Shares in India should rally this week with State Bank of India, ICICI and HDFC Bank leading the rise after the central bank slashed the cash reserve ratio (CRR) by a hefty 75 basis points, which would make available Rs480 billion for lenders to give as loans.
The cut in the CRR — the percentage of bank deposits that must be kept in reserve with the Reserve Bank of India (RBI) — was announced after the stock market closed on Friday, and ahead of the central bank's policy review on March 15.
"The magnitude and the timing were a complete surprise," said equity trader Hiren Dalal. "The RBI has opened the liquidity tap, which is admirable but what can you now expect from the policy: probably, nothing more."
A structural liquidity problem has plagued the banking system for more than three months, and with tax outflows due by mid-month the situation was expected to worsen. The CRR dropped to 4.75 per cent effective Friday, with the latest reduction which followed a 50-basis-point cut in January.
There will, however, be hiccups for the stock market as investors brace for a budget that could be high on social spending to woo angry voters and low on vital economic reforms needed to boost investment and spur growth.
The Congress party, controlled by Sonia Gandhi, is expected to be on the defensive after it was soundly thrashed in regional elections. The rout could further worsen the policy paralysis that has highlighted the ruling coalition in New Delhi since it was re-elected in national polls about three years ago.
After sliding in 2011, the stock market rebounded in the past two months partly on expectation the elections in five states would give the Congress party more strength to override its disparate allies and the opposition and get the reform process moving. However, it fared poorly in four of the five states.
"The pace of policy reforms is unlikely to get a fillip from the state election results," Standard Chartered said in a note. "If the government fails to take difficult decisions owing to political motivation, then we see near-term risks to flows into India."
Foreign fund investment is the main driver for the stock market and any slowdown in inflows would pile pressure on share prices.
The top 30-share Sensex has fallen 4.3 per cent over the past three weeks as investors took profits off the table, but the key benchmark is still up 13.25 per cent in 2012 thanks to $7.5 billion (Dh27.58 billion) worth of shares bought by foreign portfolio investors.
"[The poll] raises the risks to the current rally, as expected reforms may stall; the macro could strain, and capex may slow," Citigroup analysts wrote in a report. "In effect, economic revival gains that the market has started factoring in could be challenged."
Among the reforms that would surely be put on the back burner are: allowing entry to foreign supermarket chains like Wal-Mart and Carrefour; giving bigger equity stakes to foreigners in insurance companies and banks and labour reforms.
Finance Minister Pranab Mukherjee will present the annual budget on Friday, with growth at the weakest pace in nearly three years and a fiscal deficit expected to top six per cent of GDP.
"Everyone had been betting the budget would take steps toward fiscal consolidation," said equity salesman Anmol Bhushan. "Those expectations are in jeopardy," he said, with the heavy electoral defeat. "If the government succumbs to pressure and doles out more freebies it would only add to the problem."
The Congress will have to do something quickly to boost growth rather than throw money after populist schemes, he said.