Wednesday, July 31, 2013

RBI's Trilemmas: What the fuss is all about?

Every economist and newspaper is talking about Impossible Trinity (aka Trilemma) these days. What is all this hoo-ha all about? Let’s find out.

Wikipedia defines Impossible Trinity as “a trilemma in international economics which states that it is impossible to have all three of the following at the same time: A fixed exchange rate; free capital movement (absence of capital controls) and; an independent monetary policy.

In simple words, an economy cannot have an independent monetary authority (i.e. independent of external influence) if it tries to play its hand in managing its exchange rate in order to (or not just to) control the fund flows. 

Maximum, you can choose any two of these three options. 

Let’s say a nation adopts fixed exchange rate mechanism (presumably low, to achieve export competitiveness) and opens up its capital account to foreign flow. This will eventually lead to more forex earnings and surge in central bank’s reserves in the short term. To maintain the required exchange rate, a central bank has to buy local currency (reduce money supply aka monetary tightening) via bond purchases, increasing bank’s regulatory/statutory reserves with central bank (CRR) etc etc. If continue using this strategy, then over the period of time, its official forex reserves will come under stress, and the central bank has to devalue the currency (or let go off its control on the exchange rate) to reduce the excess demand for foreign currency
In India’s case, this surge in demand for monetary tightening arose after US Fed statement regarding tapering of stimulus measures led to increase in US bond yields, which in turn led to foreign investors fleeing Indian debt. Rupee has declined by more than 12% since Fed announcement.

Our RBI got into action, setting aside its earlier focus on inflation, and started tightening its monetary policy by depriving the banks of funds available and sucking out the “excess” liquidity from the system via its bond purchases (which ominously auctioned at max yield of ~11%).

Now, rupee after moving up for some time against the dollar is back again at the level pre-RBI measures and not to say, we are few millions short on foreign reserves. I have already highlighted in my earlier post that RBI is playing with fire. If RBI insisted on targeting exchange rate by curtailing the funds available to the banks, its actions will have serious implications for India’s growth story. And, let’s just not talk about employment levels.

RBI should just STOP its "rupee stabilizing" measures right now. And let the currency find its own ground.

Saturday, July 27, 2013

Weekly Market Commentary - Jul 22 - Jul 26, 2013

Not a very good week for the markets, as weak earnings announcement from key companies disappointed the investors. L&T is facing declining margins, ITC missed sales estimates and HUL posted fall in profits. On top of that, RBI made money more expensive continuing its tight monetary stance. Sensex was down 2%, Nifty was down 2.4% and CNX Midcap 3.9% this week.

Monday - Sensex up by 0.05%, Nifty up by 0.04%, Midcap down by 0.24%
Markets pared the gains it made in its early trades post L&T results announcement. L&T, along with BHEL results, are widely seen as barometer of new investment activity by the broader market. Company’s disappointing 1Q results pushed down the investor sentiment as it reported 12.5% decline in standalone net profit, largely due to margin pressures. The stock fell 7% during the day and had a ripple effect across the broader market. Company is facing tough competition from South Korean and European firms in its stronghold West Asian markets, which is leading to squeeze in margins.

Tuesday - Sensex up by 0.7%, Nifty up by 0.8%, Midcap up by 0.2%
Indian stocks went up with their global peers as China reassured the markets that they are committed to restructuring their economy to continue their growth momentum. ITC and HUL led the surge in Sensex. There was also some buying seen in banking after PC came out and assuage the fears of monetary tightening, calling the phase temporary. RBI’s move to tighten rules on gold import to ease the pressure on rupee and widening CAD further boosted the investor sentiment.

Wednesday - Sensex down by 1.0%, Nifty down by 1.4%, Midcap down by 1.9%
RBI delivered another blow to the markets as it moved the short-term interest rates further up. RBI, in its ongoing battle against the rupee volatility, struck again, reducing the Liquidity Adjustment Facility (LAF) from 1.0% to 0.5% and thus cutting down on the amount of money banks can borrow from the central bank. RBI also increased the limit of daily CRR balance banks need to maintain with RBI from 75% to 99% sucking out few extra thousand crores from banks.

I have already highlighted that this RBI adventure, in hope of replicating 98’ Jalan experiment, is totally not required. I have only one explanation for this. After the POSCO and Arcelor-Mittal debacle and not getting single foreign retailers move here after their big bang FDI in retail announcement, maybe the policymakers have realized that none of this is going to have any benefit in the near term. Therefore, they have decided to move their focus to falling currency. PC should have something to show for, for all his efforts to reverse the damage done to the economy by his govt.

Have to win atleast one fight!

Thursday - Sensex down by 1.4%, Nifty down by 1.4%, Midcap down by 1.0%
Markets continued to lose ground as investor fear that the current bout of monetary tightening will continue in the near term. Renowned economist Raghuram Rajan, in an interview with, indicated that RBI focus is on getting the rupee to stabilize as too much volatility is hurting the investment climate in the country.

