Budget 2020

We need a buyer of last resort for capital market: Nilesh Shah

If small savings rates are aligned to government securities, then RBI allowing retail investors to open gilt accounts could lead to a lot of retail participation, says Nilesh Shah, MD, Kotak AMC.

RBI has proposed to provide funds from banks to NBFCs under the TLTRO on tap scheme. This has been a long-standing demand for the NBFC sector. How do you look at this announcement?
Number one, this is a very positive announcement because this gives assured financing to NBFCs. Secondly, NBFCs are able to reach many customers where the banking sector has not yet reached and that allows credit expansion in the economy. More importantly, this also brings NBFCs formally under RBI’s provision.

Retail investors can now open gilt accounts with RBI. What kind of appetite do you think there will be in the secondary market?
A lot will depend on what we do with small savings instruments. If small savings continue to give 1% or 2% more than they give, then this step of opening up guilt for retail investors will not really take off in a big way. But if small savings rates are aligned to government securities, then this will entail a lot of retail participation.

On a half yearly basis, government gilt yields move much quicker than the small savings rates. Are retail investors the kind of people who invest in gilts? Do you see that really happening?
Retail investors today have bank deposits which are explicitly guaranteed up to Rs 5 lakh by DIC JC and implicitly guaranteed by the Government of India. The small savings instrument is also guaranteed by the Government of India. From a credit point of view, they are not really going to find differentiation between bank deposits versus small savings versus government securities directly. The reach and the distribution of banks and small savings is far better than RBI’s. So, unless and until we see a scenario where gilt starts yielding better return than bank deposits and small savings instruments, it is unlikely to be hugely popular among retail investors.

How do you see the RBI discussion paper impacting the RBI’s decision to periodically open the LTRO windows to NBFCs?
It is a great move. We have seen liquidity issues impacting NBFCs far more than credit issues. For some time, we followed a policy where liquidity was defined as minus 1% to plus 1% of NDPL. Without liquidity, how can the banking system or financial system function? In April 2020, we saw an upheaval in Indian the bond market.

In the banking system such upheavals are controlled by RBI which acts as a lender of last resort. We need a buyer of last resort in the capital market for participation of NBFCs in TLTRO. Opening up of a buyer of last resort by sitting up a corporation as proposed in the Budget will deepen the bond market and the capital market.

The term lender of last resort is used all over the world only and only in the context of banks. Nowhere in the world is there a lender of last resort for the capital markets. Isn’t the capital market is all about risk and reward?
Things have changed significantly. Now central bankers are like Mario Draghi who says whatever it takes. The Bank of Japan is buying equities in the capital market and they are becoming buyers of the last resort in equity markets. What you said was true for the ‘50s, ‘60s and ’70s. What I am talking about is true for 2020. The US Fed intervened decisively in the junk bond market, the European Central Bank is providing money to South African companies to go and do leveraged buyout of European companies. The Bank of Japan is buying equities. Times have changed.

But you are comparing apples and oranges. The inflation rate in Japan has been negative for years. Look at the rate of inflation, the percentage of people below poverty line, the percentage of food in the consumption basket. Aren’t you comparing apples and oranges?
Don’t you want India to become rich like Japan and the US? If yes, then we have to follow the same path which they are following.

No. But they have done this after they became rich.
Obviously not. If we want India to grow, then we have to do what westerners are doing and not what they are preaching us. During the 1990 crisis, what did the IMF and World Bank tell us? They said cut your fiscal deficit, raise your interest rates, open up your economy, devalue your currency. Take the pain. Then in the 2008 subprime crisis hit, what did they do? They cut interest rates and raised the fiscal deficit to stimulate their economies.

So at the end of the day, we have to do what is right for us. If today we deepen our capital markets, what is wrong in it? We are not saying that you take the credit risk. This buyer of the last resort in the capital market is at a price, no one is buying at par. People will price and they will buy. Let the capital market function at a price. This is about orderly functioning of the capital market, this is not about providing subsidy.

But not when the Sensex is at 50,000 plus while the real economy is at minus 7.7%. Once we are a rich economy, we can do whatever you have suggested but can we afford to do it now? Shouldn’t we have growth with equity?
Undoubtedly, but for 70 years we have followed policies which have kept us poor. Now it is time to change policies which will make us rich. We have to create inclusive growth, there is no debate about it. I will explain how India has handled the crisis versus America. In 1929, piano was the second most valued asset in an American household because every household had a piano. When the Great Depression came, piano became a useless asset. The entire piano manufacturing industry shut down, piano repair institutes, piano coaching institutes, piano tuition teachers all shut down. There were trucks which were carrying pianos, they all shut down. America allowed destruction of their piano industry, they did not intervene to support it.

Now look at the textile industry in Mumbai, lower Parel and all those areas were populated with textile mills. When they came under pressure, we created the National Textile Corporation to support them. Those mills were not producing economic output but the government continued to pour money to support them. Now when the market took over, the Phoenix Mall was set up in mill land where all the mill workers are getting jobs. There is consumerism going on. Now should we go on creating National Textile Corporations to support sick mills or should we let market function which will close the mills but create a Phoenix Mall on top of it?

Do you think the equity markets right now should take the governor at face value or try and balance out the inflationary impact that commodity prices are going to bring on growth and margins of the companies going forward?
Markets will be continuously processing data. It is not dependent on just one source of information. Now undoubtedly inflation seems to be coming back. We have seen local steel prices moving from Rs 40 a kg to Rs 65 to a kg and that is a big move. Packing materials are up and so are chemicals and dyes and various other expenses. But is this inflation sustainable or is it coming because of supply chain bottlenecks?

The shipping rates have gone up significantly not because there is a shortage of ships but there is shortage of containers as they are scattered all over the world. They are no longer as efficiently moving as before. Similarly, there have been disturbances on the supply side because of Covid-19. If we look at our capacity utilisation, we have surplus capacity. On one side we say private investment is not taking up because there is surplus capacity, on other hand, we are saying that there is inflation because of shortage of goods. We need to ensure that the supply bottlenecks are removed so that capacity utilisation keeps on inching up to meet the demand.

If this scenario plays out, it is the best for consumers, manufacturers and the economy. This is where here we need the government to play an active role in removing the supply chain bottlenecks. On the other hand, if an exactly opposite scenario plays out, we will have lower capacity utilisation because of supply issues. Demand will rise and that will result in price inflation. We need to ensure that our capacity utilisation takes care of inflation side problems.