Nifty Tumbled From The Day High By More Than 80 Points After RBI “Shocker” Of “No” Rate Cut

Market Wrap: 07/12/2016 (17:30)

Indian economy may be now in an uncharted territory amid uncertain prospects due to demonetization & political disruptions and lots of global headwinds; market may not like such uncertainty for long irrespective of any RBI rate action or any liquidity management measures.

Technically Nifty Fut (Dec) now (LTP: 8137) has to sustain over 8165-8225 area for further rally towards 8275-8330 & 8395-8430 Zone.

On the other side, sustaining below 8135-8085 zone, NF may further fall towards 8040-8000 & 7940-7900 and 7840-7675 area in the near term.

Nifty Fut (Dec) today closed around 8137 (-32 points) after RBI “surprised” the market with no repo rate cut of even 0.25% as highly expected by the street. Moreover, overall statement of the RBI regarding inflation trajectory was quite hawkish contrary to the earlier perception of most of the market analysts. 

As expected, RBI slashed the FY17 GVA projection by 0.5% to 7.1% from the earlier estimate of 7.6%. As par the RBI statement, the MPC did not find any ground for an immediate rate cut amid hawkish Fed stance (US rate hike), uncertain domestic economy & inflation trajectory as a result of demonetization, upside risks of Oil and incomplete transmissions of previous 1.75% rate cuts by the RBI from Jan’15 (only around 1% may have been transmitted by the banks so far).

But, RBI’s subsequent comments and some accommodative consolation that, “if situation gives any space, then it will surely consider rate cuts in the near future” and the stance that the 100% CRR on excess demonetization bank deposits will be back to normal (4%) from 10^th Dec, has limited the market fall by some extent towards the closing session. RBI will use the MSS & other liquidity adjustment measures to take care of the excess banking liquidity (as expected).

As par RBI, so far people deposited around Rs.11.55 lakh cr worth of “demonetized” notes; although some source based news may be indicating a figure of almost Rs.13.50 lakh cr till last Monday. Incidentally, RBI highlighted the issue of “perfect counterfeit currency notes of old 500 & 1000 denominations” as the actual cause of sudden demonetization instead of the Govt’s firm stance for the “black money” issues.

RBI also dismissed the speculation of any “windfall gain” for itself/Govt and denied any so called “balance sheet” effect for the “cancelled” demonetized notes, which may not return in to the banking system and there is no question of transferring any excess surplus out of this. 

Thus, the highly speculative “windfall gain” of around Rs.4.5 lakh cr by the Govt and the subsequent use of it as “fiscal stimulus” concept gathered dust and the whole concept of finding “black money” and use it for the economic development of the country may be in jeopardy also. 

Incidentally, the overall cost for the demonetization on the economy may be around Rs.1.50 lakh cr and an an amount of around Rs.1.55 lakh cr may not be returned to the banking system as par some reports. Thus the Indian economy may have suffered irreparable collateral damage for this demonetization without any significant "gain".

After two years of successive droughts, when the Indian economy seems to be on a recovery path, especially for the rural landscape, the sudden decision of demonetization without proper preparations & digital infra in place has resulted in a severe all round economic slowdown and may affect the GDP by around 0.40% on an average per month, till full remonetization (at least 3-6 months more). The Govt's stance of "war on black money" may also destroy the story of Indian consumption by at least 30% even for the long term (as par various retail surveys).

Nifty gyrated by a wild swing of more than 100 points within few minutes after the RBI announcement and made a session low of 8095 with a day high of 8219 in the post lunch session.

As expected, after the RBI announcement, INR got more strength & G-SECS Bonds tumbled (yields gone higher).

But, Indian bond yields may affect in the coming days, when some of the excess liquidity will come in the banking system after 10^th Dec. Although, the excess demonetized liquidity will be absorbed by the MSS/LAF mechanism by a significant portion, it’s almost sure that a large part of it may also enter into the banking system. 

Although, apparently for the short term, the RBI CRR reduction action seems to be positive for the banks for liquidity purpose & lending and they can also earn some interests by way of reverse repo, while they are earning nothing now, it may have also huge negative implications for them in the long term.

There is no incremental demand for loans at this point of time either from the corporates/business/MSME or also from the retail segments and banks have already enough liquidity for the existing credit demands from the economy. These excess demonetized funds have to be parked in G-SECS by at least 21% on a daily basis as par SLR requirements by the banks. Already there is scarcity in the market for these G-SEC Govt bonds and more buying from the banks will cause another leg of bond rally, resulting in free fall of Indian bond yields. This may also make more FPI(s) outflow (exits) as in US and also in other advanced G-10 economies, bond yields are surging now. Thus, consequently INR will be weaker, which is again not good for the Indian economy and the market.

