The Reserve Bank of India (RBI) did the expected, cutting the repurchase rate by 25 basis points (0.25 per cent). In a "bonus", it also cut daily minimum requirements of the Cash Reserve Ratio (CRR) from 95 per cent to 90 per cent, while maintaining CRR at four per cent. Requirements for the Statutory Liquidity Ratio (SLR) were also eased. Despite the easing, equity prices fell. There could several reasons for this somewhat unexpected selloff.
Some optimists were expecting a larger cut in the repo. They opted for what is called "tired bull unloading". The market has already travelled up a significant distance since the Budget. Booking profits on the policy statement may be a sensible action.
It may also be noted that another rate cut is unlikely for a while. Chances are the central bank will see out the monsoon and start closing out forex swaps starting September 2016, before it considers cutting rates again.
Global market sentiment encouraged profit-booking. Most major markets have seen a subdued trend this week, although there has been no particular trigger for bearishness. However, as RBI mentioned in the policy review statement, the global economic situation has not improved.
According to RBI, there are still risks to most major world economies. World trade remains "subdued", China faces "formidable headwinds", the US has a "clouded near-term outlook" and Europe is facing "stress in the banking sector", the threat of a possible Brexit and the uncertainty rising from the migrant crisis. Emerging economies are struggling with weak growth and tight financial conditions.
The statement also noted "exceptional accommodation" has affected the euro and the yen and gold prices have risen 16 per cent in calendar 2016. However, the "uneasy calm" in financial markets could be dispelled by a "sudden return of risk-off sentiment" if poor data comes from China or the US.
On the domestic front, the central bank is worried about slack rural demand, a muted capex cycle and contraction in the capital goods segment. Like everybody else, it has its fingers crossed for a good monsoon. On the positive side, the PMI for March indicates the potential for strong expansion in 2016-17 and so does the positive sentiment from RBI's own industrial outlook survey.
Importantly, household inflation expectations have declined. Food inflation dropped in February (the last month for which data is available), after six straight months of rise. Fuel inflation across gas, kerosene and electricity also declined. Inflation expectation for households over the next three months came down to single digits. A strong indicator, since expectations actually drive behaviour.
However, this could be balanced by the inflationary impact of the pay commission, One rank, one pension, etc, as more cash in the hands of consumers percolates through the economy.
The rupee should see some weakening. Most hard currencies are maintaining status quo in rates, while the rupee is dropping. So, the rupee should ease down as the rate differential narrows. This could have a beneficial effect on trade. Anyhow, RBI sees an improvement in external trade indicators, with the rate of export contraction slowing down while non-petroleum, non-gold imports actually grew. The negative impact of rupee weakness might, however, be seen in September, when various swaps mature and FCNR deposits must be rolled over, or redeemed.
The sell-off today could be of significance in terms of establishing a new trend. The macro fundamentals for India will not change much for several months. The next set of triggers will come from corporate results and those are not expected to be great.
The author is a technical and equity analyst
