The latest hike in Statutory Liquidity Ratio (SLR), tightening of norms for non-performing assets, and the expected hike in key policy rates create fear of liquidity drying up in the market. Reduced liquidity in the system will increase the borrowing cost of consumers and of business in general. This is likely to reduce expenditure, resulting in diminishing demand for goods and services. Profitability of corporates will be impacted both by the rise in interest costs and by reduced sales.

An increase in interest rates also makes equity relatively less attractive as an asset class because the risk-free return available elsewhere increases. As interest rates go up, bank deposit rates rise and new issues of government securities are made at a higher premium rate. This means that the risk premium associated with stock markets declines. As the relative reward for investing in stocks falls, investors move money out of the stock market and put it in bank deposits and government bonds, pushing down the prices of shares.

Much of the volume in the markets these days, whether retail or institutional, is made ‘on margin’. This means that initially the investor only puts up a fraction of the funds needed to buy shares. The remaining funds are loaned by the broker on a short-term basis. An increase in interest rates increases the cost of margin trading.

All the above factors are likely to pull down the indices in the short run. For investors this will provide interesting buying opportunities. Here are a few good stock ideas for investing:

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