Gujarat elections and rupee

Author: Rushabh Maru

The rupee has appreciated yesterday as exit polls released by various media organizations have predicted swift victory for the BJP in Gujarat and Himachal Pradesh. State elections have become a huge issue as bold reforms taken by the Modi government have affected business activities in the country. Hence, the state elections are a litmus test for Prime Minister Narendra Modi ahead of general elections in 2019. With the conclusion of second and final voting phase in Gujarat, the focus would now shift to results of the elections which would be announced on 18th December.

State elections results would give further direction to the rupee. An outcome of Gujarat election is more important than that of Himachal Pradesh. We are projecting different scenarios for the rupee depending upon election result in Gujarat.

1) BJP winning Gujarat election:

This is the most favored outcome of the various exit polls released on Thursday. Almost all exit polls have predicted BJP would win the election in Gujarat. Most of the exit polls predicted that BJP would repeat its performance of 2012 this time too. In 2012, BJP had won 116 seats out of 182 assembly seats. This time too, on average, BJP is expected to get around 115 seats. The prime minister himself led an election campaign in Gujarat. Hence, if this scenario plays out then it would provide relief to the market and to Prime Minister Narendra Modi. This would prove that Narendra Modi remains popular despite bold reforms hurting the economy.

2) BJP losing Gujarat election:

A possibility of BJP losing Gujarat election is very low. However, this cannot be ruled out as demonetization and GST have badly affected GDP growth. There are a lot of problems in the implementation of the GST and this affected business activities. There are lots of business and trade communities in Gujarat; who have been severely impacted by GST and demonetization. Secondly, opposition parties have been aggressively campaigning against economic policies of Modi government. Opposition parties are also taking the opportunity provided by Patidar community’s agitation. Patidar community has been demanding reservation in employment and education. Patidar is one of the largest and influential communities of Gujarat. They have always been a supporter of BJP and Narendra Modi. However, since its demands have not been fulfilled, there are chances of cross-voting by Patidar community which could alter political situation in Gujarat.

                                                    Chart: Various exit polls on Gujarat election

                                                   Rupee projection based on different scenarios

Debt ceiling set to haunt markets again

Author: Rushabh Maru

After 2013 high drama between the Republicans and the Democrats, the debt ceiling issue is once again set to haunt financial markets all over the world. Before we discuss in length about the issue, first let us understand what debt ceiling is and why it is important. The debt limit is the total amount of money that the US government is authorized to borrow to meet its existing obligations. These obligations include social security and medicare benefits, military salaries, interest on the national debt, tax refunds and other payments.

When the ceiling is reached, the treasury department can no longer issue treasury bills, notes or bonds. Its only available action is to pay bills via tax revenue. If tax revenue is not sufficient enough to offset the costs, then the treasury secretary must choose which federal functions will continue to operate. The choice often comes down to paying federal employees, social security benefits or interest on the national debt. For this reason, the debt ceiling raises concerns about the federal government shutting down. Under Article I section 8 of the US constitution, only Congress can authorize borrowing of money on the credit for the US.

The issue is of paramount importance for the financial markets because if the current debt ceiling is not raised then America could default on its debt. If it happens then it would be unprecedented event in the history of the financial markets. To avoid this situation, the US has always raised the debt ceiling despite brawl. In 2011, the US reached a crisis point of near default on public debt. A delay in raising the debt ceiling resulted in the first downgrade of the US credit rating by S&P. This led to sharp sell-off in the stock market and increased borrowing costs.

The Congress raised the debt limit with the Budget Control Act of 2011, which added to the fiscal cliff when the new ceiling was reached on 31st December, 2012. Another debt ceiling crisis arose in early 2013 when the ceiling was reached again, and treasury adopted extraordinary measures to avoid a default. The debt ceiling would again have been reached on 3rd November, 2015. On 30th October, 2015 the debt ceiling was again suspended to 16th March 2017.

