Do it yourself: GFC

Showing posts with label GFC. Show all posts

Wednesday, April 9, 2025

Tariff Tantrums – Where do we stand?

The global markets are shaken by the trade war initiated by the US by announcing arbitrary unilateral tariffs on all of its trade partners. Some large trade partners of the US, like China and EU, have reportedly threatened to join the war with full vigor, making the global market extremely jittery.

The prices of most risky assets and commodities have corrected sharply due to fear of widespread economic repercussions resulting in a global recession or even a depression like condition. The benchmark indices in most developed countries have corrected 8% to 18% in the past one month. Commodities, especially metals and energy, have also seen 7%-15% cut.

In my view, it may be a little early to assess the short-term impact of the latest events. Things are evolving fast and chances are that better sense would prevail and leaderships of the US and its trade partners would be able to prevent the current stalemate from becoming a game of ego between them; and arrive at a mutually agreed solution. Millions of research reports and several hours of media commentaries, analyzing the short-term impact of the latest tariff war, have already happened. I am in no position to add anything more meaningful.

However, if the situation does deteriorate and more people begin to think like Prime Ministers of Singapore (watch here) and the UK (read here), the global ‘reset’, we have been talking about since the global financial crisis (GFC: 2008-10), may take a tangible shape much sooner than presently anticipated. It is critical to make an assessment where would India stand in the new global order, if it were to take shape in the decade or so.

The impact of the GFC on financial markets was mitigated in a couple of years by collective efforts of the governments and central bankers. However, the social, geo political and economic impacts of the crisis largely remain unmitigated.

The "Reset" button pressed by the crisis has resulted in widening of socio-economic divide across the world. The geo political tensions have intensified materially. The rise in protectionism has adversely impacted global trade. The rising unemployment in Europe and most commodity dependent economies in Asia, Africa and Latin America, declining growth in China, substantial cut in developmental aid to least developed nations due to fiscal pressures, has caused widespread human suffering for over a decade now.

The onslaught of novel coronavirus (COVID-19) and Russian invasion of Ukraine, has accelerated the "Reset" process. I have written this before, but it would be in order to reiterate a brief account of the changes in world order that have taken place since the advent of the 20th century.

In 1917, the Russian revolution successfully dismantled the Tsarist autocracy and laid the foundation of the USSR. In the following decades, many smaller independent European states became subservient to a mighty Russian socialist army, and together formed one pole in the emerging bi-polar world, forever shrouded by the specter of cold war.

In the same year, the USA decided to join the War as an associate of the Allies - a development that tilted the scale in favor of the Allies, bringing the War to an end in 1918. In the following decades, the USA emerged as a formidable military and economic power, and led the democratic allies to become the second pole in the emerging bi-polar world.

The imperialist global order that existed in the preceding centuries began to dismantle. Many colonies of the European empires gained freedom. The British Empire that was built in three centuries and covered almost one fourth of the world population and area before the War, was completely dismantled in the following three decades. In these three decades (1918-1950), a new world order acquired a concrete shape. For the first time in modern history, the world adopted a rule-based order, characterized by multilateral agreements and institutions like the UN, NATO, WARSAW Pact, GATT, NAM, Bretton Woods, World Bank, energy cartel (OPEC), et. al. Mao, Israel, and the Cold War were key interludes in the main play. This world order lasted for about four decades.

The German Wall fell and the USSR disintegrated in early 1990s. This unleashed a new wave of globalization in a world dominated by just one superpower – the USA. Global Trade (WTO), Internet, dematerialization of assets, Europe integration into a single market, China's entry into mainstream global trade (through WTO), free flow of capital, G-20, BRICS, numerous FTAs, global war on Islamic fundamentalism, energy security, climate control and global financial crisis, dominated this phase.

Cracks started to emerge in the global order after GFC. The global economic behemoth China started to express its global ambitions in terms of domination over trade, technology and territories. Russia, which had become a dominant player in the global energy market, also expressed its ambitions. Both these countries now led by unchallenged, ambitious, and strong leaders were openly challenging the US hegemony; and looking for a rightful place for themselves in the global order.

In the past five years, the outbreak of a global pandemic and Russian invasion of Ukraine has accelerated the process of a reset in the global order. As things stand today, we could have a concrete shape of the new order emerging in the next 5-10 years. I personally do not believe that the emerging world order will be based on isolationism, parochialism, localization of trade and closed borders. Though smaller trade blocs, more regional blocs like the European Union, neutral currencies, and redrawn global maps may be some of the key features of such an order.

A more relevant point is where does India stand in this critical transition? I would share my thoughts on this next week.

Wednesday, March 26, 2025

Loving silver on my scalp

A friend recently remarked, “I don’t want to be young for the first time in my life”. He was alluding to the challenges Gen Z (born between 1997-2012) and Generation Alpha (born after 2012) children are likely to face in the coming years. I fully agree with him. The silver on my scalp gives me comfort that a relatively well lived life may end as comfortably for me, and many people my age. But young people in their 20s have no such comfort.

