Economic Roundup, July 13, 2018

Economic Environment

  • US economy

  • Trade war

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

This week we also present an analysis of the US economy because of some concerns about whether the US economy has peaked and if there could be a recession in the world’s largest economy which could affect the rest of the global economy due to exposure to the US and especially given the start of the trade war, in particular, between the US and China.

  • Both Federal Reserve Bank of Atlanta and Federal Reserve Bank of New York produce what are known as Nowcasts of the US economy, in real time, as data becomes available. These Nowcasts show a strong economy with the second quarter from April-June 2018 being particularly strong in the range of annualized GDP expansion of 2.8-4 per cent. This growth has been accompanied by continued strong employment numbers with muted wage increases thereby assuaging concerns about wage increases passing through to inflation. The Fed-preferred US inflation measure is currently at the central bank’s target of 2 per cent and the Fed is on the path of gradual rate increases as expected by the markets.
  • Growth has been buttressing any downside effects of the US trade war with its major trading partners China, the EU, Canada and Mexico which, on net, is providing positive global cues. As a result, Indian financial markets reacted positively to upward movement in the US markets after the recent strong US employment data. The effects of the trade war on the US economy will not be known until after the third quarter of 2018 depending on the level of escalation of tit-for-tat tariffs between US and China and other non-tariff barriers China might erect against US companies doing business in China.
  • Some observers are looking at the narrowing spreads between short term and long term US treasury bonds and becoming concerned that the flattening of the yield curve, especially given the age of the current US economic expansion, could mean an eventual yield curve inversion with short term yields rising above long term yields signaling the prospect of a recession in 6-18 months after the inversion. US bonds are a safe haven asset and the flattening is the result of the rising short term rates, albeit gradually. The yield curve, despite the narrowing spreads between the short and long bonds, shows no signs of inverting and it is a fallacy to think that economic expansions age and die. It depends on government policies and domestic demand in the US and both monetary and fiscal policies are now conducive to continued growth. Should the trade war escalate further, the US economy could adjust to the new reality through import substitution while still not slowing down into a recession. The trade war, if fully escalated with no resolution, will adjust global supply chains to avoid tariffs. In fact, it could boost US economic growth because of trade war-induced higher domestic investment to cater to domestic demand even as some US companies shift production to other countries to avoid tariffs on imports from the US by those countries of the US companies’ goods.
  • Foreign portfolio and institutional investors (FPIs and FIIs) are repatriating their dollars due to concerns about Indian macros, pressuring Indian forex reserves, the rupee and the equity markets. Home bias, on net, however, is supporting Indian equity markets with domestic funds investing in them and therefore, there is a net flow of capital into the Indian equity markets countering the selling pressure.
  • CPI inflation for India is at 5% in June and IIP is at 3.2% in May. Both of these numbers are not encouraging because industrial production slowed while inflation rose. The inflation data points to at least another rate hike by the RBI this year, pressuring GDP and the Indian financial markets.

    What to expect from the markets next week?

    The equity markets in India and in other major economies 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 is adjusting to the trade war.

Quarterly Economic Summary, July 06, 2018

Economic Environment

  • Macro-indicators

  • Oil price

  • Trade war

  • General emerging market weakness

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

Indian economy entered the new fiscal year 2018-19 (FY 19) on a strong footing. The GDP is projected to be in the range of 7.3-7.7% in FY19 with the RBI pronouncing that the gap between actual and potential growth has been nearly closed. Industrial production and capacity utilization are rising and the credit cycle is reviving. Some risks are present though. Consumer price index (CPI) inflation – the indicator followed by the Reserve Bank of India (RBI) for policymaking – is projected to be in the range of 4.3-5.1 percent. In April-May – the first two months of FY19 – the budget deficit for FY19 has already touched 55% of the target of 3.3% of FY19 projected GDP and it is yet to be seen if in this year the government can meet its budget deficit target. The current account deficit (CAD) in the 4th Quarter of fiscal year 2017-18 (FY18) has widened to 1.9% of FY18 GDP. CAD data for the 1st Quarter of FY19 is yet to be released. Unemployment is turning out to be an issue for the government despite the strong GDP growth. In the second bi-monthly monetary policy meeting in June, the RBI has raised the policy (repo) rate by 25 basis points citing inflationary trend. Should inflation rise further up and away from the RBI’s medium term inflation target of 4%, more rate hikes can be expected given the strong growth and inflation and inflationary risks such as minimum support prices (MSP) for farmers, budget deficit and CAD. These macro risks to the Indian economy, primarily the risk of rising interest rates, together with cues from the global macro environment discussed below, have put a consistently downward pressure on the Indian financial markets.

