The puzzle of a market boom in economic gloom

Syllabus subtopic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Prelims and Mains focus: on the recent economic slowdown in the Indian economy and why it is not affecting the stock market

News: Benchmark indices Sensex and Nifty have touched fresh highs in the last couple of months despite fresh concerns about a rise in bad loans, risks in the banking and non-banking space and the economic slowdown.

Why is Sensex peaking amid slowing growth?

Reforms such as the goods and services tax, insolvency and bankruptcy code and the recently announced corporate tax cuts suggest a positive mid-term outlook for India’s growth once banking and financial sector stress is resolved. The other equally important factor is low interest rates in developed economies that have led to fresh inflows into India. More Indians are participating in retail equity markets as a viable investment through special investment plans and mutual funds. All this, coupled with expectations that the direct tax code will be enforced in the next budget, has improved market sentiment.

Aren’t they supposed to move together?

Not always. Ideally, markets and the economy should move together as price of shares of a company should be correlated with its future earnings. Expectations of future earnings are formed from past and present earnings. Thus, during a slowdown markets should correct to reflect the current level of earnings. But several other factors influence the pricing of shares. Fresh availability of surplus liquidity at cheap rates, along with speculation of future earnings being better than today, can lead to such divergence. The convenient argument during a bull run has been “this time it is different” however, it never is.

Does this mean the Sensex is likely to correct?

There’s a greater chance it won’t correct. Growth will recover over the next few quarters and the corporate tax cuts will have a positive impact on the balance sheet of all firms. What will happen to benchmark indices depends on the budget, the monetary policy panel’s February meet, availability of liquidity, global growth and the pace of recovery.

What if there’s a global economic recession?

Many anticipate a global economic meltdown due to a slowdown in the US economy caused by the US- China trade war. The slowdown in the EU has been explained using arguments including heightened uncertainty over Brexit. However, the recently concluded phase 1 of the US-China trade deal and the Conservatives’ thumping majority in the UK polls reduce uncertainty. Geopolitical factors will thus be conducive to growth. The only factor that can cause a recession is a severe correction in US stock markets, which is less likely.

So what will happen by December 2020?

While the indices are performing well, well-governed companies are driving this show. BSE Midcap is down roughly 600 points, even as BSE Smallcap is up around 200 points. So, capital has moved away to strong companies with consistent earnings. This suggests a correction in their valuation is unlikely. The economy bottomed out in the second quarter of FY20; thus, economic indicators by next December will be positive and in line with India’s potential.

RBI shifts assets into US Treasury bonds as a share of deposits drop

Syllabus subtopic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Prelims and Mains focus: about Forex and its constituents; why RBI is keener on investing in US treasuries?

Context: In September 2008, the year that saw the global financial crisis unfold, deposits with other central banks formed more than 57% of the Reserve Bank of India’s (RBI’s) foreign currency assets. US Treasury bonds and other securities had a lower 40% share of the forex kitty.

• Fast forward to September this year, the share of foreign securities, which includes US government bonds, has surged to 63% and that of deposits with other central banks and the Bank for International Settlements has dropped. The share of the latter fell to about 29%.
• During this 11-year period, India’s central bank has increased foreign exchange reserves by 51% to a record $433.59 billion. Reserves were even higher at $454.50 billion as of 13 December. It would seem that much of this increase has been invested in foreign securities, predominantly government ones. To be sure, the central bank’s latest Report on the Management of Foreign Exchange Reserves showed that the share of foreign securities has increased.

What explains the increase in the share of this asset class in RBI’s reserves?

• Part of the answer is obvious. Most global central banks have been on an unprecedented expansionary path in their monetary policies. Governments too have adopted a loose fiscal policy.
• In essence, dollars, euros and pounds have been printed more and more. Since government bonds are the safest asset class, central banks typically prefer to deploy forex reserves into these. And India’s central bank is no different.
• RBI goes by the mantra of safety, liquidity and returns when picking out asset classes to invest its forex reserves. Given that safety is of the highest importance, investing a large share of reserves in sovereign bonds of advanced economies is a prudent approach.
• Another factor is the valuation. US Treasury yields have plummeted since the crisis. For instance, the US 10-year Treasury note’s yield has dropped by 1.8 percentage points since the crisis erupted in September. The UK gilt has dropped by an even bigger margin. When bond yields fall, the value of the bond holding increases as prices go up. Yields and prices move in the opposite directions.

Conclusion

• Before the crisis, the RBI had preferred to park a big chunk of forex assets into fixed deposits because the bond yields were rising at that time. Perhaps they may have shifted now away from deposits to bonds since yields are on a downward spiral.
• Indeed, the Treasury International Capital data from the US Federal Reserve showed that India moved up to 13th place from 19th in October 2009 in terms of the size of investment in US securities.
• Central banks like risk-free assets and what is better than US Treasury bonds. It should not come as a surprise that India’s central bank has grabbed them in a big way.

PM chairs first meet of Cabinet Committee on Investment and Growth (CCIG)

Syllabus subtopic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Prelims and Mains focus: about CCIG and its significance for India’s economy

News: The newly-­formed Cabinet Committee on Investment and Growth (CCIG) held its first meeting on Monday as the government looks to boost spending to bring back a sputtering economy on track.

