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Key Events and Their Impact on Markets


12.1 – Overview

For a market participant transacting just based on company specific information may not be sufficient. It is also important to understand the events that influence the markets. Various outside factors, economic and/or non-economic events have a key impact on the performance of stocks and markets in general.
In this chapter we will try to understand some of these events, and also how the stock market reacts to them.

12.2 – Monetary Policy

The monetary policy is a tool with which the Reserve Bank of India (RBI) controls the money supply by controlling the interest rates. They do this by tweaking the interest rates. RBI is India’s central bank. World over every country’s central bank is responsible for setting the interest rates.
While setting the interest rates the RBI has to strike a balance between growth and inflation. In a nutshell – if the interest rates are high that means the borrowing rates are high (particularly for corporations). If corporate can’t borrow easily they cannot grow. If corporations don’t grow, the economy slows down.
On the other hand when the interest rates are low, borrowing becomes easier. This translates to more money in the hands of the corporations and consumers. With more money there is increased spending which means the sellers tend to increase prices leading to inflation.
In order to strike a balance, the RBI has to consider all the factors and should carefully set a few key rates. Any imbalance in these rates can lead to an economic chaos. The key RBI rates that you need to track are as follows:
Repo Rate – Whenever banks want to borrow money they can borrow from the RBI. The rate at which RBI lends money to other banks is called the repo rate. If repo rate is high that means the cost of borrowing is high, leading to a slow growth in the economy. Currently, the repo rate in India is 8%. Markets don’t like the RBI increasing the repo rates.
Reverse repo rate – Reverse Repo rate is the rate at which RBI borrows money from banks. When banks lend money to RBI they are certain that RBI will not default, and hence they are happier to lend their money to RBI as opposed to a corporate. However when banks choose to lend money to the RBI instead of the corporate entity, the supply of money in the banking system reduces. An increase in reverse repo rate is not great for the economy as it tightens the supply of money. The reverse repo rate is currently at 7%.
Cash reserve ratio (CRR) – Every bank is mandatorily required to maintain funds with RBI. The amount that they maintain is dependent on the CRR. If CRR increases then more money is removed from the system, which is again not good for the economy.
The RBI meets every two months to review the rates. This is a key event that the market watches out for. The first to react to rate decisions would be interest rate sensitive stocks across various sectors such as – banks, automobile, housing finance, real estate, metals etc.

12.3 – Inflation

Inflation is a sustained increase in the general prices of goods and services. Increasing inflation erodes the purchasing power of money. All things being equal, if the cost of 1 KG of onion has increased from Rs.15 to Rs.20 then this price increase is attributed to inflation. Inflation is inevitable but a high inflation rate is not desirable as it could lead to economic uneasiness. A high level of inflation tends to send a bad signal to markets. Governments work towards cutting down the inflation to a manageable level. Inflation is generally measured using an index. If the index is going up by certain percentage points then it indicates rising inflation, likewise index falling indicates inflation cooling off.
There are two types of inflation indices – Wholesale Price Index (WPI) and Consumer Price Index (CPI).
Wholesale Price Index (WPI) – The WPI indicates the movement in prices at the wholesale level. It captures the price increase or decrease when they are sold between organizations as opposed to actual consumers. WPI is an easy and convenient method to calculate inflation. However the inflation measured here is at an institutional level and does not necessarily capture the inflation experienced by the consumer.
As I write this, the WPI inflation for the month of May 2014 stands at 6.01%.
Consumer Price Index (CPI)– The CPI on the other hand captures the effect of the change in prices at a retail level. As a consumer, CPI inflation is what really matters. The calculation of CPI is quite detailed as it involves classifying consumption into various categories and sub categories across urban and rural regions. Each of these categories is made into an index. This means the final CPI index is a composition of several internal indices.
The computation of CPI is quite rigorous and detailed. It is one of the most critical metrics for studying the economy.  A national statistical agency called the Ministry of Statistics and Programme implementation (MOSPI) publishes the CPI numbers around the 2nd week of every month.
The CPI stands at 8.28% for the month of May 2014. Here is a chart for the inflation for the last one year in India.

As you can notice, the CPI inflation has kind of cooled off from the peak of 11.16% in November 2013. The RBI’s challenge is to strike a balance between inflation and interest rates. Usually a low interest rate tends to increase the inflation and a high interest rate tends to arrest the inflation.




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