Will The Rupee Get Stronger?
We expect private consumption growth to remain supported in FY18 due to higher wages and salaries on pay commission awards, government spending, low global commodity prices, low interest rates, among others. The slowdown in cash intensive construction activity in urban areas after demonetization reduced the need for rural workers to migrate to cities. However, a pick up in productive government spenspending is helping support rural economic activity and thus non-agricultural wage growth.
Waiver of farm loans have most definitely been populist decisions rather than from an economical point of view and to this amounted to about US$15bn (0.6% of GDP). If such decisions are taken to till the 2019 elections, it could support consumption but most definitely delay investment cycle recovery. Given still-low capacity utilization, new projects have remained pretty weak due to low business confidence.
Due to global cyclical recovery, India’s exports have improved in line with Asian markets. However, we believe trade momentum is likely to soften owing to slower expected growth
What to Expect?
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The high level of stressed assets in the banking system (mainly public sector banks) continues to pose risk to financial stability and is also weighing on credit growth in the economy. The government has now empowered RBI to look into the system and this should help bring about a solution.
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Expect quarterly average headline CPI inflation to be broadly in line with the RBI's forecast of 3.5-4.5% in 2HFY18 versus an average of 2.5% estimated in 1H. Expected CPI inflation at 4-4.5% as of end-March 2018 and to average around 3.5% for full-year FY18.
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There is scope for another rate cut by no more than 25bps in the coming year, even though the timing of it is data driven. It could also be driven by Real Nominal Interest Rates. We believe the onus is on the government to be on the path of fiscal consolidation while taking steps to revive private investment. Notably, any fiscal slippage in the form of populist spending by the government (including farm loan waivers announced by a few states) ahead of the 2019 general elections remains a key risk and could lead to inflationary spill-over.
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Stressed asset situation with the banks are an issue and needs to be resolved by recapitalizing PSBs. Specific announcements in that regard would be expected but bank mergers may not be an effective solution.
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The current account deficit should be contained to 1.2% of GDP in 2018 while global crude should also be contained within $60/bbl. FDI inflows should go on increasing on the back of continued reforms and 2017 might have seen the highest inflow so far.
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China has received foreign investments far in excess of India. However, rising wage costs, withdrawal or phasing out of FDI-favoured policies and incentives in recent years and government steps towards rebalancing the economy have reduced the economy's attractiveness for FDI in some industries. We believe India, on the other hand, is increasingly recognised as a favoured FDI destination if growth is accompanied by continuous structural reforms.
Rupee outlook
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The structural reforms helped to bring about a steady FDI inflow.
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The external risks and India’s fragile state to global shock waves have been strengthened through policies and buffers, please post the sub-prime and Quantitative Easing.
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The CAD has dropped to 0.7% of GDP in FY17 from a high of 4.8% in FY 13, albeit due to easing of oil prices.
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The rupee is overvalued based on the real effective exchange rate (REER) and even after adjusting for productivity.
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Our reserves seem adequate, being close to $400 bn in FY17 and should be able to withstand sudden shockwaves.
The Indian rupee has fared well and has appreciated to the dollar, being outpaced only by the Korean Won and the Thai Bhat. Macro analysis dictates that the rupee should be holding the 61-65 range in the medium term but weaken to 63-66 range in FY18, on the back of higher inflation. FDI inflow should continue north, thus opening the door for further strengthening of the rupee by Feb 2018.
However it looks highly unlikely that the rupee will test 60 in the near term. FDI inflow should continue north, thus opening the door for further strengthening of the rupee by Feb 2018.
Debt inflow is likely to become much slower , with G-Sec and corporate bond limits are almost fully utilized. Equity would be dogged by larger than life growth expectation, even though continued FII inflow would help the cause.