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Mumbai: Battered Indian shares are unlikely to see respite this week as another interest rate increase appeared imminent after inflation raced to 11.6 per cent, the highest in over 13 years, while steaming oil threatened to keep the upward momentum on prices.
The Reserve Bank of India (RBI) is scheduled to review policy on July 29, but expectations are mounting the central bank may act faster like it had done in June, when the key short-term lending rate was hiked by three-fourth of a percentage point to a six-year high of 8.5 per cent.
That increase, along with a 50 basis point rise in the deposits that banks must keep in reserve with the central bank, has already pushed up the prime lending rate of commercial banks to more than 16 per cent.
Rising rates are bound to take a toll on economic growth, as consumer spending winds down and squeeze the earnings of companies.
"You have to grit your teeth and bear this out," said equity trader Kevin D'Souza. "We're in a tough economic environment and the going will get harder."
World oil prices have jumped 45 per cent this year and look set to breach the $150 a barrel mark, probably as soon as this week, as speculators move money away from tumbling equities to oil and other commodities.
If this happens, the blue-chip Sensex index could head toward 11,000, D'Souza said. The index, which fell 2.8 per cent last week to 13,454, had at one stage slid to 12,822.75 - its lowest in more than a year.
The index has fallen for seven successive weeks, losing about 22 per cent in that period.
For India, which imports 70 per cent of the oil it consumes annually, soaring prices are cause for much unease. Last week, Oil Secretary MS Sreenivasan said India's oil import bill could reach $120 billion in 2008-09.
He said the government would review retail fuel prices in October. Inflation shot into double-digits after the government had raised prices of petrol and diesel prices by about 11 per cent in early June, and another rise could fan inflation pressures.
There will be more pain for bank stocks, which have already lost more than half their value this year. Rising rates have raised the risk of customer defaults and have slowed demand for loans, while tumbling bond prices are set to cause heavy erosion in the value of banks' investment in bonds.
Morgan Stanley last week slashed its target price for Indian banks, saying their earnings would be crimped by slower loan growth and bond market losses. It cut the price target for State Bank of India by nearly 40 per cent to Rs942 from Rs1,550.
The US investment house also lowered the price target for Punjab National Bank, Bank of Baroda, Corporation Bank, Canara Bank, Union Bank of India, Bank of India, and Oriental Bank of Commerce.
These stocks can be value traps," Morgan Stanley said in a note. "Given current macro-environment and recent regulations, we continue to believe that they should not be bought."
Earlier it had said private sector lenders such as ICICI Bank Ltd and Axis Bank Ltd would face severe pressure on margins because of bond losses and slowing loan growth.
The bank index has plunged by half this year, while the Sensex shed a little over a third.
On Friday, 10-year bond yields soared the most in at least eight years to a seven-year after the government sold similar-dated debt at 9.13 per cent, the highest since 2001. The benchmark yield climbed 0.57 percentage point last week, compared with 0.18 percentage point in all of 2007 and 0.5 percentage point in 2006.
Banks in India are required to invest at least a quarter of their deposits in government securities. As bond prices move inversely to yields, the spike in yields would have sharply diminished the value of bond holdings - and banks have to write down the notional losses in their books.
Rising yield
The yield on the 8.24 per cent note due April 2018 leapt 34 basis points on Friday to 9.15 per cent. The price fell by Rs2.11 to Rs94.15 per bond, which has a face value of Rs100.
Analysts said the jump in yields reflected the outlook for inflation and interest rates, with some traders forecasting the central bank would raise the repo rate by 25 basis points.
They said RBI Governor Y.V. Reddy's speech last week that the central bankers' priority was to douse the euphoria about inflation added to expectations for higher rates.
"The most urgent and short-term priority for central bankers at the current juncture seems to be to calm the nerves about inflation or to anchor inflation expectations, with an implicit recognition that a somewhat elevated headline inflation in the short-term may be difficult to avoid," Reddy said in a speech delivered in Manchester on July 1.
The writer is a journalist based in India.
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