On Wednesday, 19 June, the United States Federal Reserve Chairman Ben Bernanke came out with an optimistic assessment of the U. S. economy. Normally, a favorable outlook by a country’s economic head honcho should have a positive impact on the market; it appears, this is not so when the optimism comes from the Federal Reserve Chairman.
The Fed chairman had said the central bank would gradually scale down its monthly purchases of Treasury securities and mortgage-backed bonds beginning later this year and ending when unemployment rate hits 7 percent, which the Fed expected to happen by the middle of next year. Once the jobless rate fell to 6.5 percent or lower, the central bank would, over several more years, unwind the rest of its extraordinary stimulus campaign, slowly raising short-term interest rates, from the practically zero rate today, to more normal levels.
But the chairman’s positive spin on the U.S. economy did not sit well with investors and seemed to have spooked the markets, not just in the United States but across the world. What’s wrong with a bit of optimism, you might ask. Well, the chairman’s cheer cloaked a hint that the Fed might end its bond buying program by the end of the year and ease out its stimulus package that has pumped over USD85 billion into the economy every month since the crisis began.
On the Fed Chairman’s remarks, the Dow dropped 206 points, the Nasdaq Composite Index dropped 36 points and the broader Standard & Poor’s 500-stock index dropped 21 points or nearly 1.39 percent. French and German stock markets were down almost 2.5 percent; Japan closed down 1.75 percent and China was down 3.3percent. The blue-chip FTSE 100 index in London tumbled by 189 points, or nearly 3 percent, in its biggest percentage fall since September 2011.
The Turkish stock market fell into bear market territory, down over 21 percent since its peak last month, while the yield, or interest rate, on Spanish, Greek, Italian and Portuguese shares all rose sharply. Commodity prices also joined in the rout, with the gold price falling below the $1,300 an ounce mark for the first time since September 2010 and Brent crude dropped 42 cents to $105.60 a barrel. Forbes headlined it as, “Stocks react like junkies as Bernanke yanks away low rates”, while the Bloomberg Businessweek put it less tactfully, “Markets tell Bernanke to take his optimism and shove it.”
The exit of Bernanke as Fed Chairman at the end of his second term, means whoever replaces him will be left to hold the economic baby as it is weaned off its federal assistances. If the Fed bungles the transition and the country stumbles back toward recession it would not only be bad for the economy but also for the prospects of the Democratic Party candidate for presidential elections in 2016.
In India, the Federal Reserve Chairman’s statement had a bombshell effect, rattling stock markets and causing the rupee to stumble to an all-time low of Rs 60 to the dollar. The Sensex index dropped 526 points or nearly 3 percent to close at 18,719 points. Eventually the sharp fall of the rupee was stemmed by the Reserve Bank of India intervening and the rupee ended the day down 87 paisa to Rs 59.58 to the dollar.
Foreign institutional investors offloaded net equity worth Rs 2,094 crore, while domestic institutions bought equity worth Rs 1,333 crore. Retail investors on the BSE were net buyers of equity worth Rs 133 crore. Meanwhile, the Indian bond market saw a huge sell-off forcing a halt in trading. The prices on Government securities fell sharply by 90 paisa and yields were up 16 basis points.
Worried by the market’s reaction to Bernanke’s comments, India’s top economic policy makers tried to reassure the markets. Seeking to assuage the sentiment in the equity, bond and currency markets, policy makers said the country’s economic prospects are solid and can weather the storm. Finance Minister P. Chidambaram said there was no need to panic over the recent slide in the value of rupee and the Reserve Bank of India (RBI) would take steps to control it. He said the dollar has appreciated sharply against major global currencies due to misinterpretation of Ben Bernanke's recent comments on stimulus.
Despite the minister’s interpretation that his U.S. counter-parts words were misinterpreted, experts agree that ultimately the rupee’s status and the country ability to attract foreign liquidity will depend on its economic fundamentals. Experts believe that if foreign money has to flow in and growth rates are to revive, India urgently needs better governance and fiscal reforms in core sectors like infrastructure.
