Wrong Move?

The US Fed, in its last policy meet for the year, held on 15th and 16th of Dec, decided to break it’s near zero interest rate trends. The US Federal Reserve on 16th Dec, 2015 decided to raise its interest rates for the first time after the sub-prime crisis era. Although, the hike was anticipated much earlier in the year, lack of strong data in terms of unemployment rates and inflation was a hindrance. Ultimately, on the basis of fairly strong data, the Fed has decided to step on the gas. The question is” was this a wrong move”? In this blog, I will focus on the data considered by thr Feds for a policy action, inflation targeting, rationale behind the rate hike decision, why is the hike unconventional and the history of the impact of such unconventional measures. To conclude, I would provide an insight on the policy modes of the major economies, the likely impacts on the US economy, global growth and the financial markets worldwide.

The Federal Reserve, in its final policy for the year, increased the interest rates by 25 bps from 0%-0.25% to 0.25%-0.50%. Fed was focusing on the data from the past 5 years to understand the feasibility of a rate hike. For the readers, it is important to know that a rate hike will start taming inflation and choke the growth in the medium term. Feds have been closely tracking two critical indicators namely, unemployment rate and the retail inflation numbers. Feds had their targets for unemployment rate to drop below the 5% levels while inflation rates to touch 2% trending northwards. The growth rate so far has been on the lower side, but as every other developing and developed economy, the US is has a focused inflation targeting.

Here’s a graph to explain the readers briefly the interest rates and inflation trend:

Fullscreen capture 12232015 122333 PM.bmp
Interest Rate Trend 2005-2015
Fullscreen capture 12232015 123056 PM.bmp
Inflation Trend 2005-2015
Fullscreen capture 12232015 125258 PM
Feds Target Line Not Crossed

The rationale of the US Fed behind the rate hike was a fairly upward trending inflation and lower unemployment rates. The above images show that, despite not achieving the inflation target and the unemployment rate benchmarks, the Fed increased its interest rates in a non conventional manner. The tone of the policy statement indicated that they are expecting the inflation figures to rise further and the unemployment rate to continue its downward trend as shown in the graph. Inflation is rising but the average figures for the year 2015 is 0.5%. It is unlikely that the figures will rise up to the 2% levels  in the near future due to lack of domestic demand in the US.  On the other hand, a rate hike will choke the growth as well as tame inflation, which will beat the purpose of the rate hike  in the first place. Secondly, the Fed said they expect the unemployment rate to inch downwards from here on. But here’s what has happened from 1971 till date to the unemployment rates whenever the interest rates have been change. Unemployment is directly related to the movement of the interest rates. The below graph and the movements suggest that even the intent of bringing the unemployment rate down is not achieved with a rate hike. Its a challenge from here on how the Feds are going to contain the effects or if I may say the ill-effects of the decision.

Wherever-US-Fed-Funds-rate-goes-unemployment-follows-eventually
Whenever interest rate has increased, the Un-employment rate has increased as well and vice versa

Lets take a look at the history of the effects of unconventional policy actions. European central bank raised the rates twice in 2011, killing a nascent recovery and plunging the euro zone into a double-dip recession that it is still struggling to overcome. In between the years 2004-06, Feds steady quarter point increase in the rates (which was an attempt to avoid the bubble creation), was not enough to stop the implosion of the housing bubble in 2008. In the above mentioned scenarios, the problem was either the central banks acted too slow or too fast, whereas it would have been prudent to take appropriate actions. 

With growth still sputtering in Europe, the ECB has been embracing the tools used by the Feds years ago to revive the economy i.e Quantitative Easing. ECB has kept its rates to near zero levels to try and revive the economic conditions with QE, although the revival might take a little more time than expected. Whereas in Asia, PBOC (People’s Bank of China) is also on a easing mode. Similarly Japan is keeping its interest rates at rock bottom levels to encourage growth. India as well has joined them by reducing its interest rates by almost 125 bps from Jan 2015. With the globe on easing mode, it is going to difficult for the US to justify its tightening with the global growth being already quiet subdued. The growth rates for the US in the first half of 2017 are expected to be on the lower side because of the tightening. US also has been a reasonable contributor to the global growth, and with this tightening we can expect a much lower share from the US and consequently lower global growth. The USD as well is expected to harden against the rest of the currencies hurting the exports and thus undermining the trade balance. Markets all over the globe are expected to reap fairly low returns as compared to last year in the medium term. To sum up, with its unconventional policy actions of a hike when the rest of the economies easing to spur growth, the Fed has increased the probability of a further slowdown in the US. If there is no inflation, the growth cannot happen or if I may say if there is no growth, there might not be any rise in the inflation. Currently, US does not have either in place (Insufficient growth to drive inflation and insufficient inflation to drive growth). But, on the brighter side, with US, China, Europe and Japan on a slow lane, India might be the star performer in the coming year with highest growth rate in the emerging economies as well as the world. But, with winter session wiping out without the GST passage, the path on the fast lane does not seem to be easy. However, the prospects for India are significantly good from here on with an expectation of the reforms rolling out in the budget session.

