Vijay Kumar Gaba

2023 was a watershed year in many respects. The global economy, politics, geopolitics, climate, and technology witnessed some material changes that would have critical long-term impacts on human life.

Global economy

The global economy resumed the process of normalization after two years of disruptions caused by the pandemic and the Ukraine war. Supply chains were mostly restored. Fiscal and monetary stimulus unleashed to mitigate the impact of Covid-19 started to wind up. The prices of most commodities that had witnessed a sharp surge in the previous couple of years retraced back to their pre-covid trajectories. The interest rate cycle, which witnessed one of the sharpest hikes in policy rates in decades to rein the runaway inflation, also appears to have peaked.

The developed economies have been mostly successful in avoiding a meaningful recession, despite material monetary tightening, higher rates, and fiscal restraints. Most notably, Japan, which has been struggling with deflationary pressures for over a decade, managed to return to the path of growth with moderate inflation.

The overall economic growth is moderate as two of the primary engines of global growth the US and China stuttered. Germany and Sweden flirted with recession for most of the year, while the UK, France, and other European countries barely grew. In Latin America, Brazil managed to grow its economy by 3%, Argentina, and Chile were in recession, and other economies barely grew. The leading commodity-producing economies in Middle East Asia, Africa, and the Pacific (Australia) were either stagnant or contracted.

Geopolitics and politics

The Ukraine war in 2022 opened multiple fault lines in global geopolitics. The post-Cold War thaw in US-Russia relations evaporated completely. The US-Sino trade conflict that started to worsen in 2017 transformed into a major geopolitical standpoint. In 2023, the conditions seem to have worsened materially.

The latest episode of hostilities in the Gaza Strip has further widened the abyss. There were some indications of the Arab world mending its way with Israel. However, the Hamas attack on Israel in October changed everything. Middle East Asia is now a major flashpoint for a wider escalation of the conflict as groups of larger forces have pledged support to Israel and Palestine. The regrouping of Arabs with Russia and China alliance against the interest of the Western world is a clear pointer to the potential shape global order may be taking in the next couple of decades.

Hyper-nationalist right-aligned leaders/parties won elections in Italy, Argentina, and the Netherlands; while hardline leftists won elections (re-elections) in many jurisdictions, e.g., Germany, France, Australia, Chile, Mexico, Bolivia, Brazil, Peru, Honduras, and Columbia, etc. Both the Chinese Premier Xi Jinping and Russian Premier Vladimir Putin are firmly entrenched in their respective offices for as long as they wish, and actively working to polarize the world.

The commodity-producing and most populated emerging economies which felt that they had been at the mercy of the financialized Western world due to the overwhelming dominance of USD on global trade, regrouped (expansion of BRICS) to be in a position to command terms of trade.

Climate change

As the emerging economies and the developed economies made some progress in finalizing a workable deal to set effective emission targets at COP28 (Dubai), the weather conditions in the world worsened materially. Countries across the world witnessed dramatic changes in weather patterns, affecting crops, livestock, and human life. The global temperature continued to rise as many countries in Europe, North America, and Latin America witnessed episodes of extreme heat, rain, and snow. Floods were seen in many countries. The incidences of earthquakes, cloudbursts, cyclones, etc. also increased in many countries.

Technology

Artificial intelligence and blockchain technologies entered the mainstream in 2023. Cryptocurrencies and digital currencies gained much wider acceptance both as a store of value and a medium of exchange. Generative artificial intelligence entered the common man’s sphere, impacting the lives of households. Significant advances were made in the fields of biotechnology, green energy, astronomy, and space science.

Some of the key events of 2023 could be listed as follows:

·         Croatia adopts the euro and joins the Schengen Area, becoming the 20th member state of the Eurozone and the 27th member of the Schengen Area.

·         A deadly cold snap in Afghanistan kills 166 people and nearly 80,000 livestock.

·         A massive earthquake strikes southern and central Turkey and northern and western Syria causing widespread damage and at more than 59,000 fatalities and 121,000 injured.

·         The European Parliament approves a ban on the sale of new petrol and diesel vehicles in the European Union from 2035.

·         Lawmakers in the Russian State Duma vote to withdraw Russia from 21 conventions of the Council of Europe.

·         Vladimir Putin announces that Russia is suspending its participation in New START, a nuclear arms reduction treaty with the US.

·         The 2023 Chinese presidential election is held with the National People's Congress unanimously re-electing Xi Jinping as the President of the People's Republic of China to an unprecedented third term.

·         Iran and Saudi Arabia agree to resume diplomatic relations which were severed in 2016, at talks mediated by China.

