 "Currency: A threat to import")
Nothing is permanent in this world and nor are the days of abundant and cheap liquidity in the world’s richest nations. Therefore, it is not the question of whether, but when, this unwinding process will start.
However, the markets world over will not wait for the actual event to take place and; the discounting and adjustments will take place much before that. Imagine a situation where you are getting an easy loan at a very attractive rate of say 2%. What will you do? You will borrow and then buy a property or invest in the stock market. As a result, the prices in these markets will soar high, and you make money.
This is what we call in the investment world as “risk on” trade. Now, someone tells you that in next six to nine months the bank will recall this loan. What will you do then? Will you sell the assets after the loan is called back or you start selling from now?
If you are a sensible trader, then you will do the latter, as you are sitting on risky assets built on borrowed money and you are still in profit. This is what we call “risk aversion” or “risk-off” trade. If the risk-off trade takes place, then the emerging markets will get sold in a big way and so does India, as in the last calendar year - Indian stocks accounted for more than one third of the entire emerging market buying by the Foreign Institutional Investors (FIIs).
The moot question at this point of time is whether the developed nations and USA in particular will start unwinding the excess liquidity in any time soon? We do not know the answer yet. But it has been more than five years that the US has adopted the liquidity expansion policy through several QEs (a process in which the Central Bank buys bonds from the market to increase liquidity in the system) to boost the economy. It has its share of danger too as the US is trying to resolve its debt crisis with further debt creation and not with much structural reforms. It is like treating cancer with chemotherapy. You have to stop somewhere as too much of it will be fatal. So far, this policy has produced mixed results in improving the real economy but far from bringing economy to a desirable growth path.
The USA is fast running out time and also the patience to continue with this excess liquidity policy. The US treasury yield has now reached to a new high indicating that the bond market in US has started factoring in the withdrawal of this excess liquidity policy at some point of time. We have also witnessed some sell-off in the emerging market equities in last few days. However, it still may be the very early days, but there are warning flashing lights that can no longer be ignored.
On the domestic economic front Q4 FY13 GDP growth came in at 4.8% Y-O-Y, while FY13 full year GDP growth came in at 5% marking the weakest growth since FY03 when GDP grew by 4%. The demand side GDP decelerated to a 21-year low of 3.2% on the back of a sharp slowdown in government and private consumption. Government consumption during the quarter slowed down to a 16-quarter low of 0.6% as the government went on a fiscal tightening overdrive. The only saving grace was the revision of the FD/GDP ratio for FY 13-14 getting revised down to 4.9% from 5.2% which would give some respite to the Rating Agencies.
Going into the new financial year, things don’t seem to have improved. Purchaser Manager Index (PMI) is a survey based index that indicates the future growth trend. HSBC's India manufacturing PMI for the month of May barely managed to stay above the 50 level that divides expansion from contraction of the economy.
However, service sector was a face saver in the month of May and rising to 53.6 as against 50.7 in the previous month. As a result, the composite PMI index barely managed for a very marginal gain over last month’s number indicating no traction in economic growth in the days to come. Inflation pressure is clearly easing as a result of softening commodity and oil price. However, the bigger threat to inflation is now currency, as falling rupee will only make the import costlier.
With the RBI conducting a monetary policy review every six weeks, the expectations from the market is of a rate cut. But one must understand that, neither are high interest rates the problem, nor cutting them a solution to the woes. In fact, the easy days of cutting interest rates to stimulate consumption and support growth are well and truly behind us. The current slowdown is a result of a sharp slowdown in investments and unclogging investments is the only way out.
However, the markets world over will not wait for the actual event to take place and; the discounting and adjustments will take place much before that. Imagine a situation where you are getting an easy loan at a very attractive rate of say 2%. What will you do? You will borrow and then buy a property or invest in the stock market. As a result, the prices in these markets will soar high, and you make money.
This is what we call in the investment world as “risk on” trade. Now, someone tells you that in next six to nine months the bank will recall this loan. What will you do then? Will you sell the assets after the loan is called back or you start selling from now?
If you are a sensible trader, then you will do the latter, as you are sitting on risky assets built on borrowed money and you are still in profit. This is what we call “risk aversion” or “risk-off” trade. If the risk-off trade takes place, then the emerging markets will get sold in a big way and so does India, as in the last calendar year - Indian stocks accounted for more than one third of the entire emerging market buying by the Foreign Institutional Investors (FIIs).
The moot question at this point of time is whether the developed nations and USA in particular will start unwinding the excess liquidity in any time soon? We do not know the answer yet. But it has been more than five years that the US has adopted the liquidity expansion policy through several QEs (a process in which the Central Bank buys bonds from the market to increase liquidity in the system) to boost the economy. It has its share of danger too as the US is trying to resolve its debt crisis with further debt creation and not with much structural reforms. It is like treating cancer with chemotherapy. You have to stop somewhere as too much of it will be fatal. So far, this policy has produced mixed results in improving the real economy but far from bringing economy to a desirable growth path.
The USA is fast running out time and also the patience to continue with this excess liquidity policy. The US treasury yield has now reached to a new high indicating that the bond market in US has started factoring in the withdrawal of this excess liquidity policy at some point of time. We have also witnessed some sell-off in the emerging market equities in last few days. However, it still may be the very early days, but there are warning flashing lights that can no longer be ignored.
On the domestic economic front Q4 FY13 GDP growth came in at 4.8% Y-O-Y, while FY13 full year GDP growth came in at 5% marking the weakest growth since FY03 when GDP grew by 4%. The demand side GDP decelerated to a 21-year low of 3.2% on the back of a sharp slowdown in government and private consumption. Government consumption during the quarter slowed down to a 16-quarter low of 0.6% as the government went on a fiscal tightening overdrive. The only saving grace was the revision of the FD/GDP ratio for FY 13-14 getting revised down to 4.9% from 5.2% which would give some respite to the Rating Agencies.
Going into the new financial year, things don’t seem to have improved. Purchaser Manager Index (PMI) is a survey based index that indicates the future growth trend. HSBC's India manufacturing PMI for the month of May barely managed to stay above the 50 level that divides expansion from contraction of the economy.
However, service sector was a face saver in the month of May and rising to 53.6 as against 50.7 in the previous month. As a result, the composite PMI index barely managed for a very marginal gain over last month’s number indicating no traction in economic growth in the days to come. Inflation pressure is clearly easing as a result of softening commodity and oil price. However, the bigger threat to inflation is now currency, as falling rupee will only make the import costlier.
With the RBI conducting a monetary policy review every six weeks, the expectations from the market is of a rate cut. But one must understand that, neither are high interest rates the problem, nor cutting them a solution to the woes. In fact, the easy days of cutting interest rates to stimulate consumption and support growth are well and truly behind us. The current slowdown is a result of a sharp slowdown in investments and unclogging investments is the only way out.
The Author is Chief Investments Officer of AEGON Religare Life Insurance