Economy in year 2016: Brexit, Trump victory, demonetisation turn conventional wisdom around

Year 2016 was a fairly turbulent year for both the world economy and India not so much because there were any great surprises in terms of economic events or extraneous shocks but on accounts of forced developments which will have a long lasting impact.

When the year started, the question really was as to when the world economy would turnaround as there were differing signs emanating from different countries. The direction of movement of the Federal Reserve was more or less known while the ECB was to continue to maintain status quo while Bank of Japan was to reflate. The world economy has been moving along expected lines and the Chinese recovery was also almost on course. Therefore there did not seem to be any perverse sign to think otherwise.

 Economy in year 2016: Brexit, Trump victory, demonetisation turn conventional wisdom around

Representational image. Reuters

Two major developments however have changed the perception not so much from the point of view of things going wrong this year, but more from a futuristic perspective. These are the BREXIT followed by Donald Trump's victory, which though unexpected has been convincing with the Republican Party having a majority in the Congress and Senate. BREXIT is symptomatic of the world turning towards becoming more closed and the dictum of free trade and investment is being questioned seriously today. While the referendum in Britain could have termed a ‘one off case’, similar undercurrents prevail also in France and Italy where public opinion is veering towards movement away from the Union and probably at some time from the euro currency.

Countries have started thinking more of isolationism as it is believed that globalization progressively impedes growth as the benefits could be leaning more towards the rest of the world. USA for example believes that the major challenge today is jobs and that they are being lost to outsiders at both the unskilled and skilled levels. This was probably one reason why Donald Trump succeeded. When dealing with the strongest economy, there is always a case of the weaker countries benefiting more than the former, and this perception has led the Americans to believe that they have been losers. This has given a shot to pro-protectionist policies.

BREXIT does not mean the end of ties with the EU but Britain no longer has to accept the goods and people of the continent based on these water tight agreements. Quite clearly conventional wisdom is being turned around now and while presently no singular action has been taken, the future of the world economy is going to be far from normal once these ideologies are implemented. In fact, even the progress made by the WTO which is always a conflict between developed and developing countries will be questioned within the former set of nations as they compete with one another. The latter would also tend to be reinforced through trade barriers once it is realized that they are disadvantaged on the basis of restrictions in export of services.

Closer back home, the growth story had been building quite firmly with even the second quarter corporate results giving one the impression that things were turning around. The consumption story was being told rather convincingly with the pre Diwali sales laying the road of optimism. This was when the government embarked on the big demonetization exercise. While the entire nation has welcomed it unequivocally, there have been doubts raised in terms of the economic impact and it is almost certain that growth will slow down and that it will take two to three quarters for recovery – which will be mid 2017 at the earliest. While the objectives of dealing with black money and forcing the public to be technology-savvy are localized issues, from the point of view of the economy, things have been pushed backwards.

The impact on growth has been debated and while the numbers are a matter of subjective conjecture, the fact is that jobs have been lost and consumption buffeted mainly due to absence of currency which still dominates 90 percent of our transactions. Arguably, the impact would, be of a temporary nature as money is only a means of payment and is a facilitator rather than a commodity on its own. Therefore the production processes will continue as before once normalcy steps in. However, specific industries have taken a major blow like real estate, consumer goods, automobiles, tourism, transport, hospitality to name a few. The timing of the bounce back will vary but for sure will take a couple of quarters.

Hence, we too are ending the year on an uncertain note, though there is the feel good factor that black money has been slayed or at least an attempt has been made to do so. This would, also be an interesting phenomenon to watch out for in the New Year whether we change, what the economist Alfred Marshall have said, our ordinary business of lives.

The major concern however, for the entire world is the decision taken by OPEC to cut back output. Presently it does not seem to be an issue, but given that the last two to three years have been very hospitable as oil prices have been depressed, this may be a warning. It is still uncertain whether the OPEC nations will stick to their targets as there are signs of desperation as these countries which run only on oil may be tempted to ‘cheat’ to improve their incomes which could make this decision self-defeating. This can be a defining event for the world in 2017 as higher crude prices have always pressurized economies in terms of higher inflation and lower growth prospects. As most countries are on the anvil of such a turnaround, higher oil prices can delay the process.

Hence, the world will have to look at what the European countries do and what Donald Trump actually does when he becomes President. Will he drive immigrants out or dilute the free trade agreements and turn fully protectionist? It is hoped that what he has promised is political rhetoric and would get moderated along the way. But the dollar has become stronger as have the stock indices which mean that the markets are positive about these outcomes. Back home in India, the final numbers of growth will tell the story but for sure the deferment of the certainty of high growth due to the twist in tale on account of demonetization will remain a contentious issue for discussion.

(The writer is Chief Economist, CARE Ratings. Views are personal)

Updated Date: Dec 28, 2016 07:32:26 IST