Talk about changing weather. 2016 began on a dismal note. RBS, an international bank, warned its clients to brace for a “cataclysmic year” and “sell everything except high quality bonds.” This global wave of fear and panic hit home in February when the Sensex closed below 23,000 on February 11, a level not seen since May 2014. In January 2016, the Indian rupee rose above Rs 68 to the US dollar, a level not seen since the current account deficit crisis of August 2013.
Growth interrupted
This panic came despite India’s Gross Domestic Product growth remaining relatively stable.
On February 8, the Central Statistical Office announced that GDP growth in the third quarter (October to December) of the financial year 2015-’16 was pegged at 7.3%, lower than the 7.7% printed in the previous quarter. Growth for the full financial year was still robust at 7.6% and up from 5.6% printed three years ago in Financial Year 2012-’13. However, this was not enough in the face of global panic.
India’s famed growth story, its much-spoken of demographic dividend and its resilient services sector demand seemed to have been thrown out of the window by investors who were headed for the exit. Consider this: When the Sensex closed at 23,002 on February 29 (budget day), it was 7.5% lower than its close a month ago and a whopping 21.5% lower than its close compared to budget day 2015. The rupee had fallen 11% against the US dollar over the same period.
Banks in the spotlight
Global fears aside, what ailed the Indian economy? If the Sensex was a barometer of the economy, it spoke of a choppy future. Indeed, the Indian banking sector was in the spotlight with the continuing woes of non-performing assets. Via its “asset quality review” the Reserve Bank of India was pushing banks to recognise loans that could potentially turn bad and, accordingly, make higher provisions in their accounts. The non-performing assets problem has been more acute in public sector banks compared to private sector banks – leading to a stark difference in the rate of credit growth between the two.
Explaining why credit growth in public sector banks was lower than private sector banks, in a speech in February 2016, Reserve Bank of India governor Raghuram Rajan said:
“The most plausible explanation I have is that the stressed balance sheet of public sector banks is occupying management attention and holding them back, and the only way for them to supply the economy’s need for credit, which is essential for higher economic growth, is to clean up.”
The results of this clean-up exercise was unknown and added to the overall gloomy atmosphere.
The great recovery
Markets have a way of surprising everyone. The doom and gloom in February was followed by a huge rally in global markets. Across the board, stocks and commodities staged strong recoveries. Fears on all fronts eased – China did not collapse in economic chaos and the US did not raise interest rates. Investor confidence returned slowly but surely. Six months later, indices are touching new highs. The Dow Jones Industrial Index and the S&P 500 broke records in July 2016 and are holding on to elevated levels.
A world of negative yields
What brought about this change in sentiment? In two words – central banks. The central banks of Japan and the Eurozone, which are large market movers in terms of their policy actions, are resorting to “negative interest rates”. What this means is that these central banks are sending a message that they want banks to lend money and revive growth. If, instead, banks keep certain specified balances of money with the central bank they will earn interest at a negative interest or, in other words, they will lose money.
Japan implemented this policy in late January 2016. A similar policy is followed in European countries like Denmark, Sweden, and Switzerland. Meanwhile, the US has not hiked interest rates and that is also serving as a source of relief to the markets.
We live in extraordinary times: central banks are forced to keep interest rates low (even negative) to ensure that domestic growth revives, inflation picks up, and demand comes back. Thus, when you earn negative interest in the bank, as an investor, you have to look for growth in other markets. And hence, investors began pouring money across other assets.
India, and other emerging markets, have been beneficiaries of these fund flows. The buying and selling by foreign institutional investors has a large impact on the day-to-day moves in the Sensex. Hence, with the increase in FII flows to India, the Sensex registered a sharp rise. From the low of 23,000 at budget day, the Sensex is now above 28,000 – a move up of 22%.
Is the future really that rosy?
Have things really changed on the economic front? Corporate earnings of listed companies indicated a mild recovery for the fourth quarter of the financial year 2015-’16. First quarter results for the current financial year (2016-’17), currently underway, don’t show any major surprise. In fact, the banking sector doesn’t appear to be out of its stress as yet. However, the outlook on the monsoon appears positive and should help in reviving customer demand. In case the Goods and Services Tax Bill is passed in the Rajya Sabha in the current Monsoon Session, it would add to optimism.
Finally, the recently approved hike in salaries under the Central Pay Commission could act as an economic stimulus of sorts.
Thus, in hindsight it appears that the rally was backed by improvements in the Indian economy.
However, what of the future? Yet again, global markets hold the key. Any unexpected event – for example, continued slowdown in economic growth despite negative interest rates – could drive flows out of India just as soon as they came in. After all, we do live in uncertain times.