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The Next Economic War Will Be Fought Via Currencies: Prabal Basu Roy

In an interaction with Annurag Batra, Chairman and Editor-in-Chief, BW Businessworld, Director and Advisor to Chairman of Corporate Boards, Prabal Basu Roy discusses about the global market condition, China’s strategy and the Indian economic scenario post Covid-19

How do you see the economy going vis-a-vis the Coronavirus pandemic?

It is important to contextualize it before answering the question. The entire world is in a lockdown situation and  flattening the curve means staying at home. But this is only to slow the disease and give us the time to build our health infrastructure and preparedness. It will not help in eradicating the disease at all unless there is a therapy or a vaccine. When people try to make future projections, it is just shooting in the dark because we just do not know how effective the lockdown will be, how the governments will respond, when will we get a vaccine, the trajectory of the virus post lockdown. We know none of this but what we do know that there is no going back to the normal. India needs anything between Rs 10 lakh crore and Rs 15 lakh crore as a stimulus boost. This is just 30 per cent of the potential output lost in phase I of 45 days lockdown and rollover effects. Only  once we start testing more in India, we will actually know what the real numbers are and the spread. The forecasts have to be realistic and not optimistic based on all this. I am in the camp of Raghu Ram Rajan and Arvind Subramaniam which does not share optimism of IMF and others who predict a V shaped recovery. Asia which has been the growth engine of the world will be at 0% this year as per IMF…for comparison during 2008 4.7% it was 1.7% in 1997. Elevated debt levels make social distancing and lockdowns  more damaging and  US, Canada, France, UK, Japan and China already have  between 150% to 210% of GDP as debt vs India at 66%. So it is grim.

The RBI interventions are welcomed but they might not help the economy in the way they should. What are your views?

In the past, the financial crisis was relatively simpler because they were localised like in 2008, 2001 or in 1997, which affected certain countries, sectors or industries. But this time it is truly global. There is absolutely nothing by which we can go by. So three crisis points have come together – from the supply-side, the demand-side and  the financial side. The crisis has affected the real economy, every person across the globe. While in 2008, people mostly with white-collar jobs and investments in the market were affected, today it is the entire global population. In such a situation, the entire confidence has been hit. And this  is a vicious cycle, which creates financial market shocks, destroys wealth leading to financial distress, then job losses, etc. 

Coming to the RBI, there are two responses which are possible. One is the fiscal side response from the government and other is the monetary side response from the RBI. As far as the RBI is concerned and given the constraint of the government, which is silent on the economic front, I think the RBI has done a commendable job in ensuring high levels of  liquidity  and making sure that there is no financial stress in the system. However, the TLTRO money is not being utilised by banks so impact is not seen on bond yields primarily because the fiscal response and consequent government borrowing program is yet unknown to the market to price in risk. Hence,what we await is the fiscal response. Unless we are able to save the MSME sector, which has 85 per cent of the workforce, there will be chaos. The government also needs to look at it from the rural and urban perspectives. For rural side, they have done direct transfers but there are many people, who still do not have Jan Dhan accounts. Food and shelter is the minimum along with MNREGA related employment and protection of crop commerce during the rabi harvesting season at present. On the urban front, the first and foremost is the MSMEs. Basically, the government will have to protect these enterprises. And on the demand side underwrite the wages and provide wages support directly to start with apart from interest subvention. Essentially a four pronged targeted program : direct grants, cheap credit, tax waivers, work programs.

Now we need to look at the positives, the balance sheet support given by all governments has  been extremely speedy and upfront, about $ 8 T globally. But it is not uniform and  concentrated in certain countries. The second thing is that no one sector is frozen. Like in 2008, credit sector froze and that is what lead to the crisis. The RBI remains India’s only AAA rated institution. Its forex reserves are high and its aggregate reserves are high which should always be preserved for the rainy day and this is a downpour now. Bimal Jalan committee must be applauded for standing up to the massive government pressure a year ago to release reserves accumulated over decades. India has massive foodgrains  stock of 80 MT which must be released immediately, lower oil price is another positive for India.

The IMF has predicted a V-shape recovery for India in 2021-2022.  But this is not a localised problem; it is affecting the real economy and can flow through the banking sector pretty fast once there are delinquencies. Globally one bank is close to it. Many countries including India entered the crisis on weak macros and a weak banking and financial sector, hence the exit strategy from this fiscal expansion, of say aggregate 10% of GDP, will be critical to understand before we form an opinion. In case RBI directly monetizes the government borrowing, it will be problematic for us like any emerging economies without a strong currency like the USD, Euro or Yen. Thus, we cannot shut our eyes from the prospects of a downgrade of Indian paper from BBB- to junk. 

You interact with pioneers, leaders, influencers both from the government and the industry leaders. So what are these leaders thinking and suggestions about this? Do you think that there is a possibility of substantial manufacturing part of China shifting to India as countries like the US are finding a new manufacturing base?