·         OpenAI launches GPT-4, a large language model for ChatGPT, which can respond to images and can process up to 25,000 words.

·         Brazil and China sign an agreement to trade in their own currencies, ceasing the usage of the United States dollar as an intermediary.

·         San Francisco-based First Republic Bank fails and is auctioned off by the US FDIC to JPMorgan Chase for $10.7 billion. The collapse surpasses March's collapse of Silicon Valley Bank to become the second largest in US history.

·         Russia and Belarus sign an agreement in Minsk allowing the stationing of Russian tactical nuclear weapons on Belarusian territory.

·         Indian oil refiners started payments for Russian oil imports in Chinese yuan as an alternative to the US dollar due to increasing sanctions against Russia.

·         The world's oceans reach a new record high temperature of 20.96 °C (69.73 °F), exceeding the previous record in 2016. July is also the hottest month on record for globally averaged surface air temperatures by a considerable margin (0.3 °C (32.5 °F).

·         The global average temperature temporarily exceeds 2°C above the pre-industrial average for the first time in recorded history.

·         At the COP28 climate summit in Dubai, a consensus is reached for countries to "transition away" from fossil fuels, the first such agreement in the conference's 30-year history

·         India's Chandrayaan-3 becomes the first spacecraft to land near the south pole of the Moon.

·         The European Central Bank (ECB) raises eurozone interest rates to an all-time high of 4%, amid ongoing inflationary pressures across the continent.

·         Hamas launches an incursion into southern Israel from the Gaza Strip, prompting a military response from the Israel Defense Forces. Israel launched numerous air strikes on Lebanon after rockets are fired by Hezbollah and further attempts are made to penetrate Israel.

·         A series of earthquakes occur in Herat Province in Afghanistan, killing over 1,000 people and injuring nearly 2,000, with tremors felt in Iran and Turkmenistan. The earthquakes are the deadliest in the country since 1998.

·         The first AI Safety Summit takes place in the United Kingdom, with 28 countries signing a "world first agreement" on how to manage the riskiest forms of artificial intelligence.

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.

 Some of the most popular video clips shared on social media in India in the recent past were of India’s External Affair Minister, Mr. S. Jaishankar, giving stern replies to the global media about India’s stand on Russia-Ukraine war. In these clips, the minister is seen ‘exposing’, the hypocrisy of European media and politicians in raising questions over India’s purchase of energy from Russia, despite sanctions imposed by US and EU, while the European countries continue to buy natural gas from Russia. Most social media constituents who shared these clips cited the confident and unabashed counteroffensive by the Indian minister as a harbinger of ‘rising India’ and ‘declining west’.

I personally have no disputes with the social media warriors on this issue. It does feel good to see a representative of the Indian government taking a firm stand against the developed nations on global platforms. However, the point I am presently more concerned about is ‘declining west’.

Worsening demography

With a total fertility rate of 1.6, the European Union’s population is on the decline. European Uinon, whose working population (aged 15 to 64) shrank for the first time in 2010 and is expected to decline every year to 2060. In contrast, the proportion of people aged 80 or over in the EU population is expected to more than double by 2050, reaching 11.4 %. In 2006 there were four people of working age (15-64) for each person aged 65 or over – by 2050 this ratio is projected to be just two people. Migration from other Eastern Europe is helping it to compensate for workers’ shortage to some extent, but it is far from adequate. Most European countries are therefore open to relax migration rules for the Asian immigrants. India’s demographic dividend may, to some extent, come from migration of young workers.

Climate change – Mother Nature showing no benevolence

Historians cite numerous reasons for the decline of the once Great Roman empire. Climate change and disease are also listed as prominent reasons from the Empire, once considered invincible (for example read here). European economy and strategic powers have been diminishing slowly in the post cold war era. The recent climatic disasters are threatening to acclerate this decline further.

As per a latest report by European Union Joint Research Center’s Global Drought Observatory (GDO) Analytical Report titled Drought in Europe – July 2022 – Europe Europe is experiencing its worst drought in at least 500 years. Hot and dry conditions are fueling wildfires and adversely impacting crop yields and electricity generation. About half part of the European continent is facing an alarming situation with a clear deficit of soil moisture. The summer temperature has risen to record levels disrupting transportation, displacing people and causing numerous deaths. Deficient rainfall has affected river flows across Europe – hitting the energy sector for hydropower generation and cooling systems of other power plants.

This climate catastrophe came soon after the Covid-19 pandemic severely crippled many European economies, besides causing numerous deaths and health complications.

