IMF World Growth Forecast

The International Monetary Fund (IMF), a heavyweight Washington based institution comprising of 188 countries, with its publicized benign goal of maintaining financial stability, fostering international trade, employment and eradicating poverty, has previously been criticized in some circles for being overly optimistic in its forecasts and getting it wrong. The Greek media recently reported quoting Monetary Fund Chief Christine Lagarde as describing 2011 as “a lost year,” partly because of the IMF’s mistakes. The IMF had publicly admitted that it had wrongly gauged the detrimental impact that austerity would have on the Greek and other stricken states of Europe. 

Credit needs to be given where it is deserved, for at least the IMF has publicly admitted that it
underestimated the effects of austerity in parts of Europe. The economic and social consequences of fiscal consolidation, austerity, are now well documented, suicide rates doubling in Greece, social deprivation on the rise. Austerity may have provided a quick fix, short to medium term solution to financial stability but it has come at a huge social and political cost with chronic mass unemployment in the peripheral states of Europe and a corresponding widening income gap. Moreover, austerity is testing political legitimacy to the maximum in Europe. Certainly, advocating austerity and underestimating its effects has been at complete odds with the IMF’s supposed goal of increasing employment and eradicating poverty.

So what should we now make of the latest July IMF global growth forecast? They don’t make entirely upbeat reading, and that’s a surprise for an institution that has been criticized for making overly optimistic forecasts. Global growth has been revised down to 3.4 percent this year from 3.7 in April, according to the latest IMF report. There are four unforeseen risks in recent months, which have already had an adverse impact on the global economy, resulting in the IMF slashing its growth forecast this year by 0.3 percent. The main culprits are the US, China, Russia and the emerging markets. 

In the US, over capacity in the economy in the final quarter of 2013 has been underestimated and is providing unwelcome headwinds. This implies the likelihood of stronger correction when it comes, according to the July IMF report. Additionally, a hasher winter, apparently dampened demand as shoppers stayed at home. With respect to US exports, they have also declined sharply in the first quarter on 2014, but this did follow a strong fourth quarter in 2013. US output also contracted in the first quarter of 2014. US economic output has been slashed to 1.7 percent for the year, down from 2 percent, previously forecasted by the IMF.

Over to the Far East, in China there’s no cheer either. The Chinese economy is now forecasted to decelerate at a faster rate. The People’s Bank of China, China’s central bank responsible for controlling monetary policy has problems of its own making to contend with. The recent boom in the Chinese real estate, fuelled by loose monetary policy, has spurred on construction without limits with the undesired consequence of creating unaffordable housing and ghost urbanizations. So the People’s Bank of China is on a mission to cool down the red hot economy and tackle inflation by tightening monetary policy. Nevertheless, China is expected to grow 7.4 percent in 2014 down from the 7.7 percent last year.

Moreover, no rave in Russia also, the Russian economy is decelerating sharply as capital outflows gather pace, in light of the growing Ukraine tensions, according to the IMF report. Russian economy is now expected to grow just 0.2 percent. 

With respect to other emerging markets economies the falling demand for their exports, notably from China and the US is having a knock on effect on their projected economic growth for 2014. Economic growth for emerging economies has been revised down to 4.6 percent for this year, down from previous estimate of 4.8 percent.

However, one relatively bright spot is Britain. Growth forecast figures have been revised upwards for 2014 to 3.2 percent, which is up from 1.7 percent a year earlier. The latest April-June Gross Domestic Product (GDP) figures were also relatively cheerful showing GDP expanding by 0.8 percent during that period. The countries service sector expanded by 1 percent in the second quarter of the previous three months. However, manufacturing barely registered an increase to just 0.2 percent and construction activity fell to 0.5 percent during the period April to June. While Britain’s economy is now larger than it was when 2008 financial crisis hit industrial output and construction are both still 10 percent smaller.

The recent IMF report recommends that advanced economies should not rush with monetary restrictive policies, the economic recovery if any is still too fragile. Moreover, the report highlights the fact that geopolitical concerns are more prevalent now than back in April. Particular reference is made to the Ukraine crisis and tensions in the Middle East that could have adverse knock on effects on energy input costs.

