Brief on RBI Credit Policy and Equity Markets

The Policy: No change in policy rates. No major change in stance, except a verbal stress – ‘high priority’ in terms of inflation. Though, there is admission that ‘growth’ is important and RBI does not want to hamper growth at this stage. Clearly, the current bout of inflation is a supply-side issue and that too global commodity price led and tinkering with policy rates would not have been a good for an already slowing economic growth. RBI has opted to further increase the CRR and squeeze liquidity in the interim, while expressing readiness to act swiftly in case of any further adverse developments on the inflation front. It is debatable whether tinkering CRR is going to be enough in fighting this kind of inflation. Rupee appreciation appears to be a more direct and effective way in combating inflation in the current context and for the large good.
Markets: Equity markets main worry is growth and no action on policy rates is a sigh of relief. Interestingly, RBI has projected GDP growth at 8.0-8.5% and seems more bullish than the street. Most projections are in the range of 7-.0-8.0% for FY09. Is the RBI behind the curve? Not really, considering the fact that they have been ahead of the curve in the last couple of years and have achieved a caliberated slowdown in growth through their tightening earlier in 2007. Effectively, however, the credit policy does not change much in so far as equity markets are concerned. What is crucial, going forward, is whether global growth slows down appreciably or not. If not, then the inflation pressures will continue and that can lead to serious tightening at the cost of domestic growth, especially in the light of upcoming political environment. If yes, then we benefit as inflation will come down and we can actually decouple from the rest of the world. Global slowdown and global commodity price correction is important for us to maintain the ‘higher growth, lower inflation’ period of the last few years. Meanwhile, we maintain our view expressed in our note ‘Testing Time, This too will pass’. We expect continued volatility in the short term, but in the medium to long term expect superior returns from Indian equities. Use the volatility to your advantage. Invest in a phased manner over the next few months, but with a long term horizon of at least 2-3 years.
Our Portfolio Strategy :No change in strategy. Impact on banking sector is minimal. Banking sector is a classic pass-through sector as it effectively passes on any rise/fall in interest rates. In terms of sector strategy, we are overweight on banking, oil & gas, media, consumer, and engineering sectors. We are underweight on metals, pharma, construction, IT services and real estate sectors. We continue to play our three themes – domestic consumerism, domestic investment and beneficiaries of global slowdown - in differing orders of preference