Vijay Kumar Gaba

 The US and European equity markets had a strong counterintuitive rally in the month of October. The benchmark indices gained 6 to 15% amidst reports of worsening economic and geopolitical conditions. The benchmark Dow Jones Industrial Average (DJIA) gained 14%, its best monthly gains since January 1976. Of course these gains have come on the back of some of the worst months in history and a pathetic overall performance in the year 2022 so far. Nonetheless, these gains have provided some relief to the embattled investors, keeping the hopes alive.

The latest meeting of the Federal Open Market Committee (FOMC) of the US Federal Reserve is being watched even more intensely, as its outcome tonight is widely expected to determine the market direction from here. One of the largest global brokerage firms J P Morgan Chase & Co. has reportedly stated that “The S&P 500 could surge at least 10% in one day if the central bank raises interest rates by a slower-than-expected half of a percentage point, and Chair Jerome Powell signals willingness at the press conference to tolerate elevated inflation and a tightening labor market”.

Apparently, lots of bets have been placed on softening of the Fed’s stance on monetary tightening. If the Fed disappoints tonight, we may see these bets unwinding; or even changing direction towards a bearish stance. A sharp reversal in the US stock markets might reverberate across markets – USD might strengthen; bonds may weaken; gold and silver may correct; and emerging markets may witness some outflows and hence give up some of the gains made in the past one month.

We shall see the expert engaged in animated discussions over Fed’s strategy and likely outcome. The market economists will term the rather hawkish monetary stance of Fed as totally unwarranted and counterproductive, citing elevated inflation and heated job markets as evidence of the ineffectiveness of the Fed’s aggressive tightening. The macro economists on the other hand would call for even more aggressive policy to completely destroy the menacing inflation and restore the credibility of monetary policy.

We shall also see buzzwords like “imminent housing crash”; “dollar debasement”; “crypto crash”; “deep recession” dominating the headlines in every form of media. A variety of experts will make prophecies about the imminent apocalypse; so that on a later date they could say “I told ya so”.

On the other hand, if the Fed obliges the markets by hiking less than 75bps; or hiking 75bps but hinting that Fed might pause sooner than earlier expected (pivot) – the market might respond as enthusiastically as people at J P Morgan et. al. are expecting. We might see an intense battle as the ‘shorts’ rush to cover and ‘longs’ happily lighten their positions.

Regardless of what Fed does and says, or refrains from doing or saying - few things appear certain:

·         The mortgage rates in the US and elsewhere will rise further.

·         Putin will maintain its hard stand on Ukraine and Europeans will be paying through teeth this winter to keep their homes warm.

·         China will continue to push its agenda of “larger role for China in global order” more aggressively.

·         Inflation will come down from a combination of demand destruction and demand transformation (as consumers move to alternative products, methods and technologies). The rate hikes will have a role to play in demand destruction but with a lag. To the contrary the impact of rate hikes on efforts to augment supplies will be visible much earlier. Higher costs would discourage capex, inventory building and debottlenecking; especially when the inflationary expectations are being managed to moderate.

Anyways, I will not stay awake till midnight to hear Mr. Powell. I am also not waiting to hear Mr. Dass tomorrow either, even in the less likely event of him choosing to make a statement post the unscheduled meeting of MPC.

As I understand from the notice of the meeting, this meeting has been called under section 45ZN of the RBI Act. The meeting under this section is called for the limited purpose of discussing and finalizing the contents of the letter to be written to the government explaining the reasons for failing to meet the set inflation targets and enumerate a corrective plan of action. Policy changes are not discussed under section 45ZN. For that a meeting under section 45ZI needs to be called.

However, if the MPC does choose to make an unscheduled hike tomorrow to catch up with the Fed, I may consider a 10-15% underweight on equities for 2023, in my investment strategy, simply because I do not like a central banker who is not in full control of monetary policy and is just managing the spreads with the US Fed.

The present narrative in the global market is definitely not comforting. In the developed western economies, in particular, even the investors who took the classical moderate approach to asset allocation, e.g.,“100-age” (percent allocation to risk asset 100-investors’ age and the balance to fixed income) or “60:40” (60% risk assets and 40% fixed income for working people and vice versa for retirees) have witnessed material losses as both risk assets (equities, crypto, etc.) and fixed income (Bonds, REITS, etc.) have witnessed sharp correction. Reportedly, 60:40 Portfolio of US stocks and Bonds is down 21.6% in YTD2022, the worst performance since 1931. In India also, most balanced funds (funds that invest in a mix of equity and bonds) have yielded marginally positive or negative return YTD2022.