Overall the July IMF World Output report errs on the side of caution, underscoring potential black swans in the economy. For Britain the IMF report is flattering, but whether this upward trajectory in the economy can be maintained remains to be seen. If the IMF forecast is accurate, then there is likely to be little upside for British exporters. Additionally, domestic demand is expected to remain sluggish, in a climate of stagnant/falling real wages. How this all pans out is anyone guess, but it does feel like this calm in the markets won’t last for long and being on the right side of the volatility is what it’s all about.

MPC Meeting

All eyes will be on The Monetary Policy Committee’s (MPC) interest rate setting meeting, which is scheduled for today, August 6. The market is anxiously trying to gauge whether UK interest, which have been held at historic lows of 0.5 percent for the longest period in history, are going to rise either sooner, say towards the end of 2014 or sometime later in 2015. Certainly, yesterday’s release of the UK’s Purchasing Managers Index (PMI) survey, which exceeded all expectations comes as a relief for those traders betting on a rate rise before the end of the year.

Yesterday’s PMI, an economic indicator derived from monthly surveys of private sector companies, was bullish at 59.1 percent, bearing in mind that a figure of 50 percent indicates a cutoff level separating expanding from contracting services. So the latest PMI indicator suggests that the trajectory for UK service industry is both upwards and momentous. Indeed, Britain’s service sector was stronger than expected in July, with activity rising at the fastest rate in eight months according to the Markit/CIPS PMI. 

The service sector amounts to more than 75 percent of UK’s Gross Domestic Product (GDP) and it including hotels, bars, restaurants, IT, transport and business services. Such an upbeat PMI data is further evidence that the UK’s economic recovery is gaining traction. The PMI data follows the UK’s April-June Gross Domestic Product (GDP) which showed GDP expanding by 0.8 percent during that period. Reaction on the foreign exchange markets was predictable with the pound rising against the dollar and the euro after the survey was published. 

Interest rate hawks are now screeching louder for rate hikes. Many investors/traders are now wondering, in view of the recent upbeat economic data, whether these calls for a spike in rates has now finally gained the ears of the MPC. To date the Bank of England’s MPC has unanimously voted for interest rates to remain pegged at 0.5 percent.

However, while the latest PMI figures are upbeat it may actually be a red herring for the MPC when weighing up whether to go with the interest rate hawks and raise rates. It’s worth mentioning that the PMI is merely a survey, which doesn’t amount to any official economic data. Indeed, the survey is not totally comprehensive as it excludes retailing, energy and government-provided services. Moreover, in recent times it also tended to point to rather stronger growth than the official data from the Office for National Statistics (ONS). 

Nevertheless, assuming the MPC weighs heavy on the bullish PMI survey, they may have good reason to do so this time around since it is in harmony with April-June GDP figures showing an expansion of 0.8 percent. But the UK economic recovery is patchy. For example, manufacturing barely registered an increase to just 0.2 percent and construction activity fell to 0.5 percent during the same period. Moreover, both Industrial output and construction are down by 10 percent respectively, since the financial crisis. If MPC decides to set interest rates above 0.5 percent towards the latter part of 2014 the impact on already these struggling sectors would be adverse. Higher interest rate for industrial manufacturing implies higher investment costs as the cost of borrowing is increased. Furthermore, higher interest rates trigger a flight of “hot money,” speculative money into the pound, thereby appreciating its value against a basket of other currencies. The appreciating pound make it increasingly more difficult for UK manufactures to sell overseas, hitting exports as UK manufactured goods become more expensive and less competitive in foreign markets. 

The latest June UK British Industrial Output figure underscores the problems, output for industry as a whole rose 0.3 percent in June, lagging a forecast of 0.6 percent, according to ONS. Industry continues to struggle following the financial crisis 2008 and a further appreciation in the pound, brought about by higher interest rates would further hamper UK exports.

To some extent the bullish PMI survey is a double edged sword for the MPC because it highlights the growing problem of an unbalanced recovery in the UK economy and the complications of implementing monetary policy in such an economic environment. 

