Enter the Shakti - A much needed Market Stimulus

It has been an eventful week as markets went from a panic attack to hope in no time. Well i was expecting hope the first time we hit 10940 but some reason sentiment remained poor at that time. Good news was missing. Now even after the loss of votes by the ruling party sentiment has turned. Timing of the change of hands at the RBI played a key role in distracting the market from a case where all is lost to one where anything is possible. 

So what are we looking at. RBI will give over all the money needed to the government. They already do via OMOs and dividends in case you forgot. So it is not about giving but giving more if at all. is this only a sentiment boosting measure or can the change of guard solve anything. You can ease PCA norms but that does not change the idea that the said bank does not have any money. You can give the banks all the money they need and allow them to give it back to the next crony capitalist or maybe the same ones who are stuck with loans.

But if all goes well the banks get the money with new rules and guidelines on lending so that they conduct more due diligence than before. In the end the fear of getting pulled down for bad loans in a poor economic environment can itself keep banks from lending at the pace needed for economic growth.

Remember that credit growth is the lifeblood of a monetary economy. So for any reason we get a contraction in credit growth you can forget expansion in economic growth. This is the center of the problem and money alone does not solve it. On the other side if you bail out the banks what about the corporates that are now marked as NPAs? Do they go scot free? Do they get loan waivers? If not they have to restructure their businesses so that they can pay back over the next 10 years or more. That will make them cash flow positive but not in growth mode, they will not get new loans and will not be adding jobs. On the contrary some down sizing might be advised to stay afloat. So far they were living off new credit lines as banks were not acknowledging the bad loans and money circulation really did not stop. Now there will be a slowdown in demand from a large part of the business world that cannot borrow endlessly. If their debt is written off credit will contract at an alarming rate and push down growth simultaneously unless you can 

And if you intend to buy the banks that are being bailed out without knowing at what price you may get a bad deal. So far they have been asked to get the money from the market. The market will ask for a better price and that always pushes down the stock price and the eventual degree of equity dilution. Unless dilutions are done at a predetermined book value the PSU banks will lose equity value from where they are. And unless management of these banks is reformed investors will not take interest in them. 

The market will like the news of bailouts and funding sentimentally but it does not solve the growth problem. Growth is not a butterfly you can catch with a net. The growth of the last 8 years was bought by a 25000cr spending stimulus in 2008 followed by OMOs, Pay Commissions - salary increases, MSP - to raise farm incomes and loan waivers etc. All of these are economic stimulants of a sort needed in difficult conditions to boost growth. However when growth is inherent in an economy like after 2001 you did not need all of this. Over stimulating can create bubbles and overvaluation of assets.

You cannot correct all of the above by bailing out banks and expecting growth to walk past. Most of the growth narratives in India overlook the role of credit and mood. 

We are in the midst of a economic slowdown across world economies.The hope is that India can go unscathed. But the rub off effects are going to make walking the tight rope on the above issues difficult. Tough decisions are coming and some very good for the long term. But to believe that there will be no pain along with way is to believe that a balance sheet only has an asset side and not a liabilities side. Back to the basics, for every debit there is an equal and corresponding credit. 

For all the costs that have to paid someone has to foot the bill. Usually that means all of us together. Only the means can differ.

The last solution during a debt deflation is to lower interest rates till the time the economy gets a bid. The process can start before or after dealing with the bad debts issues, ideally afterwards, because if you start early you end up with moral hazard in future. And you cannot lower interest rates till inflation cools off and inflation cools off after growth slows. Then you can ask what came first.

An instant solution to the credit problem by getting a new RBI governor sounds like a fairy tale. Now you can believe in fairy tales but if you get the math then let me know.

What you should know however is where you are in the credit cycle to know what comes next and how it ends and for that I monitor macro economic data.

The Truth About the Markets