The irony about the Index of Industrial Production (IIP) numbers for January is that most economists, who usually set great store by such data, believe it to be an aberration, while the stock market, which normally views macro numbers with healthy scepticism, decided to take it seriously.
The market is worried that it may not just be global credit problems they need to bother about—a slowing economy, lower earnings growth and financial risk to Indian companies from exposure to derivatives and international debt are additional concerns.
There’s little doubt that the Indian economy is slowing, but a dramatic drop in capital goods growth to 2.1% from 16.6% in December and 24.3% in November does seem too steep.
The Central Statistical Organisation’s advance estimates had earlier implied that growth in gross fixed capital formation would be 14.7% in the second half of FY08 compared with 15.5% in the first half. Another indicator of the slowdown has been the New Orders index of the ABN Amro Purchasing Managers’ index, which fell in both January and February.
Lehman Brothers’ economist Sonal Verma says: “Perhaps the rising cost of overseas borrowing is starting to hurt. CDS (credit default swap) spreads on Indian AAA-rated companies have widened to more than 200bp (basis points) from 50-60bp a year ago.”
Nevertheless, Gaurav Kapur, ABN Amro’s India economist, points to one plausible explanation. He says imports of capital goods may be behind the rise of 65% in non-oil imports in January. In other words, capital investment is still strong, but the orders are not going to domestic engineering companies.
Capacity constraints in the economy are cropping up, seen in the marked slowdown in the growth of the 60 million infrastructure industries and in inflation in the wholesale price index for manufactured products, which has gone up from 3.7% at the beginning of the year to 4.3% year-on-year by 23 February. That will add to the Reserve Bank of India’s dilemma.
On the positive side, consumer non-durables grew at 10.1%, compared with 10.3% in December. But, the positive growth seen in consumer durables in December was short-lived and growth fell back into negative territory. And, finally, while there’s no doubt that the IIP numbers affected market sentiment, it’s a bit strange that the Bombay Stock Exchange Capital Goods index ended flat on Wednesday, while the IT and metals indices were the main losers.
The ease with which Wednesday’s rally faded is an indication of the fragility of the market.
The Fed provides a crutch to the US financial sector
US Federal Reserve governor Ben Bernanke sparked a global rally in equities simply by decreeing that the US central bank will lend US treasurys in exchange for a wide range of financial instruments, including private mortgages rated AAA. As a Bloomberg report pointed out, most of these mortgage-backed securities (MBS) do not deserve the triple-A rating (it cited one of them as having 49% delinquency) and the rating agencies have deferred downgrading these ratings, perhaps to give banks some breathing space. In effect, therefore, the US Fed has agreed to accept what amounts to junk in exchange for treasurys.
The measure will allow banks to use the treasurys borrowed to get cash and will therefore add to liquidity. Also, by increasing the supply of treasurys, it will lower their price and bid up their yields, which have been pushed down to ridiculous levels as investors saw treasurys as a safe haven. At the same time, it should increase the demand for MBS, pushing up their prices.
The US markets reacted by selling treasurys, lowering premiums on credit derivatives and frantic short covering in beaten down financial stocks as confidence returned to the market. The central banks hope that the 28-day facility will create a market in MBS and allow banks some breathing space before the rate cuts kick in and help alleviate the basic problem in the US housing sector. And they will probably roll over the facility till it happens. But banks are strapped for capital and are likely to be very selective while lending—the Fed move had little impact on mortgage rates, which continue to be higher than where they were six months back. Despite the rally, it’s very likely that the Fed’s move will be seen as another band aid and this move too will go the way of its previous efforts—that’s the reason why the Asian markets closed well below their intra-day highs on Wednesday. But then, we have the next Fed rate cut to look forward to.
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