Articles in Category: Macroeconomics

India is booming, the Indians would claim — and who could deny they are doing well?

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The economy grew at 7.7% from January through March, expanding gross domestic product (GDP) to $2.6 trillion, eclipsing France to become the world’s sixth-largest economy.

Source: Stratfor

But while growth has been impressive, questions are being asked about how much longer the economy can keep it up.

Rising U.S. Fed rates and increased U.S. Treasury bond issuance are squeezing global dollar liquidity and depressing the Indian rupee (relative to external currencies in which India imports).

The rupee has tumbled more than 8% against the rising dollar in 2018, according to a Stratfor report. India is the world’s third-largest consumer of oil and imports nearly 80% of its crude, the report states.

Since oil is a key input across various sectors of the economy, rising crude prices will put upward pressure on inflation, which rose to 5% in June (a five-month high).

With an election coming up in 2019, Prime Minister Narendra Modi will be unlikely to raise interest rates too much, or rein in spending as he courts the farmer vote, or worry unduly if the deficit reduction targets are not met this year or next.

Securing a new five-year term will override such considerations at the expense of longer-term fiscal improvements. In the process, he will store up issues for the next administration; the longer they are allowed to grow, the more severe the corrective action will need to be.

On the plus side, a lower rupee will boost exports, making Indian industry and service providers more competitive — or, at least, more profitable on the international market than previously.

But with only 18.9% of GDP attributable to exports, the economy is more likely to be harmed by higher import costs fueling inflation and an outflow of currency reserves than it is the benefit from an increase in exports.

India’s current account deficit in the fourth quarter of fiscal year 2017-18 ballooned to $13 billion, Stratfor reports, while by comparison, its current account deficit for the whole of fiscal 2016-17 was only $14.4 billion.

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India may be growing strongly this year, but history has shown it needs to. With 12 million young people coming onto the job market each year, if India is to grow its minuscule middle class to become the engine of consumption that it has in China, the country has to generate a lot of well-paying jobs in the year ahead.

Steady as she goes should be the captain’s orders, not boom and bust.

Stock markets in the West react to peaks and troughs on the Shanghai stock market as if the market were a true indicator of the health of the Chinese economy. Shanghai has been down since talk of sanctions has spooked markets in China, Europe and the U.S.

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But in some parts of the world, where dependence on China is more than a simple +/- 0.1% of GDP, whole economies are reacting to the fear of a slowdown in China.

A recent Financial Times report details how the Aussie dollar has slumped 4.5% in just two weeks. Trade tensions have risen over investors’ fear for the prospects of the country’s largest trading partner, an indicator of how dependent has Australia become on China’s health and prosperity.

Likewise, copper, which for decades has been dubbed “Dr. Copper” for its supposed sensitivity to the health prospects for global growth, should maybe be renamed “Sino Copper” for the way in which it increasingly has become tied to the fortunes of one country (China) rather than the global economy.

After touching a four-year high of $7,348 a ton on June 7, copper has plunged 14%, or more than $1,000 to $6,303 a ton, the Financial Times reported, as investors fear a slowing China will be detrimental for copper demand later this year and next.

China is the world’s largest importer of copper, and Australia — the fifth-largest copper producer — is intimately tied to the world’s second-largest economy. China is its biggest customer, not just for copper but also for iron ore, coal, aluminum, bauxite and a range of other materials.

A follow-up article will analyze a wider range of metrics to better understand the state of the Chinese economy and to what extent the country’s growth trend for 2018 is a direct result of tariffs (compared to factors in play before April).

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What that will show is that China had much to contend with prior to tariffs and a trade war broke out. While massive foreign exchange reserves and a well-funded banking system means the economy is essentially sound, the current trade issues have come at a bad time for policymakers in Beijing and may partly explain the relatively restrained response from the authorities.

Last week was quite the week in Europe.

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U.S. readers may only be picking up the roller coaster in Italian politics via the fluctuations in their pension fund share portfolio values, but it is probably no exaggeration to say European democracy has been tested this week … and the process is far from over.

Italians kicked the process off with March parliamentary elections that ushered in months of wrangling between the two biggest winning parties, the anti-establishment Five Star Movement (or M5S) and the far-right League, formerly known as the Northern League. Both are considered to be the most extremely populist parties Europeans have voted for in decades. When they finally formed a working coalition with an aim to form a government, markets got nervous that many of their campaign promises may actually be put into practice.

