Vivek Kaul
The government of India has tried to blame the recent depreciation of the rupee against the US dollar on everything but the state of the Indian economy. Rupee has fallen because Indians buy too much gold, we have often been told over the last few moths.
Rupee has fallen because foreign investors have been withdrawing money in response to the decision of the Federal Reserve of United States to go slow on money printing in the time to come, is another explanation which is often offered. While there is no denying that these factors have been responsible for the fall of the rupee, but the truth is a little more complicated than just that.
Mark Buchanan uses the term disequilibrium thinking in his new book Forecast – What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics. As he writes “one of the key concepts of disequilibrium thinking is the notion of ‘metastability’ which explains how a system can seem stable, yet actually be highly unstable, much like the sulfrous coating on a match, ready to explode if it receives the right kind of spark. Inherently unstable and dangerous situations can persist untroubled for very long periods, yet also guarantee eventual disaster.”
The situation in India was precisely like that. The rupee was more or less stable against the dollar between November 2012 and end of May 2013. It moved in the range of Rs 53.5-Rs 55.5 to a dollar. This stability in no way meant that all was well with the Indian economy.
In a discussion yesterday on NDTV, Ruchir Sharma, Head of Emerging Markets Equity and Global Macro at Morgan Stanley Investment Management, provided a lot of data to show just that. In 2007, the current account deficit of India stood at $8 billion. In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
The foreign exchange reserves of India in 2007 stood at $300 billion. So the foreign exchange reserves were 37.5 times the current account deficit. For 2013, the current account deficit is at $90 billion whereas the foreign exchange reserves are down to around $275 billion. So the foreign exchange reserves are now just three times the size of the current account deficit, in comparison to 37.5 times earlier.
Another worrying point is the import cover (foreign exchange reserves/monthly imports). It currently stands at 5.5 months, the lowest in 15 years. This is very low in comparison to other emerging markets (like China has 18 months of import cover, Brazil has 11 months).
Now what does this mean in simple English? It means that the demand for dollars has gone up much faster than their supply. And this did not happen overnight. It did not happen towards the end of May, when the rupee rapidly started losing value against the dollar. The situation has deteriorated over the last five to six years, while the government was busy doing other things.
Sharma gave out some other numbers as well. In 2007,the short term debt (or debt that needs to be repaid during the course of the year) stood at $80 billion. Currently it stands at around $170 billion. As and when this debt matures, it will have to repaid (unless its rolled over) and that would mean more demand for dollars and a greater pressure on the rupee. Given this, its not surprising that analysts are now predicting that the rupee soon touch 70 to a dollar.
What remains to be seen is whether companies which need to repay this debt are allowed to roll it over. The situation is very tricky given that 25% of Indian companies do not have sufficient cash flow to repay interest on their loans. The amount of loans to be repaid by top 10 Indian corporates has gone up from Rs 1000 billion in 2007 to Rs 6000 billion in 2013. This makes the Indian economy very vulnerable.
Politicians like to compare the current situation to 1991 and tell us that the current situation is not a repeat of 1991. In 1991, the import cover was down to less than a month. Currently it is around 5-6 months (depending on whose calculation you refer to). Hence, the situation is not as bad as 1991.
But the import cover is just one parameter that one can look at. The current account deficit in 1991, stood at 2.5% of the gross domestic product. Currently its around 4.8% of the GDP. Hence, the situation is much worse on this front than in 1991.
The government has tried to control the fall of the rupee against the dollar by making it difficult for Indian companies as well as individuals to take dollars abroad. But that was already happening. The amount of money Indian corporates invested abroad in 2008, stood at $21 billion. It has since come down to $7 billion. The amount of money taken abroad by individuals through legal channels remains minuscule.
The point is that the Indian economy has been extremely vulnerable for sometime, “much like the sulfrous coating on a match, ready to explode if it receives the right kind of spark.” It is just that where the spark will come from leading to explosion of the match, is hard to predict in advance.
As Buchnan puts it “the disequilibrium view….explains in simple terms why the moment of collapse is hard to predict: the arrival of the key triggering event is typically a matter of chance.” And this matter of chance in the Indian context came when Ben Bernanke, the Chairman of the Federal Reserve of United States, the American Central Bank, addressed the Joint Economic Committee of the American Congress ,on May 23, 2013.
As he said “if we see continued improvement and we have confidence that that is going to be sustained, then we could in — in the next few meetings — we could take a step down in our pace of purchases.”
