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US Elections-Indian Cash Ban-MPS !

November 23, 2016

After June 23 Brexit, in last 2-months, couple of major global activity was witnessed such as US Elections and India banning Rs 500 and Rs 1000 currency notes.

Result of US Election was in line of our expectation, as we correctly called for Republican Party victory. There was temporary uproar after Republican win, but financial market wasted no time to stabilize.

US Dollar sky rocketed against Major/ Minor currencies and Gold that initially rose was soon offloaded. Global Equity market bouncing back sharply, but Bond yields tumbled on fear of interest rate hike.

Interestingly, after Trump’s election victory against market expectation, financial market is so far looking very stable proving every one wrong that feared unstable market condition after his victory. Prior to US elections the World Media, Political Analyst and World Leaders had one-sided view and were predicting economic collapse.

The sentiment against Trump was so negative that a group of 20-Nobel Prize Winning Economist warned that his win could jeopardize the foundation of American prosperity and global economy.

Until now it is proving to be a hoax and false call. I think the real test for the market will be witnessed only if US imposes harsh and one sided trade restrictions. Fiscal policy adjustment/implementation is every newly elected government’s prerogative.

The cause of current rally is because market has high expectation that Trump will ease regulation, cut taxes and increase infrastructure spending. This has given boost to the US stock market because strong economy means higher earnings.

But it also means higher risk of inflation, which increases probability of rate hike and worsen chances of further bond gains. It is because bond investors will get fixed return, which may not be at par with expected higher inflation that will be caused by robust growth, which is why market is witnessing sell off.

Soon after the US elections, immediate impact was that reallocation of funds wiped out nearly USD 1.3 Trillion across the globe. There still is a possible risk that if another 25-50 basis point move occurs, then it may further hurt Bond market to a certain extent and could destabilize or minutely undo the impact of stimulus that may ultimately cause damage to the nervous asset market.

India Bans Cash

Last week, in another surprise move Indian government clamped down black money hoarders by putting a ban on Rs 500 and Rs 1.000 currency notes.

This an extremely risky and dangerous move that have caught everyone wrong footed. The risk is that it can cause extreme damage to both Modi’s government and the economy. The delay in normalizing the banking system by another 4-8 months will have severe adverse consequences unless corrected at earliest.

As per Reserve Bank of India (RBI) the sole purpose behind this move is to arrest the abnormal rise in fake currencies of higher denomination and black money in the system. India’s blame game is that it will help to counter printing fake money by Pakistan. Imagine estimated amount of Fake Money is Rs 400 Billion, so time will tell that if this logic makes any sense.

Further, if cash comprises 86 pct of the cash money in circulation, which is India Rupee Rs 14 Trillion or equivalent of USD 205 Billion and as Modi has said 90 pct of all black wealth is out of country the estimate suggest that only 6 pct of the assets are held in currency notes.

My fear is that backlash is unavoidable if delay occurs because India is a cash dependent economy. It has nearly 22 Million credit cards. Out of 215.000 ATMs, less than 50.000 ATM’s are in Rural Area, hence there is a high probability of extreme social unrest likely to pop up in coming days if enough cash is not provided, as rural population is nearly 850 billion.

When there is cash squeeze in a cash economy everything goes on hold. Tourists are struggling to find cash. Purchase of essential goods becomes difficult, marriages are delayed or cannot take place because it’s an expensive affair, items of daily consumption cannot be bought freely, farmers cannot purchase seeds due to cash crunch, small business are blocked in a cash based economy and in India festivals are regular feature, which cannot be celebrated.

So the economy will definitely take a hit that can lead to hold on meeting of exports orders. The only gainers will be credit card agencies and all other sources that provide goods on credit.

Overall impact on economy could be severe. According to RBI until two days ago Indian Rupees equivalent of USD 80.8 billion (INR 5.33 Trillion) was deposited in banks against disbursement of USD 15 Billion (INR 1.03 Trillion) over the counter and via ATMs.

This suggests that the ratio between Withdrawals of money against Deposit is 5.86 times lower and is very alarmingly, which means banks will have liquidity in abundance.

Banks will be biggest beneficiary because of surplus liquidity in the system. Until Monday banks parked INR 4.32 Trillion of excess liquidity with RBI. Since deposit is piling up regularly there is every possibility that Indian Central Bank may face security crunch that has a total bond holding of INR 7 Trillion as of June 30, 2016. RBI offers bond against cash balance with the regulators and cash amount is never disclosed.

But it all points to slow down of economy that should lead to sharp fall in Indian wholesale inflation, which was at 4.2 pct in October that will comfortably fall towards 3-3.5 pct and hence, further aggressive rate cut in unavoidable. Indian Bond yields have already crashed by nearly ½ pct.

In such a scenario my estimate is that its GDP could take a hit of around 1 to 3 pct depending on cash availability in the banking system.

Though initially it sounded a brave decision, but the trap looks set as symptom of “Sever Money Paranoia” is probably unavoidable. Miracle is surely cure to this disease.

Pakistan’s Monetary Policy

I do not see direct or immediate impact of the two events on our economy, but Pakistan, despite all claims, which is going under an economic transformation period, is surely in a struggling mode.

I would like to focus on recent visit of Christine Lagarde IMF MD’s visit to Pakistan. She rang the alarm bell, according to her, 2-Million young people enter job market every year.

She pointed China’s slow growth that has average 20 pct trading volume with Pakistan as an alarming trend. She thinks we need to shift our stance accordingly and retool to gather economic momentum. China’s slowdown has impacted global economy that could be one factor hitting our exports as well, which makes sense.

She did show her concern about managing debt. She was blunt about very low number of people registered in tax net, which she thinks is unfair. She focused on public enterprises losses due to poor management as one of the cause of deficit burden, which is hindering growth.

In other words basically her message was Chrystal clear that our growth pace is pathetic. It is because we are far behind in terms of global standard.

Private investment is 10 pct of the economy against 18 pct average growth in emerging market. Pakistan’s export is 4-times lower and is only about 10 pct of the GDP.

Her recommendation includes improving business climate, increase transparency, accountability and remove red tape hinting corruptions as main cause of problem. She did strongly focused on completion of energy sector reform.

I think the message to State Bank of Pakistan from IMF MD, is very clear that for sustainable growth Pakistan is required to stimulate its economy.

What are we waiting for and delaying rate cut (Discount/Target/Coupon) ? The nation is paying heavy cost as financing debt (External & Domestic) due to major part of undocumented economy that has become a curse.

The economy demands sharp cut to re-balance and to activate industrial and manufacturing sector growth. SBP is also required to reconsider and widen its corridor gap for substantial increase in Private Sector lending activity, which will compel banks to lend money to corporate sector.

Here I would also like to add that we should not be complacent and take developments in India very seriously, because Indian economic woes is going to linger on for longer period of time that will ultimately impact/hurt our economy in coming months/years. Due to pressure on Indian economy smuggling activity is likely to increase and our borders surveillance should be tightened.

Indian currency can potentially suffer and is likely to further weaken. Indian remittances will surly fall and businesses will suffer. Hence, PKR adjustment could be possible.

If we do not act by taking pro-active measures our economy too will suffer badly. It’s never too late.

(Disclaimer applies in my post, which means that the perspective is my personal view. I have made every effort to ensure accuracy of information provided. However, accuracy cannot be guaranteed. This article is strictly for information and not intended for Trade or Business Transaction). 

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