Jun 24, 2013 08:22 AM IST | Source: CNBC-TV18

Mkt to fall another 15-20%; rupee at 63/$ possible: Experts

Industry experts see worse times for the Indian economy. They expect the Sensex and the Nifty to fall by another 15-20 percent and the rupee may touch 63-65/USD levels.

The global markets had a terrible week with the Dow Jones losing 5 percent, Nikkei 19 percent, Nifty, European markets and emerging markets (EMs) lost 10 percent. The currencies in the EMs like India witnessed a five percent fall.

Industry experts told CNBC-TV18, things are likely to get much worse ahead. Bhanu Baweja, of UBS expects the Sensex and the Nifty to fall another 15-20 percent from the current levels. He anticipates the rupee to touch new lows of 63 or 65/USD levels. Baweja also foresees a ratings downgrade for India given the macro economic meltdown.

Samiran Chakraborty, of Standard Chartered Bank expects India's gross domestic product (GDP) to feel more heat as the crash in the rupee could create a panic in the economy. One should not be surprised to see rupee touching 63/USD plus levels ahead, he added.

However, Richard Gibbs of Macquarie Securities believes that emerging markets will see a revival by November 2013.

Below is the edited transcript of their interview to CNBC-TV18.

Also read: Global mkts in selling exhaustion mode; Nifty may fall 3-5%

Below is the edited transcript of their interview to CNBC-TV18.

Q: There has been a 10 percent evaporation of value across asset classes, bonds, commodities, EMs, developed markets. Is the hype created by liquidity over now? Will the markets now settle down? Will more selling happen across asset classes because probably our estimate of global growth itself has to be lowered?

Baweja: Over the last 10-12 years, there were two major forces in the global economy that underpinned every asset class. One of these was the secular decline in real interest rates in the US; the risk-free rate.

The second was the firm entrenchment of China in the global trade and manufacturing sectors. This, especially post China's privatisation of their property market.

Both these forces underpinned the dollar, the surge for yield, EM equities; every asset class that you can think of.

Both these forces are now at a very mature stage. In fact, US real interest rates are now turning up even before the Fed became hawkish. The 10-year rate in the US, the real rate in the US began to go up. Admittedly, we haven't seen that yet in EMs.

So there is at the margin a slight tightening of monetary conditions in the US. But we have not seen the growth improvement; certainly not in emerging markets. As these 10-year trends mature, a lot of the baggage is going to be compromised.

The bulk of this baggage is in the form of short dollar positions, in commodities that is financing the commodities, bonds and equity market trade in EMs.

The slowdown that we are seeing in EM today is not cyclical. It is a structural slowdown because the deleveraging in the developed world will continue for sometime.

EMs' growth model has effectively been broken because you are not able to export at 25 percent any more. That has been replaced by the domestic credit. That is fine as we managed to survive and keep growth going from positive 5 percent to negative 5 percent.

But, in the process, there has been weaker trade balances, current account balances. The currency has come under pressure. That is the weakest link in EM and is radiating further to other asset classes. Indian equities could be vulnerable from here.

Q: This week's fall was all round; without any discrimination between developed and emerging markets; stocks, bonds or commodities. After this funds will become more discerning. In that second round which asset classes will they favour? What will be the hierarchy of favoured assets?

Gibbs: We can probably see 3-5 percent more decline in overall valuations as asset markets come back to more credible and solidly based valuations. One reaches a point when the liquidations and the capitulation if you like and then those investment funds are then searching for investment and to be redeployed.

The issue for emerging markets is not that they won't be redeployed. They will be. But that will happen in the United States (US) where the growth potential looks like being more attractive and the yield potential from those stocks in particular also looks like being more attractive in the near term than what we are seeing in many emerging markets.

Q: How much fall are you expecting in emerging markets (EM) as an asset class? If discriminated between asset classes, and emerging markets, where will steep falls in equities and currencies be seen?

Baweja: The most vulnerable asset class is at this minute forex and equities. Not so much of Indian debt but EM debt is giving negative returns year-to-date. I would prefer debt over equity or forex even today.

EM has a strong balance sheet relative to the developed world. The debt trade in EM should do reasonably well because EM does have credit worthiness. However for the equities and forex trade to do well good income statements are needed.

