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Weekly Economic Review - India, UAE & Global Macro

|Includes: Market Vectors Indian Rupee/USD ETN (INR)

Week ending August 15, 2015


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Equity markets in UAE were hit hard by the fall in crude oil prices and the sell-off in emerging markets emanating from the Chinese Yuan devaluation. Crude Oil prices and government spending are the key drivers of liquidity and growth in the region where this sector contributes about 70-80% of GDP. The fall in Crude Oil Prices and the slowdown in government spending will have a cascading impact on the regional GCC economy.

The implications for UAE from the fall in Chinese Yuan will also be on Tourism. Chinese tourists had become the fastest growing segment in the tourism industry over the last few years and with the fall in Yuan it will impact this segment. Currencies like the Indian Rupee and most of the far eastern currencies fell sharply on the back on the Chinese devaluation and tourism from these countries will also be impacted especially India which forms a large chunk on inbound tourism into UAE. It is during times like these when, the US Dollar is excessively strong or like in 2007 when it was excessively weak that the fixed peg that the UAE Dirham has against the US Dollar, starts hurting the economy. The strength of the US Dollar and consequently the strength of the UAE Dirham against most currencies also makes the other key sector in UAE housing, more expensive and unattractive. This sector had witnessed some nascent interest from Chinese buyers in recent times and this could slow down for the time being.

Another impact of the weakening of the Chinese Yuan is that the Forwards for the fixed-peg GCC currencies have become volatile with Saudi one year trading around 200 pips up sharply from the levels of around 10 pips in late June. The initial move higher to around the 100 pips was due to the move lower in crude oil and with the fall in the Yuan it has moved further higher. The move in the UAE dirham forward has also been sharp after the Yuan devaluation this week, last week it had closed a discount of around 6 pips, but on Thursday it traded a high of over 40 pips. The currency pegs in the GCC will face a questions of continued usefulness as oil prices remain low and the US Dollar remains strong.

The Indian Rupee fell just under 2% in wake of the fall in the Chinese Yuan. Amongst the BRIC countries, India seems to be a spot of calm in otherwise turbulent waters. Brazil's rating was cut by Moody's to the lowest in Investment Grade to Baa3. Russia is facing a second round of crisis after some stability in the first half of the year. As a result Indian equities and Bonds have turned out to an attractive destination for fund managers who have to stay invested in BRIC & Emerging market funds. While we have seen outflows from Foreign Institutional Investors it has not been alarming enough to send stocks & the Indian Rupee lower. This week we witnessed outflows of $587 million from the equity & debt markets combined. The large accretion to Foreign Exchange reserves we have witnessed in the first half 2015 has tapered off after hitting an all time high of $355.46 in mid-June. FX Reserves as per data from RBI is down to $353.46 billion as of June 19. The reason for the fall in reserves could be largely accounted by the fall in value of Gold and other non-US Dollar currencies held in FX Reserves.

Indian equities traded with a negative tone for most of the week, but roared back to life on Friday posting large gains on hopes of a rate cut & hopes of passing of the GST Bill. The next RBI meeting is scheduled on September 29 & CPI falling to 3.78% (Y-on-Y) in July, raised hopes of an interest rate cut. At the Wholesale level inflation dipped further into negative territory with July WPI at -4.05% (Y-on-Y). Industrial Production data was upbeat at 3.8% for June (Y-on-Y) well above May's 2.7%. The Manufacturing sector grew at 4.6%, while lower mining and electricity output dragged the overall Industrial Production number lower. On the GST Bill, there were rumors that the government could call a two-day parliament session to get it passed. The poor performance of Indian exports in the global market continued with exports contracting for the eight straight month falling to $23.13 billion. Trade deficit in July increased to $12.81 billion, but imports also contracted falling to $35.94 billion. Crude Oil imports fell by 35% falling below $10 billion, due to falling prices. The structural imbalance in foreign trade, which is one of the largest in the world, has increased further in the first four months of this fiscal year posting a deficit of $45 billion.

