cash reserve ratio by 200 bps. The rate cuts were made to deal with the slowing growth in gross domestic product (GDP) over the past few quarters. However, the fear of spiralling inflation has kept RBI from pursuing a more aggressive rate cut policy. The GDP growth rate assumption for FY13-14 has been moderated to 5.7 per cent. Inflation is also expected to be low, but there is a danger of it spiking any time. While the wholesale price index-based inflation is showing signs of slowing at 5.96 per cent in end-March, inflation based on the consumer price index remains beyond the comfort zone at 10.4 per cent.

The current account deficit (CAD), which had ballooned to over six per cent of GDP, from sustainable levels of 2.5 per cent, gives an illusory picture of being under control, with prices of commodities, such as gold and oil, declining. The CAD is currently pegged at 5.3 per cent. While there are expectations that foreign direct investment (FDI) flows will materialise and foreign portfolio flows will remain strong to fund the deficit, these factors are not in India's control. Additionally, the view that commodity prices have corrected and will remain low due to slower demand, may be correct. But it is risky to completely believe this, given the money printing exercise in the US, Japan and the European Union. In the absence of demand picking up in these economies, some of the extra currency may find itself flowing into assets, creating a bubble-like scenario. The bubble could be in stocks, particularly in the absence of earnings growth.

Changes in interest rates alone may not be enough to spur growth; the supply side of the economy needs to be stimulated. For this, either the government should increase its investment spends or create an environment to increase the confidence levels of the private sector to begin investing. Given that elections are just a year away and in fact may be held by this year end, it is unlikely that any significant improvement can be seen in policy making or real reforms for the private sector to invest for growth.

Against this backdrop, foreign institutional inflows have been $11 billion year-to-date. These will depend on the confidence they have on the Indian economy, their risk appetite to invest here, yield outlook in India-earnings growth for equities, yields on bonds and easy availability of liquidity. Currently, access to liquidity is not a problem. The risk appetite is unpredictable and very fragile. There could be another Cyprus looming ahead and flows to India for global reasons could stall or reverse. Earnings outlook for FY13-14 is muted. The pass through of lower commodity prices into corporate profitability will take time. Unless one is willing to look at FY14-15 numbers, the excitement based on next year's earnings is lacking. Given the not-so-cheap valuations for the Sensex at 16.5x, the fundamental triggers of bright earnings outlook and attractive valuations are absent. While remaining invested, it is best to be cautious and investors looking to invest afresh may think of investing only a part of their money in the markets now.

The author is director - Quantum Asset Management