The Sensex and Nifty are up by over 0.5% post RBI policy on the 3rd of June. RBI has not done much for equities in the policy but the market is trending up towards record high close. Why is the policy bullish for equities?
RBI cut SLR (Statutory Liquidity Ratio) of banks by 50bps from 23% of NDTL (Net Demand and Time Liabilities) to 22.5% of NDTL in its bi monthly policy on the 3rd of June 2014. The SLR cut is largely to enable banks to provide more credit to the economy and will free up around Rs 350 billion of liquidity.
Banks typically earn more spreads by lending to the economy rather than buying government bonds and a SLR cut is seen as positive for banks profitability. However it must be noted that lending carries credit risk and with bad loans plus restructured assets at over 10% of total advances, banks credit risk appetite is low.
The equity rally is more towards what RBI said in its policy review. GDP growth for fiscal 2014-15 is forecast at around 5.5% against growth of 4.7% seen in fiscal 2013-14. Inflation as measured by the CPI (Consumer Price Index) is expected to trend towards RBI forecasts of 8% and 6% by end of this and next fiscal years. Core CPI has moderated and this is positive for maintaining repo rates at 8% for a while to come.
RBI believes that a stable government at the centre will control subsidies, allow pass through of fuel prices to the end user and also bring about fiscal consolidation. All these measures are positive for inflation as it rationalizes demand.
Fiscal consolidation helps lower interest rates in the economy, as government borrowing does not crowd out private sector funding. Lower interest rates are positive for improving investment and consumption demand and this filters down to higher sales for the corporate sector.
Government bond yields have trended down post policy by around 5bps, as the market believes that the budget will show a fiscally prudent government. The budget is to be presented in July by the FM, Arun Jaitley.
Equity markets will look forward to a more responsive government towards the economy even as RBI does it bit to control inflation expectations. Hence the equity rally will continue on expectations that the economy will have a firm footing going forward.
RBI is not likely to have any surprises for the market given that the INR is stable after rallying by 15% from lows. The central bank has also mentioned that it is open to lowering rates if inflation falls faster than expected.