JP Morgan is expecting that there will be a rate hike by the Reserve Bank of India in October and followed by another hike in December, said Sajjid Chinoy, India chief economist of the firm.
"The inflation targeting framework is quite clear and has worked very well that the central bank should focus on it to the extent that rupee depreciation creates more inflation," Chinoy said.
On the current economic situation, Chinoy said emerging markets are caught between the US exceptionalism and China growth slowdown.
Watch: Structurally, India remains one of the best-emerging markets: Bharat Iyer of JP Morgan
Chinnoy was speaking to CNBC-TV18 ahead of the two-day JPMorgan India conference, which begins from September 19. Kalpana Morparia, CEO of South and South East Asia, Bharat Iyer, head of equity research also discussed the market fundamentals and emerging macros.
Edited Excerpts: The market has responded to that package of measures with further fall in the currency; not touching Wednesday lows but still 72.50. What is your sense, do you think we just go with the emerging markets (EM) irrespective of what the government does, all EM currencies are lower? Chinoy: That is the point here, over the last 48 hours all emerging market currencies are lower. Asian currencies, many of them are current account surplus economies are also weaker today. India is simply mirroring that effect.
I would like to make two points which we have discussed before. One is that some amount of rupee depreciation was inevitable in this global environment. I would argue it is healthy, it will help correct these growing imbalances externally. So we should not panic and I am glad to see the government and the Reserve Bank of India (RBI) are not panicking.
Now there is a balance here between allowing a calibrated depreciation and not letting entrenched expectations grip the market such that you get self-fulfilling expectations. I think maybe over the last 10 days we have occasionally seen signs of that, exporters are not hedging, importers are frontloading. So there are things that policymakers can do to reverse those expectations.
My sense is that what you saw over the weekend was just a start. There was a clear commitment to staying on the fiscal course, there was a belief that we have got a big battery of measures we can introduce so let us not bring out the bazooka right now because it is too premature and not necessary.
So I think we should just take a deep breath. If India moves with other emerging markets, I think it is par for the course because we do not want our trade-weighted exchange rate to appreciate any further. We have come off a 20 percent appreciation and we have seen a 6 percent depreciation this year.
At some point, India would become attractive. I remember that in 2013, one fine day, I think it was April 28 or April 29, the rupee just stopped falling. The stocks have fallen considerably, at this moment it is not considerable, it is just 5 percent from highs, but Reliance and TCS are cheaper by about 10-12 percent compared to last two or three months. Considering that you would have spoken to a lot of investors ahead of your conference as well, does India become attractive for an equity investor? Iyer: It does. What we have to appreciate is, structurally India is still one of the best emerging markets out there be it in terms of the medium-term growth profile that we have. Near-term we have seen some cyclical headwinds, particularly because oil really was in a rip and that has impacted all the macro variables.
However, as Sajjid has pointed out, the depreciation in the rupee, within an extent, is actually par for the course.
Corporate India is not going to fret too much because we have to appreciate that we need a competitive currency not only to boost exports but also to protect our domestic industrial complex from imports. Look at the number of industries which have asked for protection in the last two years; steel, carbon black, tyres, rubber etc. So quite a few of them would actually welcome the rupee depreciation within nominal levels.
You have been a veteran of a couple of these cycles, we saw it in 2013, before that in 2008 and, of course, in the late 90s as well. What is your sense, is this a situation where we are radically different. The guests you spoke to while inviting them, what sense do they exude of India? Morparia: I think India is radically different from 2013. In 2013 as you know we were one of the infamous ‘fragile five’. Since then, India is far stronger than before. Sajjid has been saying this for the last two years that the real effective exchange rate (REER) appreciation of the Indian currency is certainly not helpful for the country and industry at large.
All of us were lulled with oil at $40 per barrel, and if you look at last year when we had the conference, our big worries were certainly not macro, it was all about banks being undercapitalised, will GST settle down, will Insolvency and Bankruptcy Code (IBC) really play out.
However, such is human nature that we do not talk about any one of these three successes one year down the line, but the currency gyrations is what is completely on everyone’s mind.
What are they saying already, Sunil Garg, James Sullivan, people who look at India as part of the emerging market basket and who look at emerging market very closely, are they saying that this pain will endure? After all, the Fed tightening has in a way probably been only mid-way, probably the middle of a curve, what are they saying? Chinoy: I think that is the point. We don’t live on this island, step back and emerging markets, the analogy I use is have been living on a ventilator for the last seven to eight years. That ventilator, this unprecedented accommodation of central bank balance sheets, has been now changing. So what emerging markets are caught between two dynamics.
One is US exceptionalism. The fact is growth in 2018 has been very desynchronised. The US has grown at 4 percent in the second half, growing at 3 percent in the second half of the year, wages have finally gone up last week, the unemployment rate is below 4 percent, this is an economy that is steaming along. The problem is that the rest of the world is not keeping pace.
When you have the largest economy in the world growing above potential, where the central bank will have no choice but to raise rates aggressively once a quarter we believe for the next year and a half, at least till they get to neutral and you have got China which is actually slowing and investors are not seeing tangible signs of a fiscal stimulus, emerging markets are caught in between.