From whatever is happening around the world; and whatever is being prophesied about the future, at least the following five things are reasonably clear to me–

(i)    The economic growth is declining and it is not an immediate priority for the policy makers.

(ii)   The “innovative monetary policy” adopted post global financial crisis (GFC) has outlived their utility and is no longer effective. In fact the side effects of these policies are now appearing in most of the economies.

(iii)  No policy maker is in control of the economic events happening in their respective jurisdiction. Most have resorted to conventional means of policy management to tackle a situation which is largely created by unconventional policies, misplaced political aspirations; demographic transition; natural calamities; and egotistic pursuits of some political leaders.

(iv)   The cost of factors of production (wages, interest, material, and machines) is rising across the globe due to factors like demographic changes; under-investment in physical capacity building in the past 2 decades; climate change; and unwinding of unprecedented monetary stimulus.

(v)    The Indian markets are walking on a tightrope (of hope) passing through a deep valley of concerns like, worsening global macro; poor domestic macro; worsening valuation-corporate fundamental matrix; and tightening liquidity etc. The best case for markets is that it will cross the valley of concerns with no or little damage. The worst case is that it will lose balance and fall down. Generally speaking, the risk reward of investing in Indian markets is not very encouraging at this point in time.

In my view, the markets have already called the Central Bankers’ bluff, as I had expected five months ago (see Markets will call central bankers' bluff). There is no evidence of aggressive rate hikes leashing the prices; while growth has been crushed.

In the words of reputable William Hunt Gross (popularly known as Bill Gross), without interest rate “carry” (the positive difference between 2 and 10yr treasuries, for instance), our half-century-old, financed-based economy cannot thrive. In the 1980s the then Fed chairman Paul Volcker slayed 13% inflation by introducing a negative carry of 500bps or more for 3yrs. This resulted in a deep 3yr recession. Today central bankers are employing the same tactics, but our significantly higher levered economy cannot withstand the same amount of negative carry. The question is how much and for how long…..while inflation is the Fed’s seemingly solitary focus at the moment, economic growth and financial stability may soon gain equal importance……Recent events in UK, cracks in Chinese property based economy, war and a natural gas freeze in Europe, and a super strong dollar accelerating inflation in emerging market economies, point to the conclusion that today’s 2022 global economy in no way resembles Volcker’s in 1979. A negative carry of 500bps now would slay inflation but create a global depression."

Besides, Volcker tightened with the world progressing towards the end of the cold war era. Today, the world is entering an era of a fresh and perhaps more intensive cold war.

In India also, fissures have been reported in the Monetary Policy Committee. At least two members of the MPC have warned against unmindful rate hikes in the current circumstances.

My feeling is that central bankers would be forced to review their tactics and USD will revert to its rightful place. The only uncertainty is if this would happen well in time to avert a global depression.

Considering these circumstances, what should be the strategy of a small investor like me!

More on this tomorrow…

In its latest meeting (6-8 June’22) the Monetary Policy Committee (MPC) of RBI unanimously decided to hike the policy rates by another 50bps. Last month, the MPC had announced an unscheduled 40bps hike in rates. With this hike, the policy Repo Rate (rate at which RBI lends short term money to banks) is 4.90%; Standing Deposit Rate (rate at which banks can park their surplus funds with RBI) is 4.65%.

The market participants in India must be relaxed after a strong equity market rally in the past 4-5weeks; and stable INR and bond markets. To that extent the RBI has played its part rather well. It has repeatedly reassured the markets about its commitment to the economic growth and stability in the financial markets. Despite turmoil in the global energy and food markets and geopolitical concerns, the RBI managed to contain the volatility in currency and debt market to very moderate levels.

With this background in mind, the market participants are obviously complacent to the likely outcome of the meeting of the Monetary Policy Committee of RBI this week. It seems to be a consensus view that the MPC may use some stronger words to express the concerns about rising prices and exacerbated fiscal pressures, but may stop short of hiking policy rates or changing its accommodative policy stance. Given the fragility of the economic recovery and elevated global uncertainty, the last thing RBI would want to do is to make a disruptive move.

