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Global Economies 2015 – Once More Off-the-Cliff, Dear Friends…IV-b - BRICs (#40)


Russia, economically, is in deep winter.

Its current problems started when it decided to annex the Crimea Region of Ukraine in March 2014. Prior to that the Russian economy, although no star performer, was still holding its own after it rebound post the 2008 crisis. But after is annexation of Crimea, it faced the displeasure of the Western countries who decided to punish Russia with economic sanctions. Russia’s economy felt their impact almost immediately, and growth started to stall, even though President Putin remained defiant and dismissive of World opinion.

But then, in mid-2014, the World crude oil prices collapsed, and Russia fell with them.

As energy export revenues fell (exports of oil and natural gas), Russia’s heavily energy dependent economy (74% of GDP) took a nose-dive into full blown contraction.

Russia’s currency, the ‘Ruble’ collapsed, and the Russian Central Bank had to drastically raise its lending rate to 17%, on December 15, 2014, in an era of near zero percent interest rates in the West, to stop the slide. As oil prices have continued to fall, the Ruble has continued its lock-step decent against most major currencies, and is now at approximately 0.142 of the American dollar.

With the material devaluation of the Ruble, high interest rates, falling revenues, slashed jobs, eroded wages, and soaring prices, inflation has soared.

Russia is a natural resource rich country and therefore like all resource exporting countries, is negatively affected by the global commodities slump in demand. In addition to the drop in demand, Russia is further hurt by the economic sanctions imposed by the West, especially by European countries, some of which are its largest energy customers and trading partners.

As the sanctions and the drop in oil prices took hold, manufacturing and services output shrank.

With the economy tanking, the beleaguered Russian consumers had no choice but to curtail their spending dramatically, which in turn put additional pressure on economic growth, which further impacts the consumer. And thus the Russian economy is locked into a downward spiral until, either the sanctions are lifted and some relief is obtained or, and more importantly, the international price of oil rises materially, restoring a major portion of Russia’s energy export revenues.

Russia’s economy is overwhelmingly weighted in hydrocarbons (74%) and therefore very susceptible to energy price drops. Unless global oil prices rise, and stabilize at much higher price levels than where they are currently (sub $40), Russia will descend towards a deeper crisis.

Russia has tried to diversify its energy market dependency on Europe and near Europe, such as Turkey, by entering into long term energy and trading deals with China. While those deals have been signed, including agreements to pay in their respective currencies, thereby bypassing the need to pay in U.S. Dollars, the reality of actual, meaningful transactions are still years away, as the massive infrastructure required to transport large quantities of oil and gas from Russia to China are still to be built.

Russia is in a difficult position that gets progressively worse as global oil prices stay low. Its political and economic spats with the West do not help it. But President Putin is determined to win the war against what he perceives as unfair dominance of the United States and the North Atlantic Treaty (NATO), of Russia, and its relevance in international affairs. That war he has been handily winning.

Prime Minister Modi’s election in June 2013, generated an almost euphoric glow of optimism and hope within Indians and foreigners alike, based on the premise that finally a strong and experienced leader had come to power that would transform India for the better and unleash its full potential. Unfortunately since then, the speed of change has been far below expectations, and currently there is a sense of tremendous disappointment amongst all except his core supporters.

We think it too early to pronounce the verdict just yet. India is affected by the global slowdown and its industry is struggling in the face of erratic demand internally, and weakening demand externally. Plus, a few years ago, the biggest companies in India took on significant foreign currency denominated debt because of the significantly lower interest rates available outside of India. Now, even though interest rates are still at their lowest, the foreign currencies have appreciated significantly against the Rupee, especially the U.S. dollar, increasing the amount of the debt in Rupees to be paid back.

Additionally, Modi’s Government has been hampered in its efforts to pass meaningful reform legislation in key areas, by the lack of control of the Upper House (just like the blocking of the U.S. President Obama’s agenda in the Congress and the Senate by the Republicans). Elections for the Upper House take place in 2017 and if - Modi’s Party, the BJP, wins control, then progressive change, at least in the area of economic development, should accelerate. Until then change is coming to India, in most cases for the better, but in smaller and slower increments than had been hoped for by most everyone in and outside of India.

Regardless of the pace of change, and the current challenges due to the global slowdown, India’s fundamentals remain stronger than most economies.

India may not be an economic powerhouse like the U.S., or a powerful speed demon like China, but its economy is also not facing immediate threats from internal excesses of over-stimulation, problematic debt and rampant speculation like both those countries. Instead India is chugging along, as is its wont, modestly but solidly, mostly in the positive economic territory. GDP is estimated by Indian Government, currently, to be well above 7%, making it one of the fastest growing economies, but, more independent sources estimate the number to be more in the range of 5% to 6% (and we are in this camp). One thing is certain though, India is growing, albeit modestly compared to former highs, and recent expectations, while others are slowing down significantly.

