Will Fed’s QE taper talk topple Rupee again?

When U.S. Federal Reserve chairman Ben Bernanke spoke of reducing bond buying quantity (Presently Fed is buying $85 billion per month and the program is popularly known as QE, quantitative easing) first time in the month of May, markets were surprised and spooked.

U.S. Benchmark 10 year treasury yields jumped more than 100 basis points within a short duration, equity markets throughout the globe slumped, hot money from emerging markets started flowing out, developing countries’ currencies tanked and Indian Rupee was the worst performer of the league. Rupee touched historical all time low of about 69 per dollar in August from as high as 53 per dollar in May.

After continuous speculation in the markets, markets were prepared for QE tapering in September, but Fed took a cautious call not to taper and surprised markets again.

Following 2 successive months of Non Farm Payrolls jobs data around/above 200,000 and unemployment rate falling to 7%, there is again speculation of tapering in the markets. Timing and quantity of the tapering is a debatable question but will that talk of tapering cause volatility in forex markets again? Will Rupee again tank to such drastic level with such aggressive bearish bets.

I think, pace and level of volatility what we saw after Chairman Bernanke comments in May were too fast and too much and that may not repeat if tapering happens also. Obviously there will be some reversal in recent gains attained by Rupee as whenever U.S. sneezes rest of the world catches cold! So there may be slide in the level of Rupee but with not such aggressive pace and the level, seen earlier because of the following five reasons.

Priced in the market

Tapering news was new when Chairman Bernanke spoke about it in the month of May. After that various regional-Fed presidents either talked against it or in support of it. Markets participants started analysing for and against the tapering. Markets were prepared for tapering in September month’s Federal Reserve meeting itself. So this time whenever it happens or mere talk of tapering may not cause such drastic moves in Rupee markets as it is already priced in the markets that eventually tapering had to be done, it’s just a matter of time and quantity.

Bond yields

When Bernanke talked about it first time in May, Benchmark 10 year treasury yields were as low as 1.6% and now they are trading at 2.8%. Talking about Indian government 10 year bond yields, they were around 7.5% in May and now trading at around 9%. Both the countries yields are elevated levels indicating tighter liquidity scenario in coming months and looks like they are prepared for tapering.

Current account

Indian current account deficit (CAD), the difference between outflow and inflow of foreign exchange, was one of the worst among the emerging countries. But CAD reduced substantially over the last quarter. India's current account deficit narrowed sharply to $5.2 billion, or 1.2% of GDP, in the July-September quarter of 2013-14 on the back of turnaround in exports and decline in gold imports. Thanks to RBI and governments moves to curb the gold imports and improvement in exports helped by Rupee depreciation as well as recovery in global economy. The current account deficit was USD 21 billion, or 5 per cent of the GDP, in the second quarter of last fiscal. On Sequential basis also CAD improved from $26.9 billion in previous quarter.

Bottoming out of growth rate

India’s gross domestic production growth rate on decline from 2010 peak and it seems that it is bottoming out around 4.5% - 5% levels. GDP expanded 4.8% in the three months ended 30 September, compared with 4.4% in the preceding quarter. From last 4 quarters Indian GDP is hovering around 4.675% (4.8%, 4.4%, 4.8% 4.7% in reverse order) indicating the bottoming out of the Indian GDP growth rate.

Rajan effect

After Raghuram Rajan became RBI governor, markets showed confidence in his ability and credibility to curb the inflation, bond market reforms, clear communication with market participants and forward guidance. His strategy to attract Dollar deposits through FCNR route helped Rupee to regain some of the losses in the forex market. His shifting focus towards CPI inflation from WPI inflation is good for Indian economy in longer run, even though it may hurt in immediate future. After yesterday’s CPI inflation of around 11%, Rajan may increase repo rate by another 25 basis points in next week’s meeting, which indeed in turn helps Rupee as hot money will be chasing for high yields.

Micro-decoupling factors in a macro-coupling world

During early part of the recent financial crisis, decoupling concept started popping out in financial markets, that certain part of the world is not dependent on the rest of the world. But as crisis deepened, people started realising that in the present globalised world, it’s very difficult say that we are no longer dependent on others!

But there are certain factors, which are very micro, country specifics and are decoupled in macro-coupling economic world. To begin with end, I am still saying global world is a coupled one and no country or state can say that they are fully immune from the rest of the world. Nobody can say that, they are growing only because of domestic reasons.

