RBI’s dovishness delights stock market but risks lurk

File photo of Reserve Bank of India (RBI) Governor Shaktikanta Das (Source: PTI)

The Monetary Policy Committee’s persistence in supporting economic growth while its global peers look at increasing interest rates to tame inflation pleased the domestic stock market.

Weighed down by the possibility of aggressive interest rate hikes in developed economies this year, the domestic equity market had been under pressure recently. The Reserve Bank of India’s monetary policy on February 10 and the growth-oriented Union Budget before that helped alleviate some of that burden.

The MPC retained its status quo on the repo and reverse repo rates while reiterating its pledge to remain accommodative for “as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy.”

“I think it is a welcome surprise,” said a co-chief investment officer at a life insurance company who manages assets worth Rs 6,000 crore. “India’s story now seems to be completely different (from the rest of the world) if we take this policy as an indication.”

The central bank projected that India’s economy would grow 7.8 percent in 2022-23, lower than the Economic Survey’s estimate of 8-8.5 percent. Governor Shaktikanta Das attributed the lower growth estimate to vagaries of the base effect while stating that the underlying economic momentum was strong.

“The conducive financial conditions engendered by the RBI’s policy actions will provide impetus to investment activity,” Das said in his policy address.

The RBI’s surveys reveal that capacity utilisation is rising and the outlook on business and consumer confidence remains in optimistic territory, which should support investment and consumer demand, Das added.

Long-term costs

The central bank’s projection of retail inflation, in effect, moderating towards its long-term target of 4 percent in the second half of next year and its suggestion that a change in stance may preclude any rate increase, bred optimism among investors that interest rate hikes will be deferred to next year.

“The big surprise is the extremely dovish inflation guidance, which many would suggest may be somewhat of a gamble purely basis visible data. Essentially if these projections hold – a big ‘if’ – we can almost forget sharp repo rate hikes in FY23,” said Amit Tripathi, chief investment officer of fixed income at Nippon India Mutual Fund.

That’s positive for the equity market, which has been concerned about the impact of higher domestic and global interest rates in the future on capital flows and valuations. No surprise then that the Nifty 50 index jumped more than 150 points from the start of the governor’s address and ended 0.8 percent higher.

But could the short-term support entail long-term costs for the central bank and the economy?

“The call is to maintain the economic momentum by using the public balance sheet, but this is now coming at the cost of another public good – financial stability,” the co-chief investment officer at the life insurance company said.

Money managers highlighted the delay by the central bank in withdrawing support for an economy showing robust growth risks may force it to take action too aggressively later.

Further, with the US Federal Reserve likely to increase rates more than four times this year, the narrowing interest rate differential could accelerate capital flight from the Indian economy. The weakening of the rupee against the dollar reflects the currency market’s anxiety of a central bank increasingly falling behind the curve on policy normalisation.

Foreign investors have already withdrawn more than $15 billion from domestic equities in the past four and a half months, with only an equally high inflow from domestic investors providing support to the market.

While the equity market may rejoice that the RBI refused to board the global bandwagon of higher interest rates, it may find that joy to be short-lived amid rising external macro-economic risks.

“This suggests that the RBI is likely to remain behind the curve until macro circumstances warrant a shift of gears,” said Aurodeep Nandi, India economist at Nomura Securities India.

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