Nonetheless, the participants in the equity markets must be keeping a close watch on the developments in the bond markets. The bond yields have been rising ever since the RBI announced government’s borrowing calendar for 1HFY23. The government is likely to borrow Rs8.45trn form the market in next 6months. This is about 59% of the total budgeted borrowings for FY23. A view is developing that notwithstanding the robust tax collections and consistent alignment of fuel prices to the market prices, the government might need to borrow more than the budgeted due to higher farm and food subsidies. Accordingly, the yield curve in India is very steep in the 1 to 10yr maturity band and mostly flat in the 12-30yrs maturity band. This is in sharp contrast to the inverted yield curve in the US.

As per the conventional wisdom, an inversion in yield curves (2yr yields higher than 10yr yields) usually precedes recession. A steeper yield curve on the other hand reflects expectations of a stronger economic activity and therefore higher inflation in the short term.

The impact of a steeper/inverted yield curve could however be different. As per the conventional wisdom the stock market factors in the future events well in advance. The earnings forecasts and stock prices are adjusted to factor in all known future events. Of course there is subjectivity in the analysts’ assessment and pricing methods used, recognition of the event itself is usually uniform, with very few contrarian views.

It is therefore reasonable to believe that the US equities are already pricing in a recession in next six months and may not see much correction from the current level despite few rate hikes by the Federal Reserve. Whereas, the Indian equities might be pricing in a stronger economy and there could be some scope for disappointment. A rise in benchmark yields to 7.25-7.5% (as presently forecasted by most analysts) could cool the heated equity markets.

However, this view is subject to deftness of RBI in managing the bond market. Higher FII allocation; continued use of innovative tools; and a sharper global commodity price correction could keep the bond yields under check (or even result in lower yields) and fuel the equity prices further.

Whatever be the case, for sometimes the bond market may be the guiding factor for equity markets.

The Reserve Bank of India (RBI) made its last policy statement for the current fiscal year FY22. The statement is unambiguous on all four key issues:

1.    The inflation is likely to peak in the current quarter and fall to the RBI’s tolerance range from next quarter onward.

2.    The overall growth has recovered to the pre-pandemic level, but private consumption is lagging. The risks to the growth are on the downside and 2HFY23 growth should moderate to ~4.5%.

3.    The Monetary Policy Committee (MPC) is unanimously of the view that in view of the present growth vs inflation dynamics, there no case for a hike in the policy rates.

4.    The growth recovery is fragile and requires monetary policy support. Hence, MPC has decided to keep the policy stance accommodative by a majority vote of 5 to 1, as was the case in the previous two policy statements.

This accommodative stance of the RBI in total defiance of the global trend of monetary tightening led by inflation concerns is not surprising, given the fact that the RBI has been solely focused on growth for past 3years, since the incumbent governor has assumed the office.  In the post meeting press interaction also the governor and his deputy sounded calm, defiant and confident.

Obviously, the RBI knows much more than most of the market participants and commentators and is certainly in a much better position to decide the best course of action. From the policy statement and officials’ replies to the press it appears that RBI is relying significantly on (i) the outcome of the monetary tightening by global central bankers and consequent cooling down in global inflation; (ii) a favorable monsoon; and (iii) full success of government’s plan to catapult private capex and consequent pickup in private consumption. The RBI also appears to be assuming that “India’s inflation” is different from the “global inflation”, and it will ease without any monetary policy intervention.

The argumentative Indian in me is restless to explore between the lines and find what has not been said and what could wrong. I am sure a trader who takes the governor’s statement at face value and places his bets accordingly would make more money than someone doubting the words of the governor and taking a deep dive to explore the words that were not said.

Citing the first part of a verse from famous Shailendra song from Movie Guide raises suspicion whether the governor is gambling with Knightian Uncertainty. He only mentioned “Aaj phir jeene ki tammna hai (Today I wish to live again), signifying strong survival instinct. What he did not say was ‘Aaj phir marne ka irada hai (…even if I have to die for it today) signifying the willingness to take high risk.

Regardless, I would like to argue that the RBI is worried about—

·         A prolonged growth recession. 2HFY23 growth projection of below 5% is not in consonance with the projection made by the Economic Survey and professional forecasters.

·         Rise in cost of borrowing for government and consequent interest burden on the budget.

