The RBI in its recent MPC meeting changed stance to neutral in line with the Flexible Inflation Targeting (FIT) framework. While the change of stance and rate action make the most headlines, we find more insights when we go through the Govt statement and the minutes of the meeting that is published after a couple of weeks.
Central banks across the world place a lot of importance on signaling upcoming changes to the markets. Given the kind tantrums markets have the tendency to throw, policy makers take pains to ensure that there are no surprises for the markets. History tells us that the market hates surprises, it doesn’t bother too much if an expected disaster unfolds. The market is a forward looking, discounting information that usually runs ahead of policy actions by 6-12 months. A cursory look at bond yield curve tells you that bond prices lead actual interest rate movements.
So what is the RBI signaling right now post the MPC meeting earlier this week?
That the RBI is comfortable with the current growth inflation dynamics. While a section of the market was anticipating rate action in this CY, the RBI has reiterated that it would rather wait for things to play in the global macro environment before committing to a clear course of action. US Fed action, geo politics in the Middle East & the upcoming US election will all provide greater clarity by the time the RBI meets again in December. The RBI does not foresee any challenges for FY25 growth, they are very confident that growth will pick up from Q2, given the slight pace of relaxation in Q1 due to the general election
The RBI wants to be doubly sure that domestic inflation will stay within the targeted band for the medium term before they pull the trigger on rates. The RBI does not want to appease growth markets at the risk of inflation rearing up again, they are prioritizing consistency of messaging and action rather than giving the market what it wants. The unsaid factor here could be that India is moving towards an era of more “handouts” compared to the past decade in response to political compulsions. While the RBI doesn’t have a say in such matters, it is expected to manage policy action after taking into account the monetary and fiscal situations. The silver lining here is that the current RBI Governor and the panel is on good terms with the Central Government, the RBI has one of the best track records at managing the COVID dislocation.
Regulatory action on lenders, more specifically NBFCs and HFCs could pick up. This is where it gets interesting. In the previous eras, India’s growth had to be funded by strong credit offtake. This resulted in many issues as banks were bonkers on retail lending in the 2002-07 era, followed by indiscriminate corporate lending post the 2008 GFC. NBFCs played their part in ensuring some or the other issue every 4-5 years, more recently in the 2018 crisis.
This time however has been different so far, with real GDP at 7%+ while credit growth is hardly crossing the 15% p.a. mark. The RBI is very clear in its thinking that it wants to proactively preempt bubbles before they become big. What started with an audit of processes and technology on credit cards went further with policy action on gold loans and unsecured retail lending. It does appear that the RBI would rather have a 10 year period of 7% p.a. GDP growth at credit growth of 13-15% p.a. rather than an aggressive growth era of GDP at 8%+ and credit growth at 20% p.a. Like we investors do, the RBI wants to prioritize the quality, longevity and sustainability of growth rather than giving growth markets what they want. This is a good policy in our opinion for the long run, even if one gets the feeling that more can be done for the medium term.
In this broad context, the RBI Governor has fired a salvo at some NBFCs and HFCs
“Excessive returns on equity”, “usurious interest rates”, “push effect”, “business targets driving growth”, “significant accretion to capital” – this is very strong language and tone by the regulator. The RBI would rather see hygienic NIM’s, conservative leverage, prudent equity dilution & hygienic growth rather than aggressive growth even if the market opportunity exists.
You can read the full text of the RBI Governor’s statement here
While we aren’t experts in financials or macro economics, our reading between the lines tells us that a few business models will come under pressure in the next 12 months. History tells us that the RBI has rarely given empty warnings over the past 5 years, once words are unleashed action usually follows soon.
If you have a high exposure to NBFC and HFC categories now, right now is a good time to think more in terms of balance sheet and risk underwriting quality rather than loan book growth. Incremental exposure to non banking lenders should be very nuanced and after understanding the underwriting culture at the organization. This might call for you to do qualitative work and go beyond a superficial analysis of growth rate, NPA’s and leverage. Pay special attention to lenders that have raised capital aggressively over the past 12 months and are giving guidance of 25%+ loan book growth for the next few years.