RBI’s policy has come and gone. Irrespective of the decision the policy was to have a very low impact on the markets and that is something that we will see over the next few days. RBI’s assessment of upside risk to inflation is unlikely to play out, however given the strong rally in Indian bonds contra to global yield movements the policy is a signal on RBI’s discomfort on bond yields. The positive has been the reversal of incremental CRR.
Central banks are in a unique position to justify any of their actions by picking out the data that supports it. We should see the current RBI Policy following the same trend. Post demonetization there has been a surge in banking sector liquidity, a decent part of it can be durable and that is something we will watch for going forward. Market interest rates, bank deposit rates etc all have come off significantly over the last 2-3 weeks. In this context whether RBI had cut or not would not have mattered anyways. Interest rates in any case are heading lower as further transmission takes place over the next few months. The reversal of the CRR which impounded Rs 3.5 lakh Crores is a positive which will help avoid market distortions grow further.
RBI’s stance on the impact of Demonetization on growth is that it will be transitory and the bounce back should be rapid. My view is the same and to that extent I would agree with their assessment although their assessment of near term slowdown seems to be more on the optimistic side as the near term impact has been significant given lower availability of replacement currency and its impact on consumption. However the bounce back will be rapid as cash replacement crosses 30-40%. As per RBI’s statement today Rs 4 Lakh Crores of new currency has come into the system. Once another Rs 2-3 Lakh crores is in we should see normalcy return very fast. I expect a V shaped recovery in 2017 and that is what the RBI seems to be betting on.
Banks are flush with liquidity and will now have no reason not to cut rates. When RBI started to cut rates more than two years back the constant refrain of banks was that liquidity is tight. Now liquidity is abundant and as such market transmission will happen automatically we did not need an RBI cut for that.
The more important events are happening globally where a huge shift to risky assets is happening. It started with allocation to US and Japanese Equities. It has now spread to Eurozone and it is a matter of time when we see Emerging Markets start to participate. A huge shift out of bonds to equities is likely to play out over the next 3-5 years globally. Its time for Indian Equity investors to look past transitory events and focus on what lies ahead. The last two years have seen the markets go nowhere. On 5th December 2014 Nifty was at 8500 levels, today two years later we are at 8100. Growth revival has got disrupted temporarily but the longer term outlook has improved. Equity Markets will soon start seeing ahead. The next two years will be exciting for sure.