Economic Roundup, September 28, 2018

Economic Environment

  • Non Banking Financial Companies (NBFCs) and imports

How are the Indian and global economic environments affecting the financial markets?

  • Adding to the continuing concerns about the oil price and trade war, Indian domestic problems with questions about the liquidity of NBFCs after Infrastructure Leasing & Financial Services (IL&FS) defaulted on payments on its bonds greatly concerned the markets with both SENSEX and NIFTY ending more than 6% down from their 52-week highs, the banking and financial services sector causing most of the fall that was punctuated by whipsawing of the indices. Related sectors such as Realty and Autos also fell due to concerns over liquidity amid worries about a market contagion that could lead to a steep fall in the indices to a 10% correction or a 20% bear market. Government assurances have thus far averted such possibilities and the markets have stabilized though their future behavior will depend on how the NBFC issues are resolved by the regulators.

    What to expect from the markets next week?

    As during this week, next week’s market behavior will be primarily determined by government efforts to deal with the weakness in NBFCs, oil price and imports. Tariffs are being levied by the government on 19 ‘non-essential’ imports to reduce the import bill and counter the slide of the rupee. Also being considered are strategies to increase exports. The US Federal Reserve continues to remain on the path of raising interest rates and this coupled with the NBFC issues and current account deficit (CAD) concerns is putting a dampener on inflow of foreign portfolio investments pressuring foreign exchange reserves. Domestic banking and financial services sector and external oil price and trade war concerns will continue to cloud the movement of the equity markets. Next week the Reserve Bank of India (RBI) will release its Fourth Bi-Monthly Monetary Policy Statement for the year 2018-19 on October 5th. The balance between on the one hand the continued strength of the Indian economy and on the other macro and banking and financial services sector concerns will determine the interest rate outlook. RBI may not be inclined to sap liquidity from the market by raising the repo rate amid talk already about lowering the reserve requirement and RBI bond purchases from banks to ensure that the markets are sufficiently liquid to prevent panic selling. As NBFC regulator it will also need to address what steps it may take, if any, about possible defaults by companies in that space.

Economic Roundup, September 21, 2018

Economic Environment

  • Supporting the rupee

How are the Indian and global economic environments affecting the financial markets?

  • The Indian rupee continues to weaken in reaction to any news of the rising oil price and increase in other imports. The Reserve Bank of India (RBI), since April 2018, has intervened in the foreign exchange markets to the tune of about USD 25 billion to support the rupee but the currency has continued to fall. The government, taking advantage of higher import prices due to the weak rupee, is considering import curbs and levies on steel imports to encourage import substitution through its Make in India initiative. Higher interest rates – to stem any further rise in the current account deficit (CAD) and the fall of the rupee – to stabilize the currency are under consideration. The money markets are pricing in two 25 basis point hikes by the RBI in the repo rate before the end of the year. Indian equity markets have fallen during the week in reaction to the oil price and the rupee and the news of further tariffs by the US on Chinese exports to the US and China’s retaliation. The US-China trade war continues to escalate even as the US negotiates with other countries, including India, with which it has trade grievances.

    What to expect from the markets next week?

    Indian equity markets will continue to remain sensitive to oil price and the rupee. The news that Saudi Arabia, the biggest member of the Organization of the Petroleum Exporting Countries (OPEC), has indicated its preference for Brent crude price above USD 80/barrel is benefiting energy stocks but is pressuring the currencies of oil importing countries such as India by putting pressure on the CAD and foreign exchange reserves. External macro pressures are expected not only to contain the rise in stocks but also pressure them down. Though India, with its strong growth rate, is attractive to foreign investors, rising US interest rates and domestic macro concerns are putting a damper on Foreign Portfolio Investment (FPI) and hence on dollar reserves. Oil and trade concerns in an otherwise sound Indian economy could whipsaw stocks. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war and global growth concerns but could rise somewhat due to the build up to the reimposition of sanctions on Iran by the US in November. It is yet to be seen if, after November, oil price will rise above USD 80/barrel. Other commodity markets will move based on, among other factors, how the Chinese economy and the rest of the world economy is reacting to the trade war and concerns about global growth. There are as yet no worrisome triggers to drive the markets down by a large extent. However, the developing situation between US and Iran merits watching carefully because it has the potential to disrupt world oil supplies due to any actions by Iran in the Strait of Hormuz which could push oil prices higher.

