Analysis:Smart move to drive investors into 'risk-on' mode

Sensible move to drive investors into "risk-on" mode by shift into policy reversal stance, says Moses Harding, Head - ALCO and Economic & Market Research, IndusInd Bank.

RBI considers weak rupee and high fiscal deficit as major risks to inflation. While rupee fears are out of the way; it is important not to allow slip in growth momentum to prevent further slippage in fiscal deficit. The need is to improve investors' confidence to get them back on "risk-on" mode; resultant stability in equity market will help the Government to raise monies through disinvestment. The system cannot afford slippage in revenues at this stage; hence the need to support growth and get into balanced approach between inflation and growth dynamics. On the other hand, market dynamics are deep into anti-growth mode with tight liquidity and high cost of short term funds despite series of OMO purchases by RBI; single beneficiary being the Government to keep its borrowing cost in check, driving the 10Y sovereign bond yield from 9% to below 8.20%. Therefore, the agenda with RBI is to control anti-growth factors by shifting the market to adequate liquidity mode at affordable cost and get the equity market into bullish mode to divert investment from Fixed Income into equity. It is also important to keep domestic cues positive when external cues are negative and complex. Given these expectations into the monetary policy, it was sensible for RBI to deliver 50 bps CRR cut while considering rate cut not very relevant when overnight MIBOR is trading well above Repo rate.

What is the impact on the markets? There will be stability in Interest rate market with 10Y bond yield at 8.0-8.20%; 1Y OIS at 7.75-8.0% and 5Y OIS at 7.10-7.35%. Stock market will get into bullish mode for near term objective at 5350 with strong support at 4950. The reversal in interest rate cycle may not hurt rupee at this stage driven by robust FII flows and supply-driven mode in the FX forward market; consolidation at 49.85-50.35 would be in order. The risk is for extension into 49.25-48.50 if RBI does not shift its stance from USD sell mode to USD buy mode.

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