Can India survive QE tapering by Fed? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Can India survive QE tapering by Fed? 

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In this issue:
» Debt woes continue for India Inc
» Will India become energy independent by 2030?
» 7 new bank licence coming soon
» Does monetary policy help in boosting jobs?
» and more....

For years, emerging-market currencies benefited from the US Fed's ultra-low interest rates and easy-money policies. Since the time the US Fed adopted near zero interest rate, cheap money in the developed markets found its way to emerging markets, particularly ones in Asia.

But this trend showed a sharp reversal when Fed Chairman Ben Bernanke signaled the move to exit quantitative easing (QE). More than US $47 bn has been withdrawn from global funds' investments in emerging market stocks and bonds since May 2013. The largest reaction of this was on the currencies of current-account-deficit (CAD) countries. These include the Indian rupee, Brazilian real and Turkish lira. These currencies were most vulnerable to Fed guidance because they rely so heavily on foreign capital flows to fund their current account gaps. This sell-off reminded everyone of the 1997 Asia financial crisis. But, according to CNN Money, the present situation is very different.

The depreciation in Asian currencies is not a reflection of their regional economic weaknesses. The economic fundamentals of the region have strengthened due to the prudent economic policies implemented since the 1997 crisis. Similarly, Asian companies and financial institutions have built stronger balance sheets and healthier gearing levels. This has made them more resilient against market volatility. Asian policy makers are also more proactive and pre-emptive in managing asset price inflation and consumer credit.

Additionally, Asian economies have benefitted from rising intra-regional trade, investments and consumer affluence. These trends will continue to drive the region's economic growth and cushion it from possible global capital outflows. It is true that QE pullback announcement has put pressure on Asian currencies. But it is more due to the result of improving growth prospects in the US. As a result money is starting to return back to the US.

The US Fed's decision to postpone the "tapering" of its easy money policy has given emerging Asia valuable breathing space. But with continued uncertainty over the Fed's actions, how long before the Asian market sell-off begins afresh?

It remains to be seen to what extent a scaling back of QE will impact financial market conditions in emerging Asia. What is clear, however, is that asset prices that have become unnaturally inflated by cheap money will correct. Whether or not in the proportion of 1997 crisis, the correction will be painful, for Asia in general and India in particular.

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How could the QE tapering affect Indian stock markets? We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!

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01:12  Chart of the day
The Reserve Bank of India (RBI) in its September quarter review surprisingly increased the repo rate on concerns over inflation. One macro issue in India that deserves renewed attention is the preference for the wholesale price index over the consumer price index for tracking inflation. Indeed, the WPI is given much greater importance than the CPI by the Reserve Bank of India for calibrating its monetary policy. This is a serious policy faux pas. Or core inflation - defined as non-fuel, non-food inflation? In the past, WPI and CPI inflation moved closely together, so ambiguity on which rate to focus on was not such an issue. But over the last five years they have consistently diverged - largely due to food inflation, which has a much bigger weight in the composition of the CPI Index. India's use of WPI inflation for monetary policy is in contrast to the reliance on CPI inflation by central banks and governments in other countries. Perhaps the RBI should rethink the way it gauges inflation.

Inflation by WPI and CPI
Source: Business Standard

It is not at all an overstatement when they say that debt is dangerous. The problem is that interest expenses are a fixed cost. You have to pay them irrespective of how the sales and profits are performing. This is the reason why too much debt in an adverse economic scenario can wreck havoc with a company's finances.

The woes of debt-laden Indian companies are getting worse. The quantum of debt for restructuring in India Inc has been growing at an alarming rate. Here are some worrying figures reported by Business Line. During April-September 2013, debt aggregating about Rs 645 bn was referred to the Corporate Debt Restructuring (CDR) Cell. This is a 63.5% jump from Rs 394.35 bn referred in the corresponding period of the previous fiscal. It must be noted that the quantum has increased despite tightening of the CDR norms.

What are the reasons for the financial problems of the highly indebted companies? Poor economic environment and regulatory hurdles rank as the key reasons. The outlook for the Indian economy continues to remain bleak at least over the medium term.

One of the largest components of India's import bill is oil. This is why variations in international crude prices as well as movements in the Rupee make our policy makers so jittery. Therefore it would be a relief to hear that the Oil & Gas Minister thinks India would be energy independent by 2030. In a recent interview carried by the Mint, Mr Moily has stated that he thinks oil imports could come down by 50% by 2020. He expects imports to come down further by 75% by 2025; and for India to be energy independent by 2030. What is he basing this statement on? Well India does have energy resources. It is just a question of mining and exploiting the same. On the face of it such declarations are indeed welcome ones. But the question is if India really does have these resources, then why haven't they been exploited before? More importantly will companies be interested in exploiting them now?

This is where the problems of India's energy sector become even more glaring. The current regulated pricing of fuels has resulted in massive under recoveries and losses for the companies. Such losses provide little incentive to new companies to get into this sector. In addition to this pricing issues in existing fields have resulted in low outputs. Projects are also getting delayed thanks to the rigid clearance system. So if the Minister and the government are actually interested in boosting India's oil output, they would have to take a look in to all of these issues. Unless they are resolved, such statements would remain only that - statements; nothing more than that.

