Shares in India are firmly on course to rewrite their all-time highs after the central bank cut interest rates for the first time in more than a year, pleasantly surprising markets by its timing less than three weeks before a scheduled policy meeting. Lower borrowing costs should provide a welcome boost to a fledgling recovery in Asia’s third-largest economy, and give consumers and investors much to cheer.

The Reserve Bank of India (RBI) lowered the repo rate by a quarter of one percentage point on Thursday, citing benign inflation as well as expectations that prices would remain low in the coming months. The move signals a shift in the central bank’s monetary stance, which has been mostly hawkish until now.

“We believe that this is a beginning of a big rate cut cycle,” Morgan Stanley economists Chetan Ahya and Upasana Chachra said in a note to their clients. “We expect a further 125 basis points rate cuts over the next 12 months, cumulative 150 basis points in this cycle.”

“Our rate cut forecast is predicated on our view that CPI inflation will stay at closer to 5 per cent in most of the calendar year 2015, as the reduction in fiscal deficit, sustained deceleration in rural wages and lower global commodity prices will mean that inflationary pressures in the economy will be contained,” they wrote.

Foreign funds led the buying frenzy following the rate reduction, gobbling index futures and options worth $1.2 billion (Dh4.4 billion) on Thursday, according to data from the National Stock Exchange.

The top-30 Sensex and the 50-share Nifty rallied the most in eight months on Thursday, before closing the week up 2.4 per cent and 2.8 per cent respectively at 28,121.89 and 8,513.80 — both within sight of their record highs of 28,822.37 and 8,626.90 hit last year.

Global investment houses Deutsche Equities India and Macquarie expect the widely tracked Sensex to reach 33,000 by end-December, a potential gain of more than 17 per cent from Friday’s close.

“The rate-cut cycle has started and that’s one of the reasons for our index target this year,” Rakesh Arora, the head of research at Macquarie Capital Securities India told Bloomberg. “Political stability, faster decision-making, higher spending on infrastructure and falling crude prices are excellent conditions for a sustainable bull market.”

Stocks in focus

Undoubtedly banks stand to gain as a drop in borrowing costs would boost credit offtake, both by the companies as well as retail consumers. Further, an improvement in the economy would help tone down non-performing assets, which have been a big concern for lenders.

Reflecting this realisation the Nifty bank index leapt as much as 4.3 per cent on Thursday to a record 19,410.40. Bond prices, which move inversely to yields, have also rallied in anticipation of more rate cuts.

“It does signal a shift in the underlying (monetary) stance going forward,” Arvind Subramanian, the government’s chief economic adviser, said after the RBI rate action. “We can expect strong disinflation going forward. Therefore, that will create the room for possibly more monetary policy easing.”

The industrial sector, which has been struggling for months, should also benefit from lower interest rates. Industrial output in November grew 3.8 per cent from the same month a year earlier after contracting 4.2 per cent in October.

Ridham Desai, equity strategist at Morgan Stanley, said historically lower short yields has been a trigger for both relative performance as well as relative valuations of industrials.

“We believe that rate cuts will boost the multiple of industrial stocks as the market attempts to price in a recovery in capex. Private sector banks, wholesale banks and discretionary consumption are the other two sectors we think benefit from falling short-term rates,” he said in a report.

“Our favourite stocks in these sectors include Axis Bank, HDFC Bank, LIC Housing, IDFC, Shriram City Union, Sobha Developers, IRB Infrastructure, Gujarat Pipavav, Bharat Forge, Tata Motors, Maruti Suzuki and Hero MotoCorp — all part of our Focus List,” Desai said.

More rate cuts

Even after Thursday’s rate cut, which was the first since RBI Governor Raghuram Rajan took charge 16 months ago, the repo rate at 7.75 per cent is still relatively high and among the highest in the region. With global growth, save the US, in disarray the Indian central bank, unlike its counterparts in much of the world, has lots of room to loosen policy to provide a boost to the country’s nearly $2 trillion economy.

While Morgan Stanley, Deutsche Equities and Nomura expect the RBI may again reduce rates at its scheduled meeting in February, other investment houses believe that Rajan, a former chief economist at the International Monetary Fund, would rather wait for the government’s annual budget on February 28 before making another rate move.

“We expect a further rate cut of 25 basis points in the next monetary policy review on February 3. We expect the RBI to front load the rate cuts by potentially taking up a 50 basis points rate cut in one of the monetary policy meetings after February 3,” economists Ahya and Chachra at Morgan Stanley wrote.

They argued that lower interest costs would lead to improved productivity and would not pile upward pressure on prices.

However, many pundits believe the next rate move would depend upon how Finance Minister Arun Jaitley addresses key issues such as fixing fiscal imbalances and removing bottlenecks in the way of investments.

“The speed at which interest rate trends downwards will depend on Jaitley’s next budget and the government’s overall stewardship of the economy,” the Times of India, the country’s largest circulated newspaper, said in an editorial.

Mixed earnings

Meanwhile, Tata Consultancy Services, the country’s biggest software services exporter, reported a lower-than-expected 5.1 per cent rise in quarterly profit and said it was seeing robust demand for outsourcing.

“Indications from customers are very positive. Key industries in which we operate are seeing good momentum and deal sizes are good as well,” Chief Executive N. Chandrasekaran told reporters.

Smaller rival Wipro posted a better-than-expected nearly 9 per cent rise in quarterly earnings and said higher technology spending by its main clients in the US and Europe should underpin sales in the coming quarters.

Energy conglomerate Reliance Industries, which owns the world’s largest refinery complex in Gujarat, said on Friday its December quarter profit fell 7.7 per cent — worse than street forecasts — as a near 60 per cent slump in crude oil prices since June squeezed refining margins as well as demand.

Results in the coming week include consumer goods giant Hindustan Unilever, leading tobacco maker and diversified company ITC Ltd, Hindustan Zinc and Biocon.

 

The writer is a journalist based in India.