Obama's re-election will boost $, pressure the rupee

President-elect Barack Obama has his work cut out for him. He first has to address the “fiscal cliff” that is facing the US starting 2013. The fiscal cliff is the Bush era tax breaks coming to an end, leading to higher taxes for the citizens of the US. At $16 trillion, US government debt is at an all-time high. This is forcing the government to adopt spending cuts from 2013. Rising taxes plus the spending cuts are expected to take the US economy into recession.

Obama has to arrive at a solution to stem the tax increases and spending cuts and still look to keep down government debt. One solution, which his opponent Mitt Romney advocated, is to grow the country out of trouble by encouraging investments and markets with lower taxes.

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[caption id=“attachment_517762” align=“alignleft” width=“380”]  Obama is not a supporter of encouraging investments and markets to pull up the economy. AFP[/caption]

A market friendly policy with money thrown in by the government and the Fed (US Federal Reserve is acting independently by buying bonds to pump liquidity into the economy) can help the economy come out of trouble.

However, throwing money into the system is a US dollar-negative policy and if the policy does not work it can lead to the dollar falling off the cliff, taking the economy with it. Obama is not a supporter of encouraging investments and markets to pull up the economy.

The other solution that Obama has is to get the support of policy makers to defer tax increases and spending cuts. This approach can help the economy grow at the pace it is growing now (around 1.5 percent). The Fed is anyway helping the economy by keeping interest rates at all-time lows and by purchasing $40 billion of mortgage-backed securities (MBS) every month. Obama will be more inclined to this solution.

The US economy has been trudging up under Obama over the last two years. The unemployment rate is down from highs of over 9.5 percent to levels of 7.9 percent. The economy has been steadily adding jobs month on month over the last two years. The US dollar has gained over 7 percent against majors since early 2011 while the S&P 500 has returned over 7.5 percent. US 10-year treasury yields are down by over 150 bps (10 basis points make 1 percent) over the last two years.

The US economy appears the strongest in the world despite its impending “fiscal cliff” problems. China has its troubles with over-investment, property bubbles, bank loans that are threatening to go bad, weak export markets and falling economic growth (at 7.4 percent of GDP for the third quarter of 2012, a three year low).

The eurozone is saddled by debt and recession. Japan is hit by a strong yen and weak export markets. Hence even weak US growth will help push the US dollar higher, giving rise to more capital flows into the country.

India is struggling with domestic issues that will take time to get resolved. The government is facing a weakening economy (forecast at decade lows for 2012-13) and a rising fiscal deficit (at 5.3 percent of GDP for 2012-13 against budgeted levels of 5.1 percent of GDP). The government is borrowing Rs 20,000 crore extra to fund its deficit. Inflation at 7.8 percent levels is much above the comfort levels of the RBI.

In addition to economic issues the government is facing a plethora of cases of corruption leading to public dissatisfaction. There are threats of early polls and in this current state of public outrage on corruption, there is no clear winner in any polls.

The Indian rupee has borne the brunt of the country’s macroeconomic and political woes. The rupee is down over 20 percent against the US dollar over the last one-and-a-half years and is trading at just 3 percent above all-time lows. The Obama victory being positive for the US dollar will keep the rupee pressured at lower levels.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.