Chief Economist at the National Stock Exchange of India
Amidst the relatively fertile area of opinion and received wisdom in the immediate aftermath of the Russia-Ukraine conflict was the almost universal agreement on its duration, given the perceived imbalances in the military balances. As the war enters a second month and has yet to show signs of any resolution, commentary and forecasting based on peace returning after a short, terrible war needs to be realigned with reality. One month on, crude prices remain on the boil, despite the marginal drop in risk premium. Natural gas, food, and commodity indices in general have remained elevated, and little seems to have changed in the underlying causes that led to these conditions. The sanctions imposed by the West on Russia have only expanded in scope, without a peak in sight, and seem unlikely to be ephemeral in any way.
Despite the relatively small size of the two economies in terms of GDP, their impact on energy and food prices is likely to disproportionate. For instance, Russia accounts for ~30% of global crude and natural gas production; Ukraine and Russia together account for a third of global wheat exports. Our Chart of the month is a quick study on the impact of Russia and Ukraine in global trade, and good measure, their linkage with India.
For global central banks, the need to contain inflationary expectations remains, partly exacerbated by negative real rates that may not help anchor them. The US Fed’s 25bps hike earlier this month with six more to follow, and later commitment to go even more hawkish as necessary shows where we are, now. In this concoction we can mix in a Chinese slowdown, engendered by their zero-COVID policy. China’s growth target of 5.5% this year is the lowest in decades and could still be out of reach.
For the rest of the world, a not-yet-post-pandemic recovery gets an extension with negative results. The response from fiscal (spend even more?) and monetary policy (delay tightening or worry about inflation) worldwide would be divergent, and may not yield the right results, in the absence of a concerted effort.
Longer-term tendencies towards autarky, and the resultant impact of supply-chain efficiency would be only of the many unintended consequences of a great-power geopolitical conflict. The IMF’s current forecast for global growth in 2022 is 4.4% but could see downgrades by the April WEO. “May you live in interesting times”, as the Chinese say. Please see our Story of the month, “Escalating Russia-Ukraine tension add to stagflation woes”.
While the MSCI World Index is down 2.7% in February and 6.8% in 2022 thus far (As on March 23rd, 2022), EM equities have underperformed, with the MSCI EM Index falling by a tad higher 3.1% in February and 7.4% in the year thus far.
Indian equities tracked global markets and sold off sharply in February owing to intensified geo-political tensions, rising commodity prices and attendant inflationary pressures and aggressive rate hike outlook of global central banks, particularly the US Fed. This was partly offset by sustained accommodative stance by the RBI, a credible growth focused Union Budget, and resilient corporate earnings. The Nifty 50 Index ended February with a loss of 3.2%, but has risen by 2.7% in March thus far, contrasting EM peers.
Gains over the last month have been primarily led by commodity-oriented sectors that have benefited from a spike in global commodity prices. Mid- and small-caps have sharply underperformed this year, pointing towards a strengthened risk-off environment. Strong buying by domestic institutional investors (DIIs) has failed to make up for heavy selling by foreign capital outflows over the few months.
Global debt markets remained afflicted by aggravated inflationary pressures and aggressive rate hike stance by the US Fed, with yields rising across the spectrum. The selling was far more intense at the short end of the curve, with the US 1–5-year treasury yields rising by a steep 110-140bps in 2022 thus far, while 10-year yield has risen by 82bps to 2.3%. Other developed economies also saw yields inching up sharply, with German and UK 10-year bond yields rising by more than 60bps in 2022 thus far. India fixed income markets has remained under pressure too, albeit not as intensely, thanks to the RBI’s easy policy stance and incrementally strengthened dovish rhetoric. Strong dollar, rising crude oil prices, worsening geo-political tensions and a hawkish Fed have all weighed on EM currencies including the INR (-2.3% in 2022TD to 76.3).
On the macro front, inflation continues to rise (6.1% in Feb’22), steadily undermining the assumptions of the RBI MPC that led to a 4.5% figure for FY23. Despite the arguments against imported inflation in food, this component of the basket has been rising for five consecutive months. The general direction of wholesale inflation in the country remains due North, since August 2020. What is also worrisome is that core inflation has been inching higher on a sequential basis. Third quarter GDP at 5.4% missed expectations and could be heralding more woe as aggregate demand reels under input costs rising faster than incomes. January IIP print at 1.3% (two-year CAGR at 0.4%) outlined the problem well. The April meeting of the RBI MPC promises to be interesting. As usual, the Insights section of the Market Pulse affords serious thought with its ideas. The first featured paper by Mrinal Mishra and Steven Ongena studies how loan off-take behaviour is affected by a novel event: Conflicts. While the disbursement of loans does not change, the cost of lending does. Another paper by Shohini Kundu and Nishant Vats examines the geographic variation in investment, not through agglomerative forces like the availability of factors of production, or a favourable geographical location, but through history. Does where you end up really depend on where you began? Two other highly cited papers explore interesting questions: How does founding-family ownership relate to firm performance, and if momentum in stock prices is really what it is. Speaking of ideas, an interesting one is the so-called Amara’s Law. It posits that we tend to overestimate the impact of new technology in the short run, but we underestimate it in the long run. In other words, there are high hopes attached to a new idea, only to see the dashed over the course of the next few years, at which point the changes wrought by it really ‘move the needle’. There are several examples in the past, like the telephone, steam engines and computers in the past, all with promise, then disappointment, and eventual transformational change. Experience does not necessarily lead to wisdom, however. Amara’s law could be equally true today for the distributed ledger, digital currencies, ADAS and climate change. And why technology, indeed. Consider the Russia-Ukraine conflict in the same prism, and the world no longer looks the same.