Donald Trump arm-twisted Fed Chairman Powell into cutting interest rates, presumably in order to improve the economy, and hence, his chances for getting re-elected in 2020. Powell cut the overnight rate by 0.25 per cent. This cut may help sustain the stock market party for a while, but dangerously reduces the cushion for a rate cut in case of another global financial crisis like the 2008 one.
In other words, Trump is creating an economic swamp, or quagmire, into which global economies can sink.
Can PM Modi help steer India from getting sucked into this swamp?
The problem is this. Since 2008, central banks have flooded the world with liquidity, in an attempt to boost consumption and investment. A lot of the money has, instead, gone to bloat asset prices. Cheap money made it attractive for companies to buy back their stock, and boost valuations, which benefited a few. Corporate profits rose because interest costs were lower. Yet companies were not preparing for the future.
Apple’s buyback & Huawei’s 5G
In a panel discussion on www.rt.com, ‘US-China trade talks stall in China’, Peter Schiff, CEO Euro-Pacific Capital, and Richard Wolff, Professor of Economics at Massachusetts Amhurst, pointed out that Apple’s operating profit is roughly unchanged from four years ago, but its stock price has doubled. This is because Apple borrowed money, at lower interest rates, to buy back its stock. They point out that while Apple was using funds to buy back stock, Huawei was using funds to invest in 5G technology, for the future, and is now a leader in this field.
This is what happened in 1984 when AT&T was broken up by the US Supreme Court into ‘baby bells’. One of the spinoffs was Lucent Technologies, which inherited the amazing research capabilities which had made AT&T a global leader. Post listing, Lucent’s management succumbed to the lure of increasing quarterly earnings, under shareholder pressure, which nearly bankrupted it.
Besides enriching a sliver of population through buyback of stock aided by low-cost debt, the flip side of the coin is that it hurts the retirees, who have worked hard, saved money in pension funds, and expect to be looked after with these savings. But pension funds are all broke because the lower interest rates no longer give them the needed returns to meet their obligations.
Bizarre as it may sound, $13 trillion funds are invested in negative interest rate earning bonds, globally! Even more bizarre, UBS, ranked # 30, is planning to charge its high net worth clients negative rates on large deposits!
So politicians like Trump, combined with central bankers, are destroying the value of money and are creating an economic swamp that can suck other countries into.
Can Modi steer India clear of this swamp? Yes, if it steers well.
However, the current signs are not so good. The fiscal deficit is already, in three months, at 61 per cent of the full-year target and will certainly overshoot. Core sector growth of eight key industries has slowed to 0.2 per cent in June, down from 6.3 per cent in April and 5.1 per cent in May. India faces several challenges, other than its fiscal deficit, which includes employment, its current account deficit (CAD) and environment.
Fortunately, several ideas to overcome these challenges are available, should the government care to listen and keep an open mind on employing them.
Some of them are in a book worth reading, ‘Game India’ by RN Bhaskar. He writes, e.g. about the potential to create millions of jobs by encouraging solar roof top energy. In 1999 German MP Hermann Sheer initiated the ‘feed in tariff’ programme to encourage roof top solar. Under this, those who produced roof top solar industry and fed it to the grid, were paid twice the tariff applicable to conventional energy. As a result, employment was created in installation of rooftop solar panels, in fact more employment than in Germany’s engineering and auto industry combined!
Bhaskar points out that encouraging roof top solar, with attractive feed-in tariffs, can address India’s employment problems and can help provide green energy to propel India’s economic growth. What prevents Modi from considering such ideas?
Another idea in the book is the use of animal and human waste, to generate methane, which can even wipe out our current account deficit as we reduce dependence on fossil fuel.
The Government is, instead, propping up its failing PSUs, pumping in money into these black holes. After Air India, it now plans to pump in ₹74,000 crores into VSNL and MTNL. This injection will not save them; in fact it will harm other private players who do not have equal access to government largesse. This happened, as we have seen, in the airline industry where Kingfisher and Jet failed because Air India got tax payer funds and they not.
The Fed injection was not enough to satisfy markets. The prospects for another global financial crisis are real. Modi can help steer India away from this danger, if his government accepts and explores sensible ideas from others, and stops wasting money on bailouts that are doomed to fail, and speeds up the judicial process. Slow dispute resolution keeps foreign investors away.
(The writer is India Head — Finance Asia/Haymarket. The views are personal.)