The World This Week
August 12 – August 16, 2013
Macro Economics and Debt View:
It is expected that Fed will start tapering its QE III bond purchase by the end of the year. There is clearly a
reduced risk appetite amongst developed market investors which also means they might not invest in
India or other emerging markets at all. Our worry is that FIIs pull out has not begun yet in equities (and
we are hoping that it doesn’t begin); the additional inflows have stopped. Reduction of risk capital
because of QE would necessarily pull down all risk assets globally, some of which we’ve already seen -
emerging market debts, emerging market equity which is what India gets classified under. Unless US
markets deteriorate extensively, only then Fed will be compelled to put QE back on track because of
which again there might be a surge, but barring that there are no possibilities of redemption of QE, we do
not expect the flood of capital to restart.
The falling rupee is the main topic which is being talked about. We are a country with a Current Account
deficit (CAD) and till we have capital account surplus to pay for it, we are fine in terms of exchange rate.
The moment the capital account surplus stops, we are always going to face a downward pressure for the
currency. In the past it has happened through devaluations, like 1991 and 1976, when we had
devaluations of 60% and 40%, this time we are facing a slow depreciation. This fall is still not speculative
but it is fundamental in our view. We do have a CAD and it is growing and hence the rupee fall is not
likely to be arrested anytime soon.
The clearest way to address this fall of rupee is to improve CAD by taking some long term measures like
export promotion which is very laborious and hard to pull off in an election year. Simpler measure is to
cut down on gold imports and other luxury item imports. With the increase in the value of dollar, some of
the discretionary imports are already starting to come down which will hopefully reduce CAD, but gold
imports are a little bit of a peculiarity as rise in value of gold is not deterrent to buy gold, infact it is a
trigger to buy gold whereas investors do not realize it is - because rupee has depreciated. Gold has not
come back to its original level. By imposing import duty the GOI is trying to convey that it does not want
more gold to be imported but that is not clearly reflecting in the gold demand.
The other measure the government is taking is the capital account side which is essentially trying to get
more capital in from abroad. There is a draconian measure which the government is not taking and we
hope it does not happen is to impose capital controls. Finance Ministry has stated they will not take this
measure. We might see some measures like NRI bond issuance or dollar denominated bond issuance by
the Indian banks, state sponsored or a combination or something like infrastructure bonds and liberalized
norms which are already starting to come for NRE deposits. With that the government is trying to
improve the capital account. With the current account measures and capital account measures and also
the money market interventions the RBI is probably going to defend rupee at current levels or arrest the
fall to make it more gradual but our expectation is the rupee will continue to depreciate at a slower pace
maybe, but certainly so.
On the back of that the bond yields have spiked. We have still not fully understood the linkages between
the money market - which is why the bond yields have been rising - and the currency markets, which is
where RBI expects the rupee fall to be arrested. We are in a tight monetary scenario and will remain so
for foreseeable future. We don't expect the short term rates to fall by a big way anytime soon, nor do we
expect long term debt yields to fall in a big way anytime soon.
We expect the rates to be cut early next year, till then indirect tightening like CRR might be applied if
there is further depreciation of rupee. If rupee fall stops we might actually see some relaxation on the
CRR front or MSF front but nothing on the repo side. With that the growth climate continues to suffer.
Any promotion of investments through door interest rates will lead to inflation and further slide of rupee
potentially, and in terms of priority, the Government as well as RBI have clearly put rupee fall arresting as
the first priority followed by inflation followed by growth. We do expect that the Indian growth potential
is above 5% and it's really a question of priorities due to which RBI is focusing on inflation control and
eventually the growth rate will return. It is a short term firefight.
We maintain our stance on bonds - Neutral (Don't buy and don't sell) and stick to short term debt and
any specialized terms which target credit.
The Indian equity markets collapsed by 4% largely due to the dramatic decline in the rupee. As we have
been seeing for the last couple of months, rupee has been under a significant depreciating bias because
of which RBI has been forced to tighten interest rates in the short term. Because of the QE tapering
concerns, it is unlikely that we would see a very dramatic reversal of this trend anytime soon. However
there are ways for equity market participants to benefit out of this. Overall, if we look at how the equity
markets have been behaving, we’ve seen a significant fall in Nifty from the levels that it topped out. We
had Nifty at 6100 levels last month from where it has collapsed almost 10%.
