Indian monsoon deficit is now at 15% of national average. If one leaves aside the excess rainfall in western Rajasthan, the actual deficit can be even bigger. This is becoming one of the worst monsoons in many years. Who got their prediction right? It was IMD, outsmarting some of the notable private forecasters. However, met dept. had to face a lot of ridicule and flak way back in the month of May when they predicted a deficient monsoon.
Having said that, the timing of the current dry monsoon could not have come at a worse time for rural India. Rural India is facing the third weather related blow over the past 12 months; first it was the deficient 2014 monsoon, second it was the unseasonable rains during Rabi harvest and now the significantly dry monsoon.
Rural India is already reeling under the stress of 1) commodity bust, 2) real estate and land down turn, 3) focus of the present government on diverting a restrained spending plan towards building of more public infrastructure, than towards social schemes to promote consumption, 4) focus on ways and means to curb corruption and black economy, through implementation of DBT and implementation of stricter laws. Yes the measures that government has taken are good for the long term, but like any economic and political phenomenon, this too will have its share of winners and losers. I am here highlighting that cost, which is necessary, but nevertheless painful for a section of the society.
I have been warning about the above structural headwinds since middle of 2014, when I had turned bearish on hard assets, expecting it to underperform financial assets. From Corporate honchos, economists and govt officials all are now complaining about lack of demand on the ground. Therefore, it has not come as surprise to me at least that the aggregate demand has become so weak. Remember, it was the strong demand from rural and semi-urban India which drove growth over past 10 years.
Industrial growth for India over the month of July has seen a bump up at 4.2% but do not draw too much comfort from that data. The period between July 2014 and November 2014, saw one of the weakest phases of industrial growth, as y/y growth ranged between negative 2.6% to positive 2.7%. If in spite of a low base, IIP clocked just 4.2%, then it shows that absolute growth remains weak. As a matter of fact if we compare the month over month growth in headline IIP index, it has registered -10.2%, 1%, -0.1% and 0.4% growth over the past four months. Culprit remains manufacturing index, which constitutes 75.5% of the overall index and mining, which constitutes 14.1% of the overall index.
Drilling deeper into manufacturing, we find that trend of durable and non-durable consumer goods remains weak. However, capital goods has seen a strong bounce back, registering strong trend growth as well double digit y/y growth as well. I do not see private capital expenditure coming back in strong but central government has invested enormous financial and political capital in roads and railways. I see that part of the economy as a major silver lining. At the same time, channel checks suggest that there is lot of private domestic and private foreign investor interest in warehousing and logistics, agricultural services as well as alternative energy. All these areas would have positive rub on the economy as we move along. However, we should be careful not to extrapolate too much a positive bump higher on aggregate growth of India, from these spaces. It will take a very long time, for them to offset the damage done from slowdown in other sectors, terms of investment and consumption.
Interestingly, Government of India (GoI) launched a sovereign gold bond scheme and a gold monetisation scheme. The intention is to lower the import of gold by allowing domestic stock of gold to circulate like paper money. Gold is money and the above move from the government only underscores that point. They will now offer something which gold lacked all through – rate of interest. At the same time, if one goes through the nuances of the scheme, one realizes that GOI may have just turned a big bear on Gold against the Indian Rupee. As there is no mention of government hedging the gold price risk yet, we would assume that price risk remains with the government. If news channels are to believed, then government may end up paying between 2-3% by way of interest each under both schemes. One can refer to the following article for details (http://ftalphaville.ft.com/2015/09/11/2139909/aapka-gold-chahiye/). It appears that GoI will issuing foreign currency bond (here the fcy is gold) at rate of interest of 5-6% and the same will be issued to domestic citizens. If over the next 3-5 years, if Rupee manages to strengthen against Gold, then GoI would make windfall, assuming they do not hedge the exposure. However, in case of a large rise in Gold prices, it may become a drag on the fiscal balance. The question is will it be successful? For that we have to wait and watch. However, if it is successful, it may have its share of un-intended consequences, as fall in demand for physical due to availability of paper form of gold, will affect the people engaged in their trade.
Globally, all eyes are on the US Fed, where the call is a tough one for the Fed. It seems to be that US Fed is finding itself in an unenviable position. They may feel that they have missed the bus as far as policy tightening in concerned. With the full benefit of hindsight, one can argue that US Fed would have been better served to normalize rates at least 18 months back, when they announced taper. However, it will be naive to believe that such an action would have not had turbulent effect on world markets and world economy. World wants additional demand, as excess supply is now adjusting painfully, leading to threat of unemployment and debt default. US remains a major source of net demand for the world, hence if they continue to tighten monetary and fiscal policy, it would tantamount to curbing demand, something that the world economy and hence financial markets do not want. Have a look at the length of the economic recovery in the US, relatively one of the strongest economies in the world right now.
The chart is from the fabulous insights on the US economy from Lance Roberts. It shows the predicament of US Fed. The current recovery is one of the longest on record, if we parse though the data since 1879. At the same time, the recovery was the weakest in post war period. US Fed would not like a situation where an economic recession occurs with them bound at zero rates, i.e., no conventional monetary firepower. However, their choices are becoming limited. If they do not like now, will they want to shift to a more neutral gear. For that they have to sound very dovish, and that markets would love it, as it would mean that, if push comes to shove, US Fed is there to intervene with fresh round of easing. In that case EM assets and EM currencies can appreciate meaningfully. However, if they sound hawkish even after not hiking, the recovery in EM currencies and EM stock markets may be for a shorter duration.
USD-INR SPOT CHART-DAILY CLOSES
Over the next week, USD/INR traders should watch for the key support level of 65.80 on spot, which if breached on a sustained basis (watch for false breaks), can mean that an intermediate top is in place and then Rupee can appreciate towards 64.50/70 levels on spot. However, at the same time, in case of a break above 67.00, it can aim for levels of 69.00/70.00 levels on spot.
Anindya Banerjee is an analyst at Kotak Securities