India: prepared, not immune

Transcription

1 Economics India: prepared, not immune DBS Group Research 16 December 15 Ahead of the impending US rate hike, foreign sentiment is under watch Improvement in India s current account balance has lowered reliance on hot-money flows Foreign reserves have risen, but are low compared to regional peers, especially compared to external debt Rising non-government external debt remains a point of concern Any stress on external debt obligations could aggravate domestic leverage ratios Markets put the odds of US rate lift-off this week at over 7%. A 5bp hike is thus largely priced in but guidance on the pace of normalization next year will dictate market reaction. The US dollar has gained on these expectations and Indian markets are unlikely to be immune to volatility. In the run-up, the Indian rupee has fallen to a two-year low against the US dollar and equity markets remain under pressure (Chart 1). Implications Indian markets were volatile back in 13 when the US Fed signaled tapering of QE purchases. This time around, the Fed is at the cusp of tightening policy, though at a slower pace than in the 1993/94 and 4/6 hiking cycles. Risks of a stronger dollar accompanied by a rise in US real rates are under watch. If this materializes, India will face pressure on a) current account funding needs Chart 1: Equity price action vs USDINR s, Index USDINR (reverse) 3 58 Chart : Short-term US rates inch up on hike expns % pa % pa Jan-14 Jul-14 Jan-15 Jul-15 SENSEX - rhs USDINR (rev) - rhs Y UST yields - lhs Y UST yields - rhs 1.6 Jan-15 Apr-15 Jul-15 Oct Radhika Rao (65) radhikarao@dbs.com 1

2 and b) weakened external debt profile. India s current account balance has improved significantly but reserves remain low and debt high. FY15/16 current account deficit will stay below % of GDP for the third consective year Rising FDI flows provide stable source of financing Low commodity prices have improved India s terms of trade, which should help keep the current account deficit below. for a third consecutive year. A past IMF study pegged India s sustainable current account deficit at a range of , based on assumptions [1]. In nominal terms, the deficit has shrunk from USD 88bn in FY1/13 to USD 8bn in FY14/15. Funding needs have accordingly moderated, with net FDI at USD 33bn in FY14/15 sufficient to fund the current account gap on its own. In other words, the basic balance of payments (current account deficit plus net FDI) continues to improve. The basic balance recovered to 1. in 1H15 from -.% in 14 (Chart 3). Given the recent relaxation in FDI ceilings in insurance, banking, construction, defence and civil aviation etc., inflows are expected to strengthen. The emphasis on ease of doing business coupled with the government s efforts to forge deeper international ties will also be a shot in the arm for investment flows. Moreover, foreign holdings of government bonds is capped at 5% of the outstanding issuance (INR terms), limiting exposure to hot-money flows. With higher FDI providing a more stable source of financing the current account gap, reliance on short-term flows has eased. This has provided a cushion against external volatility. Higher FX reserves act as a buffer... The Reserve Bank of India remains concerned about US interest rate normalization and this has prompted the bank to focus on building a stronger foreign reserves buffer and maintain macro-stability. Capitalizing on the favorable market environment, the RBI has absorbed capital inflows and rebuild its foreign reserves. Reserves bottomed at USD 75bn in Aug13 at the worst point of the US taper tantrum and were up to a record high of USD 355bn by Jun15. Since then, effort to contain rupee depreciation has trimmed the reserves stock by USD 3-4bn. This is a modest fall compared to the nearly USD 8bn increase over the past two years. India s import cover (reserves vs months of imports) at 8-9 months is higher than the global norm of 3x and consistent with the 3-7x seen across most developing countries. Chart 3: Basic balance of payments improves USD bn Jun-9 Jun-11 Jun-13 Jun-15 Basic BOP (CAD+FDI) (RHS)

