by Suman Gupta
INR tends to depreciate in the run-up to general elections
DXY is likely to test 97-98 levels on the lower side but may rebound
Mumbai, May 2023: Emkay Global Financial Services held a media roundtable on macroeconomics and strategy. The media discussion led by Ms Madhavi Arora, Lead Economist, Emkay Global Financial Services revolved around the outlook for the Indian economy, the next steps of the RBI, the impact of the US Fed hiking key interest rates, currency, INR, and finally the inflation trajectory given the current setup.
The research house believes India will likely witness a sub-5% inflation early this year, with an average rate of CPI at 5.2% for CY23. The RBI action, normal monsoon year, supply-side constraints getting addressed will help with ease in inflation. On the currency front, stronger relative growth outside the US and divergent G-4 policies moves high beta FX more concretely to bullish territory vs. USD. INR may be party to it, however the extent of weaker DXY may not fully spill on to EM Asian FX including INR. While improving CAD will augur well for INR, pre-election year have historically not augured well for the currency. Internationally DXY is likely to test 97-98 levels on the lower side, before strengthening again. The current account deficit could moderate to ~$50 billion by next year. The India 10-year benchmark bond yields may ease to see a sub-6.75% level this year, helped by global bond rally, and amid case of OMOs and Durable liquidity injection in FY24. Lastly, while Emkay Global sees a static Fed in coming months, they continue to see a case for tricky sacrifice ratios and financial cracks, implying a moderate recession to play out. For RBI, this will mean that there has been a shift in weightage of the RBI’s reaction function in favor of external policy dynamics, which will be influenced by the extent of global disruption and disinflation ahead. The Pivot theme however is more a next CY story, unless something breaks massively.
The current economic setup
Retail inflation is likely to ease well below the 6% aim of the central bank. The CPI inflation will likely slip below the 5% level later this year and average 5.2% for CY23.
The lower odds of a near-term recession in the US in combination with stronger relative growth outside the US and divergent G-4 policies moves high beta FX more concretely to bullish territory vs. USD. INR may be a party to it, however, the extent of weaker DXY may not fully spill onto EM AsianFX including INR. Given the factors, DXY is likely to test 96-97 levels on the lower side. The other scenarios that will be positive for the the INR are current account deficit moderating to levels of ~$50bn in FY24 (1.4% of GDP); BOP in mild surplus of $5-7bn. The new CAD growth agents will be Business services, remittances, and smartphones. The above scenario will likely help the INR touch the sub-79 level this year, but an average of ~81 for FY24. The negative factors for the INR will be the trend of a Pre-election year historically not auguring well for INR.
In Emkay Global’s view, the G-Sec has more legs to correct – to see 6.75% this year on 10 year. There is a case for OMOs in FY24, durable liquidity injection, peakflation, and peak RBI.
The Year of Disruptions and Disinflation and Pause and Pivots?
The global economy is witnessing a phase of a non-linear disinflation path. The debate on the path to disinflation is now more about how quickly it decelerates and how that pace of deceleration shapes the Fed’s pivot.
Recession is a very reliable disinflationary agent, but a multi-decade period of stable growth and inflation is over now. Over the medium term, the higher inflation regime is here to stay due to structural changes, which, we argue, needs a new investing approach. The conventional playbook of “buy the dip” or “time rallies” which worked during the sustained bull markets of the “Great Moderation,” needs a re-watch ahead.
Policy Repricing Redux?
Markets rapidly pulled forward pricing of rate cuts now implying over 75 bps of Fed rate cuts in 2HCY23 and the Fed funds rate to be below 3.50% by late summer of 2024. The pricing looks difficult to fathom and also implies that there has to be an economic disaster in the next two months, to see such a sharp pivot — signs of which are yet to emerge. However, in such rapid tightening cycles, speed can kill, if stress extends beyond the banking system, and central banks will have a more difficult time limiting this contagion.
Historically, the median gap between the Fed’s last hike and the first cut is ~7+ months and followed by pretty marked easing cycles. The dispersion around the duration of these pauses is big. The late 80s period of an extremely patchy growth cycle and hyperinflation period stands out, which saw a gap of a mere one month in the pivot. In the summer of 2006, the pause was as long as 15 months – followed by GFC.
Fed is expected to remain static in the coming months and cutting rates by early next year, Emkay Global continues to see a case for tricky sacrifice ratios and financial cracks, implying mispricing by equities. The research house believes the US will face a moderate recession camp with a hard landing.
RBI: Tiptoeing from “Hawkish” to “Gracklish” on pause
Emkay Global believes the fear that “speed can kill” has led to a dovish turn from a number of central banks in both DMs & EMs, amid growing concerns over transmission of policy tightening to growth and the same rub-off is happening in RBI’s reaction function. The bar to increase rates will only raise from hereon. This is despite almost all members having insisted on keeping an “open-ended policy” with no change in stance in the MPC minutes. There has been a shift in the weightage of the RBI’s reaction function in favor of external policy dynamics, which will be influenced by the extent of global disruption and disinflation ahead. Besides, in the external sector, INR support emanating from material improvement in the CAD/GDP outlook gives a further breather to the RBI. It appears the pause is for good, especially as the ex-ante real rates at ~1.4% give comfort and flexibility on their supposed stance and actions.
India decoupling: India not insulated from the global recession
Past instances of India’s growth decoupling have been followed by recoupling with the world. Exports, which were growth levers post covid, may fade. India still has the highest export exposure to G2 in EM Asia as a share of its exports. Services exports are particularly vulnerable to a DM slowdown.
Rural-urban divide continues to weigh on the consumption story
The real rural wage growth of both agri and non-agri sectors has largely remained negative, having rarely been positive over the last few years. The quick proxy of rural ToT remains sharply negative for two years, with recent improvement seen though. The urban wages will see moderation ahead as well.
Capex missing angle
The private consumption and investment are endogenous to each other; unlikely to see a secular capex cycle in a pre-election year and amid impending global slowdown/recession. Overall, Emkay Global expects the GDP to print 5.7% in FY23.
INR: Fading pressures, and tactical positioning amid sharply correcting CAD?:
- Lower odds of near-term recession in the US in combination stronger relative growth outside the US and divergent G-4 policies moves high beta FX more concretely to bullish territory vs. USD. INR may be party to it, however the extent of weaker DXY may not fully spill on to EM Asian FX including INR.
- (+) for INR: CAD could moderate well to ~$50bn in FY24 (1.4% of GDP) ; BOP in mild surplus of $5-7bn : New CAD growth agents: Business services, remittances and smartphones
- INR to see sub 79 this year, but average ~81 for FY24 ;
- (-) for INR: Pre election year have historically not augured well for INR.
Bonds: Demand Supply vs other fundamental play for rates mkt
– Gsec has more legs to correct – to see 6.75% this year on 10 yr.
- Case for OMOs in FY24, Durable liquidity injection
- Peakflation and Peak RBI
- Global rates trajectory
About Emkay Global Financial Services Limited: Emkay Global Financial Services Ltd., headquartered in Mumbai, India, is an integrated securities firm offering a wide range of investment avenues including investment banking, institutional broking, private wealth management, asset management, and financial products distribution. Its institutional broking division services clients across all-important global geographies and its research has received recognition from important bodies including Thomson Reuters, Institutional Investors, Asiamoney, and The Wall Street Journal amongst others, over the years.
