Sensex and Nifty nosedived and will (perhaps) rebound sooner rather than later but that doesn't tell a thing about the policy.
Chief postulates:
Measure: SLR lower limit restored to 25%
Impact: In isolation, not much because banks are in any case being forced to subscribe to more and more of never-ending G-Sec issuances. Besides, SLR holdings of most banks are way above the limit. However, the increase signaled intention to improve the demand for the balance 25% of annual government market borrowings and consequently, the bond yields fell and prices rallied to 2-3 months highs.
Measure: Hike in provisioning charges for standard assets
Impact: Norms pertaining to IRACP (Income Recognition, Asset Classification & Provisioning) are only going to be strengthened from here on. Though temporarily, in the wake of deteriorating global economic situation, they were relaxed, but the regulator has just got it right in tightening the screws when the financial machinery seemed to be moving a bit too fast. Real estate loans will be dearer for developers) and that will prevent any rebuilding of asset bubbles that was being observed over past few months.
Measure: Hike in PCR (Provisioning Coverage Ratio)
Impact: Banks had long known that they'll have to hike their PCR. In fact, RBI had raised apprehension about very low levels of PCR at State Bank of India in it's previous policy statement in July 2009. While the deadline of its implementation (Sep 2010) may have caught ill-provisioned banks like ICICI Bank, SBI, etc. by surprise, the measure holds well for strengthening the banks' balance sheets and eliminating any possibility of built-up of toxic assets.
Measure: Closure of refinance windows for NBFCs, Mutual Funds, Sector specific exporters, etc.
Impact: This too was just a reversal to a pre-lehman status. While most of these windows were not being used by banks, etc., they had served their purpose of preventing a liquidity crunch (during September 08 to March 09 when it looked like everything around the globe might just collapse).
Did stock indices over-react?
Not really...markets were over-heated and were in any case trading at P/E multiples in the range of 20-22 and the real economic situation did not merit that kind of valuations. DOW is back at sub-10,000 levels and is unexpected to stay above 5 figures, any time soon. Today, US saw 19 bank closures in one single day clearly indicating that there's more of toxic assets, all around, and that things aren't as good as news reporters, in their misplaced over-excitement, tend to make others believe.
Why US growing by 3.5% in Q3 (FY09) is not a reason enough to be ecstatic?
The growth was largely due to the federal government's stimulus packages like: Tax rebates on resale of houses (because that is included in US GDP, unlike Indian system of National Accounting); Cash-for-clunkers scheme which saw all automobile manufacturers lightening their inventories so that the manufacturing cycle starts again. Unemployment numbers too, continue to surge above 10%. The growth is more of government induced one and its effect will start waning sooner rather than later. While US state governments continue to issue billions worth of "Build America" bonds every month, re-building what was one of the most ill-regulated and leveraged economy, is a tall task.
Conclusion:
Till August 2009, RBI was trying to curb inflation. Come crisis and rejuvenating economy became the primary concern. Now, after the situation world over looks to be improving, it was very important for RBI to pre-ride the curve and preempt building up of demand side inflation (Although, given the systemic nature of Indian economy, supply side constraints continue to create inflationary pressures). Inflation, I expect, will surpass 7% by March '10, well above RBI's target of 4-5% as expressed in the Annual Policy in April '09. Still, kudos to RBI for what looks to be a great job done, in spite of new founded intervention of finance ministry in RBI's monetary policy management.
P.S: This was the first time, that a finance secretary expressed his views on a RBI policy within hours of its release. While the government continues to intervene in RBI's matters (right from appointing IAS officers as governors in place of prolific policy makers to influencing RBI officials by repetitive none-of-thy-business briefings), it will be interesting to see how independent RBI can function in days to come!
