The Hindu Business Line : Central banks’ stance to soften?

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Central banks’ stance to soften?

The Fed will be forced to effect another cut, given the clear signs of a decelerating economy. There is no sign of inflation breaching acceptable levels to block this action.

S. Balakrishnan

That a week is a long time in financial markets was proved yet again last week.

Just days back, the betting was how quickly the Sensex would touch 20,000. Opinions varied from Diwali to the New Year. Suddenly, the market looks vulnerable to a crash. And the more or less certain increase in the CRR in the half-yearly Monetary Policy Review now seems much less likely.

While the focus was on the effect of the SEBI’s proposed actions on PNs (participatory notes), a larger risk looms. US stocks tanked Friday, following profit warnings from several frontline corporates, not only financial institutions (which were widely expected) but also manufacturing companies, which was a surprise, considering the widespread belief that the housing crisis would leave the rest of the economy unscathed. The market is further spooked by memories of the October 1987 crash (Black Monday). Will history repeat itself?

Worsening matters is the climb in the price of oil to $90 levels. The one bright spot is that it has (perhaps) gone too far. A significant drop in crude would be a welcome tonic and stimulus to the global economy. The current market slide might then become a dim memory. In any event, it is surely the best prescription for an all-round revival.

Prospects of a CRR hike have receded significantly after the market’s steep fall accompanied by the rupee. There will be less pressure on liquidity management if the RBI stays away from the forex market, as it will if the rupee weakens in the absence of capital flows.

Till things settle down, a soft line on liquidity and interest rates is likely, particularly as inflation is not troubling. It has negative implications for the rupee but bonds will benefit. 7.75 per cent levels on 10-year G-Secs wouldn’t surprise.

Crucial period

In the last week, rate equations in the US have changed too. The Fed will be forced to effect another cut, given the clear signs of a decelerating economy. There is no sign of inflation breaching acceptable levels to block this action.

A crucial period lies ahead. The billion dollar question is if the US economy, markets and financial system will absorb the shocks without a stock market, dollar and bond collapse. Recent signs are not happy. A number of reserve-rich countries are diversifying away from the dollar, latest figures show. The US currency’s share of global reserves is significantly down, while the euro’s is up.

Other things are mere sideshows.