  • Consumer confidence, according to the RBI, has improved though the expectations of consumers about spending and inflation have somewhat deteriorated in the period from March 2018 to May 2018 (Source: RBI, June 06, 2018).

  • The Indian basket of crude oil represents a derived basket comprising of sour grade (Oman & Dubai average) and sweet grade (Brent) of crude oil processed in Indian refineries in the ratio of 72.38:27.62 during 2016-17 (Source: Petroleum Planning and Analysis Cell, Ministry of Petroluem and Natural Gas, Government of India). The oil price of the Indian crude basket in the table is the average of daily prices of the respective month. Oil price has risen because of effective supply cut (due to supply distruptions in Venezuela, Libya and Angola) by OPEC and Russia of about 2.8 million barrels per day (bpd) though the target was only about 1.8 million bpd. The inventories have come down and the market is currently tight with supply barely meeting demand despite shale oil production in the US. Prospective re-imposition of sanctions on Iran by US by November is also expected to bite into the supply. It is expected that OPEC and non-OPEC will pump more crude of about 1 million bpd which can only alleviate the market tightness so much. High oil price is already proving to be inflationary for India contributing to downward pressure on the markets. More about supply will be known when OPEC meets again in December of 2018. Until then the high oil price is here to stay for India, having a negative impact on its CAD and the rupee which has depreciated against the US dollar breaching INR 69 toward the end of June as can be seen from the chart below for the quarter April-June 2018.
    • When they come into effect, tariffs by the US on imported goods from Canada, Mexico, EU, China and some on India and retaliatory tariffs by the affected countries on US goods is threatening to raise prices, slow global trade and slow the global economy. However, tariffs appear to be US president Trump’s way of negotiating a free, fair, reciprocal and balanced global trade regime with low or no tariffs and lowered or no non-tariff barriers. This global trade war by US on its trading partners is expected to last for the rest of FY19 before any agreements are reached by the various countries with the US on trade, putting downward pressure on the markets particularly in China and the EU.
    • Emerging market currencies are under pressure because of rising interest rates in the US. Foreign Institutional Investors (FIIs) are withdrawing money from the emerging markets and repatriating the dollars to the US and this combined with the high oil price is weakening the Indian rupee against the US dollar which has strengthened due to a strong US economy.

What to Expect in the July-September Quarter from the Financial Markets?

  • Pressures that would weaken the macro factors are expected to continue in the July-September quarter. Government spending in India such as on MSP and health insurance for the poor could rise because of the upcoming elections in 2019 pressuring the budget deficit though the budget deficit of India has remained well contained since 2014 because of the growing economy and tax reforms such as the Goods and Services Tax (GST) which are improving the tax receipts of the government. Though China is the country to be most adversely affected by the trade war with the US, any Chinese financial market downturn may not spillover into the Indian markets. In fact, India could stand to benefit from the US-China trade tiff because of the lowering by China of tariffs on Indian exports to China to source some goods as an alternative to US exports to China. Should the US dollar strengthen further and the oil price remains firmly in the USD 65-80/barrel range and closer to USD 80/barrel (or above), rupee can be expected to depreciate further to about INR 70/USD. This would be good for Indian exporters but threatens to weaken the Indian macro situation because of the prospect of higher interest rates to contain inflation and the burning of forex reserve dollars to pay for CAD and to put a floor under the rupee, further pressuring the Indian financial markets.