3 Chart 4: India's reserves are small vs Asian peers 1 1 Chart 5: India's international Investment position 5 Liabilities * 4 ID IN SK MY CN TW SG *effective reserves (incl forwards) 3 1 Assets Reserves Others (incl 1 s-t trade credits/ loans) Portfolio Inv Direct Inv However, despite the sharp rise, the reserves stock is low compared to the Asian counterparts (Chart 4). At 16, India leads only Indonesia at 11%. Most other countries holdings hover at 3%-5. Quality of the reserves build-up is also debatable as we discuss below. Reserves are higher but so are liabilities Persistent rise in total external debt is led by rising nongovernment debt Higher reserves but higher liabilities too Although foreign exchange reserves have risen, India s foreign debt (and other liabilities) has also risen. Liabilities have primarily taken the form of higher foreign portfolio investments (up USD 5bn in Sep13-Jun15) alongside increase in short-term credits and offshore borrowings. Non-resident deposits are also up another USD 16bn, receiving a hand from the RBI s concessional swap arrangement in late-13. This has left India s net international investment position (NIIP) in the red (Chart 5). The NIIP widened from USD 63bn in Mar7 to USD 366bn in Mar15. On the assets side, reserves amounted to USD 343bn by Mar15. But this is counterbalanced by a sharp rise in liabilities in the form of portfolio inflows at USD 8bn and short-term credits worth USD 83bn. Additionally offshore loans also climbed to USD 177bn by Mar15, which cumulatively surpass the foreign reserves stock. In sum, even though authorities have focused on building buffers against external headwinds, its composition could be at risk if the global environment worsens. High non-government external debt is a cause for concern A stronger dollar and / or rise in real rates will hurt economies where reserves are low or debt is high. While India s foreign reserves are rising, they remain low relative to external debt. Back in 1, external debt [] was fully covered by reserves. But by Mar15, external debt had risen to 1.4 times reserves. As a share of GDP, debt rose from 18% to 3% over the same period. Encouragingly, short-term external debt is manageable. At 5% of foreign reserves, short-term debt is consistent with ratios seen in other Asian countries. However, based on residual maturity (the part of total debt that matures within one year), it accounts for more than half of the reserves. In addition, the rising share of non-government external debt is a concern. While government external debt has been stable at 4-5 since FY8/9, the share of non-government obligations is up from 13 to 19% in FY14/15. This rise is also responsible for the overall increase in external debt. 3

4 Chart 6: Domestic leverage ratios - government and private sector Private sector - domestic credit Government debt Source: World Bank, IMF, RBI, DBS Group Research Digger deeper, the biggest and fastest rising component of the non-government/ private sector debt is external commercial borrowings (include bank loans, notes and bonds raised overseas etc.). These have grown by two and half times since 8 in dollar terms and now amount to 8. Currency swings and higher US rates could see unhedged foreign obligations emerge as a pressure point for the economy. Thankfully, moral suasion and regulatory tweaks have led to an increase in the hedging ratio to 39% of the total foreign currency exposure by Mar15 from 15% year before, according to the RBI. The INR has appreciated 13% on the real effective exchange rate basis since 14 Rising external debt could aggravate domestic leverage ratios This increase in offshore borrowings is set against a backdrop of rising private sector domestic debt and a stressed banking sector. Private sector debt ticked above 5 last year from 35% in FY4/5 (Chart 6). Higher corporate leverage and tough economic conditions, in turn hurt the banking sector, pushing up NPLs and restructured loans to 1-11% of total advances this year. Any signs of additional stress in external debt exposure could aggravate domestic leverage ratios. A recent IMF study also echoed these concerns [3]. The Fund cautioned that economies like India, along with other select EM peers face high FX leverage. Debt-servicing capability was also assessed, under which any shocks to borrowing costs and earnings could see India s median ICR (interest coverage ratio) weaken further from already low levels. The Fund estimated that around 6% of total corporate debt would be at risk if FX, interest and earnings shocks were dealt simultaneously (unhedged exposure). Rupee to remain under pressure Like most emerging market currencies, the rupee is vulnerable to higher US interest rates. We believe the INR will follow a managed depreciation path into 16, driven by a stronger dollar bias and domestic developments (see Economics-Markets-Strategy 1Q16, 1Dec15). This case is also strengthened by our long-held view that sharp INR appreciation on real basis will see the authorities tolerate bouts of rupee weakness against the dollar (Chart 7, next page). The need to preserve competitiveness and support the Make in India manufacturing push will be a priority, whilst ensuring that the inflationary impact is contained. 4

