Post Fed tapering, it'll be a tough for emerging markets fundamentally, says Richard Iley, Chief Asia Economist, BNP Paribas. He expects the developed markets to continue to outperforman, particularly the US moving forward.
Also Read: India better prepared to deal with Fed tapering: FM
For India, he believes, Q2FY14 numbers were a little better than what he had expected. He says this puts full year FY14 growth at 4-4.25 percent. He had earlier expected growth to be around 3.7 percent. However, he says there are quite a few roadblocks to growth, such as the disappointing industrial production data, among others. He expects pressure to gradually mount on the rupee too. "We are looking for a dollar-rupee rate of about 66 by the middle of 2014," Iley told CNBC-TV18.
He feels if US fundamentals continue to gain strength and India's macro fundamentals remain as challenging and there is no breakout election result, whatever shape or form that takes, there will be risks to the downside for the equity market over the next six months or so. He feels RBI will hike rates in its January policy.
Below is the verbatim transcript of Richard Iley's interview on CNBC-TV18
Q: The Federal Reserve's confidence on economic growth in the US markets raises the possibility of liquidity flowing back into developed markets rather than emerging markets and within the emerging markets as well India has featured at the bottom-rung of the ladder. How do you approach emerging markets now? Do you believe there could be a risk of the liquidity tap getting switched off?
A: There is some risk of that. Clearly last night's decision by Federal Reserve is an important staging post. It shows that after much speculation over the summer the US Federal Reserve is now beginning the long process of normalising US monetary policy that is consistent with the very slow improvement in the fundamentals of the US economy, though the Federal Reserve now has the confidence to begin this, albeit in very slow measured fashion.
Fundamentally we are going to be in a tougher climate for emerging markets. We are going to see more of the same outperformance by developed markets, particularly the US moving forward. Very noticeable the equity markets really cheered that decision last night by the Federal Open Market Committee (FOMC), even though it was somewhat of a surprise. The key for the US equity market is the fact that the Fed has signalled that it will go relatively slow. It intends to pullback its asset purchases at a measured pace and any hike in the Fed funds rate is still some way off.
Q: You have about the lowest growth forecast for the Indian economy among economists, when I last heard it was 3.7 percent. Are you still looking at such a bearish note or do you think we may have troughed out at 4.4 percent in the first quarter?
A: The Q2FY14 numbers were a bit better than I thought. That means we are now probably on course for the full year FY14 growth of around 4-4.25 percent. I think what is very clear is that there are still substantial headwinds to Indian growth and to be fair RBI acknowledged this in its statement yesterday which was quite candid about the growth risks. If we just look at some of the incoming data that we have had, very disappointing industrial production data for October with the Year-on-Year growth in negative territory. That shows that Q3 data is going to struggle to show any pick up and may fall back again.
Also key surveys which is what I envisaged to you last time such as the PMI services survey still really at levels we have not seen since the immediate aftermath of the global financial crisis back in early 2009, add in the fact that I think there is no scope for any boost from fiscal, if anything, departmental spending is going to have to be tightened towards the end of the year then it is still a very challenging growth environment.
Q: How should an India investor approach the Fed tapering in terms of expectation of fund flows into India? Obviously because the US economy is growing well it is the US exposed economies in Asia that will be higher up in the pecking order. India would not be up there. How would you gauge fund flows and therefore what would your view be on the rupee? Is it a slow depreciation in 2014?
A: Certainly I would expect pressure to gradually mount on the rupee. We are looking for a dollar-rupee rate of about 66 by the middle of the year when these type of pressures will probably reach their maximum, so I think a slow depreciation in the rupee probably makes broad sense. What has been very noticeable really on the fund flows is the extent to which foreign flows into the Indian equity market have revived, they have very strongly despite that challenging growth backdrop we were discussing a moment ago. The macro fundamentals really have not improved and again to quote from the policy statement yesterday financial conditions have tightened over the summer. I still think we are yet to see the full lagged impact of that.
That is one reason why Dr. Rajan decided to take a timeout or pause in hiking rates yesterday. My concern is that this hot money coming into the equity market is really chasing a potential game changing election result next year and my fear is that it may prove chimerical. So if we continue to get better news on fundamentals in the US, if India's macro fundamentals remain as challenging as I think they were and we do not get a breakout election result, whatever shape or form that takes I think the risks are very much to the downside for the equity market over the next six months or so.
Q: What do you think the trajectory of inflation will look like as we head into the end of the fiscal year? Do you think we are on for a rate hike in the January policy?
A: I do very much so, yes. Clearly the RBI decided to pause yesterday in the hope which I suspect may prove forlorn that we could see a decisive pullback in Consumer Price Index (CPI) inflation as soon as next month. Certainly there is some anecdotal evidence that vegetable prices are pulling out, but when we run through our models we find that base effects from last December are actually quite challenging. There was a seasonal pullback in fruits and vegetable prices and also protein source food prices were pretty muted December last year.
Our sense is we are not going to see any radical improvement in the CPI numbers, just a gradual drip down, we are still going to be in a double digit territory for several months to come. Any improvement, both on the headline and the call measure will be very slow. I think we are going to see further rate hikes, at least one, maybe two more and when we get those inflation readings in the middle of January RBI may well decide to pull the trigger before the next scheduled policy review on 28th.
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