EM has very ordinary income statements. Their earnings per share (EPS) growth is lower than EPS growth in the US despite EMs growing at a gross domestic product (GDP) level faster than the US. So, that is not translating the headline GDP growth into better EPS growth.

EMs are not as efficient in terms of their costs as the developed markets are. That is why they can underperform. So, in terms of asset allocation within emerging markets, debt is still a preferred asset class over equities. I certainly feel that way about India.

How much further can we fall from out here? Equities in EMs can certainly go another 10-15 percent more from here. It is not a question of after 15 percent they would be fairly valued.

A positive catalyst for emerging market equities to go up now is needed. Europe hasn't really begun to rebound – it has stabilised. The US is indeed rebounding but you have not seen better import numbers in the US.

Q: When do you see EMs re-emerging as attractive asset classes? Will it be by the year end or will it be after another 5 percent of decline? Which of them are likely to look attractive?

Gibbs: We will see some attractiveness come back around November 2013 when a capitulation and redeployment initially into the US of those investment funds happens.

Investors will look for solid domestic demand and where growth would be seen in the corporate sector's earnings and expansion in domestic demand. That obviously places markets like India in very good stead.

India is principally a domestic demand-driven economy. The economies that would be lower down the spectrum will be those that are trade exposed which were production driven and trade oriented.

The reason for that are the reflation policies at work in the global economies such as Japan. That is putting on going pressure on exchange rates. Many of those trade exposed economies particularly in Asia but also in Latin America.

At the bottom of the spectrum now will be a lot of the Latin American economies as they are looking like growth will become less buoyant. There will be some financial issues to be addressed and that is going to raise the risk premium on those markets.


Q: You just said that EM debt will not be badly affected but equities and forex will be impacted in India. Over the last six to seven weeks, there has been a flight of foreign institutional investor (FII) capital from Indian debt. Equities has relatively seen perhaps just about USD 500 million of flight. Will more FIIs be pulling out? How much worse can it get for the Nifty and the rupee, if you can put some percentage to it?

Baweja: Since January 2012, about USD 39 billion came into the equity market. Since 2010, India has been the single largest recipient of foreign portfolio capital across all EMs.

Most of these people have not factored in the dollar-rupee trading above 60. So, rupee earnings have been weak and dollar earnings have been very weak. Domestics have been selling in India and foreigners have been buying many of these folks who have come in over the last two to three years. Many of these have come in this year are not deep in the money.

In fact, many of them would be suffering because of the currency. Even if they have made the right choices in terms of security selection, the currency would be hurting them.

The risk of an equity market sell-off and an FX sell-off in India becoming a vicious cycle is not a small one. 60/USD is not far away at all. So it is very possible that dollar-rupee trades above 63 perhaps towards 65 and along with that Nifty and Sensex drift down about 15-20 percent from out here. That is certainly possible.

But, if foreigners continue to pour into India; growth and investment cycle, and exports rebounding in India my opinion will change. Focus squarely on gold and oil imports, duties on gold imports; nobody ever speaks about exports. Exports have been weaker across EMs including India.

What about the competitiveness of EMs? EMs needs weaker currencies to gain competitiveness. In a world where income effect is as weak, currencies will need to move more to be able to secure that competitiveness.

So, we are not done at all. The risks of a messy move between equities and FX, one that builds on each other is high.

Q: You were there in the market in 1998 when on January 15 the Reserve Bank of India (RBI) had to respond with a 2 percentage point rise in cash reserve ratio (CRR) and repo. Do you think a scenario where you have to go all out to protect the currency could happen yet again?

Chakraborty: It is a difficult question. As of now RBI has not shown serious effort to stem the currency depreciation as long as the move in INR has been more or less in line with other EMs. So, this whole theory of relatively market determined exchange rate has gained prominence.


From there to a situation where we will be taking extraordinary steps to stem currency depreciation in my view is quite a long way off. Since we have a high current account deficit (CAD) a relatively depreciated currency is needed to bridge that gap.

At the same time, would accept the current policy making circle this is accepted wisdom. So, I am not expecting any significant measures or extraordinary measures to stem this depreciation at this point of time as long as it is because of global factors.

Q: Bhanu was speaking of a sizably more depreciation yet to come in the rupee or at least possible in the rupee what is your sense? Do we still need a seminal amount of correction in the currency, 63 probably 65?

