Battered India rupee lacks a warchest
The Indian rupee’s plunge this week to record lows will have surprised no one. After all, the currency has been inching towards this for weeks, propelled by the government’s paralysis on vital reforms and tax wrangles with big foreign investors. These are leading to a drying up of FDI and accelerating the exodus from stock markets. Industrial production and exports have been falling. High oil prices have added a nasty twist to that cocktail. If the euro zone noise gets louder, a balance of payments crisis may loom. The rupee could fall further to 56 per dollar, most analysts predict.
True, the rupee is not the only emerging currency that is taking a hit. But the Reserve Bank of India looks especially powerless to stem the decline. (See here for an article by my colleagues in Mumbai) . One reason the RBI’s hands are effectively tied is that India is one of the few emerging economies that has failed to build up its hard currency reserves since the 2008 crisis and so is unable to spend in the currency’s defence. Usable FX reserves stand now around $260 bilion, down from $300 billion just before the 2008 crisis. See the following graphic from UBS which shows that relative to GDP, India’s reserve loss has been the greatest in emerging markets.
But there is worse. The relative decline in reserves since 2008 coincides with a ballooning in India’s external debt, both private and public. Comprising mostly of corporate borrowing and trade credit, the debt stands at $350 billion, up from $225 billion four years back.
No wonder investors have upped their bearish bets on the rupee: a Reuters poll of Asian fund managers shows these at a six-month high and significantly higher than any other Asian currency. For now, the trade looks worryingly like a one-way street.
Three snapshots for Thursday
The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank’s target level, because of the euro zone crisis, a source at the central bank said on Thursday.
Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc’s average.
As this chart shows, historically the Bundesbank was quick to react to any signs of inflation:
The Bank of England voted on Thursday not to give the struggling economy another injection of cash as concerns over stubbornly high inflation outweighed the risk of a prolonged recession.
The number of Americans submitting new applications for jobless benefits edged down last week, easing concerns the labor market was deteriorating after April’s weak employment growth.
Poland, the lonely inflation targeter
Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?
The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.
(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.
The rate rise is especially notable given many central banks in developing countries appear effectively to have surrendered their inflation-fighting mandate. Nowhere is the push for lower interest rates more pronounced than in Brazil where the government last week announced plans to scrap fixed-rate savings deposits in a move that is seen paving the way for more agressive rate cuts. Clearly there is tolerance here for higher inflation, which will still end 2012 well above target.
But many analysts such as Manik Narain at UBS consider Poland’s decision a high-risk one given the growth issues. Narain sees it possibly motivated by the need to signal Poland will not welcome further currency weakness (the zloty like most emerging currencies has shed much of its early-2012 gain) Therefore a prolonged monetary tightening cycle is unlikely, he says. Indeed many reckon the NBP may find itself, like the European Central Bank last year, reversing an ill-considered rate rise. Analysts at Capital Economics write:
If we are right in expecting growth and inflation to slow by more than most expect over the second half of this year then this may well be the NBP’s “ECB moment”. Recall that having hiked rates twice in the first half of 2011, the ECB was forced to start loosening policy once again by November as the economy weakened. In Poland’s case, we think there is a good chance that today’s rate hike will be reversed by the end of the year.
Hungary can seek IMF aid now. But can it cut rates?
The European Union has given Budapest the green light to seek aid from the IMF. (see here) In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence. It remains to be seen if Orban will actually cave in.
But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds, CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely) talking of issuing bonds on world markets.
What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.
In the aftermath of this, the central bank may be prompted to cut short term interest rates. If the risk premium comes down a lot, the central bank may feel that 7 percent interest rates are not justified. I’m expecting them to at least take this 100 bps back assuming they can reach an agreement with the IMF.
Hungary’s FRAs (forward rate agreement), are still pricing slightly higher short-term interest rates and have not yet reacted to the shifting picture. Many urge caution however on the rate cut expectations, noting that Orban and the IMF may struggle to reach common ground and the central bank will want to see money on the table before it actually acts.
Petronikolos is right in that the economy is moribund, credit growth has slumped and there is a big output gap. But headline inflation is running at 5.5 percent, well above the central bank’s 3 percent target, due to an increase in sales tax. Sandor Jobbagy, at CIB Bank in Budapest is one analyst who says inflation risks have forced him to push back the date of likely interest rate cuts.
No hard landing for Chinese real estate
The desperate days when Chinese property developers offered free cars as an inducement to homebuyers look to be over.
Sales and earnings figures indicate some of the gloom is lifting as developers have enjoyed a second straight month of rising sales. Vanke, China’s biggest developer by sales, said last week that March sales had risen 24 percent year on year, while 2011 profits rose 30 percent. Another firm, China Overseas Land, posted a 21.5 percent profit rise last year.
