Over the last few days, TV channels, newspapers and magazines have been filled with reports of the so-called power struggle at the RBI. This unexpected turn of events with the RBI and the government on opposite sides has played out many times in history. So, what is the big deal about this? Well, even though the relationship between these two is strained at times, the public nature of this latest spat has caught the eye of everybody. The central bank and the central government are usually never on the same side. This is because the central bank is an institution managing and executing the monetary policy, while the central government is an executive power dealing with day-to-day responsibility of managing the economy. But investors, who are rattled by this government versus RBI battle, need not worry. Investors don’t really lose in this battle. It may make for some great headlines, but nothing catastrophic will happen. Read on to know why.
There will always be disagreements between the RBI and the government about whether interest rates should be lower or not. Lower interest rates are business-friendly and also borrower-friendly. But the finance minister and the RBI governor have been in a war of words regarding the RBI’s autonomy for some days now. The latest flashpoint has been the concept of a payment regulator, which the government wants to keep out of the purview of the central bank. Many saw the government’s proposal of an independent regulator for Payment Banks as yet another attempt to clip the RBI’s wings. There can be arguments for and against the move from both the central bank and the central government side.
About two weeks ago, RBI deputy governor Viral Acharya warned the government of ‘wrath of financial markets’ if the independence of the central bank was curbed. Soon, FM Arun Jaitley blamed RBI for indiscriminate lending from 2008 to 2014. As things stand now, for the time first time in independent India, the government reportedly initiated consultations under the Section 7 (1) of RBI Act. The finance ministry also is understood to have written separate letters in the past few weeks to the RBI on issues ranging from Prompt Corrective Action (PCA) framework to liquidity management and sought consultation under Section 7 of the RBI Act. The government wants the RBI to carve out an exemption for power companies under the PCA framework that outlines triggers for declaring a loan account as stressed or NPA.
Although deputy governor Acharya used Argentina’s example as one where the government had undermined the autonomy of that central bank, India is not expected to see this happen. There are political reasons why this would not happen in India. The current regime is in its last lap, and is already in election mode, with state elections and then the biggie, Lok Sabha 2019 polls slated to happen in a matter of months. The government does not want to rock the economic boat now. So, while the government may get into a stand-off, matters will never escalate to a point where the RBI governor resigns. This fear is unfounded. But markets are driven by emotion. The stock market so far has shown remarkable resilience. Except for Raghuram Rajan, India has had few central bankers who spoke in the context outside monetary policies. Yes, it is rare for the RBI to express dissent publicly. But by speaking out, the RBI and the government have practically solved it on their own. When a spat becomes public, there is pressure on both sides to call it a truce.
The tussle between the government and the RBI about lending to small corporates and RBI’s handling of the NPA crisis is known. But, India has taken serious and credible steps to handle the crisis. Small corporates are risky business. And the bad loan situation in India is due to large corporates as well. Strong recognition of bad assets, a process started by Raghuram Rajan, has hurt the economy. But, both the RBI and the government have worked in tandem to make the Insolvency and Bankruptcy Code (IBC), the bankruptcy law of India that came into effect in 2016, a grand success. It has just a few successes so far, but they have been big ones — in Bhushan Steel and Electrosteel Steels the lenders put together have already recovered close to Rs 42000 crore. Consider Essar Steel and Binani Cements, the amount goes up. The government expects close to Rs 1.8 lakh crore through the IBC. So, both the RBI and the government know that working together brings demonstrable results.
Bears on the prowl
Even if one were to assume that the markets will crack due to the RBI versus government tussle, this will again help investors ultimately. For many months, stock markets have been trading above their long-term average valuations. It’s been a sticking point. Old and new investors have been speaking about how mid and small-cap stocks were getting highly valued, based on hope and a rush of money coming in. This situation is changing. Smallcaps, as a group, today are trading at 15-20 per cent lower valuations than they used to. The same holds true for midcaps. Most large-cap stocks have not borne the brunt of selling that much, even though the weak rupee, rising oil prices, fears of interest rate hike and slowing down of foreign flows after the US Federal Reserve’s rate hiking moves have happened.
If the RBI and government tussle actually lead to more trouble, in the short-term there will be volatility, which will drive stock prices further down. This is good for the long-term investor. Imagine being able to buy good and top quality stocks at a discount. We all know what happens when there is high volatility during such events. There is panic, but there is also the opportunity to buy stocks cheap. In the last two months, many such events happened that do not directly affect the stock market that much but have led to pricing mismatches. In October itself, the Nifty witnessed an 8.5 per cent fall as liquidity pressure continued to play out in the financial sector post last month’s ILFS (Infrastructure Leasing & Financial Services) default & DHFL CP sale at discount. Investors who took advantage of the opportunity have made money because the Nifty finally closed 5 per cent lower for the month (recovering from 8.5 per cent down levels). The government and the RBI have taken a raft of measures to boost liquidity conditions and this has helped the market sentiment.
While volatility is likely to continue, the corporate sector’s earnings health is good. There has been a pick up in earnings and that can balance other negatives and support market over medium to longer term. EPS estimates for Nifty Index (Bloomberg consensus) for FY19, FY20, and FY21 are Rs 575, Rs 692 and Rs 788, respectively. As per blended estimates, the index is currently trading at PE of 15.6 times 1 year forward. This is not in the expensive zone anymore. Valuations on growth portfolios have undoubtedly gotten cheaper. So if the current RBI versus government tussle at some point in future gets really ugly, markets will get to attractively cheap levels. So, long-term investors have nothing to worry about.
The author is a financial journalist with 13 years of experience