At least some in the Monetary Policy Committee (MPC) panel who advocated a rate pause in the last policy review would be having a rethink now looking at the current developments in the global and domestic financial markets.
The rupee has touched a fresh low of 74.50 against the dollar and the Sensex opened close to a 1,000 points lower on the Bombay Stock Exchange (BSE). Equity, bond and currency markets are in a chaos. Any child will know the reason for the high volatility and panic in financial markets of emerging market economies with no respite even after a few months of downtrend. The US interest rates are inching up and global crude oil prices remain on the higher side. Added to this are fears of a brewing US-China trade war and there is nothing positive for emerging markets to cheer about. If the NBFC-led stock crash in the Indian market was largely because of domestic financial sector woes, what lies ahead for the markets will be contributed mainly by global factors.
Donald Trump’s ‘the Fed has gone crazy’ remark has added to the madness in stocks, bonds and currency markets across the world. In early trade, Japan’s Nikkei 225 was quoting in red, down by 4.37 percent while Hang Seng was down by 3.95 percent, South Korea’s Kospi was also down by 3.63 percent. China’s Shanghai Composite index was trading in red, down by 4.74 percent.Overnight, Nasdaq closed in red, down by 4.26 percent while FTSE 100 was also down by 1.29 percent at the closing.
The 10-year US paper yield is trading around 3.20 percent, the highest in seven years and up sharply from 2.82 percent seen in late August. With the US economy strengthening and inflationary fears, it would mean interest rates are set to harden further. This will have ripple effects across markets. The Fed hiked interest rates three times this year itself and is set to go for another hike before the year-end.
Rising interest rates is worrying Donald Trump, unlike in India where the ongoing financial market chaos warrants a rate hike. Now, what has been the response from the Indian government and regulators to contain the high-volatility in financial markets? The IL&FS liquidity crunch triggered a major rout in stock markets and some relief came when the government when it acted just in time to avoid an Indian Lehman-like moment by taking over the company management and appointing some reputed names at the top–this worked to some extend to arrest the market carnage. But, that was only one side of the problem.
The Rupee was playing the villain all along seeking new lows every day. The financial markets were expecting guidance from the central bank to draw some relief. This, surprisingly, never came when the Reserve Bank of India (RBI) announced the latest monetary policy review. On the contrary, the central bank top brass repeatedly harped on its primary mandate of tackling inflation and only that no matter how much the rupee depreciated. This destroyed the last hope of investors that the rupee would get some support from the central bank. RBI governor Urjit Patel effectively communicated that the rupee will have to manage on its own and that the central bank was not too worried about the depreciation. The RBI kept repo rate steady citing inflation strategy despite widespread expectation of a rate hike. Did it miss the larger picture?
The RBI’s rationale was that its change in stance from ‘neutral’ to ‘calibrated tightening’ was good enough currently and the changed stance would tell the markets that future rate options are either a pause or a hike. But, has the markets bought this assurance? Not really. There were economists who opined that the central bank committed a policy error by not hiking rates. Well, the sudden jump in US interest rates seems to vindicate their judgment.
As this writer pointed out in an earlier column, the central bank’s fixation on inflation target amid economic chaos could prove to be a mistake. It attached too much focus on price stability seemingly ignoring financial market stability. With global interest rates hardening and domestic financial markets continuing to fall, the central bank will have to hike rates sooner than expected. Further delay in rate action can prove more harmful both to a free-falling rupee, local equity, bond markets.