Here’s an amazing statement from the Wal-Mart earnings conference call, as reported by the Britain’s Daily Telegraph:
“It’s no secret that many customers are running out of money towards the end of the month,” chief executive Lee Scott said. “The paycheck cycle is, in fact, more pronounced now than it ever has been.” Economic woes had got so bad, Wal-Mart said, that more and more people—both staff and customers—were resorting to stealing from its stores as the financial pressures began to bite. Theft of cosmetics and electronics were particularly rife. “If you think about the macro environment, where customers are under pressure, there’s generally a correlation between theft and macro-economic pressure,” chief financial officer Tom Schoewe said. “Unfortunately that’s what we are seeing.”
If that assessment is right, then the US consumer, the Buyer of Last Resort who held up the global economy, is on his last legs. The US Federal Reserve certainly thinks so, which is why it has cut the discount rate, or the rate at which it directly lends to banks, by 0.5%. The US central bank is clearly worried that the credit crunch, with its reluctance to lend to weak borrowers and higher lending rates, will slow the American economy.
At the same time, economists have been warning about the moral hazard involved in the central bank underwriting the market and stepping in at the first hint of trouble. This is the kind of behaviour that has encouraged excessive risk taking all these years, leading to the present crisis. Clearly, something far worse than a mere 10% drop in market indices is amiss.
The markets are, of course, ecstatic, with their wildest dreams coming true. The Fed’s action is actually more of a signal than a source of additional funding, because the discount rate is higher than the Fed funds rate, at which banks can borrow from the money market. In the short term, though, it’s a powerful signal that the Fed will support the markets.
Of course, the Fed’s action will help not just the US economy, but also the rest of the world. Huang Yiping, the Citigroup Asia economist, writing in the latest issue of the Chinese business magazine Caijing, says “a potential US recession could have major negative impacts on Asian economies. However, despite the recent deterioration of sentiment among market participants, the US economic expansion remains robust outside the housing sector. Our comprehensive model puts the probability of a recession in the US at merely 20%. If the US economy can maintain its slightly below-trend growth, then the direct economic impact on Asia may be more limited.” It’s also true that, a few weeks ago, the International Monetary Fund raised its growth forecast for the world economy while at the same time lowering it for the US economy.
But recent data seems to show signs of slowing in Japan and Europe. Second-quarter GDP in Japan grew at a y-o-y rate of 2.3%, lower than the 2.5% rate notched up in the first quarter. For Europe, the numbers were 2.5% and 3.1%, respectively. And these numbers too, especially for Europe, are likely to be affected by the freeze-up in the credit markets.
CLSA equity strategist Christopher Wood writes in his “Greed & Fear” newsletter that “the much-publicised problem in the world of credit will lead in due course to a significant slowdown in the real economy”. That seems only logical, given the importance the financial sector has in Western economies. As Wood points out, 30% of S&P 500 profits generated in the first half of 2007 was by the financial services sector. But will a slowdown spread to the East? Much depends on what happens to the commodity sector and especially to oil, says Wood. “The anticipated correction in this asset class will exacerbate the growth scare, which will be a negative for Asia.” Yiping believes that “Asia’s strong fundamentals, including healthy current accounts and fiscal positions, should generally support asset prices.”
Notice that India’s position is slightly different. It runs a current account deficit, and its fiscal deficit, although improving, is still high. Those are the points that Morgan Stanley economist Chetan Ahya makes. In a recent research note he writes, “We believe that, in the event of a sharp risk aversion in the global financial markets and/or a global hard landing, India’s growth cycle is far more vulnerable than the rest of Asia.” And further, “Unlike other emerging markets, India’s balance of payments surplus (a key source of liquidity supply) has been driven by capital inflows. Almost 82% of the total $98 billion (Rs4.5 trillion)of capital flows that India has received over the past four years has been in the form of non-FDI flows. As a result, India is more exposed than other emerging countries to a potential sharp reversal in global risk appetite. Non-FDI capital inflows account for only 25% of the total in emerging countries (excluding India).”
From the point of view of the markets across the world, therefore, the Fed’s rising to the rescue is entirely a good thing. Economists have argued against a bailout, most of them insisting that the hedge funds and the investment bankers should pay for their sins.
The US Fed certainly thinks otherwise and has once again come riding to the rescue. At the time of writing, the markets had staged a huge rally as a result. But the question remains: will the Fed’s action restore banks’ willingness to lend and end the credit crunch?
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at email@example.com.