Two Issues that The Indian Economy is dealing with

Two steps taken by the Modi government have dealt a blow to the way business is done in India. Short term impact has been  disastrous though long term benefits will be good. The point is will people suffering listen and wait long enough?

1 - Demonetization of 8th November 2016
2 - GST of 1st July 2017

Demonetization at least temporarily has destroyed the informal sector mainly working on cash. GST threw the economy off balance for 2 months as everyone was busy complying to the new law. Job creation has been negligible and particularly the age group of 38 years and above are finding it extremely hard to find jobs. Many are simply sitting and waiting it out for the turnaround to happen. Many of these experience professionals have opted for raising funds and opening startups. The Middle class particularly is finding the going extremely tough. With no incentive to pay taxes  demonetization has not been very helpful as 98% of the money has come back to the banks. Finding out who did what and whose money it is, is a herculean task and could lead to a lot of people being unnecessarily harassed. 

The way out could be some creativity from the finance ministry like abolishing income tax as advocated by Mr. Subramaniam Swamy or at least taking a flat income tax of 10%. A massive Public Spend on projects could be another way to move forward. Massive incentivization to sectors that employ huge people forces could be another step.

USDINR

USDINR continues to strengthen. I expect Rupee to reach 60 by year end. RBI had done a good job in slowing down the speed for the rupee. Looking at the decline in the US dollar Index rupee should have already been at 60.

EuroUSD - Nifty50 & WTI Crude

Below is my analysis on INR. In addition i have reposted my analysis of August 2015 so you can compare the waves.

Nifty50 Analysis

WTI Crude Weekly

I expect Crude to make a bottom of 30 against the USD and then reverse and close above 35 for the week. If that happens i will consider crude to have bottomed out.

FED Rate Hike Decisions

FED Rate Hike Decisions

The Fed meets 10 times a year to decide on US interest rates. 

Inflation: - when demand starts overtaking supply we have a situation where the prices will automatically start rising.  In other words inflation is too many people chasing too few goods.  Once the economy reaches a stage whereby aggregate demand starts overtaking aggregate supply prices will rise and so inflation will set in.  The central bank of any country will respond to this by hiking interest rates in order to reduce money supply in the economy and thereby curtail inflation.  Thus from a trading perceptive it is important for a trader to gauge whether inflation is setting in and whether the central bank will move in to hike interest rates.  The trade should therefore look at the following data to check whether interest will go up.

Inflation can take place in the following ways for which different data has to be looked at.

Growth Push Inflation

Price Push Inflation ‘

Wage Push Inflation

Demand Push Inflation

Growth Push: - this results as s result of strong growth in the economy.  For ascertaining whether inflation is going up as a result of the growth we need to look at the following indicators: - 1) GDP figures 2) Unemployment & 3) Non-Farm Payrolls.

Price Push Inflation: - This results because of the prices going up.  For ascertaining whether inflation is going up as a result of the prices going up we need to look at the following figures.

PPI Figures

CPI Figures

Wage Push Inflation: - This results when there is wage pressure and earnings go up. For ascertaining whether inflation is going up as result of wage pressures we need to look at the following figures:

Average hourly earnings

Employment Cost Index

Demand push Inflation: -This results because of demand pressures. That means that consumer demand is so strong that the prices are pushed up as supply is not able to cope up with demand. For ascertaining whether inflation is up as a result of demand pressures we need to look at the following figures.

1-      Retail Sales 

At any point of time for the central bank to move in to hike interest rates it is important that out of the above four factors at least three should indicate a rise in inflation. Even if two of the above four indicate that there is a rise in inflation there is a possibility that the central bank may move in to hike interest rates but with three factors indicating inflationary pressures, hiking interest rates becomes a certainty.

                              Eccles Building. Head Quarters of Federal Bank in Washington D.C 

Effect of Interest Rates:

Inflation goes up – Interest Rates go up

Interest Rates go up – The currency whose interest rate has been hiked becomes stronger

So FED increases interest rates – US dollar becomes strong.

FED decreases interest rates – US dollar becomes weaker.

Further

Interest Rates go up – Stock Markets & Bonds come down & Vice Versa.

After the 2008 crisis the above might not be as simple as described above, but traditional wisdom dictates this is how the FED would respond.

A general rule of thumb is that if the FED responds by hiking interest rates 3 times, the US economy goes into a recession.