But below mentioned micro economic factors, which are country specific, are giving signals that they are decoupled in nature in short to medium term.

Inflation

As all of us know inflation, change in the price levels of essential goods and services in a country, plays important role in the country’s economic policy making. I am not such a big fan of Milton Friedman’s proposal of inflation: Inflation is always and everywhere a monetary phenomenon.

I think inflation can also be because of fiscal expansion, like government spending more but without actually increasing output of the country, leading to bigger amount of money chasing same goods and services, which in turn creating demand-supply mismatch in an economy. Also there can be various other causes like, monetary policy cycle, demographics of the country, savings and expenditure pattern and currency fluctuation.

Keeping aside these causes, Inflation in countries like India, Indonesia and Venezuela is beyond central bankers’ comfort zones whereas in certain parts like Japan, Euro-zone and U.S. it is much below their central bankers’ targeted levels. These developed countries' central bankers are trying pump up the inflation or trying to avoid the deflation whereas developing countries central bankers are trying to minimise the inflation and inflation expectations. Reasons for both the cases vary from country to country, but in above mentioned each part, central bankers are struggling to anchor the inflation in different directions! 

Interest rates

Central bankers of each country (or zone) will be having different mandate/s like growth and/or inflation or only price (inflation) stability or currency stability. Depending on these mandates central bankers decide their course of action in deciding the interest rates and also cycle (upward or downward trend).

Now without getting into each central banker’s mandate, it is easy to say from currently available picture that each country’s interest rate is decoupled from rest of the world. For example India, Brazil, Indonesia are following contractionary monetary policy whereas U.S., Euro-zone, Japan are following ultra-expansionary monetary policy because of the issues these countries (zones) facing are different for different parts of the world.

Current account

In layman terminology, current account is nothing but difference between imports and exports. Depending on the difference between exports and imports, countries will be bifurcated as current account surplus and deficit countries. I believe global trade is a zero-sum as ones loss is others gain, so always there will be current account surplus and deficit countries as long as trade is global and liberal.

Countries like Germany, China and Saudi Arabia are current account surplus ones whereas U.S.,  India and peripheral countries of Euro-zone likes of Greece, Portugal and Spain are current account deficit ones.

Reasons may vary from efficient productivity, economies of scale, natural resources and others but countries are clearly decoupled in this context way above margin!

Equity markets

I would like to cast equity markets in a coupled-macroeconomic section as free capital (hot money) flow in a globalised world is not a country specific phenomenon. Easy money strategy followed by developed world like QE (1, 2, 3 and operation twist) of U.S., low interest rates and LTROs from Euro-zone, Abenomics in Japan is not only pumping their domestic equity markets to new (or regaining historical) levels, but also other countries’ equity markets are also trading at record levels.

Dow Jones and S&P 500 (@highest levels), NASDAQ (@13 year high) of U.S. and Dax of Germany are trading at historical levels. Japan’s Nikkei 225 is at almost 6 years high, India’s Nifty and Sensex are trading either highest level or around historical high levels.

Raghuram Rajan’s balancing act of (im)possible trinity

When Raghuram Rajan took over the charge of the governorship of Reserve Bank of India (RBI), India was facing multiple issues. Because of Federal Reserve bond buying tapering speculation (at that time) hot money started flowing out of the emerging countries and India was no different. In addition to that India's unsustainable current account deficit (CAD) fuelled the bearish sentiment of the Rupee. It was the worst performer among the emerging countries currencies.

Meanwhile, then governor D. Subbarao hiked Marginal Standing Facility (MSF) by 200 basis points to prevent the currency outflow and so called excessive speculation. MSF is the rate at which banks borrow from the RBI in times of tight liquidity and it used to be 100 basis points above repo rate. Markets started speculating about RBI’s next possible move of capital controls, which Finance Minister and RBI governor denied repetitively.

Furthermore, India’s growth rate was (is) at its lowest pace in a decade. Inflation dilemma was continuing due to divergence between high level of CPI and moderate levels of WPI. Everybody was contemplating new governor’s stance on monetary policy at this crucial state of the economy.

Governor Rajan was supposed to prevent free fall of rupee, manage market expectation of not pursuing capital controls and have a monetary policy which is independent of all this. Which is impossible trinity and as name suggest it’s practically impossible to achieve all three at the same time.

In his first monetary policy meeting he took two important decisions.