Economic Roundup, September 14, 2018

Economic Environment

  • Steady growth, lower inflation but external macro pressures

How are the Indian and global economic environments affecting the financial markets?

  • India’s industrial output in July had risen 6.6% year-on-year – slightly below June’s 6.9% but in line with expectations due to robust demand for consumer durables. Inflation cooled to 3.9% year-on-year in August. However, external pressures on the macro economy continue to persist because of the increase in oil price and the depreciation of the rupee. The cheap rupee is widening the current account deficit (CAD) despite higher exports due to the higher cost of imports. Foreign Portfolio Investment (FPI) needs to be watched for its affect on India’s foreign exchange reserves which are, at the moment, sufficient for 8 months of foreign exchange payments assuming no inflow of reserve currencies. Though India is better off than its fellow emerging market countries on foreign exchage reserves, it needs to be careful about its balance of payments situation. It will be a close call for the Reserve Bank of India (RBI) on interest rates in October because of the build up of macro pressures. The Monetary Policy Committee (MPC) could preemptively raise the repo rate by 25 basis points or wait for any pass-through of oil price and the rupee to inflation. Higher rates by the RBI could dampen enthusiasm for stocks, attempt to put a floor under the rupee, and raise bond yields. There are also new warnings about an increase in the non-performing assets (NPAs) of banks due to possible loan defaults by medium and small enterprises (MSMEs) which puts downward pressure on bank stocks.

    What to expect from the markets next week?

    Indian equity markets, although trading near all-time highs, will continue to remain sensitive to oil price and the rupee. External macro pressures are expected to contain the rise in stocks. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war and global growth concerns but could rise somewhat due to the build up to the reimposition of sanctions on Iran by the US in November. Other commodity markets will move based on, among other factors, how the Chinese economy and the rest of the world economy is reacting to the trade war and concerns about global growth. There are as yet no worrisome triggers to drive the markets down by a large extent. However, the developing situation between US and Iran merits watching carefully because it has the potential to disrupt world oil supplies due to any actions by Iran in the Strait of Hormuz which could push oil prices higher.

Economic Roundup, September 07, 2018

Economic Environment

  • Global political-economic situation, oil price and the rupee

How are the Indian and global economic environments affecting the financial markets?

  • The prospect of reimposition of US sanctions on Iran in November with the primary aim of removing Iranian oil from the global market has led to rise in oil price. This, in turn, has led to fears of Indian current account deficit (CAD) rising because of rising import costs due to India’s oil imports. On net, such a development would put pressure on India’s US dollar reserves if inflows of foreign direct investment (FDI) and foreign portfolio investment (FPI) do not return to the country in at least the same measure as the FPI which recently left the country after the commitment by the Fed to gradually raise US interest rates. Though a cheaper rupee is good for Indian exports, the cost of rising imports will put pressure on inflation making the Reserve Bank of India (RBI) look closely at inflation, of course, depending on the inflation outlook, to make future interest rate policy. The high gross domestic product (GDP) growth of 8.2% year-on-year in the quarter ending June 2018 (first quarter of fiscal year FY 2019) will give the RBI some leeway in controlling inflation should the need arise assuming that strong growth will continue for the rest of FY 2019. Global cues have been sharply negative for Indian equities over the past week. It is clear that the equity markets shifted their focus to geopolitical (Iran), global trade (primarily US-China) and emerging markets (Brazil, Argentina and Turkey) risks after the end of the earnings season to sell-off on a high for profit-taking. The Indian equity markets continue to hover near all-time highs despite the sell-off.

    What to expect from the markets next week?

    Indian equity markets will continue to remain sensitive to oil price and the rupee. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war and global growth concerns but could rise somewhat due to the build up to the reimposition of sanctions on Iran by the US in November. Other commodity markets will move based on, among other factors, how the Chinese economy and the rest of the world economy is reacting to the trade war and concerns about global growth. There are as yet no worrisome triggers to drive the markets down by a large extent. However, the developing situation between US and Iran merits watching carefully because it has the potential to disrupt world oil supplies due to any actions by Iran in the Strait of Hormuz which could push oil prices higher.

Economic Roundup, August 24, 2018

Economic Environment

  • Equity markets

  • Global political-economic situation

  • US Fed policy

How are the Indian and global economic environments affecting the financial markets?

