We have begun 2016 with deep
falls in global markets driven by fear of the Chinese ‘unknown’ and the
crushing impact of commodity prices on earnings and the financial system (loans
and derivatives backed by these commodities) and in the backdrop of sharply
rising schism between Saudi Arabia and Iran with the execution of a Shia leader
by Saudi Arabia followed by diplomatic reprisals. With this it is difficult to
invest in hope, but hope we must. So what I write about below are some developments
if they were to occur or begin in 2016 would augur well for the future. Given
their importance some I have already talked about in the past in depth so will discuss
it briefly and refer to my earlier articles.
Economic
1. My previous article on Imbalance had highlighted
the lack of internal demand in key countries like Japan, Germany and China (http://poleconomyindia.blogspot.in/2015/12/imbalance.html).
The scale of these excess savings can only be absorbed by the US. And, the only
way to do so productively is to embark on the next round of infrastructure
creation by giving fiscal incentives and policy impetus to private companies.
The U.S. ranks
#16 globally for infrastructure, according to the World Economic Forum:
- U.S. air travel is the world's most congested, due to "a shortage of airports runways and gates along [with] outmoded air traffic control systems";
- Only 2 of 14 major ports on the eastern seaboard will be able to accommodate the super-sized cargo ships that will soon be coming through the newly expanded Panama Canal;
- Almost one-third of the major roads in the U.S. are in poor condition;
- There are more than 14,000 miles of high-speed rail operating around the world, but none in the United States;
- US ranks #35 in Maths and #26 in Science globally (Based on average scores of 15 year olds taking 2012 Program for International Student Assessment);
- The last mile bandwidth has substantial copper coaxial cables which mean a slowdown in bandwidth speeds as they transition from fiber optic layer.
There is substantial opportunity to up the productivity
of the US economy through these investments and consequently also help generate
second order demand for commodities and other manufactured products.
2. Germany has always been a
formidable export engine with its engineering might. But these exports to the
European countries were subjected to the vagaries of exchange rates prior to
the Euro. Once the Euro came in Germans benefited the most, not only did the
export uncertainty to the Eurozone go away the Euro was the weaker than the
Deutschemark as it was sum total of Europe rather than just Germany, thus
helping exports to the world. Along with this Germans kept productivity
adjusted wages much lower than most countries in the Eurozone, almost to the
point it was 20-30% below Spain, Italy and France. This enhanced the
competitiveness of their exports. While household wages did not grow fast
enough restraining consumptions, the Germans used the export surpluses to
finance the consumption in the Eurozone. Unless this process reverses where the
Germans allow the rest of the Eurozone to become competitive by becoming less competitive
and consuming more, the risk to the Euro continues. Greece, Spain, Portugal,
Italy and others cannot continue to just internally adjust in the form of lower
wages or fiscal savings or lower employment. The recent pressure of immigration
has only increased the stress.
3. China has no choice but to face the adjustment. The
high investment to GDP and leverage in the system has to be unwound and I have
written multiple times about the same. This adjustment will result in very low
GDP growth barring a crisis. But the political reality of China is still
creating high growth in leverage relative to nominal GDP. Their inability to
manage market expectations with regard to their currency and their stock
markets is causing heartache in global markets. But there response has been
rather elementary - putting circuit breakers on the stock market, getting the
banks to expand leverage to market participants, getting the banks to intervene
in the offshore yuan market to drive up borrowing costs to astronomical 67%
among others. It is important to address some of the core issues which will
expand domestic consumption markets – free labor markets to enable movement of
people and their costs, paying real rates of returns to the savers and steps to
address income inequality. Higher interest rates domestically will also ensure
stabilization of the currency. But this will mean significant pain for the
corporate sector, impacting wage costs, interest cost and for the first time
they are managing currency risk. And, unless the market believes there is a two-way
risk on the currency the pressure on forex markets and domestic liquidity will
continue – China has lost almost a trillion dollars of foreign exchange
reserves.
4. The UK’s referendum for withdrawal from Eurozone
is scheduled before 2017 and it may happen in 2016 itself. The key sticking
points have been immigration and overwhelming EU rules on areas like trade,
environment, transport or consumer rights. If the UK elects to step outside of
the EU, politically it may impact its say in global affairs and business will
have to them comply with an alternate set of guidelines to access the European
markets. Britain’s exclusion from the EU single market could expose exporters
to external tariffs - cars imported at 10 per cent tariff, with food and
beverages facing surcharges of, on average, at least 20 per cent. Some Japanese
firms having European headquarters have already said that they may need to quit
or shift substantial operations to the mainland. This exit will have also have implications
for London as a center for European financial services – the companies may have
to establish subsidiaries on the mainland for their operations to additional
taxes. In all this will impact the levels of trading in sterling.
5. Over the last few years, India’s public debt has
been declining owing high nominal GDP growth rates and inflation. If real GDP
continues at >7% and CPI inflation stabilizes in RBI comfort zone of 4-5% (and
positive real interest rates) and GDP deflator stabilizes in the positive 2-3%
zone, then the debt will decline to comfortable levels. But GDP deflator has
been low to negative since January 2015 given the low global commodity prices.
If this situation continues India should then push for a more aggressive fiscal
deficit correction. The second big issue is the level of bad assets in the
financial system – NPL are at 4.8% and stressed assets another 6.2%. The number
may be in reality as high as 15%. The government needs to get the revised bankruptcy
act through, push recap of banks as a combination of state and public fund
raise, expediting stuck investment projects and finally better governance at
PSU banks.
Political
1. Ukraine
is very important for Russian security in more ways than one (http://poleconomyindia.blogspot.in/2014/10/global-disorder.html)
– Black sea provides the only access to warm waters of Mediterranean, gas
pipeline infrastructure, food security that Ukraine grain production provides and
geopolitical space. That Russia would respond to a Western influence
enhancement in Ukraine was inevitable. While lower oil prices is sapping
Russian capacity but Russia in the end only thinks geopolitically. Despite the economic
situation it has launched its act in Syria. It does not care about Assad but
finally having a seat at the table for the settlement where it will look to
extract concessions for its core interests. There is already a significant
constituency forming in Germany to lift the sanctions led by ex-Chancellor
Schroder but it is the Americans that the Russians want to reach a settlement
with. I think this settlement may elude in 2016 but it is one of the crises
sapping energy of multiple players.
2. The
most urgent political crises facing the world are the radicalism, sectarianism and
revisionism of the Middle-East (http://poleconomyindia.blogspot.in/2015/10/1979-and-middle-east.html).
It is a very difficult situation with no easy answers. The first step in this
affair will be dialing back the insecurities of the Saudis and reaching a
settlement on Syria. A settlement on Syria will take Russian active
intervention out of the equation, limit the space for Islamic State and address
to an extent the European immigration situation.
3. The
internal economic and consequently political pressure will keep rising in China
as the social contract undergoes stress. But it is important they do not redirect
public attention through external belligerence. This has already led to neighboring
states Japan and Vietnam to increase defense spending dramatically. The
nine-dash line issue and the building of artificial islands is creating
significant friction across the countries bordering the South China Sea. I had
written in September 2015 how China should look at the model of Bismarck’s
Germany to restrain itself (http://poleconomyindia.blogspot.in/2015/09/total-recall.html).
As you will notice China finds a
mention twice – economic and political - in the above article and will continue
to be the #1 risk for 2016. The Middle-East is the other powder keg. Both have
begun the year reaffirming that status but the hope is it won’t end that way.
“We must accept finite disappointment, but
never lose infinite hope” – Martin Luther King, Jr
…2016
