labels: rbi, markets - general
CRR hike could dampen equity markets: J P Morgannews
15 February 2007

Reacting to the hike in the CRR, Adrian Mowat, chief Asian and emerging equity strategist, J P Morgan, says that the CRR hike has the potential to significantly dent equity markets.

According to him, the risk involved in such a stance is that the RBI is likely to end the growth party in India.

He says that the RBI move might result in lower PE for the market. That being the case, he says that this is not yet the peak for markets overall, but certain sectors will have to struggle; PSU banks, real estate and autos will see a fall.

CNBC-TV18 shares with domain-b its exclusive interview with Mowat:

How are you reading these inflation figures and what the Central Bank is trying to do? Do you think it will significantly dent equity markets?
I think it has the potential to significantly dent equity markets. When one looks at Indian equity markets there are three levels of macro risk; you have got a high P/E, a relatively overvalued rupee and interest rates that have stayed relatively low considering the level of economic growth, and we associate these things with growth.

The P/E multiples are high because growth is strong, the rupee has been firm because strong growth has attracted capital and that capital has helped keep interest rates low. Now we are seeing the market pushing up interest rates and if one looks at three-month commercial paper rates, you have gone from around 7 to 9.5, so the market is already tightening.

Now we have got the RBI coming in with further tightening measures, which are going to push up market rates both of the deposit and the lending rates.

So the risk is that RBI is about to end the growth party and if growth begins to slow down then you are likely to see a lower P/E, a low rupee and a potentially higher interest rates and so we are concerned about this.

It makes me reflect back to September 1994 when the Indian market was doing very well back then, there was a lot of capital spending going on however inflation was picking up and the Narsimha Rao government was concerned about that ahead of an election and they raised interest rates and that marked the top of the market for a number of years.

But I don't think we are in such a dramatic situation at the moment but certain sectors may struggle over the next 12 months.

How much collateral damage are you expecting then for the equity markets and for those interest rate sensitive sectors?
I think the chances are that the markets will under perform the emerging markets for the balance of first half of this year and people are going to be anxious about the thematic sectors whether that be construction building material, to some extent public sector banks, which we think will see some problems as interest rates have moved higher.

We would be recommending clients to focus on big blue chips. Be quite cautious about smaller mid caps; they tend to be the areas that suffer the most when interest rates are rising.

So our advice is to buy stocks, which should get market share gains as interest rates go up, like those banks that are less likely to be competing in the home loan market and IT companies that benefit from a weaker rupee. They tend to be very cash rich and so are less concerned about rising interest rates.

Do you think these rate hikes and the tightening in the economy can actually cool some of the demand for things like autos and white good for which we have seen very good demand or are you worried about their growth, and of course real estate being hit by rising rates?
I think it is big-ticket consumerisation such as autos as well as real estate, which are vulnerable to this. The mortgage rates going up, and there are fixed rate mortgages in India, but there are also lot of floating rate mortgages, so there will be pressure on disposable incomes as interest rates move higher.

So I think you have identified the right sectors to be cautious about.

When we stepped into February the sense was that there was some money waiting on the sidelines to be pumped into the market. Given what's happened in our macro picture, do you think that might get tempered a bit and this market will have to live with much lesser flows?
There are definite flows still going into the emerging markets, and India will always get a share of those. However, there was a very interesting trend in the last couple of months when we were following the clients positioning in "India versus the index"; most clients have now made the decision to go neutral in India and so they are actually adding money to the market in the last couple of months.

So I think there is a vulnerability that people might decide to asset allocate to an underweight and you could see a flow of capital out of the Indian market.

Could all of this trigger a sharp correction in India or do you think that around the Budget you may not see such a sharp correction? What is your near-term tactical call on this market?
I think there is a risk in emerging markets is that once people start selling, which you see sharper falls and that was certainly the lesson in May last year, but we saw the same thing in April and May 2004 and two smaller sell-offs in 2005 in emerging markets. So you can sometimes get this compounding effect.

Aside from the domestic liquidity situation do you foresee any global problems that this market might have to lumber under as well?
I think there is a concern that we have is that the US yield curve in inverted and that doesn't seem to make much sense when the US economic growth looks reasonably good and so we fear a sharp normalization in US yield curve and that has been associated with sell-offs in emerging markets.

But generally the macro economic environment is very favourable for emerging markets. But I would make a distinction - one of the other guests was talking about US interest rate rises, do you remember that those are going from the level of 1 per cent in fear of deflation.

Also, we don't have the inflation problem in the US that we have in India. I think this is important. Short-term inflation may prove to be good in so far as the government cuts excise taxes during the Budget in order to reduce inflation temporarily.

This situation of inflation that is what you should best worry about because that is what the ministry of finance is worrying about and that is what the RBI is worrying about and this is quite a complicated story.

We have already had things like the banning of export of sugar in order to take down the head line inflation rates, we have had the control of petroleum product prices, etc, so the inflation is probably understated here.

We produced a paper recently, in which our economist Rajiv Mallik looking at the late rate of wage inflation, said was around 20 per cent. There is a serious issue here the metro areas rapidly rents are going up and that's about reform.

We still need to reform the other land ceiling act and the rent control act is still preventing the redevelopment of the property, which is causing inflations higher than it needs to be. India does suffer from a lack of supply side management in order to maintain a relatively low inflation rate. You do see that supply side management happening in other economies around other emerging markets.

What is your call on the two stocks, which have made big acquisitions globally, Hindalco and Tisco?
In principle I think it is a good thing that Indian corporations are globalising, that FDI is actually flowing out of this economy because businessmen are thinking strategically.

also see : Inflation and the CRR hike
CRR hike: Avoid interest-rate sensitive sectors
Costs of deposits bound to rise: PNB

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CRR hike could dampen equity markets: J P Morgan