Vijay Kumar Gaba

Every day the stock markets in India (and other parts of the world also) are cheering the "positive data" and rising towards the previous highs. In my view, it may be a case of total cognitive dissonance. The market participants are selectively choosing the data that gives them hope of better days ahead; completely ignoring plethora of evidence indicating that economy is tottering on a long and winding road entering the dark woods with only scattered sunlight and no end in sight. Many experts have highlighted this case of dissonance between equity markets and economy, questioning optimism of investors and corporate managements. For example—

• The incumbent RBI governor Shaktikanta Das recently highlighted that "There is so much liquidity in the system, in the global economy, that's why the stock market is very buoyant and it is definitely disconnected with the real economy. There will definitely be a correction but we can't say when."

The minutes of the Monetary Policy Committee's last meeting also highlighting the regulators' concerns about the specter of stagflation, clouding the visibility of further rate cuts and also bringing on table the probability of change in RBI's accommodative stance over systemic liquidity.

• The former RBI governor (2008-2013) who sailed the Indian economy through the rough waters of global financial crisis also reportedly termed the recent positive macroeconomic as mere mechanical rebound, highlighting that India's short- and medium-term growth prospects continue to remain grim and the government should not read too much into the economic activity coming back from the depressed base of lockdown.

He categorically told PTI in an interview that "I don't believe we should read too much into the green shoots that you refer to. What we've been seeing is just a mechanical rebound from the depressed base of the lockdown; it will be misleading to see it as a signal of a durable recovery."

• The brokerage firm Kotak Securities highlighted in a recent research note that "certain high-frequency indicators show some level of stagnation—(1) diesel sales declined 19.3% in July 2020 versus 15.4% in June 2020; diesel volumes are a good indicator of freight movement and general economic activity, (2) daily e-way bills in August 2020 are 18% yoy lower versus 10% yoy lower in July 2020) and (3) electricity demand is still marginally lower in August 2020 than previous period level after being higher in the month of July 2020.

• As per a recent research note of Edelweiss Securities, "PMIs have moved up from all-time lows. However, this leading indicator is stalling now, showing the effect of state-level lockdowns and absence of demand stimulating fiscal support While market is cheering the denominator managed positive data, a number of experts are questioning the validity of green shoots."

• As per the brokerage firm, Nomura Securities, "medium-term outlook of lower inflation and the growth challenge remains largely unchanged – we estimate GDP growth to average -5.0% y-o-y in 2020 – falling to -15.2% y-o-y in Q2 2020 and recovering to a still-subdued -5.6% in Q3, -2.8% in Q4 and -1.4% in Q1 2021."

  Numerous other economists and strategists have also highlighted that growth trajectory may remain poor for longer. Surprisingly, the corporate leaders are not echoing this sentiment and are showing agreement with the political view of an imminent recovery! Either they are scared of speaking the truth or the experts are totally out of synch with reality. As Shakespeare said, "There are many events in the womb of time which will be delivered." I do not mind waiting for the labor pains to get over and the child be delivered. Till then, I shall stay cautious and conservative on my asset allocation (see here)

The first Monetary Policy Committee (MPC) of RBI met for the last time during 4 to 6 August 2020. To commemorate the end its four year term, the Committee thankfully did not take any populist decision. It prudently kept the policy rates unchanged, as I had wished for (see To cut or not to cut is not the question), and focused on mitigation of stress caused by the economic lockdown due to spread of COVID-19.

In line with the stand taken by the government, the MPC refrained from issuing growth and inflation estimates. However, the governor's statement makes the following things clear:

(a)   Inflation, especially food & energy inflation, is a matter of serious concern at present and development on this front need to be watched carefully; though the governor expressed hope that as the monsoon progressed well and base effect comes into play, the food inflation will ease in 2HFY21 leading the headline inflation below the MPC target range. It is pertinent to note that for past almost one year the headline inflation is running above the MPC target range of 2 to 4%. Despite this violation, MPC has continued on the path of substantial monetary easing even before the COVID-19 breakout.

(b)   GDP Growth for the current year shall remain in contraction mode, despite robust recovery in the rural sector. MPC noted that "Manufacturing firms expect domestic demand to recover gradually from Q2 and to sustain through Q1:2021-22. On the other hand, consumer confidence turned more pessimistic in July relative to the preceding round of the Reserve Bank’s survey. External demand is expected to remain anaemic under the weight of the global recession and contraction in global trade. Taking into consideration the above factors, real GDP growth in the first half of the year is estimated to remain in the contraction zone. For the year 2020-21 as a whole, real GDP growth is also estimated to be negative. An early containment of the COVID-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks."

(c)    There is scope for further cuts in rates. Most likely these cuts will be implemented in 2HFY21 as the outlook for inflation and growth becomes clear.

(d)   The Statement on Developmental and Regulatory Policies, the Monetary Policy Statement, 2020-21 Resolution of the Monetary Policy Committee and the Statement of the Governor, totally avoided any mention of the word "Fiscal". This makes it very clear that monetary policy function has chosen to overlook the fiscal digressions at present at least.

(e)    RBI is mindful of the stock markets digressing from the economic realities and surge in the prices of gold. However, RBI refrained from making any specific provision to control the excesses in stock and bullion markets. Rather, it has relaxed conditions for loans against gold when gold prices are ruling at highest levels. The central banker obviously does not want to rock any boat at this point in time.

(f)    RBI is actively managing liquidity and short term rates through various tools, and it seems to be enjoying the game. Expect this to continue for next few months at least.

(g)    The realization within RBI is growing that a large number of MSME and individual loans may be terminally sick. Setting of a Committee under chairmanship of K. V. Kamath, a vocal supporter of one-time restructuring of stressed loans indicates that there is virtual acceptance within RBI that these loans would need to be restructured. I guess, the only thing that remains to be decided is the modalities of restructuring and who takes how much hit. The complete omission of the term "Moratorium" from the statement explains the caginess of RBI on this issue.

To sum up, RBI has impregnated the markets with the twins - hope and caution. The morning sickness will keep bothering in coming days; and joy and bliss will keep it hopeful.

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.