Vijay Kumar Gaba

Early this year BRICS, a bloc of leading emerging economies, announced the induction of five new members, viz., Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates, to its fold. The ten-member bloc has a significant presence in global trade. More specifically, it exercises significant control over the global energy markets, controlling 42% of global oil production and 35% of total oil consumption.

In July 2023, the then President of BRICS, South Africa claimed that over 50 emerging nations have expressed their desire to join the group. Recently, Russia’s Federation Council Committee on International Affairs, stated that BRICS would be expanded further as more than 40 countries are desirous of joining the group.

The cooperation between BRICS members is free, and flexible and extends to a variety of subjects of common interest amongst members. The members and other countries desirous of joining the group, view BRICS as an alternative to global bodies viewed as dominated by the traditional Western powers and hope membership will unlock benefits including development finance, and increased trade and investment.

Defining the vision of BRICS, President Putin said, “BRICS is attracting an ever increasing number of supporters and like-minded countries that share its underlying principles such as sovereign equality, openness, consensus, aspiration to form a multi-polar international order and a fair global financial and trading system.

The expansion and strengthening of BRICS could, therefore, be interpreted from different perspectives. From the geopolitical perspective, it could be seen as a vote of no-confidence in the extant global order, dominated by Western developed countries (especially the US), by the emerging economies. A larger BRICS could undermine the dominance of NATO, the UN, and even the IMF.

From India’s perspective, it could act as a strong resistance to any material escalation between India and China. We have already seen the traditional rivals Iran and Saudi Arabia bridging the differences and coming together on the Palestine issue. We have also witnessed ineffectiveness of the NATO sanctions against Russia over the Ukraine invasion issue. BRICS and other developing countries have increased their trade with Russia materially in the past couple of years, as reflected in a larger current account surplus for Russia.

From an economic perspective, a larger and stronger BRICS could play a significant role in determining the terms of global trade. Its present and prospective members would control a significant proportion of the global human, mineral, and manufacturing resources. Besides, helping in securing better terms of trade, ensuring energy security is seen as another key advantage of a stronger and larger BRICS.

From a financial perspective, post global financial crisis, a large number of developing countries have reported a slowdown in financial aid from developing countries. The conditions appear to have deteriorated further post the Covid-19 pandemic. A deeper and wider cooperation between the enlarged BRICS grouping, the humanitarian aid to the developing nations could be restored.

From a monetary perspective, there is an intense debate about limiting the role of USD in global trade. A BRICS agreement on adopting a common independent currency or increasing the bilateral trade in local currencies could help in achieving this objective. There is strong evidence of a material rise in yen trade between Saudi Arabia-China and Russia and China. India has also made some advances in promoting INR trade with traditional trade partners like UAE and Russia. We might see more developments on this front in the next couple of decades.

These may be the early days to term BRICS as a foundation for change in the post-USSR unipolar global order to a multipolar world order that shall facilitate much-delayed reforms in the global institutions like the UN and IMF etc. Nonetheless, the developments are encouraging and offer hope.

Shri Ram Janmabhoomi Teerth Kshetra (SRJBTKshetra), a public trust, is building a grand temple dedicated to Lord Rama at his birthplace in Ayodhya of Uttar Pradesh. Recently, the consecration ceremony of Lord Rama’s idol at the temple was performed with great fervor. To facilitate the devotees visiting the temple, the Government of Uttar Pradesh and the Central Government are investing in developing civil infrastructure in and around the Ayodhya town. Reportedly, the Master Plan 2031 envisages the redevelopment of Ayodhya to be completed over 10 years with an investment of over Rs 85,000 crore.