Over the last few years, the Federal Reserve has been pumping money into the American financial system by printing money and using it to buy bonds. This ensures that there is no shortage of money in the system, which in turn ensures low interest rates. The hope is that at lower interest rates people will borrow and spend more, and this in turn will revive economic growth.
After nearly 5 years, some sort of economic growth has started to comeback in the United States. And given this, the expectation is that the Federal Reserve will start going slow on money printing in the months to come. This has pushed interest rates up in the United States making it more interesting for big international investors to invest their money in the United States than India.
This has led to them withdrawing money from India. Since the end of May nearly $10 billion of foreign money has been withdrawn from the Indian bond market. When these bonds are sold, foreign investors get paid in rupees. They need to convert these rupees into dollars, in order to repatriate their money abroad. This puts pressure on the rupee.
And this is how the decision of the Federal Reserve to go slow on money printing in the days to come has led to the fall of the rupee. This is the story that the government officials and ministers have been trying to sell to us.
But the point to remember is that the decision of the Federal Reserve of United States to go slow on money printing was just the ‘spark’ that was needed to explode the ‘sulfrous coating on the match’ that the Indian economy had become. The spark could have come from somewhere else and the ‘sulfrous coating on the match’ would have still exploded leading to a crash of the rupee. Also, it is important to remember that foreign investors have not abandoned India lock, stock and barrel. When it comes to the bond market they have pulled out money to the tune of $10 billion. But they are still largely invested in the equity market. Since late May around $2 billion has been pulled out of the Indian equity market by the foreign investors. This when they have more than $200 billion invested in it.
Ruchir Sharma’s panelist in the NDTV discussion referred to earlier was Arun Shourie. He called the current rupee crisis a swadeshi crisis. It is time that the government realised this as well because the first step in solving any problem is recognising that it exists.
The article was originally published on www.firstpost.com on August 21, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Ben Bernanke
Wall St rules: Why the Fed will continue to print money
Vivek 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 gentlemen no longer prefer bonds
Vivek Kaul
“Gentlemen prefer bonds” is an old bear market saying. It essentially refers to a scenario where investors sell out of the stock market and invest their money into bonds, particularly government bonds.
But we live in ‘interesting’ times where investors are selling out of both bond markets as well as stock markets. The yield or return on the 10 year American treasury bond rose to 2.66% on June 24, 2013. The treasury bond is a bond issued by the American government to finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
Investors have been selling out on the American treasury bonds. When a spate of selling hits the bond market, bond prices fall. But the interest that the government pays on these bonds till they mature, continues to remain the same, thus pushing up the return or the yield to maturity for those investors who buy these bonds.
The return or the yield on the 10 year American treasury bond has gone up at a very fast rate since the beginning of May. As on May 1, 2013, the return stood at 1.64%. Since then it has jumped by more than 100 basis points (one basis point is equal to one hundredth of a percentage) to 2.66%.
The first repercussion of this is that the borrowing cost of the American government will go up in the days to come. Any fresh bonds issued by the American government to finance its fiscal deficit will have to match the current return on a 10 year American treasury bond. In fact, between May 1 and June 24, the return on the 10 year American treasury bond has gone up from 1.64% to 2.66%. This is a rise of more than 62%, which will ultimately reflect in the borrowing costs of the American government.
But that is not the major reason for worry. The return on the 10 year American treasury acts as a benchmark for other interest rates, including those on home loans (or mortgages as they are called in the United States). So if the return on the 10 year American treasury is going up, then the interest rates on all kinds of loans goes up as well. This is because lending to the government is deemed to be the safest and hence returns on all kinds of other loans need to be higher than the return made on lending to the government.
This has led to the interest on the 30 year home loans rising by around 100 basis points(one basis point equals one hundredth of a percentage) to 4.4%, writes Mark Gongloff on The Huffington Post, website. This rise in interest rates means higher EMIs (equated monthly instalments) on home loans. “It is the biggest single move in interest rates since at least 1962, according to Dan Greenhaus, chief global strategist at the New York brokerage firm BTIG,” writes Gongloff.
A higher EMI could put the housing recovery in the United States in jeopardy and thus impact overall economic recovery as well. At higher interest rates people are less likely to borrow and buy homes. Less home buying could slow down the increase in home prices. As Gongloff points out “The surge in rates will likely squeeze mortgage refinancing and borrowing and could smother the recent rebound in the housing market, which has largely been driven by investors taking out cheap loans to buy cheap houses.”
