Interest rate reversal key to market health

G. CHOKKALINGAM
Group CIO
Centrum Wealth Management

At this juncture, we are optimistic on the domestic equity markets. 2012 has already marked a reversal of exchange rates for the domestic currency and would also witness a reversal of the interest rate cycle going forward. Post February-March 2012, there are no major elections till early 2014, and hence, we expect a lot of positive economic measures (like FDI in multi-brand retail) to go through in the budget session as well as post-budget, which would provide further triggers to the markets. We expect the Sensex to cross the 21000 mark and touch 22000 by the end of the current calendar year.

On the financial front, the Q3 FY12 corporate results were showing signs of growth, which could be in the lower single digits. This has already been factored in and the broad indices are back to the levels seen in the October-December 2007 quarter. What gives us hope is that the domestic demand is not hurt – in Q3 FY12, sales continued to grow at close to 25 per cent YoY. The expected reversal of the interest rate cycle and the appreciation of the INR would moderate both interest costs and raw material costs, which would improve profitability going forward.

We firmly expect that the inflationary trend should continue to moderate, thanks to a good harvest of fruits and vegetables, an expected record high production of food grains in the current crop year and also due to the base effect. The banking, automobile and capital goods/engineering sectors would be the major beneficiaries of a likely reversal of the interest rate cycle. As manufacturing is expected to turn around, the metals sector would also be an indirect beneficiary of a reversal in interest rates.

We firmly believe that the interest rates have already peaked out. The continuous rise in benchmark rates to the extent of 375 basis points has already brought in a deceleration in the industrial economy – as per the advance estimates, the GDP growth is expected to be only around 6.9 per cent in FY2012. On the other hand, the inflation rate is expected to fall to around seven per cent by March 2012. Hence, we expect the RBI to continue with the reversal of monetary parameters, which it started in January 2012 by reducing the benchmark rates in the forthcoming review as well.

On the global front, the overall medium-to-long term outlook wouldn’t be as optimistic as that for emerging markets like India. This is because the GDP growth of developed economies is expected to be around 1.5 per cent annually, and their debt problems are also expected to continue for many more years. In contrast, economies like India and China would continue to grow faster in relative terms, and hence, would attract a lot more foreign funds. We firmly believe that Indian equities would outperform the equity markets in the developed world by a significant margin in the current year.

Going forward, the next trigger for the markets would be the actual reversal of the interest rate cycle within a couple of months. Other key factors would be economic reforms and the significant inflow of foreign investments in Indian equities by both institutional players and individual investors. As we expect the INR to remain robust and appreciate towards Rs 46 against the USD by the end of 2012, we anticipate FII funds to continue coming into India in 2012. Risks to our views largely emanate from any possible spike in crude oil prices and/or any major failure of the forthcoming monsoon.