Analysis: Liquidity-hit markets celebrate Patel’s exit

Analysis: Liquidity-hit markets celebrate Patel’s exit

People look at a screen displaying the Sensex results on the facade of the Bombay Stock Exchange (BSE) building in Mumbai, India. REUTERS

The exit of Urjit Patel as governor of Reserve Bank of India on December 10 came as a good omen for the markets. Following the exit, the benchmark indices staged their best rally seen in the past six months.

Immediately after Patel’s exit, many experts expected a bloodbath in the markets. There was a perception that if ruling Bharatiya Janata Party (BJP) loses elections in five key states, markets would collapse.

Contrary to expectations, the markets behaved in a different way – in the next seven trading sessions following Patel’s exit, markets gained over 4%. The BSE Sensex, in seven trading sessions, post his exit, gained a whopping 1,524 points or 4.36%. On the other hand, the broader index, NSE’s Nifty-50 had an inter-market arbitrage over the Sensex, which gained 30 basis points more than the Sensex.

The BSE Sensex, in seven trading sessions, post-Patel's exit, gained a whopping 1,524 points or 4.36%.

Market analysts and traders across the spectrum believe that the surge in markets was just because of Patel’s exit. “Patel was seen as a very strict person by the markets. What you witnessed in the markets was just celebration of his exit. That is why you saw bond yield going down as well,” an analyst with Motilal Oswal said.

In fact, his assertion is backed by the numbers. Domestic investors were the jubilant lot. The domestic institutional investors (DIIs) bought stocks worth a whopping Rs 9,398 crore in just two days, while FIIs, cautious of the institutional autonomy was on a withdrawal note. In an indicator of the jubilant mood, markets celebrated even when BJP was routed in the assembly elections in the Hindi heartland.

There was a general perception that Patel’s adherence to economic discipline led to a liquidity crunch. Under his governorship, the RBI went for open market operations to infuse in excess of Rs 1 lakh crore in just two months, which was seen as an attempt to counter the liquidity crunch emanating out of the IL&FS default.

But there was more to Patel’s governance style: he took the process of asset quality review (AQR) started by his predecessor Raghuram Rajan to the next level.

Under his leadership, as part of the AQR, 11 of the 21 public sector banks were placed under the prompt corrective action (PCA) scheme, thereby restricting their lending. This seems to have upset the markets more than any other, as the credit flow of 70% of India’s banking market was impacted because of this.

In fact, chairman of a PSB, who didn’t wish to be named, confessed, “We are not happy with PCA. It is like an ICU and if you keep your patient in ICU for four years, there is some issue with your diagnosis.”

Markets may have reacted positively post-exit of Patel but the way they have behaved this week only shows that they are worried about their bottom line rather than anything else.