Jamal Mecklai: Something smells different

MARKET MANIAC

Sniffing around these past two days, something smells different about the market.

The sulphurous smell of crisis that subsumed me (on March 8, right after which the dollar tumbled through 100 yen, Bear Stearns was sold for $2 a share, and, in the vernacular, all hell broke loose) seems to have given way to rancid regurgitations of editorialists ascribing blame (on variously, greed of financial market players, asleep-at-the-wheelness of regulators, even globalisation), forecasting the impact of the crisis (variously shallow to deep recession in the US, and slowing growth elsewhere), and wondering about structural solutions.

Of course, this change in olfactory perception may be simply because I am writing this from hospital, where I have just had a long-standing deviated septum straightened and my long-suffering sinuses drained. Maybe, in fact, there is no change at all, for, as they say, the more things change the more they remain the same.

Indeed, if you look at the proximate causes listed above, each of them is simply a fact of life. Financial markets are places to make money, so to rail about "" indeed, be surprised at "" greed in financial markets seems silly. Regulators "" well, given that their role is to battle the continually evolving creativity of greed with one hand tied behind their backs (e.g. the political compulsions to stimulate growth), they are born to preside over crises from time to time. Globalisation "" again, what's to say, except that this particular episode shows that tempering the pace by retaining greater control over the levers of its economy (as in, say, India) can vitiate the impact of such financial tsunamis when they hit.

And here I must admit that while, over the years, I have disagreed with the RBI's chosen balance between stability and growth, perhaps there is something to be said for their conservatism. Indeed, for the past few months, I have found myself "" uncharacteristically "" on the side of the Reserve Bank on monetary policy. For several months, there were signs indicating that the inflation cat has been scrambling out of the bag, and now that the last horrifying numbers were released, the RBI stands vindicated.

It remains to be seen whether this results in a replay of March two years ago, which led to a sharp bout of rupee appreciation followed by hysterical volatility. Even though it is clear that the current inflation is driven largely by supply-side factors and hence "" sorry, Milton "" may not be amenable to monetary action, it would seem certain that the RBI will not risk any aggravation. This means that, despite its huge MSS armoury, sterilisation "" and, hence, intervention in the forex market "" will have to become more circumspect.

The good news "" for exporters "" is that with the aftershocks of the global credit crisis still controlling sentiment, the likelihood of surging inflows is quite low, although it must be said that there was some evidence of FII buying when the index shot higher last week.

Nonetheless, I would bet that any rupee strength would be short-lived, till such time as the smell in global markets returns to normal, which could still take a lot of time. Of course, several global banks, tasting the crisis from closer quarters as they are and, in many instances, fearing for their jobs, have sharply reversed their forecasts for the rupee. One, in particular, which had held a steady 37.80 forecast for year-end 2009 for a couple of quarters has now revised it to 40+, and, get this, in the worst case 45 to the dollar.

To try and get a better perspective on how this last crisis will affect markets, we need to first recognise that the cost of capital will rise. This is partly because nobody is lending (or investing) today. But even as investment flows start to return to normal, they will be looking for higher "" probably much higher "" returns than they had settled for over the past five or six years. This is both because the cost of risk will now be fairly priced "" indeed, for some time, probably overpriced "" and also because markets, by their nature, tend to overcorrect.

So, if the cost of capital is going to rise, companies (and countries) who are perennial borrowers will be most affected. Clearly, the US comes sharply into focus, and I believe that recession or no recession, US rates have hit the bottom. In fact, over the next few years, US rates will likely rise and the dollar with it. Investors will no longer finance the US deficit if they continue to be repaid in devalued dollars "" that era is over.

And what about India? Well, we are big borrowers, too, and clearly rates aren't coming down any time soon. Thus, our excellent interest rate advantage and, of course, the India story, which is still a winner at 8+%, will be continuously pushing for a stronger rupee. On the other hand, when I read the forecast of 45 as a worst-case scenario, I didn't blink. If we are not able to control inflation "" say, in addition the monsoon turns out to be a problem "" and the global crisis worsens, it could happen.

The best I can say "" and, from my narrow perspective, hope for "" is wide-ranging volatility in the rupee over the next 3 to 4 years.

Risk remains high "" expect the unexpected.