Europe has already lost its technology leadership to the US and China. If the agriculture and energy dynamics change materially in the next one decade, the spectre of “the fall of Rome” might return to haunt Europe again. It is however too early to assess how this would  affect the rising Asian societies.

 I find nothing more disturbing than demolition of a long preserved and much cherished image or belief. Occurrence of this often gives rise to cynicism, shaking the core of the belief system. The recent act of violence in Japan is one such event.

People of my generation have known Japanese people for their politeness and commitment to non-violence. The pictures of Japanese crowds showing remarkable patience and calmness during adversities have been much cherished by post WWII generations. The assassination of the former Japanese Prime Minister Shinzo Abe, last week, while he was addressing a public meeting has shattered many images I was carrying in my mind. This is perhaps first of its kind of act of violence since assassination of Inejirō Asanuma, the then Chairman of the Japan Socialist Party. However, in the pre-war era, political assassinations were rather commonplace in Japan. Japanese people took pride in their martial and imperialistic traditions. Many believe the 1945 nuclear attack on Nagasaki and Hiroshima overwhelmed Japanese society, burdening it with the guilt of being one of the main characters in the two disastrous world wars and losing its pride to the USA.

In fact, after decimation of the manifest fascist forces (e.g., Germany and Italy) and imperialistic forces like Great Britain, Japan and Austro-Hungarian empire post WWII, the world has been a rather peaceful place as compared to the preceding 2000yrs. The conflicts post WWII have mostly been contained. Even during the height of the cold war between NATO and Warsaw Pact countries, and shenanigans of star wars, there had never been a threat of escalation to the scale of larger World War.

However, if we correlate some of the recent events and trends, the picture that would emerge is not very comforting. For example, consider the following events and trends:

·         Assassination of Shinzo Abe.

·         Numerous acts of violence across USA and Europe, apparently perpetrated by random people who are not radicalized.

·         Blatant violation of international laws by Russia in invading Ukraine, as energy starved Europe overlooks the devastation of a sovereign nation.

·         China is threatening its neighbours’ territorial and economic integrity.

·         USA handing over Afghanistan to Taliban.

·         Communists (or socialists) winning elections (re-elections) in many jurisdictions, e.g., US, Germany, France, Italy, Australia, Chile, Mexico, Argentina, Bolvia, Peru, Honduras, and Columbia, etc. Polls are indicating that Bralians are most likely to lecet a leftist eader in October election, as Chinese premier Xi Jinping further strengthens his position at 20^th National Congress of CCP later this year.

·         Reliance of population on governments for meeting basic needs rising exponentially along with the rise in the ffinancial and fiscal vulnerabilities across the globe.

·         Frequency of mass public protests rising in various jurisdictions.

·         Tendency of governments to overregulate and over govern increasing across jurisdictions.

·         Expansion of NATO.

When I look at these events and trends and many other similar things happening around, I get a feeling that people of the world are tired of pretending politeness, being democratic and practicing non-violence. They appear eager to get over their guilty conscience and establish supremacy of their respective races. We may in fact be close to the return of Vikings Age 2.0.

In the past 6-7 decades, we have seen many countries being invaded in the garb of restoring or establishing democracies or people’s rule in these countries. Russia’s invasion of Ukraine ends that façade. This will perhaps re-establish the legitimacy of colonialism and imperialism. We shall see multiple such instances in the coming decades.

Before we reach a stage when the new Roman, British, Ottoman, Qing empire would rise, we need to cover a long distance. Who covers this distance fast while conserving enough energy and stamina to occupy the post would decide the new world order, maybe 40-50years from now.

More thoughts on this later.

I am pleasantly surprised to see an overwhelming response to my random thoughts on geopolitics, economy, businesses and markets shared through yesterday’s post (see Market’s tryst with reality). Even more surprising is the fact that all respondents are in agreement with my thoughts. This has happened for the first time since I started writing this blog.

 As I indicated last week (see here) to me markets are not looking good, at least for now. And it is definitely not only due to the latest episode of Russia-Ukraine conflict. This conflict has only added to the caution. My primary problem is the lack of adequate growth drivers for the Indian economy.

 “Kaya lag raha hai?” (How is it looking?) I am sure most of the financial market participants must be overwhelmed by this question in the past week. Obviously there is no accurate answer to this question in the present uncertain and volatile times. Regardless, every market participant is trying to answer this inquisition to the best of their ability and understanding of the situation. As the situation is still evolving and new complexities are getting added with each passing day, it is natural that the answers to this question will keep changing every day, and sometimes even within the same day.