On the one hand an excessive lengthy period of low interest rates might be fueling a speculative bubble in equity, bonds and property price creating inflation in certain sectors of the economy, but to raise interest rates now would clobber the already feeble UK industry output. It’s a complicated situation-what is good for the goose isn’t good for the gander.

For too long policy makers have wrongly believed that as advanced economies matured and developed there would be a natural transition from the manufacturing sector to services. Every economic powerhouse today, Germany, USA, Japan, China has manufacturing as the backbone of their economy. It is the manufacturing that should drive the economy, which then results in a demand for services and not the other way around. Outsourcing manufacturing to China has not only resulted in technological transfers, which has directly damaged the manufacturing sector in developed economies, but it has also indirectly damaged the service sector too. As developing economies strengthen their manufacturing sector, they also develop their own service sectors, banking, insurance etc and leave developed economies in the cold. Maybe this is why Former US Treasury Secretary Larry Summers believes that there is a , “long-term, “secular” stagnation of the developed economies.”

MPC will no doubt be gauging the adverse effects that rate hikes could have on UK industry. Perhaps the hawkish screeches for interest rate rises might just be all in vain. Time will tell.

British Pay

The stagnation of British pay, and for that matter pretty much most workers pay in developed capitalist economies is concerning. So much so, that the falling real incomes, after factoring in inflation, and the inevitable deteriorating living standards of millions of workers is likely become one of the main electoral issues during Britain’s forthcoming general elections next year. But while Labor politicians will probably stand on their soapbox professing to have a solution to the plight of a growing army of working poor, the problem may be far too entrenched for any erudite politician to solve. 

Indeed, the falling real incomes for households on middle to low income, which amounts to over a third of the nation’s population, is more than just a passing storm, or a shift from one economic paradigm to another, but in the words of Former US Treasury Secretary Larry Summers, “a long-term, “secular” stagnation of the developed capitalist economies.”

The slowing growth of British wages had started well before the financial crisis of 2008. A recent think tank report, titled “Growth without Gains,” revealed that the general population’s living standards had deteriorated long before the onset of the previous recession. The report showed that despite Gross Domestic Product (GDP) growth of 11 percent between 2003 and 2008. Median wages were stagnant and per capita disposable income fell at the household level in every region outside London. Moreover, there has been a rapid shift in the way income has been distributed from wages to profits. Just 12p of every £1 created by the UK economy finds its way to the wages of workers in the bottom half of the earnings distribution, a drop of one quarter over the past 30 years, according to the report. 

While, this helps explain income inequality there are other fundamental reasons at play which could explain the slow growth of pay of workers in the low-middle income bracket. They are as follows; Globalization. While there are many upsides to globalization and free trade, such as competitively priced goods and fewer wars as nations seek to trade rather than wage wars on each other, there have also been some downsides. Without doubt, free trade has undermined the real wages of blue collar workers, countless examples can be cited of workshops being setup in low wage regions, thereby displacing factory, process workers in the UK, or forcing them to accept lower wages. Furthermore, there is growing evidence of white collar incomes being adversely affected by increasing competition from a new generation of young educated workers in developing nations. For example, Deutsche Bank cost-cutting in New York and London has been brutal in recent years. But the bank has increased its employee head count in India to 6,000 and has recently employed 125 analysts in Mumbai.

Capital’s obsession with returning greater shareholder value at the expense of rewards from ordinary workers has also contributed to lower pay rises for medium to low income workers.

Despite the fact that Technology has raised productivity in every sector it has also replaced the tasks undertaken by many other low skilled workers. Certainly, we are living in times when the digital technological revolution is evolving beyond that of the last decade. The fusion of nanotechnology, information technology and mechanics is propelling robotics to new heights. Drones are becoming more sophisticated, resulting in pilotless aircraft, which are currently being deployed by the military for surveillance and aerial combat missions. So drones can now do the job of piloted military jet at a fraction of the cost, which logically means less demand for pilots. On the civilian front, Amazon is currently requesting permission from the authorities to use drones for parcel deliveries and robots will soon probably replace people in their dispatch warehouses. Put simply, robots do the work more efficiently than humans, they are cheaper, they work 24/7 and they don’t require a pay rise. Then there is the autonomous vehicle, driverless vehicle, which is now a technical reality, apparently this will mean no more human error road accidents, which could cut the road mortality rate and insurance premiums. But it also means putting the professional driver out of business. Technology is revolutionizing education; predictions are that within next few decades half the universities won’t exist. Workers will require education and skills more than ever in the brave new world, but they will acquire it online, at a fraction of the cost. This could mean less work, or lower paid work for education workers.

