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Saturday, April 7

GK: Impact of possible trade wars on India (ECONOMIC)


Refer to this earlier post to understand the background of this post: http://sheriasacademy.blogspot.in/2018/04/gk-understanding-us-china-trade-war.html

If the trade war were to intensify — and that’s a big if — there is a possibility that a diminished US-China trade engagement could have positive results for countries such as Brazil and India from a trade perspective, at least in the short run. In case of soybean, for instance, one of the key items in the list, there could be a cascading impact in terms of openings for India to enter other markets, according to the Soybean Processors Association of India.

The bulk of China’s annual soybean import of around 100 million tonnes is for domestic consumption; the rest is used in the manufacture of soybean oil and meal for export. If the levy hits China’s import, exports could be dented, a space that India could potentially fill to meet the demands from other countries.

But in the long term, a full-fledged trade war is bad news. It invariably leads to a higher inflationary and low growth scenario. Inflation is generally good for assets such as gold, while having a negative impact on currency and some sectors in the equity market.

Bigger worry: interest rates

A greater worry for India could be the indirect impact — the potential cascading inflationary impact of the decision in the US itself. Within the US domestic economy, higher tariffs on a range of imported products escalate the threat of higher consumer prices, caused by importers passing on their increased costs of raw material. This could force the Federal Reserve to frontload its interest rate glide path — raise rates faster than it would have done otherwise.

An increase in interest rates in the US has implications for emerging economies such as India, both for the equity and debt markets. The Fed is so far on track to raise interest rates at least two times this year; market analysts, however, say Fed Chair Jerome Powell could potentially raise rates faster to prevent the US economy from overheating.

The Fed is also slated to pursue its scheduled reversal of the easy money policy of the last decade. The central bank had said in September 2017 that it would start shrinking its balance sheet by selling treasury bonds and mortgage-backed securities that it accumulated after the Lehman Brothers crash in 2008, in order to inject liquidity in the market.

From the current $20 billion a month ($12 billion of treasury securities that are being allowed to mature each month without being replaced, alongside another $8 billion of mortgage-backed securities), the sale of such securities is slated to go up in the future, according to details available from the January 30-31 meeting of the US Federal Open Market Committee. With this, the Fed would gradually wind down the $4 trillion in holdings that it acquired during the phase of quantitative easing.

Even a minor disruption in US financial markets can have major implications for India. The three external risk factors — higher tariffs, rising interest rates, and elevated bond sales — come at a time when the domestic banking system is grappling with a renewed stress of bad loans. The Indian economy, especially financial markets, will need to brace for significant volatility and stress from the combined effects of global and domestic challenges.

Outflow of money

For India, the impact of inflation action by the Fed will be significant through the channel of interest rates. Yields in US markets have been inching up since mid-2016, and have risen from a low of around 1.5% per annum to over 2.8% now. The yield on benchmark US bonds hovered around 5% in 2007, a year before the start of the global recession that forced central banks of developed countries to cut interest rates to near-zero. While a reversal to pre-2008 levels will only be gradual, the rise in yields could be faster than anticipated.

The Indian government securities market has been falling for the past seven months on cues of rising US yields and projections of increased local inflation.  

Rising interest rates in the US could mean a potentially rough ride for the India’s equity market. Higher US rates will lead to outflows from emerging market bonds and equities as American investors will look to chase higher returns in their home. While a surge in domestic inflows is a reassuring factor for Indian equities, higher interest rates do make the option of investors borrowing cheap money in the US and investing in Indian equities significantly less attractive.

Credit: Indian Express Explained

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