Most major asset classes – equities, commodities, bonds and currencies, both in India and globally, witnessed severe volatility during the month. The scale of events that unfolded was unique. Most of the events were triggered by a statement made by the US Federal Reserve. There is both good news and bad news in the announcement.
The good news is simple – if one were to go by the Federal Reserve’s statement, the global economy has started to show signs of sustainable recovery. Over the past 6 years, post the 2008 financial crisis, the global economy has been crippled by the after-effects of the resultant deleveraging that has taken place. The Fed injected a huge monetary stimulus to prop up the economy. Now, the Fed says, the patient is out of the ICU, so to speak. They feel that they can now reduce the pace at which they will do quantitative easing – mind you, they are going to continue to buy government securities from the market, but they will do it a slower pace.
The bad news in the near term is a bit more complicated. The monetary stimulus in the form of low interest rates and quantitative easing has allowed several market participants to borrow at low rates and invest the borrowed money into different assets such as commodities and emerging market assets. The impact of the Fed’s statement was for borrowing rates to go up sharply – the US 10 year government bond yield has gone up from 1.6% to 2.5% over the past few weeks – with rates going up, leveraged investors are forced to unwind their positions. This led to a severe fall in several emerging market currencies and movement of funds away from emerging market bonds. The Rupee saw one of its worst falls in a matter of weeks partly due to FII redemption of about $ 1.8 billion in equities, but more importantly due to a $ 6 bn redemption of bond investments.
This has brought to light the precarious nature of India’s current account balance. The country runs a Current Account Deficit – exports less imports – of close to $ 85 billion. If this gap is not bridged through corresponding foreign flows, primarily from FII flows in Equities & debt and FDI, the Rupee will not be stable. Due to some of the FII bond investments in India being short term in nature, the stability of the Rupee is being questioned. Though recent policies have created an environment to attract longer term FII Debt as well as some initiatives to get in more FDI, it would be some time before stable money actually flows in.
So, the news from the Fed is negative in the short term, because of its impact on liquidity flows, but the news that patient is out of the ICU is good news for the global economy. Meanwhile, most of our portfolio companies continue to deliver reasonably good results and the valuations of these companies continue to be attractive. Troubled times usually produce good opportunities to do some stock picking because this is when valuations become inexpensive.