So labor’s bargaining power will continue to erode, as the true supply of labor exceeds its demand, thereby keeping wages low.

Perhaps we are moving towards what Jeremy Rifkin describes in his book, “The zero marginal cost society,” like Marx, Rifkin thinks capitalism will consume itself. The argument runs something like this: increasingly intelligent machines will generate products at nearly zero marginal cost—in other words; the cost of producing each additional unit falls to essentially nothing. And when that happens, everything becomes free, profits disappear and… capitalism eats itself. 

What this could imply is dwindling income for governments, as their tax revenue continues to shrink. Less public finance means eroding public services in health, education and defense. So a gentle slow march into poverty for millions.

But people are resourceful and when they start realizing that the market economy is declining, along with the public sector there is likely to be a growth in the third sector, voluntary and community based jobs and self-employment. The downside is that this type of employment often pays less. 

With regards to trading, the world’s most sophisticated form of gambling, as a means of escaping the sinking ship; it could be for those who have a strong constitution, a healthy sense of cynicism, able to manage risk, numerate, literate analytical and cunning. But you need to keep in mind that trading is a zero sum game with more losers than winners and the house always wins. Mrs. Jones might be best suited to baking cakes for the local raffle. However, a trader’s academy for people who believe they already have the material to work with might be a winner.

The World Cup and Brazilian Economy.

An estimated 3.5 million people will have their eyes glued to the 2014 Football World Cup, hosted in Brazil. Investors have probably also got their eye on the ball in Brazil too, but it’s not just the football that’s grabbing their attention, it also the Brazilian economy and its future prospects.

Indeed, the Brazilian economy over the past decade in many ways has been similar to an exotic game of Latin American football, with a lot of excitable twists, turns and successive goals-comparatively enviable GDP results. But like a football team which leads comfortably against its opponent, following a number of goals, perhaps the Brazilian economy is starting to fall into complacency and stutter and maybe it has got its eye off the ball.

Most observers would agree that the Brazilian economy seemed to be well stewarded over the past decade. For example, hyperinflation had been successfully restrained with a new currency in 1994; the Real. Moreover, successive governments had stuck with sound economic policies and anti poverty programs. The results of which bared some fruits; the economy grew rapidly with GDP on the advance for a number of years, then reaching a peek growth of 7.5 percent in 2010. Notably, these economic advances had been partly spurred on by the global commodity boom, which has resulted in robust exports of Brazilian iron ore and agricultural produces. Moreover, the recent discovery of deep sea oil fields in 2007 had ensured that the economy was running on high octane.

There have also been some social advances too. Inequality went on the decline and a better safety net implemented by successive governments resulted in poverty being cut by two thirds. The income of Brazil’s poorest has almost doubled over the past decade, while on the other side of the income scale the richest 10 percent have seen their income increase by just 20 percent. The result of all this means that Brazil now has approximately 200 million people, which is half of its population in the middle class socio economic group. That’s a lot of people with disposable income and aspirations, which has meant ballooning sales for white goods, cars, flat screen TV etc.

But while the living standards for many Brazilians, underpinned by a buoyant economy and government policy, has vastly improved, Brazil still remains today one of the world’s most unequal societies.

Additionally, there are other challenges that lie ahead for Brazil. For example, as the population becomes better educated they also become more demanding of their politicians. The younger better education generation is less tolerant of corrupt politicians and they want their taxes more efficiently spent on public services.

Despite the economic momentum of the previous decade Brazil’s infrastructure has to some extent been left lagging behind. Approximately, 100,000 new registered vehicles roll across the roads each year, but the roads continue to remain in a sorry state with large pot holes and in need of tarring. Public transport is also in a rundown state with cramped decrepit buses. Despite air traffic almost doubling over the previous decade, there has been no new airports.

