Musings on 2014

As the New Year has come in so have new hopes and anxieties been kindled. 2014 is likely to be the turning point for the world in more than one way. We will have two key events play out, one political and the other economic:

• America and Iran are on course for a rapprochement, which will change the geopolitics of Asia. Israel, Saudi Arabia and Turkey are likely to feel the pressure from the coming settlement in the short and long-run. This will also create pressure points for large oil producers for the next decade like Saudi Arabia and Russia and will be beneficial for large oil importers like India and China. Geopolitically, this and Afghan draw-down will release US energy in central Asia to focus on the Russian front. India will bear the brunt of Afghan un-wind unless it can quickly move in tandem with a re-invigorated Iran and Russia to neutralize an emerging Afghan problem;
• On the economic front we are beginning to see the first phase of the massive unwind by the 2 key players: US and China. The Federal Reserve has expanded its balance sheet from less than 9% of GDP in September 2008 to ~25% of GDP currently. This massive expansion has had a disproportionate impact on asset prices and less than intended impact on unemployment in the US. Finally, the Federal Reserve has decided to scale down its level of balance sheet expansion and reduce the expansion to zero by end of 2014. China on the other hand a massive expansion in credit post the 2008 crises with M2 expansion of 175%  as against a much slower nominal GDP growth. This credit growth has stimulated sectors like infrastructure, real estate, commodity manufacturing. But this has resulted in uneconomic projects or over-capacity creating bad debts. Shadow banking structures have kept the money flow going but at higher and higher rates. This has already created 2 inter-bank seizures in the last 6 months. The communist party and the PBOC realize the follies but will move slowly but surely to wean the economy off-high monetary expansion. While these two economies unwind, emerging markets and more so commodity oriented economies will face the music and potentially, as has happened historically, a crises in one or more emerging market over the next 12-24 months. While the first sight of crises, however, is also likely to tempt the Federal Reserve to reverse course partially from its path (of reducing its balance sheet).

As these two key events play out, India will have its own political issues to deal with. The emergence of AAP as a political alternative in the medium term will further fragment the vote share and create a government with a limited life. But is this the beginning of the end of regionalism, caste and religion based politics? But this will surely not happen in 2014 and will leave it for some other time.

Indian interest rates will continue to be high as the ‘unwind’ creates currency related pressure and off-shore interest cost continue to rise. This will force a reduction in overall credit growth (domestic plus foreign). This should result in an incremental swing of savings towards financial assets (bank deposits, corporate bonds and bit towards stocks) as real estate continues to see pressure from tight liquidity and high rates. Private investment cycle continues to be in the future by at least 12-18 months. Oil prices are the joker in the pack and any significant down move will result in a positive impact on inflation, CAD and the fiscal situation. However, a word of caution will continue to dominate as the massive unwind unfolds and any crises in an emerging market could spark a significant collateral damage on India at least temporarily.

I do not expect the stock markets to do anything great in 2014. Staple consumption story has been overplayed with rural demand expected to re-adjust given lower MSP growth. Exporting sectors like Pharma & IT (although 6-8 months already in play) and high quality cyclicals are the place to be.

Ranbir and Katrina will possibly marry in 2014. And, like Socrates said,” By all means, marry. If you get a good wife, you'll become happy; if you get a bad one, you'll become a philosopher.” Finally, there will be more philosophers amongst us.