Increased volatility, selling in Bank Nifty

The Reserve Bank of India's (RBI's) policy update was reassuring. The central bank left rates and money supply untouched and the statement contained glimmers of hope. RBI says economic activity has seen “modest recovery” in Europe, Japan and the US, though China is proving to be a drag as it slows down. Russia and Brazil are also struggling.

India’s exports remain busted. But reserves continue to be accumulated. In nominal terms, forex reserves are at record levels. But in terms of import cover, higher reserves might be desirable. There is some nervousness about the US Federal Reserve’s intentions.  

Commodities are down and there has been plenty of turbulence, caused first by the Greek situation and by heavy selling in China. But there has not been a “generalised flight to safety”. Translated, that means investors have not yet been spooked into heading for dollar-denominated US government debt.

India’s recovery continues. The monsoon has been near-normal so far. RBI front-loaded its third rate cut of calendar 2015 in the hope that monsoon prospects and inflation data would not disappoint. On the monsoon front, things have been positive. There are hopes that rural demand will improve. Consumption demand might have picked up in urban areas, going by rising automobile sales in July.

But inflation rose across all groups except housing. Food inflation rose by 0.6 per cent in the Consumer Price Index (CPI) in June, month-on-month over May. Core inflation (excluding food, fuel, petrol diesel,) has been rising since April. In fact, core inflation has run higher than overall CPI (fuel, petrol and diesel fell through April-June). Household expectations of inflation rose to double-digits and these expectations drive consumption behaviour.

RBI is unhappy at the lack of transmission of rate cuts by banks. So far, RBI has cut the repurchase rate thrice in calendar 2015, by a total of 75 basis points (0.75 per cent). An estimated 30 basis points (0.3 per cent) of those cuts have been passed on by banks which have cut respective lending rates. The central bank wants banks to cut more and hinted it might not be willing to lower rates unless  banks pass on previous cuts.   

RBI also says the inflation data could be skewed by base-effects in July and August. The July and August year-on-year changes could seem low because the corresponding 2014 months had high CPI. But after September 2014,  “favourable base effects” should subside, since crude oil  prices fell in the second half of 2014-2015 and so did food prices. Presumably, RBI will deseasonalise all the data but how exactly it does so would influence the central bank perspective.

The Bank Nifty reacted with the usual knee jerk disappointment initially. But it seems the optimists hoping for a cut were in the minority, since the selloff was not steep and support came in, to push the index up again.

The Q1 results have been reasonable for banks, since expectations were low. Major public sector banks (PSBs) such as Bank of Baroda and Punjab National Bank have registered lower profits due to higher provisioning for their bad debts.

The government has also announced an enhanced recapitalisation package for PSBs. This may be throwing good money after bad in the absence of reforms. But the announcement has been well-received by the market and this could put a floor on the Bank Nifty.

The financial index could still see major volatility and more selling. But that is more due to external factors like China or the Fed than RBI policy. Bearspreads might seem tempting. For example, a long 18,500p, short 18,000p could well be worth a punt.