Indian rupee remains an interplay of global and domestic factors. Currently, global macros and financial market themes are the dominant...
Indian rupee remains an interplay of global and domestic factors. Currently, global macros and financial market themes are the dominant forces that is guiding the rupee. Domestic policymaking is more or less moving at a desired pace with Centre trying hard to build a consensus in the all-important bill on Goods and Services Taxation. Lok Sabha has passed the bill on commercial coal mining in the country and now its needs ratification of the upper house. The insurance bill is expected to sail through, which aims to provide increased foreign capital in the sector. However, disinvestment process has suffered delays and in the meantime many of the PSUs who have been flagged for disinvestment have fallen in value since the announcements. With fiscal deficit having reached nearly 90% of the budget estimate, Government of India (GOI) might find it difficult to stick to the 4.1% GFD target. As a result, we can see cut in planned expenditure, which can harm growth and or announcement of special dividend from the profit making PSUs.
We hope that GOI does not employ the statistical jugglery which the previous government did, by rolling over expenditure to next year, to stick with GFD estimates. We believe quality of fiscal deficit matter more than just quantity. At the same time disinvestment proceeds would be better used for generating quality capital assets, rather than to become a bridge towards a budget goal. It is not a prudent policy to sell family silver to pay one’s daily expenses.
Somebody who has been watching the mini carnage unfold in the broad spectrum of asset classes would not be wrong in thinking, as whether time has come for the chickens to come home and roost. Years and years of uncontrolled financial experiments from the major central banks from the developed world and also from emerging markets, to stimulate economies through the backdoor, have created, as some think, a giant liquidity feeding financial asset mania. With the oil collapsing, as if it was some marginal commodity, questions have started to be raised about the growth prospects of the world economy. Midst this carnage in asset markets, our own Rupee has lost some ground against the Euro, Pound and Yen and also dropped to a fresh 10 month low against the US Dollar.
During the early part of the week, in our research note, we had talked about the gravitational pull of collapsing petroleum prices on the risky financial assets. Over there we about the negative information feedback loop of oil on global equity and high yield debt market. Infact last year, between January and April, Gold prices had collapsed by over 20%, bewildering many as to why in the midst of a full scale QE3, have Gold fallen so much. However, as it turned out to be that from May of that year, US Dollar began a scorching rally against the EM currencies. Gold, apart from its appeal for ornamentation, is also used as a hard currency, owned by central banks, to diversify some of their fiat (paper currency) currency reserves. Gold and US Dollar, are two global currency competitors who generally move opposite to one another. Therefore, a collapse in Gold prices almost front-runned the EM currency rout against the US Dollar that unfolded in summer of last year.
Similarly, petroleum is one of the most important and widely used industrial commodity and hence it has strong linkages with global growth, and as a result, should correlate with the appetite for risk in the financial markets. With Oil prices having collapsed by nearly 50% since end June 2013 has sent a shockwave through the high yield debt market. Many of the oil exploration plays in the shale reserves of US and oil sands of Canada are financed by high yield debt or as popularly known as junk bonds. At the same time, many of these oil and gas plays have had taken financing from financial institutions. Additionally the US shale boom and Canadian oil sands boom had part financed the consumption and investment surge in those countries. Not to forget the plunge in oil revenues for OPEC and non-OPEC producers.
There are fears that some of the oil producing and natural resource nations, who do not have pretty state finances, can find it difficult to service their debt. Hence, we believe investors need to pay attention to the developing dynamic in the resource sector and its impact on the risky financial assets in general. Over the last one week, global equity markets have played in sync with plunging commodities. As a result, Yen and Euro carry trade saw some unwind pressure as well, leading to gains in the two currencies against the US Dollar and Rupee as well.
Over the past week, economic data from India has been mixed with industrial growth contracting in October but consumer inflation falling to a multi-year lows. Industrial production has contracted by 4.25% y/y in November with manufacturing leading the decline with 7.61% contraction. One can argue that due to the shutdown of telecom equipment plan of Nokia, manufacturing registered a sharp plunge. However, ex-Radio, TV and communication equipment & apparatus, which strips out effect of Nokia, we find that the IIP growth has slowed down from 7.1% in September to 2.7% in October. Infact ex-telecom, IIP growth has been trending down since July of this year. Within IIP, mining registered a growth of 5.22% and electricity production jumped by 13.3%. Over the rest of the year, we expect IIP, ex-telecom to register a rebound, though effect on Nokia can continue to haunt the headline for a couple of more months.
