 "Pressure on Asian currencies will continue: Sanjay Mathur")
The rupee’s slide against the US dollar has sent the markets into a tizzy. Sanjay Mathur, managing director, head of economics research for Asia Pacific (ex-Japan), Royal Bank of Scotland tells Puneet Wadhwa in an interview that in the emerging market pack, India needs to learn lessons from Korea and Taiwan that have managed their economic situation well. The case for buying into emerging markets equities, especially India is getting weaker by the day, he says. Edited excerpts:
The risk-off trade in the global equity markets is partly due to what is happening to currencies, especially Asia? Do you expect more pressure on Asian currencies over the next few months?
I think the pressure on Asian currencies will continue. The fundamental issue we have in the markets right now is that there is a shift in the way the US Federal Reserve (US Fed) is behaving. There is a change in its philosophy. There is a growing fear that at some stage the withdrawal of quantitative easing (QE) by the US Fed is on the cards. QE withdrawal per-se is not that negative.
On the domestic front, we have by and large exhausted fiscal and monetary policy measures by which we can expand. Real interest rates have been low, credit growth has expanded sharply. In terms of fiscal policy, we seem to have hit the edge in India and Malaysia. The QE withdrawal is happening at a time when there is a question mark over growth in Asian economies. The earnings momentum is decelerating and the cost of capital is rising, which has put us in a very tight spot.
So, where and when does all this stop?
Well, it will stop when because of the US economy there is an improvement in the Asian economies and exports as well. That will be a turning point for the Asian currencies. However, it is difficult to put a time-frame to this.
Is the world economy on the brink of being pushed into a full-blown crisis and ‘India story’ over for the foreign institutional investors?
I don’t think that the world economy is on the brink of a disaster. It is true that emerging markets (EMs) now account for a larger part of global output and global demand. However, we cannot arrive at this conclusion. I don’t think that the EMs will grow at a pace at which it used to earlier.
As regards India, it is more of a man-made story. The domestic policy agenda hasn’t been advanced. So, one can expect some chinks in the armour. The last 18 months have been strange given the widening current account deficit (CAD) and the lower industrial output amid rising inflation. I do think that going ahead the CAD will be milder but that will only bring the economy into balance. However, the next challenge then becomes how to get higher growth that will entice foreign investors.
Do you believe that the case for buying into emerging markets equities, especially India is getting weaker by the day?
Yes, it is getting weaker by the day. For a long time, there was a degree of disbelief that things could go wrong in India. There was a belief that even if the policies go wrong, Indian corporates are very versatile. This particular hypothesis that was never questioned is now being challenged. India Inc’s leverage levels have gone up amid sagging sales and weakening pricing power. So, we need a fundamental shift – both at a policy level and even at the corporate level now.
What levels can one expect on the rupee in the near-to-medium term?
Though the measures have so far proven futile, they haven’t been completely ineffective. We need to understand that this is a dynamic strategy. Until now I felt that there was also an effort that somehow there would be enough steps to ensure the stability of the currency and protect growth. Now, it is getting clearer and clearer that one cannot allow the currency to weaken and it will have no impact on growth.
There has been a shift in the thinking to stabilise the currency first and then look at growth. As a result, the policy response from the Reserve bank of India (RBI) and the government has been a three-pronged attack. The first was to deal with gold; the second was to increase the carry-adjusted return of investing in the rupee and the third is to improve the demand-supply balance for foreign exchange in India.
But the real question is how forceful are these measures? I don’t think that the RBI would have known in advance how much the rupee can slide. I think the RBI is learning by the day and will need to fortify the same measures.
Is there a solution to the problem and where does the fall stop?
It is a dynamic situation and it is very hard to predict where all this will end. Fundamentally and based on the current and expected CAD level, it does appear that the rupee is at a fair value now. It should mildly recoup some of its losses. I don’t think there will be an appreciating trend that will fall in place since we need better growth conditions for that. But certainly there is a care for being more positive on the rupee’s trajectory. In case a currency depreciates, the realised depreciation is more than what one always thinks it to be.
