Sudip Bandyopadhyay’s Blog

The Greenspan idea that monetary and regulatory policy cannot prick asset price bubbles but should deal with the consequences when the bubble has burst – now looks dangerously quaint.  The intellectual justification for the Greenspan idea – was that identifying equilibrium levels of asset prices is difficult; and policy tools to prick or limit bubbles are limited. The unmentioned but perhaps real rationale is a kind of implicit market fundamentalism: markets value assets best, and even if markets make mistakes, policymakers can never be sure in advance whether and to what extent mistakes have been made. Such “asymmetric” policy responses are out. But if they are to be replaced by more symmetric, counter-cyclical policies, then explicit or implicit target or guidance zones for the prices of all main assets – shares, housing, exchange rates and perhaps even oil – are unavoidable.  However, the wreck that is today’s financial system is testimony to the catastrophically flawed nature of that doctrine. Policymakers have no choice but to have a view on what constitutes a reasonable or equilibrium level of all asset prices. Of course, determining such levels is subject to uncertainty. The most it is prudent to contemplate is that policymakers should determine not reasonable levels but reasonable zones for asset prices. One of us has in the past argued for exchange rates to have target zones with a margin of 10 per cent around the central estimate.

Unfortunately, we are in the midst of a global economic crisis.  But much of this is already in the price of global financial assets.  This is not to say we are on the cusp of a sustainable rally in global equities and credits.  There is room for disappointment with regards to how long the recession lasts.  But it is now important to realize that while global equity rallies will be dragged back by the economic news, we are probably not too far from the bottom either.   We are close to the bottom because policy makers are finally fumbling towards a “bad bank” solution to the crisis. The “bad bank” is the tried and tested solution to previous crashes. Bad assets are put into a government funded pool without an accounting or funding requirement to sell assets early, removing distress from the markets and giving private investors confidence to return to cleaned up banks

Indian Capital markets was largely flat last week with marginal gains in both the Indices  Nifty and the Sensex. Global news-flows largely dominated the sentiment , especially news pertaining to President Obama’s fiscal stimulus of $789 bn. However volumes were still lacking from larger institutional players indicating a cautious mood. On the domestic economy front,the minus 2% growth in the index of industrial production (IIP) for December 2008 is the lowest on record since 1993, when the index was first compiled.  The sharpest slowdown, of minus 12.8% , came in consumer durables – the fate of consumer non-durables was also negative, at minus 0.1%.  The consumer durables sector has borne the burnt of consumers shying away from taking loans at very high rates in difficult times.  Needless to say, manufacturing has also taken a hit  on account of the interest rate regime, which  needs to urgently factor in global and domestic realities.  Perhaps the silver lining in all the dismal numbers surrounding the economy is the steadily falling rate of inflation – it is now down to 4.3%.  The latest figure is for the week ended January 31, which would have only incorporated the first-round effect of the cut in fuel prices. Inflation will fall further, creating more room for rate cuts.  On the other hand due to surging expenditure bill and dwindling tax revenues, the Government announced its intention to borrow additional Rs 46000 crs from the market over the next 2 months.  RBI must respond soon with bath rate cut and liquidity increasing measures, if the economy is to avoid a worse-than-possible 2009-10.  An insufficient response means we may end up short.

Market did witness a mild pre- budget  rally in anticipation of some Tax relief in Indirect Taxes and some sops to badly hit sectors like Auto’s, Real Estate, Textiles etc. However the movement in the markets could largely remain news driven and Profit taking may set-in once the news is over. Consistent follow up buying is needed to take the Indices further. This week the market will eagerly await the expected relief in both direct and indirect taxes,from the interim budget on monday.  Expectations are building around possible announcement of tax free Infrastructure bond issuance by Infrastructure or Infrastructure Financing Companies in the Public Sector  for  boosting  infrastructure spending. From the current trend of retail investments, it can be safely concluded that such instruments will be greatly in demand & should succeed in raising significant amount of funds from retail.  Market would also welcome removal of irritants like Securities Transaction Tax .Appropriate budgetary measures aimed at providing boost to growth will definitely be appreciated  by the market.
( ** this is the transcript of the weekly column I write for Economic Times )