Saugata Bhattacharya

India emerges as one of the best investment destinations in a weak global environment due to improved and improving macroeconomic fundamentals, says the Senior Vice-president & Chief Economist at Axis Bank.

Global markets remained volatile in the first four months of FY16, with protracted negotiations over Greece, a spike in yields brought on by better data, signs of inflation in the US and Eurozone and the beginning of the China equity sell-off. Major developing markets currencies and global funds flows responded to these developments, which had an adverse effect on portfolio flows into India. On top of this, came the news of an agreement reached by five major powers with Iran on containing the latter’s nuclear programme, which has the potential for structurally disrupting the oil economy’s demand and supply dynamics.

Facts & Trivia

 

Education: Delhi School of Economics & Oxford University

Previous Job: Unilever India

 

While the proximate causes of volatility were specific to each of these geographies, underlying was the common theme of excess liquidity created by all the central banks and the collateral effect of an attempt to push individual currencies down, with an eye on promoting exports – one of the few drivers of growth still alive, however weak.  

 

In the timeline, the first turbulence emerged in early May 2015 with the first set of growth and inflation numbers in the developed markets. The US economy had begun to show signs of growth beginning to get traction, with employment, housing and industrial numbers suggesting signs of a sustainable recovery. European inflation data also indicated that fears of continuing deflation were dissipating.

 

Co-terminous with this were the continuing negotiations of the creditors with the Greek government to avert an imminent debt default. Although the magnitude of the problem was likely to have been lower than the other sources of volatility, emotional and political currents magnified the Greek debt issue, as were questions on testing the limits of sovereign prerogatives. Right from the beginning in 1997, the European Union (EU) and Eurozone (EZ) have been political entities rather than economic ones. So, the maneuvering and posturing had a distinctly political tone, which stood out from the chaotic cacophony of percentages, timelines and exemptions of the proposals and counter proposals from Greece and the Troika (the EU, European Central Bank (ECB) and International Monetary Fund (IMF)). It now remains to be seen in what form the final bailout structure emerges, but it will likely  be an adverse outcome for Greece.

A big question remains on China’s growth prospects and the executive’s ability to engineer significant economic and institutional changes, thereby stabilising economic growth.

 

While this was happening, China’s engineering of its equity markets, due to the rapidity of change, began to get media attention, and began to influence global markets not least because of the sheer scale of the funds flows, private and Government. The People’s Bank of China had cut both the policy rate and the reserve ratios almost on a monthly basis, but seemed to result more in an extraordinary rise in equity markets, whose links to economic activity seemed quite tenuous. A big question mark remains on China’s growth prospects and the executive’s ability to engineer significant economic and institutional changes, thereby stabilising economic growth. The series of oscillating policy measures raised concerns that China’s established deftness in managing growth was weakening, which raised further concerns about the leadership’s ability to rebalance the economy. The key takeaway from the relative current stability of equity markets is that China has the means to get the economy to settle in the desired 7 – 7.5 per cent growth band.   

 

 Amidst these risk-off developments, came news of a non-linear, relatively unexpected deal for sequestering Iran’s nuclear program in exchange for Iran’s re-integration with the global economy. While the outcome of the deal will not be clear till it passes legislative approval in the US and other countries, the potential of an entry of Iran in the energy and other spaces is likely to be quite large. This was evident in the way crude prices reacted to the deal.

 

The next major source of volatility is likely to be the decision on raising the US Federal Reserve Board’s policy rate. Even though the effects are unlikely to be as large as during the “Taper Tantrums” of May 2013, the sheer size of the exposures of the global financial system to US debt and the economy is certain to initiate volatility. How long this volatility is subsequently likely to last would depend on evolving expectations on the extent of recovery, based on the data flow from the US.

If growth impulses pick up, reforms are in place, India might get a ratings upgrade in next few years, followed by inclusion in benchmark indices.

 

In all, the churn in global markets has been deep and widespread. Why is all this important for India? Due to the channels which will impact India: trade, capital flows, commodities, employment. India’s total engagement with the world economy – adding all the inflows and outflows of its balance of payments – has risen in the course of the past decade and half, from roughly 50 per cent of the GDP in 2002 to around 110 per cent in 2014. Over this period, India’s GDP itself has grown more than 5x. Overall, the net effect has been beneficial for India. Analysts estimate that over $2 trillion have been effectively transferred from energy producing countries to energy consuming ones since the beginning of the drop in crude prices. Not just will India continue to enjoy the benefits of lower oil prices, as a result of the consequent effects on macroeconomic fundamentals, India emerges as one of the best investment destinations in a weak global environment.

 

Global Emerging Markets macro fundamentals have improved over the past couple of years, and India’s in particular. Foreign exchange reserves have risen from $275 billion at end-August 2013 to $354 billion in July. The Current Account Deficit has come down from close to 5 per cent of GDP in FY13 to 1.4 per cent in FY15 and is expected to stabilise at these levels. India’s external debt to GDP ratio has remained stable around 23 – 24 per cent for the last four years, a moderate level compared to our Emerging Markets peers.

 

There are currency consequences of the above developments. We expect that the USD-INR pair will depreciate gradually over the year, with a level around 64.50 by December. RBI has successfully guided the Real Effective Exchange Rate (REER) of the INR against a basket of currencies, preventing any significant appreciation, which would be adverse for exports. If growth impulses pick up, reforms are put in place, India might get a ratings upgrade over the course of the next couple of years. We are likely to be more integrated with global capital pools, including inclusion in benchmark indices. This is a risk to this rupee view, but we remain confident that RBI will still need to increase its forex reserves to maintain its import cover at current levels and thus be able to prevent any significant appreciation of the rupee.

 

(Views expressed here are personal).


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