Friday - Sensex down by 0.3%, Nifty down by 0.4%, Midcap down by 1.1%
Markets continued to remain under pressure as investors turned cautious ahead of RBI meeting coming Tuesday. Street is expecting RBI to maintain its monetary tightening stance and maintain status quo on rates front.

Saturday, July 20, 2013

Weekly Market Commentary - Jul 15 - Jul 19, 2013

Markets were focusing on RBI actions, Fed comments on the macro front, while company's results and inflation numbers were eyed closely on the street. Sensex and Nifty ended this week up by 1.0% 0.3% respectively, while CNX Midcap was down by 0.7%.

Monday - Sensex up by 0.4%, Nifty up by 0.4%, Midcap up by 1.2%
Indian markets continued its upward movement for third consecutive day as inflation numbers released on Friday came within the markets’ expectation and comfort zone of RBI. WPI gain for June was 4.86%, slightly higher than May figure of 4.7%. CPI climbed to 9.87% in June from 9.31% in May.

This upward movement in inflation numbers has increased the problems for RBI, which is facing a dilemma of whether announcing a rate cut to stimulate investments, which may lead to more inflation, or go for a rate hike to help falling rupee, which will lower import cost and hence inflation. We will get to see what RBI does on July 30. My bet is small changes in the underlying rates, or there might be a cut in CRR.

Asian markets were up largely owing to release of Chinese GDP data that matched the forecast of 7.5%.

Tuesday - Sensex down by 0.9%, Nifty down by 1.3%, Midcap down by 1.3%
RBI went undercover (sort of) yesterday evening and increased the marginal borrowing rates for banks by 2% from 8.25% to 10.25% through Marginal Standing Facility (MSF). RBI, in its attempt to halt the declining rupee is trying every trick in trade available to it, led to sell off in the markets as borrowing became more expensive. RBI’s belief that excessive liquidity in the system is leading to rupee volatility also hurts the rate cut expectations.

Wednesday - Sensex up by 0.5%, Nifty up by 0.3%, Midcap down by 0.8%
Mixed day for markets as investors sentiment got a boost as govt gave a green signal to FDI in almost a dozen sector, including telecom and defence sector. Global sentiment was little cautious ahead of Fed meeting where all eyes were on Fed comments on timing of their plan of cutting down on bond purchases. Investors also focused on value picking the FMCG stocks while avoiding the banks and other interest rate sensitive space. Street was not very happy with HDFC Bank results, as its net profit grew by 30% y-o-y but gross NPA levels increased to 16% q-o-q indicating stress on their balance sheet. Stock went down 2.4%.

Thursday - Sensex up by 0.9%, Nifty up by 1.1%, Midcap up by 1.0%
Markets went up further after Fed comments on being flexible about the timing of cut in stimulus spending boosted the sentiments. Global markets went up largely as Fed suggests that it may not be too aggressive with tapering plans and will depend upon the performance of underlying economy.

Friday - Sensex up by 0.1%, Nifty down by 0.1%, Midcap down by 0.8%
The mood stayed positive for second consecutive day boosted by Fed comments. Bank stocks continued to face volatility as market is concerned about RBI current stance of monetary tightening. Street is worried that instead of rate cut may raise CRR. IT major TCS rallied by 5%, as it beat the street expectation of revenue growth while sustaining its margins, which reflect strong account management and execution capabilities.

Wednesday, July 17, 2013

RBI: Picking up fights it cannot win

In his famous book Thinking Fast and Slow, Daniel Kahnemann cites a study conducted on football goalkeepers. That study deduced that a goalkeeper would be able to save more goals, if he chose to stay standing at one place. However, a goalkeeper, like most of us, will rather risk a goal than to face embarrassment (however imaginary) of audience seeing him not doing anything. Our RBI governor Subbarao seems to be in that position.

Subbarao, in his fresh bid to boost rupee has indirectly led to hike in interest rates. Apparently, every other central banker in emerging market is busy raising the interest rates to stem the fall of their currencies. RBI has also announced that it is soon going to sell bonds to suck out the excessive liquidity from the markets, which it believes to be responsible for volatile rupee.

Indian businesses and citizens are facing less than comfortable investment climate, delays in policy implementations, which has led to higher unemployment or stagnant wages, and not to mention RBI’s key enemy, the one on which it was focused on till now, high inflation. Then, Fed Chairman Ben Bernanke issued a statement talking about tapering of bond purchases i.e. reducing stimulus spending which led to FIIs started exiting emerging markets in droves, taking the rupee down with them. Apparently, the yield gap between US debt and Indian debt has been reducing, making the Indian debt less attractive.

Now, if you are RBI governor, would you rather focus on spending your reserves on fighting off fall in your currency, which is not just India-specific phenomena or you rather try to polish bright the India investment story (by way of easing off liquidity). It is a classic buyback stocks vs. invest in your own plant situation. I will choose the latter. What inflows you lose from debt markets, you can counter them from inflows in stocks or FDIs if you start rebuilding your fundamental story. And that will in turn will help the rupee, by way of improved sovereign ratings, investment climate etc. etc. But, that is just me.

