Equity Markets and Interest Rates- what’s the link? This is with reference to the recent RBI rate cut.

Investment Banking

The 25 bp fall in the RBI’s repo policy rates for the 3rd time is an indicator for the equity markets, interest rates, and investor reactions. With the newly elected BJP government winning a clear mandate, there appear to be large concerns over the domestic rate of growth, the drop in prices of oil, tariffs from the US and a vacillating global market. Reading the trends one would say the premier bank is moderating changes and even suggesting a further drop in rates from the current 5.75% which in itself is a 9-yr low. This has been spurred by the weal economic growth, wide output chasms coupled with the poor investment and consumption growth.
Effect on Equity markets:
The interest rates cause a commotion since it is the cost of borrowing and using another’s funds. The interbank rate and RBI’s lending rate to banks normally takes a year to feel any impact in the economic scenario. However, equity markets see volatility and immediately react to such changes in anticipation of growth or decrease in it as the case may be.
There is no direct impact on the equity markets by the interest rates. Yet, equity markets move in the reverse direction generally and do have indirect cascading effects on the prices and growth in general. A cut in rates implies the stock market could move upwards and a rise in the rates normally sees a slump in it. This is a thumb rule and a prediction without guarantees especially in the present globally volatile equity market scenario.
Here is how the ripple-effects are predicted to be.
GDP growth may slump in 2020: 
The US-China trade war and tariffs imposed on India too saw the GDP projected values slumping to 7 from the current 7.2%. The weakened rural area consumption, poor domestic investment growth, and exports slowing down do not augur well. However, the premier bank also pointed out that we should factor in data from March where the stable political scenario, better financials in Q2 from more business growth, an upswing in stock markets, and greater utilization of capacities can reassure the economic growth.
The trends in Inflation: 
The variations in the monsoon patterns, vegetable prices spikes, escalating global tensions, changes in fuel prices globally, volatility of equity markets, impending trade crisis’s,  and the emerging political and government policy will hugely affect the inflation rates. Currently, the RBI stepped in with a marginal upward revision to 3 to 3.1 from 2.9 to 3 % for the April ending September period.
The policy changes: RBIs change in policy has become accommodative in a bid for timely action. This also implies further changes in monetary policies and cuts in interest rates to spur the flagging markets.
The liquidity position:
In spite of an April-May deficit, the cut-backs in governmental splurges resulted in a surplus of 66,000 Cr Rs for June. Funds injection to the tune of 70 thousand Cr for April and 33.4 thousand Cr for May from the premier bank along with its OMO auction purchases for 3 years of 25 thousand Cr and almost 35 thousand Cr value saw the liquidity positions ease. Another such auction of 15 thousand Cr is also anticipated in June.
The updates:

  • The Jalan Committee report may take some time as it is still working on its recommendations to improve the premier bank’s cash reserves.
  • The RBI though not mandatorily is monitoring the NBFC sector for financial stability and will interfere if required.

Concluding notes:
With moderation rather than being neutral being the key-word, further cuts are predicted. The 6 to 5.75% RBI-lending rate, 5.75 to 5.5 repo rate, and changes in monetary policy are predicted to ease the common-mans burdens by

  • Lower HL EMIs.
  • Automobile and real-estate sectors will get a boost.
  • NBFC lending may rise as payments banks are being reviewed.
  • Bank leverage-ratios set to 4.5 to 4 for DSIBs and for the rest of the banks 3.5%.
  • The inter-ATM bank fee may change.

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