Moneycontrol
Dec 20, 2016 03:25 PM IST | Source: CNBC-TV18

Uncertainty in global markets to strengthen dollar: Eswar Prasad

Uncertainty in global financial markets tends to be good for the dollar because money flows to the US financial markets, especially the US treasury securities markets in search of a safe haven, says Eswar Prasad, Professor Of Economics at Cornell University.


Eswar Prasad, Professor Of Economics at Cornell University believes that rate hike by US Federal Reserve is very much on the cards because inflationary pressures are beginning to creep up in the US economy. Wage growth too has picked up with a strong performance of the labour market, says Prasad in an interview to CNBC-TV18.


With the new Donald Trump administration taking office in January, and uncertain about the policies they will adopt, the overall picture is a bit clouded, says Prasad.


According to him, Trump's election has set off two very important forces. One, it has created a lot of uncertainty in global financial markets. Uncertainty in global financial markets tends to be good for the dollar because money flows to the US financial markets, especially the US treasury securities markets in search of a safe haven.


Moreover, Prasad believes Trump’s policy pronouncements suggest that he is going to give a good boost to growth in the US in the short-term and that again is going to be good for the US dollar.

Therefore, it is likely that the dollar will strengthen and perhaps diverging from the other major advanced economy currencies and certainly against many of the emerging market currencies as well during 2017.

Below is the verbatim transcript of Eswar Prasad's interview to Latha Venkatesh on CNBC-TV18.

Q: The first and the most important event of 2017 will be the assumption office by Donald Trump. What is your take on the US economy after Trump takes over and the resulting Fed action?

A: The overall picture is clouded by the economic uncertainty created by the new administration that he would be taking office in January and the uncertainty about the policies they will bring in with them.

President-elect Trump has spoken about using both tax cuts and increasing government spending especially of infrastructure to boost the economy and productivity and that would certainly lead to an increase on their fiscal deficit, possibly an increase in the inflation as well. So I think the Fed in particular is likely to keep some of his ammunition on hold for now pending the resolution of some of this uncertainty. But certainly, the policies that Trump spoken about are likely to give a boost to growth in the short run using fiscal policy more aggressively, reducing regulation on the businesses and the sort of tax reforms he has been talking about are all certainly going to be very good for growth in the US in the short-run. Growth and stability in the US in the long run are a different matter and we will have to see what sort of policies he puts in place.

Q: In that case how do you estimate global growth in 2017, will it be higher than in many of the previous years, maybe the best year since Lehman given that the US economy may get a boost from Trump?

A: That is a much harder question to answer because there is a lot of uncertainty around the world and if you look at countries in the euro zone, if you look at Japan, there the economies don’t seem to be on a very strong footing yet and many emerging markets around the world could face even more pressure especially on capital outflows on their currencies if the US does enter an interest rate tightening cycle.

So, there is a risk in the rest of the world that well performing US economy will certainly help by sucking in imports of the rest of the world but could set off financial instability and of course the big concern with Trump becoming President in the US is the uncertainty on the trade dimension. Trump has been threatening China with across the board tariffs and possibly a charge of currency manipulation, he is repudiated many trade deals that the US has been negotiating like the trans-pacific partnership, he has talked about tearing up existing trade deals like naphtha, all of this creates a lot of uncertainty especially in terms of trade. For many economies around the world, trade is a crucial factor in terms of promoting growth. So that uncertainty could hold back growth around the rest of the world.

Q: You referred to China, how do you think China's growth will pan out in 2017, will that be better than 2016 or at least as good as 2016?

A: China's growth does seem to have stabilised at least in the short-term. In the last few months or quarters we have seen that the industrial sector does seem to have something of a revival in growth. There are many indicators like the change in the producer price index (PPI), which had been falling for a few years suggesting a lot of excess capacity in the industrial sector, PPI inflation has turned positive just a couple of months ago, indicators of capacity utilisation and the industrial sector look better.

