Brace for more rupee weakness, advise Rabobank MD and senior economist

Jan Lambregts MD & global head, financial markets research Rabobank International.
Economic turmoil in Turkey affected global financial markets. JAN LAMBREGTS, managing director and global head of financial markets research at Rabobank International and HUGO ERKEN, its senior economist and country analyst for North America, Mexico and India, tell Puneet Wadhwa their interpretation of the development. Edited excerpts:

Developments in Turkey rattled the global financial markets last week. What is your interpretation?

Lambregts : Turkey appears to be on the verge of a total currency and financial meltdown, according to Piotr Matys, our emerging market strategist. It’s difficult to expect a respite for the battered lira and local assets without Turkey’s central bank raising interest rates by 10 – 15 per cent. If Turkish lira continues to fall in tandem with confidence among households and corporates, a bank run cannot be excluded, metastasising the crisis. In fact, we should seriously consider the possibility of Turkey opting to impose capital controls, a drastic step that would further undermine its reputation among market participants.

What are the key risks for the global financial markets from here on?

Lambregts: The list is long, but if I had to limit myself to three key risks, I’d say trade wars, China's economy and central banks getting ahead of themselves trying to normalise monetary policy.

How do you view the key macroeconomic data from India?

Hugo Erken, Senior economist & country analyst for North America, Mexico and India.
Erken: There is a clear divide between internal and external developments. Internal dynamics are strong and we expect GDP (gross domestic product) growth to touch 8 per cent later this year. High-frequency data, such as vehicle sales, PMI’s, loans growth data and especially investment proposals have been soaring over the last couple of months. Moreover, the rupee weakness will provide some support to the external sector.

Do you expect inflation in India to pick up pace over the  next few months?

Erken: The high internal dynamics in combination with the reasonably high oil price, the global drain of US dollars and weak rupee are producing a dangerous cocktail from an inflationary point of perspective. This has been exacerbated by tensions over trade, which has fuelled the risk-off mode and made portfolio investors even keener to redirect capital away from large emerging markets (EMs). Admittedly, inflation in July slowed, but this was largely due to favourable base effects rather than a change in fundamentals. Ultimately, we still expect inflation to peak at 6.1 per cent later this year, before levelling off to around 4.5 per cent in 12 months.

Is the Reserve Bank of India (RBI) being overcautious as regards inflation trajectory?

Erken: The weak rupee, the US Fed and high oil prices are making life difficult for RBI Governor Urjit Patel and his fellow members of the MPC (monetary policy committee), but in our opinion, the RBI is not overcautious. We believe the inflationary risk is still boiling and let’s not forget the RBI also has to follow up on the moves by the US Fed.

We expect the final Fed hike for this year in September (bringing the total in 2018 to three). However, the last statement by the US Fed suggests that the hawks in the FOMC (Federal Open Market Committee) have the upper hand, which might result in an additional hike in December, which we have not pencilled in yet. This at least suggests the risks are tilted towards the upside and we think there will be an October hike of 25 bps (basis points) by the RBI before a long pause and perhaps some monetary accommodation somewhere at the start of the new fiscal year.

What is the worst we can see on the rupee over the next six months?

Erken: There are a lot of parameters which could put additional downward pressure on the rupee. In the next couple of months, however, we even expect some strengthening to around 67.5 due to the RBI’s monetary policy, soothing movements on the global trade front and the strong blow by the BJP (Bharatiya Janata Party) to the Opposition in the recent no-confidence vote. But, this recovery will only be short-lived and in the medium-term, India should brace for more rupee weakness.

How does India look as an investment destination?

Erken: Despite high external vulnerability (the INR is the worst performing currency in the pack), India’s enormous growth potential, vast internal market, as well as government policies to open up important sectors for foreign investors will continue to bolster India’s attractiveness as an investment destination. 

What are the key risks to the 'Indian equity story' from here on?

Erken: One major risk is that the government will implement more populist measures in anticipation of the general elections or the NDA (National Democratic Alliance) will not be able to seize a majority in the Upper House after 2021/2022. In both cases, India’s reform agenda will probably stall. More concrete labour market reforms, land acquisition reforms, privatisation of state-owned banks, productivity enhancement in the farm sector and the energy transition, all need to pick up. India has been focusing on increasing investment in renewable energy but this is still a drop in the ocean. Speeding up the energy transition in order to secure energy supply and make India less dependent on external volatile fluctuations should receive key priority.

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