One Local and Three Global Risks Facing India

As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country

The beginning of a new year usually sees think tanks and insurance companies list their version of perceived global risks over the next 12 months. As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country.

India’s numerous direct and indirect geopolitical challenges are well known. Some of these are: problems with a mendacious neighbour on the western border; China’s aggressive expansionism and its belligerent posturing in the South China Sea; smouldering conflicts between Saudi Arabia and Iran and Qatar aggravating; the proxy war in Syria coming to a boil; and tensions further escalating in the Korean peninsula.

War and geopolitical conflicts have persisted throughout modern history and 2018 is unlikely to be an exception. But, India’s primary concerns spring from geo-economics, traditionally neglected in future risk scenarios and risk mitigation frameworks.

Three large risks dominate the landscape and they all impinge on both the fiscal and current account deficits.

The first one is uncertainty over oil prices and India, a large net importer, is directly exposed to this volatility. Slow but certain recovery in the global economy has pushed oil prices from the 2015 lows of $30 per barrel to over $60 now. The future direction of oil prices will be decided in a power play between USA-based shale producers and the informal alliance between the Organization of Petroleum Exporting Countries (Opec) and Russia.

The unofficial Opec-plus arrangement has been successful in cutting oil production and slashing overstocked inventories. As oil prices have risen, record volumes have gushed from the US, threatening to eclipse production from the world’s two largest producers—Russia and Saudi Arabia. There are apprehensions that as prices further appreciate, some other South American oil producers might add to the US flood. This might force the Opec-plus grouping to push for further production cuts which could eventually threaten the agreement. Added to the mix is the risk that energy prices and flows might become the next weapon in the renewed US-Russia conflict.

As things stand, the Opec-plus agreement is scheduled to be reviewed soon and is likely to be extended. Even if they agree to wind down the arrangement, it has to be done in an orderly fashion, without disrupting markets. India is exposed to these volatilities through its reliance on oil imports, and its recent agreement with the United Arab Emirates to construct strategic oil reserves might be a bit too late.

India’s second geo-economic risk emanates from the wave of protectionism that threatens the global economy, particularly the ongoing trade war between the US and China. Apart from real and threatened tariff measures affecting India’s exports to the US, there are indirect consequences also.

The Economist Intelligence Unit notes in a recent publication, Cause for Concern: “Any ramp-up in protectionism would certainly have repercussions beyond North America and China. Prices and availability for US and Chinese products in the supply chains of companies from other nations would be badly affected. Consequently, global growth would be notably curtailed as investment and consumer spending fall back.”

India’s third geo-economic risk originates from a person: Jerome H. Powell, the Federal Reserve chairman. Based on his recent testimony to Congress, markets are sensing greater aggression compared with his immediate predecessor (Janet Yellen) and, consequently, expecting three to four interest rate increases during 2018. This could inject a new degree of turmoil in the markets, especially in the face of what many find unsustainable asset markets. The Reserve Bank of India’s sixth bi-monthly monetary policy statement noted: “Financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy…The volatility index (VIX) has climbed to its highest level since Brexit.“

India, like many other emerging markets, is particularly vulnerable, given that recent asset market developments are predicated on global capital flows. Any reversal of these flows could spell trouble for not only asset valuations but also future capital raising. The World Economic Forum’s The Global Risks Report 2018 states: “…economic and financial risks are becoming a blind spot: business leaders and policy-makers are less prepared than they might be for serious economic or financial turmoil.”

It would be negligent not to account for risks on home terrain: various state assembly elections in 2018 and general elections in 2019. Governments, on the eve of elections, are tempted to loosen policy restraints, succumb to populist forces and spend more. Another election-related threat looms. Risk Map 2018 from specialist risk consultancy Control Risk states: “A political environment in which parties leverage emotive and controversial social issues for electoral support could foster the spread of adverse nationalist rhetoric, potentially posing risks for foreign businesses in 2018.”

That said, with 16 general elections already under India’s belt, the next one also falls in the business-as-usual category. Therefore, in the balance of risks confronting India, the beyond-border challenges remain trickiest as they run the risk of derailing India’s twin deficits and, as a consequence, critical macro variables like inflation and growth.

