As June ended, production data across the globe has shown some sparks of positive signs raising hopes of end of economic slowdown. However, the trade data is yet to pick up to support the increased production activity. The increased production should be supported by increased domestic consumption which in turn prompts for increased trade flows to complete the recovery cycle.
The macro economic news from United States was dominated by the FOMC meeting in the month of June. In the wake of current economic events, all eyes were on the Fed’s announcement on the rollback of asset purchase program. In it’s statement Fed expected that the current pace of economic recovery would allow them to slow down the asset purchase program by later this year and completely wind up the process by mid – 2014. It also mentioned that the time lines of asset purchase and interest rates may vary based on the economic data of the next two quarters. Sustained improvement in the housing market prompted the Fed to remain optimistic though the fiscal policy remains a significant headwind to growth. If the recovery sustains the current pace, the asset purchase program could slow down once the unemployment rate hit 7%.Once the unemployment rate reaches 6.5%, the interest rates are expected to be hiked. However, the inflationary risks will be the key governing factor in deciding the further steps by Fed.
The other important news that dominated in June was the Chinese Credit crunch situation. The Chinese economy was booming on the back of stimulus packages announced in conjunction to the global slowdown. After years of positive data from the Chinese economy, the first signs of concern surfaced in the form of credit crunch. As a part of stimulus plans, businesses used to avail loans at cheaper rates. Banks used to avail credit from the central bank at a cheaper rate and with the interbank overnight rates at lower levels; the credit borrowing among the banks was also high. Suddenly in the month of June, banks and businesses which were used to get the credit they needed found themselves deprived of credit. A loan default by China Ever bright bank triggered the credit tightening. Several Major Chinese banks closed the fund transfers in the name of computer disorders. The interbank overnight lending rate increased to as high as fourteen percent.
Over the past several years, Chinese government employed a high debt model to spur growth. But this situation failed to increase productivity in the recent times. Shadow banking, the system which provided off the book loans to private enterprises at higher rates accounted for major part of loan activity in China. Using such loans, many projects were started to raise new debt to finance the existing old debt. In such situations where the liability of bad debt raises, it takes high amount of debt to even generate a minimal amount of growth. Though China may get away from its current situation using its large forex reserves, the credit crunch situation surfaced the other major problems in hiding. An array of structural reforms is needed by the Chinese government to restructure its economy before it breaks down. However, with China being the major importer of commodities, the impact of the current Chinese situation will be substantial on the nations which import to China.
For India, the flurry of global cues, has made depreciation of Indian rupee a major cause of concern. Rupee which has been on a consistent downtrend since May, reached the all time low of 60.59 against USD in June. With foreign investors exiting at higher prices, the outflows have dominated in the month of June. Reacting immediately to the situation, the Indian government announced a flurry of reforms to control the downfall of rupee. The reform spree started with hike in gas and fuel prices are expected to be followed up with reforms in FDI norms. The main agenda of the reforms would be to stem the outflows and increase the foreign inflows. These reforms might not immediately strengthen the rupee, but may slowdown the pace of its depreciation. Despite the measures from the Indian government, rupee is expected to remain under the pressure in the coming months.
The immediate impact of the rupee depreciation would be replicated by the WPI numbers and CAD. More than one third of the commodities considered in WPI calculation are rupee exchange rate dependent. Crude oil tops the India’s import list. Rupee depreciation would result in a higher inflation numbers hampering the interest rate cut cycle being implemented by RBI. The inflation rates over the past few months have been easing giving RBI enough room to implement rate cuts. RBI has maintained its strong stand in interest rate cuts with a continued focus on inflationary situation. The rupee depreciation could trigger a raising inflation situation again in India. Complying with its stand, RBI could postpone the much anticipated interest rate cuts in the coming months. Postponing interest rate cut would essentially delay the economic revival cycle in India.