The people in their late twenties have already stood witness to three massive economic/market crises (dotcom burst, subprime burst and Covid-19 pandemic) that (i) were not caused by a war or natural disaster; (ii) did not cause human suffering which was anywhere closer to the crises witnessed during 19^th and 20^th centuries; and (iii) were brought under control through monetary and fiscal stimuli within a short period of time.

In the past twenty-five years, the governments across the world have increasingly become more socialist. While serving the interests of crony capitalists, they have made sure to provide basic necessities of life to the common people – not only in their jurisdiction but much beyond it. The central bankers across the world have remained accommodative – keeping the markets sufficiently liquid, and cost of capital low to fuel consumption, support higher asset prices and ensure availability of adequate risk capital to fund tech innovation.

This generation has mostly lived in low inflation, low interest rates, constantly improving productivity due to tech innovation, accelerating speed of everything, improving longevity, globalized economies, contained geopolitical conflicts, and an environment promoting individualism against the spirit of society. Accordingly, this generation carries a strong faith in the central bankers, governments, technology, medicine, and mobility. Personal savings, family, austerity, tolerance, sacrifice, social ethos, patriotism are only a few of the concepts this generation may not be sufficiently versed with.

A famous Chinese curse goes, “May you find what you wish for”. The Gen Alpha, perhaps is affected by this curse. Riding the broomstick of unhindered aspirations, they feel entitled to get freedom, liberty, comfort and convenience, despite being mostly selfish in their approach towards society in general. They take peace and society support for granted. The very freedoms and comforts this generation seek might become their undoing, as they may not be adequately prepared for tougher times.

The events of the past few years are suggesting that things may change rather dramatically for this generation in the coming decade.

· The governments are increasingly acquiring parochial character. The focus is evidently shifting to retraining fiscal profligacies. Frugal governments mean the younger people might have toll hard to make a living for themselves. This will happen when the technological developments would have eliminated most of the jobs requiring unskilled or semi-skilled workers.

· The central bankers, as evident from the recent Fed commentary, have developed the fear of the endgame of this unmindful monetary expansion. Cheap and abundant money may not be available to fund redundant fancy tech innovations.

· The efforts of the government to define the narrower contours of personal freedom and liberties are also conspicuous from the US to India. Conforming to social norms may become essential for survival, if this continues like this.

· Excessive use of chemicals and changes in lifestyles have severely affected the procreation capabilities of both men and women, adversely affecting the demographics. “Not having family” may soon become a disease rather than an option.

· Climate change may make food and water scarce for more than half of the world.

· Ultra nationalism may trigger a war, for which not many youths would be prepared. This could lead to several times more lethal digital, chemical and even nuclear attacks. The misery that would follow is unfathomable. Of course it is the worst-case possibility, not a baseline assumption.

I am certainly not suggesting an end of the road for Gen Alpha. I am just expressing my sadness for the fact that my children may have to learn a few life lessons rather painfully.

I am confident about the capability of the young generation to quickly adapt to the changing environment. Gen Z and Alpha have grown up with smartphones, not stability—they’re naturally used to disruption. They might lack the thrift or stoicism of boomers, but they’ve got agility and a native grasp of systems (tech, social, political) that could see them through. I am sure the pain would forge something new, not just break them.

I would be keenly watching the developments in the areas of food and water; particularly, how the food production shifts from the farms to factories.

Wednesday, March 19, 2025

View from the Mars - 3

About 17 years ago, a global financial crisis (GFC) engulfed the global markets. The impact of the crisis on financial markets was mitigated in a couple of years by collective efforts of the governments and central bankers. However, the social, geo political and economic impacts of the crisis largely remain unmitigated even today.

The "Reset" button pressed by the crisis resulted in widening of socio-economic divide across the world. The geopolitical tensions have intensified materially with rise in nationalism, protectionism and parochialism. This has not adversely impacted global trade. The rising unemployment in Europe and most commodity dependent economies in Asia, Africa and Latin America, declining growth in China, substantial cut in developmental aid to least developed nations due to fiscal pressures, has caused widespread rise in human suffering.

The COVID-19 pandemic further accelerated the "Reset" process, paving the way for the emergence of a new global order.

To put things in a right perspective, it is pertinent to note the changes in world order that have taken place since the advent of the 20th century.

In the same year, USA decided to shed its long-held policy of isolationism, and joined the War as an associate of the Allies - a development that tilted the scale in favor of the Allies, bringing the War to an end in 1918. In the following decades, the USA evolved into a formidable military and economic power that led the NATO allies to become the second pole in the emerging bi-polar world.

It took three decades for the new order to consolidate. The imperialist global order that existed in preceding centuries began to dismantle. Many colonies of European empires gained freedom. The British Empire that was built in three centuries and covered almost one fourth of the world population and area before the War, was completely dismantled in the following three decades.

The new order was characterized by the UN, NATO, WARSAW, Mao, Israel, NAM, Bretton Woods, World Bank, Cold War, energy cartel (OPEC), WEF, et. al. The globalization that was a norm prior to the first War was completely overpowered by the forces of nationalism and protectionism. This world order lasted till the German Wall fell and the USSR disintegrated in early 1990s; unleashing a new wave of globalization. In this world order, ‘market’ and ‘multilateralism’ was the dominant theme.

