Exports grow but imports remain high

The effects of rupee hammering are being felt in the forex market. Corporates with outstanding ECBs are now seriously worried about the currency situation

Trade wars and the falling rupee continue to be top-of-the-mind concerns for investors. China and the US continue to trade verbal potshots while also trying to continue negotiations. The threat of escalation remains while the US continues to say that it could impose new tariffs on some $200 billion of Chinese exports.

Meanwhile, as Iran sanctions bite, the price of crude has risen to $80/ barrel for the benchmark Brent contract. Since the Central government and the states say that they will continue to impose the current excise rates, retail fuel prices continue to rise. Transporters and airline operators estimate that their running costs have risen by approximately 30 per cent from last year.

Higher inflation on the fuel front (one volatile component) has been balanced by lower inflation on food (another volatile and much larger component). The consumer price index rose  by 3.7 per cent year-on-year (YoY) in August, which was lower than the 4.2 per cent YoY in July. Indeed, it was a ten-month low. Similarly, the wholesale price index rose by 4.53 per cent YoY, lower than 5.09 in July. Again, food was the moderating component of the basket. Core inflation also eased slightly but this may be a base effect.  

The effects of rupee hammering are being felt in the forex market of course. The rupee has continued to slide, with occasional recoveries as and when, the RBI intervenes. Corporates with outstanding ECBs are now seriously worried about the currency situation.  

The government says it’s taking measures to try and cut “non-essential imports” and it’s also trying to attract more forex-denominated investment. The trade deficit for August remained a whopping $17 billion plus, though it was a bit lower than the $18 billion plus of July. Exports did grow but imports remained high.

The finance minister says he’s confident that the fiscal deficit will be held at 3.3 per cent of GDP in 2018-19, due to better tax collections and rising growth. However, the current account deficit will rise, to anywhere between 2.8-3 per cent of GDP unless crude prices moderate.

The consumption demand will be crucial to holding the Fisc because government expenditure can’t be stepped up without ruining that number. Consumption was decent in Q1 but a falling rupee inevitably means higher core inflation going forward because over 40 per cent of GDP is tied to trade. In current dollar terms, many Indians will feel their income has fallen and that could negatively impact consumption.

There could be a burst of election-related spending (and dollops of black money) buoying up the last quarter (January-March 2019) but the festive season starts in October and most households will do their big-ticket buying in the next two months. We’ll have to wait and see if consumption holds up.

The power sector NPA situation remains unclear. Apart from the legal tangle, one issue is that much of the money has gone into incomplete projects or unviable ones. Unlike steel, where bankrupt companies have productive assets, a power sector bankruptcy might have very little in the way of assets to auction off. Hence, the haircuts will be very deep, even if the legal situation resolves. 

The market is watching the Essar Steel buyout with interest. The bids have been quite substantial but Arcelor Mittal will have to be allowed to cut corners if it’s going to be allowed to take over with its Rs 420 billion bid, since it will then have to retrospectively clear outstanding dues. The Numetal JV has also made a substantial, though lower bid and Arcelor-Mittal has claimed that it’s a shell company and therefore, ineligible to bid.  

The IL&FS situation is also having an impact on sentiment. The parent is too big to fail but it’s hard to justify a bailout without major restructuring.  Defaults could of course, hit the debt market and the relevant funds hard. The problem has arisen due to the odd structure where a holding company is invested, project-side and finance-side, via multiple subsidiaries in many projects. Right now, there is little cash-flow and no prospects of portfolio divestment to anywhere near the extent necessary. It’s also hard to make sense of the balance sheet, given 160-odd subsidiaries.  

The RBI’s Monetary Policy Committee will make its policy review on August inflation data, along with other indicators. Given the lower print, the MPC could decide to hold rates. On the other hand, it might want to raise rates in order to give the rupee some protection. This is quite logical, given that the Central bank has already spent substantial sums on intervention and this could be a factor that tilts it in favour of hiking.  

It's hard to see banks and other lenders pulling out of the mess, without more losses if rates are hiked. The G-Sec 2028 continues to rule above 8.1 per cent despite the lower inflation numbers. It could rise further if the RBI hikes.

The stock market has juddered through the past week, as FPIs pulled out money. (Sebi didn’t help until it clarified its April 10 circular, which initially seemed to debar any portfolio investments by the diaspora.) Technically, the market is in correction mode after hitting a new high of 11,760.