More Signs of the End of Easy Money: Following Brazil, the Indian Government Raises Interest Rates

The return of the bond vigilantes has prompted the Brazilian government to  set the trend of hiking interest rates, now it seems as India’s turn.

From Businessweek-Bloomberg:

India stepped up efforts to help the rupee after its plunge to a record low, raising two interest rates in a move that escalates a tightening in liquidity across most of the biggest emerging markets.

The central bank announced the decision late yesterday after Governor Duvvuri Subbarao earlier in the day canceled a speech to meet the finance minister. The RBI raised two money-market rates by 2 percentage points and plans to drain 120 billion rupees ($2 billion) through bond purchases.

Indian rupee forwards jumped the most in 10 months, and the RBI’s move yesterday left Russia as the only BRIC economy to not have reined in funds in its financial system. Brazil has raised its benchmark rates three times this year and a cash squeeze in China sent interbank borrowing costs soaring to records last month.

Media recently cheered on the one month contraction from record trade deficits largely due to gold import and trade curbs.

Yet if the rupee-US dollar exchange ratio continues to decline or if the USD-rupee persist to ascend as shown above, then statistical data may not reflect on the real state of affairs.

Gold restriction mandates have only been diverting India’s gold trade underground. Gold smuggling has massively risen, partly channeled through Nepal. 

Decline in India’s rupee has equally been reflected on consumer price inflation which increased to a three month high.

A curious mind would ask why, given India’s relatively low inflation and interest rate levels, has these been prompting alarm on Indian authorities for them to act to tighten?

Well, the obvious answer is that today’s systemic debt have reached epic proportions as shown by domestic credit % to the economy.

It’s not just domestic debt but also India's external debt has sharply risen to record highs.

All these has made India’s economy and financial system highly vulnerable to interest rate increases. (above charts from tradingeconomics.com)

But these governments sees the risks in the currency spectrum as potential tinderboxes for a crisis, and thus opt for the interest rate medium to effect policy changes.

As I have been pointing out, one cannot just compare with past data in analyzing economic events, that’s because, there are multitude of changes happening real time. 

So what may seem as relatively “low” interest rates and “low” consumer price inflation today, may be “high” relative to the changes in the debt position.

Nonetheless, theoretically the bigger the debt, the more sensitive debt conditions are to interest rate increases, which likewise implies of the amplification of credit risks.

So far India’s stock market, represented by the BSE 30, after falling 9% in reaction to “tapering” fears, from the May’s peak, appears to be challenging the record highs. Dr. Bernanke’s "put" has put an oomph to the latest rally. 

In contrast, stock markets of Brazil, China and Russia continues to flounder.

Also I pointed out that Turkey's officials previously announced measures to use record foreign currency reserves to combat the bond vigilantes, they seem to have a change of heart, after the initial forex measures, as predicted, have apparently failed to stanch the decline of the lira. 

Now, Turkish monetary officials are contemplating to likewise tighten via the interest rate channel.

Brazil and India’s tightening, brought about by the return of the bond vigilantes, which will likely to be a trend for many more emerging markets as Turkey and Indonesia and possibly too on developed economies, are deepening signs of the transition from easy money to the tight money. 

It would be reckless to ignore the risks of disorderly market adjustments should bond vigilantes continue to run berserk.