For two decades, since early 1990s, the global narrative was driven by global trade (WTO), Internet, digitalization, dematerialization, Europe integration into a single market, China's entry into mainstream global trade (through WTO), free flow of capital, G-20, BRICS, numerous FTAs, global war on Islamic fundamentalism, energy security, climate control, until the global financial crisis pressed the reset button and Covid-19 pandemic added further impetus to the process and brough us on the threshold of a yet new global order.

The imperatives of the new world include—

· Necessity to exit the accommodative monetary and fiscal policies originally adopted to mitigate the impact of GFC, which have become completely unsustainable after further loosening to mitigate the impact of Covid-19 pandemic.

· Need to find an alternative to the USD, which continues to be the only global currency despite material weakness in the underlying fundamentals.

· An urgent need to correct the imbalances that have creeped into global trade in the past three decades, due to aggressive growth agenda pursued by China & OPEC, technology developments in the US, persistent low yields in EU and Japan, and economic sanction on Russia, etc.

· Weakening of old trade and geopolitical blocks weakening and emergence of new trade and geopolitical alliances, especially Russia, China and Iran nexus.

· China is accelerating the drive to assume global leadership through mega initiatives like One Belt One Road (OBOR) and China Pakistan Economic Corridor (CPEC) and enlarging BRICS.

· Weakening of the European Union due to the exit of the UK.

· The US withdrawing from conflict zones like Afghanistan, Iraq, Libya refusing to engage in Syria, and ignoring genocide in Palestine, signaling a paradigm shift in its policy towards globalization and, free trade.

· Worsening of the refugee crisis in the western Europe.

· India’s effort to emerge as an alternative manufacturing hub to China, for the developed countries seeking to derisk their supply chains.

· Growing irrelevance of the multilateral institutions like the UN, OECD, IMF etc.

It may be little early to speculate on the likely contours of the emerging new world order. However, I do believe that the new world may not be excessively localized, nationalist and/or protectionist. Nonetheless, it is entirely possible that several new trade and geopolitical blocks get form, and define the contours of the new world order.

….more on this tomorrow.

Tuesday, March 4, 2025

Lock your car

It was summer of 2013. The mood on the street was gloomy. The stock markets had not given any return for almost three years. USDINR had crashed 28% (from 53 to 68) in a matter of four months. GDP was on course to drop to 5.5% after growing at a rate of over 8% CAGR for almost a decade. Current account deficit had worsened to more than 6% of nominal GDP (the worst in decades). The Fx reserves of the country were down to US$277bn, sufficient to meet just 5 months of net imports. The confidence in the incumbent government had completely depleted. The people were on the street protesting against ‘corruption’ and ‘policy paralysis’.

The global economy had still not recovered from the shock of the global financial crisis (GFC). The thought of unwinding of monetary and fiscal stimulus provided in the wake of being unwound was unnerving most emerging markets ((Taper Tantrums), including India.

India, which was touted as TINA (There is no alternative) by the global investors just five years back and had become a key member of BRIC and G-20; was already downgraded to “fragile five” by some global analysts. This was the time when the government of the day took some brave decisions. One of these decisions was to appoint Mr. Raghuram Rajan, former Chief Economist and Director of Research at the IMF and then Chief Economic Advisor to the Government of India, as the 23^rd governor of the Reserve Bank of India (RBI). Mr. Rajan with the full support of then Finance Minister, P. Chidambaram, took several effective damage control measures, and was able to pull the economy and markets out of crisis within a short period of one year. USDINR gained over 11%, stocks markets recorded their all-time high levels, CAD improved to less than 1% of nominal GDP, real GDP growth recovered to ~7% (FY15).

The situation today is nowhere close to the summer of 2013. Nonetheless, the feeling is that we could potentially head to a similar situation in the summer of 2025.

Worsening external situation - rising global trade uncertainties due to the US unpredictable tariff policies, depleting Fx reserves, weakening USDINR, declining FDI and persistent FPI selling, pressure on the government to cut tariff protection for the domestic industry, and rising probability of a global slowdown.

Slowing domestic growth - Prospects of a poor Rabi crop aiding pressuring food inflation and RBI policy stance, crawling manufacturing growth, limited scope for any meaningful monetary or fiscal stimulus, etc are some of the factors that suggest the probability of any meaningful growth acceleration in the near term is unlikely.

Uninspiring policy response – The policy response to the economic slowdown and worsening of external situation is completely uninspiring so far. The measures taken by the government and RBI appear insufficient and suffer from adhocism.

For example, RBI has announced several liquidity enhancement measures in the past three months. These measures have been mostly neutralized by USD selling by RBI to protect USDINR and rise in the government balance with RBI (inability of the government to disburse money quickly to the states or spend otherwise. Risk weight cut for lending to NBFCs and MFI etc. is too little and too late. The damage to credit demand and asset quality in the unsecured segment is already done, and is not easily reversible.

