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The expected interest rate increase by the US Federal Reserve will be a once-in-a-lifetime event and it’s difficult to comprehend how it will play out, says Hitendra Dave, head, global markets, HSBC India. He tells Samie Modak investors are giving a long rope to India, which remains a bright spot, thanks to its economy and political leadership. Edited excerpts:
What’s the outlook in terms of interest rate cuts by the Reserve Bank?
The number one data point which will determine where our rates go is inflation. The main thing for me is the how much it undershoots the glide path. We were supposed to be eight per cent in January but were 300 basis points (bps) lower. There is likely to be downward pressure on prices. The market consensus is currently 25-50 bps. The belief is inflation will not trend below five per cent. I think there isn’t a reason why it can’t be significantly lower. The underlying economic activity, growth plans and capital expenditure plans all are extremely weak, as is pricing power. The pace of deflation is catching a lot of people by surprise and it is not over yet.
Do you think the stock markets are overheated, as earnings are not growing?
Most of the corporate results don’t reflect the kind of buoyancy the stock market valuations reflect but you have to see the big picture. People are giving us a long rope. In that time, we have to fix our balance sheet issues. If the situation remains unchanged in the next 12-18 months, there definitely is a problem.
At this juncture, if you are an investor in London or New York, it is very difficult to find too many bright spots if you scan the world. India is clearly up there, with a strong economy and political leadership. It has a credible central bank, the fiscal and current account deficits are coming into shape, inflation is falling. Also, we are going to be the biggest beneficiary of the oil prices' slide.
Therefore, in a ‘top-down allocation’, we are getting the benefits of being a bright spot. The valuations are priced for reasonable growth, if not robust growth. Nobody is expecting robust growth in the next 12 months, at least. And, if we still can’t see robust growth a year down the line, there will be challenges. All you can hope is that in this interim period, companies in a stressed situation undergo de-leveraging.
Aren’t we seeing the de-leveraging already?
It is not playing out the way it should. I don’t think even $4 billion has taken place in the past four months, despite the stock market being robust. If stock markets are buoyant, foreign investors are attracted towards India and valuations are good, it should certainly accelerate. What is presently happening is very nominal.
What are the reasons behind significant FII (foreign institutional investor) participation in the debt market?
If you are a foreign investor, coming to the fixed income market of another country, the most important element for you is currency stability. Given the sharp improvement in our current account deficit (CAD), the rupee comes across as a currency with strong fundamentals, even in a year when the US Federal Reserve is to increase rates. This is attracting a lot of investors to our fixed income market.
The second reason is what stage you are in the rate cycle. There, too, India is favourable. Third, compared to some other emerging markets, the Indian bond market is very liquid and investors don’t have to worry about not getting an exit. Also, the funding costs for foreign investors are quite low, which gives them significant carry.
What are the key global risks at this juncture?
The biggest risk we have to contend with is the interest rate increase by the US Fed. With three months into the year, the market is bordering on complacency. This is the first time in our lifetime that the central bank of the most powerful economy in the world is going to lift rates from zero. We have never seen that sort of lift anywhere in the world. So, it’s difficult to say how it will play out.
When do you expect the Fed to raise rates?
The main thing will be not the date of lift but the rate increase trajectory. If one gets the sense that the rise is going to be more than the consensus, you will have an impact on the global financial markets, not only India. If in 18 months the policy rates going to rise to 1-1.5 per cent, I don’t think the world will be different. But if we are going back to the old normal, we will have a severe problem.
Do you see a lot of turmoil for the Indian markets when the Fed raises rates?
As a country, you can only ensure you are bullet-proofing yourself against this eventuality. The good part is some part of the bullet-proofing has already happened. If our CAD was four per cent, we were in for a disaster. As the CAD is manageable, the absolute demand for dollars is quite low. Second, we have shut out the very short-term money. It is better to over-prepare than to under-prepare. Oil prices will also come off with the increase in rates in the US. The financial market is the biggest holder of oil.
What is driving the FII interest in corporate bonds?
The government securities' (g-sec) limits are fully used up and my sense is the government will not open it. We have seen a significant number of investors who otherwise would have bought only g-secs and are looking at corporate bonds. These are good signs for deepening of the bond market. However, the government and the regulators should take steps to attract retail and wealthy investors to the bond market, rather than focusing a lot on foreign investors.
The Budget made a lot of concessions for FIIs. Will it further boost investments?
By merging the FII and foreign direct investment limits, the government has made life simpler. Now, you will clearly know the foreign stake permissible and it doesn’t matter which route you take. For an outsider, investing in India is very complex and this is part of the move to make investing friendly. The GAAR (general anti-avoidance rule, on taxes) deferral was expected but the good part is, it will only apply prospectively. Also, the move on permanent establishments is also positive. If you want some people in India to manage money regionally, the tax impediments for that have been removed.
