Markets Pegged to Liquidity Outlook

In the classic growth-inflation trade-off, the third angle of sharply depreciating rupee, has made currency management an imperative.
     Print Edition: September 2013
'Markets dependent on liquidity outlook in near future'

Sandesh Kirkire, CEO, Kotak Mutual Fund
Sandesh Kirkire, CEO, Kotak Mutual Fund
Market's ride in the past few weeks was extraordinarily bumpy . We all know that RBI slashed liquidity in two tranches. One on 15 July and another on 23 July bringing systemic liquidity to 0.5% of NDTL; with penal rate of 10.25% on MSF borrowing. The intentions were clear, to make rupee dearer in the banking system and finish any carry-trade possibility in the forex market.

The choices for RBI seem palpably difficult, which it figuratively called 'Trilemma'. In the classic growth-inflation trade-off, the third angle of sharply depreciating rupee, has made currency management an imperative. The rupee has lost nearly 10% has been in the last four months. With international crude oil prices also beginning to rise, the risk of compounded inflation (through imports) was high, necessitating an aggressive intervention. The policy response essentially seems monetarist in nature and would serve to perhaps only plug/delay the forex gaps, without forcefully addressing the real problem - the trade and the current account deficit.

India imported nearly $15 bn worth of coal, $10 bn worth of iron & steel and around $83 bn worth of gold, silver and precious stones in FY13. A lot of these imports can surely be substituted in India - and with an ever more expensive dollar - perhaps more competently.

For instance, in case of gold and silver imports, a bulk of the demand is for household savings requirement. A booming business environment with substantial investment opportunities can offset a sizeable proportion of that component.

We need a very strong and robust industrial economy with an equally abetting infrastructure to provide an employment fillip to nearly 67% of the rural population engaged in agriculture. And it is through this medium that India's middle class aspires to generate further investment and growth opportunities. Urgent Policy emphasis on productivity, both in capital and labour, is necessary in this regard.

From the immediate viewpoint, equities and debt market, both, remain pegged to liquidity outlook. Liquidity in turn remains dependent on how the rupee stabilises in the forex market. Having said that, there are signs that most of the decline in rupee might be behind us and the currency bottom might approach sooner than later.

If this happens, we can expect the present liquidity measures to ease gradually, with swift reversal in the current monetary policy stance. From this standpoint, the present debt market provides a unique investment opportunity to not only capture high carry, but also seize the potential for modest capital gain from any rate reduction.

SANDESH KIRKIRE
CEO, Kotak Mutual Fund


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