Much will be depend on the choices we make as a people and leaders. Anti-globalisation and rise of nationalism will be a popular approach though damaging from my perspective. It is not that China will be completely cut-off, they are too important in the supply chain. But some part of strategic reserves will be created by different countries and by different companies as well. To some extent, localisation thus will happen as a derisking measure, but I do not believe it will lead to anti-globalisation. India would do well to take advantage of this, albeit neither India, nor Vietnam, Bangladesh, Mexico, or others can challenge the domination of China in this regard. While anti-globalisation will definitely not happen on a large scale, but what would happen is the supply chain re-construction.

What would you suggest India should do to take a place in global supply chains ?

My suggestions would be – to start with making funds like NIIF work !, It was supposed to be a Rs 4-lakh crore fund started by former FM Arun Jaitley  5 years ago and has gone nowhere. Unless we get the basic funding structure in place and effective like Temasek for example, it won’t push the infrastructure investments forward. And then build infrastructure, especially airports and ports, logistic parks, genuinely increase ease of doing business in India, stability of laws and their execution through law enforcement agencies, taxation, etc. In other words less government more governance. Sounds familiar ?

Talking about protectionism, where do you think Chinese will be going? Vis a vis investments and economic distancing ? What is their long term economic strategy ?

There will be some economic distancing but it will not be anti-globalisation move. It will be a re-construction of some parts of the supply chain. I don’t think that India, Mexico, Vietnam, Bangladesh or Poland, etc will come close due to significant barriers to entry China has built by scale infrastructure and manufacturing plants.

Coming to China’s  long term economic strategy, I believe  it is linked to their currency. Complex topic but let me try to simplify as much as possible. In the last 40 years since China went on this path, it has achieved its first priority, which is to be a dominant player on the world economic stage. By 2025, it would have overtaken the US and be the largest economy, and by 2040, it would be three times the US. So their dream of being an economic superpower has been achieved and is progressing well. Now their ambition seems to be to become the currency super power. Remember the Yuan is only 2% of world trade against the USD at 80%+, which also comprises 66% of world reserves. They are systematically taking steps ( five pronged strategy )  in that direction to challenge the supremacy of the USD. Firstly,the attempt is to do a bilateral trade in the Yuan and not the USD for oil, gas, coal, coffee, etc with an anti dollar trade front of 25 odd countries ( Venezuala, Angola, Brazil, Iran ) jointly led by Russia. Japan, too, has stuck a bilateral deal with China recently for partial trade in their respective currencies. The problem is that China still has capital controls, limited transparency on its government data and unsound legal system. These are the three basic things that are preventing people in adopting  this at the moment. But this will change over time. Once this happens, what will matter is how confident are people for the Yuan as a currency which will not depreciate.

Secondly, open an alternate front through a digital currency. Facebook is in talks to launch Libra, which is equivalent of digital currency. People’s Bank of China (PBOC) is moving fast on the digital currency. The exit of Jack Ma from Alibaba, many believe was because the Communist Party of China wanted to control Ant Financials whose Ali Pay ( along with WeChat of Tencent )  is already a leader in digital currency with 2 bln users.That is 25% of the world population !  So with digital currencies taking shape in such a big way in China and Jack Ma gone, Ant Financial is now under effective PBOC control – a program for CPC to dominate the digital currency market. Thirdly, technology-wise too China is far ahead of the US. The PBOC is attempting to link  the digital currency to the stability of the Yuan. And traceability will be there through blockchains. No better combination ! The fourth leg of this whole strategy is gold. China has been the biggest buyer of gold in the last 15 years. They have been quietly operating on the gold market and accumulating reserves. They have recently opened the Petro-Yuan Futures, which is the only future contract of the oil market in Asia and they have been backed by the Gold reserves. And lastly, its ambitious and politically contentious Belt and Road project which is in reality a thinly veiled attempt to monetize its massive USD reserves with hard assets. If we put all these five moves together, it makes sense what their whole strategy is to shape and dominate the new economic order by challenging the supremacy of the US Dollar and the existing financial system.

As a factual data point to gauge the success of its plan, do remember that with all the turbulence in the global market, the Yuan was stable. The Swiss Bank crashed, the Yen, the Australian dollar- all the stable currencies have gone down substantially. US treasuries too fell and the spreads widened, forcing the FED to open a small swap window for a few months so that governments could trade in their US treasuries and for the US Dollar in return. In all this turmoil, the most stable currency was the Chinese Yuan. Also, the Chinese bond market is a $13-trillion market, the second-largest in the world, which saw inflows of $10 billion and returned a +1.3% return vs -5.7% for US. Make no mistake - The next economic war will be fought through the currency markets. 

For China to succeed in this strategy it is critical that Yuan stability is ensured. So an open  monetary policy is necessary along with a deep bond market which it already has built. Secondly,  its acceptance as a good global citizen. China is now also positioning itself as a good creditor; it has already talked of suspending all bilateral loan payments from all the countries its due. The next is technology in which it is years ahead from other countries. There is something called One Connect, which is a Chinese cloud-based product on which financial institutions of 16 countries today are running. Lastly, a credible legal system. And finally an open capital account. And if China can do all this, along with the crash in the oil prices and unwinding of Petro Dollar trade as a consequence, then the days of the Dollar as the global reserve currency are limited and the whole world could be on the verge of a new economic order over the next 10 -15 years. 

President Xi’s move to remove term limits for the presidency needs to be viewed in this context !

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