Wall St rules: Why the Fed will continue to print money

ben bernankeVivek Kaul
 Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, announced on June 19, that the Federal Reserve would go slow on money printing in the days to come.
Speaking to the media he said “If the incoming data are broadly consistent with this forecast, the Committee(in reference to the Federal Open Market Committee) currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year…And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”
The Federal Reserve has been printing $85 billion every month and using that money to buy American government bonds and mortgage backed securities. By buying bonds, the Fed has managed to pump the newly printed dollars into the financial system.
The idea was that there would be no shortage of money going around, and as a result interest rates will continue to be low. At low interest rates banks would lend and people would borrow and spend, and that would help in getting economic growth going again.
The trouble is that quantitative easing, as the Federal Reserve’s money printing programme, came to be known as, has turned out to be terribly addictive. And anything that is addictive cannot be so easily withdrawn without negative repercussions.
As Stephen D King writes in 
When the Money Runs Out “Bringing quantitative easing to an end is hardly straightforward. Imagine, for example, that a central bank decides quantitative easing has become dangerously addictive and indicates to investors not only that programme will be put on hold…but it will come to a decisive end. The likely result is a rise in government bond yields…If, however, the economy is still weak, the rise in bond yields will surely be regarded as a threat to economic recovery.”
This is exactly how things played out before and after Bernanke’s June 19 announcement. With Federal Reserve announcing that it will go slow on money printing in the days to come, investors started selling out on American government bonds.
Interest rates and bond prices are inversely correlated i.e. an increase in interest rates leads to lower bond prices. And given that interest rates are expected to rise with the Federal Reserve going slow on money printing, the bond prices will fall. Hence, investors wanting to protect themselves against losses sold out of these bonds.
When investors sell out on bonds, their prices fall. At the same time the interest that is paid on these bonds by the government continues to remain the same, thus pushing up overall returns for anybody who buys these bonds and stays invested in them till they mature. The returns or yields on the 10 year American treasury bond reached a high of 2.6% on June 25, 2013. A month earlier on May 24, 2013, this return had stood at 2.01%.
An increase in return on government bonds pushes up interest rates on all other loans. This is because lending to the government is deemed to the safest, and hence the return on other loans has to be greater than that. This means a higher interest.
The average interest rate on a 30 year home loan in the United States 
jumped to 4.46% as on June 27, 2013. It had stood at 3.93% a week earlier.
Higher interest rates can stall the economic recovery process. It’s taken more than four years of money printing by the Federal Reserve to get the American economy up and running again, and a slower growth is something that the Federal Reserve can ill-afford at this point of time. In fact on June 26, 2013, the commerce department of United States, revised the economic growth during the period January-March 2013, to 1.8% from the earlier 2.4%.
These developments led to the Federal Reserve immediately getting into the damage control mode. William C Dudley, president of the Federal Reserve Bank of New York, the most powerful bank among the twelve banks that constitute the Federal Reserve system in United States, said in a speech on June 27, 2013 “Some commentators have interpreted the recent shift in the market-implied path of short-term interest rates as indicating that market participants now expect the first increases in the federal funds rate target to come much earlier than previously thought. Setting aside whether this is the correct interpretation of recent price moves, let me emphasize that such an expectation would be quite out of sync with both FOMC(federal open market committee) statements and the expectations of most FOMC participants.”
What this means in simple English is that the Federal Reserve of United States led by Ben Bernanke, has no immediate plans of going slow on money printing. There will continue to be enough money in the financial system and hence interest rates will continue to be low.
After Dudley’s statement, the return on the 10 year American treasury bond, which acts as a benchmark for interest rates in the United States, fell from 2.6% on June 26, 2013, to around 2.52% as on July 3, 2013. The market did not take remarks made by Dudley (as well as several other Federal Reserve officials) seriously enough. Hence the return on 10 year American treasury bond continues to remain high, leading to higher interest rates on all other kind of loans.
It also implies that the market will not allow the Federal Reserve to go slow on money printing. As King writes “It (i.e. money printing by central banks), is also, unfortunately, highly addictive. If the economy should fail to strengthen, the central bank will be under pressure to deliver more quantitative easing.”
V. Anantha Nageswaran put it aptly in a recent column in the Mint. As he wrote “Financial markets will force the Federal Reserve to delay any attempt to restore monetary conditions to a more normal setting. Further, as and when such attempts get under way, they will be half-hearted and asymmetric as we have seen in the recent past. Since the Federal Reserve has tied the mast of the economic recovery to a recovery in asset prices, any decline in asset prices will unnerve it. Hence, the eventual outcome will be an inflationary bust due to the prevalence of an excessively accommodative monetary policy for an inordinately long period.”
If interest rates do not continue to be low then the recovery in real estate prices, which has been a major reason behind the American economic growth coming back, will be stalled. To ensure that real estate prices continue to go up, the Federal Reserve will have to continue printing money. And this in turn will eventually lead to an inflationary bust.
In fact, Jim Rickards, author of 
Currency Wars, feels that the Federal Reserve will increase money printing in the days to come. As he recently told www.cnbc.com “They’re not going to taper later this year. They’ll actually going to increase asset purchases because deflation is winning the tug of war between deflation and inflation. Deflation is the Fed’s worst nightmare.” Deflation is the opposite of inflation and refers to a situation where prices are falling.
When prices fall people postpone purchases in the hope of getting a better deal in the future. This has a huge impact on economic growth.
Hence it is more than likely that the Federal Reserve of United States will continue to print money in order to buy bonds to ensure that interest rates continue to remain low. If interest rates go up, the economic growth will be in a jeopardy. As King puts it “The government will then blame the central bank for undermining the nation’s economic health and the central bank’s independence will be under threat. Far better, then, simply to continue with quantitative easing (as money printing is technically referred to as).”
This means that a strong case for staying invested in gold still remains. Rickards expects the price to touch $7000 per ounce (1 troy ounce equals 31.1 grams).
(The article originally appeared on www.firstpost.com)
(Vivek Kaul is a writer. He tweets @kaul_vivek)

