Full Transcript: Moneycontrol's exclusive interview with JP Morgan's Jahangir Aziz

The rupee’s fundamental drivers remain that the current account is very well contained, says Jahangir Aziz.

In a freewheeling conversation with Moneycontrol, Jahangir Aziz, head of emerging markets economics at JP Morgan, highlights recent moves by RBI to revoke unrestricted access for Foreign Portfolio Investors to new 14-year and 30-year bonds as paternalistic. He highlights the need for India to tap into growth engines beyond public investment and explains why Trump 2.0 could spell challenges for India. Full transcript:

We also put out a report where we talked last week, where we talked about a rise in the recession risk. I think it is important to distinguish between the rise of a recession risk and the realisation of the recession risk. And the difference between the two of them lies in what policy makers or what does the government do in response to a rise in recession risk? We increased our recession risk profile because you've been seeing a labor market that has been very, very strong for a long period of time. There were always uncertainties about how long this labour market strength could last. Much of the labour market strength was being driven by very small businesses, businesses between one to 49 establishments. It was not the large firms. These small businesses, as in the case of India, face the same problem everywhere, which is that they don't really have that amount of cash reserves to delay layoffs, and if the earnings start falling or the cash flows turns negative, they almost immediately start shedding labour. So those were always concerns.

What happened last payroll was that you saw a gap down in the number of people employed. You saw the unemployment rate creep back up, creep up to 4.3 this is then, I would say, seventh or eighth straight month of increase in the unemployment rate. That’s not the reason as to why we increased our recession risk. First of all, the gap was probably because of hurricane peril, which, you know, reduced work hours a lot in the Midwest, most likely that's going to come back next month. And the increase in the unemployment rate is happening because the labour participation rate is going up, it is actually happening as a sign of a good thing, not a bad thing. So more people want jobs, which is why the unemployment rate is going up. However, there were two, three, probably granular points in that labour market report that made us increase our recession risk. So the first one was of, you know, a reasonably sharp drop off in wage growth. So wages that were running at about point three per month went down to 1.2 in addition to that. And the last bit, which is the number of months a person is unemployed before the person gets a job, actually lengthened. So people are taking longer to find employment once they have been fired and wage growth is slowing down, and this along with the fact that inflation in the US is almost entirely being driven by service inflation. So if you get wage growth lower, most likely service inflation will also come down, and therefore core inflation, or core PC, will start coming down. And it was the combination of these two things that made us increase the risk of recession. We are not saying there is a recession. We're just saying the risk is going up, and we need to wait and see what we do and with that, of course, we changed our Fed policy calls significantly.

So to figure out what the impact of the Trump presidency, particularly the tariffs, I think we need to first look at the baseline, right? So, in the baseline that we have, we do not expect these kinds of policies to move. As we were just talking about, we have a rise in recession risk. We have a significant increase in the rate cut call. So we now have the Fed taking rates from 5.50% to 3% by July of 2025, and because of the policy what you will actually get in the US is an extension of the expansion, rather than a truncation of the expansion. So in 2025 we are actually looking for an uptick in the growth rate in the US because of the policy actions taken in the second half of this year from the lows of the first half of this year. So it's actually a reasonably strong economy in 2025 rather than, as you're talking about, the US going into recession, right? So it is against this backdrop. We now have a separate risk, which is in the Trump 2.0 administration. Suppose they follow up on their threats of 60% tariff on China and 10% tariff on everybody else. Yeah, let's start with the 60% tariff on China, which is probably more likely than the 10% tariff on everyone else. So if indeed you have a 60% tariff imposed on China. Now there are lots of questions whether the legislative space that has been afforded to the president can be used to actually impose 60% tariffs on everything from China or any country. Because you know that that space may not be there. So setting that aside, suppose you impose a 60% tariff in China. The current tariff rate on average is about 17- 18% so you get about a 40% increase in tariffs. You have about, let's say, 15% you know, share of exports, that automatically means that, mechanically, you're going to get a 10 to 15% depreciation of CNY. So that's the first shock that hits India, and that's the first shock that hits the rest of manufacturing exporters. And if you go back to 2018 the average increase in tariffs was around 16- 17% and you saw a 7% depreciation of CNY, and you saw there was a significant drop in Chinese exports to the US. Some of the other countries benefited from it. India benefitted a little bit from it, not much. It was Mexico, Canada and Vietnam that took over that space, because they were not tariffed, right, okay, but Chinese share of global trade increased. It did not fall. And how did that happen? Because China went and used that 5-7% depreciation of CNY, it reduced prices on export goods and basically increased export shares elsewhere. Now, fast forward to a 10-15% depreciation of CNY. This is a war that is taking place between the US and China. China gets a 15% depreciation CNY, most likely in the tariff categories, Chinese exports to the US fall even more sharply, right? And then there's the other countries in the world, India, Vietnam, you know, Bangladesh, maybe in textiles, Canada, Mexico will benefit from it. There is China now, with the 15% more competitive currency going into export markets elsewhere in the world, Europe, India, rest of Asia, Latin America, Africa, and that's where it will increase its market shares. So it could again be a repeat of 2018 where the US imposes tariffs on China. Chinese exports to the US fall and then China gains market share globally by increasing the exports elsewhere. Okay, that is the impact. That's the first round impact of a 60% tariff on India. I'm somewhat surprised that even after 2018 much of the public discussions in India don't see that, that it's a massive comparative edge that China gets outside of the US.

