By the time the year 2013 gets over, the traders and investors would have got first class lessons in fiscal deficits, Central Bank actions and their impact on the currencies and stock markets. We are saying this because those who do not appreciate the evolving relationship will have to go into forced hibernation.
Our biggest risk at this point of time is the depreciating currency. The Rupee, which quoted at 53.74 to the U.S. Dollar on 2nd of May, 2013 rocketed to 60.59 by 27th of June. This 12.75% depreciation in a matter of little under two month time does not augur well for the currency, debt or equity markets.
We are weaker than 2008
The situation today on the foreign debt front is weaker than what it was in the year 2008. At that time, we needed to repay or roll over just $ 54.7 Billion. This represented just 17% of our forex reserves. Today we need to pay $ 172 billion before March 2014. This makes the one year repayable debt as 60% of the forex reserves.
The current account deficit (CAD) at that time was just 2.5% of our GDP. Today CAD is 5% of the GDP.
Weak Rupee will also hurt rollover of Foreign Currency debt
We have to repay $ 172 billion before March 2014. Such debts are usually rolled over. We should be able to roll over this debt. But the problems will arise with the rates. With a weakening currency the lenders will demand their pound of flesh in terms of higher yields. The cost of servicing this debt is likely to go up.
Fiscal Deficit is rising
The Fiscal deficit during the April-May period shot up to Rs 1,80,691 Cr. To give you a perspective, this is almost 33.3% of the full year’s budgeted deficit of Rs 5,42,499 Cr. If the fiscal deficit continues this way, we would have consumed the entire year’s quota just six months into the financial year by September 2013.
Last year in the same period, the fiscal deficit was 27.6%.
One of the contributory reasons for the larger fiscal deficit is that Government’s receipts stood at 3.3% of the budget estimates this year as against 5.5% in same period last fiscal. Corporate tax collections were negative for the period as refunds were higher than the mop up. The excise duty collections were also lower by 37% from last year.
One hope is that the Government will not cut down on expenditure as it did last year. The Government will go out and do the planned expenditure as scheduled but will try and cut non-planned expenditure, which might catalyse growth.
Fed easing has fuelled emerging markets
In order to stimulate its own economy, the Federal Reserve embarked on the easy money policy that entailed lower rates and enough liquidity in the system. For more than 4 years now the rates in the U.S. have remained near zero. The easy and low cost money soon found its way into the markets and part of it in the emerging markets.
The continued low rates and easy money enabled the Dow and the S&P 500 to reach life time high figures in May earlier this year.
Fed signals tapering
On June 18 , the Fed finally said that it would begin to taper its bond buying programme. The Fed has been buying $ 85 billion worth of bonds every month. This has been the Fed’s strategy to keep the markets well supplied with liquidity.
We all know what happened there after. Barring the U.S. Dollar, all asset classes be it Equity, Bonds, Commodities, Precious metals and currencies were beaten with a sledge hammer across all markets and geographies.
This was waiting to happen. Ever since the Fed began its QE3 in October last year, it was known that emerging markets were partying on borrowed times. Whenever the Fed music will stop, the emerging markets will sell off.
22nd May is the water shed
While this worry had been on the mind of the investors for a long time, it really caught the fancy of the markets when the minutes of the April 30 FOMC meeting were released on May 22. The minutes showed that some members had urged that Fed begin tightening its stand from the June meeting itself.
May 22 has been a watershed day in the global markets because volatility has increased since then across all asset classes. The yield on the US – 10 year, which was quoting at 1.94% on May 21 jumped to 2.25 on the eve of the FOMC meeting and it closed the month of June at 2.51%.
Fed stirs up the hornet’s nest
The mere expectation that the Fed could consider slowing its stimulus programme has sent the bond yields in the U.S. higher. This has changed the equations for the FIIs who invest in the debt market in India. While the Repo rate cuts by the RBI have not been passed on to the Indian borrowers, the yields of the bond holders have been shaved. As a result the FIIs find the Indian bonds not worth their while considering the risk they entail.
Till 21st May, the FIIs had invested Rs 30,471 Cr in the Debt market in the calendar year 2013. As of Friday 28th June, the figure stands at minus Rs 9,089 Cr. In other words, since May 2013 they have sold off more than what they had earlier bought in the whole year. No wonder the Rupee has seen a life time low last week.
Why did Bernanke hint at tapering
Ben Bernanke, who’s second four year term ends in January 2014, will probably hang up his gloves at the Fed. It first became clear that Bernanke has no intentions of going for a third term at the Fed when he spoke at Princeton University earlier this year. It became further clear when he made it known that he is not coming for the Jackson Hole Symposium, where the Fed Chairman necessarily presides. It became known to the world that Bernanke will be replaced when President Obama said in a rather unbecoming way that he had stayed longer at the Fed than he(Bernanke) had hoped to stay.
Bernanke, who’s PhD thesis was on Great Depression, was nicknamed as Helicopter Bernanke’ after his 2002 speech where he spoke on "Deflation: Making Sure It Doesn't Happen Here". He referred to economist Milton Friedman's idea of a "helicopter drop" of money into the economy.
Since Bernanke initiated the easy money policy it was only appropriate that he at least signal a winding up of this easy money policy before his retirement. That may have been the reason to actually say what he said on June 18. Having signalled now, even if the Fed does not, he has done his duty and history will record that.
FOMC is the only hope
The Fed Open Market Committee ( FOMC), the policy making arm of the U.S. Federal Reserve, will decide when and how much to taper. The Fed has clearly laid down two targets of Full Employment and Inflation. The Fed sees full employment if the Unemployment rate falls to 6.5%. Currently the rate is 7.6%. Inflation target is 2%. Currently it is at 0.74, which is very low.
The FOMC will decide on tapering based on the incoming data. The numerous FOMC members have given their version of what they think the Fed might do, prompting an economist to call the FOMC as the Fed ‘Open Mouth’ Committee. These speeches by the FOMC members have added more confusion to the possible Fed action.
We have said earlier that the Fed policy is not cast in iron. It can change on the basis of data. The only hope that we in India have is that the data coming out of the U.S. is tame enough to allow the U.S. Fed to keep its pedal pressed on the gas of liquidity so that emerging markets in general and India in particular could breathe easy.
Our fate is tied to the apron strings of the U.S. Fed.
But if the surging yields on Government paper both here and in the U.S. are any indication, it is clear that the days of low rates are numbered and we should brace for higher interest rates.
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