We are aware and it has been discussed ad nauseaum about how the lack of decision making at the government levels has bought the investment cycle at a standstill. I think we will need to discuss more about the same after the 6th of March and the Union Budget. It is obvious that this part of policy making cannot deteriorate further, however how fast it improves is critical to see.
I am more worried about the academic response on slower growth from the monetary authorities. I was particularly disturbed to see the comments of one of the key spokesmen of RBI who propounded that “Rise of crude prices over the last few days makes the task of monetary policy complicated”. My question is that should central banks be looking at weekly price movements of commodities for taking a call on monetary policy. What if this is used as an excuse not to cut policy rates and then crude prices crash by 10% in the following week. Has monetary policy become so shallow?
The important things that need to be noted are whether the increase in prices at this stage in the economy is demand related. The more important factors are
- The GDP growth has declined to a multi year low in the third quarter of the current financial year. Manufacturing growth is down to a mere 0.4%.
- Credit growth has slowed down substantially and is running below the RBIs target by nearly 150 basis points
- Money supply growth has fallen much below RBI’s forecast level for the current year
- The capital expenditure cycle is in doldrums not only due to government inaction but also crippling interest rates
- Demand growth of interest rate sensitive industries across the board has fallen substantially. Be it real estate, automobiles, consumer durables etc
- Most central bankers across the world have moved to a more accommodative monetary policy as they have taken into consideration increasing growth concerns
- The liquidity deficit in the system continues to be at all time highs. Baby steps by the RBI have not done much to alleviate the situation. There is need for much stronger action
- The incremental value of a tight monetary policy has diminished significantly and the negatives of the same outweigh positives hugely
The fact of the matter is that most large commodity players worldwide are very well off financially and enjoying huge cash flows. This combined with ultra low interest rates available to these companies has increased their ability to hold prices by holding on to their products and restricting supplies. This is a structural change (at least for some time) and as such despite extremely bleak economic growth scenario worldwide the prices of most commodities continues to remain elevated. As an example, as per the International Energy Association the growth in demand for crude in the year 2012 is expected to be virtually flat and if at all a 500000 bpd increase is possible. This is down from a forecast of over 1.5 mbpd increase just a few months back. In this scenario crude price at almost all time highs reflects extreme speculation, even after taking into account the Iran Iran
The Indian economy needs significant monetary easing as the tight policies have not had the desired impact. The utopian dream of a 4-5% inflation target should be put aside for the time being. In the new normal of zero percent interest rates in Western economies we will need to live with higher commodity prices for some time and as such inflation targets should be kept higher. As and when the US Fed starts its tightening cycle we will see much lower commodity prices, however this still has a couple of years more to go.
On a separate note I wanted to comment on the rampant commodity speculation on Indian commodity exchanges
Commodity exchanges have become the fresh grounds for rampant speculation. Commodities like guar, pepper, jeera etc have become the new penny stocks that are the favorite of speculators. The price swings in some of these commodities is much higher than in the equity markets. In the absence of commodity trading we never saw such swings. The only beneficiaries of these seem to be large speculators and not farmers or consumers. It is important for the commodity regulator to look into how trading is happening in some of these commodities. In case of global commodities where the Indian prices largely follow international prices this issue is not so significant. However some domestic consumption oriented agri commodities are falling prey to this extreme speculation.
Markets
The Indian stock markets have become volatile after a strong up move. This has largely been due to higher crude prices and the expectation that monetary easing might be pushed back. Let’s hope better sense prevails and the easing cycle in terms of policy rates starts this month itself.
Typically bull cycles have lasted 14-24 months before any major correction sets in. Under the circumstances the current bull market is still in its infancy and has a long way to go. Small dips at various points of time will be good buying opportunities. That said the importance of the 6th March election results cannot be discounted. The pace of the up move is going to be clearly dependant on the result of this event. As far as I am concerned the budget is a non event and with the little maneuverability that the finance minister has not much should be expected. Overall I continue to be constructive on the markets and am keeping my fingers crossed for the 6thof March.