Since the global financial crisis, central banks have followed an easy money policy, in an attempt to stimulate growth by easy access to funds. A lot like opening up the bar with subsidised drinks.
Most of the easy money went into building asset bubbles, in stock markets, commodities and other asset classes. The central bankers find it difficult to put the easy money genie back in the bottle, scared of what a crash in these markets would entail for their economies.
Thus, US Fed Chairman Jay Powell stated his wish to raise the bar on inflation targeting, for him to raise interest rates. A raising of interest rates now, when the US economy is growing well and unemployment is low, is needed, to provide the Fed the cushion to lower them when there is a later downturn.
The ECB head, Mario Draghi, too, has not raised interest rates. He has cut ECB forecast for Euro Zone economic growth for 2019 from 1.9 per cent to 1.1 per cent and is, in fact, offering more liquidity. The imminent Brexit would further impact growth, as it would result in a lot of realignment of supply chains and disruption of economic activity.
China, too, is not tightening, as it faces a slowdown in growth.
Markets, which love free drinks (more liquidity) rallied last week. This coincided with the announcement of dates for the general elections, April 11 to May 19 with counting on May 23; the uncertainty of elections was brushed aside by the stock market, which continued its rally.
But whatever the outcome of the elections, the pre-election spend indicates that there would be few funds for starting the investment, or capex, cycle. The government is struggling to not overshoot its fiscal deficit targets by resorting to remedies which are bad for the long term.
For example, it has realised ₹1,050 crore from the sale of its holding in Dredging Corporation of India (DCI), to four government-owned ports, at a premium of 17 per cent over DCI’s market price. Since these four ports do not have public shareholding, there would be no protest against the premium, or, indeed, the acquisition itself. In fact, in order to get a return on their investment, the new owners would probably get DCI to lower its dredging costs for them, hurting its profitability. The purchase of shares also inhibits the ability of the ports to spend on expansion/modernisation, which, in turn, affects global trade. A high price to pay just to meet fiscal deficit targets.
As per a study by CMIE, the share of the top 20 business houses, by turnover, in capex, is declining and is now 26 per cent of private sector investment.
Added to this is the dynamics of crude oil pricing. India, which imports 80 per cent of its crude requirement, benefits from lower prices. Despite the reduced supply from Venezuela and Iran, crude prices are low due to increased shale oil supply from the US, at a record high of 12 million barrels/day (largest world producer). The shale industry has never produced free cash flow (cash flow to meet its capex) and has thus to borrow for capex. The smaller companies are under pressure to reduce costs; the larger ones like Chevron and Exxon have the balance sheet to continue spending.
So, crude prices may start rising again.
This rally could thus be an opportunity to lighten.
(The writer is India Head — Finance Asia/Haymarket. The views are personal.)