This excess demonetization bank deposits will eventually withdrawn once the full remonetization is done with easing of various restrictions, which may cause next wave of G-SECS bond selling by the banks, resulting in a huge capital loss in the future (for the bond portfolio), although in the short term it will gain from some interests earned from the reverse repo window.

Govt can’t issue MSS bonds or other LAF measures indefinitely as it’s a temporary measure and also Govt has to pay some interest on it without using the same for any fiscal deficit funding purpose (like infra spending etc). In that scenario, fiscal math equation may be also in pressure along with the expected downfall in overall revenues (direct & indirect taxes) because of this demonetization fiasco and Govt may not be in position for an incremental capex, which is now need of the hour amid tepid private investments and pain of twin balance sheets.

As par some reports, NAMO has reportedly admitted to the CM of TL in a recent meeting that he has blundered for this demonetization strategy without much deeper thought & consequences, despite his public stance that this a “right move” to eradicate corruptions and the “black money” from India.

This report may or may not be true, but expect more political chaos in the coming days and the current winter session of the Parliament may turned to be a complete wash out. In that scenario, consensus on GST “Dual Control” may be very tough to be achieved in the forthcoming GST council meetings scheduled on 10-11^th Dec and subsequently it may not be possible to pass the final GST bill in this Parliament session and planned April’17 roll out of the same may also be in jeopardy. 

Govt/FM may “officially” announce shortly another tentative timeline of Se’17 for implementation of the GST, citing “constitutional compulsion” for the time being. But again, considering various political compulsions and series of state elections in 2017-18 & general election in early 2019, it may be even tougher for the Govt to implement the GST before 2019 general election. Market (FII) may not be amused for so much uncertainty out of demonetization led economic disruptions and GST roll out.

Thus the sudden decision of demonetization might be proved as a “political suicide” for the NAMO/BJP instead of a “master stroke” in the days ahead. Political risks of India may be significant in the coming days, especially amid severe under-employment or unemployment in the country along with the present demonetization pains for the public at large. The “short term” pain may be converted into “long term” pain without much “gain”.

Globally, EU market was in positive today after market buzz of Italian Govt bail out for the Monte Paschi bank. 

Japan (Nikkei) was also strong after some drops in Yen and a tweet by Trump, announcing $50 bln investments & 50000 new jobs in US by a Japanese VC firm (Softbank).

Yesterday’s wild volatility in the Boeing share after Trump’s tweet about cost of the new Air Force-one plane for him may be an indication that going forward, this “Twitter Tantrum” by Trump may be a source of significant volatility in the financial market.

All eyes will be on the ECB meet & Draghi presser tomorrow evening for an idea about extension of the current bond buying programme till March’17 or March’18 (at a slower rate due to scarcity of the eligible bonds in the market) and any tapering plan for the future. Considering the impending EU political & banking risks, Draghi may play dovish this time and the current divergent monetary policy between ECB & Fed and other G-10 economies may make USD (DXY) stronger in the coming days. 

Although, RBI has taken a “hold” stance for the time being, thanks to the “owlish” & “inflation warrior” Patel/MPC, it has to be in “accommodative” mode due to domestic audience pressure and to keep its “political bosses” in good humour, irrespective of  any rate cut utilities.

Thus, RBI has to cut by 0.25-0.50% around Feb-March’17 after seeing the actual inflation trajectory, overall scale of economic disruptions for the demonetization and further Fed guidance on future rate hikes in 2017. 

Fed may clear its stance by around Feb-March’17, after Trump take charge of the Oval office in Jan’17 and subsequent actual plan for the proposed fiscal spending. In the ideal scenario of “Trumponomics”, Fed is expected to hike at least twice in 2017.

Thus the divergent policy between Fed & RBI may cause stronger USDINR towards 70-71 level by FY: 17-18, which may not be good for the overall Indian economy & the market. 

Another point is that, domestic market is not showing any fresh panic for the demonetization led “temporary” economic disruptions on the perception that almost all the so called “black money” is being deposited in the banking system, it will be eventually exchanged for “white money” and will be withdrawn or utilized for future consumption. 

But, the present stance of the Govt that simple bank deposit and withdrawal is not enough for the “black money” to be turned into “white” and one has to pay the required tax for it (at least 50% or 85%) as par VDS mode (voluntary or non-voluntary) and discretion of the IT AO. 

Most of the people are depositing their earlier undisclosed income in the banks on the perception that it will be taxed as 30%, if they show it as current year’s income. But, the law is not so simple, considering from previous similar case laws out of demonetization in 1946 & 1978.

Thus one can expect more legal hurdles, more “surgical strikes on the black money”, chaos and consequent economic disruptions for not only the demonetization, but also for the Govt’s stance of “war on black money”, which has to be logically ended to its conclusion keeping in mind the “political compulsion” for the next series of state elections & 2019 general election, where “war against corruption for the benefit of the poor”, “digital India”, “cashless society and digital economy” might be the main theme along with “surgical strike at LOC”. 

 SGX-NF