Analyzing the Shifting Global Landscape and Its Impact on India’s Economy
Introduction
The notion of a “Goldilocks” economy is losing its appeal as the US treasury (UST) 10-year yield hits its highest level since 2007 at 4.70%, triggering a 7% rebound in the US dollar index. The resilient US economy has prompted a hawkish stance from the US Federal Reserve (Fed), defying expectations of a US recession. The Fed has revised its growth projections for 2023-24, lowered the unemployment outlook, and raised the inflation outlook to align with recent increases in inflation.( India’s Economy)
Factors Sustaining High Inflation -India’s Economy
Several factors contribute to the persistence of high inflation. Wage growth, asset price inflation, and the lingering effects of post-Covid support initiatives have kept household demand above its potential, thus fueling inflationary pressures. Additionally, the federal government’s fiscal expansion, which has risen by 61% YoY to $1.52 trillion from October 2022 to August 2023 (projected at $1.9 trillion in FY24), is generating further demand impulses.
Compounding Inflation Concerns-India’s Economy
The spike in global crude prices has escalated inflation concerns. The tug-of-war between the US administration, which aims to curb energy prices by depleting its strategic oil reserves, and the Saudi-Russia alliance pushing for production cuts to boost crude prices, has created uncertainty. The possibility of Brent reaching $100 per barrel looms near.
Impact on Core Inflation Measures-India’s Economy
The reciprocal increase in both Personal Consumption Expenditures (PCE) and Consumer Price Index (CPI) inflation may eventually affect core inflation measures, diluting the impact of the Fed’s tightening measures thus far.
The Contrasting Resilience of the US, China, and India
The US economy’s resilience stands in stark contrast to the slowing growth in China and the fragile household situation in India. This contrast raises the question: Is the world experiencing a two-track trajectory, and should we reconsider the validity of the Goldilocks assumptions?
Synchronicity vs. Dichotomy in Global Markets
While risk markets tend to believe in the synchronicity of market impulses, entrenched dichotomy might solidify into a discernable East-West divide, resulting in a changing world trade order and a focus on China plus-one territories. This transition could also alter the path of inflation, productivity, and global savings.
China’s Growth Challenges
China’s momentum has been relatively weak since the opening-up of its economy in 2023. The sustainability of the housing sector and underlying financial vulnerabilities point to nearshoring by advanced economies (AEs) as a weight on China’s structural growth, which is trending toward sub-4%.
India’s Private Consumption and Growth Outlook
India’s real private consumption has been subdued compared to pre-Covid levels (6.3% in pre-Covid period, 2010-19, versus 3.5% in 2HFY23-1QFY24) and is moving closer to the US average rate (2.6%). Despite the boost in headline real GDP growth projections at 6.5% for FY24E by the Reserve Bank of India (RBI), private sector growth, including household and private investment spending, is expected to average around 2.0-3.0%.
The Changing Dynamics of Global Trade and Financial Markets
As the global economy emerges from the Covid-19 pandemic, a significant shift in trade patterns and financial market dynamics has become increasingly apparent. This article explores the changing landscape of international trade, with a focus on the growing trend of near-shoring and friend-shoring by Western countries, led by the United States. It also delves into the implications for the Indian markets and provides insights into the potential risks and opportunities that lie ahead.
Shift in Global Trade Patterns
Over the past few years, there has been a noticeable decline in Asia’s share of US trade. From 40% in 2017, Asia’s share has now decreased to 35.8%. In contrast, Mexico, often referred to as the “New China,” has seen its share rise from 14% to 16%. These changing trade dynamics indicate a shift away from Asia and towards other regions.
Furthermore, the “China+1” strategy, which aimed to capitalize on opportunities outside of China, particularly for India, has been facing challenges due to cyclical headwinds. The contraction of the Chinese economy has had ripple effects on India’s exports and imports of goods, as well as a slowdown in services exports. This has resulted in a deceleration of the labor-intensive domestic services sector and a widening trade imbalance of non-oil products between India and China, reaching $84.4 billion, a 50% increase from FY19.