1. Increasing repo rate by 25 basis points and decreasing MSF rates by 75 points. By doing this he took first step towards managing market expectations of not pursuing capital controls and at the same time he stressed upon the anchoring inflation and inflation expectations. By taking these steps he walked towards achieving two legs of the impossible trinity, i.e. free capital movement and independent monetary policy.

2. Providing the Dollar-Rupee swap facility for dollar funded deposits which helped India to attract nearly $12 billion in less than two months from then. This took care of Indian rupee depreciation and rupee recovered from its lowest levels. Third leg of the impossible trinity talks about fixed exchange rate, in which India doesn’t operate as Indian currency is partially pegged one.

Meanwhile, other factors like tapering postponement and Central government's efforts to curtail CAD also helped the market sentiments.

But credit must be given to governor Rajan as he is doing tricky job of balancing the impossible trinity of free capital flows, exchange rate (managed, not fixed in this case) and independent monetary policy, which is anchoring inflation.

Basic tips for resume and interview

As a part of my job, now I have the privilege of scrutinizing resumes and taking interviews. Over the course of this time I have realised some basic things about resumes and interviews, which may be very common, but not finding them in most of the candidates and their resumes. Here I am mentioning certain basic tips, which we all might know but may not be giving much importance.

Information in the resume should be to the point

·         Nobody in corporate world has time to study candidate’s resume in detail for more than a minute (less than that in most cases) or two.

·         Candidate should always remember his/her resume will be competing with tens of hundreds of resumes.

·         Selecting resumes out of this bundle of resumes need lot of time, so each resume may not get much time.

·         Within first few seconds only resume’s fate will be decided whether to read further or not.

·         Resume’s length shouldn’t go beyond a page or one and half page.

·         Try to use bullet points rather than paragraphs, as information may not be as visible as in bullet points.

·         Don’t put in unnecessary data or information, which is irrelevant to job profile applying for.

·         Concentrate more on skill set, prior experiences, professional achievements, academic career and basic personal information. This doesn’t mean that other things should not be there, but give these things more importance.

·         Follow a flow; it is better to start from skills sets, most recent experience and then in downward order.

·         Better way to forward resume is through referrals rather than sending it through websites or email id provided there. 

Interview is for rejecting

·         You might be thinking that by mistake I would have written rejecting instead of selecting. No, you are wrong.

·         Even though interview is conducted for selecting right candidates, but rejection percentage will be much bigger than that of selection because of high number of applicants.

·         First few minutes of the interview only decides the fate of the candidate, whether to proceed to next level or end it.

·         So always try to give an impression to the interviewer that you are not wasting his/her time.

·         Don’t get panicked if interview is prolonging and grilling. Sometimes it might be a sign that interviewer is interested and wants to test the limits.

·         Candidate should be confident, convincing, logical and clear in communicating his/her thought process.

·         Carefully use words to construct sentences, as most of the times candidate they themselves provide an idea for next question, to be asked while answering previous questions.

·         Please don’t ever bluff in the interview, it’s very difficult outsmart the interviewer.

·         Don’t be overconfident, arrogant, and argue with interviewer.

·     Should be careful about panel interview, as each person in the panel will be an expert in     

     different field and will be looking at the candidate from his/her perspective. So gauge the 

     pattern of questions asked by each individual and tackle them appropriately.

Rajanomics and its decoding

Prannoy Roy of NDTV discussing overall Indian economic situations like Inflation, Growth (faltering), Sovereign rating and Rupee volatility with RBI governor Raghuram Rajan.  
For Video: Click here

Limitations of Dow

When I was reading an article about “Why Google and its $1,000 shares will never crack the Dow”, in Bloomberg business certain thoughts came to my mind, so thought of writing about them.

Often people look at the stock index as it is perceived to be broad representation of overall stock market. Dow Jones Industrial Average is one of the three main indices of U.S. (other two being NASDAQ and S&P 500) and it is the oldest of three. Even though “industrial” word is there in the name of the index, Dow now include non-industrial companies also as over a period of time economic composition of sectors changed. Present constituents and their weights of the Dow are as follows (Source Bloomberg and data is as of 21^st October).

Though Dow changed its constituents of the index over a period of time, but it didn’t change the calculation method of the index. It follows price-weighted index calculation method wherein stock price will decide the index proportion i.e. highest weighting will be given to a highest stock price and vice-versa.

