January 02, 2009

Stimulus package: Version 2

Barely a couple of days after I wrote that I see more rate cuts coming from the RBI, we get 100bps cut each in Reverse Repo and Repo rate, coupled with a 50bps cut in Cash Reserve Ratio. These rates stand at 4%, 5.5% and 5% respectively.

The government, from its side, has announced a number of measures as a part of its second and more importantly, last package for this fiscal. You can read the details here. With national elections expected to be held during May/June 2009, I do not expect any more fiscal measures effectively before the end of June 2009. Plus, if there is a change in government, the new team will take few more months to take any concrete actions. My fear is, by that time the damage in the economy would have been done.

Barring few specific measures like cuts in excise duties, nothing else in the fiscal package looks likely to impact the economy positively enough. With the demand side of the equation almost in a standstill in key sectors, a lot of these measures merely gives the producer class some breathing space before the inevitable happens. And that is cut in production and prices leading to cut in shops and reduction in worforce. We have already seen this in few sectors. More will come our way this year.

The fiscal package includes some shockers. Increasing the FII limit for investments in corporate bonds! Are we kidding? Considering what the spreads have been for Indian corporate papers in Euro markets, I find it improbable that they will absorb similar issuances in Indian soil. Similarly, raising the ECB interest ceiling for select integrated township developers also seems a blunt measure.

Am I, as a consumer, going to spend more based on this fiscal package? No. And that is the problem.

I am glad that the monetary measures have come again. The rate cuts I expected have come a little earlier than my sense of timing. That leads me to believe that we have to see more. At least 50bps more on all the three key rates before the end of this fiscal. Of course, considering what already has been seen, further 50bps is just nominal. But it makes a lot of difference for bond yields. 10-year yield falling below 5% on Monday is a given. 4.50% is the next level I would be watching, but not quite soon. Higher spending means higher borrowing. The supply side for bonds will temper the rally to some extent. Yet, do not expect anything to prevent 4.50% to be traded over the next few weeks.

What next? Expect a series of rate cuts by banks. Deposit rates first, followed by lending rates. They would hope that the consumers will return to borrow soon. I have my doubts. When your job is in danger, you don't think of adding a liability (for an asset) to your personal balance sheet, do you?. Sentiment is the key here too, like in markets. It takes a lot to convince a terror victim that the world is a very safe place!

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