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Posted on 17-Feb-2017 Comments  0

RBI April Policy


Why a rate cut is highly unlikely in the April Monetary Policy…



Every since the RBI shifted its monetary stance in its Feb Policy to“Stable” from “Accommodative”, there have been questions over future rate hikes. While another 2 rate hikes during the current calendar year cannot be ruled out, we still feel that an April rate cut by the RBI could be highly unlikely. There are 3 key reasons for the same…


Oil inflation is the worry…


Acursory look at the CPI inflation and the WPI inflation for the month of January makes it evident that the crux of the inflation problem is non-core inflation. Food inflation is largely in control due to a bumper Kharif crop following last year’s normal monsoon. However,the non-core inflation is highly susceptible to global oil prices.Since the beginning of 2016, the price of Brent Crude has moved up from $30/bbl to $56 /bbl. This sharp surge has been driven in the last couple of months by the OPEC supply deal. Under this deal, the OPEC and a few friendly nations have agreed to cut supply of oil by up to 1.8 million barrels per day (bpd). This has been instrumental in keeping oil prices high. Since India depends on imports for nearly 80% of its crude requirement, the correlation with inflation is almost direct. The real challenge for the Indian economy could come if Brent crosses $60/bbl. RBI would prefer more subdued non-core oil inflation before giving the nod for further repo rate cuts!


Wait for remonetization…


The benefits of remonetization are likely to be delayed due to the state elections. Normally, elections result in monetary tightness and that is already evident. The RBI may decide that April could be too early to gauge the post-poll effects of remonetization since the state results will be announced only on March 11th.Financial markets are in a Catch-22 situation currently. Rates are sharply down post-demonetization but credit is not picking up as demand is not picking up. That will happen only once the full impact of remonetization sets in. Most likely, the RBI may choose to wait and watch before going for a rate cut.


Fed continues to be hawkish…


If Janet Yellen’s hawkishness is anything to go by, then the Fedal most looks certain to hike Fed rates in March. That would directly impact the yield spreads between Indian bonds and US bonds, and could result in a surge of debt outflows from India. Having seen the harrowing experience of 2013, the RBI would not be too keen to take such a risk. More, so when the Indian economy is just about recovering from the cash crunch caused by demonetization!


From a pragmatic perspective, the RBI may choose to wait and watch for another couple of months. A rate cut in April looks highly unlikely.Markets need to prepare itself for the same!


Eye on WPI


Why the WPI inflation may become more critical going ahead…



During the month of January there was a slight anomaly in the retail and WPI inflation numbers. Normally, the CPI number over the last 2 years has been higher than the WPI number. In fact, at one point in mid-2016,the gap between CPI inflation and WPI inflation was nearly 900 basis points. That was the time when CPI inflation remained high due to sticky food inflation and WPI inflation was in negative territory.January 2017 was a classic reversal when the WPI inflation came in200 basis points higher than CPI inflation. How did this shift come about?


How CPI & WPI diverged…


Till July 2016 when the monsoon numbers started coming out, the CPI inflation continued to remain high. It was only after the monsoon data hinted at a bumper Kharif crop that the food inflation started coming down sharply. This kept the CPI inflation subdued despite the base effect vanishing in the last quarter. So, what led to the sharp rise in WPI? As is well known, WPI is weighted in favor of manufactured products and fuels. Rising prices of crude oil has been a kind of double whammy for WPI inflation. On the one hand, fuel has nearly 15% weightage in WPI inflation and hence it directly impacts the WPI inflation. On the other hand, oil has strong externalities and tends to create cost-push inflation in the overall economy. That explains why oil has an over sized impact on WPI.


Risk from oil and metals…


The question that the RBI will need to ask itself is where does the big risk for inflation emanate from? Food inflation is likely to remain subdued and consumer driven inflation will also stay low due to the effect of demonetization. That leaves us with inflation in metals and oil. With oil likely to remain under supplied, the contribution of crude to overall inflation will remain high. Metals and minerals have already been on a run over the last one year. The big story for them will be the $1 trillion investment in infrastructure that Trump is proposing. That could lead to a spurt in demand for metals and minerals. Secondly, the Chinese government is planning a multi-billion dollar investment in rail infrastructure. That is also likely to keep demand for these commodities strong and therefore prices buoyant.


WPI is where the action is…


One of the reasons the RBI has spoken about neutral stance is that they expect WPI inflation to put further pressure on the Indian economy.The inflation in oil and metals will not only raise WPI inflationfurther but also have strong externalities on other sectors. WPIinflation is more indicative of non-core inflation and that has beenthe point of worry for the RBI. Over the next few months, the RBI mayfocus more closely on the WPI inflation for fine tuning its repo ratestance


Cash Stash


What do IT companies do with so much cash?



The issue of cash on the balance sheet of IT companies has come back into the limelight for a variety of reasons. Firstly, Cognizant declared a$3.4 billion buyback and logically Indian IT giants like TCS, Infosys and Wipro were expected to follow suit. Secondly, Indian IT companies are zero-debt and cash rich. With limited investment opportunities,rewarding shareholders could be the easiest thing to do. Lastly, the questions raised by the founding members of Infosys about the use of cash have once again brought this issue to the fore…


Why worry about cash stash?


To be fair, it is not just the Indian IT companies but also the Indian PSU companies that are flush with cash. Indian IT companies are in q unique position. For years they have grown on the back of virtually zero debt and have ridden on client money. They do not have the kind of investment requirements that industries like steel, oil,petrochemicals and cement have. On the other hand, the IT industry is hardly capital intensive and hence there is a good justification for distributing the excess cash to shareholders. In the Indian context,IT companies have been quite conservative when it comes to distribution. Dividend yields on IT stocks are very low and very few IT companies have either paid special dividends or tried to reward shareholders through buyback of shares.


What is the global experience?


Interestingly, IT companies globally have been hoarders of cash. Consider the following statistics! Apple alone has a cash stash of nearly $215 billion. Microsoft sits on a stash of $110 billion while Google sits on $80 billion. In case of these companies, the cash stash ranges from 20% to 30% of the overall market capitalization of these companies. By that standard, TCS and Infosys are holding a cash stash that is just about 12-15% of their market capitalization. So, by global benchmarks what Indian companies are holding is relatively much smaller than what global IT companies are holding. At least,they cannot be accused of hoarding cash!


What to do with the cash?


Giving out generous dividends and share buybacks are not the answer. While a one-time payout is understandable, Indian IT companies need to hold on to their cash stash for a rainy day. The way the global IT spending is evolving, Indian IT companies must use this cash as its currency for acquisitions, strategic expansions and transforming its business model. Traditionally, companies that pay out generous dividends and buy back shares have never got marquee valuations.Indian IT companies have already lost their rich valuations after the earnings squeeze. It cannot afford to become just another set of divided-yield stocks!


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