OperationTwist,tradedeficitandglobalcoupling

The stock markets across the world continue the bull run, Hang Seng and Nikkei both are trading up close to 1.6% in the morning trade today. The Dow futures are also up by 200 points. Optimism on vaccine and relatively muted new case numbers, more stimulus and continued low interest rates are the ingredients of the hope trade. The worry on inflation is still not deep seated however some upward movement in the long-term yields indicates that markets are not totally unaware of that phenomenon. US 10-year treasury yields are trading at 1.25% which is its highest since last march. US 30-year yield has jumped 10 basis points from Friday to trade at 2.03% currently. The minutes of the last Fed meeting will be released tomorrow, and markets will parse it for the dovish clues like “economy still not recuperated fully”, “inflation is not a concern”, “we are targeting full employment” etc.

Now we wrote yesterday about the coupling of any economy with the global order and why it is fruitless to study only the endogenous variables for any country. A country might be running a large current account deficit but in the global liquidity surplus scenario, the deficit might be funded by capital flows without any heartburn. But the problem happens when the tide changes. Let’s see it in the context of India where the trade deficit numbers for the month of January were released yesterday.

India’s exports went up by 6.16% to USD 27.45-bn whereas the imports grew by 2% to USD 42-bn leaving the trade deficit figure at USD 14.54-bn. In his 2015 book The Making of India, author Akhilesh Tilotia writes in detail about the policy choices which the country faces regarding funding of current account deficits. He writes that the fact that country is a net service exporter and receives sizeable remittances from its diaspora cushions it somewhat from the ill effects of persistent trade deficits. The rest is then supported by capital flows either on the stable FDI flows or its volatile cousin called FPI flows. But the problem occurs when the global flows are no longer benign (scenarios like post GFC 2008 or post taper tantrum 2013). These scenarios then bring about rapid depreciation in the Rupee or drawdown of Fx reserves. One strategy which the author notes to tackle the volatility is to break India’s CAD according to the geography of its deficit (Middle east, China, South Korea) and seek funds either in the form of SWF or FDI’s from countries where we run a large trade deficit. This makes the dynamics more stable and equitable.

On the market parameters round up, the EM currencies are being beneficiary of the global risk on and the Indian Rupee is no exception. It traded close to 72.50 yesterday which was around its 1-year high levels. Other currencies like Indonesian Rupiah, South African ZAR are also witnessing the same trend.  Pound Sterling is touching 1.40 against the Dollar which is its close to 33-month highs. A better than expected vaccination drive has boosted sentiments regarding the UK economy reflecting in the Pound’s strength. The Indian long-term yields got an Operation Twist vaccine shot yesterday. The RBI announced that it will simultaneously sell and purchase 10k Cr INR worth of securities on the 25^th of Feb. The 10-year benchmark bond traded around 6.02 post the announcement.