Combination of disappointment and hope....mixed signals but weak on confidence
The initial recovery in rupee into 56.38 got completely unwound for reversal into 57.10 post release of measures; obviously the delivery was not to expectations. The first worry was from FM passing on the baton to RBI for announcement. It was not expected from RBI measures other than relating to DCM (Debt Capital Market). RBI did its best to enhance limits; review of operative restrictions and increased the pool of investors. Yes, it is positive but seen as too little given the large appetite. The hope ahead is that more measures will follow relating to ECM (Equity Capital Market) such as roll-back of tax related issues; open-up sectors for long term sustainable flows and broad base the pool of investors. The expectation of USD 15-20 billion foreign currency Bond issuance for subscription by NRIs and other eligible investors is warm. More importantly, the market also awaits action on fiscal consolidation. The near term will be action packed and it is essential that new FM delivers to expectations. If the Finance Ministry is retained by PM, then it will add to confidence.
The play is now between “shock” and “awe”; any shocker will get the rupee focus into 57.90 ahead of 58.25-58.50 while exceeding expectation will quickly revive rupee bullish trend into 55.50 ahead of 54.00. As said, rupee level at 57.00-58.50 takes into account all negative factors but positive factors (mainly from sharp fall in crude oil and resultant release of significant pressure on CAD) are yet to be counted in. The lack of confidence and no clear bottoming out signals is causing delay to shift the forward market into supply driven mode despite highly devalued rupee; exporters need to get the fear of sharp reversal in rupee into 54-52 to open the flood gate for dollar supplies. The short term range for rupee is now seen at 54-57 and extension not beyond 52.50-58.50. The strategy is obvious; exporters can look to hedge medium to long term receivables (3M and beyond) on spot weakness into 57.00-58.50. For those who look for interest cost reduction on long term loans, spot rupee at 57.00-58.50 is good to convert 3/5/7 year rupee loan to foreign currency (and can look to cover the first year on rupee move into 54.00-52.50). There is no need for importers to panic on payables/liabilities beyond short term (up to 3M) and can afford to stay aside for rupee bullish reversal into 54.00-52.50.
Higher limit for foreign investors in Gilts will address supply-side issues and reduce OMOs
The enhancement in investment limit in Gilts by USD 5 Billion for foreign investors will be absorbed immediately. The risk-reward is greatly in favour of the investment given the possible shift into accommodative monetary policy (and rate reversal cycle) sooner than later. Believe, there is enough room for further enhancement of limits; seen as simple form of pulling dollar supplies to USD Bond issuance with sovereign guarantee (underlying credit exposure and the yield are more or less the same). It gives room for RBI to reduce its OMO operations and instead resort to CRR cut for liquidity injection. These expectations into the future will drive the Bond/OIS market into consolidation mode and it is time to build steepness in the yield curve to factor time value; downward push in the shorter end (1-3 years); moderation in the medium tenor (3-12 years) and uptrend in the longer end (beyond 12 years). It is also possible that next monetary action may not be from rate cuts but from shifting the operative policy rate from 8% to 7% and shift the yard stick to 1% NDTL surplus system liquidity. The “play” will be in the shorter end with 1Y Bond yield down to 7.75% and 1Y OIS rate around 7.5%. The chances of movement in 10Y yield below 8% and 5Y OIS rate below 7.10% is low and if it does, it will considered good to conduct “Operation Reverse TWIST”; buy short and sell long. The strategy may be to maintain short duration in the investment book keeping enough room for absorption of supplies from RBI as move into rest of FY13. On the other hand, 10Y Bond yield at discount (8.15-8.25%) will look good for medium/long term play when RBI gets into rate cut mode beyond 2012 if inflation is tamed by then and GDP growth stays at 5-6% zone.
Improvement in domestic cues to shift equity market into bullish undertone
The domestic equity market has strongly withstood recent disappointments, third in a row from the Union Budget, mid quarter review of monetary policy and now. It was surprise to many who looked for sharper correction into 4800 in NIFTY but held strong above 5075-5100 support zone. It is matter of time that the Government will undo the disappointments from Budget FY13 on issues related to GAAR and retrospective tax treatment. It is also expected that there will be roll-out of next generation reforms in part if not in full. The act into fiscal consolidation and RBI’s shift into growth supportive stance will address growth and fiscal deficit related concerns of rating agencies. UPA will gear up to maintain positive (and favourable) mood before 2014 elections. Over all, concerns related to Government policy paralysis and twin deficits may be out of the way to shift focus on growth and inflation. The external environment is uncertain but loose monetary policy of Western economies and relatively stronger Indian economy will retain India as good and safe-haven investment destination. It is also essential to enhance access to those foreign entities that are eligible to invest in DCM. The undertone will turn bullish sooner than later. It is safe to assume that short term target is at 5630 to complete 100% unwind of recent fall from 5630 to 4770 (22nd February 2012 to 4th June 2012). If all goes well to enable RBI to shift into loose monetary policy stance (like rest of the Central Banks), medium term target will be at 5950-6350. Let us give up this bullish expectation on any disappointment driven fall below 4775. It would be good risk-reward for strategic investors to stay in preparedness to absorb weakness into 5100-4800.
Good luck..........................Moses Harding
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