China rocked international markets with a sharp devaluation in the Yuan on Tuesday. The closely controlled Yuan's mid-fixing was weakened on Tuesday by PBoC to 6.2298 from Monday's fix of 6.1162. The other significant change the PBoC announced was that fixings going forward will be based on quotes obtained from the onshore primary dealers each morning. This is a devaluation of 1.86% and the biggest single day devaluation since 1994. We witnessed further devaluations of over 1% on the next two days also. The Chinese economy has been in a spot of bother over the last year or so and the immediate trigger for this could be the sharp contraction in July exports of 8.3%. Earlier in the week China had announced that FX reserves dipped by $42.5 billion in July and it now down by $343 billion since it peaked at $3.993 trillion in June last year. China being the world's largest exporter, what this Chinese Devaluation means for the rest of the world is that we could see more global deflation as a fall in commodity prices and the lower Yuan combined would bring prices lower in the countries where there exports are headed. The freely tradeable CNH in Hong Kong fell by over 6% at its weakest point this week and was weaker than the onshore fixing by 1% at close. The reason for the pull back towards the latter part of the week is attributed to PBoC selling to cap the upside in the USD/CNY. If China is moving towards a market rate for the USD/CNY but at the same time intervenes to manage it's the market rate, this may not go a long way to meet the IMF's criteria to be included in the SDR basket.

Greece has agreed to a deal on the terms of the third bailout agreement of Euro 86 billion with the IMF, EU & ECB. The next step would be to get these approved by the parliaments of the individual Eurozone countries. As is the case with Eurozone, though the deal was announced by the EC spokeswoman, Finnish officials stated that more work needs to be done!! The key stumbling blocks in the deals were the structure of the new independent privatization fund & how non-performing bank loans will be dealt with. The next date to watch is the August 20 repayment of Euro 3.5 billion due to the ECB. All individual governments are expected to get their respective parliaments to approve this bailout agreement. Economic data from Eurozone was mixed. Eurozone Industrial Production fell 0.4% in June, which was worse than the 0.2% contraction that economists had forecast. Eurozone CPI numbers from across the Eurozone today were in line with expectations with signs of deflationary fears easing further. ZEW economic sentiment was better than expected at 47.6 for the Eurozone has a whole. Q2 GDP across the Eurozone countries disappointed with the three big economics all posting weaker than expected growth. German GDP at 0.4% was below 0.5% expected by economists & French & Italian GDP's were at 0.00% and 0.2% respectively. Overall for Eurozone Q2 GDP growth was at 0.3%, which was below Q1 GDP growth and market consensus at 0.4%.

Economic data from the US was strong with retail sales for Jul coming in better than expected as the Headline number at 0.6% growth (M-on-M) beat expectations. The core retail sales number excluding the volatile and auto and gas segment grew in line with expectations. The sweet spot in this report was the upward revisions for the previous month with the headline number revised upwards to 0.00% from a fall of 0.3%. , the core number had even better upward revision moving from -0.1% to 0.4%. The May number was also revised upwards and this means that with strong retail sales in Q2 we could see upward revision in Q2 GDP.

Crude Oil price which rallied higher, on Monday, after expectations of a new stimulus program in China & Brent Benchmark trading over $50 a barrel. All this changed in the wake of the Yuan move & on Wednesday International Energy Agency estimated that Iran could increase output by as much as 730k barrels per day fairly quickly after sanctions are lifted. We could see sanctions being lifted by the end of Q4 or early 2016. US equities started the week with a massive rally fueled by expectations of stimulus in China. The shivers that Yuan depreciation sent across global markets sent US equities lower through the week. The 50-day moving average for the Dow Jones Index traded below the 200-day average or the first time since 2011 (It had traded below from August to Dec 2011) on Tuesday raising fears of a deeper correction in equities. This crossover is also called the "death cross" & is considered to be a bearish indicator.

Compiled & Researched by: Shailesh N. Mulki

Disclaimer: The views contained herein are personal views of the author. These should not be taken to constitute advice or recommendation.