Economic Roundup, June 29, 2018

Economic Environment

  • Trade war

  • Oil price and rupee

  • General emerging market weakness

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

  • As the world is gearing up for the actual imposition of tariffs and retaliatory tariffs by US, China, EU, Canada and Mexico and now India, talk of more tariffs by US on China and of an all out trade war with the US by China has escalated trade tensions globally. While EU and China are warning that a trade war can possibly lead to a global recession, the financial markets are reacting to such prospects by falling sharply though there is no immediate threat to the US economy but there are slowdown concerns for China. US markets are in correction territory and China’s stocks have entered bear market by falling more than 20% from the high, but Indian markets are trading in a range-bound manner because the more immediate and tangible concern for India is not the broader sentiment in the rest of the global markets about trade (US-China trade war could, in fact, benefit India because China is lowering tariffs on Indian exports to China to cut out some of its imports from US and alternatively source them from Asian countries) but the oil price and its effects on Indian inflation, current account deficit, and the rupee.
  • The United States has asked India to stop buying Iranian oil by November or face sanctions. This has been the US warning to essentially the rest of the world over Iran. Compounding the situation, OPEC has not met market expectations about raising oil production to alleviate the tightness in the oil market. Because of supply distruptions in Venezuela, Libya, and Angola and American threat of sanctions on Iran and prospective US sanctions on buyers of Iranian oil the oil price has risen toward the latter part of this week. Oil price is expected to remain elevated and this has become a cause of concern for the Indian financial markets. It has weakened the rupee because Indian current account deficit would stay high if oil price remains high with another contributing factor to rupee weakening being the strengthening of the US dollar. Though the weaker rupee may be good for exporters, it raises the cost of Indian imports and puts upward pressure on inflation and interest rates.
  • Rising US interest rates have induced a general emerging market weakness because foreign institutional investors (FIIs) are withdrawing dollars to repatriate them back to the US. This is threatening to raise interest rates in India to put a floor under the weakening rupee.

What to expect from the markets next week?

The equity and commodity (including oil) markets are expected to remain stable and trade in a range-bound manner though it will be December before we will know how oil producers will react to global oil demand and the tight oil market because at least 1 million bpd and at best 2.8 million bpd production increase is necessary to balance supply and demand to support global growth. The Indian markets and the rupee can be expected to fall if the oil price breaches USD 80/barrel and remains there.

Economic Roundup, June 22, 2018

Economic Environment

  • US-China trade war

  • RBI meeting minutes

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

  • Global trade has once again affected the financial markets worldwide this week by initially sharply lowering the equity markets (after which they recovered) because of the escalating trade war between the US and China and much of the rest of the world. India has also slapped tariffs on some agricultural and steel products it imports from the United States in retaliation to US tariffs on its global aluminum and steel imports. The hope is that the United States’ strategy is to escalate to descalate trade tensions because it is really negotiating with its trading partners for reciprocal and symmetric bi-lateral trade relations and, as US president Trump stated at the recently concluded G7 summit in Canada, it ideally prefers low or no tariffs and a more open Chinese economy in technology and financial services. Global trade tensions need some time to work themselves out and until then it is expected that the process of their resolution will continue to affect financial markets worldwide but more so in China, Europe, Canada, and Mexico than in India given India’s relatively less exposure to the trade issues involved as compared to these other countries/regions.
  • As discussed in the June 08, 2018 issue of the Economic Roundup, the RBI meeting minutes clearly reveal that its neutral stance is to give itself flexibility to act in the future based on the developments in growth and inflation. However, as much as consumer spending is raising growth, it is also becoming inflationary adding to other inflationary factors such as the oil price and the RBI’s recent rate increase which will raise the cost of capital investment and eventually prices across the economy. With the RBI saying that the gap between actual growth rate and potential growth rate has closed, any higher growth rate would also be inflationary because of lack of slack in the economy. Higher interest rates in the future will slow growth because of the higher cost of business financing but may not lower inflation as much due to sectors in the CPI basket such as food, health care and education being less interest rate sensitive. RBI may need to raise interest rates more times in the coming months to keep CPI inflation at its target of 4% in the medium term.