This is expected to establish Ayodhya town prominently on the world tourist map. It is pertinent to note that just three years ago, Ayodhya was a small municipal town with a population of approximately 70000 with poor civil infrastructure. Impressed by the government’s investment in Ayodhya’s civil infrastructure, Global brokerage firm Jefferies commented in a report, “The grand opening of the Ram temple at Ayodhya by PM Modi on Jan 22nd, is a big religious event. It also comes with a large economic impact as India gets a new tourist spot which could attract over 50 million tourists per year. An Rs 85,000-crore makeover (new airport, revamped railway station, township, improved road connectivity, etc.) will likely drive a multiplier effect with new hotels & other economic activities. It can also set a template for infra-driven growth for tourism”.

Incidentally, it is not Ayodhya alone. This is, apparently, the template of development chosen by the government. In the past few years, the government’s emphasis has been on the development of infrastructure, especially logistic infrastructure, and encouraging private enterprises to build manufacturing capacities taking advantage of improved infrastructure and logistic facilities.

It is pertinent to note that the contribution of manufacturing to India’s economy peaked in the mid-1990s and has been on the decline since then. In the year 2022, manufacturing contributed 13.3% to India’s GDP, the lowest level since 1967.

Earlier some East Asian countries, and lately China, used this strategy to accelerate their economic growth with mixed outcomes. Though years of high growth ensured a decent quality of life for their citizens, none has been able to become a developed economy. The high growth phase could not be sustained even for two decades. The economies are now mostly growing below par. In recent years, Chinese economic growth has also been decelerating. The authorities have clearly shown a tendency to shift focus on domestic consumption to support the economy.

The Indian economy has mostly been dominated by services on the supply side and consumption on the demand side. Now there is a concerted effort to change the model to manufacturing and investment-led growth.

The questions that need to be examined in this context are:

·         Given the fact that the Indian economy may probably be in its last decade of demographic dividend, is it desirable to cut spending on building social infrastructure, reduce the education and healthcare budget, and invest in long gestation infra projects?

·         Agricultural sector contribution to India’s GDP has been stagnating around 16-17% for a long time. The proportion of the population directly dependent on this sector is close to 44%. Would it not be better to invest in developing agro-technology, infrastructure, and logistics than focusing on manufacturing (with much lower employment intensity now) to make growth sustainable, faster, and equitable?

·         What is the probability that in one decade India can meaningfully increase its share in global manufactured trade? Curtailing domestic consumption to augment exports may be a high-risk strategy at this point in India’s economic growth journey. Of course, if it is successful, the rewards may be exciting. But the odds do not look great at this point.

·         Self-reliance in defense production, full energy security, and net exporter status in manufactured electronics, are three key expected outcomes of the current policy direction. Healthcare, higher education, advanced technology, water, urban planning, etc. are some of the areas that are getting lower priority than required. Failure to achieve the outcomes could prove to be exponentially disastrous.

The point is that this midway diversion in the growth strategy could be fraught with significant risk. Our social, political, cultural, and economic structures are not the same as China’s. Adopting the Chinese strategy of economic growth and development may neither be desirable nor effective, in my view.

Also read

View from my standpoint

One of the key factors that may influence the performance of Indian equities in the current year would be how the global asset managers rebalance their portfolios in light of the changes in interest rate trajectory, movement in USD and JPY, geopolitical tensions, disinflation/deflation, etc.

2023 has seen significant disinflation in most developed and emerging economies. Most central bankers are well on course to achieve their inflation targets. Global growth, especially in advanced economies, commodity-dominated emerging economies, and China has taken a hit.

Presently, many European economies are struggling with stagflation. Japan is witnessing positive real rates after a decade. US COVID stimulus has faded, leaving consumers vulnerable. Higher positive rates are impacting discretionary consumption and investment in many other economies.

It is to be watched whether the current trend stops with disinflation or pushes the major economies to a state of deflation. Particularly, since the strong deflationary forces like the use of artificial intelligence to replace semi-skilled and skilled workforce; aging demographics, dematerialization of trade and commerce, etc. continue to gain strength.