There are certain limitations of this method. For example as mentioned in the above article, it becomes difficult to include a stock in the index if its price is too high as is in the case of Google or Apple. Even though both of these companies are technology sector giants it is difficult for Dow management to include these companies as these companies’ stock prices are substantially high as compared to Dow components’ stock prices. For instance Google trading at $1000+ and Apple at $500+ will fetch almost half of Dow index weighting if included at these present price levels. So because of high price these companies can’t be included in the index calculation.

Second limitation is price of a stock does not represent the size of the company. To be precise, price of the stocks doesn’t reveal the companies’ position in their sector or overall market. For example Visa is a highest-weighted stock in the Dow because of its share value, which is highest among its components. But revenue wise Visa is smallest company (around $11 billion) whereas JP Morgan whose revenue is almost $100 billion (9 times of Visa’s revenue) is at 21^st position in price-weighted stock in the index. Chevron, whose revenue is less than half of the Exxon Mobil, influence Dow more than Exxon as it is the 6^th highest weighted and latter being at 10^th position.

Third limitation or complicated situation is of corporate action. Corporate action may be stock split or reverse split or bonus share issuance. Companies can split their stock prices for various reasons into smaller priced ones by any ratio. Reverse split is nothing but opposite action of stock split, wherein companies merge their stock. Bonus share means companies issues shares in certain ratios for existing share holders. For all above actions stock price will be forced to adjust. So according price-weighting index method company’s position will be changed even though not much change happened to company except its share price.

Fourth would be question of index representing all the shares in it. In price-weighted index it may or may not give due importance to all companies' share, which it has. Means if divergence between heavy and low weighted stock prices increases then index may move in either direction just because of heavily-weighted stocks rather all stock prices in it! For example in above case if Visa, IBM, Goldman Sachs and other top companies share price increases and GE, Intel and Cisco price decreases or remains constant over a period of time then latter ones lose on their weight and earlier ones gain on their weight. If this persists for a long period of time then Dow will majorly move by the top weighted companies. This means index value may not represent exact status quo of its constituents itself! These results in a situation like index regaining its lost value but most companies' stock value still at abysmal level!

Interesting readings on Economics Nobel Prize

The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2013 to

1. Eugene F. Fama
2. Lars Peter Hansen
3. Robert J. Shiller

Trendspotting in asset markets:
There is no way to predict the price of stocks and bonds over the next few days or weeks. But it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years. These findings, which might seem both surprising and contradictory, were made and analyzed by this year’s Laureates, Eugene Fama, Lars Peter Hansen and Robert Shiller.

Nobel Prize winners say markets are irrational, yet efficient
Are stock markets irrational, driven by greed and fear, subject to euphoria and panic? Or are they highly efficient indicators of intrinsic value? Both, says the Nobel Prize Comittee for Economics, with no sense of contradiction.

The economics Nobel matters for India
The recent announcement of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has gone to three extremely deserving recipients. The combination of deep economic insight and clever methodological contributions that Eugene Fama, Lars Hansen and Robert Shiller have brought to this field has revolutionized our understanding of the determinants of asset prices.

Split Nobel prize shows bubbles are worth watching
Economics is the only field in which two people can share a Nobel prize for saying opposing things.

Economists Clash on Theory, but Will Still Share the Nobel

Nobel Prize U.S. winner warns of 'bubbly' global home prices

Fama, Shiller, Hansen Win Nobel Prize for Asset-Price Work

What is happening in U.S.?

When one of my friends asked me what’s happening in U.S., so I thought of writing about it in a layman terminology, so that non-finance guys like many of my friends can understand.

Most of you might have already read or heard about American government being shut down from last one week or so. You might be wondering, what is this shut down. Why it happened and what is the impact of it?

To start with America follows the financial year from 1^st October to 30^th September just like our financial year, 1^stApril to 30^th March. For every new financial year a new budget is prepared and once it is passed, fund can be transferred to various departmental activities. Means funds allocated for each department can be utilized according to their plan of expenditure.

But if Congress (Parliament in Indian context) does not pass the new budget presented then Congress needs to come up with contingent bill, which allocates funds as per previous year allocation, to work around for time being. If that is also not passed by the majority in the both the houses of the Congress (Senate and House of Representatives) then government needs to shut down some departments which are not exempted from Anti-Deficiency Act (ADA). ADA is legislation, which prevents some government departments spending beyond their allocated funds.

You might be wondering why Congress didn’t pass the budget or contingent bill. Bill is implemented only when both the houses of Congress pass the bill by 2/3 majority or more. Senate, the upper house of the Congress is led by Democrats (52/100) and House of Representatives; the lower house of the Congress is led by Republicans (232/435). So bill should be satisfactory to both the parties.

