Economic Roundup, February 15, 2019

This week’s economic roundup is essentially unchanged from our February 08, 2019 edition. A notable piece of data is that consumer price index (CPI) inflation is 2.05 percent in January 2019. It continues to stay close to the lower end of the Reserve Bank of India’s (RBI’s) inflation targeting range of 2 – 6 percent justifying RBI’s monetary policy stance to favor growth. Moreover, there continues to be macroeconomic stability on the front of India’s budget and trade deficits though the government must be wary of fiscal slippage (indicating higher fiscal deficit – the government’s fiscal deficit target for both 2018-19 and 2019-20 has increased 0.1 percent to 3.4 percent from 3.3 percent) and slowing global growth (indicative of possible reduction in India’s exports) even as India’s growth continues to remain on target looking into 2020. The financial markets will continue to be range-bound.

Economic Roundup, February 08, 2019

Economic Environment

  • Reserve Bank of India (RBI) monetary policy

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

  • The new RBI governor Shaktikanta Das, given the low consumer price index (CPI) inflation reading – closer to the RBI’s lower end of the 2 – 6 percent range – in December 2018, has declared victory on achieving price stability and reoriented monetary policy to be pro-growth by changing the policy stance to “neutral” (as we expected 2 weeks ago) and at the same time also cut the repo rate by 25 basis points to 6.25 percent while staying committed to the 4 percent medium-term inflation target. It assured the markets that it would ensure adequate liquidity through open market operations as needed. The RBI is also open to transferring some reserves to the government as determined by the RBI’s central board. RBI policy has thus resolved the issues the central bank had with the government before Urjit Patel stepped down as governor. Low inflation and macroeconomic stability have helped the cause of both the new governor and the government. The financial markets responded accordingly by moving into positive territory.

What to expect from the markets next week?

Corporate earnings reports will continue to determine the path of the major Indian indices next week amid international concerns about slowing global growth and continuing trade tensions between the US and China. Even as growth is projected to be lower around the world, the United States – India’s principal export market – is holding steady and will remain so especially because the US Federal Reserve has signaled a “patient” approach to future rate increases given the tenuous global situation particularly in Europe and China. Indian financial markets will respond to economic developments around the world only insofar as they affect India’s exports.

Economic Roundup, February 01, 2019

Economic Environment

  • US Federal Reserve policy

  • India 2019 interim budget

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

  • US Federal Reserve stated in its policy statement at the end of the Federal Open Market Committee (FOMC) meeting on January 30, 2019 that it will be “patient” in future monetary policy actions implicitly recognizing the possibility of a slowdown in the US economy primarily due to external factors in the global economy at large and “muted inflation pressures”. It has assured the markets that it has the tools necessary beyond interest rate policy to stimulate the US economy should it become necessary in the future. This has boosted financial markets which were concerned about slowing global growth in the face of rising US interest rates and the US trade war with China.

  • The Indian interim (not full fledged) budget in the election year is scheduled to be presented on February 01, 2019. Rural and jobs-related spending will be in focus, though the deficit as a percentage of gross domestic product (GDP) is expected to remain under control. The financial markets will be scouring for information that will affect the various sectors and so some volatility can be expected but the market reaction to the budget could be muted because it is only an interim budget before the general election in April – May 2019. The general election outcome will have a bigger impact on the Indian financial markets than this interim budget.

What to expect from the markets next week?

Continued range-bound and flat behavior can be expected in the coming week with some volatility due to the budget. It must be noted that corporate earnings reports will continue to determine whether the major Indian indices will recover from being close to correction territory.

Economic Roundup, January 18, 2019

Economic Environment

  • Interim budget and macroeconomic indicators

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

  • Government of India is scheduled to present the interim budget in this election year on February 01 for the parliament’s approval. The government appears to be keen on expansionary fiscal policy before the general election which is making many observors doubt the government’s commitment to a fiscal deficit target of 3.3 percent of GDP in the year 2018-19. It is also expecting to persuade the Reserve Bank of India (RBI) to transfer an interim dividend of Rs 30,000-40,000 crore to the government by March. All of this is to be able to raise consumer spending and create jobs which have become a drag on the economy. That being said, domestic politics aside, Indian economy is doing well, projected to grow in the range of 7.2 – 7.5 percent in 2018-19 and 2019-20 despite the slowdown in the rest of the global economy. India’s trade balance is less negative and consumer price index (CPI) inflation on a year-on-year basis is low at 2.19 percent in December 2018, far less than what the RBI has to worry about, closer to the lower end of the RBI inflation targeting range of 2-6 percent. Therefore, unless growth forecasts are seriously wrong or inflation rises to be of concern to policy makers at the RBI, the Indian financial markets – other than reacting to developments abroad – can be expected to depend on corporate fundamentals.

