Nifty jumped to a 5-month high on US debt deal optimism but slips on RBI concern

RBI raised corporate governance concerns and smart/innovative accounting methods being employed by some banks to hide NPA and ever-green stressed assets

India’s benchmark stock index Nifty made a 5-month high around 18640.35 and closed around 18598.65 Monday (30^th May), surging +0.54% on U.S. debt deal optimism. After days of political squabbling and lingering uncertainty, the Biden admin reached the debt deal on principle with House Republicans late Saturday by cutting some deficit spending. The US will be on a holiday Monday and thus Congress is aiming to prepare the legislative text by Wednesday so that it could be passed by both houses of Congress before reaching President Biden’s table for final signature by Saturday (3^rd May), well before the latest X-date (doomsday) of 5^th May, set by Treasury Secretary Yellen.

But on Monday (29^th May), Nifty Future also stumbled from the opening session high of around 18740 to 18667 after RBI Governor Das raised some corporate governance innovative/smart accounting concerns about certain banks to ever-green stressed assets in a prepared speech (Governance in Banks: Driving Sustainable Growth and Stability):

·         Over the years and especially in recent periods, Banks have been able to maintain financial and operational resilience in the face of extreme stress originating from the COVID-19 pandemic, the continuing war in Europe, and the banking sector crisis in certain advanced economies (AEs)

·         Today our banking sector stands out as strong and stable with CRAR at 16.1 percent, Gross NPA at 4.41 percent, Net NPA at 1.16 percent, and Provision Coverage Ratio at 73.20 percent at the end of December 2022

·         It is in times such as these that complacency may set in. We have to bear in mind that risks often get overlooked or forgotten when things are going well. Therefore, Boards of Directors of Banks and their senior management should maintain a constant vigil on external risks and build-up of internal vulnerabilities, if any

·         In the last few years, the Reserve Bank has significantly strengthened the regulation and supervision of the entire financial sector. We have issued guidelines on governance in banks and also rationalized the regulatory architecture for Banks, NBFCs (including MFIs) and UCBs

·         Our supervisory approach and methods have become much stronger and deeper. Our priority is the protection of depositors’ money and ensuring a robust financial sector for the country to progress

·         As you are aware, banks do their business primarily with depositors’ money and it is, therefore, the responsibility of Boards of Directors and Management of Banks to keep the interest of depositors uppermost in their mind

·         The RBI has come across gaps in the governance of certain banks, with the potential to cause some degree of volatility in the banking sector

·         Necessary that boards & management do not allow such gaps to creep in

·         Risks often get overlooked or forgotten when things are going well

·         Priority is the protection of depositors’ money & ensuring a robust financial sector

·         The business models of Banks are expected to be robust and prudent

·         The recent developments in the banking sector in the USA bear ample testimony to this. These developments in the USA have also demonstrated that aggressive growth strategies with disproportionate or excessive focus on the bottom lines and/or market capitalization often lead to the building up of vulnerabilities

·         Banks should exercise caution and prudence in their growth strategies, pricing of products, and portfolio composition

·         Over-aggressive growth, under-pricing or over-pricing of products both on the credit and deposit sides, concentration or lack of adequate diversification in deposit/credit profile can expose the banks to higher risks and vulnerabilities

·         From time to time, the Reserve Bank has engaged with certain banks on the need to make suitable adjustments in their business strategies where it was observed that over-aggressive growth in certain business segments (be it in credit/deposits) was creating avoidable vulnerabilities

·         Problems or risks can come from one corner of the balance sheet which might appear insignificant in the beginning

·         Let me emphatically state that the Reserve Bank does not interfere in the commercial decision-making of the banks, but only gives them a nudge to address potential risks and vulnerabilities. It is expected of banks that they put in place robust risk management policies and practices to address the risks associated with their business model/strategy

·         One of the critical areas where the role of Directors is very significant is in ensuring the integrity of financial statements published by the bank. We have come across instances where so-called smart accounting methods were adopted to artificially boost the financial performance of the bank