The fiscal stimulus (tax cut on for individual taxpayers) could support the economy if at all, from 2H2025 only. There is a risk that the taxpayers in lower income segments (Rs 7 to 15 lacs) might use the tax savings to deleverage their balance sheets by repaying some of their high-cost personal loans etc. In that case this stimulus could have a negative multiplier on growth.

The short point is that (a) we are yet not in a crisis situation; (b) if not handled effectively and with a sense of urgency, the current situation may not take long to turn into a crisis.

The government, especially the finance minister and RBI, would need to urgently take several steps to take control of the situation and inspire confidence in the businesses and investors. Leaving it to the external developments, e.g., USD weakening due to falling bond yields in the US; energy prices easing due to Russia-Ukraine truce; trade normalcy restoration due to Sino-US trade agreement and normalization of Red Sea traffic; a plentiful monsoon easing domestic inflation; etc. may not be a great strategy - even if it works this time.

As they say – “it is great to have faith in God, but always lock your car”.

Wednesday, August 7, 2024

No escape!

The legendary Warren Buffet has been on an equity portfolio selling spree in recent weeks. His fund, Berkshire Hathaway, has reportedly raised over US$275bn in cash; which is over 20% of total assets under management. His selling in the stocks of Apple Inc and Bank of America have been reported the most. Apparently, either his team is not comfortable with the present market conditions (valuation, growth, macro, geopolitics etc.) or believes that they can get much better buying opportunities in near to short term, or both. They may be looking for better buying opportunities in terms of better stocks or better price points in the same stocks.

It may be pertinent to note that it is not Berkshire Hathaway alone. A number of reputable investors have taken note of the conspicuous warning signs flashing on billboards for the past few months in particular.

Yen carry-trade

Hike in the policy rates by the Bank of Japan (BoJ) and strengthening of Japan is perhaps the most talked about event in the market space. Young traders in their twenties, with one or two years of trading experience are confidently talking about the disastrous impact unwinding of “JPY carry trade” will have on the global markets, almost trivializing this important event.

World War III

The older and more mature investors on the other hand are preferring to discuss the impending World War (WWIII). They are worrying that (i) the countries producing about 60% of the global energy resources may be on the one side of this war; (ii) most NATO members may not be fully committed to the cause, due to economic and demographic constraints; (iii) many western countries may implode due to a strong internal resistance to the war at Israel’s behest; and last but most important (iv) the war this time will involve the fragile and totally intertwined digital world, which could be more debilitating.

US recession

A sharp rise in unemployment indicators; a marked slow-down in real estate market; the Federal Reserve hinting a rate cut on the table and the markets extrapolating it to full one percentage point cut in 2024 leading to sharp fall in bond yields; hedge funds raising their short position in commodities to the highest in over a decade; etc. have triggered a wave of concerns over sustainability of stock market euphoria in the US; especially the high valuations for a few technology stocks that have been at the core of the US equity bull market in the Post-Covid period.

Is a 2008 like collapse coming

In my view, there are genuine concerns for the market at present. However, the present narrative, which is revolving around the yield curves (and whether the central bankers are running much behind the curve) and geopolitics, may not be enough to cause a market collapse like 2008-09. We may need something bigger to break.

My worries

Notwithstanding, my worries are as follows:

· Unlike 2008-09, the global economic growth is not strong. China and India were growing 8-11% 15 years ago. Now both are struggling in the 5-7% band; more so China.

· In 2008-2013 the peripheral Europe faced problems that caused a lot of volatility and concerns in the global markets. A US$32bn bailout of Greece made headlines for many weeks. Sovereign debts Portugal, Iceland, Greece and Spain (PIGS) totalling less than US$120bn were primary talks of the table. But this time it is in Europe. Germany, France, and the UK are facing problems – economic, demographic, social and political. The primary talk of the table now is US$35trn debt of the US, ~US$10 trillion debt of Japan and mammoth but unknown amount of bad loans in the Chinese banking system.

· In 2008-09, most countries had adequate financial leverage to stimulate their respective economies and mitigate the impact of the crisis. Today, not many global economies enjoy that kind of fiscal leverage. The recovery this time therefore could be a slow and long-drawn process.

· 2008-09 was more of a financial market crisis than an economic crisis. This time it might be an economic crisis driving the financial markets into a deep abyss. Moreover, the treasury bonds of many large global economies are technically junk (dipropionate to their respective GDP and debt servicing capabilities). Selling more of this to bail out struggling markets and economies may not be feasible.

· A large number of developed and developing countries are facing internal social and political unrest. Besides, the mutual trust that characterized the globally coordinated action in 2008-09 may not be prevalent today. The efforts of various global powers may be focused on sinking the larger ships rather than bailing out the smaller boats.

Insofar as India is concerned, there are not much macro concerns at present; though the fiscal leverage to provide meaningful stimulus in case of a wider crisis may be limited. On the market valuation side, few pockets are clearly in bubble territory and need to retrace a long way back to the realm of sanity. Otherwise, a large part of the market is fairly valued. Maybe a 10% correction would make it look attractive again.