President Barrack Obama is trying reform the healthcare (bill is also known as Obamacare) by reducing the cost of insurance and increasing the coverage of uninsured Americans (Around 15% of the population is not insured in America). But Republicans are opposing it for obvious political reasons and burden on expenditure, so not ready to negotiate in House of Representatives. President and Democrats are not ready to negotiate the budget without Obamacare. So because of the deadlock and new financial year U.S. government needs to shut down some of the departments until deadlock is resolved and pass the budget.

Now question is what is the impact of the government shut down? Immediate effect is around 8 lack government employees are on forced temporary leaves without pay and around 13 lack government employees need to work without pay. Major tourism spots like historical places, libraries and museums will be closed. And economic impact is different as per different estimations. According to Goldman Sachs estimates 5-6 days shut would shave off around 0.2% of GDP, 10-12 days shut would cost around 0.5% of GDP and 20-24 days will be of 1% of GDP.

So ultimate question would be what is the way going forward?  How long deadlock can continue? As long as both parties come to table with some amendments from both of their demands deadlock can continue. Historically the longest deadlock has been for 21 days in 1995-96. So what if present deadlock continues for more than 2-3 weeks like one in 1995-96? That’s the worst thing to happen to U.S. as it will be facing debt ceiling negotiation on October 17. Debt ceiling means, the limit on the amount of debt America can issue. If this deadlock continues till October 17 then there is possibility that debt ceiling may not able to increase. If that happens then treasury department may not able to repay the amount on debt maturities beyond a point, where it runs out of its reserves. After this treasury department needs to prioritise its debt service obligations and there might be partial defaults or in worst case full default, which is unthinkable and unprecedented! Because of the debt ceiling issue and the way it was handled in 2011, Standard & Poors downgraded U.S. from AAA rating.

Conclusion: Hope American politicians realise and recall the phrase “it’s the economy, stupid” and resolve the issues as early as possible.

Raghuram Rajan questions his peers’ policies!

Recently the Center for Financial Studies (CFS) awarded the Deutsche Bank Prize in Financial Economics 2013 to Raghuram Rajan. He presented his recent research paper on monetary response after the crisis.

He started his keynote lecture by saying “we seem to be in a situation where we are doomed to inflate bubbles elsewhere to boost the domestic demand” to question the low interest rate, “whether ultra low interest rates are part of the solution or part of the problem”. He called central bankers as “heroes” for rescuing the world from the brink of the collapse but warned his (now) counterparts, they may not be addressed same for the second half of the crisis i.e. recovery, as growth is not as expected!

He accepted the fact that he doesn’t have answers to the questions, he is raising, but he would like ask the questions!

He goes on to question the usage of monetary policy (over targeted fiscal policy) to drive the growth with the help of ultra low interest rates. He argues retirees as well as other people (who used to spend before the crisis) may not start spending in ultra low interest regime. In fact they may start saving more because spenders are under the water of debt over burden due to the crisis and retirees may not be able to get anticipated returns in these ultra low rates. Also he mentioned about “debt fuelled demand” is highly localised by quoting different spending patterns of Las Vegas and New York.

Moving on he questioned the credibility of the central bankers’ forward guidance like keeping interest rates low either time bound or conditional (like unemployment) dependent. Since recently markets started questioning the guarantee of central banks credibility and their talk.

He talked about amount of tapering may not alter much in long term Fed’s bond holding portfolio, which in turn should not have much impact on bond stock and flow.  But in reality it is not happening as per theory.

Talking about Bank of Japan, he hoped the balancing act of raising inflation expectation not too high and not too rapidly while maintaining bond yields low so bond portfolios don’t get beaten up, BOJ will succeed.

Unintended consequences of unconventional monetary policy

He said unconventional monetary policies may be intended to take more risk from entities like insurance companies and other financial corporation’s but he is not sure about that risk taking translates into real risk taking in real economy! But unintended consequences like spill-over and capital flow to emerging markets leading to asset price boom in those countries might raise the question. Politicians in emerging markets may forego the countercyclical policies during the capital inflow phase.

Even in industrial countries, monetary policy doing too much may take away the pressure from government and politicians and their focus. Because when central bankers say monetary policy is the only game in town they become the only game in town as everybody else then willing to wait. Damned if you do and damned if you don’t!