The question is, so you buy your phone from China, right? Chinese earphones suddenly become 10, 15% cheaper. You then, as a consumer in India, would you want to buy that? Or would you want to go and buy something from an alternative source, which is 15% more expensive?

I do not see what exactly is the benefit of imposing tariffs on China, unless we also produce that product correctly, but we don't. In the first instance, as to why we are buying things from China is either because it's better quality or cheaper, yeah, or it's both, or we do not produce that. We do not produce lithium ion batteries. We do not produce solar cells. We do not produce, you know, carbon steel. We do not produce so many things that modern manufacturing in India needs, right? And we import them from China because they are either in quality terms or in price terms as the best place to buy things from.

The proof of the pudding is in the eating right? The proof of the pudding is that the trade deficit with China has risen, continues to rise, and Indian consumers and Indian producers continue to buy things in China. We have tried doing this tariff protectionism. We've tried stopping investments, etc, etc, or scrutinising investments. But the proof of the pudding is that the cost advantage is so large that until, unless we are able to produce at a scale and bring down prices to a point that we can compete with China, these kinds of tariffs, of protectionism. All it does is increase either the cost of production within China or within India, or the cost of inputs within India, or the cost to consumers.

India’s core inflation has been falling every month for the last nine months, there's been happening everywhere else in the world, too. And what, one of the key factors is that Chinese export prices have been deflating. They're deflating less now. They were running at minus 16% sometime in October and November of last year. They're running at about minus 4- 5% this right now. Our core inflation is coming down partly because of that, just as US core inflation is coming down. Goods inflation has come down because of that. So if you stop that by imposing tariffs, then the first thing that happens is the prices of those goods go up, and your nice core disinflation disappears.

In India's case, it is probably the most telling sort of variable which tells me that not only is there excess capacity in India, but that capacity is widening. Because it is not only that core inflation, it is falling. It is at its lowest point since this index was started in 2012 and so what does that indicate, in terms of our productive utilization, of our productive capacities. That there is a significant amount of slack where the slack is in the labor market. It is a significant and widening excess capacity, and you don't have to look far, even if you take CSOs recorded data, which is India growing at 8.2% real growth rate. And to compare it with what should have been our level of GDP based on the pre pandemic trend, we are about five percentage points below that, even with the 8% which is, you know, marred and significant statistical issues, Even if I take that 8% on face value, you still get a five percentage points gap between what the pandemic, pre pandemic path, growth rate, implied level of GDP should have been, and where we are. We are not closing that gap. That gap keeps widening.

So, I'll come to the consumption story a bit later, because that, to me, is a very absurd story that's floating around in India. Okay, but let me start with this. So look at the growth drivers of India, not just last year, the year before that, not just the year before that, the year before that, it's been just two drivers of growth, public infrastructure and services exports. That's it, right? Private corporate consumption, investment have flatlined . There isn't any other sector, manufacturing exports, is just skating water at this point in time, despite all of the effort to make in India, et cetera, there are only, literally only, two drivers of growth. There are services exports that are booming, and there is, you know, public infrastructure. So let's come to the budget. Now. What did the budget do for either of them? They just pushed more public sector infrastructure, right? So there is that. That driver of growth remains and the services sector is independent of what happens to the budget, right? It's being driven by relocation of again, you know, global back offices, back to India. We just call them global capability centres. But we are back to the same two drivers of growth, and that is the reason as to why we aren't able to deliver. We aren't able to remove that gap, that excess capacity doesn't go away. It is because it's the same driver of growth. The budget does not address changing those or broadening those drivers of growth. And if you do not broaden the drivers of growth, that excess capacity will remain. You're running just to stay at the same spot. The issue is that there is no broadening of the growth drivers of India.

We are not tapping into what drove growth during the pre- global financial crisis days, which is private corporate investment. Private corporate investment used to run around 16-17% of GDP. It gapped down back in 2012 so it's, you know, just after the global financial crisis, it gapped down to 12% of GDP. And since 2012 to 2024 for 12 straight years, it has remained more or less around that 12% of GDP. In the meanwhile, you know, public infrastructure spending has increased, both by the state, both by the center and by the state. Yet, and you know, we used to talk about crowding in investment, right? Some of the chief economic advisers brought that term to India. Where is the crowding in of investments taking place?