What to expect from the markets next week?

The equity and commodity (including oil) markets are expected to remain stable and trade in a range-bound manner. There are no sufficient domestic or global triggers yet to push the markets down in India because actual enforcement of tariffs by US economy and its major trading partners is not yet sufficiently large to have a significant economic impact on any country.

Economic Roundup, June 15, 2018

Economic Environment

  • Economic data: IIP, CPI, CAD

  • US Fed policy

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

A slew of economic data has affected the markets this week.

  • Though the index of industrial production (IIP) has shown growth in April 2018, the reaction of the markets to it has only been moderately positive because year-on-year IIP has gone up only by 4.9%, moderately, below expectations. Year-on-year CPI headline inflation accelerated to 4.87% in May 2018 but is still within the forecast of the RBI for 2018-2019. As expected, the current account deficit (CAD) widened to 1.9% of GDP in the last quarter of 2017-18, an inflationary development that is largely attributable to the higher price of oil imports. The RBI is facing a situation of rising inflation and higher growth and could, therefore, raise the repo rate by another 25 basis points in its August 2018 meeting if inflation data shows continued increase by July 2018. It should be noted here that the output gap for the Indian economy – the difference between potential output and actual output – has not yet closed despite sound growth numbers while core CPI (inflation excluding fuel and food) is above the upper limit of RBI’s comfort zone of 2% to 6%, though the RBI typically prefers to use headline CPI (inflation including fuel and food) to make policy. Ideally, the RBI’s monetary policy expectation is that, in the medium term (1 to 2 years), core and headline inflation should converge to the RBI target of 4%. If inflation continues to rise and exceeds 5%, the RBI will need to change its stance to ‘hawkish (tighten)’ from ‘neutral’ in the second half of 2018 which may not be good for growth and the financial markets.
  • Rising rates in the US due to the Fed policy of gradually removing monetary accommodation through 2019 but on a data dependent basis is proving to be a difficult development for emerging markets such as India. Interest rates are rising in the emerging markets in part because of the repatriation of foreign institutional investor (FII) funds back to the US due to rising domestic US rates. This will pressure the Indian equity and bond markets.

What to expect from the markets next week?

The equity and commodity (including oil) markets are expected to trade in a range-bound manner. There are no domestic or global triggers at the moment to push the markerts down. On the downside: (1) intensifying trade disagreements between US and Europe, Canda and Mexico and between US and China could cause some perturbation in the global markets which may not strike the Indian markets with the same intensity because India is not a stakeholder to the same extent as the other countries are in trade disputes with the US; and (2) oil price has stabilized in the range of USD 65-80/barrel but the price will continue to adversely impact the Indian trade deficit. On the upside: (1) capital investment by companies in India is expected to continue to increase though spending on consumer durables may be moderate, keeping the IIP moderate; and (2) corporations will begin releasing quarterly earnings reports again starting in the first week of July and there are no indications of any undue stress on earnings. Therefore, on balance, the markets will be less volatile, stable and positive next week. To watch, however, would be the market reaction in India to global cues about the monetary policy stance of the European Central Bank (ECB) and China’s weak economic data.

Economic Roundup, June 08, 2018

Economic Environment

  • Oil price

  • RBI policy

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

The Indian financial markets this week primarily awaited the RBI monetary policy decision.

