Indian economy is progressing, but at a tepid pace, with antipodal high-frequency data. The 2003 and 2009 recoveries, in contrast, were swift, broadbased and persistent. A good monsoon and Pay Commission should modestly tail-lift near-term activity, but unlike consensus, our exuberance on their lasting impact is tempered. Besides, we anticipate terms-of-trade benefits to recede hereon. Hence, domestic policy support—fiscal/monetary—is essential to turn it into a full-blown recovery. The global milieu remains iffy. History shows that Fed tightening is USD bullish in divergent business cycles (US versus EMs). The goldilocks equilibrium—dovish Fed and stable US recovery, is essential for sustained healing of EMs; but will it sustain? US yield curve and financial conditions along with China’s CNY are some of the early signposts to guide us.
Global set-up: Of Fed, dollar and global growth divergence
Fed tightening and USD enjoy a tight relationship, but the direction of influence varies. Fed tightening in 2004 foreshadowed bear market in USD, but a bull market in 1990s. It is the context of diverging (1990s)/converging (2000s) business cycles that is at the heart of the matter. The global situation in the past two years is analogous to 1990s, reflected in sustained strength in USD. Where do we go from here? EM growth is still sluggish and, thus, Fed backing off from further hikes is critical for a softer USD. However, if US growth itself loses momentum, global growth concerns could reignite USD rally. While the situation remains dynamic, we use the framework of Fed tightening in divergent business cycles context to assess the situation. Watch out for signals emanating from US yield curve behaviour, labour market conditions, financial conditions and, above all, Chinese Yuan.
Indian economy: Improving amidst cross currents
A gradual economic recovery is currently under way, though unlike 2003 or 2009 recoveries, it is neither pervasive nor pronounced as yet. High-frequency data is still antipodal. Looking ahead, a few questions are in order: is good monsoon a panacea for rural ills? Can we count on Pay Commission for a sustained revival in urban consumption (a la 2008)? To us, these diverging forces do aggregate towards assisting economic activity, but we doubt their efficacy as game changers. Beyond these, though we are constructive on RBI’s changed liquidity stance, we believe it will unfold gradually. Overall, we believe economic recovery is tepid and susceptible to unfavourable global shocks.
Recovery on, but not pervasive
We foresee 40-50bps acceleration in economic activity to 7.7% y-o-y in FY17 led by good monsoon, waning exports drag and some monetary policy support. However, terms-of-trade (ToT) will be a headwind. On the global front, Fed tightening against divergent business cycles set up is unfavourable for EMs. Goldilocks situation—dovish Fed and stable US growth—is necessary for EMs’ healing to sustain.
Global set-up: Of Fed, USD & global growth divergence?
Fed tightening cycle and USD enjoy a tight relationship, although it does not always work in the same direction. While commencement of Fed’s tightening cycle in 2004 foreshadowed bear market in USD, Fed lift-off in 1990s (1994, 1997) fuelled massive greenback rally. What explains this difference? In our view, the context matters. A Fed lift-off against the backdrop of divergent business cycles (US vs EMs) is bullish USD (case of 1990s). In this regard, the global situation in the past two years has been analogous to 1990s with US monetary/business cycle diverging from EMs. This dynamic is critical to understanding where we go from here.
In our view, in the backdrop of sluggish EM economic momentum, Fed backing off from further hikes is critical for EM stability. However, if US growth itself begins to lose momentum considerably even as EMs remain in search of revival, it could ignite global growth concerns. This would be bullish USD. Thus, the situation is dynamic and one needs to assess key incoming data to gauge the situation.
Global markets’ near- to medium-term dynamics critically hinge on the Fed’s actions, the USD’s response to the same and divergence in global growth. Historically, the direction of capital flows to EMs has been heavily correlated to the USD trend.