Home prices in the United States have gone up by nearly 10.9% between March 1, 2012 and March 1, 2013, as per the Case-Shiller 20 City Home Price Index. A demand for greater homes creates jobs in the real estate and ancillary sectors. And more homes are likely to be bought at low interest rates than higher.
Low interest rates also get the ‘home equity’ loans going. Home equity is the difference between the market price of a house and the home loan outstanding on it. American banks give loans against this equity. People are more likely to borrow against this equity when interest rates and EMIs are low.
In fact, extraction of home equity became a very important driver of consumption in the United States in the years running up to the financial crisis which started in September 2008. As is the case with any advanced economy, consumption formed a major portion of the US GDP. Home equity loans were used to buy SUVs, furniture, other consumer goods or simply to pay off the debt that accumulated on other expensive forms of borrowing like the credit card.
Charles R Morris writing in The Trillion Dollar Meltdown: Easy Money, High Rollers, And the Great Credit Crash explains this phenomenon: “Consumer spending jumped from a 1990s average of about 67% of GDP to 72% of GDP in early 2007. As Martin Feldstein, a former chairman of the Council of Economic Advisers, has pointed out, that increase was financed primarily by the withdrawal of $9 trillion in home equity.” Feldstein’s study was carried out for the period between 1997 and 2006. Home equity supplied more than 6% of the disposable personal income of Americans between 2000-2007, another study pointed out. In fact, by the first quarter of 2006, home equity extraction made up for nearly 10% of disposable personal income of Americans.
But this is possible only when interest rates are low. With returns on 10 year treasury bonds rising, the interest charged on home equity loans is likely to go up as well. Hence, this means that people are less likely to borrow against their home equity. Also, with home loans becoming expensive the price of real estate is unlikely to continue to go up at the same speed as it has in the recent past, because Americans will now buy fewer homes. If home prices don’t rise, there is lesser home equity to extract. All this means less consumer spending which in turn will lead to slower economic growth.
The rise in bond yields or returns is essentially a reaction to the decision made by the Ben Bernanke led Federal Reserve of United States, the American central bank, to go slow on the money printing operations. The Federal Reserve has been printing $85 billion every month to buy both government and private sector bonds. By buying bonds it pumped the printed money into the American financial system. With enough money going around, the Federal Reserve managed to keep interest rates low encouraging people to borrow and spend.
But now it wants to change track. As Bernanke told the press on June 19, 2013 “If the incoming data are broadly consistent with this forecast, the 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.”
Bernanke further said that “in this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains.”
Hence, if economic growth in the United States continues, the Federal Reserve will gradually slowdown and finally stop money printing by the middle of next year. The message that Bernanke wanted to give was two fold. One of course was the fact that the Federal Reserve would “taper” its money printing operations in the days to come. But the other more important message was that the Federal Reserve felt that strong growth was “finally” returning to the American economy.
But the markets (particularly the bond market) has bought only one part of the two-fold message from the Federal Reserve. The growth message clearly hasn’t gone through. The bond market has clearly come around to believe that the days of “easy money” will be soon coming to an end, as the Federal Reserve will stop its money printing operations.
This will lead to interest rates going up. Interest rates and bond prices share an inverse relationship. As interest rates go up, bond prices fall. And in the expectation of the interest rates going up and bond prices falling, investors are selling out of bonds, and thus driving up interest rates. As The New York Times reports “A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.” That has clearly not happened.
In fact, Bernanke made it very clear that the Federal Reserve is only planning to slowdown and stop future money printing. It has absolutely no plans of withdrawing the money that it has already printed and put into the financial system. Or as Bernanke put it “akin to letting up a bit on the gas pedal.” “Putting on the monetary brakes would entail selling bonds out of the Fed’s portfolio, and that’s not happening any time soon,” Bernanke said.
But the bond market is already taking into account the Federal Reserve pumping out the money that it has printed and put into the financial system, in the days to come. As and when that happens, interest rates will rise sharply.
At a global level, it has meant a slowdown in the dollar carry trade. Interest rates on loans raised in dollars are going up, making it unviable for investors to borrow in dollars and go searching for high returns, all over the world. This has led to investors selling out from stock and bond markets across the world. And that is likely to continue in the days to come.
The article originally appeared on www.firstpost.com on June 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why Ben Bernanke must be now singing the Hotel California song
Vivek Kaul
Ben ‘Shalom’ Bernanke is the Chairman of the Federal Reserve of United States, the American central bank. In the Monetary Policy Report to the Congress issued on March 1,2011, the Bernanke led Federal Reserve had assured the world at large that they had the tools needed to “remove policy accommodation at the appropriate time.”