If deflationary forces gain material ground, we may see the policymakers loosening money policy to calibrate controlled inflation. This will see the Japanification of major economies like China, the US, and the EU. Emerging markets and independent currencies (e.g., Bitcoins) could be major beneficiaries in such a case. The asset managers might therefore change their allocation strategies for EM vs DM, Equity vs Debt, China vs Japan, Physical Assets vs Financial Assets, Gold vs Bitcoin, etc.

Presently a majority appears to be favoring soft landing (no recession), gradual rate cuts (50-100 bps in the US), lower bond yields, and strong earnings growth. Equity valuations and allocations are congruent to this view.

In recent years, domestic equity flows have materially increased in India. The relative importance of the foreign flows has thus diminished. Nonetheless, for the overall growth of the Indian capital markets, global flows remain important.

Many global investment strategists have indicated their preference for Indian equities in recent weeks citing resilient economic growth, stable macro indicators, supportive political regime, and robust earnings growth momentum as the primary reasons for their positive view. This augurs well for the optimism over foreign flows and supports the positive view of domestic asset managers and strategists.

In this context, it may be pertinent to note that—

·         Emerging market equities have massively underperformed the US equities in the past decade. The current relative underperformance of emerging equities as compared to US equities is the worst in fifty years.

·         Emerging markets are about 40% cheaper as compared to their developed market peers, and the earnings momentum is likely to gather more pace.

·         The sharp rise in the EM discount relative to DM is driven to a significant extent by China’s low valuations. Ex-China, however, EM discounts are in line with the 10-year average. Currently, the price-to-earnings (P/E) ratio for the MSCI EM Index is trading at approximately 12x over the next twelve months, or slightly above its long-term average of 11.3x.

·         Within emerging markets, Chinese stocks have recorded their worst-ever performance. Currently, Chinese equities are at the lowest-ever level as compared to their emerging market peers.

·         Indian equities are presently trading at a significant premium to their emerging market, especially Asia ex-Japan, peers.

·         The earning momentum is expected to slow in India over the next couple of quarters, while Developed markets ex-US, offer attractive valuations.

I have been tracking the news flow and experts’ opinions regarding the developments in global commodities markets for the past couple of years. Of course, I am a novice in matters of global economics, trade, and finance; but the commodities markets are particularly something I could never understand.

From my elementary understanding of economics and human behavior, I understand that aging demography, deeper & wider penetration of dematerialization & digitalization in human lives, rising awareness about climate change, and deteriorating growth potential of the developed economies, and perhaps China also, definitely do not augur well for the commodities’ demand in the long term (10-15yrs). However, the opinion of experts is overwhelmingly in favor of a bull market in commodities in the short term (2-5yrs).

The key arguments presented by experts in favor of a bull market in commodities could be summarized as follows:

(a)   Energy prices have corrected back to the pre-covid period. European power prices, US gas prices, natural gas prices, coal prices, and crude oil prices are back to more “normal” levels. The latest inventory, consumption, and production forecasts for 2024 and 2025 are indicating further easing in energy prices over the next couple of years. Energy being one of the major costs in the production of commodities, lower energy costs and adequate supply is a bullish argument for commodities.

(b)   Focus on the use of clean energy, particularly for mobility and electricity production, is changing the demand mix for metals. The demand for metals like copper, aluminum, lithium etc. is rising much faster than the supply. The stockpiles are diminishing fast.

(c)   Commodity producers, mostly emerging economies, are getting stronger in global strategic balance. The expansion of BRICS to include more commodity producers in the emerging market alliance is just one instance. These economies are now in a much better position in determining the terms of trade, which are dominated by the financialized developed world in the extant global order.

(d)   The geopolitical conditions are worsening. Presently, two fronts (Palestine and Ukraine) are witnessing open war. The fear is that more fronts could open in the next couple of years as the political stands are hardening and no one is showing signs of backing out. Wars have been traditionally bullish arguments for commodities as demand for war equipment and reconstruction work need more metals and building materials.