·         During our supervisory process, certain instances of using innovative ways to conceal the real status of stressed loans have also come to our notice

·         To mention a few, such methods include bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments; good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress; use of Internal or Office accounts to adjust borrower's repayment obligations; renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans; and similar other methods

·         We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, was replaced by another method. Such practices beg the question as to whose interest such smart methods serve. I have mentioned these instances to sensitize all of you to keep a watch on such practices

·         The Board of Directors, especially the Audit Committee of the Board (ACB), should bestow close attention on the accounting policies followed by the banks and implement preventive controls to preclude smart or aggressive accounting practices. The Board or the ACB should engage with the Statutory Central Auditors of the bank to ensure that their financial reporting is transparent and prudent

·         Let me now conclude. On behalf of the Reserve Bank, I have enumerated a 10-point charter in my address today. The safety and soundness of the banking system rely critically on effective corporate governance which helps to build an environment of trust, long-term stability, and business integrity in banks

·         Governance frameworks can be pictured as a complex mesh of nuts and bolts holding the financial pillars of capital, assets, deposits, and investments in place and keeping the structure of the bank upright

·         Raising financial resources would not be a constraint for banks with robust governance frameworks as they can command a governance premium. This premium in turn will be driven by the quality of leadership at the top

·         As a Regulator and Supervisor, the Reserve Bank has taken several measures to ensure sound corporate governance in banks

·         The Banks themselves have taken steps to face the recent headwinds and exhibited remarkable resilience

·          The leadership and governance in banks have played a vital role in the nation’s journey so far and we believe that together we can drive growth that is sustainable and a financial system that is resilient, stable, and inclusive

On Monday (29^th May), Nifty was boosted by HDFC duo, ITC, RIL, M&M, SBIN, Titan, and Tata Steel, while dragged by ONGC, ICICI Bank, HCL Tech, Maruti, Infy, and TCS. HDFC surged as market regulator SEBI granted final approval for the proposed change in control of HDFC Capital Advisers in its capacity as an investment manager of the HCARE Funds and investment manager cum sponsor of HDFC Build Tech Fund. Further, there was another report indicating that HDFC may sell its education loan arm Credila to Baring EQT fund by around $1.5B for 90% of the stake and the remaining 10% may be sold in tranches over 2 years. An official announcement is expected by June end, ahead of the mega-merger between HDFC Bank and HDFC to create the world’s 4^th largest bank.

RIL was boosted by consumer business optimism and analyst upgrades. Reliance Consumer Product, the FMCG arm of the company, partnered with U.S.-based General Mills to launch the international corn chip snacks brand Alan’s Bugles in India. Reliance’s Jio Cinema app is now also upgrading itself like Netflix/Amazon Prime video streaming services with quality and quantity of web series and movies.

In May, Nifty was also boosted by the Adani group of stocks after SC appointed committee said in a preliminary report that prima-facie there was no regulatory failure in the Adani-Hindenburg report. But some entities have taken short positions before the publication of the Hindenburg report and profited from those positions as prices crashed after the report. Overall, the report is a great relief for Adani, but it’s not a clean chit for the group.

Adani stocks were also boosted as GQG Partners' Rajiv Jain, a veteran influential investor raises Adani's stake by about 10% for $3.5B. As a reminder, in March’23, GQG acquired almost $2B worth of shares in four of Adani’s firms from a family trust (after Adani stocks tumbled on the Hindenburg report). Jain termed Adani stocks as ‘the best infrastructure assets available in India’. Jain said: “Within five years, we would like to be one of the largest investors in the Adani Group depending on the valuation, (after the family). We would certainly want to be partners in any of Adani Group’s new offerings”.

