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What is driving valuations on the Indian exchanges? After a extremely volatile ride last week, which saw the key S & P Nifty Index and Sensex drop 6.2 % and 7.2 % in two trading sessions and come back 4.3% and 5.9 % respectively in the next three sessions, analysts and anchors alike are debating a gamut of reasons that span the investment spectrum.

But the two causes that stand out with some respectability are the Reserve Bank of India's decision to raise the Cash Reserve Ratio [CRR] by 50 bps at one go, and the Index of Industrial Production [IIP] unexpected October dip to 6.2 % for year on year growth, a total shocker compared to the feel good figure of 11.4 % for the previous month.

Last Monday, it was a matter of sell first and ask questions later, as the indices tumbled in a fashion reminiscent of the May 2006 meltdown which saw markets giving up 28 % from their May peaks in just one month. It was not that market participants didn't foresee the RBI's double point increase in the CRR. Governor Reddy had clearly telegraphed his intent on reining in inflation which had increased to 5.3 % in spite of retail cuts in fuel prices. He had also openly expressed his concerns on the steep increases in the country's real estate markets and other asset classes. The IIP number initially sent another wave of selling in late Tuesday trading, but was soon explained away as a mere blip due to changes in time periods used for comparison this year.

The mild dissent between the Finance Ministry and RBI over raising of interest rates had gone down well with market. After being downplayed by the mainstream media, the markets decided that the RBI could only make noises about controlling inflation, while the Finance Ministry, headed by Mr. P.C. Chidambaram, would be more accommodative on the interest rate front and would try to bring some political pressure on the RBI's decisions.

But with concern rising in Parliament over recent sharp price increases in food and other essential items that hit the middle class [read: voters] where it hurts, monetary policy was let to play out its role and gave nervous fund managers and traders reason to furiously punch the "Sell" button on the banking stocks, sending the Bankex Index tumbling as much as 9.5 % in 2 trading sessions. The sell off was most pronounced in the gov't controlled public sector banks such as State Bank of India, Bank of India, Punjab National Bank and a host of other public banks. Private sector banks were left bleeding too, but they fared better than the public banks. The banking index regained a bit of lost ground but closed well off last week's highs, down 3.03%.

All sectors of the market took a beating as traders sold off other interest rate sensitive sectors such as housing, cement, autos and metals on concern that rising interest rates would affect consumption and corporate performance in the coming quarters. What was truly impressive was the indiscriminate fashion in which widely touted important technical support levels were snapped as the selling took on a panic feel towards the middle of the week.

Bargain hunting by institutional investors who saw value at lower levels helped firm up indices towards the end of the week. Solid advance tax collections for the forward year in the cement, steel and auto sectors also helped in a late recovery towards the week's close. But traders are still on edge as all this action happened in a week which saw global markets trade flat to positive and took opportunity to lighten up positions into the weekend and ahead of the CPI number in the US markets.

This week should be interesting to say the least.

Disclosure: Author is long above-mentioned stocks.

Source: This Week's Indian Market Report