Emerging Market FX: USDINR Fundamental, Technical & Trade Update
Emerging Market FX:The most striking aspect about India’s current macroeconomic picture is the contrast between weakness in various economic sectors (production, consumer and labour market) and the relatively fast pace of economic growth in the country. At the moment and in the 2016 projections, India is in fact the fastest growing economy in Asia and more broadly in EMs, notwithstanding the fact that macro indicators such as exports, PMIs, and imports all seem to suffer from both Y/Y and momentum (3M/3M) weakness.
Such generalized weakness mostly stems from an international juncture that is still not supportive of growth, and which continues to penalize exports and contributes to delaying more visible signs of acceleration in economic activity in spite of the low international commodity prices. At the same time, low commodity prices and subdued domestic demand favour a continuation of the disinflationary trend and foster a low current account deficit environment. Clearly, low inflation and a modest C/A deficit also reflect a state of poor domestic demand that constrains growth. The real GDP growth remains fairly buoyant at around 7.4% in Q3.
Conventional measures of potential output additionally show that annual growth is above potential since 2014, but that this result is biased to the downside and would argue in favour of a higher level of potential output, likely around 8-9%. By the end of FY2015/16, markets expect a further acceleration of GDP to around 7.5-7.6%, that should extend to 8% by the end of next FY ending in March 2017. These expectations are not too far off consensus and definitely account for the still strong base effects, whereby India remains a fundamentally poor economy that will continue to enjoy solid growth rates in pretty much every market condition.
Also, the revision of the GDP series and the rebasing to 2011 from 2005 that was introduced early in 2015 have contributed to cosmetically improve historic GDP performance. It remains difficult to determine whether the new GDP series overestimates growth vis-à-vis the old one, especially as the old series has now been discontinued. The new series tracks GDP data more accurately, even though the passage from the old to the new methodology has translated into the acceleration of quarterly GDP figures over the past two to three years at least. The GDP dynamic, however, has not changed significantly, with both the old and the new series exhibiting a modest acceleration in growth since 2012-2013.
Therefore, while the macro picture is not entirely positive, it does offer elements for optimism. Domestic demand remains crucial to stronger growth in the future and, given inflation is relatively tame and the C/A gap contained, the Reserve Bank of India should accommodate growth by lowering rates in the coming months, but unlikely before end-February or March. In February, the government will present its next budget and will decide whether to implement the Seventh Pay Commission’s recommendations. The Commission has suggested in November to raise central government wages by 23.6%, which is more than the market had expected and, if implemented, would weigh by approximately 0.4-0.7% of GDP on the fiscal deficit. Inflation implications would also be structurally adverse, at risk of compromising the 5% CPI target the RBI has for Q1 2017, while the 6% target for January 2016 should not be at risk.
All this suggests that Governor Rajan may want to wait for the February budget decision from the government to see if they incorporate, and how much in case, the Commission’s proposal to raise wages. This is why the market continues to have a 25bp cut priced in for February, or possibly later under the assumption that fiscal consolidation continues and any wage rise is offset by increased taxation, higher tax collection or expenditure reduction somewhere else. But even before we get there, rates in India are likely to continue falling as monetary easing so far delivered by the RBI has not yet fully transmitted into the economy. Also interestingly, on 7 December, Fitch reviewed India’s ‘BBB–’ rating and affirmed it with a stable outlook. In that report, Fitch saw GDP growth strong in the medium term, while external finances remain favourable, including a strong FX reserves buffer.
The government is steadily rolling out its ambitious structural reform agenda, but it has so far turned out difficult for the government to garner the required support in the Upper House (Rajya Sabha) for some big ticket reforms, including a national Goods and Services Tax. If this situation continues in 2016, with the flagship reforms procrastinated for months, India may start losing the market support it has enjoyed for over two years. However, those reforms that only require executive approval continue to be implemented. As a result, India’s weak business environment and governance standards are slowly improving, albeit from low levels. This is also a factor that should continue support growth in the future, while infrastructure bottlenecks and, especially, limited improvement in its fiscal position remain the largest constrains to India’s ratings.
Technical & Trade Takeaways
- On the weekly chart above you can see how trade has developed since we went long the USDINR at 65.00 we are currently running an open profit of just over 150pips and maintaining a break even stop on this position giving us a risk free position.
- Technically the weekly chart has a bullish structure as we continue to print higher highs and higher lows in this cycle. My target for this trade is a retest of the spike highs at 68.60 which will deliver a 360pip profit from our initial risk of 100pips.
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