How dark are the dark hurricane clouds for the economy?
The storm clouds are here, the ones that you see – high oil prices, the war in Ukraine, high inflation – these are all storm clouds, it can get worse. I don’t think any one of us knows how bad it is going to get, because some of those things can easily get worse. I’m not as concerned about the Fed’s activity… raising rates 75 or 100 basis points. That’s a drop in the ocean as it makes virtually no difference other than a little bit of a psychological twist about how tough the Fed’s gonna be.
The market is obsessed as to whether it’s going to be 75 or 100, but you don’t think that is such a big deal?
The actual effect of the 25-basis-point difference in rates is not that relevant, other than the psychological element which will be a short-term effect. If they raise rates by 100 basis points, you’re going to have two questions. You’re gonna say to yourself, they’re being tougher, that’s great. And then you will ask yourself, well what are they worried about?
The question now is how strong or how likely is a recession?
The amount of monetary and fiscal stimulus was so large; how could it not drive more inflation and thereby higher rates. We have gotten used to the rates moving to 3% or 4% now, but I think it’s just as possible that we get used to the idea that the rates will move to 5%. I think it will be more difficult for the market to absorb because I think it had a 3.5% rate in their mind rather than 4.25% or 4.5%. Because the fiscal stimulus is still being spent, inflation may go down a bit but pieces like rental prices in most cities and the CPI equivalent, or wages are not going to go down. And therefore, I assume that the Fed may have to go up a little bit more and then their curve will reset up a little bit.
You warned about an impending economic hurricane. What kind of a trail of destruction this is likely to leave?
There are serious storm clouds up ahead, but we don’t know whether it will be a modest storm that dissipates or a more serious hurricane. Some think it could be a bad recession because war itself is unpredictable, oil and natural energy and food are precarious, inflation is higher and geopolitics is far more tense with America and China. So, you have all these things taking place, creating this turbulence, that might make things worse. You can look at any war, most of them have unpredictable outcomes. They can cause much more problems for humanity than for markets. I am not really worried about the market.
A generation of central bankers haven’t seen this kind of price pressures. The one that is recalled is Paul Volcker’s times. How do you expect central bankers to react?
This is complex. First of all, I respect what they did to recover from Covid. And I think we should recognise that. But in hindsight, it is clear that they’re late. And that probably means they’re going to raise rates more later than they might have done earlier. The other thing is we never had fiscal stimulus like this. We’ve never had QE (quantitative easing) like this. So, the Fed is acting literally in uncharted waters. There’s never been global QT (quantitative tightening). Think of the alternative: As long as this economy is rolling down the tracks, and inflation is running at 7% or 8%, the Fed is going to raise rates. If the first 75 basis points doesn’t do it, they will do another 75 and if that doesn’t do, they will do another 75. At one point, when they first see inflation coming down, they may take a pause or do a small rate increase. One of the lessons from Volcker is, he did it very aggressively. And Volker spoke about the fact that he waited too long, and then made it worse.
The US Fed and the ECB are on the same path whereas the Bank of Japan hasn’t moved yet. What does this mean for the financial markets?
That was part of my storm clouds too. What we know is that it will lead to hugely volatile markets. That’s an absolute given. That’s a given because every day you wake up, you got to be asking the same questions. You are using that day’s data to determine it’s good, it’s bad, it’s wrong, it’s too high, it’s too low. And that’s going to cause episodes like this. And of course, interest rate markets affect all markets. This churning I’m talking about is going to cause very volatile markets as well as close down markets like the IPO market or the high-yield market. It’s completely expected that’s going to go on for a while. There hasn’t been capitulation or fear or panic in the markets.
Do you foresee capitulation?
The odds of that one happening are higher. I hope it doesn’t happen and I’m not predicting that. I just think there’s a chance for that and we’re prepared for it. So as a company serving Indian clients and the Indian government, I need to be as prepared as I can to serve my clients. I don’t worry that much about the volatile markets, we are used to that, and we can deal with that.
Which is a bigger threat: inflation or monetary tightening?
I think they’re equal threats, but one you are used to and one you are not. I don’t know what the full ramifications of QT is. And I think, in hindsight, they would be writing books about QE for 50 years. And I think people would realise at one point that negative rates were a bad idea. But I may be wrong. I don’t know – let the history books write that. But I think, there’s a third one, which is far more important. And that’s the war in Ukraine. I mean, it’s a humanitarian crisis, it’s nuclear blackmail. People are talking about potential starvation. The winter hasn’t happened yet. Oil supplies are precarious by their nature. I put that as a much higher risk to mankind than bad markets.
How much of a concern is a China-Taiwan conflict?
It’s a black swan event. A war in Taiwan will be devastating for the global economy for many reasons. I think the globe has realised after the war in Ukraine that national security is paramount. The nuclear issue is scary. And if you look at energy supplies, China and India will be looking at it and say, what do we need to make sure my country is secure. I do think people will restructure trade to make sure they are more secure as opposed to getting rid of trade. I think some of this around the world is good for India, because as people diversify supply chains, India should pick up some of that manufacturing.
Because of the sanctions, there is a parallel payments system that has emerged between Russia and China, and even India-Russia. What does this mean for the US-dollar dominated international system?
America should be very careful how it uses financial sanctions. They should only be used for serious reasons and probably in conjunct with allies. I will put Russia in that category. I think if we overdo it, we are giving reasons not to trade with America or bank with America or leave your money in dollars. The reason the dollar is strong is because there is a rule of law. You’re free to do what you want with it. In the back of your mind, you are not worried about the rule of law in America or about the debasement of currency because you know, the central bank is trying to maintain the currency. The payment systems are a little different because people can find alternative ways to pay. In the Swift payment system, a lot of banks are hooked up into each other. We don’t need the Swift payment system for certain things. So, when America says, okay, you can’t use Swift to pay the oil company, you might find a way to pay them. But if America says that if you pay the oil company, we’re going to put restrictions, that’s a much tougher thing.
India has been an outperformer. How do you view it in the global context?
India should strive to be the fastest growing economy on the planet for the next decade. Anything shorter than that target is not high enough. And the question that you should always ask is, what are we doing to get there? We deserve it. Why are we not there?
India has done some brilliant things over the last 10 years. The biometric identification to do transfer payments with banks. You have a national infrastructure Bill, which hasn’t started yet. Anything that reduces regulatory — and I’m talking about bureaucratic regulatory burden — is a good thing. Free competition, stronger financial markets, I hope that GIFT City works for you and now this huge opportunity with people having to move supply chains out of China, of course, you should be a big beneficiary. You are looking at the world, trying to be a peaceful nation, you’re right next to Russia and China, but your best ally in the world in the next 20 years will be America.
When you look at this region — China and India — from America, how does it look in relative terms?
You have done great. You recorded 7% growth this year and 7% last year, I think that’s very good. Obviously, China’s having a lot of issues, but you shouldn’t rejoice over it. That’s not good for you. It’s not good for us. Some of these issues are solvable. The real estate issue is real, but they have the wherewithal to overcome it. They can tell the banks to roll over the loan, finish the building, let the people move in. And I think they will do smart macro policy to accelerate the growth a little bit. And sometime after President Xi’s elected a third term, I think they would be able to overcome this. I don’t think that they’re in a static position. I do think over a long period of time, autocratic management of financial markets will lead to misallocation of capital, corruption, and that will be the next decade’s problem.