In your opinion, do you think that the policy makers have failed to deliver as regards economic reform policies since most of the measures adopted thus far have been ineffective? What all could have been done different?
I think the response could have been more forceful. We have reacted with a delay. Particularly, inflation management could have been done better. The gold issue, for example, I don’t think we are trying to cap jewellery demand. Gold jewellery is a natural cultural thing for us. What has changed over the last few years is that gold also took on an additional role of an investible asset class. This, in turn, added another $20 billion to our import bill. The real deposit rates, too, were negative. Had we taken care of that, we would not have had such a situation. Now we need a more forceful measure to overcome all this. I think over the last few days, there have been such measures.
We also need growth and confidence of India Inc. We cannot have a situation where Indian corporate are always actively scouting abroad for opportunities. The growth of the Indian MNC (multi-national company) is a landmark achievement. Had we carried out reforms – and this is not about FDI (foreign direct investment) but simple things like policies on land acquisition, mining and overall governance that need to change.
Can you highlight which markets / economies could do better going ahead and why?
I think that there are countries that are likely to do well in the EM pack. In north Asia, Korea and Taiwan are certainly good stories. The countries with minimum imbalances are the ones that are holding up reasonably well. It is also true that if the US recovers, Korea and Taiwan at an aggregate economic level will feel the benefits first. China, too, will gain but it is a large economy with a significant domestic demand component as well.
Are there any lessons to be learnt for India on how Korea and Taiwan have managed their overall economic situation?
Yes, I think there is something to be learnt. First is fiscal prudence. We all have to learn when to put in policy stimulus and when to withdraw it – not on the monetary side but on the fiscal side. Secondly, when the crisis got over, we should have retracted to stabilise the fiscal position. However, we did not do that.
On the contrary, we continued with excise duty cuts, expanded the scope of NREGA (National Rural Employment Guarantee Act) etc. We should have known what to do. Thirdly, in terms of improving overall productivity, not much effort has been made. One cannot have infrastructure related issues lingering on as a bottleneck.
Do you think India’s sovereign rating downgrade can be a reality and why?
I think that the downgrade can be a reality not because of the currency but the falling growth rate. Currency fluctuations come and go and I don’t think it will impact sovereign rating. The CAD, in my opinion, will improve.
On the fiscal side, I am a little more hopeful. I think the government recognises the situation we are in. The government did a good job in January – March in terms of complete crackdown on expenditure. I think they will be forced into that if they want to maintain fiscal stability.
Where the situation has become dire over the past few weeks is where people are talking of India going to the International Monetary Fund (IMF). This, I feel, is too far-fetched an idea right now. Just because that the currency has taken a beating, it does not mean that one becomes an IMF candidate.
What are the implications of a downgrade?
Well, there will be a second round impact on the currency. That said, our assets are already trading as if a downgrade has happened. So I don’t think that the impact will be incrementally much worse.
FOMC’s minutes have not given us any guidance as regards the tapering off plan. What is your expectation from the US central bank?
I think that they (US Fed) will wait for a signal that the labour market has strengthened further. They might want to assess what the impact of rising mortgage rates would be on housing demand. Of course, the housing numbers that came out recently were very strong. So while there is a commitment to end the bond buying programme or to gradually start tapering, it should start by the end of this year or next year. I don’t think it will be a radical shift.
How bumpy has the road to recovery become for India Inc now? By when do you think a recovery will start to get meaningfully reflected in the financial performance and the stock prices?
I think the road has extremely bumpy now. It requires a very strong and concerted effort and response in terms of policy. And it is not the monetary policy but the real reforms. Given all that and assuming that everything falls into place, the earliest you are looking at is H2FY15 when it will get reflected in the performance of companies. Profitability parameters of companies have deteriorated. So now, we have the corporate sector coupled with policy underpinnings that have made the overall situation more demanding.
Are there any pockets of strength or opportunity for investors in the equity markets as things stand or will investors be able to buy stocks cheaper in the next three months?
Avoid resources, banks, building materials and the auto pack. Look at safe bets like pharmaceuticals, information technology (IT) where some benefit has already accrued.
