Opinion | The RBI sends out the wrong message
The RBI’s noble intentions have led to the decimation of crores worth of investor wealth in the BFSI sector
One of the sterling features of India’s equity market over the last two to three years has been the deepening of the equity cult. This was due to the tireless efforts of the mutual fund industry in reaching out to small investors across the country and convincing them to invest through systematic investment plans (SIPs). In an environment of heightened risk aversion towards emerging markets (EM) in general and particularly those EMs (India included) which have a twin deficit problem, the sharp rise in SIP inflows provided strong support to the equity markets.
This inflow has held steady at around ₹7,500 crore per month. The total number of SIP accounts has surged to 2.38 crore with an average SIP per account of ₹3,200 per month. This represents a true democratization of equity investing among India’s middle class. The inflows are in sharp contrast to foreign institutional investors’ (FII) outflows of around ₹57,000 crore in equities and ₹50,000 crore in debt since the start of 2018.
The Reserve Bank of India’s (RBI’s) recently announced monetary policy—specifically, the comments in its post-policy press conference—was the straw that broke an extremely nervous, fragile and battered banking, financial services and insurance sector’s back.
The primary responsibility of any central banking regulator like the RBI is to ensure macro-financial stability and throttle any attempts to destabilize the markets by forces inimical to the economy’s well-being.
After the sharp plunge in the rupee since the start of 2018, market participants were eagerly expecting the RBI to send unambiguous signals to investors (and particularly FIIs) that a free fall in the currency market from here on would be arrested. RBI’s blasé attitude in its presser—that it would be comfortable in tamping down aggregate demand by allowing a ‘terms of trade’ shock to filter through the economy by letting the rupee depreciate—has sent shockwaves through the forex market. This is the deepest and most influential market and its impact looms large over other asset markets like debt and equity.
The necessity to stem large FII outflows must be seen in the context of a robust US economy with a record-low unemployment rate necessitating a sharp rise in the US Federal Reserve funds rate and the unwinding of its quantitative easing program. With increasing interest rate differential between the US and India, the danger of massive unwinding of carry trades and exodus towards a risk-free safe haven of US debt markets is being under-appreciated by the RBI.
If the trickle of FII debt outflows turns into a torrent, the Indian economy will suffer a devastating blow. India’s fast rising current account deficit (CAD) in FY18-19 is unlikely to be covered by its capital account surplus in these skittish times.
Many FII equity investors would have started nibbling at Indian equities after a large dollar-denominated drawdown since the start of 2018. A necessary precondition for such a stance was a signal from the RBI that it would not leave the rupee vulnerable to further ferocious speculative assaults. After the muddled monetary policy, even this constituency will wait for a better entry point into Indian equities at substantially lower rupee value.
The non-banking financial company sector (NBFC) was already wobbling in the wake of defaults by IL&FS and heightened trust deficit among various market participants due to evaporation of liquidity in many ‘high-quality’ corporate credit papers. The bitter medicine sought to be administered by RBI mandarins in their presser was unexceptionable. The need for NBFCs to avoid asset and liability management mismatches by relying more on long-term sources of funding including equity capital, while reducing their dependence on short term money market instruments, is an apt prescription.
However, there is a time and place to deliver such a bitter dose. A comatose patient lying in an intensive care unit needs to be resuscitated and stabilized before being preached on the steps he needs to take for his overall well-being. By reading the riot act when the sector is in deep distress with a run on share prices, the RBI simply added fuel to the fire. What they should have done was to attempt to bring about a semblance of sanity among investors in the sector.
Before engineering tremors in the vulnerable NBFC sector, many private sector banks had to endure the RBI’s wrath. Although the issues flagged by the RBI in all the instances were strictly in adherence to the letter and spirit of the law, what led to the violent market erosion in these stocks was disbelief at the indelicate and heavy-handed handling of the issue by the regulator.
Could the chairmen of these banks not be invited and suitable orders given to make amends rather than scaring the market with terse communications? As highly leveraged entities that are repositories of faith among millions of depositors, banks are especially vulnerable to rumour-mongering. This makes it all the more important for the regulator to exercise caution.
To restore calm and credibility, RBI needs to heed astrobiologist David Grinspoon’s advice ‘There is a real danger of unintended consequences, of encouraging people to give up. Pessimism, if it becomes a habit, can reinforce a narrative of unstoppable decline. If there is nothing we can do, that releases us from our obligations”.
Ajay Bodke is chief executive officer (portfolio management services), Prabhudas Lilladher.