Global Risk Sentiments and US
dollar over the next 3 months – a period of increased uncertainty
· Trump’s
deteriorating political capital: Trump’s
failure to push through the healthcare bill is going to make the tax reforms,
which he had promised and basis which the US equity markets rallied, a very
difficult legislation to pass. The last tax reform in 1986 had taken 5 years by
a much more popular President (Reagan) and therefore regardless of the actual
outcome the markets and specially risk assets should remain wary of the
political arm twisting that happens over the next 3 months.
·
Debt ceiling
impasse: Related to the above point, is
the US debt ceiling which would need to be increased to enable further
government spending after June, let alone a fiscal stimulus. A debt ceiling
raise is generally accompanied by promises of a spending cut and therefore
passing a fiscal stimulus along with a debt ceiling raise is going to be an
uphill task.
·
US dollar and
equity market weakness: The above 2
factors could push US yields and USD index lower, along with equity markets. I
would think, that emerging market currencies are more correlated with equity
markets (read risk sentiments) than with USD index of G7 currencies and hence a
relatively spoilt risk sentiment, would not bode well for INR.
·
French elections: Marine Le Pen is likely to go through to the second
round, would also keep markets jittery of a possible outcome where another
large EU country could vote for a right wing political leader. (late April and
May beginning)
·
Optimistic growth
outlook: US data continues to surprise
on the higher side along with data prints in the EU and Japan. China seems to
be faring better than it was in the last 2 years along with the commodity
markets, painting a rosier picture of global growth outlook. The macro economic
situation globally would prevent any sharp selloff in risk assets.
·
US rate outlook: Market seems to be factoring in 2 more rate hikes by the
FED for 2017 and 3 more for 2018. This is assisted by positive data print in
the US. Reduced government spending in case of failure of Trump’s fiscal
expansion plan could negatively affect the rate hike expectations for 2017 and
2018. Therefore the next 2-3 months could see a period where UST yields remain
capped or move lower as Trump moves ahead with his tax legislations.
Locally: Inflows and good
news bunched up in March 2017
·
Bunched up
inflows: The inflows in Equity and Debt
have accelerated in March 2017 post pro Central government, UP election
results. Substantial part of these inflows have also come in March to optimize
tax benefits which expire on 1st Apr 2017. Thus inflows in the next
3 months could slow down.
·
Seasonality: Generally the June quarter and specifically the month of
May has been the worst for INR. This is due to increased capex/spending and
negative trade balance in the new financial year. This could negatively impact
INR and specially so if there is even a moderate risk off globally due to
factors mentioned above.
·
Competiveness of
INR: The recent INR appreciation has led
to further overvaluation of INR. The government in its new REER indices had
given 30% to 40% weight age to Chinese Yuan. CNH has not appreciated in the
last 2 months as compared to INR which therefore would further negatively
impact India’s trade balance with China. This could lead to accelerate
intervention by the government through RBI to restore INR’s competiveness.
·
RBI’s balance sheet
argument: RBI’s FX mtm on the balance
sheet (argument mentioned below in detail) would perhaps also assist the
government and the RBI, to restore INR’s competiveness. If USDINR closes 30th
June 2017 at current levels of 65 then RBI’s capital erodes by Rs. 1 Lakh crore
and reduces RBI’s ability to pay dividend to the government.
·
Macros: The macros for India remain favourable (as mentioned in
the chain mail) and that should ensure a steady trickle of FDI and FPI inflows,
preventing any accelerate INR depreciation.
View
·
Immediately USDINR
should find a bottom near 64.75 levels.
·
By June 30th
2017, USDINR could trade upwards towards 66.50-67.50 levels.
Regards
Saket
Agarwalla
_________________________________________________________________________
From: Saket Agarwalla (FM)
Sent: 03 March 2017 14:58
Subject: INR - Medium term view - Mild Depreciation
BOP – Current account deficit plus FDI flows should
continue to remain positive for the visible future. Although oil price is
expected to rise to 60-70 USD, the negative impact would be made up for
continuing investments into India through the FDI route given the higher growth
rate domestically. I would ignore the FPI inflows, as such inflows are more
likely to find its way into RBI’s reserves.
Fiscal Situation – The government’s track record
since 2014 shows respect for fiscal targets and with tax collection likely to
grow in 2017 (due to GST and demonetization impact on Direct taxes), a negative
view on fiscal situation is very difficult to form.
