India braced for a new era under Modi

Dear readers, it’s been a long while since I wrote a blog post and I must apologize for their absence. I have left my job at Credit Agricole CIB and will be moving from Hong Kong to Singapore to work for another bank. I am currently on gardening leave and am therefore not following market developments anywhere near as closely as I was until I start my new job at the end of June. Nonetheless, given the major events in India over recent days, with the victory of Narendra Modi and his Bharatiya Janata Party (BJP) in general elections, I felt compelled to write something.

Firstly the fact that the BJP won a landslide victory with 282 seats out of a total of 543 ensures that for the first time in decades the government in India does not have to be encumbered by a wide range of political beliefs and views. The consequent inaction a wide ranging coalition would have entailed would lead to renewed policy paralysis. As it is the BJP can form a majority government, with Modi able to emulate the successful reform policies he implemented in his home state of Gujarat while he was Chief Minister there. Being a Gujarati I can’t help but be caught up in the euphoria of what this could mean for India.

In contrast the Congress party and its leaders from the Nehru/Ghandi dynasty suffered a massive defeat, not only throwing them into opposition but shoving them to the margins in terms of political strength. Admittedly there has been a lot of money that has poured into Indian stocks and bonds over recent months but this does not necessarily mean that a BJP majority was priced in. On my last visit to India many of the clients I met actually thought that Modi may have been ousted while it was not felt that he and the BJP would be able to gain an outright majority. In the event he proved doubters wrong. In other words there is still plenty of scope for upside for the rupee and Indian stocks and bonds.

Now before we all get too excited a dose of reality needs to be brought into the mix. The “Gujarat model” was one of rapid improvements in infrastructure, reduction in bureaucracy and red tape and an encouragement of foreign investment. Clearly nothing in India is going to change overnight and adapting the model implemented in Gujarat, a state of 60 million people, to a country of over 1 billion people will not be easy. There will also be risks in terms of social tensions given the more right wing views of Modi and his party. Nonetheless, the strong mandate given to Modi by the electorate was for tough reform and this is what Modi and his style of government is best at.

There is little to time for a Modi honeymoon. The country’s bloated fiscal deficit, persistent current account deficits, elevated inflation, high indebtedness in some sectors, job market rigidities, inconsistent tax policy and masses of red tape and corruption, are only a few of the issues to contend with in a country with a wide spectrum of socio economic standing and religious views. Modi may also have to show some new secular credentials to ensure that his policies do not fuel sectarian tensions, something that may not come easy.

The hope among Indians and foreign investors is that Modi can once again push the economy back onto its fight and move to growth rates closer to 8-9% rather than 4-5% that the country under Congress rule has settled into. The selection of officials especially the Finance Minister will give important policy clues while ensuring that the well regarded central bank governor Rajan retains his post will help solidify confidence. Having been disappointed so many times in the past it is tough not to be skeptical but it may finally be time to throw caution to the wind and give Modi the benefit of the doubt. If anyone is up to the job it appears that Modi has the right credentials for it.

RBA on hold, RBI hikes rates

News of the death of Osama Bin Laden gave the USD a lift and its gains have extended for a second day. Extreme short market positioning as well as increasing risk aversion (perhaps due to worries about retaliation following Bin Laden’s death) have helped the USD.

However, the boost to the USD could be short-lived in the current environment in which it remains the preferred global funding currency. Indeed, the fact that US bond yields have dropped sharply over recent weeks continues to undermine the USD against various currencies.

The USD firmed despite the US ISM manufacturing index dropping slightly, albeit from a high level. The survey provided some useful clues to Friday’s US jobs report, with the slight decline in the employment component of the ISM survey to 62.7 consistent with a 200k forecast for April payrolls.

Ahead of the European Central Bank (ECB) meeting on Thursday hawkish rhetoric from new Council member and Bundesbank chief Weidmann (replacing Weber) and more reassurances from Greek and EU officials that there will be no debt restructuring or haircut on the country’s debt has helped the EUR although it is notable that it could not sustain a foot hold above 1.49. Eurozone bond yields have risen by around 20bps compared to US yields over the past month, a fact that suggests that the EUR may not fall far in the short-term.

USD/JPY is trading dangerously close to levels that may provoke FX intervention by the Japanese authorities. General USD weakness fuelled a drop in USD/JPY which has been exacerbated by a rise in risk aversion over recent days (higher risk aversion usually plays in favour of a stronger JPY). The biggest determinant of the drop in USD/JPY appears to a narrowing in bond yields (2-year bond yields have narrowed by around 20bps over the past month) largely due to a rally in US bonds.