 
 

Why rupee might even touch 65-70 to a dollar

rupee
Vivek Kaul
The rupee crossed 60 to a dollar again and touched 60.06, briefly in early morning trade today. As I write this one dollar is worth around Rs 59.97. This should not be surprising given that the demand for dollars is much more than their supply.
The external debt of India stood at $ 390 billion as on March 31,2013. Nearly 44.2% or $172.4 billion of this debt has a residual maturity of less than one year i.e. it needs to be repaid by March 31, 2014. The external debt typically consists of external commercial borrowings (ECBs) raised by companies, NRI deposits, loans raised from the IMF and other countries, short term trade credit etc.
Every time an Indian borrower repays external debt he needs to sell rupees to buy dollars. When this happens the demand for dollars goes up, and leads to the depreciation of the rupee against the dollar. The demand for dollars for repayment of external debt is likely to remain high all through the year.
Data from the RBI suggests that NRI deposits worth nearly $49 billion mature on or before March 31, 2014. With the rupee depreciating against the dollar, the perception of currency risk is high and thus NRIs are likely to repatriate these deposits rather than renew them. This will mean a demand for dollars and thus pressure on the rupee.
External commercial borrowings of $21 billion raised by companies need to be repaid before March 31, 2014. Companies which have cash, 
might look to repay their foreign loans sooner rather than later. This is simply because as the rupee depreciates against the dollar, it takes a greater amount of rupees to buy dollars. So if companies have idle cash lying around, it makes tremendous sense for them to prepay dollar loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for dollars and thus put further pressure on the rupee.
Things are not looking good on the trade deficit front as well. Trade deficit is the difference between imports and exports. Indian imports during the month of May 2013, stood at $44.65 billion. Exports fell by 1.1% to $24.51 billion. This meant that India had a trade deficit of more than $20 billion. 
Trade deficit for the year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013) had stood at $191 billion. The broader point is that India is not exporting enough to earn a sufficient amount of dollars to pay for its imports.
The trade deficit for the month of April 2013 had stood at $17.8 billion. If we add this to the trade deficit of $20.1 billion for the month of May 2013, we get a trade deficit of nearly $38 billion for the first two months of the year.
With the way things currently are it is safe to say that the trade deficit for 2013-2014(or the period between April 1, 2013 and March 31, 2014) is likely to be similar to that of last year, if not higher. What will add to the import pressure is a fall in the price of gold.
Hence, if we add the foreign debt of $172 billion that needs to be repaid during 2013-2014, to the likely trade deficit of $191 billion, we get $363 billion. This is going to be the likely demand for dollars for repayment of foreign debt and for payment of excess of imports over exports, during the course of the year.
A further demand for dollars is likely to come from foreign investors pulling money out of the Indian stock and bond market. 
The foreign investors pulled out investments worth more than Rs 44,000 crore or around $7.53 billion, from the Indian bond and stock markets during the month of June, 2013.
This is likely to continue in the days to come given that the Federal Reserve of United States, the American central bank, has indicated that it will go slow on printing dollars in the days to come. This means that interest rates in the United States are likely to go up, and thus close a cheap source of funding for the foreign investors.
Now lets compare this demand for dollars with India’s foreign exchange reserves. 
As on June 21, 2013, the foreign exchange reserves of India stood at $287.85 billion. Even if we were to ignore the demand for dollars that will come from foreign investors exiting India, the foreign exchange reserves are significantly lower than the $363 billion that is likely to be required for repayment of foreign debt and for payment of excess of imports over exports.
