Industry wants quick fixes that do not work
The clamor has started. Rate cuts, stimulus package, government intervention in markets etc. Global financial market volatility, which has taken down world equity markets by over 10% since the beginning of August, is the reason for the clamor. The truth is that the clamor is the reason behind what is happening now. Hopefully policy makers will understand and not give in to the market’s demands.
In fact policy maker’s moves are not settling down markets. The ECB (European Central Bank) bought bonds of Spain and Italy on the day when European markets tanked by 6%. This market mayhem is almost fully due to the mistakes of policy makers in giving stimulus post the 2008 crisis. Government took up public debt to spend while central banks printed money to buy government bonds. The result, economies on steroids, and when the effects wore off, markets fell. Policy maker’s actions post 2008 weakened foundations leading to a collapse now.
Markets by now should have realized that its demands cannot be met by policy makers. The government is struggling with its finances and is overdrawn with the RBI. The government spending on subsidies is weakening its finances, and despite weekly government bond auction of Rs 12,000 crores, the government’s account with the RBI is negative. The government has no room left in its finances to provide stimulus to the industry.
The RBI is struggling with inflation that is at 9.5% levels. The rates hikes of 125bps in the past three months may have been too much, but the fact is a sudden reduction in policy rates signals an RBI, which is clueless on the direction of a global economy. The RBI should pause in its hikes given current outlook for commodity prices and economic growth but a rate cut will drive out any confidence in investors on the central bank. Turkey is a good example where surprise rate cuts weakened the currency by 3% and markets actually sold off the currency on the back of the central bank’s move.
An India which is fiscally strong with falling inflation expectations is much better than being fiscally weak with rising inflation expectations. If the government gives in to demands of stimulus and RBI gives in to demands for rate cuts, the country is more likely to see a flight of capital as investors gives a thumbs down to the moves of the policy makers. The fact the India is on firmer footing than highly indebted countries and that the RBI is conscious of its role in price stability is what is keeping the FII’s invested in Indian equity and debt. Let’s not lose that confidence.