"Soft landing, Decoupling to Re-coupling of markets, Re-pricing of risk"

Advent of New Year 2008 has started giving clear evidence of a soft landing under way for Indian economy and most of the overheating concerns appear behind us. Inflation numbers if not too benign, appear to be in comfortable range. Index of Industrial production for November grew just 5.3% as against 12%. Slower credit off take and reduced housing loans are showing the impact of repeated money tightening measures of central bank

Liquidity conditions turned comfortable as the RBI reversed the spree of unwinding bonds under the Market stabilization scheme (MSS). RBI nearly unwound Rs 18,000 crore bonds during November and December while sold nearly Rs 8,000 worth bonds in first week of January, indicating the return of easy liquidity conditions

Recent spurt in MSS indicates improvement in liquidity, which the central bank is mopping up. Though there is not a significant pick up in foreign direct investments as against the hyped anticipation for January, this time of the year, there tends to be sizeable provident fund inflow in the system

So far central bank has lapped up forex inflows worth $ 76 bn (nearly Rs 2,18,775 crore). Outstanding MSS amount to nearly Rs 1,77,838 crore against Rs 62,000 crore in April’07

Continuous release of deteriorating US economic data strengthens the expectation of US Fed rate cut. Fed futures discount nearly 1% rate cut by June’07. European and England central banks have held their rates unchanged and may see a cut in second half of the year

It has been extensively debated that emerging markets are decoupled and would sustain unabated growth. Its true that any rate cut is good news for emerging markets including India as the funds flow gets directed to them

However, the exuberance may be short lived as US goes into recession. The problem occurs not because of direct economy linkages but because of financial market linkages. As US economy goes in recession, magnitude of re-pricing would matter, as it will be unidirectional for a prolonged period

Developed markets are expected to under perform the emerging markets while triggering the correction in asset prices globally. Liquidity and risk aversion will continue to push precious metals to higher levels with intermediate corrections

Given sizeable funds targeted from Middle East (e.g. shariat fund), and expected rate cuts in US, India is expected to see huge inflows in coming weeks. This would add to the conundrum of RBI while balancing the interest and currency rates. Economic data would compel RBI to maintain a cautious stand with a softening bias leading to softening of yields

Story of global meltdown, Capital Inflows & Liquidity

News wires have been glut with news related to weak US economy data; newer sub prime delinquencies and unwinding of carry trades and among all increasing Indian stock market index

No wonder there has been excesses perpetrated by US market. At the time when the US Federal bank should have tightened the economy, allowed those free money and result was subprime balloon to burst today. Today the same central bank is resorting to allow further free money to manage a crisis. (Note: US Fed cut the benchmark rates twice to 4.50%)

No wonder, tightness in liquidity and slow down in economy is visible in fall of asset prices. US, UK and Japan stock markets are trading below their 14 months low levels. Once a poster currency, USD has been battered against all major currencies and woes doesn’t seem to fade away. USD is currently trading at all time lows against Sterling, Euro and Swiss Franc

Ensuing weak data and tight liquidity bolster the expectation of further cut in US rates. Rate cuts increased the flow to emerging markets resulting in higher volatility and surge in asset prices. Cut in interest rates have also fueled the commodity prices to higher levels. As a hedge against slowdown and weaker USD precious metals have touched all time highs. Gold is trading above USD 800 per ounce

In the wake of higher crude oil prices and tight liquidity there are clear worrying signals for global economy

While Indian diaspora continues to be in growth trajectory, regulator faces the conundrum of balancing capital inflows, exchange rate and price stability. Recent measures including CRR hike, regulation of capital flows, ban on participatory notes and routine forex interventions have left market groping in dark about the future policy action

Indian capital market attracted nearly USD 16 bn during Apr'07-Nov'07. Foreign Exchange reserves as of Nov 02’2007 increased to USD 266.5 bn as against USD 199.17 bn as on March 31’ 2007. During the same period Indian INR appreciated nearly 10% against USD

