INDIA’S “TURNAROUND STORY” CONTINUES

Takeaway: With its recent rate hike, India continues down the path towards much-needed monetary and fiscal policy reform. That’s a good thing.

This note was originally published October 29, 2013 at 15:26 in Macro

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SUMMARY BULLETS:

  • A continued pursuit of demonstrably tighter monetary policy in India would be positive for the country’s structural GIP outlook in three ways:
    1. Inflation decelerating to levels consistent with its regional/global peers (benchmark WPI has averaged +7.6% since the Congress Party took the helm in mid-2009 vs. a GDP-weighted average of +5.1% YoY for “BRIC” economies since then);
    2. Fiscal policy stability amid lower inflation (i.e. the #1 political issue in India) and a reduction in the fiscal deficit/GDP ratio (5.8% in 2Q13) via lower subsidy expenditures (13.7% of total expenditures); and
    3. Lower domestic demand and higher real interest rates contributing to an improved domestic savings/investment ratio would tighten up the bloated current account deficit (the latest current account deficit/GDP ratio came in at 5.3% for 2Q13).
  • Additionally, India is also developing some noteworthy tailwinds with respect to its intermediate-to-long-term fiscal policy outlook that are likely to make the country’s equity and debt capital markets look increasingly attractive on the long side at the current juncture (CLICK HERE for more details).

In conjunction with its newfound hawkish bias, the RBI hiked its benchmark policy rates today by +25bps, taking the repo rate and reverse repo rate up to 7.75% and 6.75%, respectively. The bank, led by its new governor Raghuram Rajan, also lowered its marginal standing facility rate -25bps to 8.75% (a continued unwind of former governor Subbarao’s INR crisis measures) and held its cash reserve ratio flat at 4%.

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Today’s hike was predicted by 32 of 42 analysts surveyed by Bloomberg, a marked shift from Rajan’s first hike roughly 1M ago when we were the only firm on the Street calling for this demonstrable shift to tighter monetary policy in India. Indeed, the Indian rupee has appreciated +2.2% vs. the USD since we began to call for the currency to strengthen amid this drive to combat inflation back on SEP 20. That is the largest gain across the 21 currency markets we actively cover across Asia and Latin America over that time frame.

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At the time, we thought investors would penalize India’s equity and debt capital markets for what appeared to be the start of a prolonged series of rate hikes, but with the SENSEX Index up +3.3%, 10Y INR Yields flat and 2Y INR Yields down -44bps since then, it appears investors feel very comfortable looking through this obvious near-term headwind to economic growth with an eye towards an improving structural outlook – a scenario we discussed then, but ultimately failed to sign off on at the time.

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Going back to the aforementioned rate hike, accompanying commentary from the Dr. Rajan-led RBI board was undeniably hawkish:

  • “We can’t live with close to double-digit CPI for an extended period of time.”
  • “It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth.”
  • “Wholesale-price inflation is expected to remain higher than current levels through most of the remaining part of the year, with consumer inflation probably remaining around or above 9 percent.”

Indeed, a continued pursuit of demonstrably tighter monetary policy in India would be positive for the country’s structural GIP outlook in three ways:

  1. Inflation decelerating to levels consistent with its regional/global peers (CPI has averaged +9.9% YoY since over the past 3Y vs. a GDP-weighted average of +5.3% YoY for “BRIC” economies over that same duration);
  2. Fiscal policy stability amid lower inflation (i.e. the #1 political issue in India) and a reduction in the fiscal deficit/GDP ratio (5.8% in 2Q13) via lower subsidy expenditures (13.7% of total expenditures); and
  3. Lower domestic demand and higher real interest rates contributing to an improved domestic savings/investment ratio would tighten up the bloated current account deficit (the latest current account deficit/GDP ratio came in at 5.3% for 2Q13).

It’s worth noting that the +90bps premium to the benchmark repo rate is a signal that participants in India’s on-shore swaps market are pricing in the equivalent of 3-4 more +25bps rate hikes over the NTM.

 

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Indeed, this is the three-pronged “turnaround story” we think investors have begun to speculate on recently and, with Global Macro entropy at levels not seen since early 2Q, we continue to think it pays to play the long and short side of EM assets on idiosyncratic country fundamentals in the absence of a clear, co-directional trend in the USD and US interest rates.

On that front, India is also developing some noteworthy tailwinds with respect to its intermediate-to-long-term fiscal policy outlook that are likely to make the country’s equity and debt capital markets look increasingly attractive on the long side at the current juncture (CLICK HERE for more details).

Of course, a confirmed quantitative breakdown in the DXY through its long-term TAIL line of support in conjunction with a breakdown in the UST 10Y Yield through its intermediate-term TREND line of support would make us broadly bullish on emerging market assets, amongst other asset classes (CLICK HERE for more details).

 

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Our central planning overlords at the Fed convene today and tomorrow to determine which asset classes we are allowed to speculate in; we await their commands with baited breath. If the most recent fundamental and quantitative signals (CLICK HERE for more details) are correct, investors will continue getting paid to speculate in emerging market assets with respect to the intermediate-term TREND. In the context of India’s real GDP growth basing here in the fourth quarter, that bodes well for INR denominated assets.

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Lastly, the SENSEX Index is within a half-a-percent from its all-time high; we would interpret a close above that price as a quantitative signal that India’s well-documented policy blunders (email us for “the list”) are likely/finally in the rear-view mirror. That would be HUGE for helping India finally tap into its vast growth potential. It’s worth noting that real GDP growth has decelerated to a decade-low of +5% in the most recent fiscal year and even further to +4.4% YoY in 2Q13 (-1.1x standard deviations below the trailing 3Y mean); additionally, today the RBI reduced its FY14 GDP forecast to +5%, which is -50bps below the previous estimate of +5.5%.

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Please feel free to ping us with any follow-up questions.

Darius Dale

Associate: Macro Team