Nifty under stress on RBI regulatory tightening despite Gaza war pause

Ahead of the general election, RBI/Modi admin may officially restrict MFI/NBFCs to charging sky-high interest rates for priority sector lending

India’s benchmark stock index Nifty closed around 19794.70 Friday; slipped almost -0.04% for the day and almost -200 points from the multi-week high of 19875.25 scaled late Thursday. Overall Nifty inched up almost +0.32% for the week and +3.75% for the month on hopes of an early RBI rate cut (Feb’24) and a temporary pause of the Gaza war. Nifty recovered over +1000 points from the September low of 18837.85 on the easing of Gaza war tensions (from becoming a wider regional conflict involving Iran), progress of Gaza war ceasefire/pause negotiations, and hopes of Fed/RBI pause/pivot/early rate cuts.

As a recapitulation, on late Thursday (16^th November), Nifty stumbled from around 19875 after RBI unexpectedly decided to increase risk weight assets (RWA) on unsecured personal lending, consisting mainly of credit cards, personal loans, and LAP. RBI, to an extent, goes back to withdrawing the relaxation it had given in 2019 to boost consumer spending and the overall economic activities from the DEMO surgical strike, but a big impact now may be visible in the credit card segment.

On Wednesday (22^nd November), RBI Governor Das said in an event (FIBAS’23): Winning in Uncertain Times: The Indian Experience

·         Moderation in core inflation shows monetary policy working

·         Rupee movement consistent with underlying macro fundamentals

·         The rupee has exhibited low volatility, orderly movement

·         Need to take a balanced approach to financial, and price stability

·         Indian banks were ready for a change in the rate cycle

·         Fully mindful of risks to the banking system

·         Have to keep balance sheet resilient when rate cycle turns

·         MPC needs to be watchful, stance must be disinflationary

·         Our actions didn't endanger financial stability risks

·         Headline inflation remains vulnerable to food price shocks

·         Monetary policy prioritized inflation over growth for the last 1 year

·         Various steps have facilitated the softening of CPI inflation

·         Confident can work together to navigate the stormy weather

·         World grappling with unending challenges

·         Steady shift from consumer-oriented to tech-enabled services

·         The services sector remains the anchor of India's overall growth

·         Huge potential in areas such as aerospace, defense

·         Important for us to be part of global supply chains

·         The private sector needs to invest strategically in the agri sector

·         Opportunities for the private sector to invest in farm sector areas

·         Must find a way to carry out reforms in the farm sector

·         See farm sector stable despite uncertain monsoon

·         Can withstand shocks better on diversification of exports

·         Manufacturing firms optimistic of demand in Oct-Dec

·         Business outlook has improved

·         Jul-Sep earnings reflect improved health of banks, corporates

·         Have moved to an era of twin balance sheet advantage

·         Indian economy continues to grow on reliance on domestic demand

·         Indian economy recovered strongly from COVID-induced shocks

·         Central bank communication can steer inflation expectations

·         Mindful of other factors while focusing on the inflation target

·         We keep Arjuna's eye on inflation target

Relevant text of RBI Governor Das’s speech:

“The Conduct of Monetary Policy in the Year Gone By:

The monetary policy actions of the Reserve Bank over the last one and half years consisting of prioritization of inflation ahead of growth, narrowing the Liquidity Adjustment Facility (LAF) corridor, increasing the policy repo rate by 250 bps, draining out excess liquidity – together with supply-side measures by the Government – have facilitated significant softening of headline inflation to 4.9 percent in October 2023. The moderation in core inflation, in particular, is noteworthy.

There is also recent evidence of household inflation expectations becoming more anchored. Headline inflation, however, remains vulnerable to recurring and overlapping food price shocks coming from global factors and adverse weather events. The frequency and intensity of such shocks have increased in recent periods. Monetary policy in such a scenario needs to remain watchful and actively disinflationary while supporting growth.

I must add that our actions over the past one and a half years did not engender any financial stability risks as witnessed in some advanced economies in the early part of 2023. This may be attributed to the regulatory requirements prescribed by the Reserve Bank which banks are expected to follow to manage their interest rate risk. These requirements act as safeguards for future stress that may arise when the upturn of the interest rate cycle takes place.