Inflation (WPI) has shown a decreasing trend over the period of last five months and is largely due to higher base effect of previous year. Inflation for the week ended Oct 27th stood at 2.97%. The base effect appears fading in coming months and inflation appears to be in the vicinity of more than 4% by March’07

Globally crude oil prices have risen by more than 30% over the period of five months. Further to it, the fuel as a component in WPI has shown a negative inflation as against overall WPI number. This is noticeable in the context of not passing of fuel price hike to the consumer. It is estimated that increase in fuel prices alone would push inflation up by nearly 1%. Considering this inflation is expected to be in the range of 5% by March 2007

As a cost free tool RBI resorted to repetitive increases in Cash reserve requirements. RBI raised CRR for the third time during the year and increased by 1.25% so far to 7.5%

In a surprise move most of the banks have reduced deposit rates across maturities and this has been mostly aimed to counter increased pool cost on account of increased CRR requirement. In spite of festival season and slew of measures to boost retail demand, slow down in credit off take has not shown any sign of reversal. The YOY credit growth for the fortnight ending Oct 26th slipped to 22.47% as against near 28% at the beginning of FY’07


Further corrections in global asset prices can not be ruled out. However, emerging markets would continue to see higher valuations on account of further rate cuts in developed economies and better return on investments.

Slower credit off-take would provide ground for lower interest rate regime but this moderation seems unlikely till the clarity on capital inflows emerges. Given huge inflows and higher prices, RBI would be right to maintain a tough stance. The direction of near term interest rates would be critically dependent on RBI policy targeting the liquidity conditions

Indian equity market story remains intact and any developed country loss is India's gain. Its right the global turmoil would be contagious but in near term India stays insulated. Any investor requires greener pastures and india and other emerging markets provide the same. As long as cheaper money trade off available India money would keep flowing into emerging markets. However, while we wallow in this borrowed pleasure, caution cant be unwarranted

Problem of Plenty: Hail RBI

Finally the rabit is out of central bank's hat that used the ruled out tool of CRR hike. Some how market was sitting largely on one side expecting rates to peak and should gradually start falling. RBI has received criticism from various treasury desks for doing the unexpected, citing the wrong measure

Lets look at central bank's action in the back drop of changed scenario. Unlike ten years back, craving for a pie of foreign funds, India todays faces a problem of abundance. The first three month for the fiscal received nearly $ 23 bn against the annyal target of $ 25 bn. Clearly India is an attractive destination for investments, but it calls for robust monetary management

The huge flows can simply fly away with same pace and cause severe shocks to the economy and needs proper channelisation of money in productive areas on a sustainable basis. Further in the short term surplus money gets created in the system and cause inflationary pressures. To manage this, it requires RBI to suck the liquidity out of system

Call money rate in last many weeks have remained below 1% , this scenrario appears dangerous when the economic is growing at 9% rate and inflation above 5%. Allowing abysmal low call rate persistently, may give a permamanent belief to banks who in turn start funding longer term assets with overnight borrowings

Give the urgency RBI was right in hiking CRR rate and removing cap on reverse repo borrowings. A lot more needs to be done by increasing the limit of MSS so as to remove excess liquidity. Parrallely India needs to evolve a sustainable FDI policy and a deeper monetary system

Once the economy opens up and the India gets used to the funds inflow and outflow, it should see the least intervention from central bank. Till then stance is right to have liquidity management and market needs to be ready to face frequent changes in policy

Looming inflation or overheating!! who is getting it right??

“Government would act strongly against companies not controlling prices”, sounds like a statement made in a pre-liberalization era against erring money lenders. Make no mistakes, these are the sentiments echoed by our own finance minister who is well acclaimed for pro growth polices, making attempts to control the prices

For a moment let’s overlook the retrograde statements and look at the broader picture. The question is, how critical the inflation is or whether its the real culprit?