Sound familiar?

Well, those fears crystallized when Five Star Movement head Luigi Di Maio announced the appointment of Euroskeptic economist Paolo Savona for finance minister, before the Italian president overruled them (at the behest of Brussels, many believe).

Even if President Sergio Mattarella acted in isolation, his willingness to go against the politically elected representative with the avowed aim of protecting the Euro and the European ideal, is a remarkable case of prioritizing European stability over national democracy. His actions were no doubt attended by sighs of relief in Brussels, Paris and Berlin, where the rise of populist parties in Europe and elsewhere have been met with disdain and derision.

Savona is well known for his anti-Euro views and his proposed appointment spooked markets, which promptly took fright. Investors dumped Italian debt and spreads between Italian and benchmark German rates spiked.

Source: Reuters, Adam Samson/Financial Times


Meanwhile, bank shares across Europe were dumped as investors feared Italy could crash out the Euro and banks would be left nursing massive liabilities, despite the fact most debt is held by the European Central Bank (ECB) after months of bond buying under quantitative easing (QE).

The bank share price collapse is what led downfalls in share prices across the world. Yet, after a few days of uncertainty, markets are recovering after M5S indicated it may be willing to reconsider the appointment of Savona. The League is not sounding quite so conciliatory, but the two parties are back in discussion to try to find a solution.

The irony is if Italy is forced back to the polls, the two parties will probably increase their share of the vote. There has been widespread support across Italy for their actions since the March election, but if they increase their share of the vote it will provide an even clearer mandate for an anti-austerity, reflationary, debt-fueled agenda.

Early comments from European politicians — such as Günther Oettinger, Germany’s E.U. commissioner — that upheaval in the markets would exert healthy, pro-European discipline on Italian voters were met with derision across the country, as it was seen as Brussels telling the Italians how to vote. Oettinger’s comments on German television — “My concern and expectation is that the coming weeks will show that developments in Italy’s markets, bonds and economy will become so far-reaching that it might become a signal to voters after all to not vote for populists on the right and left” — were promptly slapped down by more media-sensitive officials, like European Council President Donald Tusk, forcing Oettinger to issue an apology.

Italian President Sergio Mattarella tried to appoint Carlo Cottarelli, a former International Monetary Fund (IMF) official, to form an interim government, but that simply encouraged M5S and the League to get back to the negotiating table to find a solution of their own.

This story has a long way to run.

Italy has lagged behind the rest of Europe’s major economies for the last decade with minimal growth. Voters blame the E.U. — and, in particular Germany — for the trend. Germany is running a persistent current account surplus of 6%, well above E.U. rules, yet is not being held to account.

Italy feels if Germany can break the rules to the detriment of fellow E.U. states, then why cant they? Why should the economy be hobbled by debt limits and austerity when fellow E.U. members flout the rules?

You can see their point.

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In such an atmosphere, the rise of populist parties is understandable, even if their solutions make little economic sense.

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It is a question we often see on the financial pages of newspapers or news sites, but rarely take time to seriously consider the consequences – why is the West apparently in a period of stagnant productivity growth?

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A recent article in The Telegraph explores the position for the U.K., but many of the trends observed — and, likely, reasons behind — Britain’s poor productivity growth are very similar to those in the U.S. and the rest of Europe.

For the sake of good order, we should define productivity growth. Simply put, it is a measure of the efficiency of production, usually measured as the ratio of inputs to outputs, or output per unit of input. Clearly, for workers to be paid more without a firm going bankrupt, just as for a country to raise living standards without living beyond its means, productivity per unit of labour has to increase over time. And so it has broadly over time, but not in a straight linear fashion, and therein lies a clue to our current malaise, the authors of the article suggest.

The article draws substantially on comments made and work done by Ben Broadbent, the Bank of England’s deputy governor. Broadbent fears Britain is past its peak and destined for a sustained period of poor growth in living standards due to stagnant productivity growth. Measuring productivity growth is far from easy, not least because “work” changes. In the days when most outputs were delivered by the manufacturing industry, it was easier to measure inputs and outputs; in today’s digital world, many services, like the internet, are largely free at the point of use.

Yet even so, the trend is clear: over the past decade, productivity has grown by just 2.1%, according to the Office for National Statistics as quoted by the news source. That is compared to before the financial crisis, when it typically grew by more than 2% every year. As a result, for much of the 2008-2014 period, real wages were in negative territory, a situation that was variously blamed on the financial crash, low interest rates perpetuating companies that would otherwise go bust, and lack of finance to allow firms to invest.

