CRR hike bad news for stock & bond markets,economy

The RBI moved on Friday, and perhaps has changed the financial landscape quite significantly. All markets will react on Monday, but there is considerable surprise at what the RBI has done, in changing the CRR and the repo rate. Rates are hardening in the system once again, maybe unexpectedly so; and that has deep ramifications over where the economy will pan out over the next few quarters and where all the markets stock, bond, real estate will pan out because these are some serious moves which came through on Friday.On the markets:It is very bad news for markets. It is almost certain that stock markets and bond markets will both sell off on Monday morning. You could see a little bit in the ADRs overnight for the bank stocks but I think we are in for a big bath on Monday morning because this has come as a surprise, particularly because the markets were expecting that rates might actually start cooling down in the end of April as inflation cools down but the RBI has not even waited for its monetary policy meeting which is a surprise.Hiking both CRR and repo might have been a bit unexpected. Led by the rate sensitive sectors, one will see a big sell-off on Monday and it may last for a while. I think this last bout of tightening might be changing the ramifications for the financial markets to a dire extent - the other being what’s happening with the economy next because if this is the kind of tightening which is happening then where do we end with the slow down we are expecting, where will the GDP growth be? So far we have been talking about 9% inching up to 10% and if this is the kind of interest structure we have and the kind of slowdown it will lead to many key sectors, then we would be lucky to get away with 7.5-8% forget 9%. This will probably lead to a big economic slowdown and the rates don’t need to go up for that even if they remain where they are right now, that will be enough to push the economic growth down quite significantly. So it’s bad news for stock markets, bond markets and the economy as well.Credit growth:I don’t think it will be over very soon because you can see what the RBI is trying to do, while the market is obsessing about WPI number, the RBI is going around quite ruthlessly about cooling credit growth. It is still seeing that credit growth is dangerously close to 30%, it wants to cool that and unless that happens, it will not take the foot of the pedal which is why brakes are coming down hard. I don’t think this is a WPI problem at all. The RBI is targeting different things, it wants to see credit growth slow down, it wants to see specific-sector credit growth slowdown and it will only be satisfied when slowdown is clearly manifest in the numbers of many sectors of the economy. The timing might be a surprising on why RBI has chosen to do it now and one wonders whether there is a bit of political element because just two days back the Finance Minister who has typically been resisting rate hikes, has been sort of paving the way for it. I am wondering if inflation is becoming a political item, strong enough for the Finance Minister and the RBI to see eye-to-eye on this matter finally which is why we are seeing such strong tightening measures. Its bad news every way you look at it but the market will have to deal with it.On bankers and bank stocks:Rates have to go up. Bankers typically talk like this when the first move comes in. In fact I would go so far as to say that the last people that you should be looking at or hearing-in about expectations of interest rates and what their reactions to interest rates by the RBI is ask the banking lot. We tend to do it because its newsy but they have no clue where rates are heading they are consistently wrong with where interest rates are going because they are vested with that, they tell you what they would like to see but they would never tell you what they think might happen and I think it’s a foregone conclusion that rates will go up in this system they do not have a choice, they will almost certainly raise rates. Almost certainly they will sell off. We have been making this point that the pain might not be over for the banking system and this is a bit of a triple whammy for the banking system because (a) credit growth will slowdown which is their topline (b) because of this CRR changes margins will be hit (c) now bond yields will move up which means treasury losses will also mount. So I don’t know how banks will perform very well. The only defense for the banking sector is that valuations are very attractive for many of the PSU banks but that presupposes that the book value and the adjusted book value that you are calculating will remain this way and that will not shrink. What if growth is affected to very sharp extent and then book values next year do not look like what they look this year at all? Its like earnings and earnings per share, PE multiples therefore, when earnings start coming down PE multiples automatically start to look expensive. I think we haven’t assumed that the banking book values might start contracting and what about adjusted book value?In this whole sub-prime thing playing out in the US, I don’t hear too many people talking about a potential NPA problem in the banking sector in India. Rates are going up, one doesn’t know whether many of these banks will be stuck with sticky loans and if they do then adjusted book values will also changed around and in that context valuations may not look very attractive which is not to say that there is no point looking at banks but I think the sell off is in order. Fundamentally too banks will struggle over the next one-year with what is happening in the system. Its bad news for the banking system, both from a stock market and from an operation’s point of view. Rate sensitive sectors: A whole lot of rate sensitive sectors will do very badly now. Rates are very high in the system if you just look at home loans, consumer loans, auto loans any kind of PLRs , maybe the sub-prime categories rates are very high. So you are already seeing a bit of a pinch happening in the auto takeoff. Last 20 days’ car sales has been hit, two wheeler sales have been hit and maybe even commercial vehicles have been hit as well. In that scenario when rates harden even more from here I think autos is something you need to be extremely careful. These are all sectors which are extremely important to the economy and to the stock market and they will all get hit because growth will slowdown, that is what the RBI is trying to do. RBI is trying to curtail loan growth and consumption growth and demand growth. So autos will be hit I think property stocks will be hit once again because real estate is something, which the RBI is almost directly targeting. So real estate and construction both will get hit.Now the way home loan rates have moved up I think at some point, the inflection point has been reached and crossed. So I think you will see sluggishness in home loan as well. Many of these rates sensitive sectors will be hit very badly because of this rate hike, both from an overall corporate perspective and from a stock market perspective. Corporate sector:Most companies are running at 90% plus capacity utilisation. This is the time in the next two years when whole of India Inc is going in for a capital expansion programme. At a time when capex is about to take-off your rates are hardening very significantly. So you need to ask yourself barring the top 30-40 companies - which can do FCCBs, equity and ECBs, what happens to the rest of the mid-tier companies? It’s just not enough to say that companies don’t borrow any more and therefore the impact will not be too high. I think the impact will start coming in where as soon as company starts borrowing at very high rates in the midst of this capex cycle and I think as a stock market perspective you need to worry about what’s going to happen to the bottomlines of many of these companies. It’s going to be tough, whether its going to be very tough or you just get away with a lot of damage on the bottomlines is something that you will have to see.