While replying to a comment from Thomas Piketty on how little taxes Indians pay, Bibek Debroy had remarked, “Indians pay one of highest tax rates in world, only problem is bulk of those taxes are private in nature, and move around as bribe and extortion money. Government gets a smaller share as official taxes.” An apt remark we must say. However it also outlines the job in front of GOI. It is to lower corruption and bring larger share of Black economy under the lens of tax authority. We are indeed seeing progress on that front. Yes it will extract a hefty price from growth and employment creation over the short to medium term, but if handled smartly, it can reboot Indian economy over the long run.
Indian Rupee continues to exhibit low volatility against the US Dollar, as inflows from FPIs and demand for reserve funds from RBI continue flank the prices. Over the past week there some instances of state run banks selling dollars, but that could be part of Rupee liquidity management operation of RBI. We see little possibility of Rupee trading below 66:70/80 against the US Dollar over the next 4-6 weeks. Upside in USDINR remains capped by the technical resistance around 67:30 zone, which when consumed, can create opportunity for 67:70/80 levels.
G-20 meeting has begun today. Over the past week, Chinese central bank was heard selling dollars over, probably to window dress their currency ahead of G20. However, it must be appreciated that since Feb G20 meeting, central banks globally have more or less adhered to the alleged truce pact. Barring a few odd skirmishes, global currency war is still in its phase of ceasefire. British Pound’s collapse post Brexit has exerted strain on that truce but still there are no explicit commitment from any major central banks in G-20 to opt for a tit-for-tat reply. The bonhomie is good for global financial markets, as the speculators can focus on abundant global liquidity pool, which remains the biggest driver of asset prices globally.
From the United States Federal Reserve passing through the Bank of England, the European Central Bank , the Japanese central bank, etc., monetary policy remains at a standstill. Some of these central banks may be waiting to see if there will be some help coming from the fiscal side of the policy equation, i.e., the Bank of England and Bank of Japan. Last week, the Euro central bank meeting was expectedly a nonevent as ECB hinted at possible easing post September. As to the Italian banks, M. Draghi said he was in favour of a public backstop under exceptional circumstances to avoid fire sale, while letting the decision up to the European Commission. From time to time, questions have been raised about the sustainability of the asset purchase programs of the ECB or Bank of Japan, as they may run out of enough unencumbered eligible assets, but we do not share the same concern. Central banks, who are desperate to keep asset prices higher, as they believe it is the asset boom that is standing between muddle through growth and a full scale recession, would be able to tweak their policy of easing in a manner to bypass such shortfall. Be it through changing of asset quality norms or through direct monetization of foreign currency reserves, they will always find the necessary ways to do it.
US ECONOMIC SURPIRSE INDEX (Citigroup)
Next week is going to be an eventful one. Two major central banks, Bank of England and Bank of Japan are scheduled to deliver their monetary policy. US economic data has improved over the past one month. Last week, housing starts came in strong. US Job market is still holding strong, though some deceleration is witnessed in the trend growth, which is natural after 7 years of acceleration. The bust in commodity sectors, global economic slowdown and a strong dollar are also taking a toll. However, various employment surveys point towards employers finding it difficult to get their vacancies filed. Beyond reasonable doubt one can claim that US economy remains the relatively strongest economy right now in the globe. One should not make the mistake of judging the strength from the GDP growth rate, as that does not account for the size of the economy and how sustainable current pace of growth is. However, that economic strength is not enough for the US Fed to consider hiking rates any time soon. The Bond market is still pricing in no hike in rates till mid-2017. The market seems to believe that post-Brexit, US Fed may want to err on the side of caution as they don’t want to push for a hike at a time when global economy is so weak. However, we believe the Fed probably wants to move away from the zero lower bound as quickly and as far as possible. Therefore, if the global risk-on mood holds out for some months and the UK economic slowdown is not as bad as feared, we can see the talk of a hike make rounds before the year end. It is the relative outperformance of the US economy and still a divergent path of the monetary policies, is what going to keep the US Dollar strong for some time to come.
Next week, we also have to keep an eye on the Bank of Japan monetary policy. Market expects a combined stimulus from Bank of Japan and the Japanese government. Though the Japanese officials have shown unwillingness to an explicit helicopter money, but such a combined push if done, will be nothing different from a helicopter drop. How impactful would be such stimulus would depend on how swiftly it can get money into the hands of consumers. Therefore, if the fiscal push is more directed towards stimulating consumption over investment, it can have immediate positive impact on growth and inflation expectation and negative impact on the currency. We anticipate a fiscal stimulus between 25-30 trillion Yen with an expanded QE from BoJ. Such a move can be negative for Yen, which in turn will be positive for emerging market equities and bonds. Nevertheless, if BoJ-MoF disappoints, then we can see a sharp reversal in Yen towards 100 against the US Dollar and an adverse impact on global risky assets.
