Fed Rate Hike
This 25 bps could just be the beginning in a series of hikes…
As the 2-day meet of the Federal Reserve concluded on Wednesday, the rate hike of 25 basis points was almost a fait accompli. Analysts and economists had long seen this coming. What was more significant was that this was Janet Yellen’s last Fed policy announcement as the next policy will be handled by Jerome Powell. This marks the 5th round of rate hikes since December 2015 and the Fed rates have moved from 0-0.25% to 1.25-1.50% in the last 2 years. What were the triggers and what are the larger implications?
Grand economic data…
US economic data has been flattering to say the least. Inflation finally appears to be getting tantalizingly close to the 2% mark. Although it is still short of that mark, it is expected that higher gasoline prices should do the trick. Labor market is at a 17-year peak with jobless rate down to just 4.1%. This is likely to fall below 4% in 2018. But the big factor has been growth projections. The Fed estimates that the US GDP growth for 2018 could end up at 2.5%, nearly 40 basis points higher than the original estimates. Of course, Trump is expecting GDP growth to touch 4% next year although there are not many buyers for that line of argument. What this means is that the level of consumption and spending is likely to reach a new plane in the coming months, making a very strong case for a rate hike, now and in 2018 too.
The $1.5 trillion tax largesse!
Another strong reason for this rate hike was that the Fed may be looking at neutralizing some of the impact of the tax largesse. The massive tax cuts that have already been cleared in the Senate are likely to reduce tax costs by nearly $1.5 trillion. While corporates will see huge tax cuts, individuals will get massive tax deferments. Either ways, it is likely to have a huge salutary impact on spending and consumption. Now, that is going to be inflationary and any spike in inflation will be something the Fed will not be comfortable with. It also opens the doors for more aggressive rate hikes in 2018; 4 instead of 3.
Implications for other economies
If the reaction from the PBOC (hiking short-term rates) is any indication, then many more central banks could now shift to a more hawkish approach. That could be the best way to avoid monetary divergence and the resultant volatility in markets. The RBI has already indicated that any rate cuts for now may be ruled out. Remember, the RBI has continued to maintain its stance at neutral since February. That means; the RBI may not really hesitate to hike rates if the situation actually warranted. If the US Fed goes for 4 rate hikes instead of 3 in 2018, then the RBI may have a tough time stemming portfolio outflows. Then a rate hike by the RBI may not really be too far away!
Gujarat Matters
Gujarat elections are a lot more critical than they seem to be…
The most keenly watched election currently is the Gujarat election. Let us forget about exit polls and relent that the actual results will only be known on 18th December. The bigger question is why is Gujarat so important to the ruling NDA and to the equity markets at large? After all, in terms of assembly size, Gujarat is much smaller than states like Uttar Pradesh, Bihar, West Bengal or Maharashtra. There are 3 reasons why Gujarat punches above its weight…
BJP story began here…
From the ruling BJP point of view, Gujarat has a special place in its own history. This is perhaps the only state that the BJP has managed to consistently rule for over 22 years. Only the CPI-M in West Bengal has managed to rule a particular state for a longer period of time. From its abysmal performance of 2 seats in 1984, the BJP came a long way in 30 years and that journey began in Gujarat in 1995. Gujarat is also special because it is this state that saw the rise of the current prime minister. Thorough the vagaries of politics; even when the BJP lost power in 2004 and 2009 at the center, it was Gujarat that stayed with the BJP. Also, considering that Mr. Modi was formerly the CM of Gujarat, the Gujarat elections have become a referendum on the government’s performance since 2014. Gujarat, more than anything else, has a symbolic meaning for the BJP and its rise in the last 30 years.
Basis the Gujarat Model…
Gujarat is not just politically significant but also has larger economic meaning. The NDA won the 2014 general elections on the plank of growth and development. Obviously, there was no better model to showcase than the Gujarat model. The industrious and enterprising Gujarati spirit was just one side of the story. More importantly, Gujarat had re-built itself after a series of cataclysmic events in the early part of the millennium. The massive earthquake in Gujarat in 2001 virtually devastated large parts of the state. Then the unrest of 2002 raised many questions about the sustainability of the Gujarat Model. The very fact that the state of Gujarat bounced back from all these crises was a tribute to its dynamism. And the one man synonymous with this bounce was the current prime minister of India. That is why Gujarat matters a lot!
It also matters to the opposition…
The opposition, led by the Congress, realizes that if ever there is a time to make a big noise at the national level then it is in Gujarat. They know very well that the BJP cannot afford to lose Gujarat which is what makes it all the more critical for the opposition. For the markets, a reversal in Gujarat will mean a greater bias towards popular economics. That possibly explains why the state of Gujarat matters a lot to the equity markets too!
Trade Data
Exports flatter but trade deficit remains a major worry…
After a disappointing first 6 months of the current fiscal, the trade data for November finally showed a semblance of recovery. Of course, imports were higher but exports grew much faster. However, the trade deficit continues to be at elevated levels and that remains a major worry for the government. Here are the key takeaways from the trade data for November…
Export flatter on the upside…
Exports at $26.2 billion were nearly 30% higher than the level touched in November 2016. That is a sharp change from the negative growth in exports witnessed in October. Of course, one can argue that November 2016 was a tepid month due to the impact of demonetization. However, what is really important is that Indian exports have shown a sharp growth despite worries over GST and exporter refunds to the tune of $7.7 billion stuck up. The 3 key product export groups of gems & jewelry, petroleum products and engineering goods all showed over 30-40% growth in the month of November. Of course, imports at $40 billion were up by 19.6% and that is still a worry in absolute terms. Oil imports were the major factor which is hardly surprising considering that crude oil prices are up by 35% on a YOY basis. The good news is that the sharp increase in gold imports since the start of the current fiscal year finally appears to be tapering down! But imports are a worry!
Trade Deficit is widening…
The trade deficit at $13.8 billion for November 2017 continues to be on the higher side. At the current rate of imports, we could end the year with imports of close to $500 billion. With the current forex reserves at around $400 billion, we may see total import cover of less than 10 months. That is lower than the kind of import cover that other BRICS nations are enjoying. The net deficit (after adjusting for the services surplus) is well above $8 billion, which means we could end the year with a net deficit in excess of $100 billion. Through the last fiscal the monthly trade deficit was under $10 billion and the net deficit was substantially lower. That comfort zone does not exist any longer. That makes the economy a lot more vulnerable to oil prices shocks.
Exports hold the key…
On the imports front, while gold imports may be controllable, there is not much choice on the crude oil front. Oil prices are likely to remain buoyant till the Saudi Aramco IPO and that means the trade deficit will remain under pressure. Strong FDI flows have kept the INR strong and that has been a big boost for imports over exports. That is a situation that the RBI needs to correct. The INR is already overvalued in REER terms. A weaker rupee will help INR attain a more acceptable level and push exports. That could be the real solution!