By completely side stepping the large borrowing program of the central government in the policy statement, the RBI has opened the doors to the speculation of a significant balance sheet expansion (QE in simple words). The reliance on foreign funds for financing the deficit is also seems high, implying that RBI is expecting the yield differential between developed market bonds and Indian bonds to remain attractive and also inclusion of Indian bonds in global indices.

The RBI has categorically accepted the subordinate role of monetary policy to the fiscal policy; though the statement claims “equality” of two policies.

Both the government and the RBI might be hoping and praying that Russia-Ukraine conflict is averted; US and China growth cools down and OPEC+ agrees to increase the oil production materially so that the global energy prices cool down materially. Else, the government may be forced to take the incremental fuel prices on its fiscal account, either by way of duty cuts or subsidy to the OMCs. This not only takes the BPCL disinvestment off from the table, but also brings a downgrade of India’s sovereign rating in the frame.

Notwithstanding, what the RBI statement reads, the inflation projection chart of the RBI is sufficient to raise suspicion. From 0 to 8% inflation range would render any forecasting method meaningless. It is reasonable to suspect that “hope” is one of the horses pulling the policy cart.

The steep yield curve that allows short term borrowing at 3.75-4% vs long term borrowing at 68% to 7% .This is obviously encouraging borrowers to borrow more through short term instruments. The risk of ALM mismatch that played havoc with non-bank lenders and real estate developers in recent past is thus increasing. By not doing anything to flatten the yield curve, the RBI perhaps has stretched its luck little too far.

Last but not the least, “staying put” is the best strategy when in doubt. The complete status quo in the RBI policy, when the things have changed so much since the last policy statement, signals a banker in doubt and not a confident policy maker as the governor has pretended to be.

The Monetary Policy Committee of the RBI has been consistently facing the growth vs inflation challenge for past three years at least. However, the conditions have become significantly more challenging and complicated for the MPC in the recent months. Hence, in the past couple days MPC may not have spent much time on resolving the growth vs inflation conundrum.

While the equity markets have generally welcomed the Union Budget for FY23, the bond market seems to be majorly disappointed. It may be pertinent to note that the government bond yields had started rising in December 2021 itself, even though the April-October 2021 deficit numbers were very encouraging; and the RBI had categorically assured that the policy stance will continue to be “growth supportive” irrespective of the rising price pressures.

YTD 2022, the benchmark 10yr yield has seen a sharp surge, rising over 55bps. With this the benchmark yields are higher by 100bps from 2020 lows. The higher yields have however not transmitted to the lending rates.

Perfect storm in the bond street

A perfect storm seems to be developing in the Indian bond market.

·         The net government market borrowings are most likely to stay elevated in the midterm as fiscal consolidation is expected to take longer than previously estimated.

·         The inflation is persistently hitting the upper bound of the RBI tolerance range. The Monetary Policy Committee (MPC) of the RBI is widely expected to yield to the pressure of staying close to the curve and begin hiking the rates.

·         The US Fed has already announced the pathway to normalize the near zero interest rates. Besides, the US fed has also announced termination of Covid related quantitative easing (QE) program by March 2022. This could impact the global demand for emerging market bonds

·         The domestic household savings are continuing to slow down, forcing the government to reduce its reliance on small savings funds for deficit financing.

·         The banks are anticipating acceleration in credit growth, shrinking the pool available for bond buying.

·         The RBI has already started unwinding the excess liquidity infused in the system to complement the government’s Covid relief measures.

The ambitious capital expenditure plan of the government would need to be evaluated against a rising rate environment; especially when it largely hinges on the private sector participation in capacity building.

Historically, bond yields had a good negative correlation with the equity returns. The correlation has been much stronger in case of broader markets. It would be interesting to see how things unfold in the coming months.

 In its latest policy statement, RBI has reiterated its unwavering commitment to growth, ignoring the concerns about it missing the inflation curve. There are not many precedence in past two decades when the RBI has shown such unwavering commitment to growth despite mounting inflation concerns and global tightening pressures.

The decision of the Monetary Policy Committee of RBI to maintain status quo on policy rates and keep the policy stance “accommodative” despite mounting inflationary pressures has provided some relief to the financial markets. However, it has divided the experts on the mid-term economic impacts.