What to expect from the markets next week?

Continued range-bound and flat behavior can be expected in the coming week. It must be noted that corporate earnings reports will continue to determine whether the major Indian indices will recover from being close to correction territory last week.

Economic Roundup, December 21, 2018

Economic Environment

  • US monetary policy

  • Government infusion of funds into public sector banks (PSBs)

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

  • The US Federal Reserve, just as we expected, despite pressure from the markets not to raise the federal funds rate, has raised the rate to the range of 2.25 – 2.5% while slowing down the number of expected rate increases in 2019 to 2. This gives the Fed time to take stock of the US and global economies perhaps until June 2019 before deciding on interest rate policy again while being mindful of whether the interest rate is at neutral – the interest rate at which economic growth is neither supported nor restrained – with inflation hovering near the Fed’s target of 2 percent year-on-year rise in core (meaning excluding the volatile food and energy costs) personal consumption expenditures (PCE). The US financial markets which fell interpreted the Fed’s December 19, 2018 decision to raise the interest rate by 25 basis points while slowing rate increases in 2019 as being dovish, reinforcing their bearish sentiments about US and global growth. For India, as with other emerging markets, interest rate increases by the Fed coupled with apprehensions about slowdown in global growth pressure the financial markets because of dollar flight back to US and fear of domestic economic slowdown.

  • Indian government’s decision to infuse funds into PSBs to ease credit crunch in the system and the Reserve Bank of India’s (RBI’s) decision to ease liquidity in the financial sector will boost PSB and NBFC stocks.

    What to expect from the markets next week?

Indian financial markets will continue to takes cues from global markets on global growth though little else can be expected in terms of news before the end of the year to have any major impact on them. Continuing decline in the oil price because of oversupply concerns due to expectation of global economic downturn despite agreement to cut output by 1.2 million barrels per day between the Organization of the Petroluem Exporting Countries (OPEC) and Russia. For India, the falling oil price balances any downward pressure on the economy and rupee from US Fed rate increases and slowing global growth.

Economic Roundup, December 14, 2018

Economic Environment

  • New Reserve Bank of India (RBI) Governor

  • Elections in 5 states

  • US-China trade tensions and global growth

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

  • The government has quickly appointed Shaktikanta Das as Urjit Patel’s replacement after his sudden resignation. Signals of business continuity at the RBI from the new governor have prevented market anxiety. Given that annual inflation in November is well below RBI inflation target and October industrial production has surged, RBI policy is expected to be status quo on interest rates.

  • In the run up to the general election in 2019, 5 states have gone to the polls on December 07. The results announced on December 11, despite the loss in all 5 states of the ruling BJP, have not led to any unusual volatility in the markets which have, in fact, welcomed the winners’ promises to deal with youth unemployment and farmer sentiments as a sign of support for the economy.

  • The primary concern for the markets has been uncertainty about US-China trade which they have linked to the slowing global growth. The global markets, with India taking cues from their reaction to developments in the US-China trade situation, want a resolution to the trade tensions to alleviate their concern about any possible global economic slowdown. However, it is unlikely to be resolved within the next 90 days unless China meets US demands on bilateral trade. The global markets, as a result, will remain somewhat volatile through the end of the first quarter of 2019.

    What to expect from the markets next week?

Indian financial markets will continue to takes cues from global markets on global growth though they could breathe a sigh of relief because of expected slower pace of Fed rate increases due to probable slowing of US growth at around the Fed’s inflation target and the RBI status quo, despite a new governor, but with a watchful eye on Indian economic growth outlook also at around the RBI’s inflation target.

Economic Roundup, December 07, 2018

Economic Environment

  • Reserve Bank of India (RBI) monetary policy

  • US-China trade uncertainty

  • The Organization of the Petroleum Exporting Countries (OPEC) and Russia

  • Global growth

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

  • The RBI left interest rates unchanged given the slowdown of the Indian economy in the July-September quarter and lower than target inflation while maintaining its stance of ‘calibrated tightening’. This decision by the RBI was widely expected though the markets also expected a change in the RBI’s stance to ‘neutral’. The reaction of the Indian equity markets was bearish because of the RBI signal that it is not bullish on the economy. Some deterioration in the macro situation was also reported by the government with the Indian fiscal deficit exceeding the fiscal year target with the year still one quarter away from being completed. It must be noted here that the trade deficit is also increasing and is highly sensitive to the oil price. The twin fiscal and trade deficits do not bode well for the strength of the rupee. If inflation holds at or below target, we expect the RBI to return to ‘neutral’ stance with a bias of lowering interest rates next year depending on economic growth to boost the economy though we also expect the RBI not to act on lowering interest rates because of inflation concerns until Indian gross domestic product (GDP) growth rate falls to about 6.5% in 2019. Therefore, given the forecast of 7.2% for GDP growth rate in 2019, we expect, on balance, the RBI to maintain status quo on interest rates through the end of the fiscal year 2018-2019.

