Will the RBI soften its stance?

Thu, 28 Jan Pre-Open

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India's central bank, the RBI, will review its monetary policy tomorrow. And till until a week back, there would have been no prizes in guessing the outcome. Asset prices were soaring and inflation was inching towards levels beyond which the RBI gets a little uncomfortable. Hence, it was quite obvious that the RBI would undertake a small CRR hike.

However, things are somewhat different right now. The stock markets have undergone a violent correction of the magnitude of 8% in a matter of few days. While the correction may not be that significant, investor sentiment is definitely on the edge. And any strict measure by the RBI is likely to weaken it further. In fact, we won't be surprised if markets crack by a similar magnitude on any negative announcement by the central bank.

Aside of investors and the central bank, there is one more entity who is keenly watching the development. And that entity is the Government of India. As we are all aware, the Government is in the midst of a divestment exercise. And every rupee coming out of the divestment proceeds is important as it helps further bridge the fiscal deficit. Hence, it could ill afford any significant correction in the markets right now since it could lead to the government having to offer a discount to the issue price in order to lure the investors.

While this is none of RBI's business, it could be well aware that the implications of a higher than expected fiscal deficit will have to be borne by the RBI also at a later date. The RBI will certainly have this math worked out when it announces the monetary policy tomorrow. We await it with bated breadth.

Dr Doom predicts more gloom ahead
Dr Doom, Nouriel Roubini who had earlier stated that stocks have run up too much and too soon would indeed be feeling vindicated after the recent correction. So, does he see more pain ahead? Certainly. In a recent interview with Bloomberg, Roubini has opined that stock market rallies are likely to fizzle during the second half of the year in developed economies. And he attributes the correction to the fact that valuations have run far ahead of fundamentals.

Thus, when the economic reality will start dawning upon investors in the second half, there could be a significant correction in the developed markets in the second half of the year, asserted Roubini. He also sees some pain ahead for emerging markets as well as inflation returns to positive levels and central banks start taking liquidity tightening measures.

Roubini is not alone in his prognosis. Even Mark Mobius, the emerging markets guru holds a similar view. “We continue to see upside, but with substantial corrections along the way, which could be as much as 20 percent”, Mobius is believed to have said in a recent interview.