Nonetheless, when a global tide comes, it will also take the Indian markets along. No escape from higher volatility and jittery trades.

Interesting time ahead, for sure!

Thursday, June 20, 2024

Lessons learned from GFC

There is strong evidence emerging that Indian corporates have learned their lessons from the global financial crisis very well. In the post Covid global risk rally, they have avoided most of the mistakes they made during the exuberant years of 2003-2008, and have emerged stronger.

In pre-GFC buoyancy companies like Tata Steel (Corus), Tata Tea (Tetley), Tata Motors (JLR), Indian Hotels (Orient Express), Havells (Phillips), Sun Pharma (Taro), Suzlon (Hensen), Hindalco (Novelis), Reliance Telecom (Flag), etc. got lured by cheap debt and bought global businesses (in some cases bigger than their India operations), paying top dollars. Most of these acquisitions inflicted severe pain to the parent entities in the ensuing years.

This time, despite near zero rates and abundant liquidity, they have been very careful in acquiring businesses abroad. IT services companies have some niche small sized acquisitions to augment their resource pool. These acquisitions have been mostly earnings accretive almost immediately.

Indian companies have (a) continued to deleverage despite raising their capex; (b) managed their cashflows well; and (c) rationalized their operational expenses especially wages well to raise larger resources through internal accruals.

Lower dividend payout: As per a recent latest ET report, in FY24 the Indian companies curtailed their dividend payout to the lowest in nine years. As the capacity utilization increased above the long-term average, companies reserved more money for capital expenditure. FY24 dividend payout ratio was 34% (including buybacks 38%), down from 43% in FY23 and 37% in FY22.

Leverage trending lower: As per India Ratings, net leverage of top 250 companies (excluding BFSI) has trended lower in the post-Covid period. The net leverage of about 3100 other listed companies has not changed much from the long-term trends.

Indian companies have done modular capex in the past five years. Due to a calibrated approach adopted in capital expenditure, in the majority of cases cash generated from operations has been sufficient to meet the capital expenditure.

Despite the consensus expecting lower rates and a weaker USD, Indian companies are not rushing to raise money through ECBs. Peter Guenthardt, head of Asia Pacific global corporate & investment banking at Bank of America, recently commented, “After having deleveraged their books, Indian corporates are likely to go slow on overseas dollar loans as current rates are expensive, although there is "huge pent-up demand" for buying into local firms' equity”. (see here)

In the FY23 net ECB flows into India were just US$1bn and in FY24 it was US$9.5bn. Though, in FY24, registrations for ECBs with RBI surged to the highest in four years.

More importantly, learning from the mistakes made in the pre-GFC euphoria, more than 70% of ECBs raised in FY24 were effectively hedged in terms of explicit hedging, rupee denominated loans or loans from foreign parents, limiting the impact of external shocks, according to an article called ‘State of the Economy’ in RBI’s May bulletin.

This prudence augurs very well for the Indian companies and markets, as it makes the growth sustainable, predictable, and profitable.

Wednesday, November 1, 2023

Not bothering about prophecies, for now

I vividly remember it was the winter of 2007. The global markets were in a state of total disarray. The subprime crisis was unfolding in the developed world.

In the US, the financial system was on the verge of collapse. Several banks, insurers, and other financial institutions were reporting massive write-downs on their subprime Collateralized Borrowing and Lending Obligations (CBLO). The cost of protecting debt (Credit Default Swaps) was rising sharply. The US administration and Federal Reserve were mostly in denial, at least in their public posturing; even though the Fed had started to cut the benchmark fund rates from September 2007.

Signs of a sovereign debt crisis had started emerging in peripheral Europe. In countries like Portugal, Iceland, Greece, and Spain (popularly called PIGS) treasury default swaps had spiked to indicate imminent default.

The financial markets in the developed world had started correcting sharply. Both equity and bond prices had fallen. The emerging markets were however doing relatively better. The investment strategists at the large global banks were coining terms like BRIC (Brazil, Russia, India, China) and Frontier Markets (including Pakistan, Bangladesh, Bahrain, etc.) to distract investors from the crisis in the developed markets and peripheral Europe. Many of these markets like India and Pakistan had become the best-performing global markets in the October 2007-January 2008 period. Bangladesh and Sri Lanka had also done extremely well.

Despite the financial system in the developed markets collapsing and talks of bail-out gaining currency, a section of the market started forecasting hyperinflation, matched only by the inflation preceding the great depression in the 1930s. The resource-rich Latin America was becoming the hot investment theme. Numerous Latin America and Natural Resource funds were launched to collect billions of dollars in fresh investment worldwide.

This was the time when a renowned commodity guru, Jim Roger forecasted an unprecedented commodity super-cycle. I had an opportunity to meet him in person in the spring of 2008 when he was speaking at the prelaunch event of the Natural Resource Fund by an Indian fund house in Mumbai. In a brief 15-minute interaction, I found his knowledge of economics, global finance, and strategic affairs quite ordinary. He appeared to be a smart trader who would sense opportunity in commodities markets and rotate his positions swiftly.