The bankers have generally welcomed the RBI’s policy stance as credit and growth supportive. However, economists believe that this leniency on inflation may not end well. They believe that this profligacy of RBI will leave it much behind the curve and force it to make disruptive tightening in mid-term.

There are some questions over the autonomy of MPC also. A small section of analysts believes that the government may have hijacked the MPC agenda, forcing it to ignore its primary mandate of price stability; and support the government through continuing monetary stimulus.

In my view, the monetary Policy Committee (MPC) and RBI have taken the most appropriate path by staying focus on growth.

There is no conclusive empirical evidence available to indicate that RBI has been able to influence prices through monetary policy. On the other hand, the monetary stimulus (lower rates and accommodative liquidity) has invariably shown positive results. This is particularly true in episodes of inflation with negative output gap, implying underutilization of capacities.

There are ample indications to suggest that RBI is working in close coordination with the government. Sharp cut in duties on transportation fuel 2 weeks ahead of MPC meet shows that the government is addressing the RBI concerns on prices.

RBI’s lower inflation forecast for next quarter, when the US Federal Reserve Chairman has indicated that the inflation may not be transitory as believed earlier and OPEC’s resolve to maintain prices around present levels, further indicates that RBI is comfortable with the government’s assurance to reign energy prices.

The latest Monetary Policy Statement of MPC also does not seem to concur with the US Fed assessment on inflation. It continues to believe that inflation is transitory and it will ease in next few months.

To summarize, RBI has made it clear that the monetary policy shall remain consistently growth supportive for next many quarters. It will wait for conclusive evidence on stabilization of growth trajectory before changing its policy stance. Any changes till then will be implemented by managing the liquidity through open market operations.

The governor highlighted in his press statement that “the Reserve Bank has maintained ample surplus liquidity in the banking system to nurture the nascent growth impulses and support a durable economic recovery. This has facilitated swifter and more complete monetary policy transmission and the orderly conduct of the market borrowing programme of the Government. The Reserve Bank will continue to manage liquidity in a manner that is conducive to entrenching the recovery and fostering macroeconomic and financial stability.”

In an unscheduled press conference yesterday, the RBI governor admitted that the Covid19 pandemic has recently intensified in India. This intensification could derail the still fragile economic recovery. He implied that the impact on livelihoods due to restrictive access to workplace, education and income mediums could be significant and needs immediate attention.

The governor also highlighted that “The global economy is exhibiting incipient signs of recovery as countries renew their tryst with growth, supported by monetary and fiscal stimulus. Still, activity remains uneven across countries and sectors. The outlook is highly uncertain and clouded with downside risks.” He underscored that “Consumer price index (CPI) inflation remains benign for major AEs; in a few EMEs, however, it persists above targets on account of firming global food and commodity prices.”

The governor also highlighted the emerging inflationary pressures and softening bias in bond yields as follows:

·         “CPI inflation edged up to 5.5 per cent in March 2021 from 5.0 per cent a month ago on the back of a pick-up in food as well as fuel inflation while core inflation remained elevated.”

·         “Domestic financial conditions remain easy on abundant and surplus system liquidity. The average daily net liquidity absorption under the liquidity adjustment facility (LAF) was at ₹5.8 lakh crore in April 2021. The first auction under G-SAP 1.0 conducted on April 15, 2021 for a notified amount of ₹25,000 crore elicited an enthusiastic response as reflected in the bid-cover ratio of 4.1. G-SAP has engendered a softening bias in Gsec yields which has continued since then.”

In fact the governor announced that “Given this positive response from the market, it has been decided that the second purchase of government securities for an aggregate amount of ₹35,000 crore under G-SAP 1.0 will be conducted on May 20, 2021.”

It is therefore clear that regardless of the inflationary pressures, the liquidity conditions may remain benign for 2021 and no thought of monetary tightening may be entertained by MPC/RBI. Persistently, poor credit growth also supports this view.

It is pertinent to note that Banks’ non-food credit growth was just 4.9% in March 2021, almost a 4yr low. Credit growth in service and manufacturing sectors continues to remain materially below par; though agriculture and personal credit is buoyant. During March 2021, industry credit off grew a dismal 0.4% yoy, while credit to large industries segment continued to contract (-0.8% YoY). The credit growth pickup in February 2021 failed to sustain. The April credit growth number may still be disappointing, given the widespread mobility restrictions across large states.

