Shaktikanta Das: Why RBI governor Shaktikanta Das rang alarm bells

NEW DELHI: A key job description of the central bank chief’s profile is that he must take away the punch bowl when the party gets started or, in other words, prevent markets from getting overheated.
RBI governor Shaktikanta Das in the financial stability report recently attempted to do just that by warning of the growing disconnect between segments of the financial markets and the economy.
The report also indicated that, in a severe stress scenario, bad loans of banks could double. Higher NPAs has a direct bearing on the sensex as over a third of the weightage comes from banks and finance companies and their earnings could take a hit if bad loans rise.
But fund managers point out that while the 92% rise in indices from last year’s 52-week low might seem too much and too fast, the equity gains are a much more modest 22% over January levels. Also the always market moves in fits and starts.

For instance, between January 2010 and January 2020, the sensex just about doubled which meant a return of 7.4% which is measly when compared to the period between 2001 to 2008 when the sensex rose nearly 10 times.
One of the key drivers of the recent rally has been the funds released by central banks globally. “Central banks globally have eased liquidity to support their economies in the wake of Covid resulting in bonds worth trillions of dollars yielding a negative return. The rally in equity markets is not driven by growth in earnings but by an expansion in the PE, which is an outcome of global liquidity expansion,” said Saibal Ghosh, CIO of Aegon Life Insurance.
What this means is that companies do not need to earn more for their stocks to become more valuable. Increasing liquidity and making fixed income instruments less attractive can also drive up stock valuation.
“While one should rightly argue that the current upswing is a consequence of global event and policy lead, it is a reflection of an underlying restructuring that has been happening with the corporate sector, and the policy framework, which is now bearing fruit,” said a note by Edelweiss.
According to Edelweiss, the beginning of the pandemic had coincided with the end of the corporate restructuring cycle. “It had been slower than expected, but it was closer to the end. We believe the pandemic has precipitated this clean up and has set the business cycle for what could be a longer & cleaner upswing and more entrenched than a mere response to the pandemic,” the note added.

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