Economic Roundup, April 26, 2019

Economic Environment

  • US economy and India economy

How are the Indian and global economic environments affecting the financial markets?

  • US economy has performed well above expectations in the first quarter of 2019. As we have said earlier, this can largely be attributed to Federal Reserve continuing to signal (as also expected next week) that it will pause on any further rate increases because of slowdown in the rest of the world economy. Also, the Federal Reserve has slowed down its process of balance sheet normalization so that it does not adversely impact liquidity in the financial markets. Major global central banks given the favorable inflation environment, across the board have sent dovish signals, with India, in fact, cutting the repo rate twice. Such preemptive actions should hold up India’s economy and the global economy without risk of a recession during the rest of the year. Europe and Japan, as we have discussed in the previous edition of the Economic Roundup, have demographic issues constraining growth despite accommodative monetary policy though it is not something to be imminently concerned about. India, however, must work expediently on banking sector weakness independent of the elections to prevent any slowdown from taking hold because of poor monetary policy transmission, for economic slowdown could trigger hot money outflows as we also discussed earlier. Geopolitics, at least for now, appear to be under control so as not to adversely affect the oil price which, if it sharply rises because of US tensions with Iran, could significantly impact the rupee and India’s economic outlook.

What to expect from the markets next week?

The financial markets could continue to maintain their upward momentum if foreign institutional investment (FII) continues to flow into India though this also poses a risk should the economy slowdown because of the rising probability of the reversal of hot money flows which would pressure the current account deficit (CAD), potentially leading to a financial crisis. The true state of the economy would come into greater relief as corporations continue to report earnings.

Economic Roundup, January 04, 2019

Economic Environment

  • Global growth and corporate earnings

How are the Indian and global economic environments affecting the financial markets?

  • Indian financial markets have been skittish taking cues from volatility in the US markets due to political risk and uncertainty about the upcoming 2018 Fourth Quarter corporate earnings releases beginning January. Indian economy, however, has strong fundamentals while the rest of the world economy appears to potentially experience a slowdown in 2019 including the US economy though the United States may not enter a recession. Global economic concerns and political risk in relation to the upcoming parliamentary general elections in India in 2019 will continue to affect the Indian financial markets through the first two quarters of calendar year 2019.

    What to expect from the markets next week?

Indian financial markets will continue to takes cues from global markets on global growth though they may not be as volatile as the US and other major global financial markets. Range-bound and flat behavior can be expected in the coming week. It must be noted that beginning next week corporate earnings reports could determine whether the major Indian indices will formally enter correction territory because both BSE SENSEX and NSE NIFTY 50 are already hovering close to 10 percent decline from their 52-week highs.

The Indian Rupee and India’s Economic Development: Should India Emulate China?

Once again there is talk about the strength of the Indian rupee potentially hurting Indian exports because it has appreciated in the past few weeks relative to the U.S. dollar. “Should the Reserve Bank of India (RBI) intervene and if so when to halt the rise of the rupee?” has become the staple of the discussion.

The world is chained to the U.S. dollar. It is in this currency that most payments in international trade are made, severely handicapping countries from importing if they do not have adequate reserve of dollars. Conversely, to earn dollars, countries have to export their goods and services which have to be price competitive in global trade to be saleable. And this means their currencies have to cheaper relative to other currencies to spur their exports. In all of this, there is no effort made to trade in native currencies but only the anxiety to export to acquire dollar reserves. The idea is that goods and services exported by a country to other countries will cause economic development at home. Domestic investment and consumption usually do not factor in this calculus and economies are oriented entirely toward exports.

China has developed by becoming the factory to the world, thus far typically assembling imported parts of goods to export finished goods back to foreign markets. But China has also done something different. It invested in domestic capital accumulation and consumption using its export revenues in dollars to be able to eventually wean itself of export dependency while also attempting to climb up the export value chain by increasing its manufacturing sophistication to make high-end manufactured goods entirely within China and by diversifying into services. In this process, the Chinese currency, the renminbi (yuan), is gradually joining other currencies that are used in international trade and is now officially a global reserve currency.

The attractiveness of China’s economic development to countries importing from China is its vast market of about 1.3 billion people if foreign companies are allowed to compete on an even keel with domestic companies. The country has used this well to its advantage to turn itself into a global economic power but by principally subsidizing the Chinese industry giving it a leg up over foreign competitors. The next step of the Chinese juggernaut is global expansion to create and develop markets for its exports and technology acquisition to achieve advanced market economy status. None of the other developing countries are doing what China has done and by doing so the country has catapulted itself to become the world’s largest economy in purchasing power parity (PPP) terms and the second largest in nominal terms. China’s role in the current paradigm of globalization is to become a net exporter like Germany and Japan, curtailing as many imports as it can.

