US may dump strong $ policy

Its not such a bad strategy, as most of the other trade zones, are not in a position to take up the slack, says Dr Dasgupta.

india Updated: Jun 04, 2003 15:19 IST

The India Babble
The markets moved rather like a roller-coaster ride, albeit in a thin range. The week started with rather good news all around, with the global markets looking up, the monsoon looking good, inflation under control and a whole host of other good news.

By Tuesday it had dropped about 40 points off the weekly peak, driven by some fairly heavy institutional selling pressure but with an upward closing trend, which continued on Wednesday, driven by Infosys. After that it was very gently downward trending till the end of the week, driven mainly by worries that the tech stocks will get hit badly, due to the rapidly appreciating rupee against the US dollar.

The rising rupee has started to bite into the Indian corporates with a vast swathe of industries being affected, starting from information technology, pharmaceuticals, to diamonds and shipping. Inspite of a good foreign exchange reserve and a very tentative intervention by the RBI, there is really nothing that the government or RBI can do to keep the rupee down. There are much bigger forces at work, and in my opinion, there is no point spitting against the wind and wasting resources, the government should let the rupee find its own level.

The Indian Meteorological Department didn't give a good forecast of the monsoon, and projected a below normal rainfall for this season, which is not as bad as it sounds - it's about 95 per cent of average rainfall.

The anti-privatisation strikes started off very nicely indeed, costing the country 15 billion rupees. Thank you guys, that was very appreciated indeed! Let us keep on living with our sclerotic and moribund economy, while others prosper, shall we? While some of their complaints are justified, they should realise that this drive is coming from the hoary old problem of the deficits.

That yawning deficit issue is biting everybody, irrespective of political orientation, any government in power (coalition or otherwise) will have to look at and address this rapidly growing problem. I am afraid the trade unions are protesting futilely, the TINA (there is no alternative) factor is here to stay. The pension contributions were cut inspite of the strike, the Centre reduced the interest rate on Employees Provident Fund (EPF) by 0.5 per cent -- from 9.5 per cent to 9 per cent.

On the derivatives side, the market is getting quite excited about the up and coming derivatives (futures and options) market on the 10-year government bonds and 91-day treasury bills. The bond options will be listed later. Based on the previous experience of equity derivatives, this market seems to have a bright future (if you pardon the pun).

The oil minister Ram Naik gave another good piece of news and said that the prices of POL may come down further, given the strength of the rupee. There have been stirrings on the oil and gas pipeline from the central Asian republics through Afghanistan and Pakistan after the talk about the talks. I would be very cautious about accepting this proposal, you can have as many guarantees as you can have, but once the pipeline has been established and downstream
industries hooked up, interruptions to the supply will have a seriously deleterious impact on the economy. If Pakistan can't protect its own pipelines, under what conditions would it be able to protect the external pipeline to India?

The Babble in the Ivory Towers
Last week, we looked at the ongoing European process towards the creation of a single retail banking market. This week we look at another very interesting development in the gulf. The Gulf Cooperation Council (GCC) comprising of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, have, as of January 1, 2003, formally started pegging their currencies to the US dollar as a first step towards monetary union, tentatively scheduled to come into existence in 2010.

On the same day, a GCC wide customs union also came into effect. A recent working paper by George Abed, S. Nuri Erbas and Behrouz Guerami of the Middle Eastern Department of the International Monetary Fund (IMF), explores this significant step and suggests that the GCC consider pegging to a basket rather than pegging to the US dollar itself. The main reason according to the authors is, that the GCC countries will diversify their trade away from a purely American base and this will, for obvious reasons, require a broader basket, rather than purely US dollar based.

Which is pretty straightforward, but one wonders whether 7 years is long enough to change deeply ingrained trading patterns. The proportion of non-oil exports to oil-exports is miniscule and to change a fundamentally commodity based economy to an industrial or service based economy within 7 years is a tall order.

Still, it is an interesting development considering that most of the world is slowly emerging into discreet trading blocks. The GCC is also negotiating with the European Union (EU) for a free trade agreement.