On the exchange rate front, the Indian rupee (INR) has exhibited low volatility and orderly movements relative to peers despite elevated US treasury yields and a stronger US dollar. Movements in the INR are consistent with the strength of the underlying macro-fundamentals and the reassuring availability of buffers.

Growth Drivers and Opportunities

As many business leaders are present here, let me now dwell upon India’s growth drivers and the opportunities that lie ahead. The Indian economy rebounded strongly from the COVID-induced contraction of 5.8 percent in 2020-21 to a growth of 9.1 percent in 2021-22 and 7.2 percent in 2022-23.

India’s real GDP is expected to grow by 6.5 percent in both 2023-24 and 2024-25, making it one of the fastest-growing large economies in the world. India is already the third-largest economy in the world in terms of purchasing power parity (PPP). Despite the global slowdown, the Indian economy has remained resilient and continued to grow due to its higher reliance on domestic demand which enabled the economy to weather multiple global headwinds.

Although India has made rapid strides in external openness through trade and financial channels and gained competitiveness, its dependence on domestic demand provides a cushion against external shocks. At the same time, various structural reforms implemented in areas of banking, taxation, inflation management, and manufacturing sector, etc. over the last few years, have laid the foundation for sustainable and higher growth.

We have moved from an era of twin deficit and twin balance sheet stress to the current period of twin balance sheet advantage. While the balance sheets of banks witnessed significant improvement on the back of improved asset quality and profitability, corporates also display stronger financials, having deleveraged their balance sheets.

The improved health of the banks and corporates is also reflected in their recent second-quarter results of 2023-24. The corporate performance parameters based on 1501 listed non-government non-financial companies suggest strong growth in profitability and staff costs in Q2:2023-24. The Reserve Bank’s latest industrial outlook survey indicates that business outlook further improved with manufacturing firms being optimistic about demand conditions in Q3:2023-34.

Capacity utilization (CU) in the manufacturing sector, on a seasonally adjusted basis, continues to trend up, which augurs well for investment activity. The continued thrust on capex by the government is also favorable for investment activity. It is now for corporates and other businesses to evaluate the current situation and future potential of India and move forward.

On the supply side, the agriculture sector has kept good momentum over the last few years and its performance is expected to remain stable during 2023-24 despite uneven south-west monsoon and lower kharif production. Production of food grains as well as horticulture has reached record levels year after year. The diversification of exports, both in terms of products and destinations, is enhancing the economy’s capacity to withstand shocks. The agricultural sector continues to employ a large part of our workforce.

There are, however, several challenges relating to productivity gaps, water usage, irrigation facilities, shifting consumer preferences and sudden weather events. All these require heavy investments in infrastructure and innovation to modernize the agricultural sector and realise its true potential for achieving higher productivity; more efficient access to markets; maximizing farmers’ income; and increasing its contribution to GDP.

As a nation, we must find a way of carrying out certain reforms, especially in the area of agricultural marketing and the connected value chains. These reforms are critical not only for sustained high growth but also for durable price stability and mitigating the frequency and intensity of food price shocks. It is important that the private sector comes forward in a big way and becomes a crucial partner in this journey.

There are opportunities for the private sector to invest in strategic areas of agriculture and allied activities such as supply chains; food processing involving a variety of fruits, vegetables and food grains; scaling up dairy, poultry and fishing; and creating marketing infrastructure. The private sector can accelerate farm-firm (i.e., agri-industry) linkage and improve the efficiency of the entire value chain right up to the end customer.

As regards the manufacturing sector, even as its share in the economy has been around 17-18 percent over the years, it has the potential to accelerate its contribution to growth and employment. India’s demographic advantage with its young labor force also presents a unique opportunity to become a key player in global manufacturing. We need to be part of the global supply chains that are undergoing realignments in the fragmented global economy.