(e)   There is not much consensus on this point, but a strong view is that USD as a global currency may have peaked and could potentially see a steady decline over the next many years. The share of global trade invoiced in USD terms and USD reserves of global central bankers have witnessed a consistent decline in recent years. Moreover, the cross-border flow of funds from the US has witnessed a sharp rise in 2023. Unsustainable US public debt has led to a downgrade of the US sovereign rating outlook. Besides, the trade conflict with China has led to a conspicuous shift of technological advantage from the US to China. These trends may consolidate the position of commodity-producing emerging economies enabling them to seek favorable terms of trade.

(f) Bloomberg Commodity Index is presently at the same level it was in November 1995.

I have avoided investment in commodity producers for a few years now. I think more study of trends in the commodities market, and a review of investment strategy is due.

 Last weekend the already tense situation escalated materially in the Israel-occupied Gaza Strip area of the Palestinian state. Apparently, the Hamas controlled militia launched a massive ariel and ground attack on Israeli territories, killing over 700 people and injuring many more, including several civilians - women and children. In retaliation, Israeli forces attacked the Palestinian territories in the Gaza Strip, killing over 300 people, including women and children, and destroying several civilian targets. This is the deadliest episode since 1967, in the conflict that started in the late 1940s.

Continuing from yesterday (see here).

I am convinced that the current global monetary and fiscal conditions will have an enduring impact on the global financial system, trade, businesses, and markets. We may feel comfortable with the resilient performance of the Indian economy and markets in the past couple of years, but it would not harm if we factor in the global conditions and trends in our investment strategy. In particular, household investors with relatively smaller portfolios need to exercise due precautions to protect their portfolios from a negative shock.

I have negligible knowledge of global economics, financial systems, and markets. I therefore usually approach these larger issues with common sense and my elementary understanding of the basic concepts of economics. History, of course, always provides some useful support.

I usually study the historical behavior of economies and markets to anticipate the likely actions and reactions of the current set of market participants and policymakers. It is my strong belief that the reaction of investors and fund managers in their 30s or early 40s, who have never experienced borrowing costs in high single or double-digit; policymakers who have not governed through prolonged periods of war, human misery, uncertainty, lack of information, and are not particularly committed to ethics, ideologies, and standards seen during crisis during would react the same way as their predecessors acted/reacted during 1920-1940; 1950-1960, 1970-1980, and even 1990s.

I may be wrong here, but I believe that the policymakers today are governed by the principle of SoS (Save our Souls first). Their natural tendency is to protract the inevitable decision (kick the can) as long as possible rather than make hard decisions that provide sustainable solutions. Similarly, the market participants are also influenced by their inexperience. To me, this implies that the global policymakers and market participants are not adequately prepared to face a material event (credit, geopolitical, natural); and may panic easily and excessively if such an event were to occur. We have seen glimpses of such panic during the outbreak of the Covid-19 pandemic in the year 2020.

Considering that the present global economic, financial, and geopolitical conditions are much more fragile as compared to the summer of 2020, the contagion will spread much faster, wider, and deeper. Therefore, hiding under the shelter of the assumption that India shall mostly remain immune to the impending global crisis may not be a good idea for smaller investors for the simple fact that their capital is much more precious (much higher marginal utility) as compared to the larger or institutional investors.

With this background, I may now share my views about the five points I mentioned yesterday:

1.    Whether the Fed is done with hiking: In my view, this question is not important as of now. A 25bps hike in the next meeting would not make much of a difference, as the previous hikes are still permeating through the financial system. The lending rates may continue to rise even if the Fed does not hike any further.

2.    Will the rates stay higher for longer: In my view, yes. I believe higher rates are arguably the most effective method to bring down the indebtedness of the US government. The federal bond prices have already fallen by 25-40% in the past year, from their recent highs. A 2% rise in yields would shave off another 20 to 30% in bond values. In the meantime, the Fed is creating leverage (through QT) to buy back bonds at half the face value. Large corporations with tons of cash parked in treasuries, hedge funds with leverage positions in treasuries, and the US trade partners with a surplus (China, etc.) would bear much of the losses. Pension funds etc. which hold most securities till maturity may not suffer much. Savers may enjoy higher rates offered by the fresh issuances. Since most new issuances would be at a much higher coupon rate, these may automatically enforce fiscal discipline over the next 2-3 years.