Though RBI governor emphasized strongly on the need to support small, medium and unorganized businesses; the credit growth to this segment remains anaemic, highlighting the extreme risk averseness of lenders. Loans for Housing & education; and to weaker sections have also suffered recently. Given that MCLR rates are now stable as most of the transmission of policy easing has already occurred, any material fall in rates may not be expected in 2021.

 The first monetary policy statement of FY22, scheduled to be made on 7 April 2021, is awaited more for the signals and body language, rather than any monetary policy action.

It is almost a consensus that RBI, like any other major central banker, may not be in a position to cut rates from the present levels. On the other hand, RBI governor has made it clear that “...there is no way the economy can withstand higher interest rates in its current state. It is recovering but certainly not out of the woods yet”. The governor has gone way out of his way to assure the bond market and committed “orderly evolution of yield curve” in public interest.

The bond market has calmed down a bit after aggressive assertions made by RBI governor, but the traders have not retraced their steps. The benchmark 10yr yields are now stable close to 6.2%, much higher than the 5.8% to 5.9% sought by RBI.

Next couple of policy statements would therefore be watched to assess (i) how deep is the RBI’s commitment to keep the yield curve orderly and liquidity ample; and (ii) when RBI would be ready to hike rates.

The equity markets usually do not have a strong correlation with the bond market. However, a negative correlation emerges in months preceding the turning of rate cycle. The current tentativeness and loss of momentum in equity market is indicating that equity traders are also anticipating a turn in rate cycle sometime in 2021. A rate hike or a clear indication about the policy path by RBI could therefore be a positive support for the equity market.

Internationally also financial markets are focused on tapering of bond buying programs of major central bankers and eventual hike in policy rates. As per current estimates, FED tapering may begin sometime in 2022 and rate may not be hiked at least until mid-2023. Notwithstanding the expectations, the markets are definitely indecisive.

In my view, we shall have an extended period of indecision and sideways movement in equity markets before the monetary policy makes its next move. Till then happy trading.

After hearing the finance minister (and Hindi translations of what she says by her Deputy) many times in past 7 months on the issue of stimulus for economic recovery, most market participants now appear disinclined to hear her anymore. I actually found many market participants wishing that the government actually does nothing and lest the economy recover on its own.

When the RBI governor comes out to brief media about the outcome of last Monetary Policy Committee’s (MPC) meet of the current financial year at 11:45Am today, most market participants shall be praying for a very “brief statement” and “No Action” by RBI. Not many would be expecting any further easing from the RBI, given the facts that—

(i)    Food inflation has remained rather sticky and non-food inflation has also started to rear its head higher;

(ii)   Liquidity in the system has surpassed the comfort level, leading to unsustainable fall in short term rates; and

(iii)  the real rate have now turned negative and are threatening to inflate a bubble in asset prices;

The questions before RBI/MPC therefore would be—

(a)   Maintain status quo;

(b)   Change the presently accommodative policy stance to neutral but refrain from doing anything; or

(c)    Change the policy stance and tighten the liquidity through market operations (Fx sale, short term bond sale etc) and/or policy action (CRR, SLR, MSF etc.).

Besides, one of the factors in the dismal export performance over past many months is out performance of INR over other emerging market peers. RBI might have to change its stable INR policy also sooner than later.

The market participants would obviously like to hear a “status quo” decision. Anything else may dampen the animal spirits driving the markets. Also, the market participants would not like the governor to speak for long (Governor Das is known for making long statements). The fear is that is speaks long, he will leave more material for (mis)interpretation.

A recent article published in Bloomberg Quint, summarized the present money market situation and quoted some money market participants as follows:

“The Reserve Bank of India may have cause to review its ultra-easy liquidity policy when it meets this week, as short-term corporate and government borrowing rates have remained below its policy benchmark rates for an extended period.

Yields on commercial paper have traded not only below the policy repo rate, the rate at which the RBI lends overnight funds to banks, but also below the reverse repo at which banks park funds with the central bank.”

“If this (surplus liquidity situation) continues, it would lead to a persistent mispricing in the commercial paper market as the existing yields are becoming unsustainable for investors. Even the policy rates are losing relevance due to the abundant liquidity scenario. So, there needs to be an immediate intervention from the RBI.” (Rajeev Radhakrishnan, Head - Fixed Income, SBI Mutual Fund)

“A quarter of the 274 companies that tapped the commercial paper market for borrowing funds via short-term bonds, with maturity below or equal to 90 days, raised funds below the reverse repo rate of 3.35% in November.”

