Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

Central banks are born to lead. When they start following commercial lenders or asset prices, the message for investors is that the authorities have lost the plot.

That's what is happening with the Reserve Bank of India, which on Wednesday cut its repurchase rate by a quarter percentage point to 6 percent two days after State Bank of India preemptively reduced its rate on 90 percent of savings deposits by double that amount.

The unusual move by SBI, a state-run commercial bank, shows just how wrong the RBI's monetary policy committee, led by Governor Urjit Patel, has been in not cutting the benchmark rate more boldly since the government's shock November ban on 86 percent of the currency in circulation. With old notes pouring into banks, and cash withdrawals rationed, lenders' surplus liquidity swelled to $82 billion from a small deficit. SBI alone saw a 20 percent jump in savings deposits during the December quarter.

Deposit Deluge
State Bank of India saw a sharp rise in savings deposits after demonetization
Source: Bank of America Merrill Lynch

Eight months later, more than half of that excess is still swirling about in the banking system.

No wonder SBI lost its patience this week. Commercial banks can't absorb so much cash because real interest rates in India, adjusted for barely 1.5 percent inflation, are the highest in Asia. There's little appetite for borrowing amid subdued capacity utilization and stretched corporate balance sheets. 

In 2016, SBI's loan-to-deposit ratio was only 80 percent, according to Bloomberg Intelligence. In January, the bank cut its benchmark lending rate by 90 basis points to 8 percent, because it had to put the new money to use somehow. Analysts polled by Bloomberg now see SBI reporting a 2.67 percent net interest margin in the fiscal year ending March 2018, down from 2.76 percent the previous 12 months. 

Not only did demonetization lead to an unwanted bounty, the RBI's efforts to keep a lid on this year's 6.4 percent appreciation in the rupee without cutting domestic interest rates also meant it had to buy dollars from banks. Bloomberg Intelligence economist Abhishek Gupta expects the intervention will add another $48 billion to the liquidity glut by March next year. All this is good for the stock market, which has attracted almost $9 billion of foreign money so far this year.

Great Expectations
India's stock-market valuation is at its highest level since 2010
Source: Bloomberg

Expectations of a rate cut have pushed Indian households to the stock market via mutual funds and propelled benchmark indexes to record highs.

Now that we have the cut, and no hint from the RBI of more to come, how much longer can the exuberance last?

Looking at consensus expectations, little has changed. Sell-side analysts tend to be overly optimistic early in the fiscal year, and adjust down their estimates along the way; this year is no exception. Moreover, manufacturing activity is at an eight-year low and a recently introduced goods and services tax is crimping dealer inventories -- and profits -- at companies like JSW Steel Ltd. 

Overly Optimistic
Sell-side analysts are lowering their earnings estimates for the sixth year in a row
Source: Bloomberg

The 18 percent expansion in the price-earnings multiple this year for BSE 200 index stocks represents a dangerous disconnect between hope and reality. The RBI deserves at least some of the blame for failing to lead from the front in narrowing that gap.

-- With assistance from Andy Mukherjee.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shuli Ren in Hong Kong at

To contact the editor responsible for this story:
Paul Sillitoe at