Initiatives like the production-linked incentive (PLI) scheme create conducive conditions to enhance the share of manufacturing in our GDP. Sectors such as smartphones, large-scale electronics, pharma, food processing, auto and auto components have recorded good performance under the PLI scheme. There is also huge potential in emerging areas such as aerospace and defense, low-carbon technologies, electric vehicles and semiconductors. Our efforts towards building robust public digital infrastructure, which is fostering digitization and ease of doing transactions across the spectrum, will continue to provide a strong fillip to technology adoption and productivity.

At present, the services sector contributes the largest share of India’s GDP and remains an anchor of overall growth. The Indian services sector is fast adopting new technologies such as artificial intelligence, the Internet of Things, cloud computing and data analytics to improve service delivery, reach, and competitiveness. The newly emerging start-ups are also largely concentrated in the services sector. There is a steady shift from low-skill consumer-oriented services towards more technology-enabled business services. Indeed, there is a case for Indian businesses to recognize this undercurrent and work towards upscaling their activities to meet the external demand in this sector.

India commands a strong external position, thanks to the strength of our services exports, which have largely remained resilient. They have supported India’s current account deficit, even as merchandise exports have been under pressure in the face of weakening global demand. The current account deficit to GDP ratio has remained under 2 percent for almost 10 years. India’s services exports are diversifying from information technology (IT) related services to other professional services such as business development, research and development, professional management, accountancy and legal services.

Overall, India’s growth journey with active participation of manufacturing and services sectors and dependence on domestic demand could be self-fulfilling in the years to come.

Some Reflections on Financial Sector Issues

On our part, the Reserve Bank of India has significantly strengthened its regulation and supervision of banks, NBFCs and other regulated entities in recent years. We have also very recently announced a few macro-prudential measures in the overall interest of sustainability. These measures are pre-emptive in nature. They are calibrated and targeted. It may be relevant to note that major growth drivers like loans for housing, vehicles, and the MSME sector have been excluded from these measures.

We continue to focus on strengthening governance and assurance functions, ensuring effective risk management and robust lending practices. We are monitoring the supervised entities through various onsite and off-site tools, stress testing, vulnerability assessments, thematic studies, data dump analysis, etc. as part of our proactive and forward-looking supervisory approach. Banks, NBFCs, and other financial entities must continue to do stress testing of their books. There is a strong case for companies in the real sector to stress test their businesses and balance sheets. Many of them may already be doing so, but it would be desirable that many more also do this.

At the current juncture there may not be any immediate cause for worry, but to remain on top of things, Banks and NBFCs would be well advised to take certain precautionary measures. In this context, I would like to highlight four points.

First, while credit growth is accelerating in the current period, banks and NBFCs may take due care to ensure that credit growth at the overall, sectoral, and sub-sectoral levels remains sustainable and all forms of exuberance are avoided. Expansion of the credit portfolio itself and pricing of the same should be in sync with the risks envisaged.

Banks and NBFCs also need to further strengthen their asset liability management. They may give greater attention to their liabilities side. In certain cases, we have observed increased reliance on high-cost short-term bulk deposits while the tenure of the loans, both in retail and corporate loans, is getting elongated.

Second, given the increasing importance of non-bank financial companies (NBFCs) in the financial system; the increasing interconnectedness between banks and non-banks merits close attention. NBFCs are large net borrowers of funds from the financial system, with their exposure from the banks being the highest. Banks are also one of the key subscribers to the debentures and commercial papers issued by NBFCs. NBFCs also maintain borrowing relationships with multiple banks simultaneously. Needless to say, such concentrated linkages may create a contagion risk.

Though the banks are well-capitalized, they must constantly evaluate their exposure to NBFCs and the exposure of individual NBFCs to multiple banks. The NBFCs on their part should focus on broad basing their funding sources and reducing over-dependence on bank funding.

Third, microfinance has emerged as an important financial conduit to foster financial inclusion. As Micro Finance Institutions (MFIs) are catering to the marginalized clientele, they have to bear in mind the affordability and repayment capacity of the borrowers. Though the interest rates are deregulated, certain NBFCs-MFIs appear to be enjoying relatively higher net interest margins. It is indeed for microfinance lenders to ensure that the flexibility provided to them in setting interest rates is used judiciously. They are expected to ensure that interest rates are transparent and not usurious.