Nevertheless, all the assumptions of global experts and gurus were demolished in the next 12 months. BRIC and Frontier markets performed the worst. Commodity markets went into a long (almost a decade) bearish phase. Investors who relied on these experts lost money, despite the financial stability returning to most troubled countries. Smarter investors who ignored these experts and invested in Greek and Italian bonds at 60c to a dollar raked in the mullah.

I find that the global markets are in the same position as they were in 2007-2008. Experts in their wisdom are making a variety of forecasts.

For example, numerous experts are forecasting the trajectory of Fed rates in 2024 and 2025; even though there is no empirical evidence of any correlation between Fed decisions and experts’ forecasts.

One renowned global strategist has reportedly forecasted a 25% correction in Indian equities if the incumbent regime loses power in the 2024 general elections. Disregarding the fact that there is no empirical evidence of any correlation between political regime and stock market performance in India.

Similarly, there are forecasts of Bitcoin topping US$1,00,000/per coin; gold outperforming financial assets; and Japanese equities doing better than Europe and the US.

There is an intense debate over the US economy skirting (no recession), slithering (soft landing) or collapsing (hard landing) into a recession. The debate on the end game for mountains of debt developed markets have accumulated over the past 15 years, more particularly in the past three years is also intense.

For a tiny investor like me, the situation is very tough. After reading zillions of pages of research, I discovered almost no one (analysts, economists, strategists, government officials, central bankers, et. al.) has any clue about how the situation is evolving. Everyone seems to be arguing from their biases and experiences; and praying to god that their prophesies come true so that they can tell the world “I told ya so”.

The Fed chairman is no exception to this. As you would hear from him tonight, he has literally no control over prices, growth, geopolitical situation, and markets. Regardless, there is an entire industry that will try to establish a correlation between what the Fed says and what happens in the market thereafter.

I have therefore decided to read research reports only for some useful data points and indications towards future trends. I shall avoid the forecasts, conclusions and recommendations, till I find strong evidence of clarity emerging.

Tuesday, October 17, 2023

Policy paralysis – UPA vs NDA

“Policy paralysis” of the preceding Dr Manmohan Singh led UPA government was one of the main planks of PM Modi’s election campaign in 2013-2014. The business community, middle classes, and poor, all were convinced that the UPA government suffers from a severe degree of inertia in policymaking and is therefore responsible for the poor growth of the Indian economy. It was alleged that large-scale and blatant corruption, nepotism (lack of meritocracy), and weak leadership are the primary reasons for the “policy paralysis” and poor execution.

The campaign against the incumbent government was so effective that it swayed the big industrialists and SMEs which directly benefited from the government’s developmental efforts; the poor who benefited tremendously from the transformative social initiatives; and the middle classes who were protected from any potential collateral damage from the global financial crisis and events in its aftermath, against the government.

In their disappointment with the then incumbent government, few consider allowing the government any concession for-

(i) The global financial crisis (GFC) of 2008-09 threatened to push the global economy into the worst condition since the great depression of the 1930s. The Indian economy still managed to grow over 7% during the five-year (FY10-FY14) period post-GFC, notwithstanding the challenging global conditions.

(ii) A high base effect. The Indian economy had its best phase during 2004-2011; growing over 8% CAGR. Despite such a high base effect and global slowdown, the Indian economy was still growing by over 7% in 2014.

(iii) The several major policy decisions taken by the UPA government, having a transformative impact on India’s socio-economic milieu. For example—

· Employment Guarantee (MNREGA) through enactment of Mahatma Gandhi National Rural Employment Guarantee Act, 2005.

· Food Security for 81 crore poor people through National Food Security Act, (NFSA) 2013

· Right to Education for all children between the age of 6-14 through The Right of Children to Free and Compulsory Education Act, 2009. (It is pertinent to note that through the 86^th amendment to the Constitution of India in 2002, Article 21A was inserted in the Indian constitution to make Education a fundamental Right.).

· Right to Information through enactment of the Right to Information Act 2005.

· Financial Inclusion- provision of banking facilities to all 73,000 habitations having a population of over 2,000 by FY12, using appropriate technologies.

· Unique Identity for all citizens (Aadhar) through the implementation of Aadhaar and Other Laws (Amendment) Act 2009. Unique Identification Authority of India (UIDAI), has been officially acknowledged as a legislative authority, since July 12, 2016, in accordance with the Aadhaar Act 2016.

· Digitization of payments through incorporation of National Payments Corporation of India (NPCI) was incorporated in 2008 as an umbrella organization for operating retail payments and settlement systems in India. NPCI facilitates transformative payment solutions like UPI, Bharat Bill Pay, FasTag, and Direct Benefit Transfers (DBT).

· FDI in retail trade.

· Civil Nuclear Deal with the US allowing India entry into elite clubs as a key strategic partner.

· Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 to facilitate faster execution of infrastructure projects and minimize litigation in the acquisition of land.

