Balancing act

The long-awaited correction in the market finally happened last week.

The trigger was the announcement of a hike in margins by Sebi, which probably felt that the build-up in open positions, at almost Rs 49,000 crore on Thursday, was too high. Quite naturally, leveraged positions were quickly unwound, leading to the sharp sell-off on Wednesday.

The buying frenzy by local operators in stock futures had pushed up their premiums and FIIs smelt an arbitrage opportunity. They started selling stock futures while simultaneously buying in the cash market. Much of the net purchases in the cash market by FIIs earlier this month was illusory ? the effect of taking arbitrage positions. That?s why the FIIs turned net sellers in the futures market. Later on, they sold in the cash market, squaring up their futures trade. Of course, there must have been some profit-taking as well, given the high valuations in the market.

It will pay investors, therefore, to watch what the FIIs do not only in the cash market but also in the derivatives segment.

Several positives also emerged from the correction. Thursday?s market action saw support at lower levels. Mutual funds still have cash waiting to be deployed. And finally, the sharp fall was limited to the Indian market. True, there has been some weakness in international markets as a result of worries about higher US interest rates ? the US 10-year Treasury Note yield has gone up above 5 per cent for the first time since June 2002 ? but the sensex has been the hardest hit, simply because it had gone up the most earlier.

Credit policy outlook

The bond market is focused on Tuesday?s credit policy. Will the RBI governor nudge up interest rates by another 25 basis points? He should, if he wants to remain consistent. After all, the reason he increased the rate by 25 basis points at the time of the last review was because he wanted to slow things down.

That clearly hasn?t happened. Bank credit continues to expand at 31 per cent. Asset prices have moved up and the real estate market is red hot. Money supply growth has been 16.5 per cent year-on-year, which means that precious little tightening has actually happened. And while inflation continues to be tame, there?s an uncomfortable feeling that the inflation figures aren?t showing the whole picture.

Economists point out that many items in the Wholesale Price Index aren't being updated regularly and this has resulted in understating the price increase for manufactured goods.

The latest numbers show that the Index of Industrial Production was up 8.8 per cent in February, which means that growth continues to be robust. In the circumstances, it would be logical as well as prudent for the RBI to go in for another rate hike. If it doesn?t do it, the real estate market will go up even further.

The finance minister has been trying to keep rates down, fearing a repeat of the mid-nineties, when higher interest rates led to mayhem in the economy. But interest rates today are nowhere near the 15 to 20 per cent levels seen then. Moreover, even if interest rates are raised, they will be well below corporate India's average return on capital employed.

So there's no need to worry that a hike in interest rates will choke investment.