View from the Mars - 4

Continuing from yesterday (View from the Mars – 3)

In my view, the following issues may, inter alia, play an important role in shaping the contours of the new world order that may evolve in the next decade or so.

·         China presently is finding it hard to gain acceptance as a major global leader. One of the reasons is lack of democracy, which is still a major consideration for the western developed world. Besides, it is also regarded as an irresponsible power by the extant major global powers. Recently, the spread of Covid-19 virus from Wuhan laboratory, causing a global pandemic, has materially tarnished the image of China. In particular, the mistrust between the US and China have increased manifolds after the outbreak of pandemic, resulting in a Sino-US cold war. This cold war that may last for many years, or may be decades, may be a key determinant of the new world order. Important to note that Russia, which was a key WWII opponent of China, and key OPEC members – Iran & Saudi Arabia, and erstwhile strategic partner of the US – Pakistan, are overtly standing on the Chinese side in this cold war.

·         The vulnerabilities of the US and Europe have been exposed by the coronavirus. Post 9/11 incident, we saw dramatic changes in the concept of internal security in the US and many other countries. The suspects were shot dead without much provocation, disregarding all concerns for human rights and liberties. The culprits were chased and killed in foreign jurisdictions often disregarding sovereignty of these foreign lands. The diplomats, politicians and prominent personalities arriving in the US and the UK were strip searched and denied entry with impunity.

We may see further rise in xenophobic tendencies of the developed western countries. Another major impact could be a concerted effort to reverse the course of demography, especially in European countries that are turning old at an alarming rate. This could be achieved by substantial incentives for procreating aggressively or changes in the immigration policies to encourage young professionals from developing countries to settle there.

·         The global supply chain presently relies heavily on China for components as well as manufacturing services. Many developed countries get their fiscal gaps filled by China in lieu of using Chinese manufacturing services and allowing China access to their markets. The new world order may see a massive shift in this trend. Countries may seek to limit their fiscal deficits and seek diversification of their supply chains. This could present many opportunities & threats to the emerging economies like India.

·         The dominance of USD as the world's only reserve currency could face serious challenges from more neutral digital currencies, especially as a medium of exchange.

·         The ideas like free trade, personal liberties, etc. may face serious challenges from the rising tendencies of governments world over, which are eager to exercise enhanced surveillance and control over personal conduct and data.

·         The business models, valuation models, risk assessment techniques, commercial contracts etc. may need to be redefined to build in probability of frequent disruptions and conflicts.

·         The business and official ‘foreign travel’ may become ‘avoidable unless necessary’, due to rising scrutiny and excessive VISA restrictions.

·         The business continuity planning may become a mainstream subject for all businesses, not just for the mission critical processes and financial services.

·         A strong wave of debt defaults/waiver may hit the global financial system. Handling of this tsunami and subsequent recapitalization of the lenders will be a key challenge for the governments and central banks. Inappropriate handling of this challenge may eventually lead to shortage of growth capital and thus rise in cost of capital.

Where does India stand in this transition and what are the opportunities and threats?

I shall share my thoughts on this next week.

Also read

View from the Mars

View from the Mars - 2

View from the Mars - 3

Trade war cannot quick-fix

The master failing the first test

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 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, 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.

Also read

View from the Mars

View from the Mars - 2

Trade war cannot quick-fix

The master failing the first test

View from the Mars - 2

Continuing from my previous post (View from the Mars)

“Make America Great Again” (MAGA), campaign of President Trump has been one of the most successful political campaigns of recent times. The campaign won Mr. Trump and his Republican Party (GoP), a clear control of the white house, the Senate and the Congress.

From the campaign material available publicly, it is not clear what is the reference point for President Trump’s MAGA pledge. The campaign did not seem to have specified when did the greatness of the US begin to diminish and how much of the global stature, it supposedly enjoyed at some point in history, has been lost. For the lack of adequate information, it is safe to assume that the campaign of Mr. Trump, referred to the term of his predecessor, Joe Biden (2021-2025), as period of decline of America, and intends to revert to the status quo ante as on 19^th January 2021, when he vacated the White house after a four-year stay, and carry forward the unfinished agenda from his first presidential term.

