Lopsided currency swings: Implications for emerging economies in post crisis world

Here is the abstract of my paper accepted at the ADMIFMS Management Research Conference 2012 to be held at Mumbai University in December 2012

Lopsided currency swings: Implications for emerging economies in post crisis world 

World currency markets have become extremely lopsided in the last few years. The global economic crisis along with the follow up recession era measures initiated by the governments and central banks around the world have made the venerable logical flow of knowledge in economics and financial markets near obsolete.

The ever-growing interconnectedness in world economy means that such volatile and asymmetrical forces play a highly influential role for businesses; consumers and governments as the economic recovery post the meltdown in 2007-2008 shapes up. Risk assessment has acquired a new dimension in the last five years and it is difficult to explain the towering gains witnessed by the US dollar and the Japanese yen in times of extreme stress.

The currencies in advances nations, which called shots on the global stage as far as international trade and investment flows are concerned, might crumble under the weight of excessive debts their central banks have piled up in a quest to support fragile economies. The emerging economies would find themselves in a fix in such a situation, as their economies would be exposed to forces well outside their sphere of influences. These adverse currency movements are likely to affect the industrial as well as social environment in these nations.

The paper argues that global economy needs vibrant growth in emerging markets for persistent evolution of the process of globalization and a reduction of economic inequality. A reasonable response from global policymakers would be cautious optimism notwithstanding the array of competing theoretical arguments. Further, it is observed that the reactionary forces in global asset markets have been much more pronounced and far reaching in last few years and currencies are becoming the single most critical factor to maintain a strong and robust financial system.

What does low volatility mean?

The NSE Volatility Index has been in a tranquil mode for last few months and plummeted to lowest levels in two years 

While market fluctuations are part and parcel of the investment cycles, the changes in the degree of fluctuations offer useful clues for gauging the underlying sentiments. Volatility is one of the most popular measures. In major world markets, the Volatility index has developed overtime one of the key ingredients of modern day financial markets. The CBOE VIX has become a key fear gauge for equity investors across the world. In India as well, the NSE has launched an index to measure the degree of changes in direction in the broad market.

Volatility Index is a measure of market’s expectation of volatility over the near term. Volatility is often described as the “rate and magnitude of changes in prices” and in could be simply referred to as a measure of degree of risk involved in the market while investing at the present valuations. The index, thus is a measure, of the amount by which an underlying equity market is expected to fluctuate, in the near term, calculated as annualised volatility, denoted in percentage terms based on the order book of the underlying index options.

India VIX is a volatility index based on the Nifty 50 index option prices. From the best bid-ask prices of Nifty 50 Options contracts, a volatility figure (%) is calculated which provides an indication of the expected market volatility over the next 30 calendar days. In simple terms, when markets expect an increase of volatility, prices of options move higher. This same logic could be helped to reduce or add to the holdings to protect or increase profit.

Since its launch about three and a half years ago, the NSE VIX has been in a peculiar mode. The index witnessed a massive upshot in early 2009 when the Indian markets were mired in turmoil in line with their global peers in the aftermath of the global credit crisis. The local markets bottomed out from the lowest levels in years in March 2009 and trended mostly up. The benchmark NSE NIFTY hit its all time high last year before slipping and has been rising yet again in last few weeks after a troubled period during mid 2012. The VIX has been mostly trending lower over the last few months, unscathed by the gyrations in the broad markets. Apart from a quick burst of upside movement during August-September last year, the index has been mostly in a steady downward hill and plummeted to lowest level in two years on August 23, 2012.

A high VIX appears just before a market rally, and a low VIX usually augurs a slide, the historical trends in CBOE VIX reveal. The India VIX has been locked in a lackluster, almost tranquil stretch over the last few months leading to its current drop to two year low. Volatility suddenly seems to be a thing of the past even as the equity markets around the world gyrate around monetary stimulus hopes and the world economic outlook remains clouded. 

Much of the logic is imbued in investor psychology. In the current context, for the local investors, the ever-increasing connectedness with the global cues clubbed with a flagging interest from the cash market participation, could well mean that the trends and patterns in volatility could act as a useful indicator to predict market behavior. The NIFTY has rallied by around 12% since hitting its six-month lows of 4835 in early June and has been mostly aided by an influx of foreign institutional buying even as the broad set of domestic cues remained either unaltered or deteriorated. The earnings growth of the local companies has been weakest in nearly two and half years while broad macros remain unsupportive too. 

While the index can’t be used as the primary decision tool and rightly so, it’s ultra silent movement is too much for comfort.  What’s bothering me is whether the market is ready to support a low-volatility environment when inflation stays elevated, political scenario is a mess and global markets, particularly in the US, look ready to witness a retreat after hitting four-year highs.  

Financialization: In Search Of A New Normal

Here is the abstract of my research paper titled Financialization:  In Search Of A New Normal, which has been accepted at the International Research Conference on Management, Banking and Finance (IRCMBF), organized by the Jamanalal Bajaj Institute of Managment Studies to be held on March 5th - 6th, 2012.

The global financial crisis starkly revealed the punishing downside of Financialization. It also highlighted its role in boom-bust cycles as asset prices wielded a secularly increasing dominance over real economy and influenced policy thinking as well as household and corporate behavior. This paper highlights the broad contours of financialization and their evolution over last few decades. It also examines the role of financialization in exacerbating turbulence in financial markets. 

