# 44 Bye Bye Nifty 18k.

Don’t F*** With the Fed

Last week, with yet another .75% interest rate hike, US central bankers delivered on the anti-inflation stance of Fed Chairman Jerome Powell (see NL 39), who had warned that these efforts “would also bring some pain to households and business”. 

In the last week, we have seen this pain extend to households and businesses across the world. Major equity markets found new lows, gold and silver slumped, and bonds fell, as interest rates surged, both because other central bankers have followed with rate hikes of their own, and because more expensive money in the US leads to tighter money across the globe.

So far, Indian equity markets have been very resilient through most of 2022, kept afloat by the jingoistic refrain that we are the fastest-growing economy in the world. The rupee, too, had shown remarkable strength, even as other currencies drooped in the face of massive dollar strength. But, just under the surface of the market was a Reserve Bank shovelling its dollar reserves into the furnace of artificial rupee strength. This cost us dear, and along with our rising trade deficit,  India has lost nearly 100 bn USD worth of foreign exchange reserves in the last 12 months, from 650 bn, to 550 bn.

On Twitter, one interlocutor asked what I thought the RBI should do about rupee weakness.

“Don’t f*** with the Fed” was the more direct part of my answer.

There is only so long that you can fight the intent of either the markets, or the most powerful central bank in the world - in this case both. 

This last week, the RBI seems to have finally given up on defending the artificial level of 80 rupees to the dollar. This is as it should be - part of the route to reducing our quantum of imports is to make them more expensive, via a depreciating rupee. This does, of course, mean adding fuel to inflation, making it a tough decision, but I think we can no longer take our FX reserves for granted; they need to be carefully husbanded. Our trade deficit is currently running at 300 bn dollars a year, and though this is substantially offset by 90 bn dollars each of remittances from abroad, and service exports, a fresh surge of equity sales by foreign investors could rapidly deplete the cushion. 

80 rupees to the dollar is a number we won’t be seeing again in a hurry. 

Nor will we see the Nifty above 18000. 

Since October 2021, the Nifty has broken above 18000 five times, but the last such move, on September 15th, was distinctly faint-hearted, and I think that the bulls are now reconsidering the wisdom of supporting a market that is distinctly over-priced.

Many ordinary investors, too, have reason to pause. In the last 12 months, the Nifty has lost 3%, and the average mutual fund would have lost a bit more. Add 7% inflation into the mix, and an equity investor has seen a 10% erosion in the buying power of his savings. By now, more recent entrants into this asset class must be questioning their capital allocation. Meanwhile, as excess bank liquidity has dried up, interest rates on fixed deposits have moved up, and the newer private banks are offering 7% on FDs held for a year. Between the negative return on equities, and more attractive interest rates on FDs, the balance has begun to shift away from Indian equities. This is likely to slope away further, as the RBI is all but certain to raise the rate at which it lends funds to banks at the end of this month. 

The RBI is well advised to Follow the Fed, rather than mess with it. Given three aggressive rate hikes by US central bankers, if we don’t follow with higher returns on funds held in India, more funds will flow to the dollar. Our own market dynamics, too, demand higher interest rates. During the pandemic, excess liquidity with Indian banks peaked at just under 10 lakh crores, as business activity shrivelled. That’s now down to zero, and banks will need to bid more aggressively for funds, if they want to respond to the demand for loans.

Bank credit is up 14.5% on a year ago, which should be a cheery sign, as it could signal the return of the investment cycle. I’m still cautious on that front, as the nature of bank credit has changed drastically over the last decade. 

I recently pulled up data for 2014, when bank credit to industry was 25 lakh crore. Personal loans then stood at about 10 lakh crore. Today, bank credit to Indian industry, at 31.5 lakh crore, lags personal loans, which total 33.9 lakh crore. The share of credit drawn by service providers, too, has grown, and bank credit to each of these three major categories of borrowers is of the same order of magnitude, but the demand for personal demand is growing most rapidly, at 18.8%. 

When you place that buoyant demand for personal loans against stagnant employment and weak consumer confidence, you wonder whether it is cause for cheer, or for caution. I’m leaning on the side of caution, and till this cycle of global tightening runs itself out, I’m not looking out for 18,000 on the Nifty.