Nifty Slumped By More Than 100 Points Amid EU Political Risks & Fear Of Hawkish Fed; But Closed The Volatile Week Almost Flat (-0.33%) Marked By Demonetization Hang Over & Likely GST Delay; What’s Next?

Market Wrap: 02/12/2016 (17:30)

Technically Nifty Fut (Dec) now (LTP: 8110) has to sustain over 8195-8275 area for further rally towards 8335-8375 & 8445-8485 zone.

On the other side, sustaining below 8165-8090 zone, NF may further fall towards 8040-8000 & 7940-7900 And 7840-7675 area in the near term.

Nifty Fut (Dec) today closed around 8110 (-1.24%) after making a post lunch-session high of 8190 and closing hour low of 8092 amid tepid global cues and ongoing domestic concerns about demonetization led business & political disruptions.

Indian market today opened lower following tepid Asian cues, weak domestic PMI and mixed auto sales data and further dragged after opening. 

The overall market sentiment may be also affected by the reports that demonetization led bank deposits may be almost near 80% of the banned notes and as par the latest trend, it may “exceeds” the official figure of the erstwhile banned currency circulations.

Thus, the Govt may not get any so called “wind fall gain” of around Rs.4.5 lakh cr as was heavily speculated since the announcement of the demonetization. On the other side, Govt/RBI may have already incurred an expense of around Rs.1.50 lakh cr for this demonetization exercise. Thus the whole idea of demonetization and “black money” may be in peril now and Govt is now focusing more on the “digital economy” theme, keeping the whole nation standing in the banking queues now for a month.

Domestic market sentiment was further dragged as a fall out of continuous political battle in the Parliament because of this demonetization. As a direct result, passage of final GST bill in this winter session of the Parliament and implementation of the same looks very difficult for April’17 and even from Sep’17. The FM has also raised some questions (doubts) about Sep’17 GST roll out, terming it as “constitutional responsibility” and presumably attacks the “united opposition”, led by TMC supremo (Mamta Banerjee) for all the “responsibility”. 

Incidentally, TMC supremo may be fighting this “demonetization battle” to the “teeth & nail” eyeing for the 2019 general election as there is a serious “political vacuum” in the opposition for an “acceptable” (consensus) leadership.

Thus, GST and other vital reform process, such as Land & Labour bill may be continue under the political game of “ping-pong” amid the chaos of demonetization and there is little hope that the GST will be implemented before 2019 election.

The market sentiment may be also affected after FM hinted that complete printing of new currency notes to replace the 86% of currency need may take time for 1-2 quarters; i.e. 6 more months against earlier perception of 2 months (50 days). 

Market recovered to some extent for a while in the after lunch session, when RBI/Govt announced the MSS limit enhancement from Rs.30000 cr to Rs.600000 cr to suck out the excess banking liquidity as a result of demonetization. 

But this was also on the expected line after RBI imposed 100% CRR for this incremental banking liquidity. Moreover, this MSS facility is now for 28 days (Rs.2 lakh cr) and the Govt will pay the interests to the banks for this facility in a staggered manner over FY: 17-18 periods. As par the MSS mechanism, it’s only a temporary adjustment facility for liquidity in the systems and Govt can’t use it for fiscal spending purpose. 

Overall, the gradual nature of the MSS and elevated costs for the banks for the demonetization may keep the earnings of the banks under pressure in the coming months.

Also, RBI may remove the 100% CRR imposition on the excess banking liquidity shortly or on 7-th Dec (policy date) and may even cut repo rate by 0.25% without any corresponding cut in reverse repo rate to facilitate the banks for their notional loss as a result of demonetization led surge in the banking deposits. 

Banks are literally paying around 4% on its savings accounts deposits, whereas earning practically nothing on it by way of incremental lending, because there was no demand at all. At the same time, parking of this excess fund in the CRR window also does not yield anything. 

On the other side, such huge amount of excess liquidity is forcing the banks to buy G-SEC bonds in an incremental manner almost on daily basis to keep the norm of 21% SLR, which is also causing drastic falls in Indian bond yields, thus paving the way for an easy exits for the FPI(s) and softening of the INR. 

