I guess the FED TAPERING or Not Tapering event would have been the most watched show on business channels in India and abroad for the year 2013. As it turned out the FED decided to oblige the Emerging Markets and gave them a breathing space to adjust their policies and get in control of their currencies. It seems that the G20 summit a few days back worked and they were able to convince the FED officials to postpone the tapering by a few months. Obviously they will not accept this, however the pressure during the G20 event was very evident and it was the most discussed point at that time. The apparent thesis is that the US economy is not improving the way it should. However there is only so much an economy can grow at a time of deleveraging that still seems to be on. However the warning that the FED gave a few months back could really have positive ramifications for EM’s like India where a sudden withdrawal would have created a big shock.
Raghuram Rajan took a welcome decision to hold RBI’s policy meeting subsequent to the FED policy as there was no sense in taking a decision without knowing what was going to come out of the FED. The unfortunate part is that most armchair economist forecast a no change policy where it was very evident from the day that Rajan took over that the first move will be a hike in policy rates. Subbarao’s retrograde policies needed to be reversed. However that reversal had to take place in a staggered manner and it was obvious that Rajan could not snub the policies of his predecessor. There is no case to be negative on a 25 basis point hike in policy rates. The fact of the matter is that Subbarao had taken the overnight rates up to a level of 10.25% in one shot from 7.25%. This kind of hike in overnight rates was not seen in any other Emerging Economy and neither did it have any impact on the currency.
Now two things are going to happen over the next three months. The overnight borrowing rates that have been bought down to 9.5% today will further go down to 8.5% in the next policy or maybe 8.75%. Secondly, there is going to be a huge flow of liquidity into India due to the Forex Swap that has been announced by the RBI. These USD flows will get swapped into rupees and be available for lending into the domestic markets. Nearly $ 1.4 billion have already come in just 4 days of the opening of the window. A number of banks would have been waiting for the FED policy to get over before working on getting in more money. The ranges of flows that are being projected are in the range of $ 10 to $ 30 billion. My view is that given the way the swap is structured where there is no real risk to the banks and they get 3.5% from the RBI and their dollars back at the end of the tenure the total flows will be more near the upper end of this range. Now imagine what a flow of $ 30 billion means. Firstly it creates a huge Foreign Exchange buffer in these uncertain times and secondly at a conversion rate of 60 it gets in liquidity to the tune of Rs 1,80,000 Crores for the banks. This liquidity at a time of reducing trade deficit and low gold consumption is a substantial figure which will go into credit flow for the economy and aid economic growth.
This money flow has to be seen in the context of the fact that the total deposit of banks at the end of last financial year was Rs 70 lakh Crores. The growth in bank deposits last year was in the region of Rs 9,50,000 Crores and a figure of Rs 1,80,000 Crores in a period of three months is equivalent to an almost doubling of monthly deposit flows. This will ease out domestic liquidity significantly and lead to lower lending rates.
I am of the strong view that RBI under the new governor will take prudent steps that are appropriate for long term sustained growth of the economy.
Geopolitical Developments
The other important development at a global level is related to what is happening in the Middle East which in my view is very significant as far as the risk premium of Crude Oil is concerned. The Syrian situation seems to have been controlled and any attack on Syria now is at least 9-12 months away. As such an attack by Western Forces that was looking imminent is not going to happen now. The other more important event has been the conciliatory tone being deployed by the new leadership led by President Rouhani. Now what needs to be seen is, whether it is a delaying tactic or a genuine move to re-engage with the UN. In case Iran really takes moves towards reconciliation we could see a risk premium for Crude oil collapse by at least $10 per barrel. This could be quite positive for India. We should get move clarity over the next few weeks.
Markets
Stock markets started moving up since the end of August after a panic fall prior to that. The fall coincided with the fall in the value of the INR and CAD concerns. I don’t know how many people would have noticed; we hardly hear the CAD word anywhere these days. A PIG (Portugal, Italy, Greece, and Spain) similarly seems to have gone out of the dictionary. It was the most used word in the period May to August. The outlook for the Global Economy is constructive with growth stabilizing or picking up in China, US, Europe & Japan. Growth has still not picked up in India; however the growth seems to have clearly bottomed out. Directionally a number of global equity markets have made significant moves that are technically significant. A market like Germany has seen the DAX move above the peaks of 2000 and 2008 this time. The US markets as well as a number of other EM markets are in new zones. Spanish/Italian markets have formed inverted Head and Shoulder patterns which are extremely bullish for the long term. Incidentally these markets have turned out to be lead indicators for EM’s.
Euro zone was supposed to collapse last year; however these markets have actually done very well since September last year rising more than 50% from their bottoms. Is the same possible in the CAD troubled Emerging Markets next year? Very much so.