We see some market shocks next year: Nomura's Robert Subbaraman

Robert Subbaraman, MD & head of EM economics, Nomura
In an interview with Samie Modak, Robert Subbaraman, managing director and head of emerging market economics at the brokerage, says the market has got so used to the US Federal Reserve’s (Fed’s) gradualism and predictability that it will have to endure some shocks. Edited excerpts:

What’s the growth outlook for India next year?

This year, growth has surprised on the downside. Our view is that growth will surprise on the upside next year. We are forecasting a growth of 7.8 per cent in the first half of 2018. On the equity side, we are expecting pretty decent growth next year even though we have had a strong year. The growth will not come from multiple expansion but profit growth will come through. We saw the GDP (gross domestic product) number for Q3 (September quarter) pick up. The negative short-term effects of demonetisation and GST are going. Over time, there should be signs of private investments beginning to pick up. 

The Fed has embarked on a rate hike and balance sheet reduction programme. Do you see this as a risk to EM equities?

I don’t see any significant risk in the first quarter of 2018. But in the second or third quarter, we could see some market shocks from the normalisation. For the Fed, we expect a hike this month and we have three hikes next year in March, June and December. 

We are also concerned with what happens with the European Central Bank (ECB) and Bank of Japan (BoJ). The ECB has already announced that they are going to start tapering in January from ^60 billion to ^30 billion till September. They haven’t said what will happen after that. But have sounded like they will keep doing quantitative easing (QE). 

We think in June, the Euro zone economy will be so strong that the ECB will announce that it will stop buying altogether in September and start hiking in the fourth quarter. There is a risk that the BoJ may also start to relax its yield-curve control policy. 

For EMs, this could cause a risk-off as the markets are going to say they are moving away from QE, and so do we need to reassess the credit risk in the EM. 

Easy liquidity conditions have acted as a tailwind for EMs. Do you see that changing?

I think that’s a risk. What the ECB, Fed and BoJ, Bank of England do is strongly related to capital inflows into Asia. The Bank of International Settlements (BIS), in its quarterly review, states the financial conditions now are actually the easiest they have been since 1993. Ultimately, this is going into the EM. But now the US fiscal expansion is going to be bigger than we thought. If you have more expansionary fiscal when growth is strong, you have to have a bit tighter monetary policy.

Do you think the Fed will be able to balance monetary policy and market expectations?

The Fed is in a quandary. Go back to the 2008 massive crisis, the Fed was the only game in town. They did a fantastic job. They cut rates to almost zero and also did QE. But the other thing they did, was make a lot of promises. That had a big effect on the market and it worked. But the market got used to the forward guidance. In 2013, we had the tapering scare. Then the Fed learnt how hyper-sensitive the markets are. So what’s happened in the last couple of years is that the Fed’s monetary policy has become very focused on gradualism and predictability.  The market has come to expect gradualism and predictability. It means that the market doesn’t expect the Fed to do anything radical. The predictability has also lowered the risk premium. It is a big reason why volatility is very low this year. The reality is that the Fed now is not so sure about the future.

Back in 2009-10, it was very clear that it was bad and we had to do everything we can. Now they are not sure if inflation is going to pick up and how fast. Earlier, they used to shout out the forward guidance; now they are whispering as they are not sure. But the markets are leaning in even more to hear. The risk is, at some point, the Fed will have to do something unpredictable. And it is going to lead to a shock.

Do you see a lot of risks next year?

The downside risks outnumber the upside risks by nine to three. 

Despite that you are positive?

Well, these are risks. A lot of them were same for this year. The question is will they actually play out. It is very difficult to predict that this is definitely going to happen in Q2 next year. If you did that for this year, you’d have egg on your face. You can just emphasise the downside risk. We have tried to warn about the snapback risk. We even go on to say second and third are high-risk quarters. 

How is India placed relatively?

India is our number one pick in the EM. It’s got a cyclical and structured recovery underway. I think next year, the market will start to appreciate not only that this is a growth upswing but they are going to realise this is not the old boom-bust cycle, this is more like a mature economy which can actually deliver long-lasting growth. So India has the potential to grow in excess of eight per cent. We are very bullish equities and INR. The two risk for India we worry about are oil and politics.