Thus, the RBI is sucking this excess liquidity from the banking system to prevent falling bond yields, FPI (s) led outflow, weakening of INR and eventual capital loss for the banks from this bond market over heating, when excess deposits ultimately withdrawn in the next 3-6 months, once the situation will be normal.

This MSS action may be slightly positive for the banks in comparison to the CRR action, where it will get nothing, but may be also negative for the Govt (fiscal deficit), which has to pay some interests on it without utilizing the same. 

As there is practically no takers of loan, considering the stressed balance sheets of Indian corporates & SMES, banks can’t use this incremental deposits and RBI may also not very inclined for any “irresponsible” lending by the banks either as in the past because of excessive NPA in the system. 

Govt may focus on the priority lending sector (agri), keeping in view the series of state elections and 2019 general election. The forthcoming FY-18 general budget may also be more focused on this agri/rural & social security schemes for the political compulsion.

Though, market is expecting at least 0.25% rate cut by the RBI on 7-th Dec, keeping in view the probable sub 7% GDP in the coming days, this may not be a usual growth-inflation dynamics for RBI this time. 

As INR is already weak against USD due to monetary policy divergence between Fed & RBI, “Trumponomics” and this demonetization led fall in bond yields, “Owlish” Patel may prefer to wait & watch this time for an actual Fed stance on 16^th Dec and subsequent Fed guidance about 2017 rate hikes (2-3). Depending on the Fed stance, domestic inflation trajectory and economic fallout as a result of this demonetization, RBI may act only in Feb-Apr’17 to help the banks (NIM). 

Eventually, until & unless, FD & other small savings rate in India are not lowered drastically, it may not be feasible for the banks to transmit the repo rate cuts by the RBI in an incremental manner and any drastic fall in small savings rate may also be politically sensitive and may not be possible.

Also, any drastic repo rate cuts by the RBI in the days ahead may depreciate INR against USD more rapidly and in that scenario, FPI(s) may also exit more vigorously.

Thus, demonetization may be proved as a double whammy for the Indian economy as well as the market. It may also be termed as a “political suicide” instead of a smart “master stroke”.

Digital economy & cash less society sounds good, but before sudden demonetization, Govt should have ensured digital infra & required knowledge in a country like India, where cash is king.

Globally, all eyes will be on the Italy constitutional referendum on Sunday and also on presidential election in Austria. The Italy referendum may be of prime importance, because of a high probable “NO” vote, which may eventually force Italy for an exit from the EU and resignation of its current PM. Thus the political risks may increase significantly with Brexit and other forthcoming elections in France, Germany etc as “nationalism” & “trade protection” theme is on the rise, especially after “Trumpism”. Ultimately, the whole EU/EZ concept may collapse.

At the time of this writing, US NFP flashed as 178k, unemployment rate 4.6%, both in line/above expectations. But, wage growth came at (-) 0.1% against consensus of 0.2% (MOM), which undermines the US economic recovery by some extent. As a result, USD is falling; but it may not affect the Fed for its Dec’16 rate hike at this point of time. 

All eyes will be on the Fed commentary about probable rate hike plans for 2017 and market is expecting at least 2 rate hikes (June-Dec’17), if not 3 under new Trump administration. Having said that, US wage growth may be now much more important than the NFP & unemployment headline, because for consumption, one needs to have some surplus income for discretionary spending as well. On the YOY basis, NFP earnings growth today flashed at 2.5% against consensus of 2.8%.

On the other hand, if Yellen choose to stay pat for the forward guidance and does not comment too much without the real fiscal spending plan of the “Trumponomics”, USD may be weakened more in the coming days, which may also be beneficial for the EM currencies including India, at least for the short term. 

Yellen may not comment too much about future rate hikes on 16-th Dec, until Fed is confident about consistent wage growth in the US economy, despite market perception that Trump’s fiscal spending plan may create for more jobs and eventual solid wage growth.

 SGX-NF