Operation Twist: Advantage Banks

Operation Twist (OT) is a monetary policy

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operation  of the US Federal Reserve where it simultaneously purchases and sales of bonds. It was first carried out in 1961 as a way to strengthen the U.S. dollar and stimulate cash flow into the economy.

Operation Twist gives a movement of the yield curve when central banks simultaneously buy and sell securities of short-term and long-term tenor. It’s a tool which is often used by the US Federal Reserve.

The benefits of businesses and individuals having access to low-interest-rate loans include an increase in economic spending activities. But, whether the risk averse and debt laden corporates, will go for loan spree, is still a matter of conjecture. 

Anyway,  due to RBI’s OMO (OT) announcement the systemic liquidity is going to increase and the bond market should react positively. 

The catch point is: if liquidity goes up, yields will come down. This in turn would means higher treasury profits on the bond portfolios for banks.

The bank stocks are likely to continue to hold on to their Friday gains on Monday as well,  since , the RBI has hinted to hold some more OTs (simultaneous sale and purchase of government securities) in future. 

Post announcement of OT the benchmark 10-year government bond yield slided 14 basis points to 6.61%.

RBI Governor Shaktikanta Das said that the impact of recent counter-cyclical measures taken by the government was starting to play out, while stressing that it was imperative that monetary and fiscal policies should work in close coordination.

The RBI governor also acknowledged that the economic activity continued to weaken with GDP growth decelerating for the sixth consecutive quarter till the 2nd quarter of 2019-20.

He further pointed out that among the two main components of GDP: while investment activity weakened further, private consumption showed signs of recovery. 

Meanwhile, October food inflation was seen at 6.9% which is a 39-month high.

Economic growth continues to be lacklustre and Counter-cyclical monetary policy has not been as effective as expected due to inadequate monetary policy transmission. This brought in the necessity of going in for OT. 

In the rural sector, weak demand conditions has given rise to the prospect of a “one-legged” recovery driven by the urban sector.

According to a number of analysts, the vegetable prices are likely to bother the common man,  till the new crop comes up; but is expected to moderate by February 2020.

What is worrying is excluding government's final consumption expenditure, GDP growth is only 3.10% indicating an the underlining weakness in private domestic demand.

On the international arena, some signs of a cyclical upturn in global industrial growth are now in sight.

On the domestic front though the capacity utilization as per the early results of RBI survey has fallen substantially to less than 70% in Q2 of 2019-20, there are several green shoot indicators of growth recovery in the economy.

The growth recovery has to be addressed fundamentally and durably by the present FM,  Nirmala Sitaraman, by effective use of fiscal policy along with the monetary policy of the Central Bank,  even if the latter is playing only a facilitating role.

Actually, there is dichotomy which needs to be resolved with due caution: while the slump in real GDP growth warrants accommodative monetary policy stance, the uptick in headline inflation for the third month in succession after a quiescent phase of nine months calls for a 180 degree response from the Central Bank or at least status quo, until there is ground to infer that the food price spirals that are pushing it upwards, are ebbing

Besides  lacklustre revenue collections, alongside lower nominal GDP growth rate is adding to the risk of fiscal slippage.

Looking on the current fundamentals of Indian economy, it is very much clear, that the weakness in overall activity may likely prolong into Q3, if not turn weaker.

It is pertinent to mention that unseasonal rains in October and early November damaged certain crops and also disrupted the mandi arrival patterns; creating temporary demand - supply imbalance leading to price pressures in several vegetables, especially onion prices.

The current uptick in inflation is likely to give more pain in the near term as there exists a considerable uncertainty on the food price trajectory, as the quantum of impact of unseasonal rains on kharif output would be known only early next year.

In such a situation,  I would suggest you to maintain caution,  with a positive outlook on the banking sector. Steel and Construction sectors could also fare well in the near term due to the resumption of activities, post monsoon.

I am expecting the rally to continue, with mid and small caps hogging the limelight -- though stock picking remains the key issue.

On the inflation front, unseasonal rains in October and early November damaged certain crops and also disrupted the mandi arrival patterns. As a result, the temporary demand supply imbalance led to price pressures in several vegetables, especially onion prices.

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