The US dollar index, which measures the performance of the dollar against a basket of currencies, has strengthened dramatically in recent days, firming up to 74.17 on 8 August from a low of 70.03 on 15 July 2008. It’s now back to a level it was last at on 24 December.
Morgan Stanley economist Stephen Jen is associated with the theory of the “dollar smile”, which says when the US economy is in a recession, that affects the rest of the world as well and funds flow back to the US, supporting the dollar. That’s the left side of the smile. The right side is when the US has very strong growth, which too is good for the dollar.
According to the theory, it’s only when the US muddles along that the dollar is weak. As proof, the currency actually strengthened during the last recession, with the dollar index rising from around 100 in June 2000 to 110 by April 2001.
This time, however, the theory wasn’t working, simply because while the US had reduced interest rates, the rest of the world hadn’t followed suit. But that changed last week when European Central Bank president Jean-Claude Trichet warned of the risks to growth in Europe, indicating that his next move may be a cut in interest rates. Interestingly, Nymex light crude oil futures have slumped to $115 a barrel last Friday, coinciding with the rebound in the dollar. If the European and UK economies weaken further, we’re likely to see crude oil prices plunge even more.
It’s difficult to believe that the entire run-up in crude prices, from around $70 a barrel in August 2007 to more than $147 a barrel in July, was solely on the basis of higher demand. That is why stock markets are rallying, hoping that the money that went into commodities will head right back to equities.
Total money market fund assets in the US increased by $58.5 billion, the highest increase in a week since January. The big question: If the commodity bubble is bursting, where will all that money go?
Incidentally, the rupee seems to behave rather like the dollar on steroids, falling against the dollar when the latter is weak and appreciating when the dollar is strengthening. The dollar- rupee interbank rate moved from 43.20 on 14 July to 42.05 on 8 August, the period which also saw the dollar rise sharply. If the trend persists, a stronger rupee will be another factor making for lower inflation.
Sharp slowdown in credit growth
The growth in bank credit shuddered to a halt in July. Credit had been growing strongly, rising by Rs51,157 crore this fiscal year till 27 June. In the month to 25 July, however, it was lower by Rs6,637 crore, the decline being on account of a fall in food credit; non-food credit rose nominally.
One reason for the halt could be that banks have had to keep more funds with the Reserve Bank of India, or RBI, after two consecutive increases in the cash reserve ratio of 25 basis points each took effect from 5 July and 19 July. One basis point is one-hundredth of a percentage point. Bank balances with RBI increased by Rs20,996 crore in the month to 25 July.
In the three months to 25 July, banks increased deposits by Rs120,690 crore, of which Rs77,000 crore went into giving loans. Of the total credit, Rs74,500 crore were non-food loans, while Rs72,400 crore went into increased cash balances with RBI. These together add up to Rs146,900 crore. But the rise in deposits was much smaller, so where did the extra funds come from? Banks had to sell so-called statutory liquidity ratio securities to bridge the gap, bidding up yields on government bonds.
It’s also probable that loans to oil companies accounted for a large chunk of incremental credit and the direct purchase of oil bonds by RBI from June has led to lower credit. Unless credit growth revives soon, it will be seen as part of the mounting evidence that the slowdown has started in earnest.
Reassuring results from Yes Bank
Yes Bank Ltd had been singled out by analysts as most exposed to the worsening economic headwinds, as the bank’s lack of low-cost deposits and dependence on wholesale deposits were expected to hurt it badly in an environment of rising interest rates. Yet, profit after tax for the June quarter was up a healthy 50.9%.
The concerns appear to have been overblown. The net interest margin (NIM), or the difference between what it earned on loans and paid for funds, fell from 3.1% in the March quarter to 2.9%, but it was still well above the 2.3% NIM in the year-agoperiod. Combined with a 45% growth in advances, it resulted in net interest income, or the difference between interest earned and that paid, rising a huge 122% on year. Non-interest income was up a comparatively tepid 21%, because of lower treasury and distribution income. But this was offset by strong growth in transaction banking fees.
Stringent cost control also helped, with staff costs growing by just 8% year-on-year, despite a rise in the number of branches. That’s because, according to a report by Enam Securities, the bank’s staff strength declined by 350 in the June quarter. Reports had earlier stated that the staff strength had been reduced by 392 employees in the March quarter. All this has helped the bank show a pre-provision profit growth of 87% on year.
In sum, the bank has shown an ability to manage costs well and, with loan growth well above the industry average, it should be able to manage high growth in net interest income. Growth in transaction fees is also positive. With an aggressive branch expansion plan, the bank should also be able to increase its very low proportion (8.9%) of current and savings bank deposits. All this should add up to better-than-industry performance in future.
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