On the consumption side, retail sales are doing quite well. So it looks like China has turned the corner. This is not to say that growth in China is still not beset with a lot of fragilities, there are still concerns about the amount of capital flowing out of China especially with the prospect of rising trade tensions between the US and China, you could have concerns about Chinese export growth, which in turn might lead to more capital outflows, more downward pressure on the currency and more volatility in the currency markets, which would certainly not be good for growth. But my sense is that China still has enough room in terms of policy space -- both in terms of monetary and fiscal policy -- to hold growth in the range to 6-6.5 percent as always in the case of China, how they get to that number and what underlies that growth is the key question rather than the headline growth number.

Q: One of the enduring themes of the last month has been the strengthening of the dollar to 102, 103 ever since the Trump victory, can we expect further dollar strengthening, the dollar index going another 10 percent in 2017?

A: Trump's selection set off two very important forces, one is that it has created a lot of uncertainty in global financial markets and uncertainty in global financial markets tends to be good for the dollar because money flows to the US financial markets especially the US treasury securities markets in search of a safe haven.

Second as we were discussing earlier Trump's policy pronouncements suggest that he is going to give a good boost to growth in the US in the short run and that is going to be good for the US dollar especially because the surge in growth will come at a time when there aren’t that many other places in the world that are growing quite as fast and where many of the other advanced economies and emerging market economies are still trying to steady themselves. So, it is quite likely that we will see the dollar strengthening and perhaps diverging from the other major advanced economy currencies and certainly against many of the emerging market currencies as well during 2017.

Q: You are repeatedly speaking about volatility in financial markets. Do you think that 2017 is going to be marked by major jitters in the global markets?

A: It is going to be a very important theme because when you have the divergence in monetary policy that we are likely to see between the Federal Reserve on the one hand and the other two G3 Central Banks -- the European Central Bank and the Bank of Japan -- on the other hand and indeed the US versus most of the Central Banks around the world and in addition if you think about the divergence and growth prospects between the US and the rest of the world, all of this sets in motion the prospect of considerable financial market instability, many of the emerging markets are beginning to bounce back from very low rates of growth but some of them are still quite exposed because countries like Brazil, Turkey, Venezuela still have current account deficits that needs to be financed by foreign capital inflows. Some of these countries have corporate debt denominated in dollars and other foreign currencies. So a strengthening of the dollar and the weakening of their domestic currencies would certainly create more instability. So I think financial market instability and uncertainty are certainly going to be the watch words for 2017.

Q: Let us come to the big theme in India the biggest event in 2017 at the start of the year will be the Budget on February 1, given the pressure on emerging market currencies that you are talking about, will the Indian government have elbow room to raise fiscal deficit to pump prime the economy through a fiscal stimulus?

A: India certainly remains better positioned than many other emerging markets because as you pointed out, the current account deficit has fallen, the macro position was looking a little better until the demonetisation happened recently and India is least exposed to a US rate hike shock or a China growth slowdown shock certainly if you had a US rate hike leading to capital flowing away from all the emerging markets India would be somewhat exposed as well. But I think given India's relatively strong growth prospects compared to other emerging market economies, that is not a big concern but still sentiment about emerging markets including India is fragile. So I think trying to use fiscal policy very aggressively in the short run in order to boost growth could have a negative effect. It would be much easier for India to ride the wave it is on and especially with global economic weaknesses likely to keep oil prices low. That may help India both on the inflation and growth fronts. On the fiscal side, certainly some well targeted changes to the tax and transfer systems would help both in terms of the longer-term fiscal reform agenda and in terms of supporting growth but I do worry that trying to use fiscal policy very aggressively could lead to some sentiment turning negative against India.

Q: Is the India growth story at least looking good, better in 2017 than 2016?

A: I am quite hopeful that India can remain one of the largest emerging market economies in the world in terms of its growth rate and quite hopeful that the economy will bounce back quite quickly from the demonetisation hit to growth but all of this is conditional again on Modi pushing forward the reform agenda given that he seems to have some wind at his back. I am hoping that that will be the case and if so notwithstanding with any of the uncertainties and vulnerabilities around the world economy, India is best positioned among the emerging market economies to build on the growth that it has experienced over the last two years and continue to generate a pretty good growth. What that number might be is hard to tell, something in the range of 7-8 percent is quite easily achievable but again it is going to require the right side of policy actions especially economic reforms.

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