A review of Agenda:47 (Trump’s campaign for the election of 47^th president of the United States), highlights that MAGA plan of Mr. Trump involves the following five key agenda points:

(i)    Reverting to pre-WW1 policy of isolationism (no interference in the affairs of the foreign countries where the US interests are not directly affected), strengthening the military, building a missile defense shield for the US, de-pledging from the NATO and UN, etc.;

(ii)   Assuming full control of government by eliminating agencies, departments, posts that can challenge the POTUS, using military for eliminating internal threats, and enhancing the powers of POTUS;

(iii)  Limiting immigration into the US to the qualified professionals who can contribute positively to the growth of US economy & society, and systematically expelling the foreign nationals who entered the US illegally or are burdening the US economy in any manner;

(iv)  Protecting and advancing traditional (Christian) values by curtailing liberal ideas of diversity, equity, inclusion, radical ideologies (e.g., gender affirmation), dealing strictly with the menace of drugs, etc., and a complete revamp of the education system, especially by dissipating the resources of private universities to fund a sate sponsored American Academy.

(v)   Strengthening the US economy, mainly through – (a) energy dominance by diverting focus from clean energy to the conventional energy and producing more for export; (b) balancing the US federal budget and bring interest rates down; (c) turning current account positive by onshoring manufacturing at a large scale and disincentivizing imports through higher tariffs; (d) making large investments in rebuilding infrastructure; (e) revamping the healthcare system; and (f) reducing tax rates to support household consumption and savings;

This agenda certainly resonated with average Americans households, especially conservative rural folks; financially stressed (and unemployable) urban households and white supremacist. They have been led to believe that immigrants have stolen their jobs; Canadian, Chinese, Mexicans and Indians are responsible for inflation & unemployment in the US; liberals have snatched their conventional parental rights; and the US has been unnecessarily and involuntarily dragged into wars in middle east, east Europe, Afghanistan, Vietnam etc., and withdrawing from these wars will save the US trillions of dollars; climate change is a hoax and they can get their tanks full by paying $6.49, if the US begins to drill gain.

I am not at all competent to comment on the US politics, US economy, and their geopolitical strategies. Nonetheless, I feel that the MAGA agenda of President Trump is nothing but an extension of the nationalist agenda that became popular post global financial crisis and gathered significant momentum post Covid-19 pandemic.

Several countries across the globe have seen ultra nationalist (mostly right wing) political parties gaining power; governments have preferred bilateral trade agreements over multilateral engagements; and major players of WWI and WWII are no longer shying away from expressing territorial and/or economic ambitions. Brexit is one of the examples of isolationist tendencies capturing politicians’ and the common public’s imagination. President Trump may just be following the trend.

In my view, ‘unsustainability’ might be at the core of this tendency. The profligate fiscal and monetary policies followed in the past two decades have definitely resulted in unsustainable consumption patterns and ecological climate damage. Given the massive demographic and economic inequalities, at global level and within countries, it may be almost impossible to find a universally acceptable solution for this unsustainable growth paradigm. Perhaps, therefore, societies are looking inward to set things back on track.

These days, conservation of resources, protection of territories, reversing demographic decline, reducing debt, promoting patriotism & nationalism are some of the popular themes with politicians. They are not hesitant in using religion, traditional & cultural values to emphasize on the necessity of authoritarianism (or a weaker democracy) in pursuing their agenda.

Historically, similar situations have invariably resulted in major conflicts and emergence of a new order. The moot point is whether we have reached the break point yet, or it may take a few more years (or even a couple of decades) of shenanigans to reach there.

Also read

View from the Mars

Trade war cannot quick-fix

The master failing the first test

View from the Mars

Have you ever wondered why—

·         In the post WW2 popular movies and novels, all mischievous and malevolent inhabitants of other planets and galaxies (‘Aliens’) attack only the United States of America (the US), especially the richest cities of New York and Los Angeles!

Whereas, there is evidence of just one attack (9/11 WTC attack in NY) on the US soil by a non-US citizen, in the post WW2 period.

·         Mostly, agents of the US secret services (or in few cases agents of the UK secret service) assume the responsibility of saving the earth from an imminent destruction (‘Apocalypse’) and always achieve the task successfully!

Whereas, there is overwhelming evidence of multiple failures of the US secret services. For example, they failed to prevent assassination of President Kennedy (1963); attack on WTC (2001); Capitol riots (2021); assassination attempt on Trump (2024). They also failed miserably in Vietnam, Cuba, Afghanistan, Palestine, Iraq, Pakistan, India, Maldives, Ukraine, etc. There are many instances of the US secret services or armed forces failing to prevent a major conflict or coup. In fact, the US is the only state to have used atomic weapon in the history of mankind.

·         A vast majority of US citizens truly believe in supremacy and superiority of their country?