India’s economy is now supposed to be growing the fastest, certainly among the BRIC economies, as China continues to slow. For India, it is not the rate of high growth that is particularly necessary, as this generally leads to excesses in the wrong areas; like the current situation in China. What India needs, more than anything else, is better governance to manage its unwieldy size, myriad social problems due to its complexity and diversity, and its lack of basic infrastructure; which China has a lot more of and is therefore light years ahead. But India’s one strength has been its internal consumption, approximately 60%; compared to China’s 36%, which shields India better from external shocks.

India’s industrial production has been volatile this year reflecting international and internal volatility, and because the government is struggling to implement pro-business and pro-reform policies that are being blocked by the opposition parties. The lower commodity prices, especially those that are imported, would be very helpful to the Indian industry but the high interest rates and the lower Rupee will to some extent negate that advantage. Plus the general global and national uncertainty will impact the Indian business and consumer, making for a weaker market.

Its Purchase Managers Index has managed to stay mostly in expansion mode from mid-2014, although at the end of 2015 it is reflecting global and internal weakness.

India’s imports and exports have been declining since the peak of post 2008 crises years of 2012-2013, albeit the slide is not as dramatic as some of its fellow BRIC economies.

On the more positive side, India’s government debt as a percentage of its economic output has been declining steadily and quite substantially. It is not so much that Indian governments have been that much more prudent, but that India’s GDP growth rate has accelerated more in the recent years, pushing down the debt to GDP ratio. It still leaves India in a better position to handle the present tough times, and any future crisis.

Amongst the Asian economies, and as a percentage of its GDP, India has one of the lower debt levels, particularly as compared to China, whose debt ratio has climbed recently to above 280%, because of the need for emergency stimulation required to stabilize its banking, real estate and recently crashing stock markets.

Not having excessive debt, and no particular crisis except stabilizing the Rupee, India alone has been able to continue to add to its Foreign Exchange Reserves.

Inflation, at above 10% had been India’s Central Bank’s major challenge in the recent years. But the Reserve Bank of India has managed to steadily reduce India’s inflation rate to more manageable and less harmful levels. In 2015, the average inflation rate is estimated to be in the range of 5.75%, rising towards the latter part of the year, due to higher food prices. The dramatic drop in commodities, particularly the price of oil, has helped India tremendously as it is a large net importer of energy (oil, natural gas and coal) which is its biggest external bill.

Since Prime Minister Modi’s election, June 2013, Foreign Direct Investment into India has climbed steadily, as investors continue to bet on the slow but continuing economic improvement in India. On the large corporate side, for the biggest private and public sector companies, debt and deteriorating business conditions are causing problems, but the small and medium businesses, a large segment, are still very vibrant and good investments.

India, on the whole, is experiencing the headwinds of the global slowdown. The rising U.S. Dollar (USD) and the depreciation in the Rupee have caused USD denominated debt to become a serious problem for the large Indian companies that had binged on cheap credit in the recent years. Many of those companies have been forced to liquidate assets to pay down the heavy debt loads and have thus gone into consolidation mode, curtailing new investments and business expansion.

Additionally, the government’s inability to push through the required reforms in areas such as labor laws, land acquisition for infrastructure projects, public sector inefficiencies in utilities, transportation, health services and education are hampering India’s development to become a true economic giant.

The terrible state of affairs in the infrastructure sector, particularly power, is resulting in increasing difficulties in servicing of loan payments, which in turn is adding significantly to the non-performing-loan (NPL) portfolios within Indian Banks holding infrastructure financing. The pro-active Reserve Bank of India Governor Raghuram Rajan has taken steps to force Indian Banks to collect on the non performing loans and to bring them under control to reduce the exposure to the banking sector. So far, he has tamed the inflation rate and stabilized the currency. This has allowed India to grow without a particular problem area getting too much out of hand.

And that has been India’s accomplishment to date, when most of the other major economies in the World are struggling with a crisis or two, India is by and large, crisis free and only dealing with age old problems of corruption, an inefficient public sector, relatively poor governance, resulting in poor infrastructure and services. Having said that, in our view, at the moment, India is in much better shape than its BRIC peers, and therefore somewhat less susceptible to external risks building in the global financial and economic system. We think India will maintain a 4% to 6% growth rate, continue to have fairly strong internal consumption which should allow it to ride out external storms, and its governance and business climate should keep improving, slowly…

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