Despite being acutely affected by the economic slowdown, this sector remains in the wish list of government and private sector alike. The licenses for new banks in India have been under deliberation for a while now. RBI governor Dr Rajan has committed to issuing the licenses by end of the fiscal. And despite the RBI's initial reservations about allowing too many entities to foray into banking it seems the number is not too small. As per Economic Times, the RBI has decided to issues banking licenses to 7 applicants. More importantly, in the RBI's own words, the entities fetching the license will not be 'look-alikes'. The RBI had earlier proposed differentiated licensing. This is a practice already followed in the US and Singapore. Differentiated licensing could enable specialists such as infrastructure lenders or gold loan companies to do niche lending. Such banks get a regulatory treatment different to what it is for existing banks. For now, nothing except the number of licenses to be issued is finalized. However, we believe that the new entities will not immediately have a meaningful impact on the level of competition in the sector. In fact, it will be at least two years before that is the case. Meanwhile, the inefficient entities need pull up their socks.

Post the 2008 financial crisis, the US has been plagued with problems of recession and unemployment. The only solution the Fed has come up with has been is QE and more QE. Its rationale being that more money would induce people to consume more. This in turn would fuel growth. The reality has not surprisingly turned out to be quite different. Five years since, unemployment and low growth continue to haunt the economy. QE has hardly achieved anything meaningful. And it certainly does not have the potential to improve job prospects. At least this is what Fed Bank of Richmond President Jeffrey Lacker believes. As per him, the US labour market has become less efficient in matching jobs with the required working skills. For this, streamlining of education is essential. Something that monetary policies can hardly bring about. But the US Fed seems to be in no mood to listen to logic.

In the meanwhile, the Indian equity markets continued to trade below the dotted line. At the time of writing the BSE-Sensex was trading lower by about 117 points. Barring stocks from the information technology, metal and healthcare spaces, losses were seen across the board. However, midcap and smallcap stocks were trading higher with the BSE Mid Cap and BSE Small Cap indices up by about 0.2% and 0.4% respectively. Barring China, markets in Asia were trading weak overall. The European markets have also opened on a weak note.

04:55  Today's investing mantra
"There's no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or worse, to buy more of it when the fundamentals are deteriorating."- Peter Lynch
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6 Responses to "Can India survive QE tapering by Fed?"

DEinesh Vaidya

Oct 13, 2013

India can definitely survive if massive corruption and massive wasteful publc expenditure are dealt with.


Dr. Arun Draviam

Oct 9, 2013

India was lucky not to be badly affected by the 1997 South East Asian crisis.
The crisis was caused by bubble in the realty sector. One American, George Soros could cause the havoc and ultimately it was the US, as a country, which had to bail out Malysia as US investments into that country would have gone bad.
India was on the verge of going for full Capital Account Convertibility (CAC) as per the calibrated road map laid by the Tarapore Committee but India held back soon. India had 100% trade related Current Account Convertibility (CAD) in place by then.
The CAD in India is worsening not so much due trade but due to Government spending on vote-bank related unproductive policies. America has recently resorted to shut down, due to popular healthcare policies. So QE on the one hand and huge CAD on the other America is bound to suffer. India will suffer more because of the Indian urbanized population aping American work culture and abandoning thrift.



Oct 7, 2013

Sir, you have not considered the role of black money generated in India and parked outside the country. Doesn't it play its own game? For example,black money generated couple of years ago , converted to Dollar and parked abroad may come back to India when rupee value goes down will create huge profit for the black money holders.


Umesh Sharma

Oct 7, 2013

The economies of countries like India can certainly escape the vagaries of US law makers if we are prudent in how we handle the exchange of US dollar.If every dollar is used for investment purpose duly ensuring a good rate of return via exports we will always be in surplus of our requirements.This will have the effect of strengthening of our currency gradually.In the same way the consumption needs particularly for energy are to be regulated by encouraging gradual development of alternatives as well as exploiting our own hydrocarbon resources in an efficient way.Import of capital goods should be strictly on the basis of their capacity of self servicing.In short prudent policies can certainly make our currency free of the influence of international developments.


Ganesh Sastri

Oct 7, 2013

If the currencies of India, Brazil and Turkey went for a toss, they have to blame themselves and not a rank outsider like USA. Each of these countries is LIVING BEYOND MEANS - running up increasing Trade Deficits. India's problems are: MASSIVE INFLATION during last five years & MASSIVE TRADE DEFICIT year after year. Trade Deficit for Mar 2013 exceeded USD 200 B is NOT sustainable. Change in value of local currency is primarily dictated by this deficit. Dependence on fair weather friends like FDI, Foreign fund inflows to keep consuming beyond means is at best temporary and when the fund flows reverse, there is a sudden and swift devaluation of a local currency even against a fundamentally weak dollar. US government and public have also been living beyond means and if the INR devalues against $, it shows how poorly we have been managing our trade deficits. We need to increase productivity at all levels, increase exports of manufactured goods ( not just pig iron and raw materials), use solar power widely, bring costs down etc etc if we are to maintain value of INR.



Oct 7, 2013

Whether it is your home or a country that you are talking about the basic principles are always the same. If you borrow to cover the excess of expenditure over your income you will go bankrupt sooner than later. Stop all unnecessary government expenses including those fabulous perks to the elected reps and senior babus and make them pay for everything themselves just like any common tax paying law abiding citizen. If you need further cuts, then cut their salaries. Let them feel the pain of the common citizen. Impound the bank accounts of all ministers on whom there are corruption charges before they cart off the loot to foreign shores.

But what hope can be there for a country where the finance minister and the central banker want to give easy loans for spending on consumer goods, knowing fully well that all such goods have a hefty import component which will only mean that the public money will end up going out of the country?

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