Financial Market Dynamics
In tandem with the shifts in global trade, there are key financial market dynamics that are guiding investment decisions differently from what was previously expected. Several factors are contributing to this transformation:
- US Resilience and Yield Spikes: Despite tightening measures by the Federal Reserve, the US economy has displayed resilience and challenged the steepest UST curve inversion in 40 years, leading to a spike in long-end yields.
- Rising Public Debt and Sovereign Downgrades: The worsening fiscal position in the US has resulted in a significant increase in public debt-to-GDP ratios across developed and emerging markets. This trend is exemplified by the recent sovereign rating downgrade of the US.
- Declining Savings and Money Supply: US savings have declined to the lowest level since 2008, reaching 5.6% of GDP from the post-Covid peak of 25.8%. Additionally, the US money supply-to-GDP ratio has decreased from its peak, reflecting a declining global savings trend.
- Decreasing UST Holdings: In line with declining global savings, both China and Japan have collectively reduced their holdings of US Treasury securities by $400 billion since January 2022.
The combined impact of these factors has led to a widening US funding gap and geopolitical fallout, resulting in oil-producing countries cutting supplies and potential disruptions in other markets. Consequently, the US Federal Reserve may be forced to keep rates higher for longer or even hike them, rather than cutting rates as previously anticipated. This global shift is expected to impact risk-free rates across the world.
Implications for Indian Markets
These changing trade and financial dynamics have significant ramifications for the Indian markets. Key implications include:
Tapering Foreign Currency Assets:
The Reserve Bank of India’s foreign currency assets have tapered, decreasing from $578 billion to $523 billion in line with other emerging markets in Asia.
Modest Foreign Investments:
Foreign investments in India are expected to continue to remain modest. The post-SVB crisis revival in Foreign Portfolio Investments is reversing, and Foreign Direct Investment flows are experiencing a decline. The monthly average FDI flows in the first half of 2023 were $1.8 billion, compared to pre-Covid levels of $3.6 billion.
INR/USD Exchange Rate Pressure:
The Indian Rupee (INR) is facing pressure from a strong US Dollar (USD) and higher crude oil prices. The Reserve Bank of India is defending the INR/USD exchange rate at 83-84 levels, resulting in tightened domestic liquidity through forex interventions.
Tightening Gsec Yields:
Given the historically low India-US 10-year yield spread, rising US rates, weakening INR/USD, and the potential for fiscal slippage, India’s long-term government securities (Gsec) yields have tightened. The 10-year yield has hardened to 7.25% and is expected to rise further to 7.30-7.40% in the near future.
Risks to Valuations and Volatility:
Modest endogenous growth, potential earnings downgrades, moderation of Return on Equity (RoE), and hardening Gsec yields pose risks to valuations of Indian benchmark equity indices. The Nifty, currently ranked 11 out of 25 indices, has remained stagnant over the past two years, yielding only 6% on a cumulative basis. Major sectors such as Banking, Financial Services, and Insurance (BFSI), oil and gas, and IT have underperformed. Consequently, there is a potential for increased volatility in the market.
The changing dynamics of global trade and financial markets are reshaping the economic landscape. The trend towards near-shoring and friend-shoring by Western countries, the declining share of Asia in US trade, and the financial market ramifications of the East-West divide are all contributing to this transformation.
For the Indian markets, it is crucial to navigate these shifts and adapt to the challenges and opportunities that lie ahead. Understanding the implications of changing trade patterns and financial market dynamics is essential in making informed investment decisions and managing risks in this evolving global environment.
Conclusion
As global market dynamics undergo significant shifts, India’s economy faces implications that require strategic responses. Adapting to this changing landscape is crucial for sustained growth and resilience. The divergence between the US, China, and India could reshape the world trade order and impact key factors such as inflation, productivity, and savings. By recognizing and addressing these challenges, India can position itself for long-term economic prosperity.https://www.estabizz.com/
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