Moneycontrol Pro Weekender: Things fall apart

The International Monetary Fund and World Bank’s recent meetings also analysed the fallout of what they call geo-economic fragmentation

Dear Reader,

Christine Lagarde, President of the European Central Bank, made a major speech this week at New York, giving an unequivocal message that the world has changed dramatically and there’s no question of going back to business as usual.

She said, “We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values. And this fragmentation may well coalesce around two blocs led respectively by the two largest economies in the world.”

What will be the economic impact of this splitting up of the global economy? She talked of “lasting instability resulting in lower growth, higher costs and more uncertain trade partnerships” adding that, if global value chains fragment along geopolitical lines, the increase in the global level of consumer prices could be around 5 percent in the short run and roughly 1 percent in the long run.

Lagarde went on to talk about governments scrambling to secure raw material supplies, subsidising production of strategic inputs such as semiconductors and challenges to the dollar and the euro. The long and the short of it is that Pax Americana is dead and a multipolar world brings with it multiple challenges.

We are once again in a situation similar to the world of the early 20^th century, a world described in WB Yeats’ ‘The Second Coming’, which contains the oft-quoted lines, ‘Things fall apart/The centre cannot hold’.

The International Monetary Fund and World Bank’s recent meetings also analysed the fallout of what they call geo-economic fragmentation. They pointed out that companies and policymakers are moving production processes to trusted countries with aligned political preferences to make supply chains less vulnerable to geopolitical tensions. They point to “a sharp increase in countries’ exposure to financial fragmentation risk, which could trigger a significant global reallocation of capital in response to a rise in geopolitical tensions. Such tensions matter significantly for cross-border portfolio allocation and could cause a sudden reversal of cross-border capital flows, especially in emerging market and developing economies”.

Much of this is well-known and forms the basis of the China+1 thesis. People like Zoltan Pozsar have been shouting from the rooftops about it for a year. The question that is most interesting from India’s and other non-aligned countries’ point of view is: In this fight between two elephants, will lesser animals too suffer?

Thankfully, the IMF study believes there is some relief for countries such as India and Indonesia and regions such as Latin America, which have so far remained non-aligned.

Sure, the fragmentation of the world economy will affect global growth. The IMF study says global output will be about 1 percent lower after five years, relative to the no-fragmentation scenario and around 2 percent lower in the longer term.

But the IMF also says, “For the non-aligned economies, the impact depends on the outcome of two competing channels. On the one hand, the substantial reduction in global activity reduces external demand, weighing on net exports and investment. On the other hand, these regions also benefit from the diversion of investment flows, which—if sufficiently large—could boost investment and output.”

Much also depends on what they call the “elasticity of substitution” or the ease with which the shift in supply chains can be made. The study’s computations show that long-term GDP losses for non-aligned countries such as India and Indonesia are very low when there are cross-bloc investment barriers even when it’s not easy to shift supply chains. If, on the other hand, the ease with which investments can be shifted is high, then these countries stand to gain a bit in their GDP in the long term.

The calculations are very tentative and can easily change, given the huge uncertainties. The key takeaway from the IMF analysis is that compared to other regions such as China, SE Asia, the EU and even the US, non-aligned nations such as India are relatively insulated from the fallout of geo-economic fragmentation and may even gain from it. That is already being seen in the way India has been able to source and refine Russian oil and firms such as Apple and Foxconn are setting up production units here.

There is, however, one caveat. What if tensions between the two blocs ratchet up and non-aligned members are viewed with suspicion? The IMF says, “In reality, a geoeconomically fragmented world might entail substantial policy uncertainty for economies that try to remain open to both geopolitical blocs. Rather than having their non-aligned status accepted, these economies may need to walk a narrow path amid pressures from both sides, with the attendant risk of falling out with one bloc or the other… losses are significantly amplified for non-aligned regions under such uncertainty, as they face reduced inflows from both blocs.”

A word of warning. It is by no means certain that the world is splitting up into two blocs. Sino-US trade is still substantial and it’s likely that the competition may be limited to strategic sectors. As they say, the road ahead is slowbalisation rather than de-globalisation.

There is also no reason for regions like South-East Asia to be in one bloc or the other. The EU may well try to tread its own path, seen in French President Macron’s recent visit to China, rather than be completely in the US camp.

As for India, its antipathy towards China makes its non-aligned status highly suspect. As this article shows, our holdings of US Treasuries have shot up, perhaps a reflection of our political alliance with the US. That may not be a bad thing. As the IMF study says of emerging markets: “Given that the advanced-economy-dominated US bloc is the major source of investment flows, they are better off joining this bloc if forced to choose, especially if they were to face uncertainty otherwise.”

The concern is that investors have not factored in this brave new world into their views of the markets. Indeed, as my colleague Aparna Iyer writes, “Benchmark indices seem to even dodge the fact that corporate profits are under pressure.” Our columnist Ananya Roy warned that investors face a new normal, while my colleague Sachin Pal said, “Investors should remain selective in terms of capital market allocations, stick to quality names, be prepared to digest more episodes of volatility (like the collapse of SVB), and endure more pain to their portfolios in the months ahead.”

Cheers,

Manas Chakravarty

Here are some of the stories and insights we published this week, apart from our technical picks in the equity, commodity and forex markets:

Stocks 

Cantabil Retail India, Fermenta Biotech, Sapphire Foods India, Weekly tactical pick—why this insurer could turn out to be a star performer, Cyient, HDFC Bank, Infosys—when to bottom fish, Delta Corp, Manappuram Finance, ICICI Lombard, Triveni Engineering and Industries, IRCON International, Varun Beverages, HCL Tech, ICICI Pru

Companies and Industries

What China’s rocking GDP numbers mean for Indian steel producers, IT margins, Is the sugar cycle turning favourable?, Diagnostic chains, IT downturn likely to be a short-term affair, Stubborn lead prices and battery makers, US drug shortages rekindle pharma recovery hopes, GoFirst’s prospects look gloomy

Markets 

Make the most of 2023 for long-term investment

A weak dollar is good for Indian markets

Are we near a Fed rate hike pause?

Interest rate swaps are signalling a pivot Why stock holdings will get more concentrated Indian retail traders have no reason to celebrate SGX Nifty trading in India

Financial Times 

Margins will fall, but to where?

Investors bet that US dollar has further to fall Martin Wolf: The future of interest rates is a riddle

Why I am not investing in a buyout Bloomberg is contemplating life without its founder

Big Tech is racing to claim its share of the generative AI market

Geopolitics 

The Eastern Window: Is Bhutan warming up to China?

China’s domination of global renewable energy sector here to stay

Economics

The hit to GDP from the heat wave The assault on rural wages

India’s consumers holding back on big spends The challenge for India’s exports gets tougher

Economic Tracker India’s projected increase in per capita GDP one of the lowest in Asia India third largest contributor to global growth, but way behind China

Why the WTO ruling against India on ICT tariffs matters

Charts of the week

Retail investors outsmarting active fund managers Gold loans are glittering for banks

States put their shoulder to capex wheel More pain for software-as-a-service IT firms

Project awards on a high

Politics

BJP woos dominant castes in Karnataka

Others 

Startup Street: unfamiliar territory for startup founders, Twitter—all downhill from here?, The need for regulating financial spam calls, Marketing Musings: The difference between Aiyyo Shraddha and Rabindranath Tagore endorsing products, Generative AI—who owns the content, Personal Finance, GuruSpeak—the power of algo trading