One of the key things that the authors mention, was the fact that the GCC countries have to modify their labour (both expatriate and indigenous) policies, so that the non-oil sector can grow as exchange rate flexibility is heavily dependent on wage flexibility.

The World Babble
Well, the G7 finance ministers meeting happened weekend before last and surprisingly enough, didn't issue any strong directions on the dollar. A vague statement saying that the depreciation of the dollar was acceptable and these things happen didn't really help the markets. In fact, they took fright and drove the markets down across the board.

It is pretty clear now that the US administration is probably abandoning the strong dollar policy and is exporting its troubles to the rest of the world. This is a very risky strategy, assuming that the foreign investors will keep on funding its deficit inspite of the devalued dollar. Thinking a bit on it, it is not such a bad strategy, as most of the other trade zones, Europe, Japan, Asia and the emerging markets are not in a position to take up the slack.

That said, President Bush, during his meeting with Prime Minister Jochiro of Japan, expressed his view that the strong dollar policy will live on. John Snow, the US Treasury Secretary said something totally different, confusion galore?

I suspect that the markets will shrug this off, as it is pretty clear that the Americans want the Japanese to do something about their bad loans problem and not just keep the Japanese economy alive through exports. The Bank of Japan has been intervening massively in the markets and some estimate that the BoJ has spent over $20Bn this month in defending the Yen, thus giving a slight fillip to the Nikkei of about 0.8 per cent.

The US markets dropped almost 2 per cent but started to recover from Wednesday onwards. The DOW ended up just few basis points off the start of the week, while the NASDQ ended up about 1.5 per cent down.

While this was faintly good for the US exporters, the European exporters are hurting horribly, and the Footsie EuroStox 300 reflected this by dipping more than 3 per cent over the week. We are already hearing how the US exporters are undercutting the British and European exporters and the value of the Euro, which is rising hard (punching through the Euro Launch price), is not helping at all.

The industries, which are domestically focussed, such as property, leisure and utilities shouldn't get hit to that extent, but industries such as oils, pharmaceuticals, automobile and aerospace will get hit badly.

Alan Greenspan, in his inimitable and Olympian way, confirmed that deflation would be a possibility and this made the bond markets extremely nervous indeed and the yields fell across the world to record lows. It is now getting to be a certainty that there will be a strong reaction by the central bankers next month, when they meet at their regular meetings.

Interest rates will fall, and now a chorus of European political leaders have started moaning about the strong euro policy, a fine reversion from the time that the Euro was launched and immediately started to slide. The problem is, with the low rates currently, the room for manoeuvre is limited as the BoJ has found out to its peril. The advantage that USA and to a lesser extent Europe have, is that there is political will to sort this problem out, and short term pains can be endured.

Having said this, President Bush's re-election campaign may not be willing to take a hit on this account. Still, the only other option is to flush the economy with cash, by increasing bond purchases. It has to be balanced against the other silver lining, that the fall in yields will make it cheaper for the British and American governments, who need to fund their deficits. Ah!, well, nobody said that the job of being a central banker or chancellor was easy!.

Gold eased down to around the $368/ounce region, after profit taking hit the price. It had risen to $370/ounce after the terror alert was raised to Orange in the US, but it seems to have hit a resistance level. Oil rose to $29.16, after some rather discouraging news about Iraqi oil production, although coffee rose after news about frost hitting the Brazilian crop.

On the trade front, the big news was that Argentina, Canada and the United States asked the WTO for consultations on the approval and marketing of biotech products. It looks like these 3 countries have lost patience and are really putting the screws on Europe. This is looking like a right nasty spat brewing up and with President Bush complaining about European attitudes
towards GMO's, it looks like it will escalate.

President Bush said in a recent speech that due to the European attitude, African countries are persisting in repudiating GM based crops. One sad outcome of this step is that we can wave the Doha Round goodbye, if this blows up into a full row.

(Dr Bhaskar Dasgupta works in the City of London in various capacities in the banking sector. He also lectures at several British Universities. He holds a Doctorate in finance and artificial intelligence from Manchester Business School and is currently working on another doctorate at Kings College in international relations and terrorism.He will be writing a weekly Monday round-up on markets and indicators.)

First Published: Jun 04, 2003 15:19 IST