FRONT RUNNING

Central bank policy meets were the main course on the investor menu last week; the focus this week will be on the US Federal Reserve’s stance. The real economy continues to suffer from notebandi. The Reserve Bank of India (RBI) surprised by holding policy rates steady when “everyone” expected a cut. It eased the 100 per cent Cash Reserve Ratio impost. The central bank has cut gross domestic product (GDP) growth estimates by 0.5 per cent, which may be a big underestimate. Domestic inflation is not a concern. The RBI is on course to make targets.

The statement does say the “assessment of Q3 is still clouded by the unfolding effects of the note ban”. But global commodity prices have firmed up and so has the USD. Crude could also rise further if the Opec agreement holds. The rupee has seen some recovery as the FCNR swap has been completed.

Imports rose in October, including a sharp rise in gold imports and higher crude prices. But non-oil, non-gold imports were also up, after seven months. The trade deficit is down, yearon-year, by about $25 billion for AprilOctober 2016.

Global markets are groping for direction, given the incoming Trump administration. Going by market moves, Wall Street thinks it may be good for domestic US companies but bad for exporters. The USD is expected to rise and USD bond yields have shot up.

The Fed is widely expected to hike the policy rate next week. The European Central Bank has said it will continue its bond buying till December 2017 and maintains a negative policy rate. But it will cut the quantum of bond buying from April 2017, from its current 80 billion a month to 60 billion. Eurozone inflation is at 31-month highs and producer prices are at four-year peaks, hence the taper.

Rupee yields shot up as the RBI maintained its stance. The benchmark 10-year treasury is now above 6.45 per cent. It was at 6.17 per cent before the policy review. The RBI (and the revenue secretary) also admitted that most outstanding cash would come back into the banking system and the governor ruled out chances of a special dividend from cancelled liabilities.

So this exercise with all the queues, deaths and all-round misery, is being reduced to an Income Disclosure Scheme. The latest announcements of discounts for cashless transactions could well have been announced without the notebandi, if going cashless was the actual purpose.

Foreign portfolio investors (FPI) were massive sellers of rupee debt in October (~6,000 crore) and November (~21,152 crore) and that trend has continued in December (~13,220 crore sold from December 1-9). FPIs have also sold ~22,500 crore in equity in the past two months and they are marginally positive in December. Domestic institutions bought equity in October (~7,900 crore) and November (~18,277 crore). Retail also remained positive.

The October Index of Industrial Production (IIP) was down 1.9 per cent compared to October 2015. That can be explained by the Diwali effect. Dussehra and Diwali fell together in October 2016, whereas the two festivals were split across October- November 2015. When this happens, industrial production drops due to extra holidays. Under normal circumstances, November 2016 would show a rise for the inverse reasons.

But the notebandi is a watershed and it could pull IIP down a lot. The November Purchasing Managers’ Indices indicate nervousness is permeating the economy despite brave words. “Non-aligned” commentators like Ken Rogoff and Lawrence Summers say GDP growth will be down significantly. But it is impossible to judge the likely damage, since widely varying assumptions can be made.

The likely rate of note-printing and distribution suggests that there will not be sufficient cash in the system for several months, maybe even a year. Currency withdrawal controls will therefore, stay in place. The rural economy cannot go digital even in the medium term.

About 800 million Indians live in a rural environment, which contributes about 35 to 37 per cent of GDP, including all of tractor sales, about 50 per cent of two-wheeler sales, etc. Rural India has 51 per cent telecom penetration (and 10 per cent of smartphones). About 80 per cent of villages have no bank branches and bank correspondents. Power supply is poor, point-of-sale machine penetration is non-existent, etc.

There is no chance that telecom networks and bank branches can be magically rolled out across rural India in the next three or six months. So the rural economy will remain hobbled and that will impact a host of industries.

The results of the second half, and of high-speed data like auto sales, cement despatches, lay-offs, etc, may, or may not, have predictive value. Some assumptions of rapid recovery once cash is back in the system, rests on behavioural factors.

Consumer behaviour may have changed. Long spells of enforced privation often lead to cash being hoarded. If consumption falls, a lower long-term trend rate of growth will occur, rather than just a two-quarter blip. On the other hand, low base effects could trigger a jump in gross value added between October 2017 and March 2018.

Technically speaking, the Nifty is still flirting with the 200-Day Moving Average. It moved above that mark last week. That could indicate either a recovery that can be sustained. Or it could be a dead-cat bounce presaging a collapse. The Fed could be the balancing factor.