Since March 2017, the treasury department is using extraordinary measures to allow additional period of fully funded government operations. In September, the Congress raised the debt ceiling till 8th December, 2017 as hurricanes affected US economy. This provided temporary respite to the markets. However, recently the treasury department said that if the Congress fails to increase or further suspend the debt limit by 8th December, it can continue to take some temporary measures to finance the government only till January 2018. In that scenario the debt limit would be reinstated at over $20 trillion. Hence, by January 2018, if debt ceiling is not raised then the US would default on its debt.

Chart: Debt subject to limit and statutory limit on federal debt

Source: Peter G Peterson Foundation

Excessive debt creates a series of challenges for policymakers and the nation. It can impede economic growth and limit government ability to invest. A failure to raise the debt limit can lead to sovereign rating downgrade by rating agencies. US had faced similar situation in 2011 and 2013. During 2011, S&P had cut US’s sovereign credit rating to AA+ from AAA due to debt ceiling concerns. Similarly in 2013 too, the US was on the brink of government shutdown. After the global financial crisis of 2008, US debt to GDP has increased drastically.

Chart: US debt to GDP ratio

Source: Bloomberg

Source: Federal Reserve Bank of New York

Debt is rising at a rapid pace in recent years and currently stands at $20 trillion. In coming years, the debt to GDP ratio is projected to rise sharply. The projected rise in deficits is due to rapid growth in spending for federal retirement and health care programs targeted to older people. According to the CBO, by 2047, 22% of US population will age above 65 or older compared to current rate of 15%. Further, rising interest payments on the government’s debt accompanied by only moderate growth in revenue collection could push deficit higher.

Chart: Population by age group

Source: CBO

CBO projects GDP growth in coming years would be slower than it has been over the past 50 years. Under its extended baseline, CBO projects an increase in real (inflation-adjusted) potential GDP of 1.9% per year, on average, over the next 30 years, compared with 2.9% over the past 50 years. That slower economic growth is attributable to several factors, notably the slower growth of the potential labor force (the labor force adjusted for movements in the business cycle).

The budget deficit has increased to 3.6% of GDP in 2017, from 3.2% in 2016. By 2027, the deficit is expected to rise to 5.2% of GDP. Debt held by the public could rise to 91% ($26 trillion) of GDP in 2027, from 77% of GDP ($15 trillion) in 2017. The debt ceiling has become the political issue in recent months. President Donald Trump has threatened to shut down the government to get funding to build wall near US Mexico border. Republicans have demanded any debt ceiling hike to be accompanied by spending cuts or fiscal reforms. On the other hand, democrats are demanding reauthorization of health insurance programs for low-income children.

Recently, Trump floated an idea of permanently remove the requirement that Congress repeatedly raise the debt ceiling. The alternative which is being discussed is to give full authority to the treasury to borrow as much as needed to pay the nation’s bill.  In the earlier system, debt ceiling was automatically deemed to be increased with the passage of the budget. However, removal of debt ceiling requirement is easier said than done. Most of the Republicans are against this idea.

Chart: Projection of US government outlays and revenues

                    Source: CBO

On top of this, president Trump plans to reform US taxation system. Trump wants to cut taxes for individual and corporates. If this happens then pressure on revenues would increase sharply and as a result, deficit could widen further. Hence, US should raise debt ceiling when it approaches. That could avert US government default on its debt. However, as a long term solution, any hike in debt ceiling should be accompanied by spending cuts.


US shale boom to keep crude oil prices low in 2018

Author: Rushabh Maru

Recently, Brent crude oil touched $60 on growing expectations of the extension of the production-cut deal beyond March 2018. Crude oil has hit this level for the first time since 2015. Rising consumption, geopolitical tension and a sharp decline in the Baker Hughes rig count as well as in inventories have pushed crude prices higher. However, a recent warning from the World Bank could kill the rally in crude. The World Bank acknowledged that the long-awaited and much-needed re-balancing was finally taking place in crude. But higher production in the US, led by the shale-oil boom is unlikely to push up oil prices significantly.

