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In recent days, the global financial landscape has been shaken by various significant events, with each having its effect and leading to a domino effect as well, which has contributed to global volatility and growing tension in the world. Let’s look closely at each of these events and their potential impact on the Indian economy!
Brief Introduction to Yen Carry Trade
The Japanese Yen has been considered as safe-haven and a favourite among carry-funding options by global investors given the low cost of borrowing. The Japanese currency was among the most bought currencies by the G10 countries according to some analysts.
A carry trade is a popular investment strategy where investors borrow money at a low interest rate and invest in assets that offer higher returns. This approach allows investors to maximize their returns significantly.
For the past two decades, the Bank of Japan (BOJ) has maintained interest rates at 0%, and the weakened Yen Has further favoured global investors. However, recent developments have shifted this landscape dramatically.
What caused the Global Market turmoil?
Last week, the Bank of Japan (BOJ) announced an unexpected hike in interest rates from 0% to 0.25%, which sent shockwaves to global investors. Furthermore, the Japanese Yen has appreciated by 10 per cent over the last 3 weeks, from levels of 161 on July 11 to 145 now. As the Yen appreciated against the US dollar, investors had to rush and unwind their carry trade in order to cut losses. This is said to be one of the reasons for the fall in the US equity market.
In a parallel development, Warren Buffett’s Berkshire Hathaway slashed its Apple stake to nearly half. This move significantly unsettled the broader global market due to his recognition in the financial realm. High valuation is the reason suggested by the analysts for the sale.
Adding on to the turbulence on Friday, August 3rd, the Federal Reserve unveiled the latest US job report, which revealed a weaker-than-expected performance. This report sparked concerns about an impending recession and the lingering effects of the pandemic, triggering a domino effect that impacted economies worldwide.
The narrative about a global equity market has pivoted in recent weeks. The optimism and support towards Artificial Intelligence (AI), and robust growth of various large-cap companies have been overshadowed by an increasing unemployment rate, fear of the US recession, concern about monetization of AI, the formation of an AI bubble in the market, and escalating tensions in various parts of the world.
The unemployment rate has been rising to 4.3%, up from 4.1% in the prior month and from a low of 3.4% as recently as April 2023. The people were already in anticipation of the upcoming interest rate cut from the Fed but the Fed hasn’t given any indication of a rate cut. This also led to uncertainty in the minds of the investors due to which the investors started reducing their positions.
This led to an overall domino effect on other countries as well, and the effect was seen on Monday when the investors started panic selling all over the world. Markets all over the world had a tremendous downfall. Dow Jones went down by 1.71%, S&P 500 went down by 3.66%, and NASDAQ went down by 6.34%. Furthermore, spot gold fell 2%, and futures dropped to 1.4%. The Japanese index Nikkei dropped 26% into the bear market. Taiwan stocks plunged by 8%. Istanbul bourse trading had to be halted for a second time as the main index fell by 7%. Even the European markets hit a 6-month low.
This effect was not only limited to equity markets but also included other markets such as commodities, bonds, and cryptocurrency. The impact could also be seen in the Brent Crude Oil market, where prices have declined to their lowest level since January, hitting approximately $76.1 per barrel. Crude oil supply remains in question from the Libyan supply losses and increasing conflict in the Middle East. For developing countries like India, which are heavily reliant on crude oil imports, the decrease in oil prices could provide some economic relief.
Other Global Tensions
Middle East
Recent tensions in the Middle East have escalated following the assassination of Hamas leader Ismail Haniyeh. While no group has claimed responsibility, Iran and Hamas have accused Israel, particularly as the strike came shortly after Israel targeted a Hezbollah commander in Beirut. Haniyeh's killing, occurring just after he attended Iran's new president's inauguration, heightens the risk of an all-out Israel-Iran war.
Such a conflict could disrupt global oil markets further, reversing the recent downturn in crude oil prices and impacting oil-importing countries like India and China.
Bangladesh
Bangladesh Prime Minister Sheikh Hasina resigned on Monday over the violent protests that have been going on in the country since early July. She has fled to India and is likely to seek asylum in the UK, where her sister holds citizenship. The protests were due to a bill that was reintroduced by the which gave 30% reservation in civil service jobs to the students whose relatives were part of Bangladesh’s war of Independence from Pakistan in 1971. Despite Bangladesh’s Supreme Court scrapping the reservation, the protests continued, spreading beyond students due to the brutal crackdown unleashed more anger against Ms Hasina’s Govt. Currently, Bangladesh is under military rule and the Army Chief has said that an interim govt will be formed and pledged justice for people who have been killed.
Effect on India
Indian Markets
On Monday, the Indian indices made a major correction due to concerns about the US recession. Both the NIFTY and Sensex fell by around 3%. The India VIX (Volatility Index), which measures the volatility of the Indian Markets, reached an all-time high after rising 60%, breaking the record during the 2024 elections. This has created a sense of panic in Indian investors as well.
Halt of Indo-Bangladesh Trade
The political crisis in Bangladesh has halted Indo-Bangladesh trade, posing risks to India’s exports and infrastructure projects. The unrest could potentially increase the number of immigrants in India. However, Indian textile manufacturers might benefit from increased demand due to the halt in Bangladeshi exports.
Devaluation of Indian Rupee
The Indian Rupee plunged to a record low of 83.7525 on Monday and continues to fall against the US Dollar, pressured by strong dollar bids in the non-deliverable forwards market and importer hedging. The currency weakened despite likely intervention by the RBI as it faced headwinds amid continued unwinding of carry trades that used the Japanese Yen and the Chinese Yuan to fund long bets on the rupee.
A depreciating Rupee will lead to an increase in the cost of imported goods such as oil, machinery, and electronic goods. This increase in import prices will, in turn, elevate the prices of these goods in the Indian market, contributing to higher inflation. This inflationary pressure can erode purchasing power, reduce consumer spending, and dampen economic growth.
Decrease in Foreign Investments
US job declines have created uncertainty and volatility in global financial markets. This uncertainty can lead to reduced foreign direct investment (FDI) and foreign institutional investment (FII) into India, as investors may become risk-averse and pull back from emerging markets. A significant reduction in these investment flows can impact India's economic growth and development projects.
Trade
The US is one of India's largest trading partners. A decline in US employment can lead to reduced consumer spending, which in turn can lower demand for imported goods, including those from India. Key sectors such as IT services, textiles, pharmaceuticals, and automotive parts could see a reduction in orders, impacting Indian exporters' revenues.
India's IT and business process outsourcing (BPO) sectors are highly dependent on US clients. A downturn in the US economy can lead to budget cuts and reduced spending on IT services by US companies. This can result in fewer contracts and lower revenues for Indian IT firms, potentially leading to job cuts and reduced growth in the sector.
Conclusion
Recent global financial turmoil highlights the deep interdependence of countries and how disruptions in one economy can ripple through the global market. Events like the BOJ's interest rate hike, strategic market moves, and weak US job performance have significantly impacted India's economy, driving inflation, disrupting trade, and affecting investments. This underscores the need for careful navigation and strategic planning in an interconnected economic landscape.
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