There have been sectors which have done extremely well largely on the back of rupee depreciation. The
strategy for equity is to avoid aggressive sectors i.e. banking sectors and go ahead with sectors like
Pharma and IT sector. If we look at the IT sector, the IT index has delivered a 20% absolute positive
returns. There are clearly ways of monetizing what is happening and it is more difficult as one has to go
down the chain in terms of identifying ideas involved.
We believe that like every few years we see some kind of a negative event which pans out both from the
global and domestic perspective, in which they go back the equity markets. However we do not think this
shall continue for a very long time. In September – October, we may see first signs of tapering of QE III
and once the event actually happens we are going to see some serenity reverting back to the markets. In
the meantime, we believe that it is good to have a defensive portfolio. There is a lot of volatility and we
have to live through it for some time and once that dust settles on this, aggressive portfolios can be built
post that. Currently we maintain a cautious outlook; we have debt yields at around 8.9%, Nifty at 5500,
Rupee at 62 levels against the Dollar, where a lot of negatives have come together, with this it is very
difficult for things to worsen from this stage as the worse has already been witnessed.
DOMESTIC MACRO: India
India's inflation accelerated to 5.79 percent in July, the fastest pace in five months, mainly
driven by higher food prices and costlier imports as the rupee fell to a record low. The WPI -
India's main inflation measure - rose to an annual of 4.86% in June.
To protect the falling value of the rupee, the Reserve Bank of India on Wednesday announced
measures aimed at moderating capital outflows, following which individuals cannot buy
properties abroad under the Liberalised Remittance Scheme. Moreover, the limit for
remittances by resident individuals under LRS has been lowered from $200,000 to $75,000 in a
fiscal year and it also further curbed gold imports.
A triple blow stunned the financial markets: the rupee dropped to a lifetime low of 62.03, the
Sensex plunged by over 4 per cent, its biggest one-day drop in two years, bond markets went
haywire and gold surged to a two-year high.
Europe’s ailing car market grew in annual terms for the second time this year in July, supporting
hopes of a much-needed stabilization for battered producers in the second half of 2013.
Registrations of new cars in Europe rose 4.8 percent compared to the same month a year ago to
1.02 million vehicles, according to data published by the German auto industry association VDA.
The Ten-year German yields were holding at 1.81 per cent, heading back towards levels not seen
since April 2012
U.S. bond yields rose to two-year highs on Friday as investors worried the Federal Reserve will
start scaling back stimulus next month, while world share indexes registered their biggest
weekly fall in almost two months. The 10-year yield touched 2.8 percent. Treasuries drove the
dollar up against major currencies. The bond market has undergone a sharp sell-off since the
Fed started talking about paring back its bond purchases.
The number of Americans seeking unemployment benefits dropped 15,000 last week to a
seasonally adjusted 320,000, the fewest since October 2007, a sign of dwindling layoffs and
steady if modest job growth continues.
Average new home prices in China’s 70 major cities in July rose 7.5 percent from a year earlier,
marking the seventh straight month of year-on-year increase. China's monthly property
inflation moderated for a fourth straight month in July, although annual gains were the
strongest this year, complicating policymakers' task of trying to cool the sector without stifling
China attracted $38.3 billion in foreign direct investment in the first four months of 2013, up
1.2 percent from the same period in 2012.
Commodities and Currency:
Date USD GBP EURO YEN
(Rs. per BBL)
(Rs. Per 10gms)
12-08-2013 60.80 94.20 81.03 63.07 6476 28919
13-08-2013 61.43 95.07 81.77 63.09 6452 29441
14-08-2013 61.51 94.98 81.62 62.56 6563 29451
15-08-2013 - - - - - -
16-08-2013 61.81 96.56 82.45 63.29 6603 30644
Tenor Gilt Yield in % (Closing) Change in bps (Week)
1-Year 9.96 67.5
5-Year 8.94 19.6
10-Year 8.9 77.4
Satadru Mitra Varun Goel Jharna Agarwal
Abbas Naheed Kinjal Mehta
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