The above article was originally published in Mint newspaper and can also be read here

Globalization: Much Needed, Yet So Treacherous

The unravelling of the quarter-century-old global economic order will have many effects, some unpredictable but mostly unavoidable

Developments in Germany have surprised those rejoicing defeats of Marine Le Pen and Geert Wilders. Alternative for Germany (AfD) has won 13% of votes and is Bundestag’s third largest party; significantly, it’s the first time since World War II that a far-right, nationalist party has done this well. AfD will surely want to add momentum to this regained arc of history by chipping away at the economic and social policies that we now take for granted. They are no longer at the gate; they are just one step away from the round table.

It’s not happening in Germany alone. The assault on the established order has begun even in the US and UK, with policies now resolutely inward-looking. The global right wants to fashion many changes, including the framework upon which the current idea of globalization is draped. Politician Shashi Tharoor writes in his Project Syndicate column that the backlash against globalization will be felt on both cultural and economic fronts. The unravelling of the quarter-century-old global economic order will have many effects, some unpredictable but mostly unavoidable.

India’s version of the new world order is still work-in-progress, though early signs indicate a somewhat dichotomous character. India’s social and diplomatic policies are making a departure from the past, including moving away from their pluralistic, cosmopolitan and multicultural moorings. The resistance to Rohingya migrants—including hapless children, women and the elderly—under the implausible and untenable pretext of pre-empting Islamic terrorism is an example.

But, conversely, the current administration’s economic policies endorse the late 20th century world order, which includes an openness to financial globalization and a dogged belief in an economic orthodoxy that has been discarded elsewhere. Ironically, financial globalization—especially portfolio flows—is like the two-faced Janus: much needed yet so treacherous.

McKinsey Global Institute’s report, “The New Dynamics Of Financial Globalization”, sees a return to a “more stable, more risk-sensitive era of financial globalization” though manifold risks remain. India has been a beneficiary of global capital flows. Since opening up to foreign portfolio flows in 1992-93, India has received net inflows of Rs12.6 trillion, of which 32% was invested in debt instruments. In the first five months of 2017-18 (till 15 October), while equities saw net outflows of Rs7,054 crore, debt instruments received Rs1.11 trillion. This could be the fabled chink.

The first warning comes from Mervyn King, a former Bank of England governor and vocal supporter of Aston Villa football club. Writing in The Wall Street Journal, King warns of a “bumpy decade ahead” because of over-borrowing and the spectre of rising interest rates in the developed economies leading to a rash of defaults. This doomsday prediction might resonate with India’s twin balance-sheet problem (over-leveraged companies and contaminated banks). The Reserve Bank of India (RBI) is under pressure to cut interest rates, not raise them. Assuming the RBI does slash rates, the slightest disruption in the global economy could still spell trouble, given Indian corporate and financial sector’s over-reliance on foreign capital.

The second alert comes from Deutsche Bank’s chillingly titled report, “The Next Financial Crisis”. It shows how the frequency of financial crises has increased after the Bretton Woods system broke down in the early 1970s, especially since it allowed nations to issue fiat currency without any disciplining restraint. The report lists 11 probable sources for the next crisis, which include central bank unwinding, escalation of global imbalances or Italy going bust. In short, the report states that the current global economy is “particularly prone to a cycle of booms, busts, heavy intervention, recovery and the cycle starting again...there will likely be another financial crisis/shock pretty soon with their frequency continuing to be high until we create a more stable global financial framework.”

Christine Lagarde, managing director of International Monetary Fund, provides the third cautionary note, saying that balance sheet unwinding by Western central banks, particularly the Fed, could lead to capital outflows from emerging economies and the ensuing volatility could even spill over into the domestic economy. She advocates gradualism and increased communication between central banks.

The fourth arrow comes from the bow of Jerome H. Powell, a member of Federal Reserve System’s board of governors. Like his predecessors, Powell reiterates that adverse consequences from central bank unwinding will be felt only by emerging economies with fundamental vulnerabilities, thus absolving Fed of fomenting global instability. While admitting that emerging economies are better placed this time to manage outcomes, he says significant risks remain. Powell cites research that puts emerging markets’, including the Indian, corporate sector debt at vulnerable levels; any interest rate increase, accompanied by earnings drop and exchange rate volatility can create “unpredictable and outsized” surprises.

So, while growth in the US and Europe is still gradual, Indian policy managers need to urgently put some risk mitigation measures in place. An obvious one is to immediately recapitalize public sector banks. The second is to actively catalyse investment: waiting for miracles to happen while drawing up a 10-point programme is so 42 years old.

The above article was originally published in Mint newspaper and can be read here