The risk-off trade in the global equity markets is partly due to what is happening to currencies, especially Asia? Do you expect more pressure on Asian currencies over the next few months?
I think the pressure on Asian currencies will continue. The fundamental issue we have in the markets right now is that there is a shift in the way the US Federal Reserve (US Fed) is behaving. There is a change in its philosophy. There is a growing fear that at some stage the withdrawal of quantitative easing (QE) by the US Fed is on the cards. QE withdrawal per-se is not that negative.
Also Read
A rise in rates in the United States (US) is not new for us as we have seen that in the past. But what used to happen then was that the risk assets in Asia were positively co-related with rising US rates; and the reason what that higher US rates meant was that the US economy was strong and it would give other economies tailwinds in terms of exports from Asia. Unfortunately at this point in time, the US economy hasn’t quite reached the velocity yet by which these tailwinds could come through.
On the domestic front, we have by and large exhausted fiscal and monetary policy measures by which we can expand. Real interest rates have been low, credit growth has expanded sharply. In terms of fiscal policy, we seem to have hit the edge in India and Malaysia. The QE withdrawal is happening at a time when there is a question mark over growth in Asian economies. The earnings momentum is decelerating and the cost of capital is rising, which has put us in a very tight spot.
So, where and when does all this stop?
Well, it will stop when because of the US economy there is an improvement in the Asian economies and exports as well. That will be a turning point for the Asian currencies. However, it is difficult to put a time-frame to this.
Is the world economy on the brink of being pushed into a full-blown crisis and ‘India story’ over for the foreign institutional investors?
I don’t think that the world economy is on the brink of a disaster. It is true that emerging markets (EMs) now account for a larger part of global output and global demand. However, we cannot arrive at this conclusion. I don’t think that the EMs will grow at a pace at which it used to earlier.
As regards India, it is more of a man-made story. The domestic policy agenda hasn’t been advanced. So, one can expect some chinks in the armour. The last 18 months have been strange given the widening current account deficit (CAD) and the lower industrial output amid rising inflation. I do think that going ahead the CAD will be milder but that will only bring the economy into balance. However, the next challenge then becomes how to get higher growth that will entice foreign investors.
Do you believe that the case for buying into emerging markets equities, especially India is getting weaker by the day?
Yes, it is getting weaker by the day. For a long time, there was a degree of disbelief that things could go wrong in India. There was a belief that even if the policies go wrong, Indian corporates are very versatile. This particular hypothesis that was never questioned is now being challenged. India Inc’s leverage levels have gone up amid sagging sales and weakening pricing power. So, we need a fundamental shift – both at a policy level and even at the corporate level now.
What levels can one expect on the rupee in the near-to-medium term?
Though the measures have so far proven futile, they haven’t been completely ineffective. We need to understand that this is a dynamic strategy. Until now I felt that there was also an effort that somehow there would be enough steps to ensure the stability of the currency and protect growth. Now, it is getting clearer and clearer that one cannot allow the currency to weaken and it will have no impact on growth.
There has been a shift in the thinking to stabilise the currency first and then look at growth. As a result, the policy response from the Reserve bank of India (RBI) and the government has been a three-pronged attack. The first was to deal with gold; the second was to increase the carry-adjusted return of investing in the rupee and the third is to improve the demand-supply balance for foreign exchange in India.
But the real question is how forceful are these measures? I don’t think that the RBI would have known in advance how much the rupee can slide. I think the RBI is learning by the day and will need to fortify the same measures.
Is there a solution to the problem and where does the fall stop?
It is a dynamic situation and it is very hard to predict where all this will end. Fundamentally and based on the current and expected CAD level, it does appear that the rupee is at a fair value now. It should mildly recoup some of its losses. I don’t think there will be an appreciating trend that will fall in place since we need better growth conditions for that. But certainly there is a care for being more positive on the rupee’s trajectory. In case a currency depreciates, the realised depreciation is more than what one always thinks it to be.
