Risk from the US and fear of China
India financial markets volatility is mostly driven by external cues. It is also true that most times it is extremely bullish or nervously bearish. The impact is largely from high dependence on off-shore funds (and demand for India goods & services) and over dependence on import of essential items. The import of non-essential imports (as alternate to domestic production) is also growing because of cost (and value) effective foreign products. More the dependence on off-shore markets, higher is the risk of extreme bouts of volatility! In the globalisation era, it is essential to look (and move) outwards for top-line capacity build. The need however is to have a good balance between domestic and external avoiding high dependence of one over the other. Countries who built their economy from exports to developed markets are facing the heat on significant squeeze in consumption. Countries who set up huge manufacturing capabilities to build domestic production (for exports) are under pressure from sub-optimal capacity usage. All taken, countries who built domestic consumption (and investment) for optimal capacity build and used external liquidity (and demand) for top up capacity expansion stand to withstand difficult times. The ability to withstand the downturn is what matters in the survival of the fittest global scenario.
Indian economy (and financial markets) faced the major risk from the FED preparedness for start of rate hike cycle, building fear from reverse flow of off-shore liquidity and resultant pressure on Rupee exchange rate and inflation. This also meant that monetary policy cannot turn accommodative to growth. The major relief for India was from sudden and significant reversal in prices of imported commodity items, releasing pressure on the Current Account Deficit. NaMo euphoria helped to dilute the risk from fear of off-shore reverse flow.
When India had sigh of relief from FED pipe line move on rate, China currency devaluation emerged as major threat. The comfort that India got from sharp decline in CAD (supported by robust off-shore flows) is at risk, when FED prepares for September rate hike. Although China provide assurance of no more currency war, more devaluation steps in the short/medium term is not ruled out. Asian (and EM) currencies have adjusted their currency value to stay competitive with Chinese exports. India cannot stay different, else be left alone. India has problems in many, while the GDP growth base is pegged firm at 7-7.5%, it is not easy to get into sustainable momentum into set medium term target of 8-10%. It is good that fiscal deficit and inflation has come into control with minimal downside risk beyond set tolerance level. The issue now is on retaining CAD stability at 1-2% and to hold the off-shore appetite for India, while ring fencing significant reverse flow. Till the Government strengthen the domestic macros, the said risk could only be managed through Rupee exchange and interest rate (with surplus system liquidity) till resolutions to address structural woes are put into execution for desired results.
Build India for higher domestic consumption and work towards Current Account efficiency
China has aligned its monetary policy stance to support export driven growth. The measures leading to availability of abundant liquidity at low interest rate and undervalued domestic currency are already triggered, with more in pipeline. While the structural woes on fiscal deficit and inflation are seen to be behind for India, serious concerns emerge from growth and Current Account deficit. The monetary policy has to turn supportive for execution of "Make for India" (to build domestic consumption) and "Make in India" (to boost exports) themes.
With greater comfort on inflation and fiscal deficit, it is high time for RBI to stay supportive to growth and arrest risk on the CAD through export boost. The 3-point agenda for RBI is clear now: (a) deliver 25 bps rate cut ahead of 29th September 2015 policy review (b) administer USD/INR exchange rate stability at 65-67/70, preferably at upper-half and (c) shift operating policy rate from Repo to Reverse Repo rate or deliver over 25 bps rate cut.
All these are not good enough to push GDP growth momentum from 7-7.5% to 8-10%. Government should quickly remove the risk of set up of policy paralysis through execution of critical policy reforms, managing the political resistance judiciously. Combination of RBI monetary policy support and Government initiatives to ensure policy execution can restore the confidence on the Indian economy for set up of bullish momentum on India financial markets.
Let us hope for the best and stay hopeful (and positive) on India asset markets.
Moses Harding
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