The current account deficit numbers of India for first quarter of the years was recorded at 3.6% of GDP, lower than the expected rate. However, the lower CAD was dominated by reduced imports which point to slowdown in the industrial activity in India. Dependency on foreign inflows to fund the CAD still remains a major concern for Indian economy. The weak rupee is also impacting the already troubled trade deficit of India. A weak currency is often associated with increased export competitiveness. However, not just rupee but the majority of the currencies have weakened against US dollar. This does not add much of an advantage to India. The weak rupee is going to swell the import bill of the nation.
Indian investors will be faced with an interesting situation in the coming days. Over the past year, though the equity markets have been highly volatile, investors found solace in debt markets. The debt markets were buoyant on the back of high FIIs and interest rate cuts implemented by RBI. However, lately with FIIs remained net sellers and RBI would be left with no room for interest rate cuts due to expected high inflation rates. These factors would impact the debt markets negatively. With both equities and long term debt investments expected to remain volatile, implementing a prudent investment strategy becomes all more important for the Indian investors.
The major economic news in the month of July would be dominated by the earnings reports and reforms to strengthen Indian Rupee. The corporate results of the first quarter have been unsatisfactory. With a global slowdown, rupee depreciation and reduced economic activity in the domestic front, the results seasons is expected to throw some negative surprises. Especially the import heavy industries are expected to post greater loses due to weak currency. It is time that India look at measures other than interest rate cuts to drive growth.
Macroeconomic conditions in world
The economic contraction in Euro zone which started during the second half of 2011 has continued to the seventh quarter in row. Despite the efforts of Euro Union to save the single currency, the euro remains stuck in recession. Though the production and employment data of labor heavy market Germany showed signs of improvement, the unemployment rates across the EU zone are now at record highs. Increase jobless rate among the youth is a worrisome factor for the EU zone. Reducing current account deficit of the nations is being offset by the ballooning public debt.
The public debt of Greece is expected to hit around 175% of the national GDP by end of this year. Many other EU nations are also facing the same situation of carrying a public debt larger than their nation’s GDP. These nations are being helped EU Central bank by giving an interest deferraland extensions on debt repayments with lower interest rate. However, structural reforms which would address the core issues of single currency are the need of the hour for the falling Euro to gather its ground and recoup. The political pressure against austerity also has been increasing in the recent times. Political uncertainty in Portugal, Italy and Greece are adding to the existing woos of the EU. With raising unrest among the people, the coalition government in Portugal is expected to collapse. A new Anti – Austerity government is expected to take the chair of current pro Austerity coalition. This signifies the fact that political disorder is emerging as a major threat for the Eurozone Economies which are already hit by continued recession and high unemployment rates.
During the first half of the year, Japanese economy has showed positive signs of economic recovery. CPI Inflation numbers are major positive news for Japan in the month. For the first time since October 2012, the core CPI inflation numbers moved from the negative zone rising from -0.4% in April to 0% in May 2013. Deflation was one of the major problems faced by Japan since the lost decade. Apart from positive inflation data, Japanese economy as also cheered by upbeat production data posting a raise for forth month in a row now. The weaker Yen helped Japanese increase the pace of exports. With the strengthening positive signs from the US economy, Japanese exports are expected to get a boost in the coming months.
While the economic recovery in US is expected to have a positive impact on Japan, the Emerging Markets in Asia are facing a tough situation because of the US recovery. The Investors who preferred Emerging markets over US markets started moving back to US markets after the Fed’s statement. Apart from the outflow of FII’s the production data of the major Emerging markets was also on decline. Philippines, Thailand and Indonesia which attracted the investors over the past few years experienced a major slowdown in domestic spending and exports as well.
The Chinese situation also started to play its part in the developments in Emerging Markets. Indonesia announced and unexpected raise in interest rates along with a flurry of measures to control the inflation rates. Indonesia is the first Asian nation to increase the interest rates since 2011. The future growth prospects in Asian Emerging markets are highly dependent on the FIIs and Chinese growth prospects.