This clearly tells us that India is in a messy situation on this front. If we were to just look at the ratio of foreign exchange reserves to imports we come to the same conclusion. The current foreign exchange reserves are good enough to cover around six and a half months of imports ($287.85 billion of foreign exchange reserves divided by $44.65 billion of monthly imports). This is a very precarious situation 
and was last seen in the early 1990s, when India had just started the liberalisation programme. This is a very low number when we compare it to other BRIC economies(i.e. Brazil, Russia and China), which have an import cover of 19 to 21 months.
That’s one side of the equation addressing the demand for dollars. But what about the supply? Dollars can come into India through the foreign direct investment(FDI) route. When dollars come into India through the FDI route they need to be exchanged for rupees. Hence, dollars are sold and rupees are bought. This pushes up the demand for rupees, while increasing the supply of dollars, thus helping the rupee gain value against the dollar or at least hold stable.
The United Nations Conference on Trade and Development (UNCTAD) recently pointed out that 
the foreign direct investment in India fell by 29% to $26 billion in 2012. So things are not looking good on the FDI front for India. A spate of scams from 2G to coalgate is likely to keep foreign businesses away as well. The recent mess in India’s telecom policy and the Jet-Etihad deal, which would have been the biggest FDI in India’s aviation sector till date, doesn’t help either.
The other big route through which dollars can come is through foreign investors getting in money to invest in the Indian stock and bond market. But as explained above that is likely to be come down this year with the Federal Reserve of United States announcing that it will go slow on its money printing programme in the months to come.
NRI remittances can ease the pressure a bit. India is the world’s largest receiver of remittances. In 2012, it received $69 billion, as per World Bank data. But even this will not help much to plug the gap between the demand for dollars and their supply.
Then come the NRI deposits. As on March 31, 2013, they stood at around $70.8 billion, having gone up nearly 20.8% since March 31, 2012. NRIs typically invest in India because the interest that they earn on deposits is higher in comparison to what they would earn by investing in the countries that they live in.
Interest rates offered on bank deposits continue to remain high in India in comparison to the western countries. So does that mean that NRIs will renew their deposits and not take their money out of India? Interest is not the only thing NRIs need to consider while investing money in India. They also need to take currency risk into account. With the rupee depreciating against the dollar, the ‘perception’ of currency risk has gone up. Lets understand this through an example.
An NRI invests $10,000 in India. At the point he gets money into India $1 is worth Rs 55. So $10,000 when converted into rupees, amounts to Rs 5.5 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 5.5 lakh has grown to Rs 6.05 lakh (Rs 5.5 lakh + 10% interest on Rs 5.5 lakh). The NRI now has to repatriate this money back. At this point of time lets say $1 is worth Rs 60. So when the NRI converts rupees into dollars he gets $10,080 or more or less the same amount of money that he had invested.
With the rupee depreciating against the dollar, the ‘perception’ of currency risk has thus gone up. Given this, NRIs are unlikely to bring in as many dollars into the country as they did during the course of the last financial year (i.e. the period between April 1, 2012 and March 31,2013).
In short, the demand for dollars is likely to continue to be more than their supply in the time to come. This will ensure that the rupee will keep depreciating against the dollar. 
Economist Rajiv Mallik of CLSA summarised the situation best in a recent column “Prepare for the rupee at 65-70 per US dollar next year. That still won’t be the end of the story.”
The article originally appeared on www.firstpost.com on July 3, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 