But Broadbent believes it is more deep-seated than those reasons, saying the wave of benefits seen from digitization we accrued in the 1990s and early 2000s has now passed. In addition, he argues, our position now is more akin to the industrial world’s lull between the age of steam and the onset of electricity – the big gains arising from steam had all been made yet and the benefits of electrification had not been felt, such that firms did not have a technological advantage encouraging investment, growth and expansion or face the threat of being left behind.

So far, there is limited evidence of new technologies like the mobile internet, artificial intelligence and mass automation transforming productivity. Broadbent believes it is simply too soon, but that given time and further technological progress, we could see these technologies having a transformational impact.

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Let’s hope so. Combined with the impact on traditional manufacturing jobs that globalization has had in mature markets and the growing disparity in incomes during this century, populist politics could have a destabilizing effect on Western societies, which will only be encouraged by a prolonged period of flat, or worse, negative growth in standards of living.

India has over-promised and under-delivered on so many fronts over the decades.

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Home of the world’s largest and, despite its young age and huge diversity, still thriving democracy, it has promised growth to rival China. Apart from brief bursts of activity, it has generally failed to live up to its plaudits expectations.

One reason often cited, apart from chromic infrastructure and the legacy of a British love of bureaucracy, is endemic corruption.

Graft had become so deeply engrained in Indian business culture that many had written the country off from delivering sustainable long-term growth for its hundreds of millions of poor. The relatively very few rich got richer while the miserably small middle class grew so painfully slowly compared to China that many thought India would never haul itself out of its emerging-market status.

But critics had not factored in Narendra Modi. While not everyone would support his Hindu-biased populism, he has brought immense progress to India, overcoming entrenched interests with a politically astute skill and dynamism.

There is still a long way to go, but a recent Economist article describes how he has taken the fight to the ruling business elites in a blitzkrieg campaign to dismantle tycoons’ practices of personalizing gains and socializing losses.

Founding shareholders of Indian companies have long made use of a loophole of Indian corporate law that prevents banks from seizing companies in default on their loans, so owners of companies can run their organizations badly or, worse, suck out funds for personal gain with little fear of losing their money-making enterprise.

The system has actively perpetuated this system with a bunged up judicial system that takes months, if not years, to hear cases and state banks’ lending to firms on the basis of personal connections rather than sound business-lending principles. This cronyism was almost encouraged by officials not wanting banks to post losses, such that state banks are kept afloat by the government yet are carrying massive debts which will never be repaid.

Modi’s government new bankruptcy code came into force in May 2016. After almost two years of preparation, the first big cases have hit the headlines last month, The Economist reports. The fate of 12 troubled large concerns amounting to 2.2 trillion rupees ($33.4 billion) of non-performing debts is due to be settled within weeks. Another 28 cases worth a further 2 trillion rupees are set to be resolved by September. Between them, these firms account for about 40% of loans that banks themselves think are unlikely to be ever be repaid. In total some 1,500 companies are said to be insolvent, according to The Economist.

A new set of dedicated courts, backed by a cadre of insolvency professionals, is on hand to help banks seize assets and sell them to fresh owners, the article states. To focus the minds of both bankers and borrowers, if no deal can be cut within nine months the firm is shut down and its equipment sold for scrap.

As a result, those looking for cheap, distressed assets are already circling for pickings from the current 12 and 28. Such turmoil on this scale will create a short-term drop in investment as firms hold off to see what becomes available. In the longer term, the process of death and renewal will probably be highly dynamic for the economy.

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It will also focus the minds of today’s Indian tycoons on running their businesses better and courting political favor less. Indian business is shifting focus from “who you know” to “what you know,” which is definitely a good thing for the health of the country in the future.

Be assured there will be a next crisis — there always is, sooner or later.

It is the nature of economic cycles that markets get out of balance and have to readjust. That sounds like rather a benign process, but of course we all know there is plenty of pain and many casualties when it happens.

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An interesting article in The Economist analyzes the reasons why market crises arise and, from that, where it believes the next one is developing.

To quote the report, financial crises tend to involve one or more of these three ingredients: excessive borrowing, concentrated bets, and a mismatch between assets and liabilities.

The crisis of 2008 was so serious because it involved all three — big bets on structured products linked to the housing market, and bank-balance sheets that were both overstretched and dependent on short-term funding.

