India faces triple whammy of weak world growth, liquidity stress, demand crunch

By: | Updated: January 23, 2019 4:20 PM

In India, policymakers tend to under appreciate how important a role global economy plays in our domestic economic story.

GDP-economy-PMIIndia lacks a domestic engine strong enough to provide the escape velocity needed to chart an economic course contrary to world economy.

Since my column during the first week of January, where I talked about how risk aversion in financial markets can be significantly higher during 2016 ,we have got a very good glimpse of it over the past 6 weeks. Last week too, asset classes, from commodities, to corporate credit to equities were all under selling pressure. Indian equities got smacked hard, as markets have finally started to pay attention to the untenable wedge between valuations and fundamentals. In India, it has been my experience that the policymakers tend to under appreciate how important a role global economy plays in our domestic economic story.

During 2002-2010, barring 2008, our own Indian economy benefitted from the global economic boom, we were as if standing on the shoulders of the global economic giants. However, since 2012-13, that same giant global economic forces are now bearing down on us. India lacks a domestic engine strong enough to provide the escape velocity needed to chart an economic course contrary to world economy.

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Over the past week, three key economic data points from India were released, GDP, retail inflation and IIP numbers. Industrial production numbers continue to point towards an weak economy and CPI data indicated that some pick-up in inflation pressures have occurred. Higher CPI should be seen in conjunction with the latest household inflation survey from the RBI. The recent survey points towards hardening of inflation expectations amongst the household, which RBI would be sensitive too. However, there is nothing to get alarmed yet on the inflation front. Chinese markets were shut for New Year celebrations. However, global financial markets and our own stock markets saw a bout of massive risk aversion. I have been bearish on global risky assets for over a year now. Therefore, to readers of my column it should not come as a surprise as we have deliberated upon the key factors why such an outcome appears plausible. If it was long financial asset and short hard asset as the theme of 2014, I shifted to convergence in both by last year. Risky financial assets had been stretched like a rubber band, thanks to the carry flows from Euro and Yen, but finally they had to revert to their master, the economy. With global economy weakening with every passing quarter, a higher premium on risky assets became untenable.

As per the latest GDP data, headline GDP growth in 3QFY16 was recorded at a healthy 7.3% YoY. This compares to the 7.7% YoY growth recorded in 1HFY16 (which too has been revised upwards by 50bps from the first estimate of 7.2%). Whilst the official GDP numbers point to a mild slowdown in economic activity materialising in 3QFY16, we highlight that the official numbers understate the extent of the slowdown that the Indian economy is currently undergoing. Various high speed economic indicators like automobile sales, cement dispatches, cargo handled or freight volume, demand for electricity, core imports, credit growth and corporate topline and bottom-line growth, all point towards an economic momentum which has been downhill and subdued since end 2014.

India cannot wish away the fact that global economic model of the last two to three decades is largely broken. In my previous articles I have deliberated at length on this aspect. With consumers having leveraged themselves way too much in the developed part of the world and facing a credit crunch, is now deleveraging. At the same time, producers too, who delayed the day of reckoning by levering up themselves even more, post 2008, is now being forced to retrench flab. Such adjustments are not allowed to occur swiftly, as deleveraging pressure can lead to political instability. In their effort to appear to do something, policy makers throw in various kinds of pacifiers, which can sometimes exacerbate the adjustment.

Anyways, the point is, solution lies with debt reduction. It is and will happen in a combination of ways, voluntary means as well as involuntary means. Monetary inflation and liquidation assets to pay down debt are voluntary ways of bringing the debt down. At the same time, debt restructuring and defaults are involuntary ways of deleveraging. Therefore, the rebalancing process underway since 2007 is ensuring that debt levels are brought down so that sufficient room for sustainable economic growth can occur. I have in the past even used the aspect of global savings and investment angle. The above explanation is part of that adjustment process.

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Before I come to prices movement and ranges on the currencies for next week, let me touch upon an interesting development in domestic money markets. In Kotak, through our research reports we had highlighted the sharp rise in short term borrowing rates for banks and corporates in January. Now the liquidity crunch is getting widely talked in the banking community and policy making circles. We need to keep an eye on this. With corporates facing financial sector as well as a part of the non-financial sector facing deleveraging stress, weak demand and now tight liquidity can lead to a vicious cycles of deflationary pressures. In such a tight liquidity environment, transmissions of policy rates are seriously impaired.

Over the past week, Rupee had weakened against the carry currencies like Euro and Yen more than the US Dollar. With global financial markets on a capital flight mode, it is natural to see a high yielding currency like Rupee underperform low yielding currencies like Euro, US Dollar and Yen. Over the next week, we can see Rupee trade between a range of 67.60/80 and 68.50/60 on spot. We would expect central bank to remain an aggressive seller of US Dollar, mainly through the forward/futures market to support the local unit. Rupee may also see some corrective strength against the carry currencies like Euro and Yen. Rupee may strengthen a bit against GBP too. However, large scale appreciation is not expected, thanks to constant threat of risk aversion in global financial markets.

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