Pro Weekender: The RBI’s stealth bazooka

Dear Reader,

What does an inflation-targeting central bank that wants to cut rates but cannot do so because headline inflation is way above its mandated limit do? It cuts rates by stealth, of course.

That is exactly what the Reserve Bank of India did on February 6, when it introduced LTROs (Long Term Repo Operations) for one year and three-year tenors for amounts up to a trillion rupees. The upshot: yields on two, three and even five-year bonds fell immediately.

At the time of writing this, the yield on three-year government bonds had fallen 25 basis points lower than their close on February 5. And since corporate bond yields are priced off sovereign yields, the cost of capital for the corporate sector will also come down.

As RBI governor Shaktikanta Das bragged, ‘Don’t discount the RBI.’ It may not have the big guns of Quantitative Easing or negative interest rates, but it has the LTRO bazooka.

The RBI’s move to direct credit to the auto and realty sectors, on the other hand, has been taken with a large dose of salt by the market -- the Nifty Auto and Realty indices barely moved.

Instead, the markets cheered the RBI decision to keep some bad real estate loans and dodgy advances to medium and small enterprises under the carpet, sending the Bank Nifty, especially the public sector bank index, soaring. Here’s the take of our independent research team on a badly mauled housing finance company.

The RBI has done what the Union Budget failed so spectacularly to do. For starters, it has recognised that the Indian economy is in a mess--recall that LTROs were used by the European Central Bank as a tool to fight the financial crisis.

The fact that the economy is in dire straits is brought out not just by the GDP numbers, but also by RBI’s own survey on consumer confidence in January 2020 and by the startling revelation that capacity utilisation in manufacturing in June-September 2019 was lower than during the Lehman crisis.

To be sure, the PMIs for January were at multi-year highs, a good sign, but remember that it’s a month-on-month yardstick and we’re coming off very low levels.

Will the RBI’s measures ease the credit crunch and help growth? The problem, as Gaurav Kapur, chief economist at IndusInd Bank points out, is that surplus liquidity in the banking system is already at levels last seen during demonetisation, which suggests lack of funds is not what is holding back lending.

The decision to extend and pretend about loans to real estate and medium and small businesses may also come back and bite the banks later. And in an environment where everyone is suspicious about the balance sheets of financial companies, does it make sense to shove some more skeletons under the carpet?

It did not take long for the disappointment with the Union Budget to evaporate in the markets, as they came roaring back, shrugging off all concerns. Global markets dismissed the impact of the coronavirus, secure in their belief that central banks would ease at the slightest tremor of nervousness.

The Chinese have shown the way, injecting billions of dollars into money markets to boost liquidity, while state-owned companies buy shares and banks are told not to call in loans.

We love hearing short-sellers squeal as much as anybody else, but have no option but to point out the glaring inconsistency between deteriorating credit conditions and equity market highs. We also mapped the likely outcome of the coronavirus on the global economy and markets, discreetly applauding that some investors have started hedging against tail risks.

With markets already having run up so far ahead of fundamentals, stock-picking is far from easy. This week, we advised investors to stick to a boring company and to a quality company ideally placed to gain market share in the current environment.

The failure of the ITI FPO is yet another indication that quality matters, apart from being a reassuring sign that the market hasn’t taken complete leave of its senses. As always, we told investors to stay away from a stock where the good news is priced in.

In other news, Citibank warned against euphoria in the markets, the Financial Times reported that junk bond issuance reached a monthly high in January, the Wall Street Journal asked the trillion-dollar question: ‘How Long Can Chinese Property Developers Go Without Sales?’

Let’s pray the central bank artillery works against coronavirus.

Cheers,