By Manish Bhandari, CEO, managing partner, Vallum Capital Advisors
As the world was clamoring for reduction in interest rate (repo rate), the policy action of increasing repo rate by 25 bps has shocked many. The real answer lies in interpreting the policy action in the right perspective. The RBI policy has been a filp-flop over interest rates and liquidity tightening measures over the last few months and reversal thereafter. The excess liquidity of the past has resulted in high inflation and currency depreciation and as this realisation has happened to erstwhile RBI governor, he started tightening the liquidity by raising short term interest rate by raising MSF, reverse Open Market Operation and compliance of CRR. All these measures were to arrest steep currency depreciation and curb inflation.
With the transition at helms of RBI, the continuity of thoughts has carried on. However, the missing piece of action by FED over the last week, which gave some breather to Emerging markets like India to put their house in order by correcting Fiscal Deficit and Current account Deficit. Sensing the money flow to EM will not be a problem for some more time, RBI has eased the liquidity condition on short end of the yield curves. However the problem of missing deposit (financial savings) can only be solved with increasing the attractiveness of financial assets in India. The Indian banking sector is running a very high investments to deposit ratio. The negative real returns from financial assets (Fixed Deposit) has diverted capital to unproductive assets like Gold and Real Estate for the last few years. With one stroke of pen RBI has made an attempt to curb inflation, improve the attractiveness of financial savings, urgently required in the country. However, the unintended consequence of this is going to be the outflow of money from assets like Real Estate. This move of RBI has reinforced our view on burst of real estate prices in India and has pricked the bubble at right time.