Even the Nifty in India is within striking distance of breaking out to a new level. What has changed? And why are equity investors suddenly so enthusiastic once again?… From being one of the ‘fragile five’ emerging-market economies, India today is seen as one of the better ways to play this rise in global equities. This all began with the Federal Reserve’s decision to postpone tapering and continue buying $85 billion worth of securities every month. With no tapering, monetary conditions and interest rates will not normalise and risk assets are not vulnerable…But new highs in the equity market should not lead India’s policymakers to believe that all is well…
All of a sudden the world looks to be a much better place. The S&P 500 in the US is at an all-time high and even the Nifty in India is within striking distance of breaking out to a new level. What has changed? And why are equity investors suddenly so enthusiastic once again? From a position just a few weeks back in which the bears were calling for the rupee to hit 75 to the dollar and the pink papers were full of reports of how the country had to repay $140 billion in debt over the coming 12 months and was thus very vulnerable to capital market outflows, we have a situation today where the rupee seems stable and foreign institutional investors equity inflows are accelerating and strongly positive. From being one of the ‘fragile five’ emerging-market economies, India today is seen as one of the better ways to play this rise in global equities. This all began with the Federal Reserve’s decision to postpone tapering and continue buying $85 billion worth of securities every month. With no tapering, monetary conditions and interest rates will not normalise and risk assets are not vulnerable.
Given the 18-day Government shutdown in the US and the likelihood for continued wrangling between the Democrats and the Republicans, it now looks like tapering may be off the table till the first quarter of 2014. The delayed September employment report (just released recently) was weak, and the October and November reports will be polluted by the shutdown, and not provide a clean reading as to the true state of the real economy and employment. With the Fed stating quite clearly that any decision to taper will be data-driven, it seems difficult to imagine them moving before the new year, given the paucity of enough clean and reliable data points before then. Also, it seems unlikely that we have seen the last of this face-off in Washington between the two main political parties.
The can has been kicked down the road, and we will once again have to face the ghost of the debt ceiling standoff in the first quarter of 2014. Until and unless this is resolved in a more permanent fashion, it seems unlikely the Fed can move decisively to roll back its stimulus programme. Amid the economic uncertainty engendered by a political stand-off, it is unlikely the Fed will reduce monetary accommodation. In addition to this we have the nomination of Janet Yellen as the new Fed governor. Ms Yellen is perceived to be more dovish than most, and she will lead a central bank that will be more cautious and accommodative on growth and err on the side of easing for longer — taking some risks with inflation.
She clearly sees greater risk in rolling back the extraordinary monetary accommodation too early, than in inflation. Following the debt deal in Washington, markets have begun to price in a scenario of continuing accommodation among global central banks and stabilisation in the emerging-market world. Bond yields and the dollar have dropped, and stocks have been rising everywhere. The data coming out of China has also improved, further reinforcing the sense that maybe markets had overreacted to an impending EM crisis in the May to September interregnum.
The bulls have now begun talking about the possibility of another round of global monetary easing. The more the dollar weakens, the more likely it is that both the European Central Bank and the Bank of Japan will have to further ease policy. Neither can afford to let their currencies appreciate and have their economies absorb the implicit tightening of financial conditions that it implies. A weaker dollar and lower US bond yields have given some time to policymakers in the EM world to get their house in order. India was exposed as one of the ‘fragile five’ in this whole tapering-inspired EM sell-off; the markets made a run on our currency and challenged our economic fundamentals. The market riot was required to force our policy makers to take some long-pending decisions as well as acknowledge the structural weaknesses in the economy. We have now been given the time and space to sort out our issues and address the more fundamental problems facing the economy.
It would be a mistake to take this market push towards new highs as a sign that the world has once again fallen in love with India, or that it is willing to underwrite our long-term growth prospects. This is a global liquidity rally, with all high-beta markets like India doing well; it has nothing much to do with any fundamental change in view on India. Absent reform, no long-term investor is going to turn more positive on the country. They may play it as a trade, but will exit as soon as global liquidity conditions turn. Investors are not at all convinced that India can get back to an 8 per cent growth trajectory. To attract long-term capital this belief has to be rebuilt. We, as a country, are still vulnerable to a turn in global risk appetite, and we remain a high-beta play on global liquidity.
While all risk assets have been given a reprieve due to the circumstances outlined above, eventually the taper will happen and interest rates and liquidity conditions will normalise. We cannot afford to be held hostage again at that stage. The Reserve Bank of India and policymakers in Delhi have shown more courage and determination over the last few months than earlier, and have taken decisions and gotten things done. We cannot become complacent. They cannot feel that enough has been done, and that the market rise signals that investors have regained confidence in the country. The push to clear projects, allocate resources transparently, rehabilitate unviable infrastructure projects, and to cut the current account are much needed, and more needs to be done.
We have been very lucky that a period of market stress has woken up our policymakers and shaken us out of our complacency. We have now been given a reprieve to get our house in order. Unless we use this window, we will be under the gun once again. A lack of structural reform today will lead to further market panics down the road. It will be only a matter of time before the currency falters again. To avoid such an outcome, it is quite clear what needs to be done. Let us hope that new highs in the equity market have not led policymakers to believe that all is well.
(Akash Prakash is fund manager and CEO, Amansa Capital).
– BS: Indian economy: There’s no room for complacency