Managing Volatility Though our central bank would like to gradually reduce interest rates, our bond markets are dancing to the US Fed chairman’s tune Financial markets turned volatile in June, and for someone who tracks markets closely, it was like being out on a high tight-rope in the middle of a storm. Beginning at about 6,000, the Nifty dropped below 5,600, recovered to 5,900, and then in the first week of July, started plummeting again. In such times, though one has to shift balance constantly, it is worth trying to figure out the direction of the prevailing winds and, if possible, understanding the weather system from which the profound disturbances are generating. As participants in a global financial system, it is clear that we all take our cues from Ben Bernanke, chairman of the US Federal Reserve. His promise of continued liquidity has kept the world markets afloat and solvent ever since the 2008 crash, and for the last couple of years, the $85-billion question has been: When would he start tapering off his asset buying programme? In June, he made statements which some interpreted to mean that he would start pulling back sooner than later. The immediate impact of this belief was on interest rates in the US and the 10-year bond yield snapped up from under 2 per cent to over 2.5 per cent in short order. The increased cost of money and the fear that funds would tighten further sent investment managers scurrying to re-examine their risk-reward ratios. The immediate fallout was on fund flows in emerging markets. India was one of the worst hit and the fault lies entirely with our own economic management. We have become so dependent on foreign capital flows to keep our currency afloat, to pay for our imports of energy, and to sustain our equity markets that a single month of outflows had us reeling. The rupee hit a new low of `60 a dollar, first in late June, and then again in early July. Much of the pressure on equity markets came directly from the withdrawal of foreign investors. Simultaneously, a weaker rupee meant higher commodity prices, causing the Reserve Bank of India to turn tough on interest rates. For the equity investor, however, this means that a revival in Indian investment stands postponed. Bond markets sent out exactly the same signal. The 10-year bond yield had dropped to 7.4 per cent in May after RBI dropped the repo rate. With all the gyrations in the global perspective since then, the same government paper is priced at 7.7 per cent. This hardening of interest rates by some 30 bps suggests that the most basic price in our economy, the cost of money, is being set not by our central bank, the RBI, but by the interpretation of the monetary policy in the US. The popular interpretation could, of course, be questioned. Indeed, some commentators believe that Bernanke has left all his options open as a sustained recovery in the US is far from certain. If his asset purchase programme continues unabated, maybe money managers will put risk back into play. One does not know what the Fed chairman intends, but he has put a question mark under an easy money policy that lasts forever. My own sense is that we will not see US bond yields drop below 2 per cent again unless there is another financial crisis. And, with India’s vulnerability so sharply exposed, I think FIIs are going to be extremely careful about pumping billions of dollars into our economy in a hurry. The gyrations of June, in other words, are going to leave something of a deep scar on our economy. It seems as if we are fated to have the breath knocked out of us, time and again, till we take Spartan measures to beef ourselves up.
Posted on: Thu, 25 Jul 2013 00:02:13 +0000
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