In the interim, however, we may see severe pain in the financial markets as the excesses of the past two decades are obliterated.

3.    Hard landing or soft landing: In my view, it would most likely be a growth recession – a prolonged phase of low or no real growth, as the US economy adjusts to a normalized monetary and fiscal policy mechanism and the USD is freed of onerous responsibility of being the only global reserve currency.

4.    Impact of higher rates on USD: In my view, the normalized interest rates would eventually result in a much less volatile and stronger USD.

5.    Impact of a softer US economy on the global economy: A softer US economy now would be bad news for the global economy and therefore markets. However, over the medium term, a fiscally disciplined US economy (with higher domestic saving rates, positive current account balance, and refurbished infrastructure) could provide strong support to the global economy, especially the emerging economies, much in the same way it did in the 1950s and 1990s.

How do I build this in my investment strategy…will share as I figure it out.

Last week media headlines prominently mentioned that Michael Burry, the famous fund manager who earned his clients billions by positioning short on the US securities during the subprime crisis of 2007-08, has recently bought put options on S&P500 and Nasdaq100 worth totaling US$1.6bn in nominal value.

 The fourth letter of the English Alphabet “D” has held a prominent position in financial market jargon, at least since the Great Depression in the late 1920s. In the past two decades the terms like Dematerialization, Demographics, Depression, Decoupling, Demonetization, De-Dollarization, Digitalization, Deflation etc., have attracted immense interest from the market participants. Some of these “Ds” have had significant impact on the global economy; while the others have been mostly limited to being topics of interesting discussions and statistical analysis.

In the current Indian context specifically, I find three “Ds”, viz., Digitalization, Deflation and Demographics most relevant for the economy and therefore markets.

The current global situation – investment mix, geopolitics, global trade and gradual shift in strategic power – implies that supply shocks could be more frequent and much more intense in the next decade or so at least.

·         The unusual weather patterns are impacting farm output across the globe. Unseasonal rains, floods, extended periods of drought and heat waves etc. have negatively impacted the food production and livestock. As per a research study conducted in 2021 (see here), due to severity of drought and heatwave crop losses tripled over the last five decades in Europe alone. In India also similar trends have started to emerge in the past few years and are expected to strengthen in the next decade or so.

·         In the past few years, the geopolitical situations in the world have shown marked deterioration. The prolonged war in Ukraine has exposed the fault lines in the strategic power structure of the world that has been prevalent since the demise of the USSR. A drift between the US, China and Russia has never been more conspicuous in the past three decades. This drift has led to the rise in speculation over further intensification of the “deglobalization” trend that has shown some presence in the past one decade.

·         In the past two decades the investment mix in the global economy has shown a marked skew in favor of services, technology and climate change. Accordingly, the investment in augmenting the supply of conventional energy, metals and agriculture, while the demand for these has remained firm. Accordingly, the inflationary pressures have built up in the global economy.

It is widely accepted that digital technologies are bringing in enormous productivity gains; and therefore, is a powerful deflationary force in an otherwise inflationary environment. To quote, Satya Nadella, Microsoft CEO, “the next 10 years won't be like the last 10 years. Digital technology is a deflationary force in an inflationary economy. It is the only way to navigate the headwinds we are facing today”. He added, “This is the age of AI. Hybrid work is here to stay. 73% of workers want flexible remote options to stay. Every organization requires a digital fabric that includes People, Places and Processes.”

The aging demography in the developed world and China is another deflationary force that is countering the inflationary pressures. Even in India, it is likely that the population will peak and begin to age much earlier than previously estimated.

Thus, Digitalization, Deflation and Demographics could be listed as three major trends that will significantly influence the direction of the Indian economy and markets in the next many years.