Background

• The meeting came against the backdrop of gross domestic product growth slowing to a six-year low of 4.5 per cent in the July-September quarter as the twin engines of investment and exports sputtered. Adding to the woes is a slowdown in consumption. This was the sixth consecutive quarter when the growth rate fell.
• Last week, Fitch Ratings cut its growth forecast for India to 4.6 per cent for 2019-20 fiscal on significant deceleration in the past few quarters due to credit squeeze and deterioration in business and consumer confidence. Moody’s has put 2019-20 growth at 4.9 per cent and the Asian Development Bank (ADB) estimates it at 5.1 per cent. The finance minister is likely to present her second budget on February 1, 2020

About the meeting

• PM Modi chaired the meeting of the CCIG.
• The panel has four other members — Home Minister Amit Shah, Highways and MSME Minister Nitin Gadkari, Finance Minister Nirmala Sitharaman and Commerce & Railways Minister Piyush Goyal.
• The meeting took stock of the latest economic indicators and also the immediate concerns of the economy. a source added, without divulging any further details.

About CCIG

• The Cabinet Committee on Investment and Growth was set up in June 2019 after the BJP won a second term in office.
• It was aimed at boosting spending to bring back the sputtering economy on track.

Japan govt. proposes the release of Fukushima water

Syllabus subtopic: Disaster and disaster management.

Prelims and Mains focus: on the Fukushima nuclear disaster and its impact; concerns regarding releasing contaminated water into the sea

News: On Monday, Japan’s Ministry of Economy, Trade and Industry proposed gradually releasing the water into the ocean or allowing it to evaporate, saying a controlled discharge into the sea would “stably dilute and disperse” it. The ministry ruled out alternatives like continuing to store it in tanks or injecting it deep into the ground. Abe’s Cabinet will make the final decision.

• Prime Minister Shinzo Abe’s Cabinet and Tokyo Electric Power Co. — operator of the Fukushima Daiichi plant, where a triple meltdown led to the worst nuclear crisis since Chornobyl — must decide what to do with more than 1 million tons of contaminated water stored in about 1,000 giant tanks on the plant site.

Concerns

• Japan’s fishermen losing their livelihood as the government considers releasing tainted water from a nuclear power plant destroyed by the tsunami’s waves.
• With Fukushima preparing to host baseball games during the Summer Olympics next year, and the plant running out of land on which to build storage tanks, the debate has taken on a sense of urgency.

Water contamination at the plant

• The water becomes contaminated as it is pumped through the reactors to cool melted fuel that is still too hot and radioactive to remove. For years, the power company, known as TEPCO, said that the treatment of the water — which involves sending it through a powerful filtration system to remove most radioactive material — was making it safe to release.

• But it is actually more radioactive than authorities have previously publicized. Officials say that it will be treated again and that it will then be safe for release.

• Regardless of government assurances, if the water is discharged into the sea, it will most likely destroy the livelihoods of hundreds of fishermen. Consumers are already worried about the safety of Fukushima seafood, and dumping the water would compound the fears.

• Until last year, TEPCO indicated that with the vast majority of the water, all but one type of radioactive material — tritium, an isotope of hydrogen that experts say poses a relatively low risk to human health — had been removed to levels deemed safe for discharge under Japanese government standards. But last summer, the power company acknowledged that only about a fifth of the stored water had been effectively treated.

• Last month, the Ministry of Economy, Trade and Industry briefed reporters and diplomats about the water stored in Fukushima. More than three-quarters of it, the ministry said, still contains radioactive material other than tritium — and at higher levels than the government considers safe for human health.

What do the scientists say?

• If the water is processed so that the only radioactive materials that remain are low levels of tritium, releasing it into the ocean would be the best solution in terms of cost and safety. The functioning nuclear plants around the world release diluted water containing tritium into the ocean.
• Some scientists said they would need proof before believing that the Fukushima water was treated to safe levels.

Present Scenario

• More than 20 countries still have import restrictions on Japanese seafood and other agricultural products that were imposed after the 2011 disaster. Earlier this year, the European Union lifted its ban on some products.
• In Fukushima, the fishing industry brings only about 15% of its pre-disaster catch levels to market. Every haul is sampled and screened in labs run by Fukushima’s prefectural government and the fisheries cooperative.

About Fukushima Nuclear Disaster, 2011

• Fukushima accident, also called Fukushima nuclear accident or Fukushima Daiichi nuclear accident, accident in 2011 at the Fukushima Daiichi (“Number One”) plant in northern Japan, the second worst nuclear accident in the history of nuclear power generation.
• The site is on Japan’s Pacific coast, in northeastern Fukushima prefecture about 100 km (60 miles) south of Sendai. The facility, operated by the Tokyo Electric and Power Company (TEPCO), was made up of six boiling-water reactors constructed between 1971 and 1979. At the time of the accident, only reactors 1–3 were operational, and reactor 4 served as temporary storage for spent fuel rods.