Thank you.

🙂

 

The Decisive Session

The parliament winter session (the decisive one) commenced on the 26th Nov, 2015. Parliament will hold the meet till December 23rd, 2015.  The session agenda includes 19 Bills currently pending in Parliament for consideration and passage (including the GST Bill).  14 new Bills are proposed to be introduced. Out of these one will also be taken up for consideration and passing.  Two Bills will be withdrawn. With a fairly stable signals so far, the winter session productivity does seem to be significant with close to 73% productivity. In this blog, we will focus on the productivity of upper house and the lower house in terms of results as well as the time spent. We will also focus on GST and the progress so far including the Arvind Subramanian committee recommendations. Finally, I will also conclude with the likely outcomes of the session, its effects on the GDP growth and the direction of the markets in the medium term.

For the readers, here’s what I discussed about GST in detail in one of my previous blogs:

ALL YOU NEED TO KNOW ABOUT GST

Lets first understand the major bills that will be due for discussion in the session. Here’s is a brief note on the same.

Fullscreen capture 1282015 122228 PM.bmp

The productivity of the sessions has been a significant driver of the reforms and development in India. However, history suggests that no session of the rajya sabha apart from the budget session has been productive. In the NDA Govt tenor as well the history has repeated itself with low productivity in the monsoon session. GST has been facing strong opposition for the structure of the bill. To get a sense of the productivity and performance against the plan, here are a few images that might help to give a clearer picture. 

Fullscreen capture 1282015 115511 AM.bmp
Total Productivity of Rajya Sabha in the Budget Session
Fullscreen capture 1282015 115517 AM.bmp
Total Productivity of Rajya Sabha in the Monsoon Session
Fullscreen capture 1282015 115523 AM.bmp
Productivity of the winter session as on 30th November, 2015

 

Fullscreen capture 1282015 12946 PM.bmp
Budget Session – Plan Vs Performance
Fullscreen capture 1282015 13002 PM.bmp
Monsoon Session – Plan Vs Performance

While productivity has been one of the issues, the strong opposition to the GST passage is still a concern for the NDA Govt. GST has been facing an opposition in terms of the structure, exclusions and inter-state tax. With 3 committees already publishing their recommendations, opposition was persistent with their demands. NDA Govt thence decided to form a committee headed by the Arvind Subramanian(Chief Economic Advisor to the PM). The key recommendations of the CEA led committee were:

a) Recommends eliminating all taxes on inter-state trade.

b) GST panel has suggested standard rate of 17-18%

c) Panel not for specifying GST rate in Constitutional Amendment Bill

d) Panel recommends bringing alcohol, petroleum within GST

e) Committee suggests revenue neutral rate of 15-15.5% for GST

f) Allocation to states will depend on revenues raised by Centre and states

g) Two options for the states: Single rate of 15% or a range of 17-18%

h) GST rate on precious metals to be in the range of 2-6%

i) Panel recommended removal of 1% additional levy

j) Higher GST rates on tobacco, luxury cars, pan masala and aerated drinks

k) The panel kept alcohol, real estate out of GST to achieve 15% rate

The NDA Govt will now be again presenting the GST bill with the required changes if they accept the CEA recommendations. If the NDA Govt succeeds in putting up a viable solution for the oppositions demands, it would truly make GST, one of the biggest reforms since independence in India. Although, the hopes are slightly on the lower side, things might change from here on if a mutual motive is maintained. The silver lining of the winter session was the passage of the Real Estate Regulatory Bill (2015) today, which is intended towards consumer protection and might be a way to maintain the market dynamics in this era of sky high real estate prices. One of my blogs might give readers a fair idea about the Real Estate Regulatory Bill.

Real Estate Regulatory Bill

To conclude, the path towards the GST passage looks rough for the NDA Govt so far. It might be right to say that the winter session might not give be able to deliver the said reforms. The non passage of GST will definitely be a huge setback for the Govt and might affect the GDP in the coming future due to the leading weak investment sentiments. On the other hand, markets with significantly low hopes about the GST passage, might head south in the medium term (Uptil the first quarter of FY 2016. Markets look volatile in the short term and might continue to be the same at least, till the US Fed meet due on the 15th of this month. Markets will be looking forward to the Budget session for a push in the reforms from here on, if at all the winter session turns out to be an unproductive one. It would be the appropriate time to move things forward in terms of reforms and use the current conditions of low commodity prices to our benefit.I hope, the Center and the opposition will start putting up a few actionable steps in place for the betterment of the economy on a macro level, rather than hinting a political vendetta. 

Thank you. 🙂