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Make money from reverse trades
Devangshu Datta in New Delhi | February 11, 2008
The Central Statistical Organisation's latest update confirms what anecdotal evidence and Q3 corporate results strongly suggested - that the Indian economy was slowing down. Of course, GDP growth rates of 8.5 per cent or more would be wonderful by most standards.
However, it is slower than corporate honchos or the FM would like. It is also likely that the slowdown will continue for the next six months at least, due to a combination of several factors. One, consumer demand is slow due to rising rates.
The failure of Wockhardt Hospital's IPO is a signal that indicates the latter while the mass-withdrawal of portfolio investors signals the third factor is in operation.
The consumption-investment mix of India's GDP is changing. Consumption demand was responsible for about 65 per cent of GDP, five years ago. Two or three years hence, it will be responsible for about 50 per cent.
Now, the ratio of FDI to FII may change but FDI and FII trends run in tandem. There has never been an extended period where FDI flows have been strongly positive while FII flows were strongly negative.
Similarly, the tendency to consume and the tendency to invest are strongly linked in the domestic psyche. Indians are consuming more because they are saving more.
There is little or nothing that the government can do to reverse this. It would have to cut interest rates drastically just to offset the wider spreads between dollar and rupee after the Fed's cuts.
Nor can it speed up reforms. The low-hanging fruit in terms of easing the License Raj and cutting tax rates have already been consumed. What it now needs to do involves downsizing its own roles and dramatically improving its efficiency as a facilitator. Both are politically impossible with elections looming.
Without either reform or rate cuts, it is difficult to put confidence back into the economy and confidence is at the heart of attracting both fresh investments or ensuring higher consumption.
I think the government and the RBI will try to arm-twist banks into making commercial rate cuts while continuing to hold policy rates. If that is not forthcoming or if the Fed cuts another 50-75 basis points as is now expected in some circles, the RBI will cut policy rates - though it will do so reluctantly.
The impact of rate volatility will obviously be felt most keenly in the banking system. Banks will lose some more ground before cuts happen but they will also bounce more when cut do occur.
The IT sector (and other dollar-denominated exporters) could also see a sharp recovery if the rupee could be induced to correct say, 5 per cent. More efficient banks and IT companies will outperform peers.
This is a classic case for "couple trading". Pick a pair of banks or a pair of IT stocks and buy one and sell the other to profit from widening differentials during the downturn.