Statsguru: Living in times of uncertainty

With multiple triggers, policy uncertainty across the world has increased of late

Markets detest uncertainty. But if anything, policy uncertainty across the world has increased of late.
 
Consider, for instance, Indian markets. Prior to November 8, analysts believed a good monsoon, coupled with payouts on account of the Seventh Pay Commission, would provide the much-needed fillip to consumption, pushing up growth. Anticipating dividends, markets rose. As Chart 1 shows, the Sensex was testing the 29,000 level in September.
 
But all that changed on November 8. In the fortnight after Prime Minister Narendra Modi’s decision to demonetise higher-denomination notes, the Sensex fell by 6.6 per cent. Though it has recovered since then, growth concerns continue to dominate.

 

On the other hand, US markets have behaved contrary to expectations, shrugging off Hillary Clinton’s defeat. As Chart 2 shows, the S&P 500 has rallied on expectations that growth may perk up as Donald Trump loosens the fiscal tap. As this might prove inflationary, expectations that the US Federal Reserve may raise rates faster than anticipated has pushed up US bond yields, as shown in Chart 3.
 
But in India, the opposite has happened after November 8. As Chart 4 shows, a surge in liquidity after demonetisation has pushed down bond yields. In fact, prior to the recent Monetary Policy Committee meeting, the 10-year bond yield was lower than the repo rate, implying that long-term rates were lower than short-term rates.

 
If the Fed raises rates in December and the Reserve Bank of India cuts rates in its next monetary policy meeting, the current gap between the two (seen in Chart 5) is likely to lead to an outflow of capital, especially from the debt segment, putting pressure on the rupee. The rupee has already depreciated sharply against the dollar, as seen in Chart 6. But as Charts 7 and 8 show, other currencies have also depreciated against the dollar.
 
For India, the uncertainty lies in how quickly economic activity rebounds once the currency notes are replenished. For the rest of the world, perhaps the uncertainty stemming from the Trump presidency is the foremost concern.