4 Taper Tantrum – Inevitability of the Economic Alliteration

Taper Tantrum – Inevitability of the Economic Alliteration

By: Rajas Shahade (IIM Bangalore)

While the phrase Taper Tantrum can easily pass off as a fancy tongue twister, it is actually a very interesting concept having widespread implications on the global economy and markets. So, let’s set some context and try to find out why is it suddenly relevant again!

Rolling back the clock

Let’s roll back time by a few years. 2008. The housing bubble had burst to pieces in the United States, taking down the stock market with it. The world had witnessed an unparalleled crash with the S&P 500 falling more than 20%. Within 18 months, the Dow had also dropped by more than 50%. The economy was reeling under an unprecedented recession with activity levels bottoming out. It was time to take some rampant decisions to save the economy and this is where the Federal Reserve stepped in. As a reactionary measure, it increased liquidity in the market by buying bonds to pump more money into the banking ecosystem with the hope that transfer of cash in hands of the people would lead to improvement in overall demand and stability. The dents made by the crash were being straightened out and the economy seemed to be getting back on its feet again. However, with so much money into the economy, an interest rate fall was inevitable – rates fell from 5.25% in September 2007 to 2% in April 2008. While this was good news for the borrowers, a fall in interest rates always has a flipside. With abundance of money, US investors started looking for alternative investment destinations since the returns (in the form of interest) did not remain competitive in the home market. And this is where emerging markets like India, Brazil and Indonesia, South Africa, and Turkey (the fragile five) started getting pieces of the US investment pie.

Calling it a day

When the US economic revival became evident, one fine day, the Fed decided that it would stop putting more money into an already overloaded economy. It announced, in 2013, that there would be a tapering of the quantitative easing norms put in place. Emerging economies did not take this announcement in the best spirits as they believed that such a reversal would eventually restore interest rates in the US, with investors pulling out their invested money. This led to tantrums thrown by the stakeholders of these economies, with the stock markets taking a hit. While the Indian economy remained largely insulated from such an announcement, with a few minor hiccups, intensity of the ripples was stronger in other emerging countries. Eventual outflow of US dollars led to depreciation of various local currencies in the range of 20%-45%, leading to harmful effects such expensive imports, the need to increase rates and fall in activity levels. A combination of these factors had an adverse impact on the stock market due to dwindling investor sentiments about their country’s economic strength.

Back to the future

The big question now is whether such an episode is expected to recur? If we compare the situation in 2008 to the one now, the resemblance of US policy response is uncanny. The Fed has pumped in a lot of money in its economy (asset values increased from $4.7 million in March 2020 to $7.8

million in April 2021) to pull it out of pandemic’s disruption and a huge chunk has found its way across the world, which will be removed once the pandemic’s effects subside. However, this time around, the Fed has been more transparent in its signaling and the scaling back is expected to be gradual and smoother. The recent rise in the US interest rates has also been passed off as being fleeting in nature with a focus on global financial interconnectedness. The Reserve Bank of India has also recently announced the maintenance of its accommodative stance, with a focus on growth. Since the inflation is within the tolerance band (2%-6%), the RBI doesn’t seem to be interested in increasing the interested rate and curbing growth. However, this announcement has received polarizing opinions with former RBI governor D S ubbarao and current Monetary Policy Committee member Jayanth Verma opposing the RBI’s stance. These voices, being very strong and important, indicate that an interest rate hike to curb the inflationary pressure may be on the cards sooner rather than later. Time will eventually tell its tale. But if I am an investor in any of these emerging markets with US money, I would be treading very carefully since likelihood of a widespread market correction cannot be discounted.

Remember, all it takes is a single announcement!

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References: economictimes, finshots, thewire, indianexpress, reuters, groww, livemint, bloombergquint

INDIAN IPO RUSH: HOW IS STOCK MARKET TRENDS MOTIVATING COMPANIES TO GO PUBLIC?