Inflation – RBI turned its stance from accommodative
to neutral in the February policy. Inflation is likely to be adversely impacted
because of rising fuel prices plus the technical impact of 7th CPC
HRA component. The pro active approach of the RBI shows commitment to 4%
inflation target and therefore an out of control price rise in the economy is
unlikely in the visible future. Historically inflation has been the primary
factor which has led to cascading effect on other parameters causing INR
depreciation.
Growth – The negative impact of demonetization seems
to have been lesser than previously envisaged mainly due to government spending
and agriculture. The local growth factors should improve as growth outlook for
other DM and EM countries look better for 2017 with inflation picking up in EU
and US, while China and other EMs seem to be better placed than they were in
2015 and 2016.
US interest rates and USD outlook – In 2015 US
interest rate hike expectations were spooking risk assets as the world economy
was much more fragile than it is currently. Recently (since Jan 2017) USD
strength has been accompanied by equity and EM currency strength (or stability
at least). Expectations of a fiscal stimulus in the US has also helped change
the 2015 response along with stability in China which was complimented by a
moderately appreciating Yuan this year. Thus USD strength on the back of
interest rate hike expectations in the US need not necessarily lead to INR
weakness. But in cases where a higher USD is accompanied by increasing
political risks in the EU or instability in China then INR weakness could
follow.
Given the above, why I still do not expect INR to
appreciate significantly from current levels of 66.85?
-
The economic survey of the government released
in Jan 2017 created 2 new REER indices for INR. According to both of them INR
is much less overvalued than the commonly referred to RBI REER index. Although
both of them still show an overvaluation of ~7% currently as compared to 16% of
the RBI REER index. These new indices, perhaps indicate that the government is
not looking to depreciate the INR in a hurry to achieve competiveness in
exports. But at the same time the existing overvaluation of 7% would prevent
the government to allow INR to appreciate substantially from here.
-
In the economic survey, the government argues
for using the excess RBI capital of Rs. 6 L crore to improve the fiscal health
of the government or to recapitalize PSU banks. This 6L crore is nothing but
the MTM gains that RBI has accumulated through its FX assets of Rs. 24 L crore
over the last 15 years as INR depreciated from 40 to 67. Therefore substantial
INR appreciation would erode this RBI capital. The report itself says that such
substantial INR appreciation will be prevented by RBI as the central bank can
print unlimited amount of money to buy excess FX flowing into the country. To
put it into perspective a 1% appreciation in INR erodes RBI capital by Rs. 24 k
crores. Such depletion of RBI’s capital would also immediately reduce RBI’s
ability to pay dividend to the government and therefore negatively affect the
fiscal math of the government. If the government would not have argued to
use this capital, then it could have been ignored as a notional value, but
since the government seems to be keen to unlock value from the same, it becomes
important to keep an eye on this account. On 30-6-2016 USDINR had closed at
67.52 and for RBI to record gains on 70% of its assets (which is the country’s
FX reserves), USDINR needs to be higher than 67.52 on 30-6-2017. This argument
therefore rules out any substantial INR appreciation for the medium term while
indicating towards a moderate pace of depreciation.
-
Immediately, INR seems to be on an appreciating
trajectory as EM currencies and equity markets globally support risk assets.
March generally has been one of the best month’s for INR and the reason could
be bunched up inflows before the end of the financial year end.
Fundamental view
Immediately from the current levels of 66.85, half to one
percent appreciation is possible in INR if risk supports globally. The short
term, short USDINR view will get stopped out with a 67.20 or higher close on a
weekly basis. In the medium term of 3-6 months, we should see mild INR
depreciation. Mild INR depreciation would mean, depreciation lesser than the
forward premium unless one catches the bottom; Therefore making import seagulls
as a better option to hedge, than forwards, on an ongoing basis. In case of EU
political risks raising its head, we might see USDINR headed towards previous
highs of 68.85.
Technical
Immediately INR seems to be on a strong footing but
appreciation should be limited to 66.50 or at best 66.10. Given the above
factors I would expect USDINR to bounce from those levels towards 67.50-68.00
by June 2017.
View
Current levels – 66.85.
March 2017 end – 66.50, stop would be above 67.20 weekly
close.
June 2017 end – 67.75. I would enter this trade at two
levels of 66.65 and 66.25 with stops of 66.45 and 65.95 respectively (weekly
close).
