Over the last few weeks we have seen unprecedented volatility in most asset classes. It has become fashionable globally as well as in India to blame everything on ‘FED TAPERING FEARS’. It is most ridiculous that structural problems that face various economies starting right from the United States to Europe to Emerging Economies is being blamed on potential Fed Tapering.
It was very clear that bond markets were mispriced at the beginning of the year where bond yields on the US and German bonds had gone to historical low levels. I had written a piece at that time that the bond market bull phase was likely to end earlier than later. At levels touching 1.2-1.4% for a 10 year bond the yields were clearly unsustainable. Given signs of recovery in the US economy combined with clearly a deliberate strategy of the Federal Reserve to get asset pricing back to reasonable levels by making Tapering comments we have seen a significant sell off in bonds over the last six months. The most ridiculous commentary that I read is when Tapering is blamed for both rise and fall of commodities. It cannot work on both sides isn’t it?
The bigger hit in currencies, bonds and equities have been seen in countries that are perceived to have unsustainable Current Account Deficits. As such we have seen the currencies of countries like India, Brazil, Turkey, South Africa, Indonesia etc sell off severely. Now is the reason for this “FED TAPERING” as most would like us to believe. It is clearly not. If unsustainable Current Account Deficits are built up over time which is financed by hot money then the blame cannot be on a Tapering that has not even begun. Even at the level of tapering that is being talked of at this stage i.e. $ 85 bn of bond buying going to $ 65 bn it is still higher than what it was before the current level of bond buying was started last year.
Moreover there are currency and other asset class movements that totally prove the theory of Tapering Fear wrong. If tapering was the reason then the US Dollar Index should have been rallying. The reverse is actually true where we have seen the USD Index peak out in early July and actually fall by nearly 5% since then. If global dollar strength was the reason for the fall in the troubled EM currencies then this should have been visible against other currencies too. The fact of the matter is that it is wrong policies that encouraged short term Current Account funding without treating structural issues which has led to the situation today.
Supply side pressures across sectors in the country that need a domestic policy response cannot be blamed on the FED. If we have not increased supplies and need to import things that we could produce domestically is not the US FED’s fault.
In the Indian context we saw that lack of growth in exports combined with huge growth in imports led to the government loosening the entry rules for FII’s into government bonds on a continuous basis. This got short term players in, who also exited as fast. The RBI governor who famously said “The cost of a failed defence of the rupee is greater than no defence” got into the game and created a failed defence by taking policy measures that will lead to a complete collapse in growth and increase in inflation. The government on its side, instead of trying to increase exports by taking proper policy measures is trying to restrict imports which will not solve anything in the long run. Exporters unfortunately are under pressure despite a very competitive currency today due to huge interest costs and a complete collapse of domestic demand for their products which is preventing them from taking advantage of operating leverage. The success stories here are pharmaceutical and Technology exporters who have strong cash flows and balance sheets that carry no DEBT. However for most of these companies it just improves their profits as business increase especially for pharmaceutical companies is not possible just because the INR has fallen. Technology companies are leveraging the added benefit by increasing sales efforts which combined with an improving US economy will benefit them in the long run.
However other manufacturing companies facing domestic stress and high interest costs will improve their exports only gradually.
RBI on its part always knew the risks associated with the high CAD. As such if they had not used the INR appreciation as an inflation controlling tool but kept the INR low at a time when there were strong capital flows it would have helped the economy in two ways. The Forex reserves would have seen a build up and exports would have picked up. However the RBI has taken short term views which are hurting us now.
The US FED is not responsible for FDI flows drying up into India. FDI has dried up due to pathetic government policies. India offers huge nominal returns across industries to foreign investors. However if they feel unsure, unsafe and see unstable policies then they will postpone investments at a time when we need them the most. Foreign investor money has got stuck in a large number of infrastructure sectors in India. Investors have lost money not because they did not do proper due diligence on the projects but on Govt of India.
If FED Tapering was the reason for chaos it should have been more of a global phenomenon. The global environment is quite benign with most stock markets quite stable. Infact even a market like Brazil has seen strong recovery from the bottom over the last few weeks despite their currency being as weak as the INR as the government and Central Bank are not panicking. Most erstwhile troubled countries in Euro zone have actually seen their stock markets do quite well.
Although there is much more I can write on this issue I will rest now. DO NOT BELIEVE THE BOGEY OF FED TAPERING. It is just a withdrawal of steroids that is much required.
MARKETS
We have seen the collapse of all asset markets in India. Bonds, Equities and the Currency have sold off as the government and RBI seem to have lost control. It is clear that we are not in a 1991 like situation and are much better off. A large number of infrastructure projects can still get huge foreign investments if there is policy clarity however it does not seem to be happening at this stage. We see panic in all asset markets and we should see a panic bottom being formed as INR is heavily oversold, Bonds are heavily oversold and equities also look very cheap. However a structural change in trend does not seem visible anywhere in the horizon.