Financial market reforms: Time to exit from new ways of doing things that don’t work

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Published: August 21, 2016 11:48:22 PM

We are days away from the scheduled announcement from RBI on financial market reforms. The focus will be on developing the corporate bond market.

If Indian financial markets were to achieve critical mass, a long distance from the one trick pony its currently is, with just equity markets. (Reuters)If Indian financial markets were to achieve critical mass, a long distance from the one trick pony its currently is, with just equity markets. (Reuters)

We are days away from the scheduled announcement from RBI on financial market reforms. The focus will be on developing the corporate bond market. RBI panel has recommended a slew of measures to strengthen the corporate bond market. They are as follows:

1) Allow AAA rated corporate bonds to be accepted as collateral for borrowing from RBI

2) Allow primary dealers, banks and brokers to act as market makers.

3) Allow tri-party repo in corporate bonds

4) Look at increasing the upper cap on banks for offering credit enhancement.

5) Above a certain credit limit corporates may be forced to issue bonds for borrowing needs.

6) All issuance during a quarter to be clubbed under single ISIN. Such re- issuances may be exempt from stamp duty.

7) Allow FPIs greater access to corporate bond market.

We see the above suggestions as steps in the right direction. However, we also believe that above micro norms need to be augmented with bigger macro policies, if Indian financial markets were to achieve critical mass, a long distance from the one trick pony its currently is, with just equity markets.

In our opinion corporate bond market can thrive if there is a vibrant market for government bonds, derivatives on corporate bonds and government bonds and derivatives on currencies. Equity market has taught us the importance of foreign capital in deepening and broadenings our financial markets. However, foreign investments in debt comes with a bundle of risks- interest rate, currency and credit risks. FPIs need seamless access to all those markets to be able to manage their risks optimally. Currently, financial market development has been stymied by the silo nature of policy making. Time has come to exit from the new ways of doing things that do not work and embrace a holistic approach to financial market development.

From policy making let me turn my gaze towards developments in global macros over the past week. US economic data was a tad better than expected with housing sectors and industrial production looking up in July. Following strong existing and new home sales activity during the month, US housing starts grew strongly, rising 2.1 percent.

The increase was largely concentrated in the multifamily sector, but single-family also posted gains. However, the improvement in economic data is failing to get a more confident sounding rate outlook from US Fed. There were was a heavy dose of Fed speak over the past week but no clue emerged that Fed would be moving the needle on interest rates any time soon. Over the past week saw the release of US FOMC minutes for the meeting in July but no new information emerged. Fed remains confused and unsure. Its attempt to stick its neck out in not so distant past, was quite a painful one. In fact we find it quite amusing how media plays up any Fed event. It is amusing to say the least, when one looks at the record of Fed’s forecast in guidance. If a trader had that kind of a glorifying record, long back he would have had to find a different profession. It is a little too much to expect a group of men and women will know better than the collective intelligence of markets. Infact, ever since the global economic rebalancing has begun in 2007-08, the economic and financial auto pilot has gone missing. The result has been a test of the central banks ability and they have appeared out of depth.

The double speak from US Fed has not helped the US Dollar much. US Dollar Index has depreciated by 2% over the past few trading sessions. However, amidst the global dollar selling Indian Rupee has failed to capitalize on it. Infact it is not just the Rupee, we have seen a late week sell-off in EM currencies like Yuan as well. Over the past month USD/INR has been buffeted by opposing forces of reserve demand and speculative flows. RBI has used the USDINR market to achieve three objectives:

1) Infuse Rupee liquidity as a part of its monetary policy objective.

2) Support Rupee competitiveness.

3) Build FX reserve.

Ever since Dr. Rajan has taken over the reins in RBI he has masterfully balanced the opposing needs of a weak currency in current global context and a stable currency from the point of view of attracting long term foreign capital in India. He has kept real rates positive and provided with a much needed anchor. At the same time, did not allow market to dictate the price of USDINR. RBI through its FX operations flanked the pair. It has been like a clockwork the pair has not strayed much out of the invisible band of RBI. As a result, the tops in USDINR has been mostly sharp but bottoms much more time consuming and rounded on charts. The explanation for the above pattern in simple, Rupee being a currency with a positive carry, speculators are much more willing to take on RBI during times of bullish frenzy in emerging markets. However, the same works against the speculators when Rupee depreciates. A high negative carry on US Dollar prevents speculators from fighting too hard with RBI, when it gets aggressive on USD selling. This time too was no different. Last Friday, USDINR finally broke above the monthly fractal of 67.00, which was proving to be difficult resistance to break. For the last few weeks we have been arguing for a bottom formation in USDINR below 67.00/66.80 zone. Over the near term, more short covering demand can be seen in USD which can take the pair towards 67.35/50 levels. In the crosses, we remain bullish on JPYINR and neutral on EURINR but bearish on GBPINR. GOIsec 10 year prices remain in an intermediate uptrend and hence the current down move should been seen as corrective in nature.

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