In the past one year, inflation has been one of the primary concerns for most countries across the globe. Rising prices of food and energy in particular have materially impacted the lives of common people on all continents. The central bankers of most major economies have hiked policy rates in the past one year to control inflation. In the current year 2023 so far, 13 major central bankers have taken policy action(s) and all of these actions have been hike in policy rates.

However, in recent weeks inflation has shown some tendency of cooling down. It is difficult to assess how much of this cooling down is due to tighter monetary conditions; and how much could be attributed to other factors like restoration of supply chains that were broken during the pandemic and warmer winters resulting in lower energy demand in the northern hemisphere, etc. Nonetheless, some central bankers have adjusted the pace of tightening to smaller hikes. Most of them, though remain circumspect about the persistence of inflation. While the debate continues over the trajectory of price hikes in the next few quarters; an overwhelming majority of experts believe that prices may remain high for much longer.

The global growth forecasts have witnessed some downgrades in the past six months as tighter monetary conditions and higher prices are seen hurting demand for consumption and investment. As per the latest assessment of the World Bank, in 2023 “the world economy is set to grow at the third weakest pace in nearly three decades, overshadowed only by the recessions caused by the pandemic and the global financial crisis….Major economies are undergoing a period of pronounced weakness, and the resulting spill-overs are exacerbating other headwinds faced by emerging market and developing economies (EMDEs).” 

With this background, three key issues that could influence the future trajectory of global prices and therefore interest rates are geopolitical situation; impact of China ending Covid restrictions and the impact of the emergence of El Nino on global food production.

Geopolitical conflict in Eastern Europe (Russia-Ukraine) has materially influenced the prices of energy and food in the past one year. Any worsening or this conflict or expansion to Western Europe could make things worse. Some events in the recent weeks have indicated that Sino-US relations may not improve anytime soon. NATO countries hardening their stand on Russia; Russia retaliating with a cut in energy output; and some key OPEC members openly expressing disagreements with US oil pricing has materially increased the uncertainty in the energy market.

China has been gradually relaxing the covid restrictions for the past many months. This has eased the logistic logjam across the world. The supply chains that were broken due to congestion at major ports, shortage of containers, short supply of key raw materials, and poor take-off have mostly been repaired. The freight rates that had become prohibitively high have eased to pre Covid (2019) levels. The debatable question however is whether China reopening will be inflationary (higher demand) or deflationary (complete supply chain restoration and consequent destocking; improved mobility of workers etc.).

As per the latest forecast of various weather agencies (see here), the probability of El Nino conditions developing in the coming summer could impact the agriculture production in major countries like India, this year. If these forecasts come true, we may see food prices remaining at elevated levels.

A variety of views prevail on these three issues and their outcome. In my view, China reopening will indubitably be deflationary for the global economy, especially metals and other raw materials).

I am however not sure about the geopolitical conditions. I would therefore continue to expect elevated crude oil prices through 2023. By the way, the RBI in its latest statement has assumed the price of Indian basket of crude oil to be US$90/bbl for FY24, against the current price of US$84.19/bbl (see here).

It is little early to talk about weather conditions in the forthcoming summer and its eventual impact on global food prices. For now, the Rabi crop in India appears to be good; and there is enough food in the Indian granaries. Thus availability of food should not be a problem for sure even if we had a poor monsoon year after three normal/excess monsoons.

 The toughest job in the present day environment is risk management. Of course, it has never been an easy job; but when we consider the proportion of moving parts, fragility of systems, disregard for conventions, total lack of mutual trust and disillusionment with the status quo, managing risk appears the toughest job. I can now appreciate the risk managers’ plight during the first half of 20^th century; when similar conditions were prevailing.

To illustrate my point, let me highlight the following instances which may not appear ominous to a common man, but could give cold sweat to risk managers.