Japan to India: Busting the biggest myth of investing in real estate

India-Real-Estate-MarketVivek Kaul 
Japan saw the mother of all real estate bubbles in the 1980s. Banks were falling over one another to give out loans and home and land prices reached astonishingly high levels. As Paul Krugman points out in The Return of Depression Economics “Land, never cheap in crowded Japan, had become incredibly expensive: according to a widely cited factoid, the land underneath the square mile of Tokyo’s Imperial Palace was worth more than the entire state of California.”
As prices kept going up, the Japanese started to believe that the real estate boom will carry on endlessly. In fact such was the confidence in the boom that Japanese banks and financial institutions started to offer 100 year home loans and people lapped it up.
As Stephen D. King, the chief economist at HSBC, writes in his new book 
When the Money Runs Out “ By the end of the 1980s, it was not unusual to find Japanese home buyers taking out 100 year mortgages (or home loans), happy, it seems, to pass the burden on to their children and even their grand children. Creditors, meanwhile, naturally assumed the next generation would repay even if, in some cases, the offspring were no more a twinkle in their parents’ eyes. Why worry? After all, land prices, it seemed, only went up.”
Things started to change in late 1989, once the Bank of Japan, the Japanese central bank, started to raise interest rates to deflate the bubble. Land prices started to come down and there has been very little recovery till date, more than two decades later. “Since the 1989 peak…land prices have fallen by 60 per cent,” writes King.
E
very bull market has a theory behind it. Real estate bull markets whenever and wherever they happen, are typically built around one theory or myth. Economist Robert Shiller explains this myth in The Subprime Solution – How Today’s Financial Crisis Happened and What to Do about It. Huge increases in real estate prices are built around “the myth that, because of population growth and economic growth, and with limited land resources available, the price of real estate must inevitably trend strongly upward through time,” writes Shiller
And the belief in this myth gives people the confidence that real estate prices will continue to go up forever. In Japan this led to people taking on 100 year home loans, confident that there children and grandchildren will continue to repay the EMI because they would benefit in the form of significantly higher home prices.
A similar sort of confidence was seen during the American real estate bubble of the 2000s.
 In a survey of home buyers carried out in Los Angeles in 2005, the prevailing belief was that prices will keep growing at the rate of 22% every year over the next 10 years. This meant that a house which cost a million dollars in 2005 would cost around $7.3million by 2015. Such was the belief in the bubble.
India is no different on this count. A recent survey carried out by industry lobby Assocham found that “over 85 per cent of urban working class prefer to invest in real estate saying it is likely to fetch them guaranteed and higher returns.” 