US crude production would exceed 10 million barrels a day in Q4 2018, up from 8.6 million b/d in Q3 2016. The World Bank says costs of shale producers have been constantly falling, especially for services, equipment, and labor. Technological improvements and better planning have also helped reduce costs.  As a result, shale producers have been able to raise production despite low crude-oil prices. As prices declined below $50 a barrel this year, drilling in the US stalled. Despite this, drilling in the Permian Basin continued to expand. The Permian is the largest shale-oil producing basin, with a capacity of 2.5 million b/d.

Chart: Average U.S. shale-oil breakeven price

 Source: World Bank

For 2018, non-OPEC supply is projected to rise by 1.5 million b/d. This would leave little room for any meaningful reduction in inventories. Along with the US, Brazil, Canada, Ghana, Kazakhstan, Congo and the UK are expected to report an increase in supply in 2018.  Rising production from Libya and Nigeria is also a matter of concern. Both are exempt from OPEC’s cuts. Recently, Nigeria was granted further exemption from the production cut. It said it would cap crude production when it stabilizes at 1.8 million b/d. OPEC’s latest monthly report shows that Nigeria’s crude output rose by 1.86 million b/d. Libya’s crude production continues to rise as it has not made any such commitment.

The World Bank is also concerned whether OPEC and non-OPEC would extend the production-cut deal beyond 2018. There great hopes regarding the production-cut-deal extension at OPEC’s forthcoming meeting in Vienna (30th November). However, non-renewal of the pact and weaker compliance among OPEC members are major risks to the market. Though world oil demand is projected to climb by 1.4 million b/d, it is unlikely to ease the global oversupply situation.

Chart: World oil balance and oil price

Source: World Bank

Hence, re-balancing is lately happening in the crude-oil market. Consumption is also rising rapidly and boosting crude. However, US shale-oil production is expected to rise strongly in 2018. As a result, the global market is unlikely to tighten significantly in 2018. This may keep crude-oil prices lower in 2018.



Star Performer: Aluminium, with more than 28% y/y returns in 2017

Author: Jigar Trivedi


Commodity Yearly Monthly
LME_AHD 28% 2.76%

As smelters are being shut down and capacity curbed, the impact has already been seen on aluminium princes. LME aluminium has shot up from $1,400 in 2016 to $2,100 (See figure 1: white chart line) till now as inventories (See figure 1: blue line) tracked by LME warehouses have fallen continuously. Inventories tracked by the LME have shrunk 46% this year to 1.2 million tonnes, the lowest since 2008. Come 15th November, China will implement production-cuts to curb pollution concerns. Aluminium climbed to the highest since 2012 in London for gains of more than 28% this year, the best rally. Stockpiles in China fell in the latest week from a record high.

(Figure: 1)


China has eliminated around four million tonnes of aluminium capacity that fell short of environmental and energy standards this year in so-called supply-side reforms. President Xi Jinping vowed to deepen these reforms during The National Party congress that ended in Beijing on 24th October, and this has been enshrined in the Communist Party’s Charter. In addition to a crackdown on illegal plants, Northern provinces around Beijing will also halt capacity during the winter to combat pollution.

The Bank of China, one of the top-four banks in China, recently said in a note that aluminium rises further as global demand increases in 2018 and the supply crunch piles on the pressure.


Demand-side factors will also play a crucial role in coming years. Automakers are turning to aluminium to reduce vehicle weight to meet stringent fuel-efficiency requirements. Metal-makers such as Alcoa and Novelis are adding capacity to produce auto sheets in expectation of greater demand. More than 500,000 tonnes of capacity for so-called body-in-white sheets are scheduled to come online by the end of 2018. Aluminium content per vehicle will rise 39% by 2025 to 547 pounds, Alcoa says, driven by greater use of car frames and panels.

The Electric Vehicle revolution will spur demand for aluminium

The growth of the electric vehicle market will be positive for aluminium producers. Unlike traditional vehicles, EVs have fewer components and moving parts – e-cars have around 20, compared to almost 2,000 in an internal combustion vehicle. Apart from current applications – such as in the vehicle’s chassis, body (body-in-white, doors, hoods and trunk lids, bumpers and crash boxes), and wheels – aluminium will be used in the structures that carry electric batteries in EVs.