In simple English what it meant was that as and when needed the Federal Reserve would stop printing money and at the same time be able to gradually withdraw all the money that they had printed and pumped into the financial system. This could be done without much hassle.
In the aftermath of the financial crisis starting in mid September 2008, the Federal Reserve of United States had started to print dollars and pump them into the financial system. This was done to ensure that there was enough money going around and thus interest rates continued to remain low. At low interest rates the hope was that the American consumer would start borrowing and spending money again. And this spending would help revive the American economy, which had slowed down considerably in the aftermath of the financial crisis.
This process of printing money in the hope of reviving economic growth came to be referred as “quantitative easing”. The risk with quantitative easing as is the case with all money printing was that too much money would chase the same number of goods and services, and push up their prices considerably. Hence, there was a risk of high inflation. Given this, at an appropriate time the Federal Reserve would have to stop money printing and gradually pump out all the money they had printed and pumped into the financial system.
Speaking to the media on June 19, 2013, Bernanke said “If the incoming data are broadly consistent with this forecast, the 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.”
Bernanke further said that “in this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains.”
What he meant by this was that if the American economy keeps improving and growing, the Federal Reserve would reduce money printing gradually later this year and would totally wind it down by the middle of next year. The Federal Reserve prints $85 billion every month to buy both private and government bonds. It pays for the bonds it buys by printing dollars. This is how it pumps printed money into the financial system and ensures that interest rates continue to remain low.
The idea of the Fed first going slow on money printing and then stopping it totally, has sent markets (stock,bond and commodity) around the world into a tizzy. When the Federal Reserve started printing money to keep interest rates down, the hope was that it would manage to get the American consumer borrowing and spending again.
But that did not happen at the same pace as the Federal Reserve hoped it would, given that the American consumer was just coming out of one round of a huge borrowing binge and wasn’t in the mood to start borrowing all over again. Meanwhile the financial system was flush with money available at close to 0% interest rates. This led to big financial investors (the investment banks and the hedge funds of the world) spotting an opportunity.
They could borrow money at very low interest rates and invest it all across the world, and make huge returns. This trade, where money was borrowed in American dollars and invested in financial assets all across the world, came to be referred as the dollar carry trade. The difference between the return the investors make on their investment and the interest that they pay for borrowing money in dollars is referred to as the ‘carry’ they make.
The dollar carry trade would work only as long as the interest rates in the United States continued to remain low. Bernanke’s recent statement made it very clear that chances were that the Federal Reserve would gradually wind down on money printing. This meant that the financial system would no longer be flush with money as it had been, in turn leading to higher interest rates. Or as Bernanke put it “if interest rates go up for the right reasons – that is, both optimism about the economy and an accurate assessment of monetary policy – that’s a good thing. That’s not a bad thing.”
This is as clear as a central banker can get and has led to a bloodbath in markets all over the world. The Dow Jones Industrial Average, America’s premier stock market index fell by 353.87 points to close at 14,758.32 points yesterday. The BSE Sensex fell by 526 points to close at 18,719.29 points yesterday.
Stock markets in other parts of the world fell as well. This was primarily on account of the unravelling of the dollar carry trade. With American interest rates expected to go up, investors were busy withdrawing their money from various markets and repatriating it back to the United States.
The wave of selling in the Indian bond market was so huge that the market had to be briefly shut down yesterday when there were only sellers and no buyers in the market. This also had a huge impact on the rupee dollar rate. When foreign investors sell out of Indian financial assets they get paid in rupees. When they repatriate this money back into the United States the rupees need to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Yesterday one dollar was worth close to Rs 60. It touched Rs 59.98 during the intra day trading.
In fact the big financial investors are even selling out on American government bonds. The return on 10 year American treasuries rose to 2.42% yesterday as investors sold out of these bonds. The 10 year American treasury is a bond issued by the American government to finance its fiscal deficit or the difference between what it earns and what it spends. In the beginning of May, the return on the 10 year American treasuries was at 1.63%.
It is important to understand here that 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, the bond prices (including that of the 10 year American treasury) will fall. Hence, investors wanting to protect themselves against losses are selling out of these bonds. When investors sell out on bonds there 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.
This explains why the return on the 10 year American treasury bond has been going up. The trouble is that the return on the 10 year American treasury acts as a benchmark for interest rates on all kinds of loans from home loans to dollar carry trade loans. So if the return on the 10 year American treasury is going up, then the interest rates on all kinds of loans goes up as well. This is because the government is deemed to be safest lender and hence returns on all kinds of other loans need to be higher than the return made on lending to the government.
