Dalal Street seems to feel that the near-term movements of the key indices are linked to what the RBI will announce on Tuesday. The central bank's actions on the interest rate and liquidity fronts will help the market movers fine-tune their strategies.

FIIs, top HNIs and select brokerages appear to give an impression that if the RBI meets their expectations — a 25 basis points hike in rates — the market may remain in the “consolidation mode”, a current euphemism for sideways movement in key indices, with a hint of downward bias.

For the medium-term (five to six months), the consensus is that the local benchmark's P/E may oscillate between 12 and 15, depending on the expectations of the forward (FY12) earnings. Mitigation of the perceived risks — the rate, inflation and political risks — may determine the dominant strategies.

In simple terms, major players will turn bulls or bears as policy decisions unfold.

Very few have misgivings over India Inc's ability to surprise positively despite the macroeconomic challenges. Interestingly, none of the important market players seems to be ready to adopt a contrarian strategy.

Mr Manoj Pradhan, an economist with Morgan Stanley, says emerging markets' central banks look set to pay attention primarily to a monetary stance that is appropriate for the growth profile. “Signs of rising inflation expectations in China, India and Indonesia, growing attention to inflation risks in Russia and Poland, and domestic demand-led pressure on inflation in Brazil suggest that policy-makers are keenly watching developments, and their policy stance will be set to attenuate or eliminate these risks,” he wrote in a recent note.

For India, the issue is whether the supply-constrained food inflation and the demand-driven rise in oil prices would infect the core prices. The key concern is though the inflation may subside, the general price level is likely to elevate. If it does, the erosion of disposable income and profit margins might prompt demands for higher nominal wages and higher downstream prices.

Ms Sonal Varma and Ms Ketaki Sharma, economic analysts at Nomura, point out that the Government has hiked minimum rural wages (under NREGA) by 17-30 per cent across various States. The annual industrial wage revisions will be linked to the consumer price index for agricultural labourers.

Higher wages can give a push to rural consumption and demand, but can fan inflationary pressures and increase the Government's fiscal cost.

According to Nomura analysts, since the RBI's last policy meeting on December 16, the liquidity deficit has narrowed from Rs 1.5 lakh crore in mid-December to Rs 1 lakh crore. Nomura does not rule out the RBI announcing open market operations to narrow the liquidity deficit. It expects inflation to remain stubbornly high, averaging 7.5 per cent y-o-y in FY12 versus 8.5 per cent in FY11. “At our current inflation expectation, we see the RBI raising rates by an additional 75 basis points in FY12, after a 25 basis points hike on January 25.”

The consensus suggests that private consumption and export growth will remain robust. But slower agriculture growth, adverse base effects and the lagged effects of policy tightening may slow real GDP growth to 8 per cent in FY12 from 8.7 per cent in FY11.

The investment cycle is expected to mirror this trend. While the real estate and services sectors could be capex drivers in FY12, manufacturing may face headwinds from rising costs and domestic substitution.

Rising commodity prices are likely to widen the current account deficit to 4.0 per cent of GDP in FY12 from 3.5 per cent in FY11, sharply increasing India's dependence on net capital inflows, Ms Varma says.

> jayanta_mallick@thehindu.co.in

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