Mr Cool

Small investors keep faith even as the central bank shies of deep cuts, companies default and mutual funds favor borrowers

A crisis tests the will and resolve of policy makers, companies and investors. The first responder is the central bank. How it calibrates the flow and cost of money contributes significantly to the transition to recovery. Its task is becoming increasingly difficult and complex. Following the anemic growth of 6.6% on an average and consumer price index at around 2.5% in CY 2017, slashing the repo rate from the 6% level should have been an automatic response if not for oil crossing US$50 to US$70 in CY 2018, fueling fears of inflation, which had been tamed by the farm output glut, breaking free. GDP growth might not have sunk to a 25-quarter low in the three months ended June 2019 if borrowers could have had money cheap. The Reserve Bank of India’s diffidence was a reaction to the Federal Reserve embarking end December 2015 on hiking lending rates for three years after a decade to cool the heating US economy.  Despite the cautious approach, foreign investors dumped Indian stocks for most part of CY 2018 and CY 2019 to head back home to ride on the booming equity market or to park funds in safe haven gold. US-China trade tension and uncertainty over Britain’s exit from the common European market mellowed the Fed into taking a pause and then paring the discount rate twice by 25 basis points in CY 2019 so far. The move emboldened its Indian counterpart to top its four rate cuts in the year by slicing off a quixotic 35 bps. A hefty dividend using a new benchmark was transferred to the treasury. It signaled its determination to become the fulcrum of the efforts to persuade the economy to pick up speed. At the same time, the hesitation to execute a neat half a percentage cut indicated the bravado might be a one-off instance There is now renewed pressure to follow People’s Bank of China’s aggressive chopping up of the cash to advances requirement so that the rupee can weaken to stay in competition with the yuan. A slump in manufacturing does favor such a posture. The hitch is that any steep trimming might accelerate the outflow of foreign funds as there will not be any more softening by the Fed till end CY 2020 on a strong labor market and incipient inflationary pressure.

If the RBI’s dilemma is how far to go without appearing to be adventurous as well as to remain stubbornly conservative,  the finance ministry appears unable to make  up its mind if the slowdown is cyclical or structural. Credit lines have been opened to HFCs and NBFCs and affordable housing projects. Certain sensitive but safe-from-controversy sectors can have full foreign ownership. Local-sourcing irritation of single-brand retail has been addressed but the multi-brand retail space still remains out of bounds, signalling that the loss of momentum is being attributed to bottlenecks in supplies rather than stemming from lack of consumption. The merger of and capital infusion into public sector banks implies divestment of government stake will be selective rather than across the board.  If the monetary and fiscal authorities are darting between daring and dithering, the corporate sector is a picture of capitulation and confidence. Instead of introspecting about excess capacity and resorting to price hikes to boost the margins, auto makers are seeking concessions to shake off sluggish sales. Companies relying on leverage and preferring to pledge shares to entertain unrelated activities instead of diluting stake are facing the prospect of letting go control to tide over debt defaults. Meanwhile, mutual funds, after taking exposure to unlisted and junk paper to boost NAVs, are siding with borrowers by signing standstill agreements and postponing redemption.

At the other end, biscuit makers are pushing premium products.Personal-care leaders are passing on lower GST rates to push the top line. Brick-and-mortar retailers are opening branches. Cinema operators putting up screens in tier 2 and 3 cities. The order books of infrastructure and capital goods players are bulging. IT solutions providers are making the most of a resurgent US economy and a weak rupee. The surviving airlines are registering record profit and price wars in telecom services are tapering. Promoters are monetizing their holdings to pay off loans as chances of ever-greening are turning slim. Auditors are opting to quit than accede to window-dressing. In the process, balance sheets are becoming cleaner, governance standards improving and raising working and project finance from the market getting easier. In the dust, the small investor stands out for his refusal to succumb to scare-mongering.  IPOs from companies with solid business model are getting oversubscribed and listing with a premium. Inflows into equity mutual funds are steady and into debt funds surging, a testimony to the domestic investor’s faith in the India growth story unlike the fickle foreign investors.

