RBI policy review: Investment recovery positive, headwinds remain

Key data indicates pick-up in activity, some experts sceptical of revival

Key market indices such as the Sensex and Nifty, which initially reacted negatively after the Reserve Bank of India (RBI) raised its policy rates by 25 basis points (bps), recovered soon to close the day about a per cent higher. The neutral stance (unlike general Street estimates of a hawkish one) of RBI and the regulator’s expectation of improvement in investment activity propped up investor sentiment.

However, is the market reading too much into RBI’s investment expectation, especially in the light of the looming headwinds? First, some recent data. Gross Domestic Product (GDP) growth at 7.7 per cent for the March quarter (Q4) was the highest in the past seven quarters. Capacity utilisation in the manufacturing segment, according to RBI’s latest survey, also improved sharply (74 per cent in the December quarter, highest in FY18). Exports grew faster (5.2 per cent) than imports (4.6 per cent) in April 2018. And, manufacturing activities also improved in Q4, as indicated by the 4.5 per cent growth in the Index of Industrial Production (IIP) in FY18, against 3.8 per cent during April-December 2017.

According to RBI’s policy statement, with improving capacity utilisation and credit offtake (up 13 per cent over a year as on May 25), investment activity is expected to remain robust, even as there was some tightening of financing conditions in recent months. Exports are also likely to improve, with positive global demand. All these are positive for India Inc, which is struggling to grow its earnings. Investors ended in disappointment in each of the past five years, as earnings consistently fell short of expectations. In recent days, experts had already started talking of an earnings downgrade for FY19, too.

However, not all are convinced. “GDP data seems overstated and capex and industrial-related credit also contracted. Projects under implementation and announcement of new projects also dropped sharply in Q4, and return on capital employed is much lower than the risk-free rate. This shows the private investment is still very low,” says Dhananjay Sinha, head of institutional research, economist and strategist at Emkay Global.

Given the high inflationary pressure (April consumer price inflation at 4.6 per cent), there are chances of further increase in interest rates. Elevated crude oil prices and a weak rupee are other worries. Any adverse movement here could spike growth expectations.

Given this backdrop, many experts say till there are clear signs of a pick-up in investment activity, especially private, investors stick to large-caps and select mid-caps with strong past performance and management --- handy when markets turn volatile for reasons such as high crude oil prices and bond yields. The rich valuations only mean the margin for error is limited.