In a few days, we'll have the latest BOP numbers that according to an RGE note will show a narrowing of the Indian CAD. It cites, "seasonal effects, moderating crude and gold prices (particularly towards
the end of the quarter) and lower gold imports following a hike in
import duties in January".
The problem is that the tapering talk is nowhere near consensus and there's a whole lot of clearing (corrective pricing?) happening in most Emerging market economies. Any BOP numbers on the wrong side of the estimates are likely to increase downward pressure on the INR in lieu of persistent external financing gaps.
But that's a general scenario that has been enhanced by recent actions by the Federal Reserve. And while in general, a depreciating currency provides a bit of relief to the current account of an economy, India has a lot more to worry about in terms of its imports. From RGE,
"Looking specifically at crude imports is instructive. Already the INR price of a barrel of Indian crude is back above 6000 while losses per liter of diesel (i.e. the government subsidy) have inched back up to 6.31 (from roughly 4.5 a month or so ago). Between January and end-May India imported roughly 541 million barrels of crude and petroleum (~USD 83 billion). Over the same period Brent prices dropped by about 10% and INR depreciated by 6%.
In fact in April INR strengthened as capital inflows were robust and the market saw the commodity selloff as INR positive given the latter’s expected impact on the CAD. But that hope turned out to be short lived. Since then INR has fallen another 5% while Brent has stabilized thus reversing the previously expected positive impact on the CAD.
Aside from widening the CAD the higher INR price of crude will raise the subsidy bill (in spite of recent upward revisions to administered prices) and/or raise imported inflation if higher international prices are passed through to domestic consumers via more diesel hikes. This will exacerbate the tension between fiscal commitments to contain subsidies and politically unpopular (and inflationary) price hikes ahead of elections."
It's not pretty. Global sentiment has significantly adverse affects and there are strong headwinds that are waiting to provide more problems through higher deficits and more inflationary pressure. And India stands out economically among all the EMs, in the worst macro-way possible.
And in terms of the big picture? At least, the EM sell-offs have led to a slight unwinding of carry trades and corrective pricing; and while the lessons of '97 have been learnt, vulnerabilities continue to exist in the form of sizeable CADs. slowing growth and stickily high inflation. But this is just the beginning and as US real yields inch upward, there are EM economies with some monetary policy room to ease a bit or at least not tighten.
What the sell-off is undeniably doing on the surface, is making EM local currency debt attractive where inflation is less of a concern. Statistical research on EM LCY debt in the past decade shows a significant shift in the behavior of LCY debt post the Global Financial Crisis. Whereas domestic monetary policy (expectedly) is observed to be a significant determinant of yields before the crisis, the significance of treasury yields and other global factors is far more pronounced over the past few years leading to a sort of temporary "safe-asset-syndrome" for EM debt.
As another RGE note categorically states,
"On a structural basis, EM growth prospects and external balance sheets have worsened as export growth has stalled. Government balance sheets mostly look strong, even if there isn't a lot of stimulus capacity/willingness, but its the corporate balance sheets that may suffer the most from the combined slowdown in growth and higher financing costs (either actual or effective). Those high inflation/low growth countries will be most exposed to rising financing costs, which could undermine growth prospects further, holding back any reacceleration"
A round-up analysis in the FT has differing opinions on whether this is a "mini-bust" that will be handled easily or just a mild tremor and a harbinger of a bigger quake. We may not see as much "original sin" anymore but that doesn't mean that conventional macro-vulnerabilities have vanished into thin air. In all likelihood, they've been replaced by different combinations of variables spurred on by the accommodating global monetary regimes of the past few years.
And now that tapering talk has begun (never mind that there is no sign of short-term rates increasing or a favourable US employment picture), the downward pressure on bond prices in EM economies will increase. Accompanied by detrimental volatility in the markets, there will be lots of investor jitters before anything else.
As for some of the EM central banks, they might find a need to tighten monetary policy (or keep it tight) when it is perhaps the last thing desired, but something completely required.
The problem is that the tapering talk is nowhere near consensus and there's a whole lot of clearing (corrective pricing?) happening in most Emerging market economies. Any BOP numbers on the wrong side of the estimates are likely to increase downward pressure on the INR in lieu of persistent external financing gaps.
But that's a general scenario that has been enhanced by recent actions by the Federal Reserve. And while in general, a depreciating currency provides a bit of relief to the current account of an economy, India has a lot more to worry about in terms of its imports. From RGE,
"Looking specifically at crude imports is instructive. Already the INR price of a barrel of Indian crude is back above 6000 while losses per liter of diesel (i.e. the government subsidy) have inched back up to 6.31 (from roughly 4.5 a month or so ago). Between January and end-May India imported roughly 541 million barrels of crude and petroleum (~USD 83 billion). Over the same period Brent prices dropped by about 10% and INR depreciated by 6%.
In fact in April INR strengthened as capital inflows were robust and the market saw the commodity selloff as INR positive given the latter’s expected impact on the CAD. But that hope turned out to be short lived. Since then INR has fallen another 5% while Brent has stabilized thus reversing the previously expected positive impact on the CAD.
Aside from widening the CAD the higher INR price of crude will raise the subsidy bill (in spite of recent upward revisions to administered prices) and/or raise imported inflation if higher international prices are passed through to domestic consumers via more diesel hikes. This will exacerbate the tension between fiscal commitments to contain subsidies and politically unpopular (and inflationary) price hikes ahead of elections."
It's not pretty. Global sentiment has significantly adverse affects and there are strong headwinds that are waiting to provide more problems through higher deficits and more inflationary pressure. And India stands out economically among all the EMs, in the worst macro-way possible.
And in terms of the big picture? At least, the EM sell-offs have led to a slight unwinding of carry trades and corrective pricing; and while the lessons of '97 have been learnt, vulnerabilities continue to exist in the form of sizeable CADs. slowing growth and stickily high inflation. But this is just the beginning and as US real yields inch upward, there are EM economies with some monetary policy room to ease a bit or at least not tighten.
What the sell-off is undeniably doing on the surface, is making EM local currency debt attractive where inflation is less of a concern. Statistical research on EM LCY debt in the past decade shows a significant shift in the behavior of LCY debt post the Global Financial Crisis. Whereas domestic monetary policy (expectedly) is observed to be a significant determinant of yields before the crisis, the significance of treasury yields and other global factors is far more pronounced over the past few years leading to a sort of temporary "safe-asset-syndrome" for EM debt.
As another RGE note categorically states,
"On a structural basis, EM growth prospects and external balance sheets have worsened as export growth has stalled. Government balance sheets mostly look strong, even if there isn't a lot of stimulus capacity/willingness, but its the corporate balance sheets that may suffer the most from the combined slowdown in growth and higher financing costs (either actual or effective). Those high inflation/low growth countries will be most exposed to rising financing costs, which could undermine growth prospects further, holding back any reacceleration"
A round-up analysis in the FT has differing opinions on whether this is a "mini-bust" that will be handled easily or just a mild tremor and a harbinger of a bigger quake. We may not see as much "original sin" anymore but that doesn't mean that conventional macro-vulnerabilities have vanished into thin air. In all likelihood, they've been replaced by different combinations of variables spurred on by the accommodating global monetary regimes of the past few years.
And now that tapering talk has begun (never mind that there is no sign of short-term rates increasing or a favourable US employment picture), the downward pressure on bond prices in EM economies will increase. Accompanied by detrimental volatility in the markets, there will be lots of investor jitters before anything else.
As for some of the EM central banks, they might find a need to tighten monetary policy (or keep it tight) when it is perhaps the last thing desired, but something completely required.
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