The worst thing that happens to anyone i.e. fund managers, policy makers, corporates etc is when they get into the delusion that they can do no wrong. Prior success, public praise or huge valuations in the markets space for companies leads them to believe that whatever they are doing is right and they can do no wrong.
We have seen several examples of this running up to the Lehman Crisis of 2008. Banks which were seen to be infallible came down as pack of cards, Hedge Funds who could make no mistakes folded up and the stars of the bull market became fallen stars in the following years. Mistakes can always be corrected and we have seen several examples of this in the past. Nokia & RIM which could make no mistakes lost market share and went into losses as they did not adapt to changes in the market place. Now both these companies are on the way to resurrection. Sony, the company which could make no mistake and was such a huge name in India totally lost the plot over the last 5 years. Apple rose like anything with its consumer friendly and market redefining products before lately falling into the same trap where newer products were just incremental improvements over the earlier ones and as such not very successful. Who could have known even two to three years ago that a company like Samsung would be redefining product designs not only in Televisions but across the mobile universe and now in Laptops/Ultra books as well as Cameras?
In the financial world the list of fallen angles is much more prominent as the excessive risks that the banks took was never recognized, which eventually lead to the bankruptcy of so many. However we have seen some of these banks come back lately with revised business models and could grow stronger going forward.
The biggest story that used to go around when we started our professional career around 18 years back was how the fiscal surpluses in the US would eventually lead to a complete exhaustion of US Treasuries and lot of people used to wonder how countries will deploy their foreign exchange reserves. As we have it the total debt of the USA today stands at over $16 trillion and growing and the concern today is about the ballooning fiscal deficit and the balance sheet liabilities of the US Fed. Mr. Greenspan who was considered to be the paragon of virtue and someone whose moves could not be questioned is widely criticised today, albeit still not so much publically about the propensity of monetary policy under him to both create and let bubbles expand. Even if bubbles were pricked it was done much after the bubble became too big. The FED under him could not see the risks associated with growing off balance sheet items across the financial world which eventually lead to the burst of the bubble in the year 2008.
Such examples are also found across countries where the Asian Tigers could do no wrong in the mid 1990’s and the fallibility of the model was visible after the Asian Crisis. Today we see the same examples in the Euro Zone where the fall in bond yields across countries after the formation of the Euro Zone led to excesses both on the Sovereign and Private sector side. The fall in borrowing costs under the common currency despite differential macro economic trends across the EU countries has created the crisis where the stars and colonial rulers of the past today have either been bailed out or are on the verge of being bailed out. Similarly we have seen the decline of countries like Japan which could do no wrong in the 1960’s to 1980 but have been seen to do not much right since then. The country has been under deflation and subpar growth for decades now.
I think the key to bouncing back lies in recognizing the mistakes that are made and correcting them without holding on to the dogmas of the past. Unfortunately in India we today see the RBI in the same delusion as other successful institutions/corporate/countries have been in the past. Excessive praise about their handling of the crisis in 2008 & the fact that they have tried to show that they are totally independent and if a public poll thinks that they should take a particular route they normally go the other side is leading to a severe stress on the economy.
Today we see extremely out of the box thinking across the Central Bank universe. The US FED has been the leader in the unconventional policy environment which have been criticised by many but has been successful in avoiding a depression led by deleveraging as well as high leverage across the households in that country. The ECB has been adaptable, but tried to hold on to traditional monetary policy for a very long time before, under Draghi they finally realized that they need to move towards unconventional policies or else market scepticism on baby steps would force a big crisis in Euro zone. The Japanese are now becoming forceful in national interest and the central bank and the government are working together to somehow take the country out of the deflationary cycle. Whether they are successful or not will be seen in the future.
The problem of monetary policy in India is their excessive belief in the fallacy that we in India are living in a cocoon and external policy developments do not have any effect on us. In a world swash with money there necessarily will be a phase of higher inflation as commodity prices remain inflated for a prolonged period of time. I have tried to do a correlation between food and fuel inflation and RBI policy rates and have found no correlation, if at all it has been positive i.e. food inflation has risen as RBI has hiked policy rates. Excessive external praise, poor guidance of some influential FII brokerage economists combined with an inability to adapt the policy environment to the changing global monetary policy environment has now placed them in a trap laid by them. Internally they might believe today that they cannot bring down CPI via excessive monetary tightening. However they cannot be seen to be losing public face. Otherwise how do they explain record high CPI readings at a time of huge monetary tightening and record high interest rates in the economy.
The impact of high interest rates on corporate balance sheets, the investment environment as well as a lack of pick up in exports despite an extremely competitive exchange rate are there for everyone to see. The logic given for high rates is that savers much be protected in an inflationary environment. Then what explains the poor accretion in bank deposits. How can a couple of points higher interest rate on deposits protect savers from inflation when a large part of the consumer consumption basket lies outside the items that have any impact of monetary policy i.e. food, fuel and also housing where prices have refused to correct & have infact risen in an high interest rate environment.
Given the fact that the government has moved on reforms, subsidies, expenditure etc it is time for the RBI to act decisively to revive growth. Somewhat higher headline inflation will remain due to money printing globally as well as the adjustment of controlled prices on fuel, fertilizers and electricity on the headline rates. This is not inflation of today, but of the past which is getting recognized today and this difference should be apparent to the Central Bank.
If the government moves as it has over the last six months we might actually see that the government criticised for the worst governance in the last 20 years actually turn around and the Best Central Banker turn the Worst.
MARKETS
Lately we have seen a slightly different phenomenon in the stock markets globally with the developed markets outperform EM’s. Improving economic data in the US and stabilization of Credit markets in Europe are two phenomenon driving this move. Japan is attracting lot of attention due to the sharp fall in the currency and the impact of the same on the profitability of exporters out of Japan. On the other hand it is very clear now that two of the large EM’s i.e. India and China seem to be on the revival path now. As such the current market moves are just a phase of consolidation in the larger move that will fructify going forward. India is actually the best placed today with a currency that is hugely devalued, interest rates in the economy that are near the highs of 2007 and economic growth that has bottomed out. Most market players are still looking for the top rather than levels to buy; it might make sense to see things the other way.