Falling Rupee Smiling Expats
The falling rupee has sent smiles across the face of many expatriates. A lower rate means they can send more rupees home with the same amount of foreign currency. One state in particular which has more reasons to cheer at the falling rupee is Kerala. Because falling rupee means more money flowing into its banks from the millions of non-resident Keralites.
NRI deposits worth around Rs 40,000 crore account for around 25 per of the total money coming into banks. People in the industry say that in the present circumstance, there is expected to be at least a 15 percent rise in deposits from abroad. One reason for this level of confidence is the banking regulatory framework in the country. Abroad, especially in the Gulf, some Keralites have gone to the extent of borrowing money to send home when the dollar is ruling at such levels. This happened during the rupee fall in mid-2011.
Another sector which has reason to celebrate at the falling rupee is the Indian plantation and marine export sector. It will reap huge benefits as the contracts are in dollars and when converted, the inflow in rupee terms is higher. Seafood exports from the country were around Rs 16,600 crore and spices Rs 11,171.16 crore during the fiscal ending March 31.
While the fall in the exchange rate for the Indian rupee is seemingly good news for Indian expats sending money back home, it is having deleterious effects on the country’s economy. As the Indian rupee slumped to new lows, the country's middle class has been forced to cut back on eating out, buying branded products or new cars, studying abroad and other discretionary spending, as their monthly expenditure has risen by 20 percent a recent survey by the Associated Chambers of Commerce and Industry of India (Assocham) revealed.
Over 92 percent of the respondents said that their monthly bills have jumped by 15-20 percent in the last one month - the middle class and the lower class are the worst hit, said the survey. According to Assocham, those going to fancy restaurants have been hit the hardest with around 78 percent of middle-class Indians now avoiding eating out. In addition, 65 percent have stopped buying foreign branded goods, while 49 percent are spending less on home appliances and 32 percent have put plans to buy a new car on hold.
Gold losing Glitter
While physical buying especially in Asia, and lower-than-expected growth in some nations had been propping up gold prices in recent months, with the Fed now making its stand clear, gold prices are all set to come under pressure. For the domestic spot and futures markets, the drop will be despite the consequent fall in the rupee.
Reflecting the overall gloom, spot gold in early Asian trade slipped to $1,342.80 an ounce, while gold futures maturing in August fell to $1,342.10. In the domestic market on Wednesday, gold for jewelry (99.5 percent purity) was down at Rs 27,925 for 10 gm and pure gold (99.9 percent purity) at Rs 28,070.
If the rupee holds or gains gold contracts could fall to as low as Rs 27,750. The extent of fall in gold will also depend on the rupee’s movement against the dollar since any drop in the Indian currency will make imports of gold costlier.
Experts agree that bullion will seek to consolidate near current lows, but there is little chance for a sustained rebound. They say that inflation is subdued, seasonal Asian demand is yet to pick up and the greenback is stronger, so the opportunity cost of holding gold will start gaining soon. Given the macro recovery, equities will still perform better — bullion is not trading as a safe haven asset. Why hold it at all?
The prospect of the stimulus packages being withdrawn in the United States is pushing investors away from gold, analysts said. The effects of stimulus package had been hugely positive for precious metals because they weakened the dollar and pushed medium-term interest rates to abnormally low levels, which removed most of the negative carry associated with holding gold.
Holdings of physically backed gold exchange-traded funds - a popular way to invest in bullion since the financial crisis - have fallen more than 485 tonnes this year. The largest, New York's SPDR Gold Trust, reported another 4.5-tonne drop in its holdings on Thursday, taking them to their lowest in more than four years at 995.35 tonnes, 26 percent below their December 2012 peak of 1,353 tonnes.
Buying in number one consumer India remained muted despite Thursday's price drop, in contrast to the heavy buying seen after gold's April sell-off. Gold in rupee terms remains well above April's lows after the Indian currency fell to record lows against the dollar. Demand is not so much, as prices in rupee terms have not fallen due to rupee depreciation, said one trader