Let me now turn to the financial sector. As the Indian economy strives to grow in an evolving and uncertain global environment, our financial sector must remain strong. The Indian banking system continues to be resilient, backed by improved capital ratios, asset quality and robust earnings growth.

The financial indicators of non-banking financial companies (NBFCs) are also in line with that of the banking system as per the latest available data. While banks and NBFCs are showing good performance now, sustaining it requires concerted efforts. In good times like these, banks and NBFCs need to reflect and introspect as to where potential risks could originate. Now is the time for them to further strengthen their risk management practices and build additional buffers to face the situation, if the business cycle turns adverse.

Fourth, the increased collaboration of Banks and NBFCs with FinTechs is facilitating the introduction of innovative products and services and new business models. Digital technologies are offering a powerful medium to access banking and financial services. This has also brought down operational costs and helped in enhancing the reach of financial services providers.

An important aspect that merits attention in this context is model-based lending through analytics. Banks and NBFCs need to be careful in relying solely on pre-set algorithms as assumptions based on which the models are operated. These models should be robust and tested and re-tested periodically. They may require to be calibrated and re-calibrated from time to time based on the changing contours of the financial ecosystem and fresh information. It is necessary to be watchful of any undue risk build-up in the system due to information gaps in these models, which may cause dilution of underwriting standards.

Concluding Observations

We are living in highly uncertain times in an interconnected world. New risks are emerging from time to time. New sources of risk are also coming up. In such a scenario, building up further on resilience would be the best insurance against shocks and uncertainties. This holds good for all businesses and financial entities.

As I see many banking and corporate leaders in the audience, let me also stress that new opportunities are knocking at our doors. It is for us to capitalize on them. There has to greater focus on investment in capacity building, skilling of human resources, and adoption of newer technology by all players. The international confidence in India’s prospects is at a new high; it is an opportune time to make this India’s moment and work towards strong, sustainable and inclusive growth.”

RBI may officially restrict MFIs and NBFCs from charging sky-high interest rates for priority sector loans:

Overall, RBI is not so much concerned about India’s core inflation, and real economic growth trajectory, but quite concerned about fast-growing unsecured retail lending by Banks & financials (NDFCs). Thus as a precautionary measure, RWAs have increased RWAs by an average of +25% on unsecured retail lending consisting mainly of credit cards, personal loans, and LAP. RBI, to an extent, goes back to withdrawing the relaxation it had given in 2019. In Sep’19, RBI reduced RWA's requirement on unsecured retail lending by -25% (from 125% to 100%) to boost consumer spending.

RBI is now also quite concerned about various NBFCs, which are over-dependent on bank finances and banks also have significant investment/equity exposure. Now, if any NBFC goes burst, it may have a spillover/domino effect in the banking industry. Thus RBI urging NBFCs to be less dependent on Bank finances and raise capital of their own.

RBI also cautioned MFIs not to charge exorbitant/sky-high interest rates to borrowers, especially to marginalized sections of the society/poor villagers, who have usually no other option of easy credit except MFIs and private money lenders/sharks. Although as a regulator, still now RBI not in a position to officially prevent such MFIs from applying exorbitant double-digit rates of interest to poor and marginalized sections of the society (most of them are farmers), RBI/Government/Modi admin is reacting to recent SRK blockbuster movie ‘Jawan’ amid various state elections in big/important states like MP, RJ, Telangana and Chhattisgarh and also ahead of the early 2024 general election.

RBI may also officially restrict Banks, NBFCs, and MFIs from charging sky-high interest rates for priority sector loans such as farm/agricultural and SME loans in its Dec’23/Feb’24 monetary policy, ahead of the April-May ’24 general election. But at the same time, RBI may also cut rates in Feb’24 to boost up Dalal Street as well as Real Street ahead of the Aprril-May’24 general election as India’s core inflation is now moving around +4.0% targets, while there is some output gap; i.e. economy may have the potential to run around +8.00% real GDP growths on an average rather than +6.00%.

