Even as the Swiss franc fiasco stunned markets, RBI Guv Raghuram Rajan had warned a number of times in recent past, that divergent trends in monetary policies in the world, as well as extremely low risk-reward opportunities, can trigger a flood of capital to destinations like India. Under such circumstances speculative euphoria can distort currencies and local asset prices. (Reuters)
As Russian leader Vladimir Ilyich Lenin once said, “there are decades where nothing happens; and there are weeks where decades happen.” Truly, in global financial markets and back home, we were witness to some interesting chess board moves from some leading central bankers. Indian markets got a shot in the arm, as RBI Governor Raghuram Rajan obliged with a 25 bps reduction in the key lending and borrowing rates of the central bank. On the other hand, Swiss National bank triggered a “black swan” event by deciding to drop the peg on the EUR / Swiss franc.
Indian rupee yo-yoed but closed the week on a very strong note, below 62 handle vs US dollar. Offshore centers continued to dictate the trend and as usual, onshore remained a price taker. Interestingly, over the last many years, Indian financial markets have seen parallel offshore centers usurp the role of price discovery in rupee denominated financial assets. Though global trading of our local assets is a natural offshoot of an interconnected financial market but there needs to an introspection as to why we are surrendering the role of prices making to offshore centers. The answer could be in the regulatory set-up, some of which may be avoidable and changeable and some unavoidable. In fact, the decision to announce a change in monetary policy just 30/45 minutes before the opening bell in India might have had an unintended effect of augmenting the participation in and importance of offshore FX, interest rates and equity markets.
It was not so much a surprise to see RBI reduce rates, as the central bank governor had alluded in his speech during the monetary policy in December that, mid-policy moves in rates can occur and also they can happen during early part of new-year. Market driven interest rates have been already trading quite a distance below the RBI’s repo floor at 8%. Offshore traders, in their eagerness to own Indian debt paper, were leaving no stones unturned to get a seat into the lower rate cycle in India. We, through our research, had highlighted the strong deflationary forces driving India’s bond bull market. India, along with the other world economies are in the midst of a deflationary or dis inflationary cycle, coupled with little or no growth. Whatever inflationary boom is being seen is happening in the financial assets, where promise of more and more monetary stimulus is repressing financial volatility and thereby underwriting the ongoing bull market in it. Indian government is taking steps to kick start the investment cycle by building necessary infrastructure. India’s focus on investment cycle lead growth over consumption lead growth, which the country followed during 2009 to 2013, is dis inflationary in nature, as it augment supply more than demand. Demand benefits from the multiplier effect but inflation can remain benign for long.
Globally strong deflationary impulse is flowing from processed goods and services exporters like China, Europe and also from raw material or commodity producers like oil producing nations and commodity producing nations. Deflation has become a public enemy number one for central banks in the developed west. The reason is that an economy driven by large amounts of public and private debt cannot sustain a deflationary environment. In deflation, the obligation to service debt remains constant whereas the source of income to service it falls in nominal terms. Hence, it has become a Sisyphean Task to inflate an economy so that debt burden can remain serviceable. We need to keep a close eye on China, where massive amounts of leverage in the economy is now facing strong deflationary forces. China is trying the old trick of the western central bankers, of more monetary stimulus and interest rate reduction. However, for China such a monetary stimulus can further aggravate the dis inflationary pressures as excess production capacity and debt is augmented to even unserviceable levels. At the same time, lower interest income can suppress consumption.
In the global economy all the discussions were hijacked by the Swiss National Bank, which decided to drop the 1.2 floor under the Euro / Swiss Franc. The Swiss National Bank shocked the financial markets on Thursday by scrapping a three-year-old cap on the franc, sending the currency soaring against the all currencies and Swiss stocks plunging on fears for the export-reliant Swiss economy. With more than 40 percent of Swiss exports going to the euro zone, firms across Switzerland warned of a plunge in profits, with the luxury and tourism industries most exposed. At the same time, a 30/35% rise in Swiss Franc in few seconds triggered margin called related losses across the FX market. There were widespread reports of retail FX brokers being crippled by client losses and also a few bank treasuries taking a knock. Equity markets outside Switzerland took the news on stride, as traders were much more glued to the expected QE from the ECB next Thursday. There are now talk of a trillion or more Euros of asset purchase program to be announced by ECB. Under the program ECB could announce that respective national central banks would purchase their own governments debt. The program could in the footsteps of an already existing program called emergency liquidity assistance (ELA). In such a program “any costs of, and the risks arising from, the provision of ELA are incurred by the relevant National Central Bank, such as the Bank of Spain for example. In such structure, each NCB would buy some prescribed amount of its nation’s government bonds and assume all the risk of these purchases. Thus the Bank of Spain, not the ECB, would assume all the risk for Spanish government bonds it purchases via this program. At the same time, ECB might not buy the government debt of Greek Government as its rating remains too low.
There were also reports of 3 to 4 Greek Banks seeking emerging funding from ECB under ELA as country’s banks could be facing increased depositor withdrawal before the national election later this month. It is being talked that Greece could run out of money incase it is unable to secure funding from Troika before mid of the year. All in all, Greek tensions can rise post elections, depending on whether Syriza comes to Power.
Over the next week, key events to watch for would be the ECB meeting as well as PMI data from Euro zone and other major economies. UK economy would also report its December employment data, China will release its Q4 GDP estimate and IMF will release its World Economic Outlook updates. There are no major economic release from India.
Indian rupee has become one of top performing currencies in 2015, appreciating rapidly against almost all currencies. The sharp rise in Rupee will have adverse impact on the export of goods and services. However, there is little that the central bank can do in an interconnected global economy. Guv Raghuram Rajan has warned a number of times in recent past, that divergent trends in monetary policies in the world, as well as extremely low risk-reward opportunities, can trigger a flood of capital to destinations like India. Under such circumstances speculative euphoria can distort currencies and local asset prices.
India is seeing an boom in inflows into local debt and equity markets, where investors are willing to sacrifice prudent and necessary risk over momentum. It is the promise of greater and strong economic returns which is compelling investors to pay a bigger and bigger premium to take part in the boat ride. The momentum train can very well continue atleast till the Union Budget, unless cut short by a phase of massive risk aversion in global markets. Indian Rupee can continue to benefit from this influx of foreign currency into the country. From here on the extent of appreciation in Rupee would depend on where and how aggressively RBI draws the line under the pair. Speculators like to follow the path of least resistance when making money in asset classes and therefore they do not like to take on central banks, especially when the latter is on a strong wicket. Offshore speculators would be eager to buy the Rupee till the point where RBI comes in heavily and defends. Till now RBI has not shown much resolve in drawing a hard line under the USD/INR pair, which means that speculators will take it as sign that the central bank is comfortable with a rising Rupee. This is happening at a time when one central banker has already surrendered (SNB) to the market forces due to the expectation of overwhelming amount of ECB QE related flows. Will now the Indian central bank too take a back seat and allow the speculators to hammer the Rupee higher? We will have the answer this week.
Technically, USD/INR has broken through a key trendline support around 62.30/40 and is now holding above another key technical congestion zone of 61.50/75 region. Incase of a sustained trading below 61.50, it can open up possibilities of 60.90/80 and below that around 60.40/20 region. On the way up, the pair needs to clear 62.30/40 to bring the USD bulls back in the game.
Anindya Banerjee, analyst, Kotak Securities
http://www.financialexpress.com/article/economy/squeezing-decades-into-weeks-swiss-cbank-triggers-black-swan-event-with-franc-rbi-guv-raghuram-rajan-surprises-with-repo-rate-cut/31252/