Look at the inflation picture in India, the data is as presented on a year on year basis. It’s a common understanding that commodity prices are subject to seasonal vagaries. This suggests that the YOY inflation published would be seasonally adjusted to throw a right picture. However the same is not taken cognizance of & the high inflation rate that we see now is actually a past

During April’06- Aug’06, crude prices mostly remained above $70 and globally wheat prices surged by more than 26% around Oct’2006. The impact of these supply shocks can be seen in week on week inflation however that is not what is shown. The low base of 52 weeks back index has resulted in higher yoy inflation number in recent months. The problem that appears now is actually got over few months back

Given the benign crude prices & already factored in grain prices, inflation would adjust automatically by May onwards & this all would happen without government taking any measures on price control. So all measures announced by government are keeping an eye over elections and later pat its back & get the credit

Given the government besotted with the inflation number, crazy actions may create more trouble. Wrong messages go to the industry and confidence gets shaken. Lot would depend on the expected supply of grains in coming months and monsoon picture. Moreover, any trouble in Gulf can also shake the oil supplies

The time is for monetary measures & RBI needs to take appropriate measure to balance the growth and stability of prices. However, the same seems to be missing from the scene. Continuous monetary measures taken in recent past were inadequate to control the rapid growth that might not be sustainable. It would be appropriate for RBI to take right measure and give clear path to the economy. The need is of a long term policy direction and sense of urgency, before the delayed action kills the growth

Emerging India: Is it sustainable?

Stock market tumbled to 3600 levels from 4,200 a fortnight ago. Nearly 15% wiped off & analysts are once again out with the laundry List of excuses. To table a few: (1) Pro electoral budget is back & the industry was not ready to face any such measure by FM at this juncture, (2) Inflation is a concern and high interest rates are a big dampener for growth (3) & a whimper global alibi, its the yen carry getting unwound and FIIs funds are getting withdrawn

As a practice lets get back to dissection table:
NIFTY moved from 2600 levels to 4200 in less than 12 months time frame, a whopping 70% jump. Given NIFTY the barometer of economy and supposedly a bellwether index, the growth needs to be in sync with economy. Even economy manages to grow at double digit for five years; does this justify the rise in index?
Lots said about India, an emerging market and growth story in place, fundamental is strong, industry firing on all cylinders and running on autopilot. All the optimism gets tucked away under carpet once the fall starts.

Four pillars of the economy; a benign political environment, cheaper funding cost, a good infrastructure & a sound management. A country where the financial hub (Bombay) undergoes deluge every year, Industry shuts for two days every week due to power cut and regulatory bodies lacking policy directions, inflation touching as high as 7% & even after 15 years of liberalization country FM decides cement pricing

Even if the growth is there, the question here is are we prepared for this. We have come to conclusion that the burgeoning population is an asset but what about the quality. The growth needs qualified manpower & skill sets. Budget showed huge revenue collections & boasts about meeting fiscal deficit target & FM brags about industry on autopilot but drivers seems missing

Time was ripe to invest in infrastructure & education heavily but we missed to popular tunes. Once the economy grows at double digit for couple of years, shortage of skill set would kill further growth

Inflation is a concern true and there could be three ways to curb: fiscal, monetary & supply side. Monetary policy seems to lack a long-term approach and continues with only operational tools targeting liquidity. Supply side sees a crazier approach when FM urging companies to cut prices and prohibits them from accessing market

And here comes the global bang, the country that still prepares for full convertibility gets serious bouts of global incidents. Hope the yen carry does not impact much and Central bank had preempted the situation. Moot point here is not the affect of global market or Stock market movements but are we prepared for the growth. Economy is bound to grow but is it sustainable? It needs a strong infrastructure, pro developmental policies & freer play for industry and most importantly a developed demography

Lets not wallow in the happiness of short-term growth and get sanctimonious about the same. Whatever goes up has to come down & only thing we can do is to control the fall or elongate the upward & downward move.

So leaders, industrialists, regulators & investors, its time to wake up before the gas runs out of the cylinders and the firing growth turns into smoke