This is clearly an impact of real estate prices having gone up over the last decade at a very fast rate. The confidence that real estate will continue to give high guaranteed returns comes with the belief in the myth that because population is going up, and there is only so much of land going around, real estate prices will continue to go up.
But this logic doesn’t really hold. When it comes to density of population, India is ranked 33
rd among all the countries in the world with an average of 382 people per square kilometre. Japan is ranked 38th with 337 people living per square kilometre. So as far as scarcity of land is concerned, India and Japan are more or less similarly placed. And if real estate prices could fall in Japan, even with the so called scarcity of land, they can in India as well.
Economist Ajay Shah in a recent piece in The Economic Times did some good number crunching to bust what he called the large population-shortage of land argument. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
The interesting thing is that large population-shortage of land is a story that real estate investors need to tell themselves. Even
 speculators need a story to justify why they are buying what they are buying.
Real estate prices have now reached astonishingly high levels. As a recent report brought out real estate consultancy firm Knight Frank points out, 29% of the homes under construction in Mumbai are priced over Rs 1 crore. In Delhi the number is at 11%. Such higher prices has led to a drop in home purchases and increasing inventory. “The inventory level has almost doubled in the last three years. In the National Capital Region, the inventory level reached 31 months at the end of March 2013 against 15 months at the end of March 2010, while in the Mumbai Metropolitan Region the inventory level has jumped from 17 months to 40 months. In Hyderabad, it reached 49 months in March 2013 as compared to 23 months in March 2010, according to data by real estate research firm Liases Foras. Inventory denotes the number of months required to clear the stock at the existing absorption rate. An efficient market maintains an inventory of eight to ten months,” a news report in the Business Standard points out.
The point is all bubble market stories work till a certain point of time. But when prices get too high common sense starts to gradually come back. In a stock market bubble when the common sense comes back the correction is instant and fast, because the market is very liquid. The same is not true about real estate, because one cannot sell a home as fast as one can sell stocks.
Real estate companies in India haven’t started cutting prices in a direct manner as yet. But there are loads of schemes and discounts on offer for anyone who is still willing to buy. As the Business Standard news report quoted earlier points out “As many as 500 projects across India are offering some scheme or the other, in a bid to push sales in an otherwise slow market. According to 
Magicbricks.com, an online property portal, Mumbai has the maximum number of projects with schemes/discounts at around 88, followed by Delhi with 56 and Chennai and Pune with 33 each. Kolkata has 30 such offers, while Hyderabad has 18 and Bangalore has 16. On a pan India level, Magicbricks has about 274 projects with discounts offer.”
Of course the big question is when will the real price cuts start? They will have to happen, sooner rather than later.
The article originally appeared on www.firstpost.com on July 2, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)
 
 
 
 

When it comes to the rupee, ‘you ain’t seen nothin’ yet’