  • Indian equity markets, as expected, have not only been bullish this week but reached all time highs. What appears to be easing trade war tensions between US and China due to the start of low-level trade negotiations between the two countries contributed to the global cues taken by the Indian markets. Upbeat expectations of growth from the finance ministry and encouraging income tax (IT) collection numbers also pushed the markets higher. Foreign portfolio investors also appeared to be putting money back into the Indian financial markets because of better corporate earnings and an easing of the oil price. Growth prospects, better IT receipts, and lower oil price make for the prospect of improving macroeconomic conditions which have, therefore, buoyed the markets. The rupee is trading in a range-bound manner but closer to the INR 70 mark per USD and has not affected the financial markets significantly because government expectations of an acceptable trading range of the rupee is even weaker, around INR 72-74 per USD.

  • While trade and diplomatic tensions with Turkey continue, expectations of global growth are under pressure due to the escalating trade war between US and China. Even though low-level talks are happening between the trade policy delegations of the two countries, the White House is doubtful that much progress can be made because both sides are intransigent. US financial markets are hoping for a trade deal which is not yet on the horizon and, therefore, the trade tensions will continue to put pressure on US financial markets to some degree even though it may not affect India as much except if there is a crisis because of trade or debt in China which is unlikely to precipitate in the near future though there can be pressure on Chinese growth.

  • The US Federal Reserve, admirably exercising its statutory independence despite White House displeasure, is on the path of gradually raising interest rates once at its September meeting and, possibly again, at its December meeting by 25 basis points at each meeting as already built into market expectations. The gradual rate increases are not expected to pressure the US financial markets or growth. The S&P 500 index is close to an all-time high.

What to expect from the markets next week?

Indian markets could be range-bound or flat next week as the earnings season comes to a close toward the end of this month. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war and global growth concerns but could rise somewhat due to the build up to the reimposition of sanctions on Iran by the US in November. Other commodity markets will move based on, among other factors, how the Chinese economy and the rest of the world economy is reacting to the trade war and concerns about global growth. There are as yet no worrisome triggers to drive the markets down by a large extent. However, the developing situation between US and Iran merits watching carefully because it has the potential to disrupt world oil supplies due to any actions by Iran in the Strait of Hormuz which could push oil prices higher.

Economic Roundup, August 17, 2018

Economic Environment

  • Rupee

  • Commodities

How are the Indian and global economic environments affecting the financial markets?

  • This week was taken up by the markets digesting the fallout from the collapse of the Turkish lira, the gyrations in the Turkish financial markets, and the trade war between the United States and Turkey. Emerging market currencies fell against the dollar, with the rupee being no exception because initially the markets feared that a contagion would spread among the emerging markets. However, Turkish problems seem to be specifically localized to Turkey given its twin deficits of budget deficit and trade deficit and low interest rates to prop up growth despite high inflation amid growing concern that the Turkish central bank’s policy independence has been compromised by the government. Indian markets were affected to some extent by Turkey and the rupee breached INR 70 to the USD with the possibility that the Reserve Bank of India (RBI) could or possibly has already intervened in the foreign exchange market to put a floor under the rupee but the most affect has been on markets with exposure to Turkey. The fall of the rupee has not affected the Indian equity markets which, albeit volatile, particularly in the banking sector, have remained bullish.

  • Commodities including oil are being pressured due to concerns about global growth amid the US using tariffs as a weapon of choice with countries with whom it has diplomatic issues as exemplified by the Turkey situation.

What to expect from the markets next week?

Similar to this week, Indian markets may vacillate but with low volatility between being bullish and flat next week as the earnings season comes to a close toward the end of this month. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war and global growth concerns. Likwise, the other commodity markets will move based on, among other factors, how the Chinese economy and the rest of the world economy is reacting to the trade war. Annual inflation has come down to 4.17% in July and if this trend continues it could make the RBI hold interest rates at its October 2018 meeting giving the financial markets a breather from RBI pressure.

Economic Roundup, August 10, 2018

Economic Environment

  • Kharif and monsoon

  • Trade war

  • Earnings

How are the Indian and global economic environments affecting the financial markets?

  • The monsoon is 10% below normal at the peak time for Kharif crop growth which is worrisome. As a result, the sowing of Kharif crops is lower exacerbating the already lower sowing because of surplus production in the previous season. It is yet to be seen what the government-offered minium support prices (MSP) will be and how lower production this season is going to affect food prices and hence inflation, affecting Reserve Bank of India (RBI) policy. The International Monetary Fund (IMF) has already suggested that India should raise interest rates gradually to prevent inflation from rising far from the RBI medium-term target of 4%.