By: R V Pooja (IIT Madras)

Initial Public Offer, also known as IPO, is a set of shares (basically a portion of the company) that the company releases for the public to buy. This is done in order to raise funds wherein the public plays the role of the investors. Only the private companies that possess and have maintained a minimum net worth of or over one crore rupees in each of the previous three years can apply to make Initial Public Offering. The Securities and Exchange board of India (SEBI), which supervises the Indian securities market and the capital, has mandated some more criteria that need to be met to let the firm issue its IPO. These include net value of IPOs being issued be lesser than or equal to five times the value of the company, at least three crores (of which lesser that fifty percent is held in cash or cash equivalents) of net tangible assets being owned and maintained for the past three years, Earnings Before Interest and Tax (EBIT), also called operating profit of the firm should be greater than or equal to fifteen crores in any of the three years from its history of past five years.

While the above eligibility criteria hold true for the Indian companies, there are multiple other criteria that might have to be met in different countries. A clear rise in the number of IPOs globally has a trend as shown below in Figure 1.

Figure 1: This figure shows the year-wise trend and total number of Initial Public Offers made during the period 2000 to 2021. The figure has been obtained from https://stockanalysis.com/ipos/statistics/

So, what are the multitude of reasons for the huge leap, considering the 2019 to 2020 and its further jump, taken by the number of IPOs being issued? To begin with, after the major hit to the market with Covid-19, unpredictability rose. Over time, things started falling back to their places and thus stability rose. Companies and firms that decided to go public mostly saw this turning point, of the market getting back to normalcy and assuring high performance, as an advantage.

While this reason applied majorly to the medicine and pharmaceutical sector (that was and is in quite some huge demand at the moment owing to making of Covid-19 vaccines, medicines and other treatments) and some younger companies who dreamed big, the other reason for such jump in the number of IPOs is to cover up the losses they incurred when the market misbehaved during the Covid-19 breakout, to keep sustaining themselves and be in the business competition.

In addition to that, because most transactions moved to online platforms to curb the spread of the virus, the world started to adapt to the massive shift i.e., from physical to digital life. This led to more and more issuing of IPOs, by the companies that were mostly into tech driven digital platforms, so that they could expand their business, gain popularity while conquering the market.

With an increasing number of people opting for home delivered food, for a change in taste or hectic work schedule, a good portion of the IPOs made include food sectors. Most countries are pushing themselves to become independent in a situation of crisis like the pandemic, this has led to lesser international trade of specific commodities while prospering of companies that intend to produce the same commodity. Expansion of such companies also has a key role to play in the jump seen in the number of IPOs before and after the breakout of Coronavirus. Some reasons for the companies to go public is that IPOs give them the flexibility to manage losses and work around them, makes them more credible, accountable and popular, helps them take calculated risks at times and the best benefit, on their part, is that they will never have to repay back this capital to the investors as it is just sold by the holders if they do not want it.

All these reasons and the quite some record breaking number of 815 companies going public, as noticed just till the month of October (which implies 2021 still has a long way to go) has raised another concern which is the ‘Market Bubble’. This is a situation where the market performs unusually well and then ends up going down. So, with such a massive number of IPOs, the question of the market bubble should not be overlooked because this is a never-seen-before rise in the number. In hindsight, it should not be forgotten that off market trades have a role to play in the bubble too, if there is one being expected. About the bubble, nothing can be said for sure but there are chances that some valuations of the companies might be stretched to quite an extent that might be far from reality. Also, the markets behave irrationally at times. With the profits here, comes risk too. And all the investors know this. They better keep an eye out for a bubble and act accordingly. Oh! Their sixth sense might come in handy here.

References: https://www.investopedia.com/terms/i/ipo.asp https://www.5paisa.com/stock-market-guide/ipo/what-is-the-eligibility-criteria-for-applying-ipo https://www.indiatoday.in/business/story/decoded-why-so-many-companies-are-going-public-in2021-1827513-2021-07-13 https://www.bakermckenzie.com/en/newsroom/2020/12/ipo-report-2020 https://www.pwc.com/gx/en/services/audit-assurance/ipo-centre/global-ipo-watch.html https://www.investopedia.com/articles/stocks/10/5-steps-of-a-bubble.asp Image reference: https://stockanalysis.com/ipos/statistics/