The good news for the aluminium industry is exponential growth in the electric-vehicle segment will be followed by record strong growth in aluminium automobile parts. BHP Billiton estimates there will be 140 million EVs on the road by 2035 or 8% of the world’s 1.8 billion cars. This compares to a little over a 1.2 million EVs today and points to an increase of 11,500% in around 20 years. The decisive variable in the development of EVs is China, which accounts for one-third of the world’s car market.


The World Bank’s latest monthly forecast is for aluminium prices to continue to soar till 2030.

(Source: World Bank October 2017 Report)

Looking at both supply- and demand-side factors, this year’s rally is justified. For the year till now, aluminium has rallied massively; hence, we do not rule out the possibility of profit-booking, but the uptrend is expected to continue. On the MCX, aluminium has a stiff resistance near Rs.143 and Rs.156. Hence, once prices move above the first resistance, a rally may be seen till the next resistance of Rs.157. On the lower side, Rs.136 and Rs.131 are strong supports.

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Can North Korea afford a war with the US?

Author: Rushabh Maru

North Korea is one of the most isolated countries in the world because of its nuclear-weapons programme and horrific human-rights record. Ever since the Korean War (1950-1953), North Korea has cut itself from the rest of the world. Since it is a closed economy, it has not flourished, primarily being run on foreign aid (food and medical supplies) from many countries of the world. For many years it experienced famine and flood. The worst is that its nuclear programme has attracted sanctions from the UN, the US, and other countries, making it extremely difficult for North Korea to trade with the rest of the world.

Recently, it has been in the news for all the wrong reasons. Despite its tiny economy, it is rapidly developing nuclear weapons. North Korea’s leader is in direct confrontation with the US president and threatened to launch missiles in the US. Along with the US, South Korea and Japan are in North Korea’s sights. This has heightened the uncertainty and volatility in global financial markets. The country is also developing and testing ICBM missiles and this has heightened tension in the Korean peninsula. Earlier this month, it tested its sixth and most powerful nuclear bomb. This met with strong criticism from the US and even from North Korea’s allies, China and Russia. Over the years, its nuclear bomb capability has increased dramatically. Some reports suggest that the latest nuclear bomb was of 250 kilotons rather than the earlier-estimated 100 kilotons.

Source: The Guardian

North Korea has hinted at more missiles tested in coming months. However, the question arises: Will it declare war against the US, South Korea, and Japan? Or, is that all hot air? Even if it declares war, can it really afford the cost and the aftermath? The answer is ‘No’. Since the country is isolated, many areas of the economy are undeveloped. Its GDP is a mere $28.5 billion, minuscule compared to the US’s $18.57 trillion. Strict sanctions on North Korea have destroyed its economy.

Whatever small economic growth North Korea has achieved is due only to its trading partner, China. Now, US pressure has compelled China to cut off relations, and the latter has, hence, banned iron, lead and coal imports from there. Minerals are North Korea’s largest export items. As a result of the ban, the country is acutely short of funds. North Korea relies heavily on crude-oil imports and China is its only source. The US has been demanding an oil embargo on North Korea. Recently, however, the US dropped this demand to win the backing of China and Russia to slap fresh sanctions on North Korea. Poverty and food shortage are pervasive. Despite that, it maintains a very large military, draining much of its resources.

Overall, North Korea’s economy is not diversified; hence, it is hit by an acute shortage of funds. It is already under severe sanctions, which have crippled its economy. Despite this, it continues to develop and test nuclear weapons, provoking the US. If the US and North Korea go to war, for the latter it could be an economic disaster.    


Rising US debt to haunt Dollar

Author: Rushabh Maru

The latest report released by the Federal Reserve Bank of New York on the household debt has an alarming warning for the US economy. US household debt has increased to $12.84 trillion in the second quarter of 2017, up by $552 billion from the corresponding period last year. This is the 12th consecutive quarter during which debt has increased. This is higher than the previous peak of $12.68 trillion reported in the third quarter of 2008. Overall household indebtedness is 15.1% higher than it was in the second quarter of 2013.  Mortgage balances, the largest component of household debt, has increased again during the second quarter. Mortgage balances shown on consumer credit rose by $64 billion to $8.69 trillion in the Q2 2017.