  • Indian equity market reaction to US-China trade uncertainty was mixed despite a sharp fall in US markets. It is still unclear how the US-China trade dispute would be resolved while noting that India, in fact, stands to benefit from both US and China should their trade dispute continue.

  • OPEC and Russia agreed on Friday to together cut oil production by 1.2 million barrels-per-day for the next 6 months to prop up the oil price. It is unclear to what extent they would succeed in doing so given rising US production which will only stand to benefit from propped up oil prices. This, however, is not good news for India because higher oil prices will only cause the trade deficit to rise and pressure the rupee.

  • Concerns about global growth have caused all the major advanced and emerging equity markets to fall. The International Monetary Fund (IMF) has clarified that it only expects global growth to slowdown without the risk of a recession.

    What to expect from the markets next week?

Indian financial markets will continue to takes cues from global markets on global growth though they could breathe a sigh of relief because of expected slower pace of Fed rate increases because of probable slowing of US growth at around the Fed’s inflation target and the RBI status quo but with concern about Indian economic growth outlook also at around the RBI’s inflation target.

Special Note – RBI Policy, October 05, 2018

Reserve Bank of India (RBI) monetary policy outlook

The RBI will release its Fourth Bi-Monthly Monetary Policy Statement for the year 2018-19 on October 5th. It is being widely expected that the RBI will increase the repo rate by 25 basis points given the falling rupee and the rising price of oil. The mandate of the RBI is inflation stabilization – as measured by the consumer price index – at its medium-term target of 4%. Annual inflation in August 2018 was 3.69%, below RBI’s target. 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. The looming US sanctions on Iran in November and the reluctance of Russia and the Organization of the Petroleum Exporting Countries (OPEC) to raise output could tighten global oil supplies putting further upward pressure on the oil price which is expected to be around USD 90/barrel. This has the potential to put brakes on India’s gross domestic product (GDP) growth rate due to higher energy costs, raise inflation if higher energy costs persist, and raise the current account deficit (CAD) because of at least status quo imports assuming, despite the cheaper rupee, exports will be unable to offset the higher cost of imports. Higher import prices will also pass through into inflation. Slower growth could reduce tax revenues thereby raising the budget deficit. Further, on the budget deficit front, budget numbers for 2018-19 were calculated on the basis of oil at USD 65/barrel and rupee at around 66 to the dollar. Those calculations no longer hold. Oil subsidies, budgeted at just under INR 25,000 crore for 2018-19, may end up 40% higher or more in actual expenditure. The rising dollar because of strong US economic growth is depreciating the rupee which is compounded by selling rupee to buy dollars to pay for imports. These factors and rising US interest rates are driving away foreign institutional investors (FIIs) who are, on net, taking dollars out of India, putting pressure on India’s foreign exchange reserves. At the present time, however, India’s macro situation, though experiencing negative pressures, continues to be stable. Higher interest rates in India is one way to attract FIIs but 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 the non-banking financial companies’ (NBFC) regulator it will also need to address what steps it may take, if any, about possible defaults by companies in that space. A contagion involving NBFCs could drag the equity markets and the economy down with it. The RBI, while intervening in the foreign exchage market as necessary by selling dollars and buying the rupee could, however, hold off on raising interest rates for this meeting but with an eye on the affect of oil price and the macro situation on inflation outlook for future meetings rather than using higher interest rates to put a floor under the falling rupee.

Monetary Policy of India and Economic Development

India, since liberalization in 1991, has depended on foreign institutional investment (FII) and foreign direct investment (FDI) to bulk up its foreign exchange reserves, even as it built its services exports sector that depends on outsourcing primarily from the United States and Europe. Unlike China, India paid little attention to the development of domestic infrastructure and manufacturing, remaining as a primarily agricultural economy. The challenges, as a result, India continues to face are hightened poverty, among the highest in the world, and inability to create jobs commensurately to the number of young people, about a million, entering the job market every month.

On the path toward becoming the most populous country in the world by 2050, India, being a democratic polity and a mixed economy founded on Fabian socialist principles, must position itself to reap the demographic dividend in the upcoming three decades. If leveraged well, India, with its large English-speaking population, can create the needed jobs by aiming to become a global center for services similar to but beyond Singapore and by transforming its infrastructure with smart cities, “Make in India” and “Digital India” programs. This would also have a dramatic effect on poverty reduction which has not happened as one would expect after 1991. The government programs are there but the question remains about how they can be funded at the scale that is needed for India’s economic transformation.

