The Hindu Business Line : Global slowdown, rate cuts inevitable

The cataclysmic events of last Thursday and Friday in Europe and the US took their inevitable toll of Indian markets. The Sensex fell below 15,000 and the rupee dropped past 40.60 levels against the dollar. But, in a twist to the US and the European bond markets, yields on G-Secs rose to nearly eight per cent.

There was some slippage in industrial production in June, although on a year-on-year basis for the June quarter, the fall was marginal. But there is no doubting the slowdown of the economy. Non-food bank credit is climbing after a negative first quarter, but this is likely inventory financing. Anecdotal reports do not speak of great buoyancy in new investments, which is not surprising, given the recent decline in business confidence. Thus, the increase in the MSS bonds issuing limits need set off no alarm bells on interest rates.

Where do we stand? Will the domestic economy sustain a US slowdown, is the key question.

The growth forces in recent times have, in no small measure, been asset prices, fuelled largely by foreign portfolio investment chasing the India growth story. Increased global risk aversion will affect emerging market flows. The weakening of this engine has negative implications for the stock market and, by extension, the economy, because the ‘wealth effect’ of asset price inflation was a major driver of household spending which, in turn, catalysed the cap ex boom.

The imminent increase in petroleum product prices is a dampener as well. But, agriculture, given the satisfactory rains, will be no source of worry.

The external economy, it need hardly be said, will be the first casualty of the US sub-performance.

A silver lining is the good prospect of a considerable fall in global crude prices as American growth slides, followed by other major and emerging economies. This could lift global and domestic economic spirits.

Liquidity

Liquidity in the US and the European markets disappeared overnight, as more managed funds suspended valuations and redemptions amidst non-functioning credit markets.

Clearly, leverage is the culprit. Investment in mortgage securities and their derivatives, such as CDOs, are financed with bank credit lines to capture the spread and amplify returns.

Reality has dawned on lenders, who are now realising the fragility of the underlying collateral and the almost complete absence of a market for the collateral and its valuation. Margin calls and credit freeze have followed forcing central banks to offer practically unlimited liquidity, even against non-sovereign obligations.

The problems of investors in these instruments are the least from the systemic view. The far bigger concern must be the damage to banks’ balance sheets and credit ‘withdrawal’ as they repair the damage.

As far as the domestic economy is concerned, a perceptible fall in growth is ahead. Inflation will be range-bound after the one-off effect of an oil price increase. Falling capital flows and a weaker rupee are in store and stocks will be sub-performers. Liquidity will be adequate and bond yields will be in a range for now, with chances of a fall later on a persisting weaker economy.

The near certainty of a severe US and European slowdown means a Fed rate cut is a done deal. It needn’t lose sleep over inflation as sharply deteriorating consumer and business spending will keep prices well in check and below the Fed’s informal two per cent limit.

More Stories on : Interest Rates | Economy | Financial Scan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Rupee: Rising tide

60 credit-worthy years

India-Japan swap deal on cards

Axis Soft develops pixie-sized ATMs

Motor pool seen positive for PSU insurers

HSBC plans to step up SME biz

ADB aid for Bengal’s tourism sector

Global slowdown, rate cuts inevitable

Bond prices range-bound

Petronet to get $150 m loan from IFC

T-bills auction

Call rates unchanged

Exim Bank signs pact with Gulf body