Source: The Federal Reserve Bank of New York

As of June 30, 4.8% of outstanding debt was in some stage of delinquency. Of the $612 billion of debt that is delinquent, $411 billion is seriously delinquent (at least 90 days late or “severely derogatory”). Student loans, auto loans, and mortgages all saw modest increases in their early delinquency flows, while delinquency flows on credit card balances ticked up notably in the second quarter.

In recent years, the US debt-to-GDP ratio has increased rapidly, at present, standing at 104.14%. This reflects the accumulation of Federal budget deficits over the years, tax cuts and higher military spending. Interestingly, from 2008 to 2017, the debt jumped from 64.34% to 104.14%. The government provided a large stimulus package and cut taxes following the global financial crisis of 2008. As result, debt has increased rapidly in the last few years. If the government does not take measures to tackle its debt, it could create long-term trouble for the US economy.

Chart:  US debt-to-GDP

Source: Bloomberg and AR research

There is a heated debate going on in the US about the debt ceiling. The debt limit is the total amount of money that the US government is authorized to borrow to meet its existing legal obligations, including social security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. The current debt limit is $19.809 trillion. Currently, the US has exhausted this limit and the Congress has until mid-October to raise the statutory borrowing limit. Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations and could precipitate another financial crisis. Recently, US treasury secretary has urged the Congress to raise the debt ceiling by September-end. However, there is no consensus among the Congress members regarding raising the debt ceiling.

The US needs to keep a lid on rising debt levels by controlling spending. Markets would keenly monitor how the US debt ceiling issue would be dealt by the Congress once it comes back from the ongoing recess. Failure to raise the debt limit would have negative implications for the Fed’s monetary policy and the dollar.



“Global Debt”, a potential threat. Gold to be in the spotlight

Author: Ravindra Rao

Since the start of 2017, spot gold in dollar terms has been up 10% as of this writing, thanks to the dollar as the broad index has fallen from 102.21 to 92.96, approximately a 10% drop. The slipping dollar has been a boon for gold bulls as the five-year US Treasury yield, adjusted for inflation which has risen 150%, should have put remarkable pressure on gold prices. The dollar has given away almost all the gains it had registered after Donald Trump was elected as the US President in last year’s elections. The major setback came from the euro after the ECB said it would continue monetary accommodation until the year end. The euro has a great bearing on the dollar as it carries the most weight in the composition of the Dollar Index.

Although gold has climbed since the start of the year, investment demand has been slower. Investment in world’s largest ETF, the SPDR Gold Trust, has dipped 76% from the same period a year earlier. This shows that investor money is still flowing into risky assets. Exchange-traded products have attracted a record $245 billion in H1 2017. The first half of the year is weak for exchange-traded products, but 2017 has been different, clocking a record $245 billion in the first six months. Booming demand in exchange-traded products and other risky assets have contained demand for physical gold. But does this mean that gold will shine less bright

The answer possibly is NO. Why? The ballooning global debt! the Institute of International Finance puts global debt levels in Q1 2017 at $217 trillion — that’s 327% of world GDP. Before the financial crisis, the global debt was around $150 trillion. The global economy has added $120 trillion since 2008. This portends a looming risk, as it would be arduous paying off such a humongous debt. Central bankers have pumped in huge sums into the system to promote economic growth. But the quantitative easing does not appear to have been a resounding success. Now that the central bankers are looking to raise rates, the burden of refinancing the debt will be a Sisyphean task, both laborious and futile.

This opens up vast opportunities for investment in the yellow metal as part of portfolio diversification.    I have always felt that 10% investment in gold is the ideal level for portfolio diversification. But, looking at the immense potential risk, even a 20% gold level in a portfolio will not be such a bad idea. At present, ETF buying in gold is restrained. However, I feel that it will start picking up once spot gold moves above $1,300 a troy ounce. Technically, gold is set to move sharply higher once the resistance of $1,300 is broken. (see chart below)