Private sector will not respond to exhortations and be pleased by the government, right? They're going to respond to commercial, commercial calculus, right? Why am I not investing because I don't see either externally or domestically, enough demand to support these large investments, I don't think that's the only reason I wouldn't invest, right? And in the last two years, the cost of funding has moved up. Cost of funding has gone up, not just in this specific cost of funding, but also foreign cost of funding, right? You are going to wait till that cost of funding comes down. but this obviously, is just the last two years. What about the last 10 years? In the last 10 years, we didn't have the cost of funding this high. In fact, the cost of funding was almost zero. I mean, if you look at us, you know the cost of funding and why didn't the why didn't the private sector respond at that point in time? We always run into these ad hoc sort of causes. Well, the banking sector was in terrible shape. The balance sheets of banks and the balance sheets of corporations were in terrible shape. But then the balance sheets of banks and the balance sheets of corporates have been repaired and why isn’t the private sector now responding? The private sector responds when there is prospect of sustained higher growth rate, and therefore the prospects of sustained higher earnings. That's the first thing.

So this is where I think we have sort of been almost addicted to a particular view about India, right? So the view about India starting from the 1950s is that India is chronically a supply constrained economy. India's problem is that India does not have supply right, whether, that is, you know, in agriculture, whether it's in manufacturing, and the telltale sign of that that India runs large current account deficits. Because you are demanding more than you can supply, and therefore you have to run current account deficits. Right? You are buying things from abroad. That's the story.And therefore the focus of everything in India needs to be in increasing supply. And part of that increasing supply is that we need savings, right, and to generate investment. And therefore consumption is bad, right? That is, that is how we have seen India. The problem with that storyline, at least in the last 20 years, is that you take away oil imports, and India has been running current account surpluses. If you take away gold, which should not be there, because gold is actually being imported, and we put it into the current account, but it's actually a capital investment, right? I mean, I'm sure that some people use gold for, you know, jewellery for the sake of consumption, but most people use it as a store of value, and therefore it should be treated as a capital outflow and not an import. But we so you take out gold, you take out oil, India has been running sustained current account surpluses. India has been a demand starved economy and remains a demand starved economy and the demand shortage comes from both investment, which we talked about, which has been flatlining at about 12% of GDP, and consumption, which has probably worsened in the last two, three years. And a lot has been talked about this consumption puzzle. And I keep finding one news report or one op ed being written in the newspaper about the consumption puzzle wise, growth 8% and consumption only 4% right? Well, no one consumes out of GDP. You consume out of real income, what do you earn? Yes. So India's nominal GDP was 9.6% last fiscal, right? India's CPI inflation was 5.5% assuming that there was no change in the distribution of income between corporates and households. Households income also rose at 9.6%.

Their price increase was 5.5%, real income was 4.1.Real consumption was four. That's exactly what consumers and households should be doing. They did exactly that. India's consumers did not behave strangely. Over the last two, three years, their real incomes grew by four, four and a half percent. Their consumption grew by four, four and a half percent. They did exactly what they were supposed to do, but to me, the obvious answer is that, well, you consumed. Your real consumption was 4% because your real disposable income grew by 4%.

So I would say the first one is clearly a big challenge, which is that, why isnt real income growing, right? And it's not not clear because we don’t really have very good data. So, you know, I have no sense, because there is no data, right? If you go to, for example, to China, where there is more, better data, much of the slowness in the disposable income hasn't come because wage growth has slowed down. It is because their investment income has slowed down significantly, right? And there's obvious reasons as to why investment income is slow. In the case of India, I don't know that, right? I mean, I don't have data, because the government doesn't, or the RBI publishes data almost about your year and a half later. I think that one needs to understand whether this is happening because wage growth is slowing down. You know, the Klem data that shows, shows the opposite, right? You know, wages actually have gone up. So, you know, there's a lot of contradictory data to what is, you know, broadly perceived about India, right? Okay, I think the biggest concern to me is, or not. Biggest concern to me, the biggest sort of warning sign to me is that, if we take the official labor market or official employment data, whether this is the official plfs data or the new data set that the RBI has put out, the Klems data, right, which shows a very large increase in employment. Correct? Yes, and this is where you can't have your cake and eat it too. If you believe that the growth of 8% has delivered you these many million jobs, then you take one and you divide it by the other. So you take GDP and you divide it by employment to get labor productivity, you're going to get labor productivity at its lowest we have seen over the last 15 years. It is arithmetic. This is not economics or magic, right? The new numerator is GDP, the denominator is employment. You take the official numbers both, and you get labour productivity at its lowest in the last 15 years. And then you ask yourself, so what is the point of having this expansion of digital infrastructure and other physical infrastructure, if India is becoming less efficient. And I think that there is obviously some truth to it, there are massive differences between, you know, the white collared, high skilled services sector and the rest of the country, right?

