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Developments across Greece and China have captured the world's attention over the past fortnight. Nizam Idris, managing director, head of strategy - fixed income and currencies, Macquarie Bank, tells Puneet Wadhwa that risk appetite will likely take a hit should the uncertainties in Greece culminate in 'Grexit' and will also have a bearing on India. The risk to the bonds market revolves somewhat around a US Fed rate hike - earlier and more rapid increases than expected could trigger a broader sell-off, he says. Edited excerpts:
There were reports that the rupee could come under pressure in case the situation in Greece worsens. What is the worst we can see on the rupee over the next 12 months?
Greece is a binary event. Most of the impact from Greece on Asia, is likely to be transmitted via global market sentiment, rather than major economic and trade linkages. Risk appetite will likely take a hit, should the uncertainties in Greece culminate in 'Grexit'. Without a rewriting of treaties to strengthen fiscal and banking union, this could mark the beginning of the end of the euro zone as we know it. India will not be spared in such a risk event. In that case, the dollar - rupee exchange could rise to 65.
Could the dollar strengthen further going forward?
For the rest of the year, I think the dollar will be driven more by what the US Federal Reserve does and by US domestic fundamentals. More pointedly, how much can the economy reaccelerate after a poor Q1 is likely the main concern for the dollar.
We have a base case for the US Fed to hike rates in September, and then again in December. We think the economy could, however, be strong enough for a gradual hike and we are not ruling out a case for a 12.5 bps (basis point) hike, particularly in the first move. Subsequent hikes might be in clips of 25 bps. But such a move could send a message that the path towards normalisation of interest rates is a long and gradual one.
The dollar could strengthen at the first hike but subsequently weaken, as the pace of normalisation is clearly going to be slow. We expect one more leg up for the dollar to take the DXY dollar index to 100, after which we could see it consolidating around that level for some time.
What is your outlook for bond yields in India?
The global bonds market has not been under any significant sell-off since the taper tantrums in 2013. The recent sell-off was largely contained in low- yielding bonds of the developed world such as the German Bunds, which was, at one point, trading in negative interest rate territory through to the eight-year bonds. emerging market bonds, including India's, were largely stable.
The risk to the bonds market revolves somewhat around the US Fed rate hike - an earlier and more rapid hikes than expected could trigger a broader sell-off. This, though is not our base case. We think the Fed rate hike could be a more significant event for the dollar and equity markets than the bonds market for now.
Having said that, we think India's 10-year bond yields have fallen to levels around 7.5 per cent, where it could begin to look like it is priced for perfection. Domestic risks from events, such as a poor monsoon - the El Niño phenomenon still cannot be completely ruled out - or another policy debacle discouraging foreign investors could yet see modest pull-back in India's bonds.
Could these global developments trigger a risk aversion across global markets? How insulated is India, given its macros and the road ahead for reforms?
Any global development that hurt global growth in a meaningful way will have a negative impact on sentiment, if not deeper in terms of growth. The ongoing 'Grexit' risk and China's equity market crisis are probably contained. Their impact seems more likely to be transmitted via a knock-on risk appetite rather than growth.
How does India look as an investment destination among emerging markets?
I am still holding on to a cautious "buy" recommendation on the rupee. The market has been disappointed by the slow progress in delivering the promised reforms. The Minimum Alternative Tax (MAT) debacle did not help matters. Our base case is for these teething issues to be ironed out, leading to a more pro-investment/pro-growth environment in the months ahead. Sorting out the Goods and Services Tax issue is a big step forward. I am cautious because I am not sure if investors can countenance another policy debacle from the Narendra Modi-led government.