  • The possibility of Saudi Arabia, Russia and the United States raising their oil output to offset production declines in Venezuela and Nigeria and a possible production decline in Iran due to prospective reimposition of US sanctions has softened the oil price. Looking forward, slowing demand growth of oil in China is also expected to maintain a downward pressure on the oil price. This has come as a welcome relief to India though, despite the softening, the oil price for India still remains elevated from the standpoint of India’s current account deficit and pressure on the rupee and inflation as also noted by the RBI.
  • It was widely expected, given the building inflationary pressures in the economy, that the RBI’s monetary policy committee (MPC) would change its stance to hawkish on June 6th while maintaining the status quo on the repo rate, waiting for more data on inflation and growth until its August meeting to make a decision on a rate increase in a data dependent manner rather than hike the rate preemptively to avert inflation which is not as yet showing up in the data. Instead, to the surprise of a majority of RBI observers, it has done the converse: it was hawkish by preemptively raising the repo rate and neutral on the stance despite its own inflation and growth forecasts for 2018-19 remaining nearly unchanged. Perhaps the MPC thought that the policy rate was not yet at neutral and was still accommodative as comments by MPC member Viral Acharya after April seemed to suggest. Also, the MPC appears to have given itself some flexibility on future monetary policy moves by maintaining a neutral stance while hiking the repo rate by 25 basis points – an attempt to stem the rupee decline in the context of the oil price, inflation pressures, current account deficit, loose fiscal policy, and possible US rate hikes by the Federal Reserve in 2018. Mostly, however, as the April meeting minutes revealed, where one MPC member dissented by seeking a 25 basis point rate hike in April itself, the June rate hike seems to be a compromise between the doves and the hawks on the MPC because of the unanimity of the decision now and has little to do with economic developments. The neutral stance, despite the rate increase, has encouraged the equity markets to rise after the decision was announced.

What to expect from the markets next week?

As was the case this week, the equity and commodity (including oil) markets are expected to trade in a range-bound manner though, to rise, they appear to be latching on to slivers of good news even in economic developments which normally put downward pressure on the markets as was evident with the SBI earnings report and the RBI decision. The rupee has stabilized after the softening of the oil price and is expected to remain stable.

Economic Roundup, June 01, 2018

Economic Environment

  • Oil price

  • Global economic situation

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

The Indian financial markets this week have primarily shown sensistivity to oil price changes. At the same time it must be noted that the markets are displaying awareness of the building broader macro and global pressures as discussed last week.

  • The prospect of OPEC and non-OPEC oil producers raising supply to meet global demand and to ease the tightening of the oil market has lowered the oil price and strengthened the rupee, boosting the equity markets. However, this is not translating into lower prices at the pump for consumers and, therefore, could be a contributor to inflation. Sentiment in the financial markets thus has shifted to possible change of monetary policy stance to hawkish or even tightening of money supply by the RBI as soon as its June 06, 2018 meeting to address concerns about any further weakening of the rupee and rising inflation beyond the RBI’s medium term target of 4%. Growth is still expected to be above 7% in the last quarter of 2017-18 and is forecast to be the same for 2018-19 as both investment and consumption are expected to rise, but the impact of any hawkish RBI policy on growth will not be fully known until it happens.
  • On the global front, besides the continuing uncertainty about US-China, US-EU and NAFTA trade negotiations and the US-North Korea nuclear talks which are causes of market volatility, the uncertainty in Italian politics is disturbing the euro and any instability in the eurozone could both affect its growth rate and Indian exporters. Also, Indian imports of oil from Iran are in potential limbo given the threat of reimposition of sanctions by the US on Iran.

What to expect from the markets next week?

The Equity and commodity (with oil price firming in the USD 65-80/barrel range) markets in India are expected to be trading in a range-bound manner because on the upside they cannot go any higher given the fundamentals of the companies and on the downside they cannot go any lower because of the absence of major triggers though the markets are concerned about India’s macro environment, primarily interest rates, current account deficit, and budget deficit, and their affect, looking forward, on foreign institutional investment (FII), the fundamentals, and the rupee. To watch would be the second bi-monthly RBI monetary policy committee meeting on Wednesday, June 06, 2018.

Economic Roundup, May 25, 2018

Economic Environment

  • Oil price

  • Electoral politics

  • Global economic situation

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

The economic environment this week is a carryover from the prior week with emphasis on the deterioration of the macro environment.