· Deregulation of transportation fuel prices and eliminating kerosene subsidies that had adversely impacted the fiscal balance of the central government for decades.

· Including reforms in tax sharing formula between states and center in scope of 14^th Finance Commission (set up in 2013 and recommendation accepted in February 2015) to improve state and center relationships and allow states more autonomy.

· UPA government also proposed a uniform Goods and Service Tax (GST) in 2007 and a Direct Tax Code later. However, these could not be implemented due to different views of the opposition ruled states.

Instead, some unsubstantiated allegations of mega corruption dominated the narrative and overwhelmed the voters’ sentiment.

It is pertinent to note that some hypothetical charges of corruption in the allocation of 2G spectrum and coal mines raised in CAG reports were blown out of proportion and eventually led to the cancellation of 122 telecom licenses in 2012 and 204 coal blocks in 2014 by the Supreme Court. Notably, in 2017 a special CBI court acquitted everyone accused in the 2G spectrum case stating that the prosecution had failed to prove any charge against any of the accused, made in its well-choreographed charge sheet. Nonetheless, the cancellation of licenses and coal blocks led to the bankruptcies of some entities, causing massive losses to their lenders.

In my view, therefore, it is particularly important to evaluate the performance of the incumbent government in relation to “policymaking”; because good policies have the potential to catapult the economy into a higher growth orbit. Execution of policies and programs indubitably helps in sustaining the momentum, but innovative policies are key to growth acceleration and socio-economic transformation.

...to continue tomorrow

Tuesday, August 22, 2023

Layers of Nimbostratus fast covering the sun

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.

Obviously, the headlines left many traders worried about the markets, particularly, their long positions. The S&P500 index corrected over 2% last week and has now lost over 3.60% in the past month. Besides, the US, markets like Hong Kong (-6%), South Korea (-4.5%), the UK (-5.2%), and Japan (-2.6%) have also corrected in the past month. Indian markets have done relatively better, losing about 2.2% in the past month.

In my view, it’s not Michael Burry’s positioning that is the reason for the market fall; it is the concerns over the stability of the financial system and markets that may have prompted Burry to take a short position.

Pertinent to revisit 2007

Before we take note of the current situation, revisiting the sequence of market events in 2007 may be worthwhile.

By April 2007, over 50 mortgage lenders in the US, which mostly specialized in subprime lending had declared bankruptcy, the largest amongst these being New Century Financial, and over 100 such lenders had already closed their operations. Taking note of the events in the US, all global stock markets had corrected around 10% during June-July 2007 when the media headlines began to be dominated by the subprime crisis unfolding in the US and Europe.

However, to everyone’s surprise (and shock to many who had by then built up massive short positions in the financial markets) the markets rose sharply with Chinese stocks gaining over 40% in just three months and US stocks gaining over 10% during the same period. Most markets made a peak in October 2007 with the top banks like Bear Sterns, Merrill Lynch, and Morgan Stanley showing stress and raising additional capital from Asian sovereign funds; and started their final descent.

The Indian equities however continue to rise till the first week of January, gaining over 50% from the July 2007 low. The Great India Story, There Is No Alternative (TINA) to India, etc. were famously part of the global fund managers’ narrative at that time.

Plane loads of foreign investors with bags full of money were landing daily in Mumbai and Bengaluru. However, the dream run of Indian equities did not last much longer. The correction started on the 8^th of January 2008, and by October 2008, Indian equities had lost about 60% from their January 2008 highs, becoming one of the worst-performing markets in the world.

Notably, the Indian economy had grown 9.3% in FY08, on a high base of 9.5% in FY06 and 9.6% in FY07. In the subsequent three years (FY09 to FY11) the Indian economy recorded an average real growth rate of over 8%. The benchmark bond yields corrected from a high of 9.3% in January 2008 to a low of 5.3% in December 2008; only to rise again to 8.9% in the next twenty-one months.

Ominous dark clouds (Nimbostratus) covering the Sun

The events of 2023 bear some resemblance to 2007. After years of low rates, and supportive money & fiscal policies, the economies have heated. Asset prices have risen sharply showing clear signs of unsustainability and irrationality. Consumer inflation is running high despite accelerated tightening. Debt defaults and bankruptcies have started to happen. Bond yields are rising to multiyear highs. Central bankers continue to remain hawkish; indicating further tightening. Conspicuous signs of an impending economic slowdown are everywhere. The US Government bonds have been downgraded and the major US banks are also under close scrutiny for a possible downgrade. The growth engines of world China and India are not able to accelerate growth.

US economy facing strong headwinds

For the past year at least, the US economy is facing strong headwinds.

· As the Covid stimulus has started to unwind, the growth has dwindled.

· The household debt burden is at a record high with diminishing debt servicing capability.

· Household savings are depleting at an accelerated pace.

· The interest burden of the US treasury has almost doubled from pre Covid level to appx US dollar one trillion.

· Fiscal deficit funding faces hurdles as the global demand for the US treasury is declining. Reportedly, the US treasury portfolio of China alone is down by over US$500bn from peak of 2013.

