Downside pressure on EM currencies to stay: Morgan Stanley

Downside pressure on a lot of emerging market (EM) currencies, including India, will remain for a while, says Manoj Pradhan, Global Emerging Market Economist, Morgan Stanley. For pressure on EM currencies to ebb, Fed tapering needs to happen after a quiet some time, China needs to rebound for more than a quarter or two, among other things, he says.

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According to him, the first thing emerging market analysts and investors should look out for is whether the US growth story is driven by capex. Because if it is then the question that needs to be asked is - which EM is in a position to satisfy US capex demand? The answer is very few, maybe Korea, Taiwan, but this is really a story that benefits Germany and Japan, he adds.
He feels Fed tapering will happen sooner rather than later. He says, right now it’s a coin toss for the October or the December meetings because it is a matter of how much data the Fed wants to see. Below is the verbatim transcript of Manoj Pradhan's interview on CNBC-TV18 Q: The rupee after the big fall that it saw, it went to levels of 68.85. Just in the last few trading sessions it seems to have consolidated around 61-63 mark. What is your take on the Indian rupee now and is it still open to a run?
A: It is difficult to think that the worse is over. The downside pressure on a lot of emerging market (EM) currencies of which India is a club will remain in place for a while. To think that the pressure is off EM currencies quite a few things have to change. We'll have to think that the Fed is not just on hold for few months now but for quite a long time and to see that we would have to see data get much weaker, ofcourse it is a possibility but not our base case.
Second thing that would have to happen is China would have to have a rebound that will last for more than just a quarter or two, that is not our base case either so given that story.
The only thing that remains to be seen is a large surge in terms of two things. One, something that Chetan Ahya has noted very carefully along these last few months and quarters is that the real rate environment is changing, to allow that to be filtered into the Indian economy, but also to have the structural reforms story that made us both constructive on where the India story was going for a while. Q: What has confused the market is that when exactly will Fed taper take place because the expectation was that it will happen in December maybe even in the next calendar year but off late the conversation or the voices coming our of few Fed president’s indicate a possibility of even taper happening in the October policy – when according to you it will happen?
A: Before we get to Fed, it is more important to talk about the underlying macros which is a part of Fed’s reaction function and for that our base case is that we are now at an inflexion point for the US economy.
Even if one looks at the first half of the year what has been encouraging in many senses is that the drag on growth from the fiscal side has still managed to generate overall growth which leads us to believe that private spending underneath is quite good. That is the one that we expect to come to the fore more importantly and capex is likely to play an important role going ahead.
With that in mind, we are looking at 2014-2015 numbers that look quite good, the range is somewhere in the 2.75 percent which is one of the best we could have expected given the stage of the business cycle we are at and with that in mind it is difficult for us to see the Fed keeping off tapering for too long. Right now its a coin toss for the October or the December meetings because it is a matter of how much data the Fed wants to see and if the data does soften and if our expectations of growth are not realised, then we are looking at a slightly different set of outcomes whether it is short-term or long-term really depends on the quality of the data rather than any kind of an abrupt level. Q: In that sense do you then think that the emerging markets are open to maybe other route of selling when tapering finally comes through?
A: First thing emerging market analyst and an investor should look out for is whether the US growth story is been driven by capex. Because if it is it is simple question- Which EM is in a position to satisfy US capex demand, very few, maybe Korea, Taiwan but this is really a story that benefits Germany and Japan so, unlike past cycles where better US growth led to strong consumption and that consumption story dominated EM external demand and hence current account has improved. If the capex story is one that drives growth going forward then we have got a problem because that does not translate into EMs exports. However the real rates will rise.
We have already seen a large move up in real rates. So thinking of another sharp move up really depends on how strong the data is. But maybe something that we may see more gradual grind up for the rest of the year. We are looking as a house of flat profile for the ten year.
The last point is, if one is going to look at the US part of the story, if that is not benign for you, and one wants to defend oneself – unfortunately one has to take some pain on. So, if your exports are not improving, then the one thing that the domestic economy has an option of doing is allowing the real rate story to rise and take more pain on the domestic demand side.
There is one interesting example from Poland which has told us that if the delta of current account is what investors consider a benign direction then one is not as much at risk. Q: What about the current account deficit trajectory for India given the rupee deprecation which is helping exports and the already falling trade deficit that we have seen for June-July-August – is the delta on the current account deficit for India satisfactory and hence will it prevent another run in the currency?
A: There are two ways to look at it. Is the export story really rising and we have seen an uptick in China and Korea and one will see it over some other parts but is it rising enough by itself to improve the current account. Second, the summer market reaction that we have seen will clearly lead to weakness in growth. But is that happening soon enough or whenever the next rise in real rates come to convince investors that current accounts are moving. These are questions that yet need to be resolved.
The other issue on CAD is that people do want to see current accounts being put to productive use. One of the things that Poland and things that Mexico have been positive is that people do expect productivity to rise over there and they expect investment to rise and if that is the kind of saving, investment gap one has which is equal to current account then one generally tends to get sell-offs, but one tends to get rallies much faster.
For example, one may see weakness but that weakness prompts people to buy into ones long term story. Ultimately, it still comes down to ones absolute basic which is to tell investors and convince them that one does have a macro story that is worth buying into. I don’t think India is anywhere close to that story at the moment. There is a lot of convincing that has to happen to encourage foreign investors take a positive view.