The Rupee’s fundamental drivers remain that the current account is very well contained, and that you have a reasonable gain, you know, I'm leaving aside what happened last two weeks. You are seeing a reasonable amount of portfolio investment, and FDI has stepped down, as I said, because of US, interest rates are that high, and there is a reasonable chance that once US interest rate starts coming down, when the Fed starts cutting, you are probably going to see a better flow of FDI. So on a fundamental level, I don't really see the rupee actually being under weakening pressures, right? Most likely one would argue that, given the amount of reserves that they have, etc, it should be on a modest appreciating pressure. The biggest challenge with the rupee will be Trump 2.0 And a consequence of Trump 2.0 is that CNY is going to depreciate 10 to 15% and that starts getting priced into the market. In November, the market is not going to wait for the actual action to take place. Then the rupee, along with all other Asian currencies, comes under major pressure. I think instead of focusing that much on dollar- INR, we need to focus on what's actually happening with CNY, that's where our biggest competition is.And that is where the next risk is going to hit. Dollar - INR will be the consequence of what happens to dollar CNH, and therefore to what happens to CNH-INR. And I said, it's not just INR, it's what every other Asian exporting manufacturing currency will be facing. On the growth outlook, like everybody else, we're looking at some slowdown taking place, because the global economy is slowing down all of that. And there is a Trump 2.0 risk. What happens to growth in 2025 almost entirely depends right now on how we see these tariff wars unfolding. If there are no tariff wars, US, most likely will be in a better position if the rate cuts come through, and with that, export services of services in from India will be supported if the government has fiscal space public infrastructure will be done, and then those two drivers get strengthened, and therefore Indian growth, yeah, it might slow down a bit, but recorded growth will probably be somewhere around that 6.5- 7% level.

The clients that I speak to, both corporate clients and financial investment clients, haven't really been massively perturbed because the Hindenburg report came in, or what is happening right now. So, yes, it's a conversation that happens in New York, in London. It's a conversation that is, you know, you refer to it once in a while, but I don't think I, at least not in any of the conversations that I've had, is that a central piece of that corporates' or that financial institution's investment decisions, so, you know? But I think regulations and regulatory authorities' behaviour is always something that you know, clients, at least, investors, both corporate investors as well as financial market investors both focus very, very closely. The RBI decided that they are not going to include the 14 year and the 30 year bond issuance in the access, in the free access that has had an impact. This is central. Why did the 14 year and the 30 year suddenly be removed from the access route? Right? What was the logic behind it? Similarly, questions about the SEBI and probably even the RBI were also concerned about the expansion in the equity derivatives market in India, and that it is putting consumers and small investors in harm's way, right? And therefore, you know what Indian regulators mostly do? Go back to the paternalistic instincts, and now are thinking about putting in curbs and protection in that market that clearly will have an impact. That was a massive expansion of a very much needed derivatives market. Right? Derivatives are misused. But that is not the reason as to why you stop the derivatives market. The reason why you want to have a derivatives market is because a large number of people actually have a very significant portion of their savings and now invested directly or indirectly in the spot equity market, right? And therefore they need to be given an instrument to ensure against volatility.. And that is why we have the options market. We have the futures market, right? If you're going to take away that insurance, or the ability to insure against volatility in the spot market, then again, you are exposing these people, the small individual investors directly to the vagaries of the spot market . It's exactly the same as saying, well, people are misusing car insurance, therefore, let me ban car insurance.? But that doesn't mean you want to curb that market. Do you want to stop price discovery in that market? You want to make this market illiquid, right? You don't want to do that, right? So this does more damage than good. Actually, it raises this question. It raises questions about the regulatory framework and the regulatory philosophy of both RBI and SEBI, because these things are being done on an ad hoc basis, right? You must have a regulatory framework and regulatory philosophy. That philosophy and the framework needs to be transparent, well understood by everyone, so that when an event happens, investors are able to figure out that, based on this regulatory framework, what is the regulatory shift that will take place and not get surprised on an ad hoc basis, suddenly being told, well, the 14 year and the 30 year is gone. All I'm saying is that these are being done without any, any sort of transparent discussion of what is SEBI's regulatory philosophy ? What is RBIs regulatory philosophy and framework?

There hasn't been that clarity. There hasn't been that philosophy. We thought we once knew what that framework was, but the actions taken have been the opposite. Instead of deepening markets capital markets, they are making capital markets shallower. Because philosophy was that we will now move towards every step that RBI or SEBI will take to deepen markets, right? That's not what they are doing.

You can watch the full interview here