Pointing at taper talk confusions, he said we should plan our exit when we enter into something! Because of this stress he thinks emerging markets may decide not to run current account deficit, build safe structure by building reserves, focus on export led growth.

He said we need to break the cycle of one crisis to other like Asian crisis to Industrial world crisis and back to emerging market crisis again.

He ended his presentation by saying “I think I posed more questions than answers, but that’s the state of my thinking”.

Interpretations of Raghuram Rajan's monetary policy review

Business Standard: Rajan putting house in order before tapering

Business Standard: Inflation-wary Rajan skips Fed party

The Economic Times: The buck doesn’t stop at the RBI: Lowering food inflation is the govt’s job

The Financial Express: RBI wastes Fed moment

Sajjid Chinoy of JP Morgan: Balanced and pragmatic

Niranjan Rajadhyaksha of mint: Why has Raghuram Rajan hiked the repo rate?

Tamal Bandyopadhyay of mint: Repo hike: A signal of Rajan’s lack of tolerance for inflation

Andy Mukherjee of Reuters BREAKINGVIEWS-Raghuram Rajan wants to be India's Paul Volcker

Indranil Pan of Kotak Mahindra Bank: Rajan responds to the need of the hour

Saurabh Tripathi of The Boston Consulting Group: Raghuram Rajan needs to transform RBI into a multitasking innovator

Siddhartha Roy of Tata Group: Usual prudence takes over

Expert Views in The Economic Times: RBI raises repo rate, CRR on hold

How Raghuram's rate hike is a blessing in disguise

Mayur Shetty of The Economic Times:Is Raghuram Rajan walking ex-Federal Reserve chief Paul Volcker’s talk?

Raghuram Rajan’s first step towards “Walk the talk”

Reserve bank of India governor Raghuram Rajan surprised financial markets on Friday in his first monetary policy review by increasing repo rate. Repo rate is interest rate at which RBI lends to banks.

Financial markets took knock as they weren't prepared for rate hike since economy is growing at slowest pace in recent time, manufacturing/industrial production is almost at standstill and some parts of interest rates were already jacked up to defend the Rupee.

But defying expectations, he decided to,

1) Increase repo rate by 25 basis points from 7.25% to 7.5%

2) Reduce the marginal standing facility (MSF) rate by 75 basis points from 10.25% to 9.5%

3) Reduce the minimum daily maintenance of the cash reserve ratio (CRR) from 99% of the requirement to 95%

On his first day as the Governor of Reserve Bank of India Raghuram Rajan said, “The Governorship of the Central Bank is not meant to win one votes or Facebook “likes”. But I hope to do the right thing, no matter what the criticism, even while looking to learn from the criticism. Some of the actions I take will not be popular.” Guess he was giving signal to markets that he is not here to please, but do the right thing!

By taking these steps he

1) Set his priority of “anchoring inflation and inflation expectations”. He thinks in the absence of an appropriate policy response, WPI inflation will be higher than initially projected and CPI inflation is worrisome. He wants to be ahead of the curve to achieve his target instead chasing it after it goes beyond control. But that doesn't mean he will sacrifice growth to have disinflationary pressure. He believes low and stable inflation in turn boost savings and investor confidence in the economy. He said in concluding remark, “the Reserve Bank will closely and continuously monitor the evolving growth-inflation dynamics with a readiness to act pre-emptively, as necessary”. Here we should remember his first day’s “A central bank should never say “Never”!” remark.

2) & 3) Is reversing some of the steps, which RBI had taken to fight the Rupee depreciation and volatility. These will take care of liquidity pressure in the banking system, additional cost of funding and send out the message loud and clear that normalizing monetary policy operation. Going ahead once the reverse repo-repo-MSF corridor come to normalcy (100 basis points difference between each), repo rate will resume the operational policy rate role.

After watching his media address (following policy review) and listening to teleconference with researchers and analysts, one thing he made sure that he is here for change. Same thing he conveyed on the 4^th September, “It involves considerable change, and change is risky. But as India develops, not changing is even riskier.”

Repeatedly he clarified things like Urjit Patel and team working on an inflation model to target instead of either plain WPI or CPI. Unusual but unique, Rajan is trying to do the balancing act between inflation anchoring, easing liquidity measures and bringing back the normal monetary operation procedure.

Now there are pitfalls in his walk. Being election year will finance minister allow him to take his own decisions and if yes how long? Rajan needs to take Chidambaram and Prime Minister Manmohan Singh into confidence. How long will he be able resist the temptation of growth friendly policy than targeting inflation? Will he able to balance between 3 legs of the impossible trinity in worst case? Will he be transparent in communicating policy guidance, without surprising too many times?  