The Asian crisis of the late 1990s was the result of companies borrowing too much in dollars when their revenues were in local currency. The dotcom bubble had less serious consequences than either of these because the concentrated bets were in equities; debt did not play a significant part.

As for the next crisis? The Economist report indicates the cause of the next one is probably lurking in corporate debt.

Read more

Numerous factors weigh heavily on the base metals and commodity complex: the Chinese copper scrap ban, the Section 232 proclamation on aluminum and steel combined with country-specific exemptions set to expire on May 1, the Section 301 investigation, and multiple strikes at copper and nickel mines to boot. After the turmoil of the first few months of 2018, MetalMiner reviews how base metals and commodities performed during Q1.

Aluminum, copper and nickel on the rise

Aluminum, copper and nickel prices started 2018 weaker than at the end of 2017. The end of 2017 showed a sharp rally for these base metals, following the bullish uptrend that began in the summer of 2017.

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The short-term downtrend sounded alarms as prices dropped significantly, not finding a floor. However, LME prices started to climb at the beginning of April, leaving the downtrend behind.

Read more

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We have been far from alone in issuing periodic warnings about the implications of rising interest rates for a global debt market that is out of proportion to levels seen even before the last recession.

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Fortunately, one of the first test cases has deep pockets and enough experience to deal with it.

But even so, Hong Kong’s housing market is so overstretched it is at risk of collapse if rates rise too soon or too high. According to The Telegraph, 90% of Hong Kong’s mortgages are linked to three-month Hibor (HK interbank lending rates).

Because of its currency peg to the U.S. dollar, Hong Kong is being forced to intervene to defend the peg and stem capital outflows, as global interbank rates rise and the Fed tightens. According to The Telegraph, the authorities are preparing to sell “exchange fund bills” to drain liquidity, raising fears of a credit squeeze and a property correction that could quickly turn into a collapse. “The Hong Kong dollar is at its weakest level in 33 years. It suggests an imminent risk of capital flight,” Francis Chan, a bank analyst for Bloomberg Intelligence, is quoted as saying.

Source: U.S. Federal Reserve

The price-to-earnings ratio of the local property market has reached an all-time record of 19, compared to the previous peak of 14 at the onset of the East Asia crisis in 1998, the article states, noting that episode was followed by a 60% crash in house prices. The article notes the Bank for International Settlements says Hong Kong’s financial system is the most dangerously overstretched in the world.

Source: Nomura

The “credit gap” is 45 percentage points of GDP above its long-term trend, a sign of extreme behavior and the best-known predictor of banking crises. The BIS says that any persistent gap above 10 points is a warning. Currently, Hibor is still around 1%, while three-month U.S. dollar Libor rates have risen to a 10-year high of 2.29% – up 50 basis points since just early February.

Something has to give or the markets will borrow Hibor, invest Libor and massive capital flight will ensue.

Source: St. Louis Fed

Apparently Hong Kong’s banking system is 8.3 times GDP and the absolute scale is large enough to have global systemic consequences.

Some of the highest exposed are HSBC and Bank of China, who alone have Hong Kong deposits of almost $700 billion between, them the article states. Hong Kong’s banks are considered rock solid, with a liquidity ratio of 146%, the article assures, well able to weather the storm of a property collapse, but maybe not so well prepared are foreign banks and investors lending into the sector.

As the article notes, you cannot control the currency and monetary policy but still have open capital flows. In times of stress, one must give — and in short order, cheap money has to come to an end with a doubling of local borrowing costs an all but certainty over the next 12 months.

What that means for the highly leveraged housing market doesn’t bear thinking about, with roughly 90% of mortgages linked to three-month Hibor.

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Capital Economics expects house prices to fall by a third over coming years, noting that the property market “is living on borrowed time.”

The state sector has benefited better than most in China from Beijing’s environmental crackdown, which resulted in enforced closure of steel, aluminium, coke, alumina and coal-burning power plants.

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The extent to which the resulting rise in prices benefited domestic aluminum smelters was revealed last week when Aluminum Corporation of China Ltd (Chalco), filed its results for the year in Shanghai. Chalco, the listed arm of state-run aluminum producer Chinalco, made net income of 1.38 billion yuan ($218 million) last year, against a revised net profit of 368.4 million yuan in 2016, according to Reuters.