In your opinion, do you think that the policy makers have failed to deliver as regards economic reform policies since most of the measures adopted thus far have been ineffective? What all could have been done different?
I think the response could have been more forceful. We have reacted with a delay. Particularly, inflation management could have been done better. The gold issue, for example, I don’t think we are trying to cap jewellery demand. Gold jewellery is a natural cultural thing for us. What has changed over the last few years is that gold also took on an additional role of an investible asset class. This, in turn, added another $20 billion to our import bill. The real deposit rates, too, were negative. Had we taken care of that, we would not have had such a situation. Now we need a more forceful measure to overcome all this. I think over the last few days, there have been such measures.
We also need growth and confidence of India Inc. We cannot have a situation where Indian corporate are always actively scouting abroad for opportunities. The growth of the Indian MNC (multi-national company) is a landmark achievement. Had we carried out reforms – and this is not about FDI (foreign direct investment) but simple things like policies on land acquisition, mining and overall governance that need to change.
Can you highlight which markets / economies could do better going ahead and why?
I think that there are countries that are likely to do well in the EM pack. In north Asia, Korea and Taiwan are certainly good stories. The countries with minimum imbalances are the ones that are holding up reasonably well. It is also true that if the US recovers, Korea and Taiwan at an aggregate economic level will feel the benefits first. China, too, will gain but it is a large economy with a significant domestic demand component as well.
Are there any lessons to be learnt for India on how Korea and Taiwan have managed their overall economic situation?
Yes, I think there is something to be learnt. First is fiscal prudence. We all have to learn when to put in policy stimulus and when to withdraw it – not on the monetary side but on the fiscal side. Secondly, when the crisis got over, we should have retracted to stabilise the fiscal position. However, we did not do that.
On the contrary, we continued with excise duty cuts, expanded the scope of NREGA (National Rural Employment Guarantee Act) etc. We should have known what to do. Thirdly, in terms of improving overall productivity, not much effort has been made. One cannot have infrastructure related issues lingering on as a bottleneck.
Do you think India’s sovereign rating downgrade can be a reality and why?
I think that the downgrade can be a reality not because of the currency but the falling growth rate. Currency fluctuations come and go and I don’t think it will impact sovereign rating. The CAD, in my opinion, will improve.
On the fiscal side, I am a little more hopeful. I think the government recognises the situation we are in. The government did a good job in January – March in terms of complete crackdown on expenditure. I think they will be forced into that if they want to maintain fiscal stability.
Where the situation has become dire over the past few weeks is where people are talking of India going to the International Monetary Fund (IMF). This, I feel, is too far-fetched an idea right now. Just because that the currency has taken a beating, it does not mean that one becomes an IMF candidate.
What are the implications of a downgrade?
Well, there will be a second round impact on the currency. That said, our assets are already trading as if a downgrade has happened. So I don’t think that the impact will be incrementally much worse.
FOMC’s minutes have not given us any guidance as regards the tapering off plan. What is your expectation from the US central bank?
I think that they (US Fed) will wait for a signal that the labour market has strengthened further. They might want to assess what the impact of rising mortgage rates would be on housing demand. Of course, the housing numbers that came out recently were very strong. So while there is a commitment to end the bond buying programme or to gradually start tapering, it should start by the end of this year or next year. I don’t think it will be a radical shift.
How bumpy has the road to recovery become for India Inc now? By when do you think a recovery will start to get meaningfully reflected in the financial performance and the stock prices?
I think the road has extremely bumpy now. It requires a very strong and concerted effort and response in terms of policy. And it is not the monetary policy but the real reforms. Given all that and assuming that everything falls into place, the earliest you are looking at is H2FY15 when it will get reflected in the performance of companies. Profitability parameters of companies have deteriorated. So now, we have the corporate sector coupled with policy underpinnings that have made the overall situation more demanding.
Are there any pockets of strength or opportunity for investors in the equity markets as things stand or will investors be able to buy stocks cheaper in the next three months?
Avoid resources, banks, building materials and the auto pack. Look at safe bets like pharmaceuticals, information technology (IT) where some benefit has already accrued.