India’s consumer price inflation slowed sharply in November to 4.4% year over year, slowest pace since January 2012, making the case for interest rate cuts in 2015 more compelling. The current CPI is well below RBI’s short term target of 8% and medium to long term target of 6%. However, a very high base effect will begin to wane from December and as a result, CPI can show a statistical jump between December to March of next year. But with commodity prices and hard assets caught in a deflationary trend, we expect CPI to remain subdued, well anchored around the medium term target of 6%, plus minus 1%. As a result, we can see RBI take the path of monetary accommodation but the pace of cuts may be gradual and spread over many months. RBI governor has talked about the need for real rates to stay positive to stimulate saving and controlling inflationary expectation in the economy. It therefore means that he can be far more conservative than his predecessors, who allowed interest rates to fall below inflation and stay there for a considerable period of time.
In global economic data, US economy held more promise than others, as its employment survey known as JOLTS job openings, rose to the second highest level in the last 10 years, retail sales rose more than expected and also the consumer confidence ticked higher to level not seen since January 2007. In Euro zone, industrial production data disappointed and also the uptake from the second tranche of the TLTRO was lower than expected. We had expected uptake from TLTRO, or targeted LTRO from the ECB, to be better than last September but nowhere close to ECB’s expectation. Banks would not like to borrow from ECB at 15 bps and park the same with the central bank as deposit, as the rates on deposits have been reduced to negative 20 bps. Additionally, banks have less incentive to play the carry trade on sovereign bonds as yields in the 4-5 year bucket have collapsed beyond interest. Hence, only banks who had been flagged by the ECB in its latest stress test scenario would have wanted to show interest in the ECB’s liquidity.
In UK, NIESR forecasted growth of 0.7% y/y in GDP in November, in line with October data but manufacturing output and construction output both contracted in October. Chinese growth sagged, as Bloomberg’s gross domestic product tracker came in at 6.78 percent year-on-year in November, down from 6.91 percent in October. Industrial output rose 7.2 percent y/y, retail sales gained 11.7 percent, and investment in fixed assets expanded 15.8 in November. Japan national industrial activity surveys failed to impress and its core machinery orders contracted by 6.4% m/m in October.
OUTLOOK: Over the next week, we have a full plate as far as economic docket goes. We start of the week with exit poll outcome from the Japan’s snap national election followed by Tankan economic survey. Euro zone economic survey will be released on Monday and so will be the reports from ECB on covered bond and ABS purchases. On Tuesday we have the flash PMIs from Euro zone and China followed by UK inflation, UK prudential regulation authority bank stress test results and German ZEW investor sentiment reading. We will roll into Wednesday for some major event risks, in the form of Greek presidential elections and the US FOMC rate decision. Thursday has the German IFO’s business climate survey, china property price data well as US services PMI. During the last day of the week, Bank of Japan takes to stage to present their monetary policy, where the words of the governor will be keenly watched. At the same time on Friday, Japan economy minister Amari is scheduled to speak on the future of Abenomics, and we sense the possibility of hints about fresh fiscal stimulus from him.
India is scheduled to report its wholesale price inflation for November as well as the merchandise trade numbers for the same month. WPI is expected to show a decline below 1% and merchandise trade deficit is expected to show up between USD 12-14 billion. Indian Rupee is expected to remain weak against the US Dollar. We have been advocating buying on dips for so many months now and we will continue to stay with the positioning. Over the near term Rupee can slip towards 62.80/63.00 levels on spot and resistance remains around 61.80/62.10 levels on spot. Technically, USD/INR has given a breakout from a muti-month congestion, which has targets of 64.00 and above, but with central bank on the front foot as far intervention goes, we are not sure whether market will be able to express their view freely. As a result we would look at more measured pace of depreciation. Against the Yen and the Euro, Rupee remains a carry play, so during times of risk aversion, these two currencies can continue register strong gains. Similarly, a risk-on mood can cause Rupee to bounce back strongly against the Euro and the Yen. Thefeore, for traders looking for fast moving currency pairs, they need to keep an eye on Eur/INR and Yen/INR. GBP/INR is expected to be ranged between 96.50/97.00 and 99.50/100.00 for some more weeks.
By Anindya Banerjee, analyst, Kotak Securities