· Bond yields are at a multi-decade high, inflicting massive MTM losses on bond portfolios of insurance companies, pension funds and banks etc. The leveraged bond portfolios are bleeding badly, raising the specter of a major financial sector crisis.

The growth engine of the world is stuttering

China has been a major driver of global growth in the past couple of decades. In particular, after the global financial crisis, China and India have been the major contributors to global growth, contributing over 15% of total global growth.

The Chinese economy has been struggling to sustain its high rate of growth and consistently reporting lower growth. The growth rates of retail sales, property sales, industrial production, employment, investment, etc., and overall GDP have declined in recent months. In fact, China’s People’s Bank of China, is perhaps the only major central bank that has not increased interest rates even once in the past decade. Several experts have raised questions about the sustainability of the Chinese model of growth in the recent past. Some have even pronounced the end of the Chinese era of economic high growth led by investment in manufacturing and property.

In fact, it is not only China. The fabled BRICs that were seen as a major support to the global economy is struggling. Russia is engaged in a prolonged war. Brazil and South Africa have hardly grown in the past decade. India has been maintaining a decent growth rate, but not adequate to make a significant difference to the global economy. Besides, it is not likely that India’s growth will accelerate in any meaningful measure in FY24-FY25 also.

The next 6 months are critical for global markets

Given the current level of fragility and uncertainty, in my view, the next six months are very critical for the global markets. At present, few would rule out a credit event like the collapse of Lehman Bros, or a sovereign debt crisis like Greece in the near future.

The financial markets will definitely take a significant hit in such an eventuality; even if the central banks resort to indulgent monetary loosening immediately to stem the crisis.

Wednesday, April 19, 2023

In crisis – strong leadership is what would matter the most

The global financial crisis in 2008 and the unprecedented quantitative easing that followed it triggered a debate over sustainability of the USD as global reserve currency. The simultaneous fiscal crisis in peripheral Europe, especially in Greece, also created doubts over the sustainability of the European Union with a common currency. The debate subsided materially over the next one decade, as the US Federal Reserve (Fed) and Government initiated a corrective action to taper the monetary stimulus and balance the fiscal account. The situation in Europe also improved as the troubled economies of Greece, Italy, Portugal, Iceland, Spain etc. stabilized due to the combined efforts of the European central Bank (ECB), IMF and respective national governments. The European economy even endured the BREXIT rather calmly.

The onset of Pandemic in early 2020 however undid most of the corrective actions undertaken by the central banks, multilateral agencies and governments. The US Government and Fed unleashed a much larger stimulus, substantially expanding the Fed balance sheet and fiscal deficit; while many major economies, especially the emerging economies, managed the situation in a much more calibrated manner.

Notwithstanding the fiscal and monetary profligacy of the Fed and US government, the USD has endured its strength relative to most emerging market currencies. The broken supply chains across the world due to the pandemic led to severe shortages of everything leading to very high inflation worldwide. The suffering in most emerging economies due to inflation created a sentiment against US dominance on the global economy.

A strong US economic response to the Russian aggression in Ukraine since early 2022, including freezing USD assets of many Russian businesses, further exacerbated this sentiment. Russia and its allies like China and Iran; and major trade partners like India have shown interest in development of a non-USD trading mechanism. The traditional US allies like Saudi Arabia, Mexico, Brazil and even France have raised questions on continuing US dominance over global economic order, besides showing interest in non-USD trading mechanism.

Though the details of a non-USD global trade mechanism are still sketchy, the debate is intense. Maybe like many previous occasions, this debate would also subside as inflation peaks out; US Fed and government embark on a credible course correction; Russia withdraws its forces from Ukraine and a sense of normalcy returns to the Sino-US trade relations.

Or maybe over the course of next decade, we shall see the emergence of a neutral currency that may act as the medium of exchange for international trade not involving the US or its close allies, while the trade with the US continues to be done in using USD.

Or maybe we shall see multiple trade blocks using non-USD currencies to settle trades within their respective blocks; while using USD or some other acceptable currency for trades outside their block.

All these conjectures are presently predicated on the premise that the US as a global power is declining in terms of its technological edge; financial strength and geopolitical supremacy. There is evidence of economies like China and India gaining technological edge; and the US losing its geopolitical supremacy. In the past one decade, both India and China have shown remarkable progress in digitization of their economies and space program to back faster and superior digitization. The complete failure of the US led alliance in resolving Russia-Ukraine conflict; China bringing Saudi Arabia and Iran closer; and Afghan Taliban pursuing a foreign policy independent from the US and its ally Pakistan influence are some signs of declining US geopolitical supremacy. It however remains to be seen if this decline is structural or is just a reflection of poor confidence of the global community in the present US leadership.

I posses no competence to comment on sustainability of the USD as global reserve currency for long. Therefore, it would be preposterous on my part to speak about impact on the global economy, should USD lose its only “global currency” status. Nonetheless, I must say that this will be a major global event, no less than a world war. And in a war like situation strong leadership is what matters the most.