Whereas the fact is that a significant proportion of the US population is unhealthy, unemployable, financially insecure, and indebted. The country is being basically pushed by brilliant immigrants, lured from developing countries, through attractive scholarships, and promises of liberty, equality, inclusion etc. Without the promise of DEI (Diversity, Equality, Inclusion), half their universities could become unviable, making higher education even more inaccessible for a large majority of the local population.

To joke, the US is the boy, who is a poor cricket player but owns the only bat available to the team. He is entitled to play as the captain.

The short point is that the programs like USAID (mostly a disguise to bribe foreign governments and think tanks enjoying significant influence on their respective governments), DEI, NATO financing, birthright citizenship, generous contributions towards the IMF, UN and Red Cross etc., have earned the US a wider acceptability. The world has ignored all its misadventures, atrocities, and exploitations including Vietnam, Afghanistan, and Iraq.

If President Trump and his advisors want to end these programs, throw out cheap labor and brilliant students, weaken USD, alienate trusted and old-time allies like Canada & Germany, push the allies like India away and closer to the opposite camp (Russia and China), and risk the presence and security of the US resources scattered all across the world they ought to have a full proof plan that is still not known to us.

Who knows, maybe they are just testing the waters by bluffing the world and do not intend to carry out much of their threats. Maybe they would tactically unroll most of their actions taken in the past two months, changing the nomenclatures of programs like USAID.

Notwithstanding, one thing is very clear that the US economy is weakening and MAGA is a much longer project than Mr. Trump's presidential tenure. …more on this next week.

Trade war cannot quick-fix

In the year 1689, British monarch William of Orange put steep tariffs on French wine. He wanted to encourage the British to drink their own booze - make and drink. It was not a great idea because without wine, Britain turned to the hard stuff - gin. So, for the next 50 years, England was in the grip of the so-called gin craze. And newspapers wrote about the surge in crime and death and unemployment.

In the 18th century, Britain put trade restrictions and taxes on tea being shipped to the colonies. This eventually led to the Boston Tea Party, an iconic event in the American war for independence.

In the 1800s, the Brits were importing a lot of tea from China, and they didn't like the trade deficit, so they started to export opium to China, which caused an opium epidemic in China. China put a tariff on opium and then banned it altogether. This led to the very bloody Sino-British Opium Wars. The Qing lost the war. This defeat is popularly believed to be the first step in the direction of establishing modern day China.

Restrictions on the trade of cotton textile, indigo, salt etc. by the British empire on India inspired many key events in India's war of independence.

Soon after its unification in 1871, Italy turned to protectionism to foster its “infant” industries. It terminated its trade agreement with France in 1886; raised tariffs as high as 60 percent to protect its industries from French competition. The French government responded by passing the highly protectionist Méline Tariff of 1892, which famously signaled the death knell of the country’s flirtation with free trade. This eventually pushed Italy closer to Germany and Austria-Hungary in the years leading up to the First World War.

A famous example of protectionism gone awry is 1930’s Smoot-Hawley Tariff Act—which along with similar protectionist measures enacted around the globe—helped torpedo world trade, killing two third of the global trade, and exacerbate the Great Depression leading to WWII.

In the post WWII era, US trade restrictions on Cuba, Iran, Iraq, Russia, North Korea, Syria etc. have had a significant impact on global strategic balance.

Wider economic sanctions on India in the wake of 1998 nuclear tests, helped India develop indigenous technologies and evolve as a major power in space technology.

There is a strong view that America’s “trade war”, with Japan in the 1980s, was one of the best things that ever happened to American industry and consumers, because American businesspeople rose to the challenge of the time. The "quality movement" spread across the country. Businesspeople, previously outraged by the Japanese “stealing” trade secrets, decided to join the club and took to “benchmarking” on an industrial scale, often with Japanese companies as their targets. The benefits of all that attention to quality were large and durable for US businesses and consumers. In the end, the “war” did not prove to be destructive.

The short points are:

·         Trade wars perhaps as old as the cross-border trade itself.

·         Trade wars have often culminated in larger geopolitical conflicts and resulted in changes in the global maps.

·         Trade wars have been mostly caused by (i) distress in the domestic economy of the aggressor, promising protection and assurance to the local businesses; and/or (ii) eroding credibility of the extant political leadership, resulting in such leadership raising the rhetoric of aggressive-nationalism and external threats to the national integrity to protect its position.