“The mutual funds do not have access to interbank rates, as they cannot park their liquidity with the RBI in the reverse repo market like banks can, they don’t have a choice but to keep on buying these short-term commercial papers. Because of this, the rates have compressed so much that investors are buying CPs even below the RBI’s reverse repo rate.” (Parag Kothari, Associate Director, Trust Capital)

My personal view on RBI policy stance is that RBI may continue to take a pragmatic approach and change its policy stance to neutral and let INR weaken over next few months.

The excess liquidity may have already started to inflate financial asset prices beyond sustainable levels. If left unchecked, this would result in inflation of bubbles that invariably cause avoidable pain when they eventually burst.

The policy rates are already at level that is supportive of growth. Any further broader easing may not be warranted at this stage when the investment & consumption demand growth is not accelerating. Some targeted easing may however be considered to promote investment and exports in specific areas.

The fears of 2008-09 like market freeze shall materially abate in next few months and RBI may not need to augment the Fx reserve any further. It may actually consider selling some reserve accumulated over past 6 months to fund growth and higher borrowing needs of the government.

The three day periodic review meeting of the Monetary Policy Committee of RBI started yesterday. The Committee may review the monetary policy of RBI, in light of (i) the prevalent macroeconomic conditions-  especially inflation, fiscal balance, growth outlook; (ii) working of the financial system, e.g., liquidity situation, financial stress, credit off take, etc.; (iii) the global economic developments; and (iv) the assessment of economic shock in the aftermath of the pandemic.

The market participants are mostly focused on the monetary stimulus, which the MPC may propose, especially cut in the policy repo rate. Besides, the market will be watching out for the RBI stance on further extension of the debt moratorium; targeted credit for weaker sections; relaxation to the bank and non bank lenders from provisioning norms; inflation outlook and growth outlook.

In my view—

1.    Any cut in policy repo rate at this stage will be mostly meaningless, having only a symbolic value. The credit demand and the willingness to lend are abysmally low presently. Despite multiple rate cuts, incentives and assurances the credit growth has failed to pick up. The latest data shows that the in the second fortnight of July 2020, the overall credit demand slipped to 5.8%, which is close to the lowest level in a decade.

2.    The RBI has been maintaining surplus liquidity in the Indian banking system for past many quarters now. The liquidity has been boosted materially by (i) Forex accumulation by RBI in current account surplus situation; (ii) rate management actions of RBI through LTRO, etc. and (iii) other measures like CRR cut etc.

The excess liquidity is helping the government in funding the enlarged fiscal gap while maintaining the borrowing cost at lower level. However, the side effect of this has been total crowding out of private capex. The risk wary bankers are too happy to buy government securities which are available in abundance. Scheduled commercial banks’ investment in central and state government securities had increased by over 19% as on July 3 compared to last year, led by weak credit growth and surplus liquidity. 

In this situation, any liquidity enhancement measure may not yield any positive outcome.

3.    Insofar as extension of moratorium on certain debts is concerned, the situation is rather tricky. The disclosed amount of debt under moratorium varies widely across lenders and category of borrowers. The latest commentary of bank management indicates that the number of people and entities availing moratorium facility has come down materially in July. If this is the correct position, there should be no need to extend the moratorium deadline further. Even if it is extended, the number of beneficiaries would be supposedly much lower.

However, there is a section of analysts who believe that many lenders may not be presenting the true picture of the accounts under moratorium and expected recovery from such accounts. In their view, the lenders may be pushing RBI for extension of moratorium to March 31, 2021 so that they could make adequate provisions for the anticipated losses on this account.

The analysts at brokerage firm, Edelweiss Securities believe that the NPAs of banks may only peak by end of FY22, assuming material rise in FY21.

4.    The monsoon progress appear to have stalled and large parts of India are staring at deficient rains. If the monsoon fails to gather steam in August, as forecasted by IMD, the food inflation may spike further. MPC may be mindful of this event in taking rate cut decision.

5.    Last but not the least, in my view, motivating bankers to begin taking risk would be more productive than rate cut etc. For example, widening the policy corridor dramatically by cutting reverse repo rate by 50bps may encourage lending to some extent.