-Mohan Sule

Lingering taste

The 2008 liquidity crisis led to quantitative easing in the US and fiscal recklessness in India

An economic slump, however uncomfortable, offers a welcome window to retrospect, reassess and review policies and regulations. The response leaves a lingering taste, good or bad. The thread binding the capital outflow of the late 1990s, the credit crunch of CY 2008 and the global slowdown in CY 2019 is risk aversion of foreign investors. The Asian Tigers kept interest rates high to attract overseas funds. The money trail turned cold when the US started increasing lending rates to curb inflationary pressures. The exit of hot money knocked down the value of currencies across emerging economies. Russia defaulted on short-term liabilities. The rouble, freed from restrictions, lost two-thirds of its value. The contagion spread to Latin American, which had deployed the same tools as the South East Asian peers to attract dollars. The IMF prescribed spending cuts, hiking taxes and privatisation. The region got caught in a vicious cycle of bailouts and debt defaults. The US financial crisis was a rude reminder that asset prices are volatile. The reaction to it marked a departure from the usual practice of tightening the flow of money to mend the side-effects of conspicuous consumption. Instead, a contrarian approach of making more money available more cheaply has become a playbook to be copied by monetary authorities around the world. Tarp or the troubled asset relief program was accompanied by near-zero lending rates. Buying of government and mortgage-backed securities was referred to as quantitative easing.

In the process, the Federal Reserve’s balance sheet expanded from less than US$900 billion before September 2008, when Lehman Brothers collapsed under the weight of its cocktail of home-loan paper of varying credit-worthiness, to US$4.3 trillion by October 2017, when the process of liquidation of the holdings commenced. It also started the practice of forward guidance on interest rates to alert borrowers about the longevity of the current regime so that they could expedite or put off implementing their investment plan. The unmistakable message is that risk-taking, essential for growth, has to be accompanied by a safety net. Developing economies responded to the crisis by ramping up expenditure. China’s four- trillion yuan outlay for CY 2009 and CY 2010 comprised 14% of the GDP in CY 2008. India’s central bank, which had been increasing the cash reserve ratio and interest rates to fight inflation, reversed its course from October 2008 by loosening CRR five times in four months. The statutory liquidity ratio, governing banks’ holding of government securities, was sliced 100 bps.  About Rs 25000 crore was released to finance a farm waiver scheme. The first stimulus package in December 2008 earmarked Rs 30700-crore spending and brought down excise duty by 4%. Additional Rs 1100 crore was provided to refund duties paid on inputs by exporters. The second in January 2009 centered on Rs 30000-crore tax-free bonds to fund projects worth Rs 75000 crore. Commercial vehicles got 50% depreciation. The limit on FII investment in rupee-denominated corporate bonds was hiked to US$ 15 billion from US$8 billion. The third helpline in January 2009 resulted in revenue loss of Rs 29100 crore. Central excise duty was slashed by another 2% and the earlier 4% reduction extended.  Service tax was also pared by two percentage points to 10%.  

The recovery of GDP from 6.7% in FY 2009 to 8.6% and 9.3% in the next two years came with a hefty price tag. Annual consumer inflation tripled to nearly 15% in CY 2009 from two years ago and remained at 11% three years later. The current account deficit to GDP doubled to 4.8% in the three years to FY 2012. The fiscal deficit to GDP stood at 6.46% in FY 2009 and hovered at about 6% two years later. If the UPA government’s treatment to insulate India from the global financial crisis was characterized by fiscal recklessness, the approach of the Reserve Bank of India and the NDA 2 government to the slowing economy due to US-China trade tariffs is marked by fiscal conservatism. The lending rate, at 5.4%, remains higher than the annual CPI of 3.15% in July. The emphasis is on ease of doing business by foreign and Indian investors and flow of credit to vulnerable sectors. Foreign investors can undertake coal mining and contract manufacturing without permission. Consolidation in the banking space will achieve scale. The monetary, fiscal and structural changes are without succumbing to populism of out-of-turn cuts in GST and personal and corporate tax. The nuanced approach spells confidence rather than panic.

-Mohan Sule