Bond markets dictate Fed policy!

U.S. Federal Reserve chairman Ben Bernanke in his press conference after FOMC meeting on September 18 said “we can't let market expectations dictate our policy actions”, when asked about Fed tapering. But Federal Reserve did exactly let bond markets to dictate or reverse their policy guidance communication.

From last 4 months Fed wanted to prepare markets for the reduction in bond buying program. Various governors irrespective of their dovish or hawkish stance, they talked about either for or against tapering of bond buying. They communicated and convinced markets that Fed is expected to announce tapering of the bond buying in September meeting by $10 billion as per overall consensus in the markets.

When Fed started talking about tapering Benchmark bond yield started soaring and reached peak of 2.9% recently. Before tapering news hit the markets, Benchmark 10 year bond yields were around 1.6% in early May of this year. They jumped 130 basis points as heavy sell off in treasuries incurred. 30 year U.S. mortgage rates jumped to 4.2% from 2.8% around 50% jump! Markets started filtering in the news of Fed tapering.

After yesterday's FOMC meeting, in its press release, Fed said, “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” In last 4 FOMC statements, Fed used almost same language “the committee sees the downside risk to the outlook of the economy”. Where as in this meeting it talked about concerns over financial tightening conditions in recent months!

In fact recent surge in bond yields is caused by Bernanke and his colleagues’ talk of tapering. They communicated their policy guidance as usually all central banks try to maintain the transparency in their policy guidance communication and their thought process.

Actually short term money markets eased in this span of 4-5 months. Below is the table in which all indicators indicate short term borrowing rates eased in all category.

Money market indicator	May 1, 2013	September 17, 2013	Change
2 week repo	0.17%	0.08%	-52%
3 month repo	0.16%	0.08%	-50%
2 week mortgage repo	0.21%	0.10%	-52%
3 month mortgage repo	0.20%	0.13%	-35%
Fed fund rate	0.15%	0.09%	-40%

Here question is not about whether economy started recovering or started creating enough jobs; it’s about how the world’s biggest central bank failed in judging economic scenario and failed in their communication. Many referred it as “surprise”, I would like to call it call as shocking. Surprises can be like Paul Volcker doubling Fed fund rates from 10% to 20% between 1979 and 1981 to tame the inflation. But not this one, where Fed prepared the markets for tapering and in turn markets convinced Fed not to taper!

Bernanke may be worried about Greenspan legacy!

According to various polls and forecasts U.S. Federal Reserve Chairman Ben Bernanke is expected to announce scaling back the monetary stimulus in the FOMC meeting (17th &18^th September). As per consensus Fed is expected to cut down its monthly bond buying program by $10 billion from present $85 billion (Fed is buying $45 billion government bonds and $40 billion mortgage securities per month to stimulate the economy).

When Bernanke spoke about tapering down of bond buying program first time in May, 2013 global markets reacted very sharply. U.S. bond yields soared, emerging countries’ bond, stock and currency markets sold off heavily and some counties' (Brazil and Indonesia) Central banks raised interest rates to prevent outflow. Aftermath of the global markets volatility, analysts started discussing timing and quantity of Fed tapering, whether American economy produced enough employment, whether economy recovered from the crisis, if yes then is this recovery sustainable?

But Bernanke may not be worried about timing (September or December) of tapering or quantity of tapering but the way markets are expecting and perceiving the quantitative easing (QE)! He may be worried about QE boosting asset prices than real economy going ahead. He may be worried about market expectations of low interest rate for too long. He may be worried about continuing his policies in his name after his exit from Fed Chair in January 2014. He may be worried about how history is going to see him, the one who saved the world from the great recession or the one who lead the world from the great recession to one more crisis!

Alan Greenspan, Bernanke’s predecessor lowered American interest rates after dot com bubble burst and 9/11 attack. Analysts criticise him for leaving interest rates too low for too long time, which was one of the reason for housing boom during early 2000. By the time Greenspan left Fed Chair (January 2006) American economy was at the edge of new crisis. Housing prices skyrocketed and it was too late for regulation and monitoring the situation as complex derivatives products dragged investments banks, insurance companies, banks, broking firms and rating agencies into the sector leading to economic crisis. So critics say Greenspan lead America from one crisis to another crisis!

