US and European markets have lazily ignored what is taking place in locales far and wide. This is not some strain of investor xenophobia, but rather the comfort created by the Federal Reserve and ECB’s twin policies of courting complacency. Through QE/OMT and their attendant processes, hedging and the appeal of hedging have been quashed as “tail risks” have receded to the surreal historical interpretations of the perceptions of finance. Despite such a short memory, dollar funding conditions have smoldered and the growing conflagration draws nearer.
The luxury of being inside that policy umbrella by fact of geography is only a temporary reprieve. For example, the Indian economy and banking system has been dropped into a state of crisis. Part of that has been the government’s continued appeal to deficit financing, creating a huge funding hole that has to be met externally (the rupee does not have the luxury of being the world’s reserve currency, and thus cannot be exploited by fiscal authorities as such). But the dollar shortage has real impacts on India, despite the fact that direct trade with the US is relatively lacking in proportion.
As the dollar grows scarce again globally, the price rises in exchange with other currencies, including the rupee. In the last two years, the rupee has devalued by about 39%, with 13% coming just since taper was instilled in market chatter. The result is a rupee at or near all-time lows. Dollar funding conditions matter, even to India which, despite its population, is not a global financial center.
It is, however, the world’s 10th largest economy (according to 2013 figures from the World Bank). In the January-March 2013 quarter (noted as Q4 in India), GDP growth slowed to 4.8%. For the entire year (2012-13), GDP was just 5%, the worst year of the last decade. It has not gotten better since, as industrial production grew only 2% Y/Y in June.
Against that economic slowing, inflation has risen – something not supposed to happen according to orthodoxy. In July, consumer prices rose an estimated 9.6% Y/Y. The current account imbalance also widened in June, creating the kind of vicious cycle that leads to full-blown crisis.
The Reserve Bank of India has begun to appeal to currency and capital controls in increasing measures, usually the last resort of the desperate policymaker. The RBI capped bank borrowing at its repo window and sold cash management bills to drain reserves. In the business sector, the limit on overseas direct investment has been moved from 400% of net worth all the way down to 100%. These measures will have direct and negative effects on the Indian business sector and economy – all hoping to get the rupee under control while the dollar price is rising globally.
The world’s 6th largest economy, Brazil, is also caught in the dollar/currency vise. Despite massive government “investment” for the World Cup and 2016 Summer Olympics, GDP grew only 0.6% in Q1 after growing only 0.9% in all of 2012 (GDP was up 7.5% in 2010). Inflation, however, broke above the central bank target “band” of 2.5%-6.5% (inflation is targeted at 4.5% +or- 2%), coming in hot at 6.7%. Again, largely as a result of the devaluation against the US dollar, commodity prices, particularly food, are jumping throughout Brazil.
That has led to growing tension as the government wants the Banco do Brasil to loosen monetary policy, while the central bank risks credibility if it does so with inflation outside the target band. Against those concerns are balanced the need to keep order as economic dissatisfaction turns political in the recent massive street protests. But what good would “loose” monetary policy do for Brazil? It cannot get China restarted, and thus the Chinese appetite for Brazilian resources. At the same time, the US dollar is on its own course independent of local policy, transferring the initial blows of US policy inflection to the weakest markets (at first).
All of the BRICs, indeed most emerging markets, now are faced with the global slowdown cutting into organic economic growth while orthodox monetary economics wrestles with trying to manage currency adjustments inflicting a deadly dose of inflation; stagflation in the 21st century. The Bovespa has not ignored the economic dysfunction, down about 19.6% in 2013 after having been down 28.8% in early July. The index remains 25.8% lower than the March 2012 high, coinciding with this currency/central bank policy shift. The India S&P BSE 500 is down only about 10% for 2013, but far weaker than US or European asset inflation.
The inevitable slowing of global growth, whatever little there has been, is now up against the financial system overlevered to bad monetary policy. The contours of the global trade and financial system get hit first, but it will slowly creep inward as leverage unwinds and begets more instability in both the real economy and an increasing number of financial markets. Adding grating weakness in China to the mix, the 2nd, 6th and 10th largest economies (BICs?) are in grave danger of both recession and currency crises simultaneously.
Dollar policy bites hard.
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