Chakraborty: This move from 55 to 60 has primarily been on the back of bond outflows. We haven't yet seen any significant equity outflows.

So, if on the back of this quantitative easing (QE) tapering fear, a bout of equity outflows is seen then it is quite possible to see 63 plus levels on the rupee. It will not be surprising.

Q: Can things come to a pass because of probably what looks like a run on the Indian currency? The Reserve Bank of India (RBI) will be even forced to raise rates?

Baweja: It certainly is possible but because things are looking a little uncomfortable right now, let us just keep it in perspective. This is not a balance of payments (BoP) crisis in EMs.

BoP crisis are ones where your frontend rates go to 40 percent or 60 percent because of massive capital flight. There has been some selling but India has been only conspicuous for the lack of selling that you have seen so far.

Just in the last week, some selling was seen. But the staggering part is the amount of inflow that India has seen over the last 3-4 years. This is more than any money gone into any other emerging market.

In the last three or four years, India has seen more money come into itself than it has done all the way between 2000 and 2010. So, we are just about beginning to see some outflows.

It is not fair to start thinking about BoP crisis and major rate hikes right now. Certainly, if the equity capital leaves on mass which is possible in India and given that you have a major savings investment gap in South Africa, Turkey; these are exactly the kind of places where central banks may have to react with their monetary policy to stop currencies falling out of bed.

So, as far as Samiran says, the RBI doesn't seem very keen to do that. Bank Indonesia has already done that. RBI has not spent most of its reserves and can certainly spend of that money before it goes into serious rate hike.

So, is it a possibility that RBI hikes rates? Absolutely - India needs foreign capital. If foreign savings begin to leave India then India will need to incentivise foreign savings to stay and that requires rate hikes.

India has tried to entice foreign savings coming in various ways of announcing reform over the last 9-12 months. Some of them worked. But most of that faltered to deceive.

So, there is a greater risk that capital leaves and is a possibility that we start pricing in more rate hikes from the RBI in the frontend. But again; this is not a BoP crisis. India can come under severe strain. Look at your frontend and backend rates. Things are pretty stable.

Q: About 63/USD and 65/USD has a very good possibility for the rupee. What does this do to GDP? It takes a while before a depreciated currency can bring growth in terms of an import protection and even much later perhaps export promotion. In the meanwhile it can be a destabilising force. Do you see Indian GDP rates getting downgraded at least for the next 12 months?

Chakraborty: It is quite a possibility. The first impact of sharp exchange rate depreciation is simple panic. We are now in the grip of that panic. In the corporate world, there is uncertainty. So, either the importers or the exporters are not in a position to respond to take advantage of this currency depreciation.

So that panic can setback business decisions which were impacted by a negative sentiment all-around. I am slightly worried that this could have an impact on GDP.

The other way that could come is if this depreciation leads to a different trajectory for the inflation which was coming down off-late.

And that forces RBIs hands and we don't see any further monetary easing over the course of the year. That rules out another channel through which GDP could have got boosted.

The third thing; it could have an impact on worsening of the fiscal situation too. This could be on the back of the depreciation and the consequent effect on the GDP. So, from all these aspects there could be a negative effect, so that remains a big risk on GDP for this year.

Q: One can draw up a fairly ugly scenario; six months down the line – we could be completely wrong. But there could be greater political uncertainty after the elections if the currency is at 65. We will have some fairly debilitated balance sheets in India of several big companies and therefore of banks. In the context of all this, if a Food Security Bill; which now looks imminent, could we be reaching a rating downgrade?

Baweja: Yes, almost certainly. India should have been downgraded sometime back. It is spectacular how it managed to avoid it. The Indian policy makers have done a fantastic job of selling the idea of reforms whether or not we have actually seen the reforms.

A downgrade can be seen and it should already have been seen in India. All the promised reforms have either been too slow or have not arrived at all. Many people came in to this market because they thought commodity prices were falling.

The main commodity price that matters for India is energy and that price is not falling. So, there will be pressure on the external balance. In twin deficit terms, India is going to remain along with South Africa and Turkey amongst the worst places in EM.

Those exactly are the places you downgrade when the wave of capital begins to leave. That happens and when you adjust the risk free rate in the global economy; which slowly is going to happen in the coming quarters. So, I think India is a prime candidate for a downgrade.

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