Do it yourself

I shared some of my random thoughts with the readers last week (see here). Many readers have commented on my post. Some readers have raised some pertinent questions and also provided very useful feedback. Based on the readers’ comments, questions and feedback, I would like to share some more random thoughts. It is however important to note that I am a tiny insect living in a cocoon of my own. I cannot comment intelligently on the international markets, policy matters and geopolitics. Nonetheless, I reserve my rights to form strong views on global and domestic developments concerning markets, policies and geopolitics, for my personal strategy purposes.

The US debt end game

The current state of the Fed balance sheet and the US public debt is certainly not sustainable by any parameter. It is a matter of debate how the US government and the Federal Reserve would make fiscal and monetary corrections and eventually return to an acceptable level of public debt without pushing the economy into a deep recession (hard landing). One of the most talked about resolutions to this conundrum is to keep bond prices lower and buy back aggressively over the next few years. That may be one of the easiest ways to return to fiscal sanity. Creating an artificial shortage of USD and forcing UST holders to sell cheap could be one of the means to achieve this target. To create USD shortage, a reverse carry trade might be induced, by narrowing the yield spreads, besides reducing CAD through tariffs and other trade restrictions.

For context, the US is running a quarterly current account deficit in excess of US$260bn; a fiscal deficit of over US$1.7trn (2023) and USD supply (M2) of over US$21trn. The US GDP was US$27.4trn in 2023, accounting for roughly 26% of the global GDP.

The great gambler

The RBI governor's job in India might be the most unenviable one. He has to struggle 24X7 to maintain a balance between fiscal requirements, political consideration (inflation and small saving interest), growth needs (real rates) and balance of payment (USDINR exchange rates). Repo rate and open market operations are the only two major tools available to him.

The RBI has been maintaining a status quo on the repo rates for over a year now. This has sustained the US-India yield gap (to protect flows) to some extent, but the efficacy of high repo rates in ensuring price stability, which is the stated primary objective of the RBI’s monetary policy, is questionable. Besides, the RBI has been meaningfully enlarging its balance sheet in the post Urjit Patel era, while stated policy objective, until the last week, has been “withdrawal of accommodation”. This aspect is not talked about much in the public domain. One may speculate that the real objective of the RBI’s monetary policy has been to prevent USDINR appreciation (even if it means high imported inflation) and ensure sufficient inflow in small saving schemes, which are funding almost 45% of the union government’s fiscal deficit. It has been obviously playing a gamble with high stakes, US$700bn forex reserve notwithstanding.

 Indian lenders face challenges

The persistent negative credit deposit ratio of Indian banks has been a subject of discussion at all levels. The government, regulators (RBI and SEBI), bankers and analysts etc. have all expressed concern over the poor deposit growth, while the credit demand remains strong. The finance minister and RBI have even attributed the flow of funds towards capital markets as one of the reasons. In my view, high household inflation, poor real wage growth and very low real rates on deposits are the primary reasons for this trend. Besides, for most lenders the asset quality improvement trend that started five years ago may have already peaked.

I feel most Indian lenders may now face three challenges – declining margins as the cost of funds rises; flat to declining asset quality and slowing growth. Investors are cognizant about these challenges but as the response to a recent IPO of a housing finance company indicates, they may not have yet adjusted their respective investment strategies.

Focus on finding opportunities

As a wise man suggested, the small investors like me should not be wasting energy on bothering about these macro things and focus on finding the investment/trading opportunities which may be opened by policy missteps, fund flows, geopolitical tensions etc. I fully agree with this thought. For the next 4-5 months, I shall be focusing on finding opportunities and taking advantage of traders’ mistakes.