AN EXTENDED LOW RATE CYCLE AND INDIA

The last few weeks have reinforced the rate cycle assumptions that low global interest rates are here to stay longer and to that extent give a greater opportunity to RBI and the Indian Government to replug and accelerate the economy.

Low inflation globally has pushed Global Central banks in the developed world towards more and more easing. The US FED stopped pumping in liquidity into the global economy last year. However the multiplier effect of the same is still playing out. We all know that the Bank of Japan is also pumping in huge liquidity and the ECB has stepped in from this month. The impact of ECB bond buying (money printing) on global flows can be quite significant as unlike the money printing by the US FED, the ECB is starting at a time when bond yields across the Eurozone are at all time lows by a wide margin. Also with negative bond yields across the short end cycle playing out in many countries of Eurozone as well as Japan the likelihood on money flow out from these economies into high yielding Emerging Market assets is only increasing.

The US FED has also indicated slower rate increases in its last meeting.  The most important thing this time is that the cheap money that is sloshing around has not been used to pump up commodity prices given the growing surplus across commodities. Some part of the liquidity, especially in the US has gone towards a higher credit growth and lot of this money is flowing into global equity markets as well as global bonds.

From an Indian perspective the extended rate cycle is good in more ways than one.  When the US FED did its initial Quantitative Easing (QE1 & QE2) a lot of the liquidity went into speculation in commodities and pushed up inflation in India. However this is not happening now as growth is anaemic in most parts of the world and we also have a Chinese economy that is slowing rapidly. As such the tables have turned and the negatives of excessive liquidity have been nullified from an Indian perspective. As a result we have seen huge money flow into Indian Equity and Bond markets.

The opportunity is there today to attract huge FDI into India. Some part of this will flow in as primary equity into Indian Companies, however a lot more can come in via Private Equity, REITS, Annuity based infrastructure projects etc. The government in the recent past has shown some urgency in pushing economic growth. More needs to be done to get in sustainable long term FDI.

The impact of the collapse in crude oil prices is yet to flow into the Indian economy. The direct benefit is $ 40-50 billion i.e. equal to a 2-3% push to the domestic economy. On the other hand exports are suffering due to an uncompetitive rupee which has been stable at a time of carnage in global EM currencies. Although the RBI has the opportunity to accumulate Forex and push in INR liquidity into the market it does not seem to be doing that. RBI’s easing cycle has had little impact in terms of lending rates of banks. This can serve the dual purpose of inducing some INR weakness and also increasing system liquidity which will lead to lower lending rates. Being happy at a lower Current Account Deficit just due to a collapse in crude oil prices does not reflect long term vision. Exports need to move up and sustain the lower CAD. Make in India also becomes tougher with an overvalued currency as imports are much cheaper. As the economy revives and imports increase we could see the CAD move up again.

Overall lower global rates for an extended period of time give the opportunity to RBI to ease more. We should see further moves by the RBI in April which will push banks to reduce lending rates. The front loading of rate cuts is likely to play out strongly.

MARKETS

Stock Markets have corrected 6-7% from the top. Another 5-6% should take out the froth from the markets and create better investment opportunities. This could take the markets down to levels seen at the beginning of 2015 and would meet my expectations at the beginning of the year that the first 4-5 months of the year are unlikely to see any significant returns. However as things seem at this point of time the second half could be better than what I initially visualized. Will update more on this later as the correction plays out.

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