Here we are in 2012, the year when the world is supposed to end!
After the traumatic 2011, we would rather believe that we have seen the worst. After all, how much worse can things get. It is more than three years now since the world appeared to be on the brink of disaster in the aftermath of Lehman Brothers. If 2010 was the year of hope, 2011 turned out to be one of disillusionment. We saw worldwide capitulation of risk takers, who msitakenly believed that central bankers would once again trump the law of nature and manage to stunt the “bust” part of the boom-bust cycle.
We saw developed ecoomies heading into a recession. That said, the US managed to instill some confidence in its economy because of a proactive Fed. However, the Euro-zone, handicapped by the long decision-making process and the ultra-conservative Germanic central bank, certainly appears to be heading for a prolonged period of trauma.
The Euro-zone was visualized as a Union of nations, which, over time, was expected to replicate German prosperity. However, like the legendary incident that transpired between George Bernard Shaw and the beautiful lady, it is Germany that is now beginning to resemble the PIIGS nations it is defending. At least that is what appears to be the case going by the bond market, which, of late, has equated German bond yields with that of the UK. Of course, the latter’s economy is in infinitely worse condition, but it is the Bank of England (BOE)’s ability to buy its own bonds that makes all the difference.
Hence, for the Euro-zone, the solution at some point in the future will be for the ECB to step in and print notes. All other alternatives probably would entail a break-up of the Union. The impact on India would be difficult to predict. There are too many variables affecting the likely path for the Indian markets.
The most predictable outcome for 2012 would be:
• Slow but positive growth in the US.
• Euro-zone managing to muddle along to avoid a Lehman-like money-market freeze, but unable to satisfy markets.
• Global banks struggling to augment capital with help from respective central banks.
• Sporadic bouts of risk-on, risk-off mode depending on news flow.
• Rating agencies downgrading sovereigns and banks.
• China, a key driver of global commodity prices, slowing down on lower exports, thereby easing pressure on commodities.
• Geo-political issues like Iran putting a floor on crude prices.
• In India, inflation softening in-line with expectations, partly by RBI design and partly due to the base effect.
• Weakening rupee continuing to exert upward pressure, but various measures initiated by the RBI, such as decontrol of NRE deposits and resumption of protfolio flows, supporting the rupee.
• Growth slowing down further in Q4FY11 and FY12.
• RBI beginning rate cuts some time in Q1, at least to the extent of 100 basis points during the calendar year.
• Government overshooting borrowing targets and failing to meet FY12/13 fiscal deficit targets as well.
Although there are too many imponderables, in most cases, the Indian interest rate scenario should be benign and bond bullish. During th January-March quarter, slowing growth is likely to put immense pressure on the RBI to cut rates. Given the political scenario, the current policy/ decision-making freeze is likely to continue. The government has rather limited fiscal space to increase expenditure/investments, and, therefore, the onus for stimulus will squarely be placed on the RBI. Fortunately, the central bank has enough space to ease, both on the liquidity and the rate front. Hence, irrespective of the size of the government borrowings, bond yields (particularly of government securities) are likely to head southward from current levels.
The GDP growth accelerating to 8-9% appears unlikely in the short term and is dependent on the global recovery. That said, we should be able to come out of the impending global slowdown relatively unscathed for no other reason than demographic dividend and the huge scope for investment-led growth in infrastructure. Another key growth driver wil continue to be domestic demand. With new entitlement schemes like Food Security Bill in the offing, in addition to the existing employment guarantee schemes, rural demand should continue to be robust, helped by higher minimum support price (MSP) for food grains. Never mind the sheer inefficiency of such spending!
The political class figured out in 2009 that the Holy Grail for electoral victory lay in rural appeasement, which, hitherto, used to be prevalent in Tamil Nadu and Andhra Pradesh. Hence, irrespective of fiscal deficit and inflation, it looks like entitlement spending is here to stay. What it means is that even though we have a favorable inflationary scenario and bond-positive slowdown in the economy currently, the undercurrent of demand-led spike in inflation remains alive and kicking.
Hence, while it is easy at this point to predict a bull market for bonds in 2012, there will always be a lurking fear of inflation rearing its ugly head again, regardless of whether it is caused by domestic demand or liquidity-led international commodity rally. Meanwhile, my money will be on bonds of the longest duration, or debt mutual fund schemes with the longest average maturity!
K. P. Jeewan
Head – Fixed Income
Karvy Stock Broking Ltd.
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