The markets have pretty much shrugged off the hike in the repo and reverse rates and that wasn?t really unexpected because inflation hasn?t really come off although wholesale inflation for August moderated somewhat to 8.5%. And the Reserve Bank of India (RBI) had left nobody in doubt that it was determined to tame inflation. Since the RBI is equally determined to see that its measures have the desired impact, interest rates will certainly move up across the system, implying that both small and large borrowers will have to shell out more for cash credit and home loans. But the Street seems to be supremely confident that demand for everything from cars to capital goods will remain robust and that this spending will help sustain the growth momentum. Nothing else can explain ?interest rate sensitives? like Maruti, Tata Motors and banking stocks staying firm at a time when interest rates are clearly headed further north.
The central bank, as many experts have pointed out, isn?t done with making money more expensive, in its objective to curb the runaway increase in prices of both food and manufactured products. So there could be another round of rate hikes towards the end of the year, especially if the data on inflation turns out to be worse than expected.
So far there has been little reason to worry about growth; apart from one weak month in June, the growth in factory output, this year, has been pretty much on track with industrial production averaging 11.4% in the first four months. That is what is causing all the bullishness and of course the abundance of liquidity worldwide; foreign investors have now pumped in more than $15 billion since the start of the year almost close to the amount of $17 billion that came in in 2009.
While it?s true that the macro-environment seems almost invincible?even exports seem to be doing their bit?and so the growth in the GDP in 2010-11 might well hit 8%, there are a few concerns worth highlighting. First, the market is now very, very expensive; at 19,400 the Sensex now trades at just under 19 times estimated 2010-11 earnings though if one was to take a slightly longer term view, it may not seem as richly valued especially if corporate earnings continue to grow at 20% or thereabouts. At a relative level though India is now the most coveted of emerging markets attracting a premium that?s way above those commanded by peers like Taiwan or Korea. There?s really very little cushioning left for any bad news and should earnings growth falter, stocks could tumble. A recent report by Citigroup had pointed out that the June 2010 quarter was the second quarter running in which it had over-estimated earnings. Also, with the profit momentum being driven by either commodity ?based or cyclical foreign subsidiaries of many of the companies such as a Tata Steel or a Tata Motors, which performed well on a low base this year, earnings are somewhat vulnerable. The domestic performance of Tata Motors, for instance, was less impressive in the June 2010 quarter that the show put up by its overseas subsidiary JLR. In a scenario where interest rates are rising, it would be prudent to be watchful of what?s happening on the ground.