But perhaps spending more taxpayers money on public projects may not be the solution. Public spending in Brazil already amounts to 38 percent of GDP, which is far higher than other middle income countries, in 2012, according to a recent survey in the economist.

So the solution may lie in the more efficient allocation of public resources. For, example despite Brazil being a young demographic country it spends approximately 11.3 percent of its GDP on pensions and 5.6 percent of GDP on education, which happens to be greater than the Organization for Economic Co-operation and Development (OECD) average. But Brazilian schools, remain in a dire state with an unbalanced amount of money being spent on university students and not enough going into primary secondary education. Teachers also retire early and get generous pensions.

Furthermore, those few public infrastructure projects that are concurrent are well behind schedule and well over budgeted. Indeed, tackling corruption would also pay dividends, Brazil scored 43 (100 representing very clean and 0 representing highly corrupt) on the 2012 Corruption Perception Index, scoring more poorly than Cuba. Corruption has also been cited as the catalyst for the recent 2013 riots.

Brazil’s competitive needs tackling too. Unit labour costs have doubled in the past decade, driven by big hikes in the minimum wage, the strengthening currency has also seen them treble in dollar terms. For example, 100 USD in 2002 and 322 USD in 2012 and the consequence of this is that it has made Brazil an expensive place to manufacture. Businesses have also moaned about the excessive red tape and bureaucratic customs procedures. Three quarters of Brazil’s growth has been created by adding more workers, but only one quarter has come from productive gains. In view of the fact that there is not much room for the workforce to grow the need for changes are more pressing. This could mean trimming tax benefits, pension reforms, cutting red tape and updating labor laws.

Also enticing private investment in infrastructure projects could be on the government’s radar. Brazil’s credit rating was BBB minus (stable) according to the credit rating agency Standard and Poor. Business investment fell 2.1% in the first three months of 2014, the biggest decline in two years. So keeping a rein on public spending maybe beneficial, particularly if the government wants the option of financing infrastructure projects with a greater proportion of private money.

High inflation is rearing its ugly head again, inflation remains at 6 percent; above the Central bank’s target, which has been maintaining a tight monetary policy by keeping interest rates at 11 percent. The high interest rates are not only making it difficult for Brazilians to get access to cheap finance, it also appreciating the real, making Brazilian exports less competitive. GDP expanded by just 0.20 percent in the first quarter of 2014.

Nevertheless, with the abundance of natural resources that could underwrite foreign investments, Brazil still looks attractive for investors. With a young and better educated population, which usually leads to productivity growth, and a vibrant middle class, with easier access to credit Brazil’s trajectory of growth should continue.

Changes to GDP Calculation!

In April it was reported that the UK economy grew by 0.8% in the first quarter of 2014.  This was a slight increase on the 0.7% in the final quarter of 2013.  This was the fifth consecutive quarter of GDP growth, although the Office for National Statistics that compile the figure said that the economy was still smaller than its peak in 2008. Since then the National Institute for Social Research (NIESR) which is a highly respected independent economic research company has estimated that GDP for the quarter ending in May has increased by 0.9%.  These figures are normally a very accurate estimate of the official figures which will be published in a month’s time.  It should always be recognised that whatever figures are first announced that they will be substantially revised over subsequent quarters as a recognition that the data collected is refined and becomes more accurate.  It is estimated that the UK will experience a strong recovery this year of about 2.9% or more and that this compares with an anticipated average rate of growth of 2.5%.  Reports that GDP has recovered to that achieved before the recession in 2008 are small comfort as the economy should have been growing since then at 2.5% and has some way to go before it is where it should be.  It will need several years of above normal growth to achieve this

Gross domestic product or GDP is a measure of the country’s economic activity based on surveys of businesses and government departments.  It is the monetary value of all the finished goods and services which are produced in the country within a specific period and is used as a barometer of economic health.  It can be useful for comparing the various factors that make up the economy – consumers, businesses and governments.  The figure is usually updated quarterly although it is calculated on an annual basis. A contraction of the GDP figure over 2 consecutive quarters is considered to indicate that an economy is in recession.