The key issue for economic development here, however, is the existing international currency and trading system which requires, for economic development, foreign currency reserves of stable currencies in which international trade is done. Little or no thought has been given to changing the system to develop capacity within countries to use their own currencies for domestic investment, consumption, and trade. China has succeeded by taking advantage of the status quo to its benefit but this is not a model that is sustainable because the advanced countries cannot continue to be net importers of goods and services from developing countries providing reserve currency hoards in the process to developing countries. Therefore, India emulating China is not a sustainable option either for itself or for its trading partners despite India being the leading exporter of information technology (IT) services to the United States and Europe.

India should insist on making payments in the Indian rupee for its imports while working to produce most of what it needs domestically to minimize imports and must accept trading partner currencies as payments for its exports, displacing the intermediation of the U.S dollar in global trade, thus heralding a new paradigm in global trade and economic development.

Political Risk and the Financial Markets

The global financial markets, on the one hand are attempting to reflect the true health of corporate and government finances and, on the other hand are grappling with their expectations of political changes which could affect the major economies of the world. The rise and spread of populist politics in these economies is confounding the status quo and is being branded by the guardians of the mainstream as a political risk to the economic order of the day.

While the populist politicians across countries are placing their finger on the genuine economic grievances of their peoples such as the rise in migration of people from unstable parts of the world (whose integration can put host societies under considerable economic, cultural, safety and security duress) and economic displacement due to technological change and globalization, the critics of populism wish to continue to defend and advance the status quo. They cannot fathom how the populist politicians can really address their people’s concerns without upending the extant economic order. However, the financial markets are reacting positively to political promises about a brighter economic future in developed countries by building-in hopeful economic outcomes of such promises into their expectations. Thus far, the financial markets do not see two seminal populist events – Brexit and Donald Trump – as a risk, instead they see them as opportunities for economic growth for the United Kingdom and the United States.

Populism is not always necessarily detrimental to societies and economies. Many great upheavals in history have been populist uprisings by leaders who created movements to address the grievances of their peoples. Such movements dislodged the status quo and replaced it with political and economic orders which represented the people’s will about their governance. Amidst rising income disparity in societies wrought by the neo-liberal economic order of the past four decades, Brexit, Donald Trump and the nationalist movements gathering steam in Europe, if done properly, bode well for how the world’s economies engage with each other to better distribute the benefits of globalization within countries. The extant economic order has become far too beneficial to the entrenched elites around the world.

In the major emerging markets, the anti-corruption crusades in Brazil and South Korea, the policies by President Vladimir Putin to ensure that Russia’s vast natural resource wealth benefits the Russian people and not the oligarchs in the aftermath of the Soviet Empire, anti-corruption sentiment which swept Narendra Modi into power in India, and dissatisfaction over corruption in South Africa are all signs that political risk could, in fact, lessen in the long term because of the strengthening of the rule of law and institutions to provide a peaceful, stable and predictable environment for the economy and the financial markets to function.

Developed economies could bring about changes in the international trade regime to favor local investment, job creation, and development of local markets around the world by replacing the global supply and production chain with local production for local markets by multinational corporations and local companies. International trade could then mostly be in commodities instead of in offshore services and finished and partially finished goods. This is how the current international economic order could be upended to ensure the continued economic development of the world in an equitable manner.

The restructuring of international production and trade as a win-win for all participants and peoples, if this is what the populist movements are set out to achieve, is not a political risk but a transformation that is very much needed. It is a risk for the status quo interests and they do not have a choice but to bear it.


Britain has chosen to exit from the European Union (EU). Europe and the rest of the world had expected the British people to at least choose narrowly to remain in the EU. The choice to leave the EU was an unexpected result of the referendum and hence a shock for the global financial markets which have been left to come to terms with the consequences of Brexit.

The immediate reaction of the equity and currency markets has been to fall steeply in expectation of the worst case scenarios of Brexit consequences to play out: recession in the United Kingdom (UK); political turmoil in Britain as demands for the exit of Scotland and Northern Ireland from the UK resurface; the spread of political and economic contagion in EU and the Economic and Monetary Union (EMU) as other EU and EMU member countries seek to exit; and finally, the fragile economies of the EU and the global economy being pushed into recession. But really, what can be the consequences of Brexit?

UK is a small economy. It had a GDP of about 3 trillion USD in 2015. It ranks second behind Germany in Europe and mostly trades with the EU and the United States. Brexit only increases the trade friction between the UK and the EU until new trade agreements both with the EU and bilaterally with specific European countries are entered into. The exit negotiations of the UK from the EU after the invocation of Article 50 of the Lisbon Treaty are expected to take about 2 years and therefore there would be no immediate effect on trade and hence no immediate repercussions for either the UK or the EU economies.