Although RBI is maintaining a hawkish stance on inflation, RBI has done its job by hiking the interest/repo rate to +6.50%; now at around +4.00% core CPI, the real rate is around +2.50%, at the upper side of RBI’s preferred restrictive zone of 1.50-2.50%. Thus, if India’s core CPI stays around +4.00% in the coming days, and the Fed goes for rate cuts from June/Sep’24, RBI may also cut rates cumulatively by -1.00% in 2024 (@-0.25% in each quarter) to promote economic growths.

RBI appreciated various government steps to improve supply chain bottlenecks in the last few months, which along with RBI’s rate hiking action (affecting demand to some extent), helped India’s core inflation to dip towards +4.00% targets. Also, lower global oil prices helped amid slowing China, subdued global demand on the chorus of EV transition and higher supplies by the U.S., Brazil, Iran and some other OPEC+ producers. But RBI also pointed out India’s subdued productivity in key areas like agriculture, and the manufacturing sector.

India is now approaching a huge population of almost 1.50B, surpassing even China. Despite being the 5^th largest economy in the world in terms of nominal GDP in Dec’22 ($3.4T) and most probably be able to scale the $4T mark and 4^th position by Dec’23, in terms of GDP/Capita, India is lowest among G20 economies/countries, simply because of its huge population. It’s also a fact that due to the huge population and no control over Child birth policy, demand is always far above supply in India, resulting in both high inflation and high growth. 

But to cope with higher demand, the Indian economy has to grow at least +8.00% in real terms (if not +10.00%) to ensure proper price stability and quality employment. India has to also create/produce foods in adequate quantities to ensure food price stability for the general public and thus needs higher productivity in the agriculture/farm sector. India also needs a quantum jump in public transportation infra, especially in railways (both normal/slow and high-speed railways) and also social infra like quality hospitals and schools to cater to its huge population. Despite there being a huge difference/gap between India and China (democracy & autocracy), India needs to compete/follow the Chinese model in public infra and agriculture with a feasible PPP model.

Although India should have followed China's population control model (structural reform) from at least 1975, the reality of Democracy may not allow such policy, at least officially; otherwise who will fill up huge grounds in political/election rallies and who will ensure assured/block voting box? In any way, most of the middle/lower middle-class families now prefer a child policy, considering the higher cost of living. But still, to cater to the huge population demand, India needs to grow at least +8.00% in real terms for the next 15 years to ensure proper price stability and quality employment.

Thus RBI will ensure lower borrowing costs to fund both public/government and private capex at affordable borrowing costs, ensuring price & financial stability. India is now already paying around 45% of its revenue as interest on public debt, which is a huge negative for its credit rating (despite negligible external borrowing in FX currency). India has also a huge scope to grow exponentially to improve its public and social infra in comparison to its neighbor and arch-rival China. Also, India has political, policy and currency stability unlike most of the comparable big/small democracies.

Bottom line:

In any way, if RBI indeed goes for interest rate restriction for MFI/NBFCs and rate cuts, it may be negative for banks & financials, at least initially due to lower NIM.

Market wrap:

Overall Nifty inched up almost +0.32% for the week and +3.75% for the month (till today) on hopes of an early RBI rate cut (Feb’24) and a temporary/extended pause of the Gaza war. Nifty was boosted by HDFC Bank, ICICI Bank, Axis Bank (comparatively lower exposure in unsecured retail lending), RIL, Bharti Airtel, Bajaj Auto, and Hero Motor (upbeat Festival sales and no effect of RBI tightening on car/2W loans), while dragged by L&T, Bajaj Finance (RBI regulatory tightening), TCS, Kotak Bank, ONGC, Coal India, Cipla and Ultra Cement. For the week, the Indian market was boosted by realty, metal, pharma, energy, automobiles, selected private banks, media, and infra stocks, while dragged by PSU banks, techs, and FMCG stocks.

Technical trading levels: Nifty Future

Whatever may be the narrative, technically Nifty Future (19803) now has to sustain over 20100 for a further rally to 20200/20300 levels in the coming days; otherwise sustaining below 20050/20000-19950/19900, Nifty Future may again fall to 19700/19600-19500/19380 and 19300/19150-19050/18950 and 18830/18750-18625/18490-18275/18075 in the coming days.

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