rupeeVivek Kaul 
The Reserve Bank of India(RBI) painted a very worrying picture of India’s external debt scenario in a report released late last week. The total external debt of the country stood at US$ 390 billion as on March 31,2013. This was an increase of US$ 44.6 billion or 12.9 per cent in comparison to March 31, 2012.
Even on a quarterly basis the increase is substantial. As on December 31, 2012, the total external debt had stood at $376.3 billion. This implies an increase of 3.6% of the three month period between December, 2012 and March, 2013.
The external debt typically consists of external commercial borrowings (ECBs) raised by companies, NRI deposits, loans raised from the IMF and other countries, short term trade credit etc. What is worrying here is that nearly 44.2% or $172.4 billion of the outstanding external debt matures on or before March 31, 2014.
The borrower will have to sell rupees and buy dollars in order to repay this maturing foreign debt. When this happens, it might lead to a surfeit of rupees and a shortage of dollars in the foreign exchange market, leading to a further fall in value of the rupee against the dollar.
The foreign investors pulled out investments worth more than Rs 44,000 crore from the Indian debt and equity markets during the month of June, 2013. During the process of conversion of these rupees into $7.53 billion, the demand for dollars went up, and pushed the value of one dollar beyond sixty rupees. The rupee has since recovered a little, and as I write this one dollar is worth around Rs 59.24.
The broader point is that if the demand for $7.53 billion can cause a massacre of the Indian rupee against the dollar, $172.4 billion of debt which needs to be repaid before March 31, 2014, can create a bigger havoc.
The ratio of debt that needs to be paid before March 31, 2014, to the foreign exchange reserves of India is around 59%. This was at 17% as on March 31, 2008. This is another number that tells us very clearly the precarious position India is in as far as its external debt is concerned.
One factor that needs to be considered here is that all the maturing debt may not need to be repaid. Take the case of NRI deposits. As on March 31, 2013, they stood at around $70.8 billion, having gone up nearly 20.8% since March 31, 2012. NRIs typically invest in India because the interest that they earn on deposits is higher in comparison to what they would earn by investing in the countries that they live in.
Interest rates offered on bank deposits continue to remain high in India in comparison to the western countries. So does that mean that NRIs will renew their deposits and not take their money out of India?
Interest is not the only thing NRIs need to consider while investing money in India. They also need to take currency risk into account. With the rupee depreciating against the dollar, the ‘perception’ of currency risk has gone up. Lets understand this through an example.
An NRI invests $10,000 in India. At the point he gets money into India $1 is worth Rs 55. So $10,000 when converted into rupees, amounts to Rs 5.5 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 5.5 lakh has grown to Rs 6.05 lakh (Rs 5.5 lakh + 10% interest on Rs 5.5 lakh). The NRI now has to repatriate this money back. At this point of time lets say $1 is worth Rs 60. So when the NRI converts rupees into dollars he gets $10,080 or more or less the same amount of money that he had invested.
With the rupee depreciating against the dollar, the ‘perception’ of currency risk has thus gone up. Given this, NRIs are more likely to repatriate their maturing deposits, rather than renew them, and this will put pressure on the rupee dollar exchange rate. Data from the RBI suggests that NRI deposits worth nearly $49 billion mature on or before March 31, 2014.
External commercial borrowings worth $21 billion need to be repaid before March 31, 2014. Companies can pay off these loans by raising fresh loans. But in the aftermath of the Federal Reserve of United States, the American central bank, deciding to “taper” or go slow on the money printing, fresh loans may not be so easy to come by. Also, businesses may want to pay up as quickly as possible given that more the rupee depreciates against the dollar, the greater is the amount in rupees they would need to buy dollars needed to repay there loans.
Interestingly, nearly $43.3 billion of external commercial borrowings are set to mature between April 1, 2014 and March 31, 2016.
So to cut a long story shot, much of the external debt maturing before March 31, 2014 will have to repaid and this will put further pressure on the rupee vis a vis the dollar.
India’s burgeoning external debt is only a recent phenomenon. As on March 31, 2007, the total external debt had stood at $169.7 billion. Since then it has jumped by a massive 129.8% to $390 billion. There are basically two reasons for the same.
The first reason is the burgeoning fiscal deficit of the Congress led United Progressive Alliance(UPA) government. Fiscal deficit is the difference between what a government earns and what it spends. For 2007-2008(i.e. the period between April 1, 2007 and March 31, 2008), the fiscal deficit had stood at Rs 1,26,912 crore. For the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) it is projected to be at Rs 5,42,599 crore or nearly 327.5% higher.
The higher fiscal deficit has been financed through greater borrowings made by the government. In order to borrow money the government had to offer better terms than available elsewhere, and thus managed to push up interest rates. This encouraged NRIs to invest their money in India. NRI deposits have increased from $41.24 billion as on March 31, 2007, to $70.82 billion as on March 31, 2013.
Higher interest rates also led to businesses looking at cheaper options abroad. External commercial borrowings went up from $41.44 billion as on March 31, 2007 to $120.89 billion as on March 31, 2013. Interest rates were lower abroad primarily because the Western central banks had unleashed a huge money printing effort in the aftermath of the financial crisis that started in late 2008 to get their respective economies up and running again. And this is the second reason behind India’s burgeoning foreign debt.
To conclude, tough times lie ahead for the rupee. The recent Financial Stability Report released by the RBI points out that “rise in India’s overall external debt is an added source of concern.” But that is a very mild “British” sort of way of putting it. What we need here is a classic American expression. When it comes to the rupee “you ain’t seen nothin’ yet”.
The article originally appeared on www.firstpost.com on July 1, 2013

 (Vivek Kaul is a writer. He tweets @kaul_vivek)