In the past month, the Dow Jones Industrial Averages (DJIA) rose 4.5 per cent to record levels on Friday. The Nikkei 225 is up 2.5 per cent, though the gains came from a single session.
The Nifty is down 3 per cent.
The "risk-on" concerted upmoves between big first world markets and India has broken down.
Foreign Institutional Investors (FIIs) will live with volatility, but not with no-exit situations. The lack of depth in Indian markets means that prices could fall a long way on sustained FII selling. (Prices would also rise sharply on sustained FII buying). This imposes an impact cost.
A small minority of FIIs also fear India may impose capital controls if the rupee weakens much more. It's not an absolute impossibility though the chances are small. Capital controls would be the last bullet in the armoury.
Volumes have dipped, as the RBI has squeezed liquidity. Primary dealers have had to pick up bonds at the last three treasury auctions. Treasury yields have shot up. The equity market is thin. There are only about 200 stocks FIIs can trade in comfort. As rupee liquidity has reduced, the scale of FII operations has reduced.
The cash crunch led to unusual manipulation on the NSEL. A story in Business Standard on Friday explained how the NSEL was used for financing. (Paired trades in spot exchange triggered govt crackdown) https://bsmedia.business-standard.comwww.business-standard. com/article/markets/paired-trades-in-spot-exchange-triggered-govt-crackdown-113080200007_1.html
Two identical contracts in raw wool were available on NSEL. One was settled on T+2 basis, the other settled at T+25. Both had an initial margin of 2 per cent and required physical delivery. A trader could buy T+2, and sell T+25, taking delivery on T+2 and passing it on in T+25. He gained if T+25 had a higher price and indeed, the positive differential for this arbitrage was at about 18 per cent annualised.
As old time badla traders will instantly realise, the financier is effectively lending money at 18 per cent while the borrower pays that rate by taking the opposite position. The volumes generated were unreal, supposedly 25 per cent of India's annual raw wool production.
This kind of manipulation occurs only when liquidity is at a big premium and there isn't enough cash in the system to finance normal daily operations.
If the NSEL is an indication, banks, non-banking financial companies, and all rate-sensitive businesses will have a very hard time until the liquidity squeeze eases. Goldman Sachs, which has just issued an "underweight" grade to India, estimates that the squeeze could stay in force for three-six months.
Therefore, this could be a very bad quarter, or six months. There are very few rupee-income businesses that don't require working capital. FMCGs are one group that are, by and large, not debt-intensive. But FMCGs are also seeing selling as FIIs cut back holdings.
The other traditional defensive sector, pharma, is in quite a bit of trouble at the moment due to the US tightening of inspection regulations and quality-control standards on drug imports. This could be temporary but it will require time for the pharma industry to reboot to meet the new standards.
Amidst FII selling and a rupee-liquidity squeeze, the markets will eventually find equilibrium. But it could be a long way down and rate-sensitive stocks will be hit harder. There will probably be intermittent rallies but those could be false dawns.
Markets need liquidity. So do normal business operations. One way of calculating nominal GDP is to multiply the money in circulation by the number of transactions that money undergoes (the velocity). Real GDP is derived by adjusting this for inflation. The RBI has removed money from circulation. Unfortunately, there has also been a fall in velocity, if trading volumes are indicators. Hence, nominal GDP will reduce. It remains to be seen if inflation also comes down. If it doesn't, real GDP growth will also reduce.
Since corporate earnings are calculated on a nominal basis, without inflation-adjustment, the chances are earnings growth will be down. Lower earnings growth and higher interest rates add up to a toxic combination for valuations. The market could end up trading at a lower PE on lower earnings growth.
The Nifty is down 3 per cent.
The "risk-on" concerted upmoves between big first world markets and India has broken down.
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The US and Japan have convertible currencies and deep, liquid markets in equities, bonds and other instruments. If things go wrong, investors know they can exit. Conversely, there is little depth to Indian equity or bond markets, and the rupee is only partly convertible. Any investor in India risks getting stuck in illiquid assets. This has already happened to domestic investors in smaller stocks where volumes have dried up.
Foreign Institutional Investors (FIIs) will live with volatility, but not with no-exit situations. The lack of depth in Indian markets means that prices could fall a long way on sustained FII selling. (Prices would also rise sharply on sustained FII buying). This imposes an impact cost.
A small minority of FIIs also fear India may impose capital controls if the rupee weakens much more. It's not an absolute impossibility though the chances are small. Capital controls would be the last bullet in the armoury.
Volumes have dipped, as the RBI has squeezed liquidity. Primary dealers have had to pick up bonds at the last three treasury auctions. Treasury yields have shot up. The equity market is thin. There are only about 200 stocks FIIs can trade in comfort. As rupee liquidity has reduced, the scale of FII operations has reduced.
The cash crunch led to unusual manipulation on the NSEL. A story in Business Standard on Friday explained how the NSEL was used for financing. (Paired trades in spot exchange triggered govt crackdown) https://bsmedia.business-standard.comwww.business-standard. com/article/markets/paired-trades-in-spot-exchange-triggered-govt-crackdown-113080200007_1.html
Two identical contracts in raw wool were available on NSEL. One was settled on T+2 basis, the other settled at T+25. Both had an initial margin of 2 per cent and required physical delivery. A trader could buy T+2, and sell T+25, taking delivery on T+2 and passing it on in T+25. He gained if T+25 had a higher price and indeed, the positive differential for this arbitrage was at about 18 per cent annualised.
As old time badla traders will instantly realise, the financier is effectively lending money at 18 per cent while the borrower pays that rate by taking the opposite position. The volumes generated were unreal, supposedly 25 per cent of India's annual raw wool production.
This kind of manipulation occurs only when liquidity is at a big premium and there isn't enough cash in the system to finance normal daily operations.
If the NSEL is an indication, banks, non-banking financial companies, and all rate-sensitive businesses will have a very hard time until the liquidity squeeze eases. Goldman Sachs, which has just issued an "underweight" grade to India, estimates that the squeeze could stay in force for three-six months.
Therefore, this could be a very bad quarter, or six months. There are very few rupee-income businesses that don't require working capital. FMCGs are one group that are, by and large, not debt-intensive. But FMCGs are also seeing selling as FIIs cut back holdings.
The other traditional defensive sector, pharma, is in quite a bit of trouble at the moment due to the US tightening of inspection regulations and quality-control standards on drug imports. This could be temporary but it will require time for the pharma industry to reboot to meet the new standards.
Amidst FII selling and a rupee-liquidity squeeze, the markets will eventually find equilibrium. But it could be a long way down and rate-sensitive stocks will be hit harder. There will probably be intermittent rallies but those could be false dawns.
Markets need liquidity. So do normal business operations. One way of calculating nominal GDP is to multiply the money in circulation by the number of transactions that money undergoes (the velocity). Real GDP is derived by adjusting this for inflation. The RBI has removed money from circulation. Unfortunately, there has also been a fall in velocity, if trading volumes are indicators. Hence, nominal GDP will reduce. It remains to be seen if inflation also comes down. If it doesn't, real GDP growth will also reduce.
Since corporate earnings are calculated on a nominal basis, without inflation-adjustment, the chances are earnings growth will be down. Lower earnings growth and higher interest rates add up to a toxic combination for valuations. The market could end up trading at a lower PE on lower earnings growth.