The mood is reflected in stock prices. While the Shanghai shares index has risen less than 5 percent this year, a sub-index of Chinese property companies has risen 13 percent. Shares in Vanke and COL are up 13 percent and 22 percent respectively. A Reuters poll of fund managers showed that investors had upped their weighting for property stocks to 10.9 percent at the end of March, the highest level in two years.
The share rally has continued even though the government has dashed hopes it will soon wind down its two-year campaign to bring down property prices. It has also bucked a broad housing market slowdown (home prices fell for the fifth straight month in February) amid signs that Chinese authorities are unlikely to provide the economy with any further stimulus. Analysts at Citi said in a recent note:
Developers’ comfort under current tightening (policy) and confidence in a stable outlook suggests the toughest time for China’s property sector is over.
For a long time, the country’s real estate market — and the possibility of a crash there — has generated fear in the minds of China-watchers. That danger is by no means over — economic growth is cooling but inflation remains high. Companies too have warned that tough times still lie ahead.
But many such as Karine Hirn, Shanghai-based chief representative of asset manager East Capital, have never believed in an outright property sector collapse. China has an 80 percent home ownership rate and 25 million people work in construction, she points out. Real estate accounts for 13 percent of China’s GDP. So it is unlikely the government would ever have risked a property price crash. Hirn also points out that while sales in cities like Beijing and Shanghai are indeed slowing sharply,the market remains robust in Tier-3 cities – home to over half of China’s urban population.
How Turkey cut interest rates but didn’t really
How do you cut interest rates without actually loosening monetary policy? Turkey’s central bank effectively did that today.
I wrote this morning that the bank and its boss Erdem Basci were gearing for rate cuts, thanks to the lira’s steady rise (see the graphic) that should help tame inflation later this year (provided the global investment feel remains positive). But I also said a rate cut was unlikely to happen today. I was wrong — and right too. The central bank cut its overnight lending rate by 100 basis points to 11.5 percent while keeping the one-week repo rate — the main policy rate — steady at 5.75 percent.
So why is this not a real cut? Note that the former overnight rate hasn’t been used for over a month. Instead the central bank has been using the “corridor” between the lending and borrowing rates to adjust policy on an almost daily basis. The upper end of the corridor is in fact used more to tighten policy when there is a need to defend the lira, analysts point out. And most importantly, the central bank has already been providing funds at the cheaper 5.75 percent rate.
Morgan Stanley analyst Tevfik Aksoy writes:
This, in our view, did not come as a surprise, and should not be seen as a significant change in the monetary policy stance….The move, in our view, is not monetary easing but an adjustment to changing conditions…..We think that the difference between 12 percent and 11 percent are sufficiently high to stem currency depreciation in case global sentiment turns sour in coming weeks.
According to economist William Jackson at Capital Economics:
Clearly the central bank’s decision is a nod towards the more favourable external financing conditions
Brazil going Turkey? Not quite
Could Brazil be on the cusp of adopting a Turkish-style monetary policy, J.P. Morgan analysts ask.
Many central banks have of late been forced to scale back interest rate cuts (here’s something I wrote on this topic last week) but one, Brazil’s Banco Central, remains resolutely dovish.
After four rate cuts it seems determined to take the official Selic rate into single-digit territory. Aldo Mendes, a deputy governor at the bank, told investors in London last week that he was confident of meeting the 4.5 percent inflation target this year. Friday’s data showing annual inflation at an 11-month low of 6.22 percent should have given policymakers some more ammunition.
Yet it looks unlikely that inflation can fall this year to 4.5 percent — on average analysts expect 5.3 percent. That’s better than last year’s 6.5 percent but government plans for a spending binge to boost growth are bad news for the central bank’s target. Inflation expectations are steadily trending higher — analysts surveyed by the central bank predicted 2014 inflation above 4.5 percent for the first time last November and now this is close to 5 percent, JPM analysts note. The risk for the central bank is it will lose credibility if it insists on keeping policy loose in the face of rising inflation expectations. There is no “free lunch”, JPM says:
Lower rates could mean credibility costs and in turn higher inflation….It seems the BCB is losing credibility as we see changes in the market’s inflation expectations for the medium term. Taking that and our strong activity forecast from the second quarter onwards we now believe it will take much longer for inflation to converge to the middle of its target range. Therefore we are raising our inflation forecast to 5.5 percent in 2013 from 5 percent previously.
Check out the following graphic from JPM on inflation expectations in Brazil:
Greece’s interest burden, post-PSI, will remain huge
It seems Greece has finally reached a deal on austerity measures needed for a bailout. But what about PSI?
(ECB President Mario Draghi just said he heard it was close to a deal. It’s been close for a few weeks though…)
JP Morgan says Greek PSI is hardly going to change the heavy interest burden on the country and the issue of default will inevitably come up.
First of all, Greece’s interest payments are huge.
