The only thing certain is the uncertainty

Weak dollar, firm crude prices, subprime crisis and liquidity are as much India’s risks, as those of the US

Devendra Nevgi
CEO & CIO, Quantum Asset Management Co Pvt Ltd

As I write this piece, the US dollar has tumbled to historical lows versus the euro and GBP at 1.4368 and 2.0500, respectively, and even against the Canadian dollar, which has moved above par at around 0.9625.

The fallout of the housing and credit crisis is seen adversely impacting the US economy, leading to expectations of lower interest rates pushing the dollar to new lows.

IMF chief Rato said this week, “Risks of a steep, disorderly steep fall in the US dollar have grown, although it is not the most likely economic scenario.”

And what is the US dollar’s weakening doing across the world? It’s making everything that’s denominated or traded in US dollar cheaper for investors who don’t draw their balance sheets in the currency.

The crude oil rallied above $92.22 per barrel, again an all-time high, as Iraq-Turkey conflicts continued, US imposed more sanctions on Iran and Nigerian crude supplies continued to be disruptive.

Crude oil is now close to its inflation-adjusted high of $101.70 reached during the Iran-Iraq war in 1980. Crude oil is now up by 50% in 2007.

With crude and food prices globally going northwards, pushing consumer price inflation higher, gold prices (an inflation hedge) scaled a 28-year high of $780 per ounce.

It’s inching closer to its all-time high of $850. Platinum is flirting with its historical peak. Sliver climbed to its eight month high of $14.15 per ounce.

Asian currencies and stocks are conquering new historical peaks. And the central banks are struggling to invent new ways to achieve the “impossible trinity,” viz. an open capital account, independent monetary policy and a pegged exchange rate.

Cross-border capital flows continue to reach enormous sizes and distort the asset prices as well as monetary/exchange rate policies, especially in emerging markets.

Policy makers are devising newer methods to moderate the capital flows to avoid financial instability.

Money Supply (M3), a broad measure of liquidity globally, is way ahead of the nominal GDP growth rate. The European Central Bank (ECB) said the September M3 is at a 28-year high.

US Central bank has already stopped the disclosure of its M3 figures.

The US subprime crisis is getting murkier day by day. More and more skeletons are falling out of the cupboard.

Investment banks and intermediaries, which act as the lubricants of the US economy, are reporting massive losses in the housing and subprime sectors.

Financial engineering and innovation has taken more than what it gave. Large investment and other banks reported billions of dollars in subprime-related losses.

The biggest names in US with the best of risk management practices roiled in the crisis — Countrywide Financial, Merrill Lynch, Bank of America and Citibank, to name but a few.

Financial globalisation has ensured that the contagion effect was also felt in countries such as the UK & Germany.

Bank of England back-tracked on its stance of not rescuing careless lenders and was forced to provide the safety net to Northern Rock, a mortgage lender in trouble.

The bigger US banks have now mooted a $75 billion Super Fund to take over the assets of troubled and reckless investors.

US Senator Charles E Schumer, chairman of the Joint Economic Committee (JEC), summarised it very well in its report released on October 25, “State by state, the economic costs from the subprime debacle are shockingly high.

From New York to California, we are headed for billions in lost wealth, property values, and tax revenues. The current tidal wave of foreclosures will soon turn into a tsunami of losses and debt for families and communities.

The administration must act quickly to save financially-strapped families from drowning in this flood of subprime foreclosures.”

The US central Bank, Federal Reserve is doing what it has done is in the past whenever a crisis has endangered the economic growth and financial stability, viz.

“Infuse liquidity by cutting rates,” the panacea for all its problems and would continue to do so when the Fed meets again on October 31 and November 1.

The world over, central banks have pumped in billions of dollars and euros to rescue the troubled banks.

The spillover effect of the excess liquidity is felt across global asset prices, including Indian stock markets. Emerging economies with good growth potential and especially with semi-pegged currencies, were recipients to huge capital flows.

Year to date and the month to date flows in Indian markets have been $17.4 billion and $4.16 billion, respectively, taking the markets beyond 19,000 levels on the Sensex.

It’s pushed the Indian regulator Sebi to clamp down on investments through participatory notes.

Chinese markets were quoted at a PE ratio of 52 and refused to buckle under the pressure of a series of rate hikes by the Chinese central bank.

Will the US dollar continue to sink? What will be the fallout of the subprime crisis on US housing markets and the economy? Will it push US into recession? Will crude cross $100$ per barrel and add fuel to the fire?

Somehow, only the US treasury markets are factoring such risks and the stock markets continue to overlook it.

There seems to be a lot of certainty to the uncertainty.

The rising global financial integration of Indian economy has exposed India to the risk, though relatively lower, to a disorderly unwinding of the imbalances centred on the US.

A study by the International Monetary Fund earlier this year had proclaimed that with every 1 percentage point drop in the US growth rate, India’s economy would falter by 0.1-0.2 percentage points.

And who would not agree with the damage a $100 crude oil price would do to the Indian economy?

Devendra@QuantumAmc.com