One-two-three punch, but still the US Dollar managed to gain ground against the Indian Rupee. First, it was a visionary Railway Budget, followed by a marginally positive Union budget and then finally the “cherry on top” from the RBI, reducing key policy rates by another 25 bps to 7.50% on the Repo. However, the pop in the Rupee towards 61.70 was short-lived, as it closed the week around 62.20 levels, onshore and around 62.80 levels, offshore.
Over the past many months, we have been advising our clients, both commercial, as well, non-commercial, to reduce the shorts in the US Dollar, on dips below 62.00, as we see the pair forming a formidable base between 61.00/61.50 regions on spot. The central bank has shown good bit of appetite to defend the US Dollar on decline.
Over the month of March, Indian Rupee will be largely driven by trend in the global risk assets. Indian economic data will be watched for cues, but there is not much of cheer in the macro outlook in India. Indian government has laid the medium to long term plan to improve the productive capacity of the nation and improve the ease of doing business, which are all great news for long term. However, for short to medium term, between 12-18 months, Indian economy has to grapple with an economic slowdown, hostile opposition parties and stress in the financial institutions. Over the last 18 months, we have seen a dramatic reduction in the list of headwinds. A sharp fall in consumption and investment, coupled with much lower fiscal deficit has led a significant contraction in the current account balance. After all, current account in a nation is determined by the net surplus of gross income over consumption, taxes and investment. A lower fiscal expenditure, coupled with a downturn in hard asset prices (commodities and real estate) and a hawkish central bank have caused inflation rates to fall in India. Hence, India economy has moved away from a cycle of low growth and high inflation to a more manageable phase of, low growth and low inflation.
One of the engines of growth, the rural sector has come under stress lately. The drivers of rural demand, the wealth augmenting forces as well income augmenting forces, are on a reverse trajectory. Rural Indian has immensely benefitted from the inflation cycle of 2004-2013. A sharp year on year rise in commodity prices, backed by ever increasing government expenditure on minimum support prices for agricultural crops, along with higher spend on NREGA, farm loan waiver and various other social sector schemes have boosted rural income. At the same time a multi-year super cycle in metals and minerals had also augmented income of the people associated with that sector. The boom in property and land had led to surge in wealth of the rural population. Now all those forces are in reverse, as global and domestic hard asset prices fall and GOI looks at cutting on allocation to social sector scheme to augment capital stock in the nation. We have been warning about the rural economic slowdown, right from the middle of last year, when we had opined, that an era of synchronized boom in hard assets and financial assets have got over and now we are in an era of disinflation and deflation. We wrote and said that financial assets would continue to diverge away from hard assets and do well, as the former is more about central bankers and government’s actions to push more and more cheap money into the asset class to cause wealth effect.
Over the last month or so a number of domestic oriented companies, from the non-financial ones have reported dismal earnings and many of them have blamed rural demand as a major cause of the weak earnings. At the same time, financial sector companies have also reported a jump in stressed assets, which is no surprise, as NPAs rise with a lag. In the meantime, urban economy has not been able to pick up the slack in rural demand, as weak job growth and income buoyancy prevents demand from picking up significantly. Many have argued that fall in hard assets should improve the disposable income of Indians, both corporate as well as individuals, but we would not be surprised if bulk of that increase goes into augmenting savings, then augmenting consumption. During times of economic uncertainty, which is there globally, higher disposable income caused by lower cost of goods and services bought, lands up more into savings than into consumption.
