Will affect flows but will also keep commodities down
After Fed chairman Ben Bernanke delivered his big threat of scaling down the Fed’s $85 billion monthly bond purchases, world markets are reeling under another shocker, of Chinese growth taking yet another hit. China’s economy grew at its slowest in 13 years in 2012 and the fear is, based on current indications, that it could slow even more this year—while the IMF has pencilled in an 8% growth for this year, analysts are looking at a figure of 7-7.2%. June’s PMI fell to 47.1 which, apart from signalling the economy continues to contract, is the lowest reading in the last 10 months. Not only is domestic demand weakening, but even new export orders are growing slower as the US recovery remains patchy and Europe remains in a recession. What is more worrying, and this is what sent Asian stocks reeling over the past few days—Chinese stocks themselves fell 10% over the past few days, to their lowest levels since 2009—is the dramatic squeeze in liquidity which, last week, forced the inter-bank call money market to remain open for half an hour more as banks scrambled to borrow cash but found no sellers. Finally, the Central Bank had to inject more liquidity which brought down repo rates, but what is more worrying is that the credit squeeze was engineered by the Central Bank which, in turn, is trying to take on the burgeoning shadow banking sector by trying to reduce the availability of funds to it. Over the weekend, the state news agency Xinhua blamed speculative trading and the shadow banking for the dramatic spike in money market rates.
While that may be a great strategy under normal circumstances, it is fraught with risk since, as happened in the case of Lehman—and that is why the US government rushed in to save AIG—is that there is no real estimate of what the impact can be in terms of counter-party risk. So, if the shadow banking system gets badly hurt, this could affect the credit worthiness of even the official banking system. In the more immediate term, any squeeze in liquidity will affect large Chinese investments which have always been easy to fund—and justify the returns on them—as long as liquidity was abundant. In other words, there is the risk that a slight miscalculation could trigger off a full-blown banking crisis even while the economy shows fresh signs of slowing. While slowing liquidity has implications for FII flows—this heightens the pressure on the Indian government to ease rules to attract FDI—what’s good is the impact this will have on commodity prices. For an economy such as India where net oil imports are 5.5% of GDP, gold 2.8%, coal 0.8% and iron and steel imports around 1.2%, that’s a huge relief.