Dr Rajan's Successor Must Not Undo This - The 5 Minute WrapUp by Equitymaster
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Dr Rajan's Successor Must Not Undo This

Jun 29, 2016

In this issue:
» A Lowdown on Sensex performance till now
» Mark Mobius' thoughts on the Brexit impact
» Market roundup
» ...and more!
Madhu Gupta, Research analyst

Humans tend to oversimplify things.

Reserve Bank of India governor Dr Raghuram Rajan got a taste of it when he faced flak for keeping interest rates high for too long. The grouse was that the high rates stifled industry credit demand.

But nothing could be further from truth.

Historically, credit demand is seldom impacted by interest rates alone.

Bank credit yet to gain momentum

In fact, just before the global financial crisis of 2008, credit growth was robust at above 25% despite repo rates hovering over 7%. But as the RBI lowered the repo rates in the aftermath of the crisis, the pace of credit offtake slipped below 20%.

The simple reason for the divergence was that the economy had been growing more than 9% for three consecutive years until FY08. This precipitated in the form of strong credit demand during this period. As the economy faltered thereafter, credit growth tempered along with it.

In other words, credit growth is a direct function of economic growth and business confidence. While the lower cost of funds can be instrumental in the fundraising process, it cannot replace actual demand, which comes only when the economy is up and running.

But India Inc does not seem to be in the pink of health presently. The capacity utilisation of large firms was 72.5% at the end of the December 2015 quarter. That's much lower than the peak of 78% just two years ago. A large number of projects have been stuck by the demand slowdown and delay in regulatory clearances.

Resultantly, a number of the companies operating in the infrastructure sector have piled a lot of debt on their books. As these loans run the risk of turning bad, public sector banks have been caught off guard. Faced with depleted earnings from higher provisioning and lower capital bandwidth, state-run banks have become wary of lending to the infrastructure projects.

It is amply clear that private investments will be hard to come by in the immediate future. Also, the likelihood of big rate cuts by public sector banks grappling with weak balance sheets is low.

So the hard reality is that interest rate cuts alone cannot kick start the investment cycle.

Vivek Kaul debunked the theory of high interest rates in his latest article:

  • What all this tells us very clearly is that when it comes to the retail segment, public sector banks are lending as much as they can. This refutes Mitra's point where he said that the middle class isn't borrowing and spending because of high interest rates. If middle class wasn't borrowing and spending, retail lending wouldn't have grown by close to 20%, in the last one year.

    In fact, credit card outstanding of banks has grown by 31.2% in the last one year, after growing by 22.9% between April 2014 and April 2015. So, I have really no clue as to what is Mitra talking about. Vehicle loans have grown by 19.7% against 15.4% earlier. Guess, it's time he opened a few excel sheets before just mindlessly commenting on things.

Instead of blankly targeting the symptom of weak credit growth, Raghuram Rajan, seasoned economist that he is, consistently trained his guns on the underlying malaise of inflation. And his constant efforts have borne fruit with real interest rates turning positive for the first time since 2008.

This augurs well for household savings and investments that will finally aid the funding needs of India Inc in the long run. Dr Rajan's successor should not undo this.

Do you think Raghuram Rajan's inflation taming strategy will aid in economic revival? Let us know your comments or share your views in the Equitymaster Club.

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02:31 Chart of the day

2016 so far has not been too good for the BSE Sensex, which has notched gains of barely 1%. Lot of factors, both domestic and international have played a role. On the domestic front, the IMD's prediction of a good monsoon this season saw the index rise post the announcement. However, the recently concluded results season has painted a mixed picture as far as earnings growth of India Inc is concerned. On the global front, there have been various triggers too. UK's decision to leave the EU last week has only raised the extent of uncertainty in the global financial markets.

In such a scenario, how have the sectoral indices performed? As can be seen from today's chart, metals have emerged as the top performers, while the pharma sector has performed the worst. The 11% gains in the metals sector could be attributed to the fact that the sector was one of the worst performing last year. Indeed, as global commodity prices crashed, stocks of metal companies saw their stocks get a beating. Some companies have talked about how the commodity prices could have bottomed out as a result of which quite a few of them have started factoring a gradual rise in prices.

The healthcare index lost around 9.5% in the six months so far. The sector continues to grapple with USFDA issues. Many of the heavyweights - Sun Pharma, Dr Reddy's, Lupin, Cadila Healthcare to name a few - have either received major observations or warning letters on their plants. This has impacted both revenues and profits. The problem is that the timeline for resolving these issues cannot be precisely determined and depends a lot on the degree of non-compliance. Little wonder then that the index has performed the worst so far. Notably, the healthcare index was the best performer in 2015.

Metals - Top Performers in 2016 So Far


Brexit has clearly been a highly trending topic especially since the UK voted to leave the EU last week. This development has only increased the amount of volatility in the global financial markets. And has put a question mark on what it means for the UK and EU. So what will be the consequences?

The Economic Times, had an interview with Mark Mobius of Franklin Templeton Investments regarding this. According to him, countries are more and more veering towards nationalism and isolation and this poses a threat to the growth in global trade. According to him, this is not an event that will only affect the UK and EU. Given that we live in an increasingly globalised world, the repercussions will be felt in other countries as well.