  • Though the growth outlook looks bright, the emerging inconsistency between the micro and macro environments is causing concern. While the micro economy points to healthy demand for goods and services, it could soon face headwinds if the macro environment is not cooperative affecting economic growth. India’s Economic Survey, issued by the finance ministry at the end of January, estimated that a $10 per barrel rise in global oil prices could reduce growth by 0.2-0.3 percentage points, increase wholesale price inflation by about 1.7 percentage points, worsen the current account deficit by about $9-10 billion and the outlook for the rupee even though a cheaper rupee is beneficial to Indian exporters. India needs to attract more dollars as India’s foreign reserves can give it a cover of only 10 months raising downward pressure on the rupee and the financial markets.
  • Slowing growth and rising inflation would be bad news for the economy because it presents a dilemma to the RBI and economic policymakers and will put downward pressure on the financial markets.
  • Another reason for the downward bias in the financial markets is electoral politics. The markets, after the Karnataka assembly election, are building-in expectations of a possible hung parliament in 2019 which could paralyze policymaking in New Delhi and dampen any expectation of reforms introduced during the first BJP term from taking hold.
  • The ongoing US-China trade talks are affecting the global markets in the immediate term. While the markets are buoyed by any prospects of a win-win resolution of trade issues between US and China, they are at the same time apprehensive of the situation deteriorating into a trade war. Also, the US-North Korea-China diplomacy to resolve the North Korea situation could be politically getting tied to the US-China trade negotiations, complicating matters.
  • From the Fed minutes, it is clear that US monetary policy is sensitive to market sensibilities about interest rates rising too quickly in response to US inflation firming around the Fed’s target. The communication by the Fed that it will tolerate inflation being reasonably symmetric around its target allays quick rate rise fears and puts the Fed on course to achieving neutrality of monetary policy during this year and the next. Though this is good news for the stability of the US economy, the eyes of the markets are also on any emerging divergence between the developed economies and any asynchronization of global growth. More will be known about the trajectory of global growth at the end of the June quarter.

    What to expect from the markets next week?

The Equity and commodity (with oil price firming in the USD 70-80/barrel range) markets in India are expected to be trading in a range-bound manner because of the absence of major triggers though the markets are concerned about India’s macro environment and its affect, looking forward, on the fundamentals and the rupee.

Economic Roundup, May 18, 2018

Economic Environment

  • CPI inflation

  • Assembly elections in Karnataka

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

The economic environment this week is consistent with that of the past week because the same factors have carried over in combination with the release of the consumer price index (CPI) inflation data for April 2018.

  • The latest CPI data points to higher inflation because of rise in energy costs. In particular, core inflation (inflation excluding the volatile food and energy components) has risen to the level of 6% year-on-year, while overall inflation has stayed between 4-5%. The current account deficit (CAD) is widening because of the rising oil price, there is pressure on the budget deficit, and the rupee is weakening, with all three of these factors also contributing to higher inflation. This could prompt the RBI to revise its inflation forecast up and possibly change its stance from neutral to tightening in the June bi-monthly monetary policy committee (MPC) meeting, especially given that the most recent meeting minutes show a hawkish bias on the part of some MPC members. If inflationary factors continue to hold sway, India may have to sacrifice some growth to hold inflation at the RBI’s medium term target of 4%.
  • Elections in Karnataka have had, on net, a neutral impact on the financial markets because of the hung assembly. Though the BJP has emerged as the single largest party, the possibility of a hung parliament also emerges in the 2019 General Elections as seats won by the Indian National Congress (INC) party and the various regional parties could deprive the ruling BJP coalition of the required majority seats to form a government as has happened in
    Karnataka. In 2019, the BJP could end up being the single largest party without a majority in a hung parliament. As a result, similar to Karnataka now, an unstable government could result in New Delhi in 2019, reducing the prospects of much work getting done. Such an outcome is not good for the financial markets because, in particular, foreign institutional investors (FIIs) could exit due to diminished hope for, as they have come to expect from the BJP, continued reforms and solid economic growth, putting further downward pressure on the rupee.

