Why 16 Sep is not a date for investors to worry about

Investors looking to enter the market at current levels of the Sensex at 17,000 and the Nifty at 5,100 should not be worried about what the Reserve Bank of India (RBI) does on 16 September, when the next monetary policy review is due.

Investors should focus on the longer term. The belief is that the current policies of the RBI will bring down inflation, which is trending at 9.4 percent levels at present. If inflation comes down, interest rates will also fall.

The policy review on 16 September will not change that view, though the equity and bond markets are waiting nervously to hear what the RBI has to say on that day. There are expectations that the RBI will hike the repo rate by 25 basis points (bps) to take the total hikes in four months to 150 bps (100 bps make 1 percent) - but one can't be sure on that.

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[caption id="attachment_78863" align="alignleft" width="380" caption="he RBI is more likely to maintain status quo than hike rates in the current context of weakening global economic growth outlook.Reuters"][/caption]

In the September review, the large shifts in market sentiments will weigh on RBI's mind. In August, there were sharp falls in equity markets, with equity indices across the globe falling anywhere between 5 percent (China) and 20 percent (Germany). Bond yields in the US and Germany have fallen to record lows.

The fall in equity markets and bond yields reflect a sharper than expected weakness in global growth. The RBI is, therefore, more likely to maintain status quo than hike rates in the current context of weakening global economic growth outlook.

However, market sentiments are not dramatically going to be altered by what the RBI does in the policy review. If there is going to be a rally in equity markets, it will continue whether the RBI hikes rates or not. If there is going to be a rally in bond markets, the rally will continue no matter what the RBI does. In short, the policy review itself will be a non-event for the markets, though market players may believe otherwise.

Investors should look at the movement in bond yields and interest rate swap yields for cues on the RBI policy. Ten-year benchmark government bond yields have come off by around 15 bps since the last policy review on 26 July 2011. The five-year interest rate swap yield has come off by 85 bps since the July review.

The benchmark 10-year bond 7.80 percent 2021 bond is trading at yields of 8.30 percent, down 15bps from levels of 8.45 percent seen in end-July while the five year OIS (Overnight Index Swap) yield is trading at levels of 6.85 percent, down 85 bps from levels of 7.70 percent seen in end-July.

Bond yields have not fallen as dramatically as swap yields but the fact is that interest rate markets are looking at a scenario where the RBI will put a hold on policy rates either from the policy review in September or from the policy review in October.

The mid-term policy review is not a regular policy review where the RBI meets bankers and addresses the media and analysts. It is just a short document on the RBI's policy view. One cannot expect economic factors to change dramatically in a month-and-a-half since the last policy review held in July 2011.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.