Monetary policy of China, says Li Yunqi, a Chinese research scholar associated with the People’s Bank of China (PBOC), has always been about economic development. Industrialization, in particular infrastructure related, has been the focus of PBOC, together with, of course, expanding the exports sector. Both infrastructure and exports, which contributed to significant and sustained increase in real investment have propelled China to be the second largest economy in the world when measured by nominal gross domestic product (GDP) and the largest in purchasing power parity (PPP) terms.

Blessed with fertile land and fresh water perennial rivers both in its north and south, India is an economy waiting to happen on the world stage powered by all three of the economic sectors: agriculture, industry and services. Road, rail, electricity and water are the primary infrastructure areas that are ripe for transformation. With urban areas growing, the government’s smart cities initiative should be able to accommodate the migration from rural to urban areas without over-burdening the existing cities by expanding or building new cities along major highway or railway corridors.

China printed money for investment in the expanding infrastructure and exports sectors of its economy, thus raising the potential growth rate which also thereby managed inflation despite occasional, short bouts with high inflation. This created millions of jobs and dramatically reduced poverty in the three decades since 1978 when China began its market socialist reforms. Though China, as Li Yunqi points out in his 1991 Asian Survey article “Changes in China’s Monetary Policy”, has to deal with the paradoxes of a burgeoning market economy and a socialist state that intervenes in it, and also with finding growth drivers as infrastructure and exports wane, its management of monetary policy holds important lessons for its neighbor to the south, India.

The Reserve Bank of India (RBI) should expand money supply for targeted funding of economic transformation initiatives. Money supply targeted to investment and growth initiatives only raises the potential growth rate but does not cause inflation. India is not yet an economy whose monetary policy can behave as if it is a developed economy.

Will The Expected Faster Fed Rate Increases Drive the U.S. Economy into a Recession?

US monetary policy appears to be transitioning from “very gradual” to “gradual” normalization. After raising the Federal Funds Rate (FFR) twice with a gap of one year between the two increases – one in December 2015 and another in December 2016 – the Fed appears to be comfortable to raise the FFR a bit faster by possibly again telegraphing about 3 increases in 2017 after doing the same in 2016. In 2016 the Fed did not follow up on its signal of 3 increases and it may not also in 2017. Annual growth in 2016 is at 1.6% which is about 1% less than annual growth in 2015 and annual growth forecasts based on the Quarter 1, 2017 numbers indicate that growth in 2017 could be similar to 2016.

Discussion about U.S. growth data, however, is missing from the current debate about whether the Fed will raise the FFR by 25 basis points to between 0.75 and 1 percent on March 15. The markets have priced-in the rate increase looking at the recent pronouncements by senior Fed officials, inflation, and labor market data, and the rate increase seems to be a certainty with the markets wholly concurring with the Fed that the rates should go up. In fact, if the Fed delivers a surprise on March 15 by not raising the FFR, financial markets could fall fearing that the Fed signaled a lack of confidence in the US economy.

Fed’s confidence in the economy and its view that the economic environment in the rest of the world is also improving – diminishing foreign risks to the US economy and also lower risks to global economic growth – should, the Fed appears to expect, keep US growth on a solid footing. Such a rhetorical expectation appears to be grounded in data because US growth in the most recent two quarters – Q4 2016 and Q1 2017 – points to an annual growth rate in both 2016 and 2017 that is close to the potential growth rate of between 1.4% and 1.7% according to estimates by the Congressional Budget Office (CBO) suggesting that there are no risks yet to inflation from growth unless it is above 1.7%.

An important point of discussion for the rate setting Federal Open Market Committee (FOMC) of the Federal Reserve would be the natural or neutral rate of money supply: is the FFR below, at or above the natural rate of interest? If the FFR is neutral, then inflation must be stable and growth must be at the trend rate. This may already be the case. Growth is at potential and inflation – by the Fed’s preferred measure of rise in core personal consumption expenditures (PCE) – should be hovering around 2%. With core PCE currently around 1.7% there is no impending risk to the Fed’s inflation target.

Considering that annual growth has fallen by 1% in 2016 when compared to 2015, and 2017 growth rate could be the same as that of 2016, the behavior of growth in 2016 and 2017 shows counter-intuitively that, given the economic structure, the FFR is perhaps already at the neutral rate and that any higher FFR will suppress growth. It may fall to fiscal policy to identify new growth drivers to push up both the potential growth rate and the natural rate of interest. The financial markets are thus, quite appropriately, reacting positively to promises by the new US administration of fiscal expansion.

A commitment by the Fed to accelerate the pace of interest rate increases should also take into consideration growth data and not merely inflation and labor market statistics if the Fed is to avert the risk of driving the economy into a recession with faster rate increases.