23 Oct, 2008, 0016 hrs IST,T K Arun,
Unusual times call for unusual measures. The Indian stock market today calls for government-orchestrated investment on a large scale. The primary aim of such a proposal is not to prop up the market but to increase liquidity, stabilise the exchange rate and allow Indian companies to keep funding India’s growth.
There is a view, fairly widespread in India, that stock markets matter only for a tiny minority. After all, household savings invested in shares and debentures are less than 2% of India’s gross output and only about 10% of household financial savings. The percentage of households that own shares, too, is in small single digits.
So, many people, including economists, tend to dismiss stock market gyrations as of little consequence in overall policymaking. This would be a big mistake.
The battering that Indian stocks have received hurts the financial system as a whole and, therefore, the economy. This transmission of pain takes place not just by making it difficult for companies to raise fresh capital by way of equity. A nose-diving stock market dries up domestic liquidity and blocks access to foreign debt as well.
This is how it works. Fear of further losses on Indian stocks — India’s has been the worst performing stock market in Asia of late — forces foreign investors on our bourses to sell out and repatriate their money. When they buy dollars and take their money out, they reduce domestic liquidity and depreciate the currency. The tendency for the rupee to depreciate wildly makes foreign loans unviable.
Thanks to the financial crisis, developed country banks have lost faith in one another and are reluctant to lend amongst themselves. The London Inter-bank Offered Rate (Libor) is now significantly above the yield on treasury bonds, whereas, in the normal course, Libor is marginally above government bond rates.
When Indian companies borrow abroad, their rates are fixed as Libor plus a premium. Libor itself has shot up, and so has the premium. These loans are now expensive, without taking into account rupee depreciation.
If the rupee, which has now depreciated some 25% from its peak vis-à-vis the dollar in the last 12 months, continues to depreciate in an unpredictable fashion, these expensive loans become exorbitant, after taking into account the cost of hedging against wild swings in the exchange rate.
Unwarranted depreciation of the rupee will hurt domestic liquidity in three ways. Few fresh external loans would be contracted. External loans accounted for over Rs 80,000 crore last fiscal.
Indian companies that have to roll over their existing foreign loans would take rupee loans in India, convert the money into dollars and take out this money. This would suck out liquidity and further depreciate the rupee.
And a declining rupee would make the Indian stock and debt markets unattractive for fresh foreign flows. The return in dollars on their investment would be the rupee rate of return less the rate of depreciation of the rupee. All the government’s plans to bump up domestic liquidity by allowing greater FII flows into the domestic market for corporate as well as government debt would come unstuck.
So how do we prevent unwarranted rupee depreciation? The RBI can keep selling dollars from its forex hoard. It can, and should, help the fledgling currency derivatives market mature and do its work. Alongside, directly arranging for investment inflows into the stock market would help a lot.
Investing in Indian blue-chips at current valuations is a no-risk enterprise. Investors stand to make huge gains over a time-frame of three-four years. But retail investors are a scared lot and follow the herd mentality that sells when others sell and buy when others have already pushed up prices to unrealistic levels.
Long-term contractual savings — provident funds, pension funds — are, perversely enough, not present in the stock market at all. This is the time for the government to channel these funds into the market. Whereas the employees’ provident fund struggles to pay out a return of 8%, if they buy Indian blue chips at their current prices, they would generate returns that are many multiples of the original investment.
Since the board of trustees of the Employees’ Provident Fund has never demonstrated the sense that foreign pension funds display by entering the Indian market even today, the government could, as a special, short-term measure, give a guarantee of both capital and a return of 8% on investments, for funds deployed in the stock market now. The special guarantee can be extended to upto say, a fifth of nearly Rs 200,000 crore corpus.
Not only that. The government can guarantee borrowings by, say, the National Investment Fund from the RBI’s forex hoard, to bring in dollars to invest in the Indian stock market. Rather than finance FII exit, this way, the RBI would push its dollars directly into the stock market, improve valuations, discourage exit and put brakes on rupee depreciation. This would augment inflows of foreign capital and ease liquidity to lubricate growth.
So, many people, including economists, tend to dismiss stock market gyrations as of little consequence in overall policymaking. This would be a big mistake.
The battering that Indian stocks have received hurts the financial system as a whole and, therefore, the economy. This transmission of pain takes place not just by making it difficult for companies to raise fresh capital by way of equity. A nose-diving stock market dries up domestic liquidity and blocks access to foreign debt as well.
This is how it works. Fear of further losses on Indian stocks — India’s has been the worst performing stock market in Asia of late — forces foreign investors on our bourses to sell out and repatriate their money. When they buy dollars and take their money out, they reduce domestic liquidity and depreciate the currency. The tendency for the rupee to depreciate wildly makes foreign loans unviable.
Thanks to the financial crisis, developed country banks have lost faith in one another and are reluctant to lend amongst themselves. The London Inter-bank Offered Rate (Libor) is now significantly above the yield on treasury bonds, whereas, in the normal course, Libor is marginally above government bond rates.
When Indian companies borrow abroad, their rates are fixed as Libor plus a premium. Libor itself has shot up, and so has the premium. These loans are now expensive, without taking into account rupee depreciation.
If the rupee, which has now depreciated some 25% from its peak vis-à-vis the dollar in the last 12 months, continues to depreciate in an unpredictable fashion, these expensive loans become exorbitant, after taking into account the cost of hedging against wild swings in the exchange rate.
Unwarranted depreciation of the rupee will hurt domestic liquidity in three ways. Few fresh external loans would be contracted. External loans accounted for over Rs 80,000 crore last fiscal.
Indian companies that have to roll over their existing foreign loans would take rupee loans in India, convert the money into dollars and take out this money. This would suck out liquidity and further depreciate the rupee.
And a declining rupee would make the Indian stock and debt markets unattractive for fresh foreign flows. The return in dollars on their investment would be the rupee rate of return less the rate of depreciation of the rupee. All the government’s plans to bump up domestic liquidity by allowing greater FII flows into the domestic market for corporate as well as government debt would come unstuck.
So how do we prevent unwarranted rupee depreciation? The RBI can keep selling dollars from its forex hoard. It can, and should, help the fledgling currency derivatives market mature and do its work. Alongside, directly arranging for investment inflows into the stock market would help a lot.
Investing in Indian blue-chips at current valuations is a no-risk enterprise. Investors stand to make huge gains over a time-frame of three-four years. But retail investors are a scared lot and follow the herd mentality that sells when others sell and buy when others have already pushed up prices to unrealistic levels.
Long-term contractual savings — provident funds, pension funds — are, perversely enough, not present in the stock market at all. This is the time for the government to channel these funds into the market. Whereas the employees’ provident fund struggles to pay out a return of 8%, if they buy Indian blue chips at their current prices, they would generate returns that are many multiples of the original investment.
Since the board of trustees of the Employees’ Provident Fund has never demonstrated the sense that foreign pension funds display by entering the Indian market even today, the government could, as a special, short-term measure, give a guarantee of both capital and a return of 8% on investments, for funds deployed in the stock market now. The special guarantee can be extended to upto say, a fifth of nearly Rs 200,000 crore corpus.
Not only that. The government can guarantee borrowings by, say, the National Investment Fund from the RBI’s forex hoard, to bring in dollars to invest in the Indian stock market. Rather than finance FII exit, this way, the RBI would push its dollars directly into the stock market, improve valuations, discourage exit and put brakes on rupee depreciation. This would augment inflows of foreign capital and ease liquidity to lubricate growth.
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