Stock markets to consolidate ahead of F&O expiry

It was a week of surprises, and it led to immense volatility in the Indian equity market. First came some unexpected good news: the announcement from US Federal Reserve Chairman Ben Bernanke that the tapering off of quantitative easing (QE) would not begin immediately. Tapering off was what emerging markets across the world had been dreading, and the announcement - last Wednesday - promptly saw the BSE Sensex surge to a 34-month high on Thursday. In a single day foreign institutional investors (FIIs) invested more than half a billion dollars in Indian markets. Indeed the Sensex touched an intra-day high that was only 560 points away from 21,206.77, the highest it had ever scaled (on 10 January 2008).

But on the next day, Friday, came unexpected bad news as far as the markets were concerned - the Reserve Bank of India, in its latest review of monetary policy, hiked the repo rate - the rate at which the RBI lends to banks - by 25 basis points to 7.50 per cent, when most analysts had been predicting the rate would stay the same or be lowered. The Sensex promptly fell by 382 points ending the week at 20,263.71. Despite the Friday fall, the Sensex ended the week with a gain of 531 points.

The RBI's action clearly indicates that in its view, inflation, particularly food inflation, is still high enough to be disturbing, and that it will do all it can to lower it, "I believe the new governor was sending a strong signal to the markets that he has the unhesitating ability to take unpopular decisions if such decisions are warranted by ground realities," says P.H. Ravikumar, Managing Director at Capri Global Capital.

The government has taken some recent measures to show it remains growth-friendly, but with general elections due in May-June 2014, it will ultimately support the RBI view that keeping prices down is all-important. This may hamper market sentiment, but at the same time, the deferring of the withdrawal of quantitative easing by the US has given Indian equity markets a new lease of life. FII flows have been the lifeline for the Indian markets and with no tapering off for some more time they will continue.

The Indian market does not mirror the current state of the economy. The economy may have its problems but the markets will move purely on the basis of the money flowing into them. The flow will continue for the next three to six months at best till the tapering off of QE begins. Tapering off cannot be wished away forever. It is bound to happen in the next few months. But these few months are crucial. If the government brings growth back on track the money flow into India will continue despite the QE tapering. Strong growth in India in the mid-2000s saw it being one of the least affected of emerging markets after the Lehman Brothers debacle in 2008.

In the near-term the Indian equity market, though volatile, may continue to remain firm with the momentum it has gathered. In the coming week, markets may consolidate after their four week rise. There may be some volatility ahead of the expiry of September futures and options.