You are on a highway and the car ahead of you, which is China, is slowing down and the car behind you, which is the US, is accelerating, you are caught in between these two cars. I think is policymakers being nimble, being proactive, but let us not forget that India’s fundamentals ultimately will shine through.
Inflation is running below 5 percent in India, the current account deficit is high at 3 percent but not like 2013, which was at 5 percent. We have seen the biggest improvement in our twin deficits in the last five years. So when the dust settles, markets do tend to be more discriminating.
I hope that we are not one of those fragile economies, there are many other examples right now. The key is, be orthodox, stick to your fiscal target, raise rates if inflation warrants and the rest will take care of it.
Let me come to earnings itself, we have seen this big expectation of 20-25 percent earnings growth over FY19 and FY20, are you lowering your FY19-FY20 expectations because of the way yields have gone? Iyer: We have been at 15 percent for some time now so we don’t believe the 20 percent number and it is likely to come off. But that said, I guess what we need to focus on is the rate of change. Let us face it.
For the last four-five years, earnings have been growing at anaemic single-digit numbers whereas, if you look at this year, Q1 earnings grew at about 16-19 percent depending on how you slice it and dice it.
As Kalpana Morparia mentioned, bottom-up corporates exuding a lot of enthusiasm because if you look at consumption related sectors or even consumption proxies like the retail banks, for example, they are beginning to come off the twin disruption cost by demonetisation and GST implementation. They are feeling good about earnings, sector supplying to the government’s priority infrastructure areas are all doing very well.
You look at cement, commercial vehicle, tractors, all double-digit growth, the exporters are likely to benefit because of the falling rupee and let us face it, the exporters are 35-40 percent of the index. So I guess there is no reason to believe that the earnings recovery is not here to stay.
But there is a huge set of targets for foreign investors under the Nifty as well and that was the non-banking financial corporations (NBFC), that would be hurt – rate sensitives would be plenty, are you shuffling your sectors at least, are you moving away from NBFCs for instance? Iyer: This is something we have been doing for the last one year and we have moved away because as you recollect yield started going up around August last year you could see it coming that there were twin issues, right?
Between August and January this year, yields had already gone up about 140-150 basis points. The twin vulnerabilities of higher oil prices and higher cost of capital were already beginning to play out. So that was the smarter thing to have done and we have done it.
But at that time it still moved to 7.5, who thought of 8.2-8.3 at that point, which is what is freely being spoken now? Iyer: On the margin, I think 6.4 to 7.5-7.7 percent was an indication enough that look we are and Sajjid pointed out the scenario where even it is not just India, even globally the cost of capital is going up because the US is moving away from the accommodation. The European Central Bank (ECB) is likely to do so by Q4 of this year, the Bank of Japan (BoJ) potentially in the first half of next year. So we need to prepare for these things. You referred to the fact that in the previous summit, people were only worried about non-performing assets (NPAs) and happy that the Insolvency and Bankruptcy Code (IBC) is in place, has it been as resounding a success as people expected it to be? After all we have resolved only two cases in the IBC 15-16 months after a promise that everything will happen or a bulk will happen in 180 days and then 270 days, we are now like over 400 days after the first list of 12 cases were filed and only resolved two, how are the foreign investors feeling about that? Morparia: This is truly the impatience of youth. A country that was so accustomed to waiting four-five years or eight years to see a case resolve itself once it gone into winding up or recovery under a court and now you are chaffing at the fact that it has taken 365 days to get something. I think we have got to put this in perspective.
The way the RBI choreographed this entire thing is pretty admirable. We all as market participants complain bitterly when the RBI said, come what may, these are the provisioning levels you need to make, this is the recognition and the consequences.
We complained bitterly when they said if it is a non-performing loan, 90 days overdue, you have 180 days in which to come up with a restructuring or else just wind up the company and take those assets to productive use.
But all of this created a lot of cushion in the balance sheet. The government then came in and if you remember the finance minister mentioned this in a conference and said we will provide the capital to the state-owned banks.
That is what the worry of the market that they don’t have sufficient capital, the government went ahead and do that and now it is just a question of resolving this issue.
India has a strong judicial system, there will be challenges, the good news is that there are multiple bidders. So other than the power sector, which I know is a challenge there are varying estimates in terms of whether the haircut is going to be 70 percent or 60 percent or maybe even lower, if you look at the way the entire metal sector has behaved, frankly it has taken all of us by surprise in terms of the recovery rates.
What are you preparing in terms of rate hikes and therefore yields, is the JP Morgan view that we are here at 8.2 or does it get worse? Chinoy: No, I think that 8.2 is probably higher than it needs to be. Our sense is that the new equilibrium in any of these emerging markets we spoke about has to be higher rates, tighter fiscal, weaker rupee. I think we have got that balance right.
The inflation targeting framework is quite clear and has worked very well that the central bank should focus on where inflation is to the extent that rupee depreciation creates more inflation.
We expect that there will be a rate hike in October and one more in December and I think 50 bps up would be the end of the cycle. The sense is once investors are convinced that inflation is going to be under control, the yield curve will take care of itself, especially because there was a commitment over the weekend to control the fiscal deficit and you have seen another open market operation announced on Friday night.
The combination of the fisc staying on target, inflation remains under control and the OMOs should keep the bond market contained as long as the rupee doesn’t get disrupted.
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