The basic calculation for GDP uses the formula: GDP = C + G + I + NX

C is the consumer spending or private consumption

G is government spending

I is business capital spending

NX is the total exports less total imports

It can be determined in one of three ways as either the output (production) figure, the income figure or expenditure figure. The output figure is a sum of the market value of final goods and services produced in a year, while the income figure is the total of incomes of employees, profits of businesses and tax collection by government minus subsidies on production and products during the year. The expenditure approach is the sum of all household expenditure incurred plus consumption expenditure of non-profit making organisations plus government consumption expenditure and capital formation plus exports minus imports during the year.  These figures should produce the same result, however, they rarely do and the difference is dismissed as a statistical aberration but is an indication of how difficult it is to collect reliable data.

In order to compare GDP figures from one year to the next it is necessary to adjust for the effect of inflation (or deflation).  Without any adjustments the figure is regarded as nominal, current or historical GDP.  Once adjustments have been made the figure is regarded as real or constant GDP.

When comparing GDP between countries it is also necessary to adjust the value according to exchange rates.  By calculating the GDP per capita economists often make a comparison of the standards of living between countries.  It is also a problem that the components used by individual countries are not the same for all.

One frequent criticism of the GDP measure has been that it does not take into account any activity or transactions that are not reported to the government such as illegal trade, tax avoidance activities or black market transactions.  It also excludes household production and volunteer services.  Another criticism is that it ignores the value of all the assets of the economy.

Following a call by the European Union to standardise and broaden the calculations for GDP, The Office for National Statistics has announced changes to the way that GDP is measured and in September 2014 the national accounts will include a wider range of constituents including research and development costs, and black market activities.

This change will not be limited to the UK as the European Union is requiring its members to implement new statistical rules so that economies can be more readily compared.

Changes will be applied retrospectively and will result in the 2009 GDP figure being revised up by £65 billion or 4.6% with £22 billion coming from R&D and £23.6 billion from changes to the way that non profit institutions such as charities and religious institutions provide households with various free services.

The major change is that Research and Development expenditure will be treated as investment rather than intermediate consumption.  In future defined benefit pension schemes will increase the level of GDP by a further £5.1 billion and also double the UK's savings ratio. These are controversial inclusions as they may overstate economic output or worse still double count the figures.

People building their own homes will also be included and are thought to contribute a further £4bn or 0.3% of GDP. Bizarrely another £9.7 billion will be attributed from illegal drug dealings and prostitution are now to be included in the figures as estimates are already reported to government!

As a complete measure of an economy’s growth or retraction and with the inclusion of inflation in the final figure the GDP is regarded as a very useful measure against which monetary policy can be formulated.  The problem of using the measure is that it is delayed because of the time taken to collect the data but can still be compared with the monetary conditions at the time so that the right conditions could be created in order to manage inflation.  By standardising the inclusion of data in the figures across countries it should also help to refine the management of economic conditions for the control of growth and inflation. 

Modi Mania

The inauguration of India’s 15th Prime Minister, Narendra Modi, since British independence, early this week was a momentous occasion.  Guests and high level dignitaries from across South East Asia attended the ceremony to show their respect for Modi as he took the oath of office, swearing to uphold the nation’s constitution with dedication and diligence. Security throughout the entire affair, which was held at the Colonial-era presidential mansion in New Delhi, was unprecedented.

Modi, enters office with a landslide victory and also high expectations from the Indian electorate. Indeed, Modi’s newly elected government will need to hit the ground running.

On social issues despite India’s rapid growth over the past two decades, that elusive trickledown effect has not yet materialized; India remains near the bottom of the nutrition and literacy league. Moreover, the lack of jobs for young people entering the work force is another pressing problem for the government to tackle.

On the economic front there are also a number of challenges that lie ahead. Inflation remains stubbornly high 8.59 per cent in April 2014 with food and beverage price accelerating to an annual 9.66 per cent in April. Monetary tightening by India’s Central Bank, in other words raising interest rates,  is likely to be a delicate balancing between dampen price rises, but simultaneously not choking off business investment, consumption and economic growth.  Getting it right can be tricky. Speaking to journalist in Deli, India’s new Finance Minister Arun Jaitley, a supreme court lawyer and strategist for the governing BJP party said, “The balancing act will have to be done,” said Jaitley  in response to a question about how he intends to tackle inflation. “I will wait a few days before announcing the government’s program.”    

