Relevance of the Blog to Curricula: The concepts and applications in this blog pertain TO the topics in the following courses:
- Programme UG Economics: Course Money Banking and Financial Markets (Code
CEC33102), Unit 2, Topic 2
- Programme PG Economics: Course Security Analysis and Portfolio Management (Code CEC52116), Unit 4 Topics 1 and 3
- Programme PhD Economics: Course Advanced Theory of Economics (Code CEC81101), Topic 4
- Programme PhD Commerce: Course Advanced Finance (Code CCO81101), Module 2, Topics 3 and 6
The structure of a financial market rests upon a macroeconomic structure. The performance of a macroeconomic system reflects upon the pace of productive activities. Productive activities come to a halt if the staff and workers are unable to attend offices, factories and outdoor workplaces. As precaution against COVID-19, gathering and assembling are getting prohibited, in an increasing number of regions in the face of lockdown, leaving aside essential goods and services sectors. In the interest of safety senior citizens and children are being quarantined from their families. Out of fear the youth and the middle aged people are falling prey to mutual distrust and maintaining social distances because some of the infected victims are found to have hidden the fact during the incubation period of the virus. In short the supply of labour is diminishing side by side with the publics’ tendency of hoarding daily necessities and consumables because they like to avoid crowds in shops or stores when online vendors are unable to deliver. As a result production has become sluggish and side by side the saving tendency will be stronger and discretionary consumption will go down. Consequently the non-essential goods manufacturing businesses are likely to register losses pari passu with transporters, intermediary goods suppliers and financiers. In a nutshell there is a solid ground that stock indices crash. In these circumstances the investors need to turn to the fixed income market or interest rate market. On the eve of loosing sizeable tax revenues, the governments are not in a position to curtail wages and salaries of the staff, who are unable to attend work because of their compliance with the guidelines circulated by the government themselves on how to keep away from infection.
In the above circumstances the government will be a major borrower in the fund markets and most corporate houses will require much less volume of funds because of suspension of productive activities. Those banks and non-bank entities who are holding surplus cash and unable to lend will be happy to lend to the governments. The terms to maturities of these loans are expected to be longer than otherwise and accordingly the average yield to maturity or cost of capital would look to the higher end without any consideration of risk premium. At the same time, the basic goods producing sector would face augmentation of demand and need short term funds which can’t be expected from the stock market but can be expected from commercial paper market or from banks in the over-the-counter market.
Amidst suspension of work in all manufacturing and large scale industries nationwide, the demand for short term funds on part of essential commodity producers, vendors of softwares and online platform providers associated with education and internet service providers and a few hospitality providers can be catered to by the money market instruments like commercial papers in the case of rated entities or by banks. The selling prices of commercial papers are likely to be low because of expected default and consequent higher than before risk premium. Therefore not only from investors’ and lenders’ viewpoints but also from issuers’ and borrowers’ viewpoints, debt market is likely to serve the purpose of raising funds when the investors are not willing to subscribe to equity instrument because of viral lockdown of manufacturing and other productive activities. However this segment of industry is likely to face a higher than expected short term cost of funds.
Furthermore, the aggregate demand facing the locked-down sector shrinks in size, as a result, the thin demand is cleared by the inventory getting rid of any further production. Consequently demand for funds, working capital loans, project funding and similar everything evaporates as a result of which the price of funds goes down for the locked-down sector. For the sake of asset liability management or for any slowed down activity that need to be completed urgently now if at all long term borrowing is required, the top rated debt security issuers who earlier looked toward offshore currency markets can now take recourse home comfortably but it is difficult to predict who among the two – risk premium and term premium – reinforces the other.
In the other way round the demand for gilt-edged securities this time is expected to soar high but at the same time if supply increases because of the need of the fiscal policy to pull up the economy from recession. As a result it is difficult to say whether their yields consequent upon the market rate of interest are more likely to rise or fall. However this is a bad time for corporate debt market because of expected defaults. Overall the above factors are likely to exert an upward push to the term structure of cost of funds in absence of printing money by the central bank for financing government expenditure against government securities and instead, financing government expenditure through placing these securities with the banking sector. If the central bank prints money, this will push down the interest rate facing the real sector and boost some investment and employment at the cost of inflation. So a trade-off may be required between inflation and unemployment.
This is the time a profiteering dealer of rated securities should have the best buy of the chosen top rated stocks as safe as gilts at low prices on the one hand and on the other hand the best sale of his fixed income portfolio.
Disclaimer: This blog is purely academic in nature, not responsible for loss if any of any trader or investor following the suggestion here.
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