Friday, May 15, 2020

The show goes on


5 April 2020

Keeping markets open signals continuity and liquidity infusion restores confidence in the nation’s currency during disruption

Doubts that a flat world have only benefits without any downsides have been permanently put to rest after the havoc caused by the covid-19 pandemic. The credit crunch nearly 12 years ago was the first signal that if global supply chains facilitated ease of doing business, they could also dispatch pain. The source of the problem might be a single country but the casualties do not remain confined to its boundaries. The cheap money made available by the Federal Reserve found its way into risky assets not only in the US but even in emerging economies. The drying up of liquidity after many American home buyers stopped servicing their mortgages threatened the survival of several smaller nations as well as companies outside the US that had felt emboldened to borrow heavily to finance their growth. When the Fed reduced the lending rate to zero and embarked on a bond-buying program after the collapse of important financial institutions, central banks in many other countries including the European Union followed. Once again monetary authorities are slashing lending rates and extending credit lines. Fiscal packages are being formulated to support businesses facing disruptions in sourcing raw materials and transporting goods as countries around the world self-isolate.

The outbreak of the severe acute respiratory syndrome in 2003 infected over 8,000 and killed 800 people in 26 nations. It did not lead to any government or central bank to come out with stimulus. Neither was travel restrictions imposed. Practising quarantine to control the earlier epidemic, however, has now become a model to contain the spread of deadly diseases. Similarly, keeping financial markets open even if stocks and bonds suffer a severe rout is expected to become a template during future calamities. Indices tumbling to multi-decade lows and bonds with higher coupon rates finding no takers even as interest rates plummet might be an alarming situation. But no policy maker would want to signal pessimism. Rather the message is of continuity. Stocks are allowed to digest the impact of the event and move on. Circuit breakers give participants time to reflect if their reaction was appropriate or harsher than merited. The duration of halt is specified. At a time when digital technology allows trading from remote locations and seamless clearing and settlement, providing investors an exit route as well as an opportunity to enter to indulge in bargain-hunting is the best course. For one, there is no clarity who should decide on a shut-down: the government, the exchange or the regulator. A consensus might be difficult to arrive on the parameters to determine when the storm has blown away. A problem of not switching off order terminals is price manipulation. Volatility is difficult to avoid when the crisis is fluid and so is the response to tackle it. Most market watchdogs select the easy option of banning sales without possession of securities, particularly when the market’s decline is relentless. The objective of imparting stability obstructs portfolio churning by offsetting losses with quality stocks at low valuations. India treaded the sensible middle path. Margins have been hiked in the cash market and so also market-wide limits for taking positions in the derivatives segment. Even such interventions are frowned by those who believe that short-selling is as legitimate an activity as taking long position.

Besides deriving comfort that markets will work even during grave threats, another significant outcome of the current turmoil is the popularity of cash transfer to the affected or lending it at practically no cost. It emboldens risk-taking at a time there is danger of paper money losing its relevance and assets such as gold gaining currency for bartering. Of course, the post apocalypse world will not be the same as it was before. Airlines never regained luster after the September 2001 terrorist attack on the US. The transformation underway in some industries due to technological obsolescence or change in taste will hasten. The result might not be what was anticipated. Cars, whether run on petrol on electricity, will not matter if work-from-home catches traction. The dot-com bubble burst at the turn of the century and stamping of expiry date on patents has knocked off the brand premium of tech support players and pharmaceutical products. Financial institutions tagged as too-big-to-fail are under increasing scrutiny to avoid a relapse of the September 2008 seizure.  Whether malls, multiplexes, retail outlets, automobiles, restaurants, hotels, fashion brands and airlines will be the casualties of social distancing will merit close attention. The winners will be digital properties connecting with consumers.

-Mohan Sule

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