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Forward-looking statements and stock markets: How are they related
Share prices today are a function of the expected profits of companies tomorrow. Hence, you find stock market analysts dwelling deep into announcements by companies to predict the future.
The same holds true for the government data releases. All investors take note of macro-economic risks associated with investing in countries.
On Tuesday, the Reserve Bank of India cut repo rates to 7.75% from 8%. RBI cut cash reserve ratio or CRR by 0.25% to 4%. Repo rate is the rate at which RBI lends money to banks. CRR is the portion of deposits that banks have to maintain with RBI.
The stock market reacted positively but ended the day shedding gains in the negative territory. This is despite getting more than expected. Market pundits predicted a 0.25% cut in the repo rate and nothing more. The cut in CRR was a positive surprise as this provides more money for banks to lend.
Yet, benchmark indices ended the day in the negative territory.
Here are pointers that could help you comprehend RBI’s stance on outlook and stock market reaction:
RBI predicts slow growth:In its statement on outlook for the economy, the RBI has cut the forecast for India’s gross domestic product or GDP growth to 5.5% for 2012-13 from 5.8% earlier. A slow economic growth means less overall tax revenue for the government, its main source of income. “While the series of policy initiatives by the Government has boosted market sentiment, it will take some time to reverse the investment slowdown and reinvigorate growth,” RBI says on growth. Slow growth is not good news for corporate profits.
Inflation outlook:RBI’s main enemy is inflation. If inflation remains high, it eats into the growth of an economy. RBI does not expect inflation to fall too soon. ”It is critical that even as the monetary policy stance shifts further towards mitigating growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised,” RBI said in its outlook.
What will government do next:While controlling inflation is RBI’s responsibility, stimulating economic growth rests largely with the government. RBI wants the government to stimulate investment in the economy. “Achieving this will, however, depend on a number of factors such as bridging the infrastructure gaps, especially in power and transport, hastening approvals, removing procedural bottlenecks, and improving governance,” RBI said in its outlook. This is the reason why the stock market would now focus on government’s stance as it presents its last Union Budget on February 28, 2013.
Budget estimates: Whenever the Union Budget is presented, the key number the stock market looks for is the estimated borrowing the government expects to do at the end of the next financial year. This is actually the fiscal deficit or the excess spending over income of the government accounts. If the borrowing shoots up, it hurts the economy. ‘Empirical estimates indicate that the fiscal deficit significantly contributes to inflation in the long run,” says RBI in its quarterly macroeconomic development report for December 2012. So the government needs to either boost revenue or cut expenditure to control the fiscal deficit. When the budget is announced, it would be worthwhile looking at the change in direct and indirect tax revenue. You may also want to read about the plan and non-plan expenditure of the government to cover defence, subsidies, infrastructure, government salaries and other expenses.
India’s current account deficit for the financial year ending March 2013 is likely to exceed 4% for the second successive year, according to the Reserve Bank of India. It reached its highest ever peak of 5.4% of gross domestic product in quarter to September 2012. Early indications are that it may increase further in Q3 of 2012-13, says RBI in its credit policy statement. Current account deficit occurs when a country imports more than exports and has more foreign currency liabilities. The deficit is currently financed by foreign capital flows. However, RBI does not believe it is sustainable. This is bad news for the value of the rupee.