  • Weakening Indian macros due to the high oil price, rising current account deficit (CAD), increased government spending before the 2019 general election on wages for government workers and health scheme for the poor, and rising interest rates in the U.S have triggered Foreign Portfolio Investors (FPIs) and Foreign Institutional Investors (FIIs) to leave India, pressuring the stock markets and the rupee only to be buttressed, on net, by higher domestic rupee inflows into the stock market. Embracing the weakening rupee to support Indian exporters does not fully offset the rising cost of imports. The RBI intervened in May 2018 by selling USD 12 billion to stem the fall of the rupee but this is a vicious circle because unless foreign flow of dollars is reversed through inward FPI, FII, and Foreign Direct Investment (FDI) flows, decreasing foreign exchange reserves including because of RBI sales of dollars will continue to pressure the rupee.

  • The escalating trade war between the US and China could be a benefit to India to export more to the US and to China. Indian exports to the US could rise because of the cheaper rupee and any negotiated settlement of trade issues between the US and India. Adjusting to the trade war, China is lowering tariffs on Indian goods and this could increase Indian exports to China for India to be able to compete on an even keel with other Asian exporters to China perhaps contributing to lowering the trade deficit India has with China.

  • The June 2018 corporate earnings season has been good for the Indian economy. Though Indian banks still have non-performing asset (NPA) issues, they have become more profitable (or significantly less negative) as a sector in the June 2018 quarter when compared to the March 2018 quarter, year-on-year. As a result, the stock markets have given a big boost to the banking sector. Also, overall, all sectors of the economy have performed better with a positive double digit percentage profit-after-tax (PAT) in the June 2018 quarter when compared to a year ago leading to bullishness in the equity markets because nearly more than 60% of the companies have shown a positive percentage increase year-on-year of PAT.

  • Watching Nifty50, there are some concerns that the index’s trailing P/E is unsustainably high around 28 because on the two previous occasions this happened Nifty50 fell close to 50%. However, it must be remembered that those two previous occasions were the bursting of the tech bubble in 2000 and the housing bubble in 2008 in the US. It is possible that, if the earnings growth of Nifty50 component stocks is not commensurate with the rise in the index, the index could correct by about 10% as it did in February 2018 but not beyond that because there are no compelling triggers for a bear market or a deeper downturn as in 2000 and 2008.

    What to expect from the markets next week?

Indian markets may vacillate but with low volatility between being bullish and flat next week as the earnings season comes to a close toward the end of this month. They are expected to continue to remain stable but react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war concerns and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy is adjusting to the trade war.

Economic Roundup, August 03, 2018

Economic Environment

  • Reserve Bank of India (RBI) policy

  • Global situation

How are the Indian and global economic environments affecting the financial markets?

  • The Indian economy continues to expand in the range of 7.2-7.7% real GDP growth rate albeit amid steadily growing price pressures with consumer price index inflation expected to be at 5% by the first quarter of fiscal year 2019-20. The RBI, given its mandate, has paid particular attention to inflation, which, on balance, appears to be ticking up over the course of the coming year for a variety of reasons as discussed in the RBI’s policy statement released in August 01, 2018 and in our prior issues of the Economic Roundup. Given that monetary policy acts with a lag on the broader economy, it is only prudent to raise interest rates keeping the RBI’s medium-term inflation target of 4% in view and this is what the RBI has done in two consecutive meetings, as expected by us, while maintaining a neutral stance so as not to constrain growth. We expect the RBI to hold interest rates unchanged at its next meeting in October unless evolving economic circumstances during the intermeeting period warrant any changes.

  • Economic conditions appear to be tilting to the downside for China and the Asian countries in the China supply chain ecosystem because of the trade war with the United States. The affect on the Chinese economy of the US-China trade war would be clear by end-September (at the end of the third quarter of 2018) and this could pressure global commodity prices, including oil, should the Chinese economy appear to not be able to hold up. US trade war with the European Union (EU), Canada and Mexico and a few other countries such as India seems to be on hold because of the possibility of negotiated settlements of the issues involved. On balance, China, Asian countries in a supply chain relationship with China, and commodity exporting countries such as Canada and Australia could experience economic slowdown while economic growth in the EU could remain on track. It is, however, clear that global economic growth is no longer synchronized because of the trade war. Global growth could slowdown should the trade war, in particular between US and China, escalate.

    What to expect from the markets next week?

