Moneycontrol Pro Weekender | Jayanth Varma’s bombshell


Dear Reader,

“Monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy” — those brave words were spoken not by some heterodox economist, not by some market participant shaking his head with wonder at the yawning gap between the economy and the markets, but by Jayanth Varma, member of the RBI’s Monetary Policy Committee.

At the last MPC meeting, Varma was the sole dissenter to the view that the accommodative stance needed to be kept till growth is revived.

Why did he dissent? Varma says the COVID-19 crisis is like tuberculosis, which kills lots of people, but doesn’t harm the economy. He compares it to a neutron bomb, which causes extensive loss of life but relatively little damage to buildings and property. Monetary policy, says Varma, has little role to play in mitigating the human tragedy.

It is now becoming increasingly clear that even vaccines may not stamp out the epidemic and we may have to live with it for years—Varma mentioned countries like Israel which are seeing fresh cases in spite of very high levels of vaccination. Our Herd Immunity Tracker points to the waning efficacy of vaccines. How long then should monetary policy be kept accommodative?

Varma points out that the ill-effects of the pandemic persist only in some contact-intensive sectors, while others are now operating above pre-COVID levels. Similarly, it is MSMEs and the weaker sections that have been affected the most, while big companies and the well-off have been unaffected. Monetary policy is too blunt a tool to provide targeted relief to the affected groups. Instead, fiscal policy should be used for the purpose.

Varma believes that inflationary expectations are getting entrenched, because the RBI has signalled that it will support growth, come what may. He says it’s therefore time to raise the reverse repo rate, to signal it is committed to the inflation target, which would “anchor expectations, reduce risk premia, and sustain lower long term interest rates for longer, thereby aiding the economic recovery”.

Other central bankers would do well to pay heed to Varma’s remarks. The US Fed’s minutes too showed that its members have started talking about tapering bond purchases, which has, once again, started to worry the markets.

Other concerns include slowing Chinese growth and the unsettling policy changes in China. In fact, global fund managers’ allocation to emerging markets fell on account of the China scare.

In China, industrial production and retail sales slowed in July, due to a fresh outbreak of the virus and the floods in Henan. One of their busiest ports was partially shut, sending freight rates soaring. China’s GDP forecasts have been cut, but much depends on how the authorities react to slowing growth. Crude oil and commodities sold off on these concerns, dragging down the Tata Steel stock on Friday.

But while worries about Chinese growth have been par for the course –debates on whether China would have a soft or a hard landing used to be the rage a few years ago — what is new is the policy change. Cracking down on e-commerce companies is one part of it, as we noted in The Eastern Window. While some have said Xi is baring his Red fangs, especially now that he’s talking of ‘common prosperity’, reality is perhaps more nuanced. Andrew Batson, the China research director for Gavekal Dragonomics, points out that while many are familiar with Deng Xiaoping’s “We should let some people and some regions get rich first”, not many know he insisted it was, “for the purpose of achieving common prosperity faster”. Says Batson, “By talking about common prosperity now, Xi is saying the time has come to deliver on what Deng had always wanted.”

Indeed, global investment company Invesco says common prosperity will help expand the consumer base in China. The report says, “The Xi administration is trying to simultaneously deal with the instabilities of the past few decades — environmental, equity, geopolitical risks — while ensuring financial stability and inclusive growth. If it delivers such inclusive growth, we believe China will avoid the middle-income trap — and our bet is that it will be successful in that endeavour.”

As for the crackdown on tech companies, Chris Wood’s latest edition of Jefferies’ Greed & Fear newsletter says “many of the proposed rules are exactly what many, including GREED & fear, would like to see happen in the Western world in terms of long proposed regulation of Big Tech, in particularly addressing the insidious though highly lucrative business model of surveillance capitalism”.

Nevertheless, Wood has raised his weightage to the Indian market by two percentage points, while reducing the China and Hong Kong weighting by an equivalent amount, underlining how Indian markets could benefit from the Chinese crackdown.

India Ratings has revised down its forecast for India’s GDP growth for FY22 to 9.4 per cent. The reason: “Households have been sustaining their consumption needs by both dipping into their savings and incurring debt. With the COVID-19 pandemic still looming large on the Indian economy, Ind-Ra believes households are no longer hopeful of a significant upside to their income in the near to medium term. This, coupled with low consumer confidence and depleted savings, is expected to limit the growth in consumption demand.” No wonder then that ‘Buy Now, Pay Later’ is growing by leaps and bounds, although it could later bite back in the form of higher bad loans. Ind-Ra says the only bright spot is exports, and the recent export promotion scheme should help, although the amount provided is far from enough. Another positive is the rise in funds flowing into Indian start-ups, as well as the amounts being raised through IPOs in the Indian markets, which, when spent, will boost the economy.

Economic activity continued to gain momentum during the week, as our recovery tracker shows. Kharif sowing has been good. Ashok Leyland is a play on the recovery and with the Nifty Realty index outperforming the market this year, we pointed to several stocks that could benefit from the housing recovery, given that housing has linkages with 20 other sectors and sub-sectors in the economy.

Things aren’t so clear cut in the auto sector, with the semiconductor shortage and the disruption from electric vehicles looming ahead, especially with Ola Electric’s splashy entry, which could upend the 2-wheeler market. We looked at the implications of the recently announced scrappage policy for automobiles, which could be a road to a new automotive ecosystem. What’s more, all this supposedly clean and green energy may have a dirty secret. Some of these concerns are priced into the Hero MotoCorp stock.

Airlines have never been an easy business and SpiceJet’s decision to hive off its cargo business into a subsidiary, which can attract growth capital, is a first step in building a logistics chain. Only time will tell whether Akasa has rushed in where others feared to tread.

Valuations continue to be a concern. During the week, we said gains could be capped by high valuations for Cummins and several AC companies. We advised investors to buy GMM Pfaudler on declines and even for a growth play such as SastaSundar, we asked investors to wait for a correction before taking fresh positions.

On the other hand, the stocks where we found valuations comforting, given their prospects, are Repco Home Finance, Suven Pharma, Burger King India, Petronet LNG, Indraprastha Gas, Mas Financial and Mrs Bectors Food Specialties. We also recommended HDFC Bank, reckoning that the resumption of its credit card business will lower the discount to its long-term average valuation.

Will Jayanth Varma’s bombshell change the stance of monetary policy in India? We do not know, as the RBI’s state of the economy report suggests they are far above such mundane considerations.


Manas Chakravarty