Rising interest rates could very well put the American economic recovery in a jeopardy, which wouldn’t have been the idea behind what Bernanke said two days earlier.
What this tells us is that investors and markets all around the world haven’t really liked Federal Reserve’s decision to wind down money printing in the months to come and are voting against it. Also, Bernanke had clearly said that the Federal Reserve had no plans of withdrawing all the money it had printed and pumped into the financial system. It was only planning to go a little slow on the money printing. Or as Bernanke put it “akin to letting up a bit on the gas pedal.”
“Putting on the monetary brakes would entail selling bonds out of the Fed’s portfolio, and that’s not happening any time soon,” Bernanke said.
As has been pointed out earlier, the Federal Reserve had been buying bonds to pump the money that it is printing into the financial system. When it wants to withdraw this money it will have to start selling back all the bonds that it has bought. But there are clearly no such plans.
So even the idea of the Federal Reserve slowing down money printing is not acceptable to the market and the big financial investors, who have got so used to the idea of ‘easy money’ and all the benefits that it has brought to them.
Imagine what would happen once the Federal Reserve wants to start sucking out all the money that it has printed and pumped into the market. Just the idea of going slow on money printing has led to a market mayhem all over the world. Ben Bernanke and the Federal Reserve are now finding out that removing the so-called policy accommodation is going to be nowhere as easy as they thought it would be more than two years back.
Or as the last few lines of Hotel California sung by The Eagles go “We are programmed to receive. You can check-out any time you like, But you can never leave.” Chances are Ben ‘Shalom’ Bernanke must be humming that number right now.
The article originally appeared on www.firstpost.com on June 21, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Mr Chidambaram, India's love for gold is just a symptom, not a problem
Vivek Kaul
P Chidambaram, the union finance minister, has been urging Indians not to buy gold. But we just won’t listen to him.
In the month of May 2013, India imported $8.4 billion worth of gold, up by 90% in comparison to May 2012. This surge in gold imports pushed up the trade deficit to $20.14 billion in May. It was at $17.8 billion during April 2013. Trade deficit is the difference between the merchandise imports and exports. Commerce Secretary S R Rao said “As far as trade deficit is concerned, it is very worrisome…It is largely contributed by heavy imports of gold and silver.”
A trade deficit means that the country is not earning enough dollars through exports to pay for all that it is importing. To correct this, it either needs to increase its exports and earn more dollars to pay for imports or cut down on its imports. Indian exports have been growing at a very slow pace. In fact they fell by 1.1% in May 2013 to $24.5 billion. Imports on the other hand rose by 7% to $44.65 billion.
The trouble is that when India imports gold it pays for it in dollars. Indian rupees are sold to buy these dollars. Given this there is a surfeit of rupees in the market and a scarcity of dollars, pushing up the value of the dollar against the rupee. This leads to the country paying more for imports in rupee terms.
Hence, the logic goes that India should not be importing as much gold as it is. Or as Chidambaram said a few days back “I would once again appeal to everyone please resist the temptation to buy gold…If I have one wish which the people of India can fulfill is don’t buy gold.”
But the same logic applies to oil as well. India imported $15 billion worth of oil in May 2013. Of course, oil is more useful than gold, and we need to import it because we don’t produce enough of it.
And given that gold is as useless as something can be, we don’t need to import it. Or as Chidambaram said “I continue to hope and suppose if the people of India don’t demand gold if we don’t have to import gold for a year just imagine the whole situation will so dramatically change. Every ounce of gold is imported. You pay in rupees, we have to provide dollars.”
So what comes out of all this is that the government does not want Indians to buy gold. It recently increased the import duty on gold to 8% from 6% earlier. Chidambaram even set a personal example when he recently said “I don’t buy gold, I put my money in financial instruments and I am happy.”
There are multiple problems with what Chidambaram is saying. The first and foremost is the fact that buying or not buying gold is a free economic decision that people choose to make. Or as economist Bibek Debroy wrote in a column in The Economic Times “The gold policy is futile because buying gold is a free decision of rational economic agents and gold imports are a symptom, not the disease.”
And what is the symptom? The symptom is the high consumer price inflation that prevails. People have been buying gold to hedge themselves against that inflation. As the Economic Survey of the government for the year 2012-2013, released in February pointed out “Gold imports are positively correlated with inflation: High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising imports and falling real rates.”
