Mood turns dark

The mood of the investor community globally has turned dark, alongside a gloomier outlook for the world economy. Doubts about the American economy in particular have resurfaced, as states across the southern belt of the US report record high new cases of Covid-19 almost daily. This has combined in many minds with the steady uptick in tensions between the world’s two largest economies to create expectations of weak growth or at best uncertain conditions for the foreseeable future. The US-China trade war has now expanded into several other domains, including through the arrest this weekend of a supposed Chinese spy in San Francisco, and the forced closure of the US consulate in the Chinese city of Chengdu, as retaliation for the closure of China’s in Houston. It is possible that the US Congress will unveil plans for yet another stimulus package sometime in the next fortnight. But markets that have already rallied on unprecedented fiscal and monetary packages will also look carefully at the avalanche of bad news.

The immediate impact of both the stimulus and the growing uncertainty is seen in the price of gold. Globally and in India, the precious metal — seen as both a store of value in times of uncertainty and as a hedge against possible inflation — has reached levels not seen before since 2011. It is easy to see the mechanism at work here. Global gold prices have gone up by 25 per cent over the year, as most of its competitor assets have struggled, reflecting its status as a safe haven in times of trouble. In addition, there are very real questions now being asked about the eventual effect of the large fiscal and monetary stimulus packages unveiled hastily and without much thought by the central banks and governments of the developed world. In essence, there is every reason to suppose that they will lead to inflationary pressures. Unlike in regular recessions, there is not a lot of excess capacity around as a buffer against these pressures. Inflation might tell first, therefore, on asset classes like gold — so traders are running up the prices in anticipation.

Indian policymakers must be aware of the fragility of this moment. While energy prices have remained range-bound and domestic demand has been low enough to provide a rare current-account surplus, galloping prices of precious metals have never been good news for India’s external account. Meanwhile, India must brace for a flood of yield-seeking capital that will stress both rupee management and governance structures. The vast monetary expansion undertaken by central banks of the developed world means that, by some estimates, aggregate bond yields are at a record low, with more than 60 per cent of the global bond market yielding less than 1 per cent. India must see this as both opportunity and threat. The capital can certainly be put to use in building productive assets. But it must be directed towards the areas where it will provide the optimal combination of social and private return. It must not dissipate itself purely in pushing up stock and asset prices. The government must work overtime to make available appealing financial instruments that will push this flood of yield-seeking capital to greenfield investments in India.

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