Near-decade low rates fail to enthuse markets

Experts laud the move, but earnings growth may take 3-6 quarters to recover

The RBI governor surprised many with a 35-basis-point (bp) repo rate cut, given that expectations were for a 25-bp cut. Yet, for the equity markets, it passed off as just another day with leading indices up down by 0.8 per cent.

Though the rate cut and liquidity enhancing measures were in the right direction, there were multiple reasons for the markets to have had little to cheer for, starting with the lowering of GDP growth to a more cautious outlook on macro headwinds. In other words, the question is whether a near-decadal low repo rate can revive economic growth and earnings (see chart). There are two important factors, among others, to spur growth — capital expansion or capex (public and private), and domestic consumption. Both these engines are currently on weak footing, and this is well captured in India Inc’s June quarter results published so far.

“Earnings were poor and management commentary across the board — including banks — was weak,” says Vineeta Sharma, head (research), at Narnolia Financial Advisors.

In this context, unless there is enough to revive consumer and industrial demand (led by the government’s initiatives), there is little hope of a reasonable rebound in earnings. Whether a rate cut can engineer capex, at least to boost corporate India’s demand for capital and appetite for expenditure, needs to be seen.

Although the picture is gloomy given there are no signs of capex revival in traditional pockets such as metals, large infrastructure projects, and power plants, there are nevertheless some green shoots in smaller pockets such as cement, consumer staples, and specialty chemicals. “Government capex may revive soon, and private capex may return in some pockets in the next 6-9 months,” says Pankaj Pandey, head (research), ICICI Securities.

But is this adequate to revive growth? “There are reasonable triggers, but if they get delayed, then earnings growth may also be pushed to the next fiscal year,” says Pandey.

Even if the 110-bp repo rate cut in the current calendar may have some effect on corporate demand for money, consumer demand is the weak link. Dhananjay Sinha, head (strategy research), IDFC Securities, points out that there aren’t enough levers for consumption demand. “What we need is growth in spending and merely rate cuts will not revive that,” he explains.

Therefore, with the transmission of rate cuts remaining patchy and earnings outlook unlikely to materially improve, easing repo rates alone may not move the needle for equity markets.

Sensex valuations at 26 times the FY21 earnings are far from affordable; the riskreward hasn’t turned favourable yet.