Revenue came in at 180.1 billion yuan, up from an adjusted 144.2 billion yuan a year earlier. Although Reuters did not quote any tonnage figures for the firm, it is safe to say Chalco didn’t produce less than the year before; the state firm was largely protected from the closures enforced on others.

But reports that despite closures in some quarters smelters were still producing near-record output is being taken by many as a reason why Shanghai Futures Exchange (SHFE) stock have been rising inexorably during the year; the reading is the market remains in significant surplus.

But Andy Home, writing in Reuters last week, suggests the rise in SHFE inventory may have more to do with tightening credit and the pull of high SHFE prices in Q3 sucking metal from trade inventory.

If that is the case, then we may have been reading a distorted view of the market.

The realization that the winter closure program was not having as significant an impact as had been expected led to a fall in prices during the fourth quarter, from a peak of RMB 17,165 per metric ton in September that has continued into this year to stand at below RMB 14,000 today.

Not surprisingly, Chalco’s numbers were weak for Q4. The already meager margin for last year of 0.77% was further diluted in Q4, and many smelters are said to be at breakeven or less this year.

That factor is probably the only thing keeping aluminum prices in China at current levels. If smelters were making money, the restarts now that the winter heating season is over would be stronger and the overhang of stock would be worse (a precursor of further falls). The market is expecting restarts to be muted, restrained by the unprofitable prices and Beijing’s new-for-old program restricting the addition of substantial new capacity on top of existing production.

With exports likely to be impacted by President Trump’s 10% import tax, prospects for excess metal to find its way into export markets in the form of semis are less positive. But, anyway, falls in the LME have meant Chinese semis exporters have less of an advantage than they had in Q4.

The next 4-6 weeks may indicate the trend for the rest of this year. In a normal market, if primary prices fall further, the domestic market would move toward a more balanced position as smelters are idled.

China, however, isn’t a normal market, and regional or state support could keep plants running.

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Watch the domestic SHFE price via MetalMiner’s Indx. The trend this month has remained downward and inventory has continued to climb – whether it is new metal or repositioned metal previously in finance deals is not immediately clear to the market – they just see rising inventory and draw their own conclusions.

The facade of the Federal Reserve Bank. Aaron Kohr/Adobe Stock

We tend to hear the pronouncements of the Federal Reserve and take them as the all-knowing position of the Fed chairman with the unanimous support of his or her colleagues. Yet in actual fact, even arriving at a rate setting decision, let alone scoping the media announcement afterwards, requires extensive debate and the balancing of often fundamentally opposing views amongst the members of the Fed rate setting committee.

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The market expected prior to the recent volatility in share prices that the Fed would raise the reserve rate at its next meeting in March. That may still be the case, but comments reported in Bloomberg by James Bullard, president of the Federal Reserve Bank of St. Louis, highlight just how wide the range of views can be among the state Fed chairmen, ranging from doves to hawks.

Bullard led by saying the recent stock market rout was the most predicted selloff ever and should have come as no surprise given the elevated valuations of technology stocks and the absence of any recent price falls. “Something that has gone up 40% like the S&P tech sector will at some point have a sell-off,” Bloomberg quoted him as saying.

Not that Bullard believes that the market is correct in interpreting a surge in average hourly earnings as contributing to the rising Treasury yields. Bullard does not see wage growth as currently inflationary and remains confident that inflation will not derail robust U.S. GDP growth in the year ahead, saying he doesn’t see a need for the Fed to raise rates further while inflation is stuck below the central bank’s 2% target.

Indeed, Bullard appears more concerned with long-term, persistently low U.S. growth and although he is not among those Fed chairmen who will be voting on monetary policy this year, his still influential position is that there is little need to raise interest rates much in 2018.

Compare that to incoming Fed Chairman Jerome Powell, who is expected to follow Janet Yellen’s line of cautiously raising rates.

The market was widely expecting three rate rises in 2018 from Powell, but in recent weeks stronger wage growth and rising concerns about inflation have prompted more hawkish voices to call for four, with the first in March and the last one in December 2018.

What is less clear is what his policy will be on reversing quantitative easing. Considerable debate remains on how quickly the central bank should move on normalization and unwind the Fed’s $4.5 trillion balance sheets.

Hawks point out sooner or later there will be another recession (the current bull market, if it continues, will become the longest in history later this year).

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At present, the Fed has little or no tools left in the bag to tackle another recession — with rates still low and a massive balance sheet, it hardly needs to add more.