An eventful week went by, as economic and political sound bites kept macro traders busy in their desks. Indian rupee went round and round the Dollar, but strengthened quite a bit against the Yen. RBI was the center of attraction for Rupee traders and quite expectedly the central bank lowered the repo and reverse repo rates by 25 bps.
However, the tone of RBI was much hawkish this time around. It identified far too upside risk to inflation, from monsoon to global oil prices. It seems, that RBI could be in for a pause for at least 1 more meeting, if not more. With repo rates at 7.25%, it is where they were when the previous RBI governor had to reverse policy during 2013.
Interestingly, the yields on long term government securities hardened by nearly 15 bps post policy. At the same time, the 1 year overnight index swap rate on INR, refused to move down with the repo rates and infact remained around 7.54/7.55%. The global bond sell-off is spilling over into the Indian shores. FIIs hold nearly USD 30 billion of government bonds another USD 40 billion of corporate bonds.
The sell-off in the local bonds have caught many off-guard, as yields on 10 year are back above the levels where they were before the rate cuts began in January of this year. Infact over the past week, two of the government debt auctions have seen devolvement and higher yields. We believe, risk of Indian bonds stem from the large scale ownership of Indian debt with FIIs. Out of the USD 70 odd billion they hold, a chunk of it could be hold by short to medium term players, who are here for total return, capital gains and coupons on bonds. Incase, the yields start moving north in US and Euro zone in the coming weeks and months, then it can create an environment, where FIIs might be forced to liquidate even more of their long holdings, especially with rate trajectory in India facing the risk of a long pause. Currency can become an added layer of stress, if it becomes too volatile. Rupee has depreciated quite a bit against the Euro, a carry currency, but thankfully, against the Yen, the other carry currency, it has been relatively stable. Against the US Dollar it is seeing a gradual pace of depreciation, with the central bank staying quite vigilant. India’s core sector growth, which make up 38% of monthly IIP, plunged by 0.4% in April, worst show in a decade.
For readers of our reports, this should be no surprise, as we have been discussing about the rapidly slowing Indian economy for some months now. We had flagged the drivers of the slowdown last year itself. Services PMI too has plunged to contraction zone, after an upbeat performance over the last 16 months. However, the silver lining has been the manufacturing PMI in May, which rose at a fastest rate since Jan 2015.
Nominal GDP, which portrays both real growth, as well as inflation in the economy, has strong correlation with taxes that government earns, earnings of corporates and hence the price multiples that the equity markets enjoy. A decadal low in the nominal GDP is line with the weakness in corporate profits and government’s tax revenue. The combined net sales of around 1,700 Indian companies (excluding financial and oil & gas ones) rose 5.9 per cent on a year-on-year basis – the slowest rate in two years. India Inc’s bottom line fared worse, with core operating profit (excluding other income) declining 0.5 per cent annually, and net profit falling 7.45 per cent. Corporate profits as a share of GDP is at lowest level seen at least since FY04, at 4.3%.
In global economic news, a string of PMI survey reports were released, after compiling them into a single Index, under the JP Morgan Global PMI Index, we find that both manufacturing and services PMI continues to move sideways since 2013.
In US economic data, apart from May jobs reports, US ISM manufacturing surveys were mixed. ISM manufacturing survey saw a bump up but services came in weaker than April. US non-farm productivity contracted by larger than expected 3.1% plunge in Q1. However, car sales faired strongly. US consumer spending is the biggest component of US demand, accounting for nearly 70% of GDP. In the five years prior to the financial crisis, consumption rose at an average pace of 3.2% a year. During the post 6-years, the rate around 2.2%. In April, household expenditure remained flat and as a result savings rose to 5.6% of disposable income.
US headline jobs data was much better than expected but drilling deeper, that is something we do, we find not so strong employment trends:-
1) Low paying jobs dominate
2) Wages are rising, but for non-supervisory workers, who comprise the bulk of US labour force, it is still stagnant
3) Full time employment still below pre-GFC crises peak, but temp positions are doing better
4) Young workers are at a disadvantage in this recovery
5) A broad measure of unemployment is still elevated by trending down ward
6) Labour force participation is still low, but could be stabilising
The question remains will US Fed be now able to make up its mind on whether to hike rates this year or not. If economic logic would have been the guiding light, then they would have hiked rates long back but it is more political than economic. US Fed has three mandates, (i) Price stability (ii) Full employment (iii) financial stability. By singularly focusing on the first two, it has experiment too long with unconventional monetary policies, which are riddled with unintended consequences. US Fed and now BOJ and ECB, have distorted the cost of capital to such an extent, that now it is hard to say which financial or hard asset is priced fairly. The question then comes to mind is has US Fed and with it other central banks ignored the third mandate, financial stability too much and for too long and would there be a heavy price to pay in future for such ignorance.
The final chart is a depiction of how the US external trade is fairing, and what we find alarming and amusing is the way the growth rate for both imports and exports are plunging. We have removed the effect of commodities from imports, and we find the trend quite alarming. An evidence that a stronger US Dollar and weak global economy and now normalizing cost of capital, is taking a significant toll on global growth.
Anindya Banerjee is an analyst with Kotak Securities