No doubt, that RBI’s current actions have impeded the case for rate cut announcement on coming July 30 meeting, but my guess is that RBI is going to announce some compensatory measure in the form of small rate cut or cut in mandatory CRR, now the inflation data is largely range-bound and within RBI’s comfort zone of sub 5%.

Saturday, July 13, 2013

Weekly Market Commentary - Jul 8 - Jul 12, 2013

The highlight of this week was Fed comments on sustaining its bond purchases, aka stimulus spending until the moment it sees sustainable development in US economy. Markets across Asia and Europe cheered the statements and rallied as reversals of outflows have made their economies even more vulnerable. Indian markets had another reason to cheer as Infosys posted bested the street expectations. Sensex and Nifty ended this week up 2.4% each, while CNX Midcap was up by 1.1%.

Monday - Sensex down by 0.9%, Nifty down by 1.0%, Midcap down by 0.3%
Markets went down as Indian President agreed to passing of controversial Food Bill Ordinance, which provides 2/3rd of Indian population with legal right to cheap food grains. The food bill is expected to dent a big hole in Indian govt budgetary calculations. Strong US dollar on the back of positive US job data also led to rupee breaching 61 mark and causing nervousness among investors.

Tuesday - Sensex up by 0.6%, Nifty up by 0.8%, Midcap up by 0.8%
Investors’ mood turned positive after rupee recovered sharply as RBI and SEBI announced steps to curb currency speculation. Eurozone markets also rallied as Portugal moves closer to political stability and Greece got another bailout approval.

Wednesday - Sensex down by 0.7%, Nifty down by 0.7%, Midcap down by 0.5%
Markets slipped as investors turned cautious ahead of Fed meeting, commencement of earning season and release of a bunch of Indian economic data. Refinery stocks came under pressure as RBI in a bid to curb currency speculation directed all state oil companies to use one single bank for their dollar transaction.

Thursday - Sensex up by 2.0%, Nifty up by 2.0%, Midcap up by 0.7%
Markets regained their bullishness as Fed comments of continuing stimulus bolstered the investor sentiment. The comments allayed the fear of flight of foreign flows from emerging markets in hurry and hopefully will put a brake on it. Bank of Japan also reiterated its stance of keeping its bond purchase program unchanged as per market expectation.

Friday - Sensex up by 1.4%, Nifty up by 1.2%, Midcap up by 0.3%
Markets continue its upward movement as Infosys the leading IT company, announced results that beat market expectation. The company left its FY14 dollar sales growth guidance unchanged at 6-10%, which boosted the investor sentiment. India's trade deficit in June narrowed to $12.24bn from a 7 month high, helped by slowdown in gold imports. Lowering of trade deficit will hopefully provide a cushion to current account balance and rupee also.

Saturday, July 6, 2013

Weekly Market Commentary - Jul 1 - Jul 5, 2013

Indian markets have become more sensitive to global and domestic macros rather than stock fundamentals in recent times, which is in fact good news for stock pickers who follow bottom up strategy rather than top down. Sensex ended this week up 0.5%, while Nifty gained 0.4% and CNX Midcap was up by 0.5%.

Monday - Sensex up by 0.9%, Nifty up by 1.0%, Midcap up by 2.3%
Markets continued their bullish momentum from previous week as govt paced up the reforms. The recent gas price hike will attract more investments into country's oil and gas space. Investors are closely watching every govt move and expect more reforms before elections. News of above average monsoon expectations also kept the mood buoyant.

Tuesday - Sensex down by 0.6%, Nifty down by 0.7%, Midcap down by 0.6%
Investors booked profits after 3 days rallies in the stocks. Almost all sectors end up in red. Tata Motors went down 1% after company announced 16.4% fall in domestic sales of Commercial and Passenger vehicles to 48,712 units and 34.2% decline in exports in June 2013 over June 2012.

Wednesday - Sensex down by 1.5%, Nifty down by 1.5%, Midcap down by 2.1%
Markets slipped as rising crude prices and weak rupee brought back the focus on current account deficit. Ouster of Egyptian President Mohammad Morsi and subsequently army coming back to power has raised tension in one of the biggest Middle East countries, which led to increased volatility in crude prices. On the other hand, FIIs continued to offload their rupee assets further deteriorating the rupee exchange rate against the dollar.

Thursday - Sensex up by 1.2%, Nifty up by 1.1%, Midcap up by 0.7%
Investors turned to value buying, as sentiment has turned positive after recent reform announcement. Also, falling rupee has turned investors bullish on IT stocks. Meanwhile, the government on Wednesday finally cleared an ambitious Rs 1.25 lakh crore food security plan, promising subsidized food to two out of every three Indians. The move will help the Congress party gain significant political support in the run-up to the 2014 general election, although it may stretch the government's fiscal deficit. Food bill is expected to increase from 85,000 crores to 1.5 trillion rupees.

Friday - Sensex up by 0.4%, Nifty up by 0.5%, Midcap up by 0.3%
Markets went up globally as central bankers in Europe assured investors that there is no hurry to wind down stimulus. Overall, mood in Indian markets remained positive though FIIs has turned net sellers amid increasing rupee volatility.