5 Chart 7: USDINR vs Real effective exchange rate movements Index=1, 13/14 USDINR (rev), mthly avg REER USDINR (rev) In sum The Indian markets are at a better starting point ahead of US rates lift-off than they were back in 13. However, if the normalization cycle is accompanied by a stronger dollar, higher real rates and / or a bout of weak foreign sentiment, India s unfavourable external debt profile would emerge as a source of concern. Notes: [1] IMF working paper, Assessing External Sustainability in India ; 1999 [] RBI: US dollar-denominated debt is the largest component of India s external debt at two-thirds of total debt, followed by the INR, SDR, JPY and EUR [3] IMF, Spillovers from dollar appreciation, 15 Sources: All data are sourced from CEIC Data, Bloomberg, government, RBI and international agencies. Transformations and forecasts are DBS Group Research. 5

6 Recent Research Qtrly: Economics-Markets-Strategy 1Q16 1 Dec 15 Holiday Heresies 16 7 Dec 15 ID: manufacturing still a drag 3 Dec 15 CNH: billion dollar baby 16 Nov 15 EZ: will more QE help? 4 Nov 15 Rates: regional rates rundown Nov 15 FX: monetary policy divergences intact Nov 15 Rates: UST Curve - the next flattening leg 3 Oct 15 JP: deciphering the BOJ 3 Oct 15 ID: no room to cut 1 Oct 15 IN: the lowdown in exports 9 Oct 15 SG: technical recession 6 Oct 15 SGD: a lower policy band 6 Oct 15 CN: resolving the known unknowns 5 Oct 15 G4: who s winning the currency wars? 5 Sep 15 IN: RBI another window opens Sep 15 Japan s go global experience (3) 1 Sep 15 SG: mandate for inclusive policy 17 Sep 15 Qtrly: Economics-Markets-Strategy 4Q15 1 Sep 15 Triangulating Asian Angst: the US, China 7 Sep 15 and the 97 question CN: the need for institutional reform 1 Aug 15 SG: when China devalues Aug 15 TW: the impact of yuan devaluation 19 Aug 15 IN: inflation remains key 6 Aug 15 IN Gilts: greater foreign ownership mooted 4 Aug 15 IDgov bonds: Y sector looks attractive 31 Jul 15 JP: Japan s go global experience () 9 Jul 15 IN: harnessing demographic dividend 7 Jul 15 CN: fiscal reforms to accelerate () 4 Jul 15 SG: slowest growth in six years 9 Jul 15 CN Rates: stock market woes driving 9 Jul 15 onshore/offshore divergence Greece: near the tipping point 6 Jul 15 ID: investors staying put 6 Jul 15 VN: Asia s latest electronics spark 1 Jul 15 Japan s go global experience: implications for 3 Jun 15 China SG: watch core inflation 16 Jun 15 Qtrly: Economics-Markets-Strategy 3Q15 11 Jun 15 IN: weak monsoon a risk 8 Jun 15 CN: the AIIB to test diplomatic skills 4 Jun 15 Rates: the rise in global yields where to now? 5 May 15 TH: still climbing Sisyphus Hill May 15 IN: time to deliver 1 May 15 KR: what will the AIIB mean for Korea? 19 May 15 Asia: breaking new new ground 11 May 15 CNH: Q expansion heralds next stage of 6 May 15 capital account liberalization SG: saving manufacturing 17 Aug 15 Greece: the clock is ticking 4 May15 Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. 6