Signs of economic weakness, Standard & Poor’s downgrading of the U.S.’s credit rating and spreading debt crisis in Europe had heightened worries and all eyes were on Fed as it met yesterday. The global stock markets which had witnessed a meltdown over the last 2 days were hoping for some miracle.
In the announcement, the Federal Reserve said it will keep its monetary policy stimulus at least through 2013. It will hold rates low for an extended time. The more explicit time frame was to give a clear picture to the investors / borrowers of how long they will be able to obtain ultra-cheap credit. Rates have been near zero since December 2008.
The government auctioned US$ 32 billion in three-year notes which had a high yield of 0.50. Auctions of US$ 24 billion in 10-year notes and US$ 16 billion in 30-year bonds are expected on Wednesday and Thursday, respectively.
On the economic front, productivity dropped 0.3% in the second quarter, according to the Labor Department, following a decline of 0.6% in the previous quarter.
After the Feb announcement, the US stock markets slipped into red indicating that Fed is running out of ideas. However, at the end of the trading session, Dow saw a surge of 400 points. This was on account of buying stocks at lower levels. Gold prices hit a record US$1,779 an ounce in its biggest three-day rally since the depths of the financial crisis in late 2008.
Though the stable rates may bring some relief to the investors, there are signs of the weakness in the US economy. In its announcement, Fed indicated that the economy has grown inconsiderably slower than the Fed had expected
Economists believe that another round of quantitative easing was not done mainly due to higher inflation and marginal dip in unemployment rate. The Fed is in a predicament. It does not want to take any action that is not going to have a clear impact on the economy or financial markets. It does not have any monetary policy initiative to address the slowdown, thus raising concerns of a return to recession.
Impact on India:
US outstanding debt stands at US$ 15 trillion. Foreign countries own nearly US$ 4.5 trillion of this amount. Currently, India’s exposure to US debt stands at US$ 41 billion. We are ranked at 14th position in terms of country having exposure to US debt. China ranks first, having an exposure to the tune of US$ 1.15 trillion exposure.
As per the finance minister, the recent developments in the US and the eurozone have injected certain uncertainty in global markets. These developments may have some impact on India. However, according to him, India’s growth story remains intact.
Industry chambers feel India’s growth estimate for 2011-12 will hover around 8%, despite the downgrading of US credit rating by Standard and Poor’s. While there would be some short term impact in terms of slowdown in foreign direct investments into India and weakening global equities could put pressure on the Indian rupee.
Also the spike in uncertainty in international markets following a downgrade of US sovereign debt by rating agency Standard & Poor’s is expected to force Indian companies to put their foreign fundraising plans on the back burner. Further, even the borrowing cost will also go up. While the foreign debt had been cheaper than domestic debt, with the US treasury papers themselves now witnessing a higher rate, the borrowing cost will get expensive as international bonds are linked to US treasuries.
However, on the positive side, there would be a decline in crude oil prices. This may bring a pause to any further interest rate hikes by RBI. Further, as per FICCI, the spreads between a US sovereign and Indian sovereign paper of comparable duration may decline, thus enabling FII inflows into the country.
The monsoon and sowing season is going well. This also may bring in good news as inflation may go down. Further, lower commodity prices may also aid companies’ margins.
Also the government is taking actions on the policies front. For eg: GoM approves decontrol of urea prices, India’s Group of Ministers approved the draft mining bill which involves the imposition of a mining tax in India and is forwarding it to the Union cabinet, Land acquisition bill prepared for parliament monsoon session etc.
If the government takes measures to curb inflation – in the past year RBI has been hiking its policy rates resulting in banks increasing their loan rates which has made personal loans, car loans and home loans expensive for the common man. Also, he is yet to have any respite from inflation. The Government also needs to address corruption and implements reforms at a faster pace, the recent corrections in valuations would make it a good investment opportunity to buy fundamentally good stocks.
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