“The Fed got it wrong when it predicted a drop in oil prices would be a big boon for the economy. It turned out the world had changed; the US has a lot of jobs connected to the oil industry.”— Federal Reserve Bank of San Francisco President John Williams
The most powerful central bank in the world finally admitted to the fact that commodity price bust is not good for the US economy, aka, global economy. We have warned our readers many times since 2014, that do not make the mistake of thinking that coming collapse in hard assets will be positive for global growth. In order to understand that you did not have to sit down and sift through pages of data, all you had to ask a few questions:
1) Is Chinese economy significant for other emerging market economies?
2) If commodity prices collapse would EMs get impacted?
3) How much of world GDP growth has come from EMs since 2000 and 2007?
4) Has natural resource sector played an important role in the advanced economies, like in case of US, North Sea countries, Canada, Australia?
Over the past two years, through our past research pieces we have answered those questions and indicated how the street view that existed since 2014, that commodity price decline is good for world economy, is mostly hollow. Even we had warned that do not paint the entire Indian economy to be a gainer in the hard asset down cycle.
There are pockets within the Indian economy that would stand to benefit from the commodity collapse, like citizens engaged in non-resource dependent sectors, which are largely in the services part of the economy and also the people who are working in the public sector.
However, rural economy and other natural resources sectors would be impacted and so would a chunk of the manufacturing sector. Amongst the export oriented sectors, ITES and Pharma have till now weathered the storm well, due to sticky nature of their businesses.
As a result, the net impact of a hard asset bust in the world and China’s economic downturn has had an adverse impact Indian economy as well. Add to that the other factors like weather related disturbance on agriculture, fiscal tightening and its impact on crop MSP and social spending and downturn in real estate, they have all combined to knock out a major engine of Indian economic growth, rural economy.
Exports contribute nearly a quarter of our GDP and a global downturn has had an impact there as well. Currency war is hurting us more, as India is not in a position to participate in a global currency war, now by China. Government has seen its revenues plunge as its revenue is a function of domestic and global nominal growth, which has plunged to decadal lows.
Take a look at the recent IIP data and PMI manufacturing data, both showing contraction in the sector. Even adjusting for the fact that November had Diwali Holidays, the state of India’s manufacturing is in a lot of pain. Services part of the economy is holding out indicated by PMI, which could be due to some resilience in urban consumption.
However, sentiment surveys are indication that consumer sentiment has started to be dented. Job market is still going through a bumpy road. All in all, we can not depend on the urban consumer to lift the slack in rest the economy.
The oil dividend which was a major driver of our economic saving grace is not going to be there in the same magnitude this year as well, as oil prices cannot fall by another 100 dollars from here.
The result from 72nd round of Industrial Outlook survey in Oct-Dec from RBI indicates to the adverse impact of economic slowdown that has happened on that part of the economy. A majority of Indian manufacturing companies remain pessimistic about an improvement in their capacity utilization and order books, and believe that business sentiment will continue to be depressed, with the cost of borrowings unlikely to come down for the rest of FY16.
These findings are in sync with the fact that capacity utilization in many sectors are at decadal lows, aggregate top line growth is not showing growth and bottom-line growth has turned negative.
However, there is some ray of hope, as Mercer’s All Industries Total Remuneration Survey 2015 for India, released last Thursday, said companies are expected to increase base pay by 10.5% in 2016. It is also to be noted that industrialists tend to be more optimistic in surveys than they are in their day to day affairs.
A better gauge can be private conversations with the same participants, which reveal immense economic pain on the ground.
Turning our attention to the foreign exchange market, where Rupee just touched a fresh low against the US Dollar for this year. At 67.69, Indian Rupee is now at the lowest point it has been since 4th September 2013. Another 121 paise move from the last week’s lows and it can print a new all time low against the Greenback.
Central bank has been very busy for the entire of last week, possibly intervening in all segments where USDINR is traded in the onshore centers, from OTC to ETC. On the exchange they have been actively participating on near month futures segment. RBI has also increased the positions limits for banks in the currency derivatives segment on exchanges. It seems like the regulator would prefer the banks to arbitrage more between OTC and ETC.
The bigger the arbitrage activity between ETC and OTC, the more efficient is the transmission of RBI’s intervention on any segment to rest of the places where USDINR is traded.
However, we need to keep an eye on the offshore segment. Players onshore are guided by how that segment behaves in USDINR market. The offshore traders have taken USDINR forwards and futures to a premium to onshore and that is what is also pulling the onshore rates higher.
The dual theme of commodity carnage and weak Yuan is what driving the swings in global financial assets and currency markets. These two themes are joined at the hip, Chinese economy. However, they have their own set of collateral damages which are also interlinked. For example, a commodity price crash is ravaging economies of EMs and sectors in DMs. One after another commodity linked country is devaluing their currencies and the bets on a similar act from Gulf Oil producers are rising by the day.
A strained corporate balance sheet and sovereign balance sheet are also affecting credit investors and financial institutions. At the same time, Chinese currency devaluation is fallout of China’s economic malaise, very high leverage and rising domestic corporate default risk. As a result, we can expect a demand for US Dollar and Yen at lower levels. A range of 66.80/67.00-68.00/68.20 can be seen in the USDINR pair. As for JPYINR, 53.00/54.00 has been a major base building area for the pair.