• Interest rates have risen in most parts of the world in the past one year. In many cases the rise in rates has been rather steep, especially the developed economies. Most of these economies were struggling with deflation pressures for the better part of the past two decades. Obviously the rates were low (close to zero and negative in many cases). Many businesses were built assuming this to be a lasting phenomenon; or at least many investors valued businesses assuming this to be a lasting phenomenon. The pandemic however annulled this assumption. It now appears that we shall not have near zero rates for longer, even if inflationary pressures ease in the next couple of years. A large number of the businesses built on “lower for longer” assumptions are facing existential risk.

How would a risk manager handle this risk? If an investor changes the assumption of “lower for longer”, the basic case for investment in such ventures may collapse. An exodus that may thus result would only result in immediate collapse of such a venture. If the management guides change in assumptions about finance cost, cash losses and poor visibility of fresh capital, the valuations will collapse anyways.

·         The news flow in the past few days includes the following headlines:

1. “Iran fires missiles at Kurdish militias in eastern Iraq” (see here). This was to follow up 73 ballistic missiles fired by Iran in September 2022 (see here).
2. “Texas to send military armored personnel carriers to the border to escalate enforcement. The move comes days after Texas Gov. Greg Abbott invoked an 'invasion' clause to step up border enforcement.” This is part of the border reinforcement in the past 2 decades in which billions of dollars have been spent. State funding for border security has grown from $110 million in 2008-2009 to nearly $3 billion for the 2022-2023 budget cycle. (see here)
3. “Ukraine nuclear plant shelled, U.N. warns: 'You're playing with fire!” (see here)
4. “South hits back as North Korea fires most missiles in a day.” (see here)

Besides, news flow on Sino-Indian border tensions and China’s aggressive posturing on Taiwan has been consistent. A risk manager who is aware of the energy crisis of the 1970s; has been struggling to manage the fall outs of Russian invasion of Ukraine; and is aware of hardliners winning elections in Italy, Israel, Brazil etc. would find it hard to ignore these geopolitical threats.

• “Mumbai sees temperature dip, IMD issues cold wave warning for parts of Maharashtra.” (see here) This could be a worrying signal for risk managers worrying about inflation; supply of grapes, onions, pomegranates; public health etc.

Besides, in the mountains it started snowing earlier this year. Late rains have ensured late sowing for Rabi crops. If winter sets in early and nascent crops are hit by frost, we may have poor Rabi yield.

• I recently met with a company which earns substantial revenue from UN tenders. The management highlighted the substantial cut in funding of the UN as a key risk to their operations. They did not mind discussing the probability of the UN becoming redundant or even getting dissolved in the next 10-12 years.

The point I am trying to make is that in the present times investors should better avoid overconfidence in any investment idea. The black swans could emerge in flocks from nowhere. It is therefore a good idea to keep portfolios well diversified and liquid. Exposure to exotic, unproven, experimental, innovative, expensively valued businesses must be kept to bare minimum – ideally not more than what you could easily afford to write down fully.

In a world where almost every central banker is struggling to contain inflation and tightening monetary policy, the People’s Bank of China (PoBC) seems to be facing a different set of problems and hence adopting a divergent policy approach. PoBC has actually cut the key loan prime rate (LPR) twice in 2022.

It is pertinent to note that the Chinese economic growth has been on the decline ever since the global financial crisis. The pandemic has slowed the growth even further. The latest growth data suggests that the Chinese economy is growing less than 5% this year, its lowest growth rate in at least three decades. Some part of the growth decline could be attributed to the zero tolerance policy towards Covid and stringent lockdown; but it is important to keep the declining trend since 2010 in mind.

Considering that China has been one of the key growth drivers of the global economy; declining Chinese economy is a matter of concern for all.

Besides, China has been one of the primary (i) financiers of the deficit budgets run profligately by many western economies; (ii) investor for the development projects undertaken by the Middle-East and Central Asian and African emerging economies; (iii) exporter of deflation through low rates, taxes and wages to the world; and (iv) absorber of the carbon emission for many developed and developing countries which chose to offshore their polluting manufacturing to the Chinese shores. Obviously, a weaker Chinese economy is a major concern for a large part of the world.

