Suyash Choudhary

Global Policy Is Shifting, Responding To Slowing Growth

 

A lot has changed in the world over the past few months. A theme we have focused on is the changing narrative on growth which has gone from a synchronized recovery till late 2017 to significant growth divergences over most of 2018 to a synchronized slowdown since late 2018. A relatively more recent development is around policy responses to this slowdown. The starkest turn there is from the policy maker that matters the most to the world; the US Fed. From a place of forecasting multiple further rate hikes and keeping its balance sheet run down on ‘auto pilot’, the Fed has come a long way in a matter of months. For one it has turned ‘patient’ on rates. Two, balance sheet run offs are expected to end sometime late this year. Three, the Fed is in the process of discussions and debate around policy tools available to it for the next downturn. Notable amongst the discussions around this is a perspective that the Fed should allow inflation to overshoot its target at points in an economic cycle to make up for substantial periods of undershoots at other points, so that average inflation is maintained at target for the entire cycle. These debates will also add fuel to market expectations with respect to the Fed especially as growth slows and inflation continues to undershoot target.

 

China policy seems to have also turned with liquidity creation by the central bank and targeted credit getting stepped up, while the official narrative remains that they won’t go overboard with incremental credit. Indeed, given their overall debt to GDP ratios as also the fact that they only three years back had undertaken a substantial stimulus, there may actually only be limited room to again backstop growth. Finally, the European Central Bank (ECB) also seems to lately be getting perturbed by weaker growth over the past few months and may also soon undertake further rounds of long term lending operations.

 

With these developments, the risk that policy makers are ‘asleep on the wheel’ while growth deteriorates is significantly lesser. This is positive for emerging market (EM) currencies insofar that on the margin the risk of a disruptive downturn to growth leading to safe haven bids for the dollar is lesser. However, the pace of policy puts and their incremental efficacy in actually changing the momentum on growth in the near term is questionable. If at all, the incremental impact on growth data may only be visible around the latter part of the current year.

 

The Indian Perspective

 

India itself is struggling with growth drivers, after trying for some rebound early in 2018. There are two specific channels that are incrementally affecting our growth prospects. The first obviously is the international situation. Thus even though our trade dependence may be somewhat smaller, we are by no means immune to a global slowdown. The second reason is largely domestic. Financial conditions are significantly tight with some notable underlying aspects. A part of the economy as represented by housing finance companies (HFCs) and non-bank finance companies (NBFCs) has absorbed a significant chunk of incremental funds flow over the past few years. This is evident in bank credit to this sector, capital market raising, as well as growth in their own balance sheets. Parts of this sector are suddenly faced with a risk perception deterioration leading to a spike in incremental borrowing cost as well as constrained fund availability. This has obvious implications for some underlying areas especially real estate. The other more general point is that falling inflation hasn’t been commensurate with falling interest rates thus leading to a generalized real rate shock for the economy. This is happening largely owing to the fact that general government and public sector (PSU)company borrowings are causing severe excess supply pressures in the bond market. Thus the bond market is largely shut for non-government borrowers and even for PSU entities 10-year money is available today only in excess of 8.5%. Given a nominal GDP growth rate of around 11%, this creates a huge disincentive for an average economic entity to borrow for discretionary reasons. The government seems powerless in the near term to rectify this since a notable aspect of fiscal policy is the slide in indirect tax collection owing to GST still to stabilize and given the generalized slowdown. On GST, rate rationalization has been underway despite the underlying momentum not having stabilized yet thereby leading to further revenue losses. The hope here is for a ‘J’ curve effect on GST, which will down the line open up fiscal space for the government.

 

Monetary policy has potentially turned more decisive under the new Governor. He seems to be conclusively focused on growth given the RBI’s overall assessment that CPI is well contained around 4% or below for the foreseeable future. This seems the right approach for now in light of the significant challenges to local growth and the benign global backdrop provided by emerging global policy ‘puts’. Thus fears in some quarters that this is an undesirable change in policy direction are unwarranted, in our view. The test will come when the set up changes at some point in the future: for instance, if the phase of current benign global growth and dovish central banks changes.  That is when one will have to see whether RBI proves to be an adequate guardian for India’s macro stability. For now emphatic action may well be warranted and apart from rate cuts it is possible to envisage the central bank turning even more proactive on liquidity, especially if the growth – inflation mix remains as it is currently and the global backdrop remains sanguine.

 

Fixed Income Strategy

 

A benign global backdrop with an emphatic RBI Governor is ordinarily a bullish recipe for bonds. Certainly front end AAA corporate bonds between 2-  5 years are best placed in terms of risk versus reward to play this environment. The duration part of the curve has frustrated lately as the yield curve has incessantly steepened with market fearing supply absorption ahead. Our preference here, as indicated before, is via spread assets like SDLs and the best quality AAA corporate bonds; although we must admit to being 10 – 15 bps too early in this trade. Spreads to equivalent government bonds are now in the vicinity of 100 bps for these bonds. Also, the relative excess supply here fades seasonally over the next two quarters. Market for lower rated credits remains dislocated and we would continue to advise caution there. There is a genuine liquidity issue in the lower rate space and this is constraining true price discovery as well. One will have to wait for some of these issues to settle down, and in particular allow price discovery to start happening through the open market, before taking any sort of a serious relook at this space.

 

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