·         There is evidence of trade wars causing structural shifts and paradigm changes in the global economy. However, there is little to suggest that but for trade wars, the world would have been a better place.

In my view, the latest specter of a wider trade war has been unleashed by the US administration to find a quick-fix solution to economic malaise, the US economy is suffering from nearly two decades of fiscal and monetary profligacies.

The US public debt has increased from US$3.41 trillion in the year 2000 (~35% of GDP) to US$29 trillion (~105% of GDP) currently. In this period, the fiscal deficit has risen from a US$236 billion surplus in the 2000 to a deficit of ~US$1.8 trillion currently. This is obviously not sustainable and needs to be corrected.

The moot point is “Whether trade war is a good solution for correcting historical mistakes?”

The master failing the first test

Ever since the self-proclaimed master in the “art of deal making” re-entered the White House, January 2025, after a hiatus of four years, the atmosphere has been filled with greater uncertainties. Each time, the great negotiator sits behind his newly acquired table in the Oval office, or holds a mike in the James S. Brady Press Briefing Room, he adds little more to these uncertainties.

The President of the United States (POTUS) is announcing a material hike in trade tariffs, pausing his orders, deferring implementation of his orders, and reinstating his orders as if he is ordering his evening snacks and not able to decide between coffee and soup. His administration, including the Alpha male, VPOTUS, and the Smartest man in-charge of DOGE, for some strange reasons, is not briefing the POTUS that changing tariff may, inter alia, require—

a)    some preparation on the part of trade and custom authorities to adjust their systems, documentation, and software;

b)    a lot of effort for the traders – who need to renegotiate the previous contracts and adjust the pricing accordingly;

c)     significant adjustments by the downstream value chain, including the ultimate consumer who might have to bear the impact of tariff hikes;

d)    monetary authorities to assess the impact of the changes in tariffs on the overall price curve and corresponding monetary policy response, if any required;

e)     counterparties to decide on the strategy to deal with the revised tariff. The response may be aggression (reciprocal hike in tariffs) requiring further adjustments by the importers, and downstream value chain; and

f)      financial markets to assess the impact on businesses, currencies and rates, and accordingly adjust the discounting factors, option pricing, etc.

The uncertainties created by frequent policy flip-flops of the POTUS, is also impacting the supply chains globally, as both the buyers and sellers are in a state of flux. If it continues like this, soon we could see a repeat of Covid like supply chain disruptions including logjams at ports, shortages of containers.

Sensing that the POTUS may be bluffing, the Chinese authorities have already placed a 2x blind bet by announcing that China (biggest trade partner of the US) is ready for any kind of war. Responding to the 10% extra tariff imposed by the US, China’s foreign ministry spokesperson Lin Jian said: “Exerting extreme pressure on China is the wrong target and the wrong calculation … If the US has other intentions and insists on a tariff war, trade war or any other war, China will fight to the end. We advise the US to put away its bullying face and return to the right track of dialogue and cooperation as soon as possible.” (see here)

Canada and the EU have also responded aggressively to the Trump Tariff threats.

“Canada’s initial retaliatory tariffs against the U.S. will remain in place despite President Donald Trump postponing 25% tariffs on many imports from Canada for a month, two senior Canadian government officials said. (see here)”

“We will not let ourselves be bullied, not with tariffs nor with threats about our legislation,” said Bernd Lange, a usually mild-mannered German Social Democrat who chairs the European Parliament’s international trade committee. (see here)

We would soon know whether the great negotiator is actually bluffing or is serious about his MAGA pledge; and is willing to make the US businesses and consumers (and the US economy) suffer medium-term pain, as the local manufacturing base is rebuilt (without the benefit of cheap and abundant immigrant labor) over the course of next 5-7 years.

Besides the tariffs, the POTUS has also threatened to withdraw from the multilateral institutional frameworks like NATO, the UN and IMF etc. The recent developments in Ukraine and Palestine indicate that NATO is no longer a potent deterrent to war, and the UN’s credibility is eroding at the fastest pace since the attack on Iraq on a false pretense of WMD. The withdrawal of the US (the largest fund contributor to these institutions) will only precipitate the inevitable.

…more on trade war tomorrow

Correct your reference point

Recent interaction with the market participants indicates that the sentiment of fear is now strongly dominating greed. Most of the investors/traders are complaining of pain in their respective portfolios.

Indubitably, the portfolio values have corrected noticeably from their September 2024 high levels. However, the damage is far less as compared to the previous major bear market, which lasted for almost thirteen months (2008-2009), followed by a 20-month period of recovery (March 2009-November 2010) and a three-year period of consolidation (November 2010-October 2013).

