- RBI is expected to raise lending rates for the first time in over three years
- A 25 bps hike with neutral guidance may boost markets and strengthen the rupee
- Hawkish guidance with a 25 bps hike could worsen selloffs and raise bond yields
Equity market watchers are firmly expecting the Reserve Bank of India to raise benchmark lending rates for the first time in over three and a half years. Broad-based inflation, a weakening rupee, and resilient economic growth have cleared the decks for the central bank to tighten its monetary policy. The move is likely to be the single biggest factor determining the trajectory of Indian markets over the next few sessions.
The timing of the RBI rate decision is also significant, as Indian markets have been battered by a prolonged selloff, with the benchmark indices ending lower for eight straight weeks-marking the longest weekly losing streak since 2001. Since the start of this week, however, the markets have seen a relief rally, with relatively lower crude oil prices fueling a fightback from Dalal Street bulls.
Will an RBI rate hike reinforce the bearish momentum? The answer, say analysts, lies not in the Monetary Policy Committee rate decision itself, but in the guidance it shares. Here's a look at three scenarios of how the stock market may react:
1. A 25 bps hike, but no hawkish guidance
This is the best-case scenario for the markets, according to Kranthi Bathini, equity strategist at WealthMills Securities. "The market has already factored in a 25-basis-point rate hike. If the guidance indicates that the RBI is not planning an aggressive rate-hike cycle, then the indices are likely to rise, given that crude oil prices have also retreated from their recent highs," he said.
In such a scenario, the markets would also find relief in a bolstered rupee. A quarter-percentage hike would support the Indian currency amid the renewed spell of FII selloffs. For traders, pharmaceuticals, power, and engineering scrips would be attractive following a one-off rate hike, whereas banking and financial services stocks would come under some pressure, Bathini added.
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2. A 25 bps hike + hawkish guidance
This is likely to spell jitters for the market, as the start of an aggressive rate-hike cycle will spike bond yields and force traders to pull out of equities. "In such a scenario, it is possible that the selloff may resume, or perhaps, worsen," Bathini told NDTV Profit.
For the currency market, however, this would be a positive, signaling the RBI's intent to manage domestic liquidity. However, an inverse impact would be visible in the domestic equity market, as hawkish RBI guidance would likely be accompanied by elevated inflation projections. This would raise a cloud over the upcoming earnings season, diminishing the lure of large-cap Indian equities despite their attractive valuations following the recent selloff.
3. A 50 bps hike
What could trigger an extreme market reaction is the RBI escalating its inflation battle with a 50-basis-point rate hike. Such a move is expected to sharply raise bond yields, which would, in turn, trigger an exodus from the equity market, analysts say.
"A 50 bps hike may spook the markets and lead to much higher monetary transmission than the RBI may want. Why? We saw this happening last year when the RBI sounded a bit hawkish in its June policy-the RBI had to spend the next few policies trying to calm markets. If a 50 bps rate hike is done, it should be followed by dovish comments," said Sandeep Yadav, executive director and head of fixed income at DSP Mutual Fund.
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