Hawkish RBI makes FIIs nervous

Remain bullish, though, on India’s long-term prospects.

Foreign institutional investors (FIIs), which have invested around $2 billion in Indian equities this year, seem to have taken serious note of the sharp increase in policy rates by the Reserve Bank of India (RBI) yesterday. While they remain bullish on India’s long-term prospects, they feel the recent rate increases by RBI have put the markets at an additional risk in the near term and delayed the break out from the current range.

On Tuesday, when RBI increased repo and reverse repo rates by 50 basis points (bps), the Sensex fell more than 350 points. This was primarily attributed to the surprise element as the markets were expecting a 25 bps increase. The 30-share index lost another 86 points on Wednesday and closed at 18,432.

“Today’s action in equity and rates markets following RBI’s hawkish stance suggests to us that the market will likely be extra sensitive to inflation readings in the coming months,” Nomura said in a note to clients on Tuesday. To this extent, we think the markets are at a risk for the next two-three months, it added.

Interestingly, while Nomura is worried about the market reaction to inflation numbers, finance minister Pranab Mukherjee has warned that inflation may not be less than 6-7 per cent at the end of the year even as the government and RBI are making efforts to fight the rise in prices.

According to Nomura, the “potential worst-case downside scenario” is in the range of “8-10 per cent” from the current levels. It says it will start buying aggressively if the market corrects 5 per cent. Market experts believe that 5,200 will be a good support level for the Nifty, which closed at 5,547 on Wednesday.

Nomura is not the only global institution which has taken a cautious stand after yesterday’s RBI action.

Morgan Stanley went a step ahead and said the RBI move had “stymied” any probable breakout of the Nifty from its trading range.

“The case that may have been building for the Nifty to break out of its trading range since the fourth quarter of 2010 has probably been stymied by this move,” it said.

Morgan Stanley, however, remains a “buyer” of Indian equity with a 12- to 18-month investment horizon, adding that small- and mid-cap stocks are looking “more attractive” than the large caps. The global financial major is bullish on domestic cyclicals such as consumer discretionary and industrials.

Goldman Sachs, meanwhile, is of the view that the equity market is still amid “choppy waters” and that stocks are “not yet ready for an upturn.”

It, however, adds that the repo rate has “likely peaked for now” and “would remain stable before falling marginally by December 2012 to around 7.5 per cent”.

“While we do not expect inflation/rates to collapse, we believe stocks may start outperforming as rates/inflation decline, even though the bottom is at higher levels vis-à-vis the past cycles,” said Goldman Sachs. It expects inflation to bottom out at 4.9-5.1 per cent in the third quarter of 2012-13.