 

What to expect from the markets next week?

The Equity and commodity (other than oil) markets in India are expected to continue to be less volatile and mostly trading flat in a range-bound manner because of the absence of major triggers and the markets already building into their expectations firmer oil price and its affect on inflation. That said, possible hawkish RBI stance on monetary policy in June could act as a trigger to depress stocks and raise bond yields. The Indian rupee’s performance merits watching carefully as it is expected that the downward pressure on the currency would remain, especially dependent on the movement of the oil price (which could continue to enlarge the CAD), taking cues from US and European markets on their reaction to geopolitical factors such as Iran and Saudi Arabia’s desire to see the oil price around USD 80/barrel. Also, rising bond yields in the US could contribute to the downward pressure on the rupee because of exiting FII money, though the situation will not be as bad as the taper tantrum when the US exited quantitative easing. India has to carefully balance between the rising CAD and its foreign exchange reserves when selling US dollars to prop up the rupee.

Economic Roundup, May 11, 2018

Economic Environment

  • Oil price

  • Rupee

  • RBI policy on short-term bond purchases by foreigners

  • China’s import tariffs on Indian pharmaceuticals

  • Assembly elections in Karntaka

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

The economic environment this week consists of important factors which, looking forward, can have a significant impact on the Indian macroeconomy.

  • Oil price has risen to the range of USD 70-80/barrel due to the US pulling out of the Iran deal and supply tightness in the market in general because of OPEC and non-OPEC policy of coordinated supply cuts. The US, besides its own efforts to raise supply, is talking to Saudi Arabia and other OPEC members to compensate for the loss of Iran’s supply should the reinstatement of US sanctions affect Iran’s ability to put its oil in the global market. Though the rising oil price is good for energy companies and oil exporting countries, every USD 10 increase in the per barrel price of oil puts significant downward pressure on the GDP of countries, especially India, because of pressure on foreign exchange (dollar) reserves and the prospect of higher interest rates due to upward pressure on inflation arising from higher energy costs. This will have a negative impact on the equity markets and government bond yields will rise.
  • The rising oil price and the strengthening of the US dollar because of the sound performance of the US economy are contributing to the weakening of the Indian rupee. Though this may bode well for Indian exports, given that India has a significant current account deficit because its imports are larger than exports, the weaker rupee will contribute to raising inflation and hence interest rates putting downward pressure on GDP growth and on the financial markets.
  • Another spanner in the works for the Indian economy is the RBI’s decision to permit foreign investment in short-term government bonds. This could increase volatility in the bond market because of the high frequency of bond trades which puts money in the bond market and also removes it depending on market conditions. It would be okay if the bonds are rupee-denominated but it would put pressure on forex (dollar) reserves and the Indian rupee if the short-term government securities are borrowing in US dollars.
  • A good development for India in China-India trade is the exemption by China of import tariffs on 28 pharmaceuticals including all cancer drugs. This should hopefully reduce the trade deficit India has with China and give a boost to the market valuations of Indian drug manufacturers which export to China.
  • Assembly elections in the state of Karnataka appear to bode well for India’s ruling party at the centre, BJP. Should upcoming elections in other states likewise give a boost to BJP, the markets can expect continuation of reforms if the BJP can also be relected in 2019 with a comfortable majority either independently or in coalition with other parties. The worst outcome for the financial markets would be a diminished majority for the BJP that would lead to political paralysis in New Delhi, preventing the work of the government from being done at a crucial time for the growth of the economy.

What to expect from the markets next week?

The Equity and commodity (other than oil) markets in India are expected to continue to be less volatile and mostly trading flat in a range-bound manner. The Indian rupee’s performance merits watching carefully as it is expected that the downward pressure on the currency would remain, especially dependent on the movement of the oil price, taking cues from US and European markets on their reaction to geopolitical factors such as Iran.