The Hindu Business Line : G-7’s message is downbeat

Their message was hardly reassuring – more turmoil is ahead. Banks’ write-offs and provisioning will rise, reduce capital and slow credit. Equities are in for volatile times. There was no talk of a fiscal (co-ordinated or otherwise) stimulus package either (barring the US).

Meanwhile, if stocks go into a free fall, it could force pre-emptive interest rate cuts, not only by the Fed but also by the most reluctant of central banks, the ECB. Its President, Mr Trichet, changed tracks last week after the no-change ECB meeting, speaking for the first time about the risks to growth.

Little choice

The central banks have little choice. Driven by collapsing markets, the worry is that the global economy will get into a self-perpetuating downward spiral.

Practically every bit of data released in the US, Europe, Japan and the UK has been negative. Inflation ‘noises’ in the current environment make little sense. After all, if they do not act, their much-cherished autonomy from governments may be taken away.

In democracies, in times of crises, public interest, as perceived by the elected representatives of the public, must prevail over the canons of monetarism.

Thus, the Fed has (rightly) thrown its fears to the winds and aggressively cut interest rates in the last few months.

Markets will rebound

While the very near-term prospects look negative, it is more than likely that markets will rebound quickly. Value destruction beyond reason in a very short span of time will itself create the support for a rapid bounceback. Sharp interest rate cuts in quickfire succession will be the trigger.

As Mr Warren Buffett remarked last week, credit is becoming (absurdly?) cheap. Asset prices will naturally be the biggest beneficiaries of low interest rates.

Domestic inflation perked up and GDP growth trended down. The Sensex has fallen 2,000 points in a week. But even a market rally may not rescue IPOs. It is about time. Never have they been so grossly overpriced, simply riding the secondary market boom, which offered high listing gains, attracting investments from naïve investors.

Despite the none-too-happy inflation picture, the pressure to ease rates is mounting on the Reserve Bank of India.

Growth is slowing and a cut will be difficult to hold off if global rates keep marching down.

From this perspective, Indian bonds, especially short gilts and ‘AAA’ look considerably underpriced.

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