Will the RBI oblige D-Street with a rate cut?

It would be an appropriate time for the Reserve Bank of India (RBI) to cut interest rates for accelerating India's growth. All the ingredients are in place with rating agency S&P, after a span of over two years, upgrading India's credit rating outlook to stable from negative, inflation (WPI) at a five-year low of 3.74 per cent in August 2014, and a rupee that is hovering between Rs 60-62 against the dollar. Globally, the fall in crude oil prices also gives the RBI the comfort to consider a rate cut.

Even 83 per cent of fund managers in the seventh Business Today-Morningstar Asset Allocation Survey expect the RBI to reduce interest rates in the near future. But the market doesn't expect the RBI governor to cut rates on Tuesday, September 30, when the central bank reviews its monetary policy. Any positive surprises will be a big trigger to Indian equity market.

In the next six months about half of fund managers surveyed in the BT survey expect the repo rate - the rate at which the RBI borrows from banks - to drop to 7-7.5 per cent from eight per cent currently. The other half expects it to be between 7.5 and eight per cent. In the last survey, the sentiment was much the same, though only 18 per cent expected policy rates would drop to 7-7.5 per cent while 73 per cent expected the repo rate to be between 7.5 and eight per cent.

This hope of interest rates dropping is reflected in 70 per cent of the fund managers surveyed saying they were increasing their exposure to lower-rated debt instruments. The strategy is that when the rates go down, debt funds will make capital gains as a fall in yields will increase bond prices. No fund manager is willing to reduce his exposure to lower-rated paper in the coming year. In the next six months 58 per cent of fund managers say they will increase their holding in government securities while 33 per cent want to increase their exposure to corporate bonds.

Today, the rupee will be the biggest worrying factor for the central bank. Though stable, the rupee is still vulnerable. Similarly, the twin deficits - fiscal deficit and current account deficit - though not alarmingly high, but unless the government finds ways to increase its revenues it would make the RBI's job difficult to cut rates. Second, there are concerns of a hike in US interest rates. Some quarters in the US want an early hike in rates, but majority are against a hike. Fears of a rate hike in the US will keep markets in uncertainty. A rate hike in the US will be bad news for emerging markets. It would lead to an outflow of money from global markets including India to the US. The market has discounted the US increasing rates by July 2015. For India the concerns would be outflow of money from the debt market, which has seen a $19.5 billion of inflow till September 25. Overall so far in 2014, FIIs have invested close to $33.5 billion in Indian equity and debt market.

In a truncated week, the market is expected to remain range-bound with all eyes on the RBI's monetary policy. Stock markets will be closed on Thursday and Friday on account of Mahatma Gandhi Jayanti and Dussehra, respectively. India is not a runaway market but it is a market to build a strong portfolio for long-term wealth. Any correction that takes place should be taken as an opportunity to buy stocks. In fact, a correction is healthy for the local market that has seen a sharp rise in the past seven months with the Sensex surging from 20,000 levels to 27,000.

The market will also keep an eye on Prime Minister Narendra Modi's US visit and his meeting with President Barack Obama. Meanwhile on Wednesday, October 1, the market will keep an eye on HSBC Manufacturing PMI for India for September. The expectation is the manufacturing index will fall to 51.67. For August, the HSBC Manufacturing PMI Index was at 52.40. Automobile companies will report their September sales numbers during the week.