In the Evergrande episode (read here) we saw how much the global markets are sensitive to a financial crisis in China. In principle, the western democracies may not like the authoritative political regime of China, but the global investors’ confidence in the Chinese markets is mostly driven by this very regime; as it lends confidence to the investors that any crisis will be contained almost instantaneously. As President Xi Jinping gets ready to be elected for a record third term later this year, it would be important to see how he keeps alive the faith of global investors, who have not made money in Chinese markets for almost a decade now.

 In the current year 2022, inflation in India has consistently remained above the RBI tolerance band of 2-6%. For the month of August Consumer Price Inflation (CPI) was 7%, led primarily by the food inflation of 7.6%. Both rural and urban inflation recorded a MoM rise in August. Unfavourable weather conditions apparently led to sharp rise in the prices of vegetables, fruits, spices etc. However, the core inflation (CPI ex food and fuel) has also persisted over 6% since the past many months; emphasizing the persistent pricing pressures. The IIP growth in July also moderated to 2.4% led primarily by consumer non-durables – indicating pressure on household finances. The sharp rise in household debt, especially the expensive credit card rolling credits, also corroborates the rising stress on household finances.

In view of the elevated price pressures, the Monetary Policy Committee (MPC) of RBI is expected to keep raising rates in line with the global peers. The market consensus is expecting the policy repo rate to rise to 6% (currently 5.40%) by the end of 2022. In his latest statement, the RBI governor stated that he does not expect moderate hikes in policy rates and elevated prices to hurt the growth materially and the economy may still retain the momentum to grow 7% in FY23.

The RBI estimate of growth may be optimistic in view of the poor Kharif crop estimates; challenges to exports; rising interest cost and poor consumption growth outlook. The risk of a global energy crisis in winter is also looming large and could have some negative implications for our inflation and growth outlook.

Inarguably, the claim of the finance minister that India faces zero chance of a recession is tenable. But a growth of 5-6% on a low base would be nothing to celebrate in our circumstances.

Obviously, the financial markets are disregarding the macroeconomic conditions and focusing on micro opportunities, especially the ones driven by policy impetus. In particular the following are some identifiable drivers of the stock markets in the recent up move.

1.    Strong emphasis on enhancing local defence procurement, especially in view of the global sanctions on our largest supplier (Russia) and elevated Chinese threat. The global sanctions on Russia have also presented an opportunity to Indian manufacturers to gain some foothold in global defence equipment and missiles markets; where the efforts of Indian entities, made in the past many decades, have started yielding results. The stocks of the companies that could be potential gainers from higher local defence procurement are favourites of investors as well as traders.

2.    Realignment of global supply chains in the post Covid world is expected to trigger a new capex cycle in Indian manufacturing sector. The potential beneficiaries of this capex cycle like capital goods manufacturers are also gaining traction with market participants.

3.    The most favourite sector in Indian markets is the financial sector. The cleaned up balance sheets after years of efforts and increased margins as the rate cycle turns up are attracting massive investor interest to the sector.

4.    The energy crisis in Europe and the US is also creating opportunities in Indian markets. For example, prohibitively higher energy cost has rendered significant industrial capacities (especially in high energy consuming sectors like chemicals) unviable. Closure of these capacities is allowing some Indian manufacturers to gain market share as well as better pricing power.

5.    The trends in energy security and climate control (green energy, electric mobility etc.) are also leading greater investor interest in the related businesses.

6.    Given the poor growth outlook in Europe and China, the FPI flows have turned towards emerging markets like India. Significant positive flows over the past couple of months have also helped Indian equities to outperform its global peers.

It seems the divergence between the equity market performance and macroeconomic conditions may continue or even widen in the short term. However, over a longer period, say 12-15 months, both invariably converge. Till then its happy times for the investors and traders.