What this means is that because inflation is high the real rate of return on financial instruments is very low. Why would people invest in a financial instrument like a fixed deposit or a PPF account or a National Savings Certificate, at an interest of 8-9%, when the consumer price inflation is higher than that? So what do they do? They invest in gold because they have been told over the generations, that gold holds its value against inflation.
Chidambaram has asked people not to buy gold and even gone to the extent of saying that he does not buy the yellow metal and puts his money in financial instruments. Of course, being the finance minister of the country he is unlikely to face any problems while investing in financial instruments.
But here is a small suggestion. Chidambaram should try investing in a mutual fund once on his own without going through a bank or an agent. And the bizarre number of requirements that need to be fulfilled to invest in a mutual fund, will give him a real flavour of how difficult it is to invest for an individual to invest in a mutual fund.
Or take the case of a senior citizen who invests his retirement funds in the senior citizen savings scheme run by the post office and is given a thorough run-around every time he has to go and collect the interest on the money that he has deposited.
Or take case of the spate of smses banks recently sent out to their customers asking them to furnish documents and account opening recommendations, even when customers have had accounts for more than a decade.
Given this, it is not surprising that people buy gold which is available hassle free over the counter. The Economic Survey nailed it when it said “The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas. The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion…and improving saver access to financial products are all of paramount importance.” Hence, people will continue to buy gold when they want to, irrespective of the appeals made by Chidambaram.
Inflation is something that the government of this country has created. And when people protect themselves against it, you can’t hold them responsible for creating other problems.
When a country runs a trade deficit it doesn’t earn enough dollars to pay for its imports through exports. What happens in this situation is that dollars coming in through other sources like foreign direct investment, foreign institutional investment and citizens living abroad, are used to finance imports.
In India’s case remittances a well as deposits made by NRIs play an important part in filling up the trade deficit gap. As Andy Mukherjee points out in a column in the Business Standard “For every rupee of time deposits that Indian banks have raised from residents in the past year, 13
paise has come from the estimated 25 million people of Indian origin who live in other countries.”
World over interest rates on savings deposits are at very low levels. The same is not true about India where interest rates continue to remain high and hence it makes sense for NRIs to invest money in India.
But this investment carries the currency risk. Lets understand this through an example. An NRI decides to invest $100,000 in India. At the point of time he gets his money into India, one dollar is worth Rs 50. So he has got Rs 50 lakh to invest. He invests this in a bank which is offering him 10% interest. At the end of the year he gets Rs 55 lakh (Rs 50 lakh + 10% interest on Rs 50 lakh).
Now lets say a year later $1 is worth Rs 55. So when the NRI converts Rs 55 lakh into dollars, he gets $100,000 (Rs 55 lakh/55) or the amount that he had invested initially. Hence, he does not make any return in the process. This is because the Indian rupee has depreciated against the dollar, which is something that has been happening lately. This is the currency risk.
In this scenario, the NRIs are likely to withdraw their deposits from India because if the rupee keeps losing value against the dollar, chances are they might face losses on their investments. When NRIs repatriate their money, they sell rupees and buy dollars. This leads to a surfeit of rupees and shortage of dollars in the market, and thus leads to the rupee depreciating further.
This is a scenario that is likely to play out in the days to come. Over and above this there is also the danger of foreign institutional investors continuing to withdraw money from the Indian debt market, as they have in the recent past.
This danger has become even more pronounced with Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, announcing late last night that they would go slow on money printing.
As he said “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.”
The Federal Reserve prints dollars and uses them to buy bonds to pump money into the financial system. This ensures that interest rates continue to remain low as there is enough money going around.
As and when the Federal Reserve goes slow on money printing, the American interest rates will start to go up (in fact they have already started to go up). Given this the investors who had been borrowing in the United States and using that money to invest in India, would be looking at a lower return as they will have to pay a higher interest on their borrowing.
A prospective lower return could lead to some of these investors to sell out of India. In fact as I write this the bond market has come to a halt because there are only sellers in the market and no buyers. Such has been the haste to exit India.
When foreign investors sell out of bonds (and stocks for that matter) they get paid in rupees. This money needs to be repatriated to the United States and hence needs to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Now its worth close to Rs 60 ($1 equals Rs 59.9 to be precise).
A lower rupee means that the price of gold is likely to go up in rupee terms. And this can attract more investors into gold pushing up India’s gold import bill further. But then do we blame for the gold investor for that? And if that is the case why not ban all speculation, starting with real estate.
The article originally appeared on www.firstpost.com on June 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)