Devangshu Datta: Opportunity ahead... if you have patience

Waves of fear are emanating from the USA, as president-elect Donald Trump forms his team, and rumours run riot about sweeping policy changes. Meanwhile, first cut assessments of short-term and medium-term losses from India’s currency reboot are coming through. 

Trump’s policy changes will be coupled to a hawkish Federal Reserve stance. This could mean a tectonic shift in forex rates and global trade patterns. Bond markets are betting on a December hike in the USD policy rate.  

Emerging markets are taking a hit. Foreign portfolio investors sold over Rs31,000 crore in rupee assets in November (until November 25). FDI statistics look reasonably good. But given the lumpy nature of FDI, one Vodafone or Rosneft deal skews statistics considerably, so future projections are hard. 

The political fallout from demonetisation is difficult to judge, so far. It will be rather entertaining if people are queuing up side by side at ATMs and election booths when the next set of Assembly elections takes place. This is quite likely, as limits on currency withdrawals will probably continue indefinitely, given the gap between supply and demand.

It’s clear that this was badly planned, with more than 170 changes in notifications over the last 17 days. Banks and ATMs in metro cities are running dry, and the situation in unbanked and under-banked rural and semi-urban areas is worse, with many places cash-starved for days. Discretionary spending has dipped at all price points. People are buying fewer small items such as toffees and prepaid telecom Rs30 coupons due to lack of change; they are also buying fewer handsets and two-wheelers.

The liquidity crunch and enforced depositing of currency have had a counter-intuitive effect. Many people are trying to draw out as much cash as possible, to keep afloat at home for emergencies. History suggests bank runs occur when this sort of situation spills over from mass anxiety into panic. In technical terms, of course, India is seeing a massive bank run already. 

There is, as yet, no coherent estimate of the likely man-days lost and likely employment loss in the unorganised sector and in cash-intensive, manpower-intensive industries such as construction and transport. Estimates for gross domestic product (GDP) growth cuts start at the absurdly low level of 10 basis points (if we assume 14 working days have been lost, that amounts to about three per cent of annual productivity). A “conservative estimate of two per cent loss” of GDP growth comes from Manmohan Singh, who was, lest you forget, Planning Commission chief,  Reserve Bank of India (RBI) governor and finance minister as well as prime minister. Among securities firms, Ambit is calling a 3.5 per cent drop in GDP growth in 2016-17.

CMIE guesses that GDP contraction (as opposed to growth reduction) will amount to Rs1.28 trillion, which is roughly one per cent of GDP. There will be a huge number of job losses. One estimate is that around 400,000 jobs have already been lost due to liquidity shock. Another 32 million people work in sectors directly vulnerable to contraction. There will be ripple effects, as consumption collapse works its way through the entire economy.

The RBI is nearly certain to cut policy rates in December and by big margins at that. Indian government Treasury yields have already fallen below the repurchase rate on intra-day basis. Banks sitting on huge piles of cash must pump more into government bonds to maintain statutory liquidity ratios. So the Fisc will be financed at lower interest rates, at least.

Most of the new deposits are demand deposits in savings accounts. If depositors do withdraw large amounts of cash, banks will face the stress of asset-liability mismatches. However, massive rate cuts could be a stimulus for the formal economy. Bank credit was growing at the lowest rate in at least 10 years (as of November 11), so there wasn’t much commercial demand in the system.

If big rate cuts are enough to kickstart activity again, 2017-18 may see recovery in the formal growth rate based on a combination of low GDP growth base in 2016-17, and on anticipated tax reforms and better record-keeping due to an increase in cashless transactions. 

Fitch says Indian growth will still outrun China. Moody’s says the move will weigh down GDP growth “across a few quarters”, leading to lower tax revenues. Frankly, nobody really has a good idea of likely damage. Lack of liquidity has severed links between the formal and informal economy and everyone has their own guesstimates about the future road map.

The USD will move higher, maybe much higher against INR, as risk-free yields from the two currencies converge. Risk-averse debt investors will move some assets out of fixed deposits (as FD rates fall) and into debt funds (which are logging capital gains).

Technically speaking, the stock market appears to have established a long-term bearish trend. It has a pattern of lower lows, and it has fallen below the benchmark 200-Day Moving Average, despite heroic buying by domestic institutions. The potential downside looks much steeper than the upside. The ceiling is capped in the short to medium term. This could be a great opportunity for systematic long-term investors, if they can hold their nerve, through the next few months. Or years.

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