  

Additionally, reenergizing capital investments into infrastructure projects will also be a critical issue for Modi’s government to resolve.  The chronic underfunding of large infrastructure projects due to a lack of capital investment, which accounts for 35 percent of economic activity in India barely grew since the previous fiscal year that ended in March. The issue of capital investments is likely to touch on the thorny issue of alleged irregularities (corruption) of the previous administration in awarding public infrastructure projects.

Bolstering capital inflow into India is most likely going to be also on Modi’s list of things to do. India’s sovereign debt rating has been downgraded to a "BBB-minus", by the credit rating agency Standard & Poor, which has a negative outlook on the nation’s sovereign debt. What this implies is that India currently has an adequate capacity to meet its financial commitments, however, adverse economic conditions or changing circumstances could have an adverse impact leading to a weakened capacity on India to meets its financial obligations..   

So investors are eagerly waiting to see what Modi’s new government proposes to do in order to continuing meeting its financial commitments.  Reducing the budget deficit would be perceived as a step in the right direction, for investors.  Modi has a target of reducing the deficit below 4.8 percent of Gross Domestic Product (GDP). India’s deficit was 5.3 percent of GDP in 2012-13 (estimated figure).  But reducing the deficit results in fiscal leakages from the economy and the outcome of this reduced public spending is lower employment and possibly a fall in GDP.  Pedaling austerity to voters who are eager to see job creation will not be an easy sell for Modi’s administration.  Young job seekers make up 49 percent of the unemployment statistics, according to a recent study.

With respect to India’s burgeoning energy needs, the country is tipped to overtake China in 2020s as the principle source of growth in global energy demand and by 2025 India will be the world’s largest coal exporter, according to the International Energy Agency's latest World Energy Outlook.  Modi’s goal is for every Indian citizen to have access to a house with water and electricity by 2025.  Thus, Modi’s energy policy or foreign policy is likely to be not to put his eggs in one basket, which means strengthening diplomatic relations with the main energy suppliers, China, Russia and the USA.

It maybe still too early days to gauge what impact Modi’s new government will have on the true economic direction of the country. On the upside it appears that Modi has been true to his electoral motto of, “minimum government and maximum governance,” Modi’s Cabinet of Ministers has been streamlined.  All the sound bites from the newly elected government seem impressive; make the government more efficiency, energize growth, creating millions of jobs and spreading prosperity. However, little is understood about what is their strategic plan is to achieve these objectives, so far on this point the Modi government has been mute.

Admittedly, if all the stars could align, If Modi could get inflation under control, increase capital investment and net inflow of foreign capital, tackle corruption, make the administration more functional and get the youth in work, and then the opportunities could be tremendous. Consequently it is no surprise that the markets have been euphoric about Modi’s election victory.

 

But perhaps the outcome is not entirely in Modi’s hands, it may not even be within India’s sovereign boarders. It maybe thousands of miles away, within the central banking system of the USA, the Federal Reserve. If the Fed withdraws from its bond buying stimulus policy (tapering) the India Rupee falls, which would have an adverse effect on Indian Inflation, investments etc. So Modi may have an uphill struggle on his hands with the Fed winding down its monetary stimulus program, of billions of USD bond buying.

Volatile time may be ahead for the India markets.  Both the rupee and the S&P BSE SENSEX (India’s stock exchange index are down on the week, with the latter down 1.31 percent as I write this piece.  

Darren Winters

UAE the Fiscal Paradise

When Sheikh Mohammed gave the green light to his project managers to construct the Burj Khalifa, a Dubai skyscraper 40 percent taller than the world tallest building, it became fairly apparent that the Sheikh had some big global ambitions for his oil rich bit of turf, the United Arab Emirates (UAE). 

While the Burj may be reaching for the Arabian stars another manmade construction was already well underway in the UAE, a fiscal paradise.  Indeed, the Dubai International Free Zone (DIFC), which has managed to lure 313 authorized lenders, insurance firms, asset management companies and fund firms. Among them are 22 of the 25 biggest banks in the world. In figures what this all means is an inflow of foreign direct investment of 30 billion Dirham or $8.2 billion into the UAE in 2012, which is up from $7.68 billion compared to the year before.