Mobius opines that some impact will be felt by emerging countries too including India. Especially those companies who have an exposure to the UK will probably be hit the most, as uncertainty over this event deepens.

The interesting thing though is how this event will hurt London's status? Currently, it is one of the leading financial capitals in the world. Brexit could possibly reduce London's status as per Mobius. In the process, India could very well become an important global financial market. But that's easier said than done. Mobius opines that it all depends on whether the government will allow free exchange of currency and general liberalisation of the market.

But given that we live in highly uncertain times, this could very well be an opportunity or a disaster.


Indian stock markets traded firm today on the back of sustained buying activity across index heavyweights. The BSE Sensex was trading higher by 203 points (0.5%) at the time of writing. Gains were largely seen in auto, and metals stocks. The BSE Midcap and the BSE Smallcap also did well as both notched gains of 1% each at the time of writing.

04:56 Today's investing mantra

"Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols"- Warren Buffett

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst) and Radhika Pandit (Research Analyst).

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7 Responses to "Dr Rajan's Successor Must Not Undo This"


Jun 30, 2016

Well said by Madhu Gupta that interest rate cut in isolation cannot kick start the investment cycle. Dr. Rajan while having reduced interest rates moderately as required has rightly adopted inflation taming strategies. The full benefits to the Indian economy would have accrued overtime.
As a seasoned and well read economist, his exit would create a vacuum and would do no good to the Indian economy if such sensible policies are continued. Once again congrats to Madhu Gupta for having assertively put forth her valid point.


Nadir Godrej

Jun 30, 2016

While appearing reasonable Raghuram Rajan's strategy was deeply flawed. Relying only on CPI was a major mistake. The CPI has a heavy weightage of food items and is not representative of the overall GDP. Many of the items in the CPI are commodities and their prices are globally determined and not influenced by Indian interest rates or Indian demand but Chinese demand. The two exceptions are pulses and fresh vegetables (onions and potatoes are traded when there are shortages in India but fresh vegetables can't be easily traded). these prices are influenced by the monsoon conditions though when the prices of pulses goes very high global production responds with a lag to Indian demand. Credit demand in the housing sector would have responded to lower interest rates. Green energy would have grown faster at lower interest rates. Lower interest rates would have lead to higher stock market prices and FII investment which would have kept the Re firm and been a much better way to control inflation.



Jun 30, 2016

What is good for India is different from good for economy! Rajan could be talented but he might had oversight on local situation... He can't undo all the bad done by congress over 40 years in 3 years and if that is done not fair to current government...


Satyendra Sinha

Jun 29, 2016

Oh, No. What has happened to you guys? Are you a Equity Research firm or a sick political organization ! You are guys are long chanting Rajan,Rajan,....Why you should worry who should be the Governor of RBI. You must get rid of this sickness, else I am afraid you will die out of it. Please understand that RBI is a regulatory body like PFRDA, IRDA, SEBI etc under Govt of India. You seem to suffering from a syndrome that RBI Gov is above Govt of India. You must get out of it and concentrate on the business you do. You can not keep on imposing the same banals on your subscribers on daily basis.


Sanjeev Singhal

Jun 29, 2016

I would not fully agree that the credit off take will increase when the demand grows irrespective of interest rates. The consumer demand has to be revived for sure and that can happen only when the credit is available at reasonable rates. If there is demand in the system, the industry will increase capacity and take credit irrespective of high rates. However, when the demand in the industry is low, the industry may not increase capacity, but if the interest rates remain high, the industry will find it difficult to service the high interest costs on the loans they have already taken. Lower interest rates will also lead to lower inflation. It is pure economics. Today, to keep afloat the industry has to pass on the increased costs including high interest cost to the consumer thus fuelling inflation. If the interest rates are brought down, there would be an overall demand increase in the the system. You are analysing only one parameter and painting a biased picture.

I would also be concerned about the increase in credit card off take unlike the euphoria being suggested by Vivek Kaul. Credit Card off take at the current high rate of interest for credit cards (almost 3% per month) is sign of a credit default bubble building up in this sector.

Like (1)

A Simple Human

Jun 29, 2016

I, for one, do agree with about this article, what a successor to Dr. Rajan's post at R.B.I., "must not undo this".

So, it will be in the interest of India's Economy is general and the credibility of incoming R.B.I. Governor in particular, it shall necessarily be a candidate not from the banking background of India, but one who has the wide economic exposures on the world stage, with so many "swings & uncertainties" that is prevailing, as of now.

Like (1)

Ganapathy Sastri

Jun 29, 2016

India's problems are many: GOI and state governments living way beyond means: spending three times their revenue. Over the years, this has caused massive inflation. We can teach foreign central banks to achieive their annual targeted inflation in ONE MONTH. Wage inflation among government servants will only worsen this issue. Second: The country living beyond means. Massive trade deficits, exports falling by over a quarter month after month with imports also falling albeit at a lower rate. This despite falling oil and gold prices. Just imagine where trade deficit will be when both of these go up.
For banks, biggest cost is bad debts. That alone will account for over 10% of interest rate pricing. Who is going to teach banks how to reduce bad debts? Dr Rajan or his successor cannot do this. At best they can ferret out the truth. Why blame RBI for high interest when fault lies elsewhere?

Like (1)
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