Following the advent of Anglo Saxon capitalism, financial superstructure of advanced economies kept on rising in relation to the stagnant production system underlying it. Empirical evidence explains how more and more economic activity was geared not to production but to the pursuit of paper claims to wealth. The tipping point came in 2007-08 as this engrossing wave of financialization finally overwhelmed the global financial system and led to an inevitable collapse in asset markets across the board. 

Evolving global macroeconomic structure and the inevitable transfer of wealth and resources from advanced economies to emerging Asia indicate that financialization in these economies is likely to be the single most critical factor determining longer term growth prospects for the entire globe. The paper argues that given the experience of last three years, it is clear that the process of household and business deleveraging in advanced economies is likely to continue well into the current decade. 


This means that prospects of a heightened credit filled boom in emerging economies, particularly Asia over next few years are very high and its sustainability would depend upon how financialization improvises itself after debacle of 2008. The demographics and low consumption levels in these countries could complicate such booms further. The paper sums up how financialization needs to evolve in a new normal in light of experiences in last few years and avoid previous policy mishaps. 


Keywords: Financialization, world economy, crisis, emerging economies, banking 

So far…so good

After a tough time in 2011, things appear to have turned sweet for financial markets in the current year. The New Year celebrations seem to have gotten extended by quite some margin in 2012 with the conventional burst of euphoria that surrounds January 1st not relenting even as the Chinese New Year approaches- ensuring a period of impressive scaling up for the risky assets and its no surprise to guess that the winners have been emerging markets and gold. The newsflow on the economic front has been rather mixed with the backward looking data coming in mostly upbeat even as broad worries remained on the near term economic outlook for the entire global economy.

While US consumer sentiment hit a seven-month high in January and German economic confidence improved at the sharpest pace on record in January, the worries pertaining to debt strapped Eurozone economies  and moderating emerging markets continued to hover on the broad macro picture. The world bank was acutely grim of its assessment of the current year, saying that world economy in 2012 is set to grow by just 2.5 percent, weighed down by ripple effects from the 2008 financial crisis. The bank further noted in its latest Global Economic Prospects (GEP) 2012 report that the sovereign debt crisis in Europe, which took a turn for the worse in August 2011, coincides with slowing growth in several major developing countries (Brazil, India and, to a lesser extent, Russia, South Africa and Turkey), mainly reflecting policy tightening begun in late 2010 and early 2011 to combat rising inflationary pressures from overly-fast growth. As a result, developing country growth for 2012 is now forecast at 5.4 percent, the second lowest over the past 10 years. The Bank has also lowered its growth forecast for high-income countries in 2012 to 1.4 percent and -0.3 percent for the high-income Euro Area.

This is interesting stuff. The bank is very right in saying that major emerging economies appeared to slow down just as the Eurozone debt rumble rammed into top gear.  China’s latest GDP growth of 8.9% was the slowest in two and half years for the world's second-largest economy. While the country seems to be on a right track as growth is easing well in line with the policymakers who scrambled to rein in runaway asset prices last year, an imminent cooling off may not be good news for world economy. While keeping demand for commodities depressed, there is possibility that the PBOC would revert back to its rather mean game of keeping the Yuan depressed and artificially keeping the export prices low.  China’s plentiful reservoir of foreign exchange and the fact that the country is slated to undergo deep leadership changes in the current year would ensure that growth agenda would be kept intact- come what may in Europe or anywhere else. This should keep the central bank in the country busy- ensuring a rather expedited effort to open its monetary taps.

Europe has plunged into a fresh crisis after France admitted it had been stripped of its coveted AAA rating in a mass downgrade of at least half a dozen euro zone countries by the credit ratings agency Standard & Poor's. The Euro plummeted to a 17-month low against the dollar and the European Central Bank was forced to step in to buy Italian bonds after European sources admitted action by the ratings agencies was imminent.

However, despite of this, the gains in equities did not evaporate. Most of the emerging market equities witnessed good buying from foreign institutional investors- just in line with the conventional pattern, which is associated with the risky assets. Given the macro headwinds, is it fair to read too much into the good performance of the emerging market equities? May be not. Capital flows to developing countries had weakened sharply in second half of last year as investors withdrew substantial sums from developing-country markets. Gross capital flows to developing countries plunged to $170 billion, only 55% of the $309 billion received during the same period in 2010, according to World Bank data. Developing-country stock markets lost 8.5 percent of their value since July-end till December end. This, combined with the 4.2 percent drop in high-income stock-market valuations, has translated into $6.5 trillion, or 9.5 percent of global GDP, in wealth losses for the equity markets.

It is understandable that investors are latching up into the downtrodden stocks at the current valuations then. However, it will be interesting to see how equity investors play in 2012.  While its still very early days in the New Year, its likely to be a rather mixed year-something similar to 2011 with the only exception being that emerging market equities might not witness the kind of drubbing seen in last year. Investors were exceptionally cautious in 2011- entering into a new decade after enduring two painful bear markets in the earlier one and not many reasons abound as to why the sentiments would change radically in 2012- already been dubbed the year of doom!

Top performing equities- YTD
Index	Change
Argentina	16.44%
Hungary	11.05%
Finland	9.94%
Brazil	9.79%
Hong Kong	9.09%