We had a tentative two-year market cycle between 4Q2013 and 1Q2016, before the latest proper bull market started at the end of February 2016. Notably, this bull market has been the longest one (8 years); and it is still not certain that it has ended on 26^th September 2024.

Pain-check

In my view, the pain from stock price corrections could be of two types – absolute and emotional.

Absolute pain occurs when an investor or trader loses his capital permanently. This may be due to excessive leverage, error of judgement in the stock selection, and/or liquidating portfolio at a low point due to panic.

Emotional pain occurs when an investor or trader becomes greedy and internalizes the excessive returns as normal. The pain is felt when the market reverts to mean and excessive returns made during the euphoric phase evaporate, leaving only normal returns for them.

It is therefore important to use a correct reference point for “pain-check”.

So far, most of the regular investors/traders may be feeling emotional pain only, as the correction so far has been mild and they are still earning normal returns (13% CAGR on Sensex and 18% CAGR on BSE Smallcap) since February 2016 when the latest bull market started.

For traders and investors who started investing/trading in stocks and/or mutual funds in 2020, the returns are still above normal (15% CAGR on Sensex and 26% CAGR on BSE Small Cap since September 2020 when lockdown was lifted after the first Covid wave).

It is important to note that during the last bear market (2008-13), stock price correction lasted for 13 months - from the end January 2008 to early March 2009. However, January 2008 high levels were not breached till October 2013. The 2008-09 correction was so severe that it not only eroded entire gains earned during July 2006 – January 2008, but erased a significant part of the invested capital. In the end (March 2009), the Sensex was 18% lower than the starting (July 2006) level; while Smallcap (-41%) and Midcap (-36%) were sharply lower. In comparison, the investors and traders are in a significantly comfortable position in the present correction.

Growth normalizing in a lower orbit

As per the latest national accounts data released last week, the economic growth of India appears to be normalizing in 6.5% +/- 0.3% band. Optically, this growth rate may appear decent; but is insufficient for achieving the target of catapulting the Indian economy into a higher orbit and sustaining the status of a middle-income economy.

After recording a higher growth rate of 8.8% CAGR for three years (FY22 to FY24) on a low base of Covid affected FY20 and FY21, the FY25 growth is estimated to be 6.5%. The consensus estimates for FY26e growth are also hovering around 6.5%.

From the internals of the economic data, it appears that growth trajectory of the Indian economy is settling in the current band, just like we spent decades in the 3-4% growth band in the pre-reform (1990s) era. Any effort to accelerate the economic growth would require transformative socio-economic reforms in the next five years.

 

Some critical points that need to be watched closely from the perspective of growth sustainability and acceleration could be listed as follows:

·         The share of primary sector that employs the largest share of workers has deteriorated from 22.1% in FY21 to 19.8% in FY25AE. The share of the secondary sector has also declined from 25.6% in FY21 to 25.2% in FY25AE. Especially, the share of manufacturing in the GDP is low at 14%, and has not recorded any material improvement despite the material incentives like PLI, etc. FY25AE growth of manufacturing is estimated to a dismal 3.5%.

·         The gross savings rate of the economy has fallen to 30.2% of GDP in FY25AE, materially lower than 33.8 in FY12, when the new GDP series started. The investment rate has also fallen in this period from 39% in FY12 to 31.4% in FY25AE. The household & corporate savings and investments have seen decline in FY25E. The government investment and consumption has been supporting the investment rate to stay above 30% of GDP. The fiscal constraints are indicating that this support may weaken in the coming years.

·         Early reports are indicating that Rabi crop in many states has been materially damaged by unusually dry and warm winters. Sugar production for SS25 is expected to be ~14% lower; while wheat crop may be 25-35% lower. Oilseed and pulse crops have also suffered damage. This data will reflect in 4QFY25 and 1QFY26 agriculture GVA and private consumption numbers.

It is important to note that MFI sector is already burdened by a material deterioration in the asset quality. Poor Rabi crop may add to the rural stress and adversely impact the overall consumption demand, given that urban demand is not showing signs of improvement.

It is therefore very much possible that the actual FY25E growth comes lower than the second advance (AE) estimates.

·         The global trade uncertainties are rising with the passage of every hour. A situation of material trade logjam, supply chain disruption, accelerated tariff war and/or high volatility in currency markets is not completely improbable. If any such situation does materialize, it may materially hurt the growth prospects and external vulnerability of India. 

