What is your reading of the underperformance of Indian markets vis-a-vis EMs this year?
In addition to the weakness of global trade, weakness of global investment, uncompetitive currency, India now has this additional problem that consumption growth is not picking up aggressively because the savings rate has fallen. This decline in savings isn’t because people are aggressively buying real estate or other durables amidst higher incomes. It is because income generation and job generation itself has been weak. Market correction may have coincided with the budget, but the fundamentals have been poor for some time. Medium-term earnings expectations remain high despite weakening rural incomes. Valuations are still quite high, and that’s why within the global EM context we are actually underweight Indian equities and overweight Indian bonds. Fixed income is a much better asset class in India than equities from a three-to-six month perspective.
What is your assessment of the finance minister’s announcement on removing the tax surcharges and moves to improve liquidity? These announcements will not change my mind about India. These taxes were not the reason we were underweight Indian equities relative to emerging markets.
What is your outlook for EMs in the wake of trade war situation and slowdown in global growth?
Given that the trade war is likely not going away anytime soon, the chances are that it begins to encompass geopolitical issues rather than purely tariffs on imports. The risks for emerging markets are quite high. But the challenges are not limited to the US-China relationship. One of the biggest events of the last 18 months is actually not the trade war but the fact that the nature of China’s growth is changing very quickly; it is becoming much more domestically driven. Chinese growth is not just falling, its import intensity is declining very quickly. This is happening independent of the trade war and not many market participants don’t realise this. This is happening because both because China is not adding a huge amount of liquidity — at this point it does not seem to be interested in creating another credit bubble, but also because the nature of this limited stimulus is very different from 2016; it is not being directed to import intense housing market, but to the much more domestic consumption and services sectors. As these do well, there is little incremental benefit to other emerging markets, Europe or Australia etc.
What are the chances of a global recession in 2020?
We are not far from a global recession right now and certainly very close to a European recession. The weakness is concentrated in investment and trade; domestic demand seems to be strong everywhere barring China. If the trade war was to continue to escalate from here, I don’t think anybody should be surprised with us going into a short global recession. This will not at all be the same kind of recession seen in 2008 in that this is not expected to be a balance sheet recession, where the weakness in growth hits the financial system, which then creates a second round hit on growth. Tariffs are more likely to create a short, one-time hit like supply shock. We are not there yet, but if the trade war continues to escalate, global growth may slip below 2.5%, which would be consistent with what has historically been termed a global recession.
The Fed has dashed hopes of a lengthy rate cut cycle. How many rate cuts do you expect from the Fed in 2019?
They were right to dash that because the market was getting ahead of itself. Since the last Fed meeting on July 31, we have seen a new escalation in trade war. We now expect 75 basis points further rate cuts from here till the end of the cycle, 25 bps of which are going to be in September, with a further 50bps in cuts likely to be seen till June 2020. Interest rate forwards suggest market is pricing in a much more aggressive easing cycle, both in terms of magnitude of cuts and speed of cuts. The Fed is likely to be a little more conservative in cutting rates than the market is pricing in.
Is the rupee overvalued at current levels?
Yes, I do think the rupee is overvalued. If you look at the current account excluding gold and oil, it is as bad as it was in 2015. The bulk of the external improvement has come from variables which are not directly related to competitiveness. One decent way of looking at competitiveness is export volume growth and that has been very poor for India. As inflation is so well contained, I don’t think the central bank will have major issues or would be worried about the rupee correcting modestly. The fact that they have accumulated reserves considerably over the last 18-24 months also allows them to keep the rupee volatility in check. But there is no doubt in my mind that the rupee is an overvalued currency that needs to correct.
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