Easy money fuelling speculation: MPC’s Varma

The rally in the stock market and the revival in real estate are being amply stoked by the easy monetary policy, feels Jayanth Varma, a member of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI).

“The stock market is also reflecting domestic policy because if you look at the past few months even when FPI flows were negative the market was booming. This reflects that there is a lot of domestic money in the market. Retail holding is much higher than what it used to be in the recent past. There is a case to be made that a part of the boom in the market is, possibly, not unconnected with domestic monetary easing,” says Varma in an exclusive interaction with Fortune India.

While the indices have more than doubled from their March 2020 lows, investor appetite has continued unabated. As per data from Prime Database, retail investors’ holding is at an all-time high of 7.8% in the first quarter of the current fiscal, while the holding of high net-worth individuals is at 2.10%, taking the cumulative holding to an all-time high of 9.28%.

Varma points out that real estate, too, is benefitting from the lower interest rate regime. “Real estate is also another area—which after years of going nowhere—is seeing greater resilience now,” says Varma.

That seems to be the case. According to the consultancy firm CBRE, housing sales in the seven major cities of the country have shown a 75% spike in residential unit sales in the six months of CY21—with Pune, Mumbai, Hyderabad and NCR topping the charts as home loan rates have fallen to as low as 6.75%.

The primary reason for the boom in these asset classes is also because bank deposits are out of favour, following the steep correction in interest rates. At 4%, the real rate of return has turned negative with average inflation hovering around 6%. “The sense I get when I talk to people who are trying to allocate their investments is that bank deposits are no longer attractive. If you do decide not to put in bank deposits where will the money go? It will go into stocks, real estate, and cryptocurrencies. Look at the extent of the crypto boom in India. So, there is a savings pool that says ‘I don’t care what it is but please for God's sake, not bank deposits,’” tells Varma.

In the MPC meeting held in the first week of August, Varma had expressed his concern by stating that the monetary policy is much less effective than fiscal policy in providing targeted relief to the worst affected segments of the economy. “Indeed, monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy,” Varma said at the meeting.

On how long he expects the boom to last, Varma points out that a lot of that would hinge on how the inflation curve behaves. “It’s very difficult to say how long it (asset price inflation) would last…it also depends on how quickly inflation starts coming down. If the monetary policy starts normalising then the future trajectory of the inflation rate might also change. If it were to come down to 4.5-5% quickly, then the negative interest rates that you are seeing will be much milder,” says Varma.

The professor of finance at the country’s premier management school points out that, historically, depositors were willing to park money in bank deposits at a negative real rate of return because of the massive liquidity advantage it enjoyed over other asset classes. “You know its cash when you want it, unlike any other asset, and they are willing to pay the premium of half per cent or whatever to do that,” explains Varma.

The MPC member, however, feels that for money to come back into the system, the gap in the real rate of return has to narrow. “You don’t need a very high positive real rate of return on bank deposits; it’s just that the negative real rate of return should not be as big as it is today. If you compress even that a little, you will possibly see more money switching. And if that happens, probably, credit demand would also rise as it will not be easy (for corporates) to raise money in equity markets,” tells Varma.