Unsurprisingly the Reserve Bank of Australia (RBA) left its cash rate on hold at 4.75%. The accompanying statement showed little inclination to hike rates anytime soon, with credit growth noted as modest, pressure from a stronger exchange rate on the traded sector and temporary prices shocks which are expected to dissipate. The only indication that rates will eventually increase is the view that longer term inflation is expected to move higher.

I look for further rate hikes over coming months even with the AUD at such a high level. AUD has lost a bit of ground after hitting a high just above 1.10 against the USD and on the margin the statement is slightly negative for AUD. A slightly firmer USD overall and stretched speculative positioning, with IMM AUD positions close to their all time high, points to some downside risks in the short-term.

In contrast India’s central bank the RBI hiked interest rates by more than many expected. Both the repo and reverse repo rates were raised by 50bps, with the central bank governor highlighting renewed inflation risks in his statement. The decision reveals a shift in RBI rhetoric to an even more hawkish bias in the wake of rising inflation pressures, which should be beneficial to the rupee.

Financial Times Guest post: Rupee can serve as a reserve currency too

Please see below an excerpt from the Financial Times beyondbrics section in which I wrote a guest post about the Indian rupee.

Amidst the euphoria surrounding the internationalisation of China’s currency, the renminbi, attention on the Indian rupee appears to have fallen into the shadows. Admittedly China has been announcing new measures on the path to internationalisation almost on a weekly basis whilst India appears to have taken a more gradual approach, but it’s not too late for India to regain some of the limelight.

Perhaps it is surprising that the rupee is hardly talked about when discussing reserve currencies. The last BIS Triennial Survey of FX market activity revealed that the rupee accounted for 0.9 per cent (the same as the Russian rouble) of daily foreign exchange market turnover, which may seem small compared to the 84.9 per cent of turnover accounted for by the USD or 39.1 per cent by the EUR but is still ahead of many other developing currencies including China, which accounts for only 0.3 per cent of turnover. Moreover, India’s share of turnover has risen steadily from 0.1 per cent in 1998.

Read the rest at http://blogs.ft.com/beyond-brics/2011/04/14/guest-post-rupee-can-serve-as-a-reserve-currency-too/

Will India remain in the shadows?

Indian markets rejoiced in a big way following the outcome of the elections which put the secular Congress party back into power as the head of the United Progressive Alliance.   Stocks in India rose by a massive 17% and the rupee strengthened as markets gave a huge thumbs up to the outcome.   The margin of victory was bigger than had been expected and allows Congress to form a government with only minimal help from outside parties.  

Given that many had feared that the election would result in another unstable coalition supported by diverse parties each acting in their own interests,  the outcome was very positive.  In the event the result provides Congress with a strong mandate for change and reform.  The real question is whether they will grasp the opportunity or let it slip by and fall further behind into the shadow of China. 

There are of course many challenges that need to be faced on the home front including the alleviation of poverty for a huge chunk of the population, improving education, access to health care etc.   India also needs to move ahead with infrastructure spending, something which remains key to unlocking India’s potential growth and moving towards the pace of growth achieved by China.    As a comparison India spends around 6% of GDP on infrastructure spending compared to around 15% in China.   The results of such spending are obvious when looking at the pace of growth of both countries, with India growing relatively more slowly than China.

The issue is that even if the government has the mandate and the will to move forward with long awaited spending on infrastrucure, finding the money is the main problem.   The Indian government identified the need for $500 billion in infrastructure spending between 2007 and 2012 but the global financial crisis has seen a lot of potential investment disappear as banks bec0me increasingly strapped for cash and foreign investment shrinks due to lack of funding and an aversion to risk.   Restrictions on investments by funds that could potentially invest have also not helped whilst the government is limited in its spending by a huge fiscal deficit.    

The Congress party will need to grasp the opportunity that the election result has brought it and move forward to entice the investment needed to push forward with infrastructure plans.   One of the benefits of India’s slow pace of reform and gradual opening up of the economy is that the country has avoided the worst of the global economic crisis.  Even China will find it a huge challenge to shift its growth engine from export orientated growth to domestic consumption.  India is in a good position to take advantage of its relative resilience and now has a government with a strong mandate to do so.    It would be a great pity for India and the rest of the world, given the potential for the country to become a much stronger trading power, if the government did not take this opportunity by the horns once the celebrations are over.   If not, the rally in Indian markets may prove to have been a fleeting one.

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