We're less optimistic on India's medium-term prospects: Lambregts, Erken

JAN LAMBREGTS, managing director and global head of financial markets research at Rabobank International, and HUGO ERKEN, the firm’s senior economist and country analyst for North America, Mexico and India, share their views with Puneet Wadhwa on the outlook for the global economy and the markets amid developments in India ahead of the general election. Edited excerpts:

How do you see equities as an asset class playing out in 2019? What about the debt/bond market?

Lambregts: We continue to live in a world full of central bank activism. Meaningful quantitative tightening has been halted in the wake of equity weakness towards the end of last year. With central banks shifting to a “patient” stance, the equity markets are better supported as the prospect of a US recession in the second half of 2020 starts to loom. When it comes to the debt markets, we continue to think that rates are going to be lower, for longer.

Are you concerned about the continuity in reforms in case of a hung Parliament in India?

Erken: In our base case, we expect the Bharatiya Janata Party (BJP) to win the general election in May, but it will be very difficult for it to seize a powerful majority in the Lok Sabha. If the BJP is able to secure around 230 seats (our base case), Modi will have to contend with coalition politics much more than he had to in the last five years. This means that the BJP will have to focus on side projects of his alliance partners, which will definitely slow down the BJP’s reform agenda. 

There is also a chance that the BJP will win less than 200 seats. In that case, the BJP will need to either secure backing of non-NDA partners or will opt to sit in the Opposition. In case the BJP decides to team up with non-NDA partners, we do not rule out a possibility that these parties could ask PM Modi to step down in exchange for their support.

In any of these scenarios, we do not expect breakthroughs in the next couple of years in the field of land and labour reforms or attempts to reform the food and agriculture sector. This also explains why we are less optimistic about India’s medium-term growth trajectory compared to, for instance, the International Monetary Fund (IMF). However, we don’t expect any reforms to be rolled back either.

Will equities see a major sell-off?

Erken: Although we do not expect major implications for the real economy based on the election outcome, we do expect volatility in financial markets in case Modi loses the election. This will be comparable to the shock sell-off of Indian assets by international investors that we saw during the Indian rupee crisis last year. Our model calculations show that under such a scenario, the rupee could spike to 74 on the back of increased perceived political risk.

How reliable do you find the macro-economic data?

Erken: The weak economic growth print of 6.6 per cent for fiscal Q3 did not come as a surprise, as we expected growth to be even weaker (6.3 per cent) based on high-frequency data. Moreover, waning growth fits a broader pattern of slowing global economic activity. Nevertheless, we expect economic growth to rebound to approximately 7 per cent in the next two quarters. All in all, we expect economic growth to arrive at 7.1 per cent for this fiscal year and 7.2 per cent for 2019/20.

Further down the road, we expect Indian growth to level off to 6.5 per cent, based on an expected US recession in 2020, which will also weigh on India’s external sector. Moreover, without new reforms, it will be very difficult for the Indian economy to reach growth figures exceeding 8 per cent.

Do you expect an upward revision in the fiscal deficit numbers?

­­Erken: We expect the deficit to arrive at 3.6 per cent of GDP in FY20 on the back of continued GST implementation issues. Moreover, there appear to be some questionable accounting methods being used in the interim Budget, as some government spending is taken off-balance sheet through public sector entities and the government did not take into account overdue non-payments of Food Corporation of India (FCI) bills in the deficit calculations.

Nevertheless, debt sustainability risks are contained due to the long average maturity profile (average of about 10 years), negligible foreign currency denominated debt and low exposure to non-resident investors. Therefore, as long as the fiscal breach is limited to a couple of tenths of percentage points, the market response will not be substantial.

How do you interpret the recent minutes released by the US Fed and the developments surrounding the US – China trade war? Are the global financial markets factoring in the worst?

Lambregts: FOMC members still keep the door open slightly for additional rate hikes, but frankly are making every effort to signal they are patient and in no rush to recommence the tightening cycle. We see rising odds of a US recession in the second half of 2020 (2H2020), and think this patience and pause is likely to translate in no rate hikes in 2019 and actual rate cuts in 2020.

As regards the US – China trade war, the devil is in the detail here and a stable, lasting deal is much to ask for. Ultimately, the trade war is not about a few extra goods being traded, but rather part of a New Cold War between the US and China that will be with us for many years and where the hegemony over the 21st century is at stake. So even if a deal is struck, it’s likely to temporary and tensions will return. Global financial markets would see it as a clear positive if a deal is struck, because they prefer pain tomorrow over pain today. But this theme is unlikely to go away in the long run.

What’s your outlook for fund flows into the developed markets versus the emerging markets in 2019?

Lambregts: Emerging markets were under a lot of pressure last year, as the US Federal Reserve (US Fed) steadily hiked rates. The US Fed’s pause in 2019 is not going to help them much though, as it’s mainly triggered by a growth slowdown and worries about a US recession down the road; hardly the type of environment in which risk appetite will increase for EMs.