A fruitful winter session of Parliament with passage of the GST Bill can provide impetus to domestic equity markets and the Indian rupee. However, a failure to push through key bills can add a layer of risk to the rupee, causing it to depreciate beyond RBI’s comfort zone of 67.20/50 levels on spot. Historically, the month of December has been a positive month for the global equities. A possible trigger for that seasonality to play out, we could need a larger stimulus from the European Central Bank.
We are going to move from a week where no events of significance were scheduled and nothing much happened, to a week, where some firecracker events are scheduled. We will kick-off the week with an IMF decision on whether they want the Chinese Yuan to be a part of SDR or not and then move on to a barrage of monetary policy decisions from some leading central bankers around the world, along with speeches scheduled from leading US, European and Japanese central bankers. Last but not the least, US NFP and macro data from leading world economies will provide additional fuel to speculative moves in the financial assets. We can expect some wild swings in all the major currencies, including the Indian rupee as well the bond yields.
Over the past week, we saw China allow its currency, to devalue steadily in the offshore market towards 6.46 levels against the US dollar. Along with that the late week carnage in Chinese equities spilled over as weakness into the broader EM currencies. News flow from the Chinese economy has continued to worsen as there are reports of Chinese companies seeking government bailout and stress in the massive leveraged Chinese corporate sector rising. Too much debt and too little growth may finally be catching up to China’s companies and banks. Banks, though continue to report official bad debt levels to be sub-2% could be feared to have actual stressed assets well north of double digits. Add to that the multi-trillion dollar shadow banking sector, the financial squeeze around the whole of Chinese economy is becoming tighter and tighter. Yes, the Chinese government, in order counter the economic pain has unleashed fiscal pump priming, with fiscal spending in China surging by 36 percent from a year ago. However, one, we do not see much possibility for China to re-doing a post 2009 styled fiscal stimulus and two, the benefit of incremental stimulus is fading and costs are rising. Hence, we can see Chinese economy, along with it a chunk of the China-linked economies remaining a drag for the global economy for next year as well.
The spillover effect of commodity carnage is not just restricted to developing and least developing economies, but also to industries of the developed world. In US, stress is rising in US high yield debt segment. We are already seeing the adverse impact of a hard asset deflation on the lending book of the European and Asian banks. It is estimated that over the next 6-9 months, unless commodity prics recover significantly from current levels, there can be a risk of a sharp increase in bankruptcies in the corporate debt space. According to IMF, “The corporate debt of nonfinancial firms across major emerging market economies increased from about USD 4 trillion in 2004 to well over USD 18 trillion in 2014. The average emerging market corporate debt-to-GDP ratio has also grown by 26 percentage points in the same period”
We would urge readers to keep an eye on oil prices and copper prices, two major barometer of industrial commodity complex and also an indicator of EM health. As long as they remain depressed you do not need an economist to tell you the state of the world economy and the danger it poses to the lofty levels of valuations in world financial markets. When quantity of money and price of money is distorted in a manner that central banks have done over the past eight years, it is not a surprise that investment managers fall over each other, to defend the indefensible through more and more complex, convoluted and insane logics. In others, when there is enough money to throw around, you will find enough people to help your achieve that objective of yours.
In midst of all this, India does remain in a relatively better position. But please do not forget, that it is relative and not absolute. In my previous articles I have touched upon the reasons why I believe Indian economy is seeing some structural engineering which can become a game changer once the world economy moves out of the tunnel of recession. However, having said that, I would warn that we should not become complacent over the medium term. India is not immune from the global recessionary environment and the associated hard asset bust. Indian real estate as well as the commodity sector played an immense role in augmenting wealth and income in the country. With two of those major engines missing, we are not at all surprised that Indian economy has continued to struggle. At the same time, government’s clampdown on the cash economy is too taking a toll on businesses and economy. It is necessary pain for long term good. We are fortunate that all these adjustment forces are occurring with a strong government in place, as the last thing that India needs now is political instability.
Historically, the month of December has been a positive month for the global equities. A possible trigger for that seasonality to play out, we could need a larger stimulus from the European Central Bank. They have promised to move in the next policy. However, we see more chances of an extension of QE and may be a cut in deposit rates to deeper into negative zone and lesser chances of change in the mix and size of QE. In India, RBI is not expected to follow in the path of ECB and reduce rates. We can see RBI focus much more on capital market and banking reforms than anything on policy rates. However, they may reduce SLR holding requirements. Apart from central banks, what can be most impactful for the India Rupee and its financial assets would be progress in the winter session of Parliament. Post, Bihar elections, a new narrative has returned that Indian could once again face policy logjam. A fruitful winter session with passage of the GST legislation can undermine that narrative and provide impetus to domestic equity markets and the Indian Rupee. However, a failure to push through key legislations can add a layer of risk to the Rupee, causing it to depreciate beyond RBI’s comfort zone of 67.20/50 levels on spot. We have been bullish on the US Dollar since sub-65 levels a month back. We have recommended hedging import payables as risk of a move towards 66.50/67.00 remained. USDINR has touched a high of 66.88 last Friday. Moves beyond 67.50 zone may be less likely now, as RBI would become aggressive sellers above 67.00, but if the domestic policies stall, and then a risk of a move towards 68.00/69.00 may increase.
Anindya Banerjee is an analyst at Kotak Securities