The question that arises then not how government can reengineer growth in the Indian economy but what role can the government play in the economy. We will delve into this key issue in our subsequent write-ups but for a starter we would like to say that government can play the role of an enabler. India needs to adopt market driven pricing for its public goods, in case it wants to improve the accessibility to its citizens and augment its quality. Judicial reforms needs to be done with the single objective of quick resolution of legal cases so that contracts can be enforced. There has always been enough capital, inside and outside our borders, waiting to be invested in the economy. However, what private sector, both domestically and internationally have found, much to its chagrin, is that during challenging times it can be quite difficult to enforce contracts in India. At the same time, political meddling at local levels can make the best of capital goods projects or business ventures unviable. We as a nation, or, as a government, have to address these two issues, market pricing and enforceability of contract, if truly we are to re-engineer the Indian economy. A low, stable and simple taxation system is also a necessity. Indian needs to broaden its tax base, where only 3/5% of its households pay income taxes. A mix of small government and bigger private sector is the need of the day. Global environment remains quite challenging and could remain so over the medium term. Hence, for us to achieve an economic escape velocity we have to make hard trade-offs, which many a times can come at the expense of political popularity. This government has the time and the mandate to make those risky trade-offs.
Global economic data flow over the last one week have been quite mixed. Chinese PMI, both services as well as manufacturing, were a tad above expectation, but larger trend for the Chinese economy remains downhill. In fact Chinese Yuan has continued to weaken steadily as foreign currency outflow increased. Euro zone has had more positive surprises in its economic data; with sentiment mapping surveys like PMI showing improved expectation in manufacturing but slightly weaker reading in services. A weaker Euro and upcoming QE from ECB have made businesses in the Euro zone quite hopeful. In UK, though manufacturing PMI was a downer but services and construction PMI picked up. A weak GBP is also helping business sentiments. At the same time, a large current account deficit in UK is an indication of a strong investment and consumption boom in UK, but that also makes its currency vulnerable. However, hope of rate hike next year, is at least keeping GBP stronger against Euro.
In US, economic data was mixed too. On one hand, ISM manufacturing PMI and factory orders were weaker than consensus but on the other hand, headline ISM services PMI and non-farm employment report were quite stronger than consensus. However, we are little confused with conflicting trends in the data of other employment surveys like Gallop and Challenger and NFP. According to the establishment survey done by BLS under NFP, the oil and gas sector had shed around 2,900 jobs over the first two months of 2015, but challenger survey seems to suggest a probable job loss of closer to 40,000. It is no surprise that a severe pain is being felt by the global energy and commodity producers. Therefore, we can expect more negative multiplier effect from the commodity bust into the US and the global economy. At the same time, the wage growth remains weak and should keep the Fed away from any hike in interest rates, any time soon. A stronger US Dollar is not only deflationary for the US economy but also a drag on the US corporate earnings. However, at the same time, a stronger Dollar provides a boost to the real disposable income of US consumers, but as long as the economic uncertainty remains, a larger pie of that higher disposable income could get saved, and not spent.
Over the next week, we remain of the view that the decline in the US Dollar remains limited as 61.00/62.00 is a zone of significant dollar demand. We would expect exporters to step into hedging between 63.50/64.00 levels on spot. As a result, the larger range of 61.00 and 64.00 remains in play, with most of the trading confined between 62.00 and 63.50 levels on spot. Euro is expected to face selling on rise and hence 70/72.00 remains a lucrative selling zone. At the same time, on GBP, we expect a range of 90.00/92.00 and 95.00/96.00 on spot. As far as Yen goes, we can see a range of 50.00/51.00 and 52.50/53.00 on spot.
Inspite of sharp rally in the Indian Rupee, not much of fresh ground has been traversed by the Rupee. Since October of last year, USD/INR has been within a broad range of 61.00 and 64.00 on spot, with most of the trading confined between 62.00 and 63.50 levels. Two multi-year trend lines are providing intermediate term support to the USD/INR pair. We will continue to advocate buy on dips between 61.00/61.80 regions with 63.50/64.00 as the target. Risk of a downside break will increase substantially in case of a sustained breach of 60.80 levels on spot (probability of that remains low). Intermediate trend strength indicators is not in favour of the bulls. However, unless prices break down below key supporting trend line we would not like to attach much importance to the momentum indicators.