In the last 30 days, the Indian market was boosted by automobiles, realty, techs/ITs, FMCG, Energy, banks & financials, metals, and media. Nifty was also boosted by techs/ITs on higher USDINR and as Nasdaq scaled a 52-week high amid generative AI/Nvidia AI chip optimism Techs were also boosted as global rating agency S&P upgraded India’s export-heavy tech sector.

The S&P Global said:

·         Our rated Indian IT companies have good defenses against downside risks

·         That's thanks to their strong balance sheets, high recurring cash flows, and history of good strategy execution

·         A low-cost workforce is an additional advantage

India/RBI virtually demonetized 2000/- currency note:

In May, India’s Dalal Street was also boosted as RBI virtually demonetized the 2000/- currency note Friday evening (19^th May). RBI has given almost a 4-month time frame (from 23^rd May to 30^th September 23) to the general public to deposit or exchange 2000/- currency notes systematically (without creating 2016 DEMO-like chaos) and may officially declare 2000/- currency note as an invalid legal tender after 30^th September’23. Presently, around Rs.3.62T is estimated with public circulation, and most of it (almost 85%) may be hoarded by black/unaccounted/corrupted money holders.

The market is now expecting the return of a significant part of Rs.3.62T ‘black money’ (informal economy) to the banking system (formal economy) and further boost up the high-value discretionary consumer spending/economy/GDP. After the 2000/- withdrawal announcement Friday, there are reports of a sudden surge of 2000/- notes in petrol pumps, where the public is buying even 200/- worth of petrol with 2000/- as no KYC is required in such cases of exchange.

Overall, although it may not be another surgical strike against black money it’s another master stroke by Modi admin, as a recent deluge of ED/CBI raids on various high corruption cases revealed big cash seizure in 2000/- currency note. Also, various political parties have unaccounted/black money in 2000/- notes, which may turn invalid soon (before various state elections and also the early 2024 general election). But as the Indian consumption story is still largely dependent on black money (even after the 2016 DEMO), the present move to effectively demonetize the 2000/- note may also negatively affect India’s high-value discretionary consumer spending.

On Monday (22^nd May), banks & financials were in red as banks may now face higher deposit (inflow) like during 2016 DEMO days, which may result in asset-liability mismatch and lower NIM as banks may not extend correspondingly higher loans to borrowers due to tighter credit norms and the concern of higher NPA. On Monday,

Overall, Nifty jumped almost +3% in May on positive global & local cues. Wall Street was boosted by less hawkish Fed talks, and fading concern of regional bank crisis, while dragged by limited progress of U.S. debt deal talks. India’s Dalal Street was also boosted by an easing of inflation, hopes of an RBI pause in June, and an upbeat report card for Q4FY23 while also dragged by index heavyweights HDFC duo and RIL in early May.

HDFC Bank and HDFC tumbled after MSCI stated it would include the merged entity of the two companies into its large-cap index with an adjustment of 0.5 instead of market expectations of 1, driving market players to estimate an outflow of $150M from the firms. Also, the HDFC duo turned ex-dividend. Another index heavyweight RIL stumbled as the EU may impose sanctions/some adverse actions on RIL’s refined products exported to the EU, which are being sourced from ‘dirty’ Russian oil. But Nifty was also boosted by other banks & financials and Bank Nifty also made a new lifetime high.

Dow Future made a recent low around 32600 on lingering uncertainty about the US debt limit and hawkish Fed talks. But Dow Future closed around 33150 Friday on hopes of an imminent US debt deal. As the debt deal uncertainty is now over, Dow Future may further rally to around 33650 and further 34375 levels by Friday (2^nd June). Accordingly SGX Nifty Future may also scale 19050-150 levels (lifetime high) on positive global cues by May 2-5.

Technical View: SGX Nifty Future (18683 CMP)

Looking ahead, whatever may be the narrative, technically SGX Nifty Future now has to sustain over 18600 for a further rally to 18750*/18850-19050/19175* in the coming days (Bullish side).

On the flip side, sustaining below 18500-400, SGX Nifty future may again fall to 18300/225-18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (bear case scenario).

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