Nifty Soared By More Than 100 Points In An Oversold Market As USD Retreat On The Back Of Falling US Bond Yields & Heavy RBI Intervention (?) And Closed The Volatile Week Marked By Demonetization Led Chaos By Almost 0.50% Higher

What’s for the next week ?

Technically, NF (8119) now need to stay above 8145-8185* area for further rally towards 8270-8355-8475 zone.

Otherwise it may again fall and sustain below 8115-8065* zone may further fall towards 8000-7960-7900 & 7810-7675 area.

Market Wrap: 25/11/2016 (17:30)

Nifty Fut (Dec) today closed around 8119 (+1.32%) after making a late session high of 8139 and opening session low of 8006, helped by short covering & some value  buying, especially in Pharma, IT and some banks. But cement and consumption sectors are continuing under pressure. There was some report that cement prices drop in Western India following demonetization led “cash crunch”.

Indian market today opened as flat following positive global cues marked by some drops in US bond yields in an extremely overbought market after “Trump Rally”. The domestic market sentiment got a boost after USDINR dropped by almost 0.50% following suspected heavy RBI intervention and some long profit booking in the USDINR forward contracts. Still, USDINR-I has closed above 68.25 and technically, consecutive closing above it may invite 69.25-70.50 in the near term. Divergence in Fed & RBI monetary policy, bond yield & interest rate differentials, demonetization after shock and expected huge redemption pressure on FCNR & FCCB (around $16 bln) may be some of the reasons behind strong USDINR apart from “Trumponomics”.

Having said that, “Trumponomics” may have its own funding issues as till date, there is no clarity about source of huge fiscal/infra spending under Trump administration for around $1 tln in 10 years (almost 1% of US GDP). Will it be Fed’s “free money” or funded by bond investors from Japan/EU/China/Saudi Arabia? Most probably it will be the 2^nd sets of investors, who may fund it along with US Govt (PPP mode). But in that scenario, Trump has to be dependent on continuing dovish monetary policy by BOJ & ECB and may also be not in a position to irritate China & Saudi Arabia either because they are holding significant US debts (bonds). 

On the other side, after “Brexit” & “Trumpism”, nationalism & anti-establishment politics are on the rise in EU, especially Italy, France and even Germany may be affected in the days ahead. Thus, policymakers and politicians are now increasingly looking for this “Trumponomics” model of more fiscal/infra spending to spur GDP, inflation and employment instead of incremental QQE (monetary stimulus).

Thus, days of incremental QQE or 24/7 money printing may be over and this may make EM currencies extremely vulnerable and India is also not an exception for this out flow, despite being a “sweet spot” in the global economy with its appeal of 4-D (democracy, demography, development & demand) & “Modinomics”.

It’s true that the near term impact of demonetization will be sharp both on demand (consumption) & production, but may be gradually return to normal by next 3-6 months (medium term) and there may be some steep fall in the FY:17-18 GDP & corporate earnings. But, the consistent script of “war on black/unaccounted money” in the system (both formal & informal) by the Govt may put the “demand” factor in serious question, even in the long term as traditionally Indian consumption story may be significantly dependent on this “black money”. In this regard, UP CM’s comment that “India was able to beat the 2008 recession period for this black money” may not be wrong at all (some economists/analysts may have told this to the UP CM).

There is some perception that over the course this “informal economy” may add to the “formal economy” and will be positive for India’s GDP in the long term. Moreover, RBI may cut 0.75-1.00% over FY: 17-18 and with that Govt may also be in a position for a massive fiscal stimulus because of lower currency liability, net savings & spread. Depending on the overall quantum of net savings, Govt may spend over infra, defence, rural, tax sops and even bank recapitalization. Govt is also exploiting two types of VDS for the current demonetization with 60% tax plus fine or 45% tax with four years of lock-in period for the huge amount of suspected undeclared “black money” deposited in the bank accounts.

In other words, as an indirect result of this demonetization “reform”, Govt may have a windfall gain and will be in a better position to spur growth in future by spending (Govt capex).

But till date as par some reports, Govt may have already incurred an expenditure of around Rs.1.50 lac cr for this demonetization drive against net CASA of around 5-6 lac cr. Going by the present scenario, it may take another 1-2 years for scanning of all the undeclared cash deposits by the Income Tax department and then raise demands and actual collection. Thus, it may take at least 3-5 years for such expectation of huge fiscal stimulus to be a reality, everything being equal.

Another probability is that, Govt may introduce some kind of direct banking transaction tax for this “undeclared” cash deposits and make an instant windfall gain. But, in that scenario, pubic trust on the banking system & currency may be also crashed and it may invite a huge political backlash also.

Also, simple rate cut by the banks/RBI may not work well for the economy as there is lack of sufficient demand and bank credit. Govt has to create an environment of more demand in the formal economy and for that appropriate job creation may be vital and quite challenging too.

Another point is that because of this demonetization led chaos & cash crunch on the ground level, food inflation has increased significantly, primarily due to demand & supply mismatch, despite favourable seasonal factor.

If such condition of acute cash crunch persists for another 3 months, in the ground level, where digital economy does not work, then this incremental food inflation may become another political headwind for the Govt/BJP in the forthcoming series of state elections.

Thus, higher food inflation, higher combined fiscal deficits & CAD, capital out flows, implementation of GST, EU political risks and continuing tensions at PAK-LOC may be some of the headwinds for the Indian economy in the near term despite expected tailwinds of “windfall gain” & huge fiscal stimulus as a result of demonetization and overall collateral damage to the economy may be much more than the intended benefit.

 SGX-NF