Greece paid 15.5 bln euros in net interest payments in 2011, 17% of total general revenues. This is the highest among all OECD countries and more than 3 times the OECD average of 5%. It is also more than double the 8% average for other peripheral countries in the euro zone.
The U.S. bank estimates the Greek PSI is going to capture 205bln euros of private bond holders (and perhaps a further 55bln euros if the ECB participated).
Of this 260 bln euros, around 85 bln or a third are held domestically, by Greek social security funds, domestic banks to be largely nationalised post PSI, and the Greek central bank.
Greek ars great but if they dont implement the reforms specially their own pensions funds that are tied to their own greek bonds, their not helping themselves in an already unsustainable situation. they should show some cooperation. If not It may be painful to extract a teeht but if necessary it may be better than keep constant pain within the E¸U and perhaps teh world. Does an economi as large as Argentina can hurt the world if isolated ?
Can Turkey confound the pessimists again? The numbers say no
Doomsayers have been prophesying Turkey’s economic boom to deflate into bust for many months now. The recent revival in positive investor sentiment worldwide ar has helped silence some voices. Others say it is a matter of time.
Data on Friday showed annual inflation accelerated from last year’s 3-year highs to 10.6 percent in January. It is likely to remain elevated at least until May, analysts predict. And trade data released this week indicate Turkey will likely have finished last year with a current account gap of around 10 percent of GDP last year — the biggest of any major developing economy. All this appears to indicate that the central bank will have to keep monetary policy tight and might even have to even raise rates, should the current resurgence in risk appetite fade. But rather optimistically, the government is still forecasting 4 percent growth this year. The IMF says 0.4 percent is more likely. A report today by Capital Economics, entitled “Turkish boom hits the buffers”, says recession is a cinch.
Neil Shearing, the report’s author, notes that imports of both consumer and capital goods have fallen by around $1 billion over a 12-month rolling period. That indicates a contraction in private consumption and fixed investment, he writes. Some of this could of course be down to the lira’s weakness last year, that aided some import substitution, Shearing acknowleges. But he says that all signs are that:
A combination of tougher external conditions and tighter domestic monetary policy have caused a two-year boom in Turkish domestic demand to come shuddering to a halt. Our base case is for a fresh bout of risk aversion to cause the lira to hit 1.90 per dollar over the next six months, causing interest rates to spike — and the Turkish economy to contract by 1 percent this year
With so large a deficit, Turkey will always remain hostage to the ebb and flow of global risk appetite. But the country has regularly confounded pessimists. The past month has seen the government as well as corporates return successfully to international bond markets, bringing much-needed dollars into the country. The lira has rallied 7.5 percent since the start of the year, recovering more than a third of last year’s losses. Should this continue, inflation will ease and financing the current account deficit will be less of a problem. But many suggest the lira’s days of strength could be numbered — JP Morgan analysts for instance suggest taking profit on some long lira positions. Turkey’s influential export lobby has already started complaining about the lira’s rise, they note.
Good reasons for rupee’s fall but also for recovery
It’s been a pretty miserable 2011 for India and Tuesday’s collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions. That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap. The weaker currency also bodes ill for the country’s stubbornly high inflation.
Why is the rupee suffering so much? First of all, it is a casualty of the general exodus from emerging markets. As a deficit economy, India is bound to suffer more than say Brazil, Korea or Malaysia. And 18 months of interest rate rises have taken a toll on growth.
UBS analysts proffer another explanation. They point out a steady deterioration in India’s net reserve coverage since the 2008 crisis. The reserve buffer — foreign-exchange reserves plus the annual current account balance, minus short-term external debt — stands at 9 percent of GDP, down from 14 percent in 2008. Within emerging markets, only Egypt, Venezuela and Belarus saw bigger declines in net reserve coverage than India.
“What it really means for the present, in our view, is that the rupee is now joining the ranks of higher beta “risk” currencies,” UBS said.
Still not everyone is overly perturbed. Some expect the rupee to rebound as the global picture improves. One reason is that the rupee is generally seen as undervalued in nominal terms, as well as on purchasing power parity (PPP) basis, more so than most emerging currencies. The latter is the rate at which one currency would convert to another to buy the same amount of goods and services in each country. On that basis the Indian rupee would equate to 20 to the dollar, data from the World Bank/IMF shows. Given the strong underlying story, investors are more likely to buy back the rupee than say the South African rand when risk appetite improves.
Furthermore, Indian equity valuations are looking more reasonable than before, despite the slowing economy. Stocks trade now around 12 times forward earnings, compared to 17 times a year ago. That should lure some overseas cash once the dust starts to settle.
“This may not be bottom of the market but for us, investing at these levels of currency and equity valuations is an attractive proposition,” says Phil Poole, head of global and macro strategy at HSBC Global Asset Management.