The global economy is far too big for the temporary fall in the British pound and the euro to affect it too negatively. If anything, British and EMU goods would be cheaper for other countries thus boosting UK and EMU exports. Brexit, having come at a time of global economic slowdown, by hampering UK and EU recoveries could slow global economic recovery but will not adversely affect it.

The future of Britain could be similar to that of Norway and Switzerland. Frankfurt could become the second major financial center after London in Europe and that would be good for the continent as a whole.

Though the possibility of secession of Scotland and Northern Ireland from the UK is real, it is premature to expect the unravelling of the EU and EMU because of Brexit. To go on with the European project of ever closer economic and political union, the EU needs to focus on economic recovery to address unwarranted nationalist sentiments and requires responsible political leadership at a time of change.

The financial markets will subside in a few weeks after the Brexit shock.

To Brexit or Not to Brexit

The word “Brexit”, a portmanteau of the words “Britain” and “Exit”, refers to the possible exit of the United Kingdom (U.K) from the 28-member European Union (EU). The British people will vote on June 23rd in a referendum to decide if Britain should remain in the EU or leave it. The referendum attains special importance because of the current economic problems in the eurozone. To be evaluated by the voters, therefore, before voting, is the impact of Brexit on the U.K, and more broadly the impact of Brexit on the EU and the western bloc of countries in Europe.

Britain always had an uneasy relationship with continental Europe. Not part of the Treaty of Rome in 1957 which formed the European Economic Community (EEC) and after its applications to join the EEC were vetoed by France’s Charles de Gaulle, Britain eventually joined the EEC in 1973. Yet, the U.K has profound reservations about giving up its currency, the pound sterling, which it equates with its sovereignty, and adopt the euro.

Sovereignty has been, in fact, a key negotiating point between Britain and the EU for continued membership of Britain in the bloc: the U.K wanted supersession of a vote in the British parliament over any EU legislation and regulations. The EU agreed to such a special status for Britain where the non-commitment of the U.K to further political integration into the EU (or to ever closer union) will be incorporated into the Treaties governing the Union.

A sticking point for the U.K in Prime Minister David Cameron’s negotiations with the EU has been the in-work benefits for EU migrants to Britain. While Britain wanted a ban on these benefits, what was agreed upon at the end was the idea of an emergency brake where a member state could apply to the European Commission for permission to suspend benefit payments if they were placing too much burden on the social services of a member state. It was agreed that such an emergency brake can last for 7 years. Likewise, on child benefits to children of EU migrants, instead of a total ban as Britain wanted, it was agreed that the payments would be indexed to what the migrants would get in their home countries and that the change will be phased in for existing claimants from 2020.

Even though Mr Cameron has negotiated the above changes in Britain’s relationship with the EU, those who want Britain out of the EU – the Brexiteers – see as benefits the annual net contribution of about $12 billion to the EU budget that the U.K will no longer have to make and flexibility in not having to conform to EU regulations, particularly in product and labor markets and over the free movement of people across borders.

The Brexiteers have a lot of precedence on their side. Over long periods of time, gross domestic product (GDP) per capita has risen steadily and it did not much deviate from this underlying trend even during shocks to the British economy such as joining the EEC in 1973 or leaving the Exchange Rate Mechanism (ERM) in 1992. Only war and the mistake of contractionary monetary policy during the Great Depression have affected this long term trend in the growth of GDP per capita. So, the Brexiteers argue that as in the past, exiting from the EU should not cause a dent in the long term growth of the U.K. It can also be argued, therefore, that staying in the EU will not likewise harm Britain given the underlying trend in Britain’s long term growth rate. So, at a minimum, on balance, staying is no better or worse than leaving. Then why leave but to be politically quixotic?

Looking to the future, however, arguments for staying in the EU are stronger. The much larger U.K trade with the closer EU countries than with the far away countries of the Anglosphere or the emerging markets will most certainly be negatively impacted in the short run until Britain has in place new trade deals to at least compensate for the access it had to the common EU market. The pound sterling could be under severe pressure to depreciate against the currencies of Britain’s biggest trading partners in Europe, that is primarily against the euro. It is unclear at this point how long it will take to make the new trade deals. Moreover, the City of London’s de facto role as Europe’s financial center will also be challenged in the short run.

British voters on June 23rd must ask themselves if the short term risks are worth taking by leaving the EU than by being a part of it and reforming it to make the Union work for the U.K and the rest of Europe.