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”.

My watch list

Continuing from my previous post (Bull fatigue or bear charge), I would like to share some of the important things I am presently watching closely to assess whether we are passing through a bull market correction or a proper bear market cycle is underway.

Rural income: The recent corporate commentary has highlighted green shoots seen in the rural demand recovery; while the urban demand continues to remain under pressure. For meeting the latest earnings estimates, continued recovery in the rural demand is, therefore, important. Earnings growth of some sectors like consumers, automobile, textile agri inputs & equipment, etc. materially depend on the continued rural demand recovery.

I note that there are some worrisome signs for the rural economy.

First, the 2024-25 winter has been unusually warm and dry. Several states have witnessed drought-like situations and warm weather. Reportedly, Wheat farmers in the northern regions could be staring at a sharp decline in rabi production. Some farmers are expecting upto 50% fall in wheat production due to warmer winter. Pulses and oilseed crops are also feared to be adversely impacted. (see here).

Second, present El Niño-Southern Oscillation (ENSO) weather forecasts are not indicating a strong preference for La Nina (excess rains) or neutral (normal rains) during the Indian monsoon season (July September). These conditions can change materially over the next three months. Given the importance of a normal monsoon for the Indian economy, especially the rural economy, ENSO developments need to be watched closely.

Liquidity: Banking system liquidity bears a good correlation with stock markets. Post Covid-19 monetary and fiscal stimulus resulted in over Rs12.50 trillion of surplus liquidity in the Indian financial system. This massive liquidity surplus resulted in a sharp surge in asset prices, especially stocks and real estate. That liquidity has completely dried. The Reserve Bank of India (RBI) has systematically withdrawn liquidity over the past couple of years. The system liquidity continues to be in deficit despite the measures (50bps CRR cut and Rs1.5 trillion sustainable liquidity infusion through OMO) taken by the RBI. (see here) A further USD10 billion three-year swap (buy/sell) has also been announced to augment the system liquidity.

 

However, even after these measures, system liquidity continues to be in deficit, as the RBI liquidity injection has been mostly neutralized by USD15bn sale in open market by RBI to check fall in USDINR; and the rise in the government balance with RBI. Given the persistent selling by FPIs in YTD2025 and worsening CAD, the pressure on USDINR may sustain. Under these circumstances, it is important to see how RBI manages to inject sufficient liquidity in the market. A change in policy stance from “neutral” to “accommodative” may be an important hint.

In the global markets, the US and Japan money supply (M2) has started to rise again in 1Q2025 after falling in 4Q2024; while the money supply in China remains at all-time high.

Inflation: The incumbent US President appears to be quite unpredictable. Regardless, his latest actions, in tandem with his commitment to safeguard USA’s economic and strategic interests at all costs, indicate that the US may impose sharply higher tariffs on imports from key suppliers like China, India, EU etc. These tariffs, if not fully absorbed by the suppliers through a mix of currency devaluation and margin adjustments, could be inflationary for the US. Consequently, we may see higher inflation, higher policy rates and bond yields and a much stronger USD. This could eventually be deflationary for the global economy as a whole.

A stronger USD and JPY, and higher bond yields, could result in further unwinding of carry-trades. Emerging markets economies and assets may face strong headwinds.

India, in particular, could be vulnerable due to slowing growth, expanding CAD, declining FDI, higher relative valuations (continuing FPI outflows), slowly depleting Fx reserve, and contracting yield gap with the US, etc.

A poor monsoon, on the back of below par Rabi crop, could halt the RBI easing cycle, as food inflation picks up and food import bill also rises.

It is therefore important to keep a close watch on the US trade policy, and the inflation trends.

Corporate earnings: the past couple quarters have been disappointing in terms of the corporate earnings, triggering a wave of earning downgrades. After the latest (3QFY25) results, Nifty EPS has witnessed 2-3% downgrade. If this trend continues in 4QFY25, the earning downgrades could accelerate. A leading stock brokerage firm (Kotak Securities) now expects Nifty EPS of Rs 1032 in FY25E, Rs 1179 in FY26E and Rs 1348 in FY27E with the Nifty trading at 22.2x FY25E, 19.5 x FY26E and 17.0 x FY27E.

 

The Nifty valuations are presently close to their long-term average (10yr). However, as another brokerage (nuvama) highlighted, most sectors are already close to their peak margin. Hence the prospects of a PER re-rating are remote, while PER de-rating are real.