CONCLUSION: When it comes to spurring growth and protecting its currency, we are of the view that India “can’t have its cake and eat it too” at the current juncture. The benchmark SENSEX Index remains in a Bearish Formation – a clear quantitative signal to us that the recent spate of oft-conflicting policy maneuvers is likely to have a muted effect on turning around the Indian economy and the country’s poor investment climate over the intermediate term.
The phrase “[insert proper noun] wants to have its cake and eat it too” doesn’t really make sense to me. As a former offensive lineman, I generally enjoyed eating all the cake I could get my hands on. That being said, I believe the saying refers to an individual or entity’s desire to pursue an outcome that is conflict with another one of his/her/its wishes.
In the case of India, a country we have generally remained fundamentally bearish on across asset classes (stocks/rupee/rupee-denominated debt) for much of the past 19 months, the aforementioned phrase is quite appropriate. The Reserve Bank of India, in the midst of battling what we’d consider a full-fledged currency crisis (a peak-to-present decline > 20% over the LTM), is being forced to chose between fighting inflation – which is 270bps above their +4.5 YoY unofficial target (APR) and above it every month since OCT ’09 – or protecting growth, which has slowed to an 11-quarter low of +6.1% YoY in 4Q12 and looks to continue that trend when 1Q GDP is reported on Wednesday.
Rather than biting the bullet and hiking rates to protect the purchasing power of their citizenry, which is what many developing nations have been forced to do historically during periods of international stress (usually accompanied by USD strength), India has chosen the route of easing and tightening at the same time (more on this later). Their policy confusion has been rather unsupportive for the rupee, which has fallen to an all-time low vs. the USD as recently as MAY 23.
As we penned in our APR 17 note titled “IS INDIA OUT OF BULLETS?”, the country’s twin deficits, which have widened in recent years, are a real risk to the nation’s currency in times of heighted global volatility due to the typical slowdown in cross-border capital flows to developing nations like India. Coincidentally, inflows into India’s equity and bond markets peaked in the YTD right around the time we started getting loud about our expectations for a breakout in cross-asset volatility over the intermediate term (mid-MAR).
Per the aforementioned note: “No doubt, a further Deflating of the Inflation will eventually be supportive of the Indian economy; that said, however, we think India’s intermediate-term growth outlook, as well as the country’s financial markets are particularly at risk in an a higher-vol. environment over the intermediate term due to its widening current account and fiscal gap. India’s bloated fiscal deficit is of particular importance given that any slowing of capital inflows or outright capital outflows ultimately translates to a crowding-out of private sector funding.” With money supply (M3) growth at a ~7yr low, we’re seeing this phenomenon show up in the data in real-time.
Regarding the point we made about them easing and tightening at the same time, below is a list of the recent measures Indian policymakers have taken in order to combat either currency deprecation pressures (via fiscal and/or monetary tightening/capital controls) or economic growth headwinds (via fiscal and/or monetary easing/stimulus), which, if done at the same time, can seem a bit oxymoronic, or of the “having one’s cake and eating it too” variety:
- In MAR, the central government introduced an import duty on gold and platinum bars and coins, which facilitated a -33% YoY decline in gold and silver imports in APR;
- Raised interest rates on foreign currency deposits by as much as 300bps in addition to easing restrictions on foreign exchange loans for Indian exporters;
- Reduced the amount banks can hold in FX derivatives contracts to < $100M or 15% of the total such agreements (whichever is lower);
- Reduced the amount of overseas income Indian corporates can hold in foreign currency-denominated assets to 50% from 100%;
- Sold $5.4B of FX reserves (USD) to the market over the past 3-4 weeks, taking their total reserves down to $290B (-6% YoY); and
- Late last week, the central government allowed the State-run refiners to increase gasoline prices by +11% in a bid to combat fiscal deficit pressures stemming from the bloated subsidy bill (12.7% of total expenditures).
Interestingly, to point #5 above, providing USD liquidity to India’s FX market can be helpful for the exchange rate, but only because it tightens monetary conditions by curbing supply of Indian rupees in the domestic market. As such, their options here are limited given the Indian banking system’s persistent liquidity deficit (having borrowed nearly a trillion rupees from the central bank on average via reverse repo transactions a – form of monetary easing – over the last five days).
To point #6, we’ve crunched the numbers on the deficit below; the conclusion is short and simple: while the +11% increase can be taken by market participants as a signal that they are willing to cut further, it accomplishes very little in the direction of moving the needle on the fiscal deficit:
- In FY12, the subsidy bill on energy-related expenses was 59.1% of the total… holding that flat, we get to 1.123T rupees for FY12;
- Reducing that by -11% leaves us with 999.45B rupees for on energy-related subsidy expenses for FY13E;
- That takes our total planned subsidy expense 1.77T rupees or 11.9% of FY13E expenditures;
- The -123.5B rupees in savings is a mere 0.8% of the total planned expenditures and just 2.4% of the budgeted deficit;
- All in, the maneuver shaves a whopping -12bps off of India’s FY13E deficit/GDP ratio (assuming all other revenues and expenditures meet their targets).
All told, the math doesn’t lie. When it comes to spurring growth and protecting its currency, we are of the view that India “can’t have its cake and eat it too” at the current juncture. As the chart below highlights, the benchmark SENSEX Index remains in a Bearish Formation – a clear quantitative signal to us that the recent spate of oft-conflicting policy maneuvers is likely to have a muted effect on turning around the Indian economy and the country’s poor investment climate over the intermediate term.