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India – Emerging Markets sinking sentiments

, April 19, 2012, 0 Comments

RBI has slashed lending rate by 50 bps yesterday but today USDINR exchange rate has crossed 51.80 with a low of 51.90. In past one year the exchange rate has hovered in the vicinity of 55-49.

Volcano of credit crisis 2008 was still cooling and Europe crisis of 2011 is acting as another cloud burst only to make the future of our planet hazier. Funds betting on GOLD are in limelight and holding cash seems to be a suitable option for few.

Provoked by flight to quality, is appreciating USD signaling emerging economies or rather compelling emerging economies to be prepared for another Asian crisis; though it is a very harsh interpretation?

Even if it turns out to be harsh, feel of pinch would not be painful second or third time. Try putting your both hands in warm after taking out one hand from a bowl of cold and other from mild hot water. Relative experience is inborn in humans.

Amidst all this chaos, are you wondering what will be next period like and will the history repeat itself? Can we look at the rear mirror to gauge if monster is closer than it appear. To start with, let’s see Indian GDP growth rate and Industrial production, very simple, but important foundation for next step.

Take a look at GDP from 2007 to 2012, after credit crisis of 2008 India have managed to grow but of lately due to Inflation control measures growth has been sacrificed.

GDP after 2008 crisis has fallen significantly which coincides with the drop in industrial output. Post 2009, industrial output is in line with GDP. Now combine this with Government Bond 10 year yield

About the same period, circa 2009, interest rates have bottomed and were shy of 5%. Decline in interest rates can be the result of policies to stimulate an economy or money finding a better return to help grow GDP. With industrial output being low, latter seems to be less justifying.

When we talk of interest rates, inflation (without choice) demands attention. Very often, raising interest rates is a powerful weapon; Government uses to tame the inflation.

From 2010, inflation has risen sporadically and then back to its 2009 level. Sudden rise could be attributed to lower interest rate a year before to some extent

Let’s now move on to currency exchange rate, after all it was our eye brow raiser. We will probably revisit this again, in our conclusive note.

From 2009, INR has depreciated touching 52 against USD which can be attributed to many factors. Flight to quality ranks first according to my understanding which impels investors to dump emerging market currency for safe heavens.

In late 2011 INR touched an all time high of 54 plus to trade at  sub 50 in 1st quarter but now it again start depreciating.  There are many other factors too playing important role like FII’s for an example.

As this article is to pull few indicators in one small plot and analyze the role each is playing affecting other, we will not be delving into details of cause and effect of each indicators.

Depreciated currency and low interest rates in economy (no doubt in comparison to adjacent economies) swim along well. Any change in former or latter keeping one constant will blow the whistle to life guards; often heard in the form of Governments intervening manually.

Please take a note, that as currency started appreciating interest rate rose. Feel happy to reverse it. Turn for one of our favorites, easy to understand until we keep making money, widely discussed on news channels, coffee tables, morning walks and believe me in college canteens too –  Stock market.

Around end of 2011, when European debt crisis was at its peak showing the world what it was capable of, we are not aware of any stock index not have not travelled south. During the boom, Indian stock market BSE sensex had enjoyed a level of 21000 plus and slowly but steadily declining to 15000 within a span of 8-9 months.

Stooped stock market, depreciating currency and higher interest rate, lower GDP with lower industrial output all seems to be in unison if we were to refer our text books. Fun began a year after, put differently while scary, present situation where we are.

Presenting another important indicator which will help build the ground for Golden triangle; a term that we coin for the present situation.

Indian Government Debt to GDP has been declining. There could be two possible explanations to this, namely, growing GDP dwarfing the amount owed or subsiding debt due to repayment of asset owed. In either case, both can be said to have good effect on the economy.

Think it as a credit limit on your credit card. If bank extends your credit limit, it is primarily due to timely repayment of your dues or your pay has risen to level high enough to catch Bank’s attention. Waiting for latter to happen in our case, seems far away.

Coming back to where it all started, USD-INR exchange rate again trying to touch 52-54 range, will it re-trigger BSE sensex to fall to around 15,000 again withing six months. Is your investment safe or you should ponder on exit strategy now.

This is where we see a golden triangle being formed. High interest rates, depreciated currency and aim to achieve 8% GDP growth, combined together are seldom seen to cruise together.

  • Rising population in India will keep generating internal demands and increasing labor force will work to meet it. This will result in GDP increase via internal growth.
  • High interest rates will be an attraction for deposits, savings, and investments. Due to depreciated currency, money should continue to flow in one form or the other.
  • Current INR forex rates at 51.70 seems  quite alarming. High interest rates will support elevated levels.

Now read the above points in reverse order and the obvious should surface. If you hold USD or any foreign currency, convert to INR now before the creeper is pulled down manually. Investment in high interest bearing instruments is good choice for risk averse investors. If you are looking to share a pie with companies’ profit, Indian equities will suffice your needs.