There are already 38 free zones in the UAE and already there are plans to construct another nine free zones.  There are several fiscal advantages for doing business in these free zones. For example, registered businesses are exempt from taxes when they repatriate their capital, registered companies don’t have to pay import or export duties. Free zone companies are even exempt from paying municipal taxes. Moreover, each zone is treated as an “offshore jurisdiction” under UAE law and they are virtually autonomous with their own administration, legal system and favorable tax incentives with the intended aim of luring top financial institutions and other companies from around the world to set up shop there.   

The federal government of the UAE has also made, Abu Dhabi, the capital of the Emirates, a free zone last year.  The name of the new free zone, “Global Marketplace Abu Dhabi” (“GMAD”), underscores Abu Dhabi’s ambition for this new free zone to act as a hub for financial services. GMAD will be based on Al Maryah Island in Abu Dhabi and will be treated as an offshore jurisdiction.

The recent appoint of a senior executive, Jan Bladen, with extensive experience legal and regulatory experience, to run GMAD further highlights the UAE’s ambition to be a major player in global financial services.   Ahmed Ali Al Sayegh, chairman of Abu Dhabi Global Market, said: “Jan Bladen is ideally positioned to address our key priorities which are to develop the legal, regulatory and operational platforms that will provide the foundation for the growth of The Global Market.”  Indeed GMAD is a huge strategic initiative for Abu Dhabi, which is intended to become a significant contributor to the UAE economy, according to Bladen.
Chief Economist at National Bank of Abu Dhabi is optimistic that the Abu Dhabi World Financial Market can help Abu Dhabi to recycle its petrodollars. In other words, reinvest the funds earned from the export of its oil within the UAE and the Middle East.  Certainly there are a lot of petrodollars to recycle, Abu Dhabi contains approximately 7 percent of the world’s oil and has huge Sovereign reserves.

Cash and gas rich Qatar, a sovereign Arab emirate, has also set up a financial district the Qatar Financial Centre. Furthermore, what was meant to be a sober Saudi Arabian alternative to the UAE’s financial free zones the Saudi’s have also recently completed their new financial district, King Abdullah Financial District. The district will contain 42 buildings and 900,000 square meters of office space—similar in scale to London’s Canary Wharf.

A question worth pondering over is with all this spare capacity in financial services, as a result of these financial free zones mushrooming in the emirates and beyond what impact will this have on the traditional global financial centers, like London, New York and Frankfurt. Perhaps we are going to see an increase in competition amongst the world’s financial centers as they compete with each other to attract a finite demand for global financial services.

Geographically and to some extent culturally, these financial free zones maybe well placed to service the requirements of their customers in the Middle East and North Africa. Undeniably, both regions have relatively young and well educated populations. Normally, these attributes are a catalyst for economic growth.  If this region takes off it would certainly pick up demand for financial services. The Spring Arab uprisings, a series of anti-government protests and armed rebellion that spread across the Middle East in early 2011 appears to have blown over.  A few months ago the Tunisia President issued a decree to lift a State of Emergency beginning on March 5, 2014, three years after it was imposed.  Critics argue that the move was merely a symbolic gesture to try and kick start Tunisia tourism industry, which is a sizable contributor to the country’s GDP. Before the uprising 7 million tourists came to Tunisia and recent estimates now but the figure to under 6 million tourists.

Then there is Egypt with already three elections in as many years. Observers are now waiting to see what impact these new elections will have on the country’s economy and security situation. But some voters are showing signs of election fatigue and downright cynicism over the electoral process.  A BBC reporter notice a young man loitering in a crowd, “Don’t you want to vote,” the journalist asked the young man.  "I didn't take part in the revolution and watch my friends die to then vote in an election that is nothing but a show," replied the young man. The country’s former army chief has been tipped to win.

So the extent to which these emirate financial free zones triumph may also depend on how the delicate situation in North Africa and parts of the Middle East unfold. Time will tell.

Darren Winters