Indian markets will remain bullish next week as the earnings calendar continues. The behavior of the equity and commodity markets in India and in other major economies will remain consistent with that of this week. They are expected to continue to remain stable and react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war concerns and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy is adjusting to the trade war.

Economic Roundup, July 27, 2018

Economic Environment

  • Good and Services Tax (GST) rationalization

  • Oil and commodities

How are the Indian and global economic environments affecting the financial markets?

  • The rationalization of the GST by the GST council has slashed taxes on several items and made filing tax returns simpler for a larger tax base covering about 93% of all taxpayers. This will make compliance easier and could increase the revenues for the government. GST rationalization is an ongoing process until the government achieves the desired design. Rationalization, which could, at some point, even bring petrol and diesel under GST, could ultimately have only 4 slabs at 0, 5, 15, and 28 per cent, with a majority of goods and services falling under the first three slabs, while achieving the goals of simplicity, higher compliance and higher revenue. The financial markets have reacted favorably to the tax easing.
  • Oil price, rangebound in the USD 65-80/barrel range, along with other commodities is being pressured because of concerns about the trade war. In India, despite the downward pressure on the oil price, it being still relatively high compared to the past years, any downward drift is being welcomed by the Indian financial markets while the opposite is resulting when the oil price inches up. Copper, a bellwether commodity, has dropped steeply into bear market territory while trying to recover because of uncertainty about demand from China. Copper price closely follows economic growth in US and China and downtrend in its price has preceded economic downturns in both countries. While China’s economic growth is under pressure because of the trade war, and the US, looking forward, is getting off of a growth spurt in the April-June 2018 quarter, China’s targeted monetary easing measures (while continuing to deleverage the economy) and stable US growth could make copper recover. It is too soon to predict any steep downturn in economic activity in the either the US or China.

What to expect from the markets next week?

All-in-all, the Indian markets look bullish. Next week, the behavior of the equity and commodity markets in India and in other major economies will remain consistent with that of this week. They are expected to continue to remain stable and react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may continue to move in a range-bound manner between USD 65-80/barrel, falling due to the trade war concerns and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy is adjusting to the trade war.

Economic Roundup, July 20, 2018

Economic Environment

  • Monsoon, minimum support prices and inflation

  • Pay adjustment for government employees and inflation

  • Oil price

How are the Indian and global economic environments affecting the financial markets?

  • Monsoon is proving to be one of the trump cards, as it always is every year, for the Indian economy. As of date, rains have been sub-optimal for the summer – Kharif – crop and if this continues it can have several negative effects: farmer sentiment can alienate the farmers – an important voting bloc – from the government, compounding the sour farmer relations already, affecting the election outcome in 2019 and the politics of policymaking thereafter, in turn affecting the economy and the financial markets; as an immediate effect, sub-optimal farm yields could push up inflation, prompting the RBI to raise interest rates; the need to import food and subsidize farmers cramps the fiscal flexibility the government has by raising the current account deficit (CAD) and the budget deficit; companies and sectors that cater to the farm sector and whose businesses are reliant on farm produce will stand to lose, adversely affecting their market valuations. All of these primary and secondary effects could drag down GDP growth because the agricultural sector provides nearly 60% of employment in India even though it makes up only 15% of the GDP.
  • The government is considering another pay increase for central government employees after the recent 7th Pay Commission hike of 2% in Dearness Allowance (DA). Before the election, it wants to modify the index and base year for calculating the DA which is the cost of living adjustment paid to central government employees. The RBI, together with the monsoon, watches for the effect of pay raises to the large number of government employees on the budget deficit and inflation because both of these macro indicators affect the path of interest rates. The allocation of funds by the central government for the pay adjustment could increase the budget deficit and raise inflation which has already crossed the 5% threshold in June (core inflation has already exceeded 6%).
  • Oil price, albeit at the lower end of the USD 70-80/barrel range because of the recent easing of supply concerns, will still, despite the Indian equity market rally, continue to put pressure on the CAD, the rupee, and inflation because it is much higher than when the oil price was low in the past several years, pressuring the Indian macro environment together with the probability of a sub-optimal monsoon and government wage increases.

What to expect from the markets next week?

Next week, the behavior of the equity and commodity markets in India and in other major economies will remain consistent with that of this week. They are expected to remain stable and react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may move in a range-bound manner between USD 70-80/barrel, falling due to the trade war and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy, which has performed as expected in the second quarter of 2018, is adjusting to the trade war.