Bernanke, whose term is ending in January 2014, may not want to repeat the Greenspan legacy! He may want to communicate to markets that stimulus shouldn't be taken for granted. He may be suggesting real economy benefitted sufficiently from quantitative easing or monetary stimulus has reached its limits to boost the economy and beyond this there might be bubble formation! He may want to leave the office with a note to historians stating that he started it (QEs) but he also tried to end it!

Raghuram Rajan: Governorship is not meant to win votes or Facebook “likes”!

Yesterday, 4^th September, Raghuram Rajan took the charge of Reserve Bank of India (RBI) governor’s role from outgoing D. Subbarao.  He started his first day with a bang, effectively communicating his priorities, by this he has taken care of recent criticism faced by RBI of not communicating clearly!

To begin with, he acknowledges the fact that “the economy faces challenges” and “these are not easy times” and at the same time he tried to calm the nerves by saying “India is a fundamentally sound economy with a bright future”.

Never say “Never”!

Rajan said “A central bank should never say “Never”!” meaning RBI is ready to take all possible options available on the table. Also he made it clear that RBI should emphasise on “transparency and predictability”. In these volatility times he wants “RBI should be a beacon of stability as to its objectives” so that markets should know what central banker is doing where it is going.

Monetary Policy

As reported earlier, RBI postponed previously set meeting on 18^th September to 20^th September. Rajan said he postponed it to “have enough time to consider all major developments in the required detail”,  indirectly he is saying he wants to take calculated move after watching policy guidance from United States Federal Reserve meeting scheduled on September 17-18.

He talked about “monetary stability” (different from “price stability”) to emphasize confidence in the Rupee. This is a welcome change in the RBI’s usual language of “price stability” and also “monetary stability” takes care of value of currency, inflation and source of inflation.

Inclusive Development

Rajan said “the RBI will shortly issue the necessary circular to completely free bank branching for domestic scheduled commercial banks in every part of the country. No longer will a well-run scheduled domestic commercial bank have to approach the RBI for permission to open a branch” to give importance to rural banking and small and medium scale industries’ funding.

He said Dr. Bimal Jalan will head a committee to screen the licence applications for new banking licences and hope to announce the licences within, or soon after January 2014. Further he said going ahead RBI will simplify the process of banking licences and banking domain entry.

He stressed about reduction of banks investment in government securities in a calibrated way, which will improve banks productivity and competitiveness.

He talked about foreign banks and their expansion plans but with certain regulations, so that RBI is not blindsided by international developments.

Financial Markets

Rajan talked about liberalising financial markets and restrictions on investment and position taking. So that investors take positions domestically and provide depth and profits to our economy than they take our markets to foreign shores.

He talked about increasing the permitted value of re-booking of cancelled forward exchange contracts for exporters and importers, developing domestic money markets and government securities and introducing interest rate futures on overnight interest rates.

Rupee internationalization and Capital Inflows

In Rajan’s words, “this might be a strange time to talk about rupee internationalization, but we have to think beyond the next few months. As our trade expands, we will push for more settlement in rupees. This will also mean that we will have to open up our financial markets more for those who receive rupees to invest it back in. We intend to continue the path of steady liberalisation. The RBI wants to help our banks bring in safe money to fund our current account deficit”.

Financial Infrastructure

To improve the reach, speed of flows as well as quality and quantity of lending he said strong financial infrastructure is need of the hour. He talked about using Adhaar, and information sharing between credit bureaus and rating agencies.

He talked about the cleaning up of banks balance sheets, bad loan problems and capital raising programs, which might face difficulties in a decelerating growth rate. He pressed for recovering loans, improving of the recovery system and related institutions.

Households

He announced Inflation Indexed Savings Certificates linked to the CPI New Index, to protect the households against CPI inflation. He said electronic bill payment system through bank accounts to “make payments anywhere anytime a reality” and mobile based payment, which can be a revolution if implemented successfully. RBI will facilitate for mini ATMs by non-bank entities.

In conclusion he said, “It involves considerable change, and change is risky. But as India develops, not changing is even riskier. Some of the actions I take will not be popular. The Governorship of the Central Bank is not meant to win one votes or Facebook “likes”. But I hope to do the right thing, no matter what the criticism, even while looking to learn from the criticism”.

Indian equity markets and rupee welcomed Rajan with a rally and brokerages have increased their target levels. Rajan started with a bang, but walking the talk is important now and his path (read my earlier post: Raghuram Rajan’s Trilemma) is not easy.