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The Street had stayed in vain hoping that some things from the '90s would not return to haunt it. That was a time monetary policy was dictated by currency management priorities.
Between December ‘97 and January ’98, soon after the Asian crisis, the CRR was hiked 150 basis points while the policy rate was raised 200 basis points to arrest rupee’s fall.
Fifteen years later, RBI has effectively done the same thing without touching CRR or policy rate – either out of compulsions to keep benchmark rates untouched or out of impression that more sophisticated tools are today at its disposal.
Interestingly, in both occasions the measures to harden rates were preceded by a beginning of a rate cut cycle to prop up falling growth amid signs of a comparatively more benign WPI number. One should now make a mental note of what happened post the policy potion of ‘90s.
The currency hardly moved, growth choked and RBI had to reverse the measures with extra dose of softening within 112 days.
It’s no different today. After keeping markets on easy money steroid for five years to tide over a crisis that was unprecedented in recent times, the US economy seems to be recovering. We all knew that 2013 would be dominated by Fed talk on pulling back loose money.
But when Big Ben finally spoke of tapering bond buying, risk-averse trades started and dollar gained. The rupee’s fall is part of this broader global strengthening of the dollar against all emerging currencies. There’s very little that RBI can do to reverse this, being just as helpless as it was in the ‘90s. You cannot fight global flows with local monetary policy.
Here, it’s important to monitor RBI’s action from the equity market perspective. At present valuations are polarized like never before – a sign of low investor confidence. The quality stocks with reasonable earning visibility are as or even more expensive than they were at the peak of the bull market, while the rest have never traded so cheap.
A brewing storm drives everyone to look for a stronger shade, no matter the price at which it comes. But these quality hideout stocks with significant weights in the benchmark index have limited upside, if not significant downside in the light of slowing economic growth.
On the other hand the high beta non-financial stocks constitute less than a tenth of the benchmark indices today compared to a quarter it used to command five years ago. The bitter truth, therefore, is that a rally in these high beta non-financial stocks is unlikely to lift the market.
The market will surge only if there is a sustained rally in high beta banks and financial stocks. And this can never happen till RBI rolls back its measure.
All this boils down to a simple question: when would RBI “roll back”? The stern measures are beginning to hurt the broader economy and bond market. One by one, banks are raising lending rates while most economists have cut growth forecast.
Even one quarter of tight money could be too long for an economy that’s struggling to find a bottom. At some point RBI will have to take a call, as it did in the nineties, on whether it makes sense to inflict more pain on broader economy to defend rupee. Chances are the wait may not be too long…
The author is Chief Investment Officer, AEGON Religare Life Insurance
