The World This Week June 18 – June 22, 2012

Equity View: The results of Greece elections turned out to be an anti-climax. The Syriza party which is the extreme left and was against any austerity measures and other agreements with the Euro zone and IMF failed to win the majority and hence could not form the government. The other two parties also weren’t able to win the majority on the standalone basis but at least the other two parties can together form a coalition government comfortably now. There seems to be some consensus emerging in terms of Greece’s willingness and intent to stay in the Euro Zone. The Greek situation is contained for now but not yet fully resolved. We would have a closer look in terms of non-harsh austerity measures for Greece, some sort of compromise can be arrived at in the next few months or maybe longer. Currently, the disorderly exit of Greece also termed as Greexit is ruled out. Even if Greece decides on exit it probably would be an orderly exit and that too after much negotiation. RBI left interest rates and the cash reserve ratio for banks unchanged, defying widespread expectations for a rate cut as it warned that doing so could worsen inflation. The Reserve Bank of India kept its policy repo rate unchanged at 8 percent and left the cash reserve ratio for banks at 4.75 percent. The market was broadly expecting a 25 basis points cut in repo rates. The encouraging development in all this is that RBI has is observing macro economic data also and based on it made the decision. It is not influenced by industry groups, stock markets, debt markets etc. In a medium to long term it is a good thing but in short term a bit of jolt can be witnessed in the equity markets. One thing that emerges in the fine print of RBI’s decision on no rate cut is that inflation is above the RBIs comfort zone. Also, the continuous depreciation in rupee against the dollar is not helping either as the cost of imports is higher even though the prices of Brent crude has dropped to 18 months low. Also, there was a lot of expectation amongst the market participant’s that since the growth has come down and has defied the projections and expectations, RBI would anyway now want to revive industrial activity investments and cut the interest rates. Again, if we read through the fine print of RBI communication we can understand RBI seems to suggest that investments are not driven by interest rates alone and one cannot blame interest rate for low investments. Earlier, when interest rates were high people use to invest but now the climate has become very cautious and even in low interest scenario people are not investing. If we look at US and Japan where interest rates are close to zero it did not revived the investments which concludes that interest rates are not the only determinants of investments in an economy. 25 basis point rate cut is not going to change the profitability overnight and hence the previous rate cut was surprising in a positive sense and no rate cut this time was surprising in a negative sense. Instead of reducing the rate in 2 steps of 25 basis points each RBI decided to do it in a single shot for maximum impact. We could expect RBI to behave in a similar manner reducing wholly 50 basis point rather than 25 basis points gradually later on. After the last rate cut many banks had not changed their lending rates. It is only now that some banks are talking about reducing the lending rates and also reducing the deposit rates. So while the RBI action has been in the general interest of the economy. In the shorter term sense of equity market it has been negative news. The third big news is that that the US has decided to continue its quantitative easing till the year end. There was an expectation amongst global market participants that Fed would actually buy the US Debt instead of just doing a twist of selling some and buying some. Last two rounds of QE were referred as Operation Twist as the Fed had bought the long term US debt and it sold short term US debt thereby flattening the yield curve. The purchase of bonds in open market pushed the bond prices high and bond yields low, thus reducing the cost of lending by the banks, more directly than reducing the rates. The repo equivalent rate in US which is the target rate of the FED is already close to 25 bps, and that’s not spurring up the investments in the US and hence it resulted into trimming of the lending rates down almost more explicitly than just giving the guidelines. This did reduce the long term yields for a long term but not necessarily impacted the economy as expected and hence there was an expectation that the Fed would continue to buy another round of US debt to pump in some amount of liquidity in the system, there by pushing all the risk assets prices high including Indian equity markets. This did happen in last two rounds of QE and its equivalent in form of LTRO in Europe.

Positive part of this is that FED is showing intent to continue to give some monetary stimulus which would revive US economy and eventually global economy. The negative part of this is that it is a twist and not an actual purchase of bonds, so FED’s balance sheet remains constant and in the process there is no liquidity in the system, its just the yield curve adjusts to the liking of FED. Hence, there is no rush to push prices of risky assets. In the short term it is negative but in the long term it can probably be positive as it would not provide a false alarm in minds of people for why the assets have started to go up suddenly on back of cheap liquidity. After these three events, we do not have anything decisive milestone ahead. Hence, we could have an indecisive moment on either side for next few weeks hence we would recommend stock picking strategy than index investing or diversified investing.

News: DOMESTIC MACRO:

India's annual consumer price inflation remained unchanged in May at 10.36 percent, government said in a statement

on Monday.

The partially convertible Indian currency on Friday, 25th

June 2012 hit a record low of 57.32 against the dollar, before

the Reserve Bank of India's suspected intervention propped it up.

The RBI shocked financial markets on Monday by leaving its 8 percent policy repo rate and 4.75 percent level for

banks' required reserves unchanged. It released a statement after the decision saying a rate cut would "exacerbate"

inflation.

Fitch Ratings cut its credit outlook for India to negative from stable, nearly two months after rival Standard & Poor's

made a similar call, citing risks that India's growth outlook could deteriorate if policymaking and governance don't

improve.

GLOBAL MACRO

Euro:

German Chancellor Angela Merkel resisted pressure on Friday for common euro zone bonds or a more flexible use of

Europe's rescue funds but agreed with leaders of France, Italy and Spain on a 130 billion euros package to revive

growth.

Independent auditors said Spanish banks may need up to 62 billion euros in extra capital, to be filled mostly by a euro

zone bailout, after Spain's medium-term borrowing costs spiralled to a euro-era record on Thursday.

Markit's euro zone Flash Composite Purchasing Manager's Index for June, which comprises the service and

manufacturing sectors, fell to 46.0. It has contracted for nine of the last 10 months. A reading above 50 indicates

expansion.

US:

U.S. manufacturing output contracted by 0.4% in May for the second time in three months and families took a

dimmer view of their economic prospects in early June in signs the American economy's recovery is on shaky ground.

The Labor Department said initial claims for state unemployment benefits slipped 2,000 last week to a seasonally

adjusted 387,000. However, a four-week moving average, considered a better measure of labor market trends, hit the

highest level since early December.

China:

The HSBC Flash Purchasing Managers Index, the earliest monthly indicator of China's industrial activity, fell to a seven-

month low of 48.1 in June from 48.4 in May.

China on Monday offered $43 billion to the IMF's crisis-fighting reserves, rounding off a global push to nearly double

the Fund's war chest to $456 billion to help protect countries from fallout from the euro zone debt crisis.

Satadru Mitra Varun Goel Jharna Agarwal Abbas Naheed Kishan Jakotia Kinjal Mehta

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