Credit Suisse allays fears about currency crisis
Moneylife Digital Team 22 April 2013

The market is very positive on the fall in prices of crude oil and gold. Net effect on the currency is likely to be limited, as “all else” is unlikely to remain the same, according to the Credit Suisse report

Most India observers are concerned about the rise in India’s current account deficit (CAD).

That this is part of a global trend does not make it desirable, but makes it more sustainable. Since 2007, as developed economies have slowed consumption, emerging markets (EMs) have stepped into that gap, accelerating local demand: the expansion of India’s CAD and even its level are not as excessive on a relative basis. These observations were made by global investment bank Credit Suisse Equity Research in its India Market Strategy report.


For India, while “net oil” and “net gold” imports did rise, the bulk of the adjusted import basket remains non-oil/non-gold. Now, with domestic growth slowing dramatically, imports are slowing, and the investment bank believes that imports will fall further. Capital goods and electronics exports have the most potential downside (could correct by $25 billion over 1-2 years). Exports are also likely to improve, driven by pharmaceuticals, autos and agricultural commodities. The unconvincing part of the rise in exports in FY11 is now history, Credit Suisse believes.


While the market is getting excited by the fall in oil and gold prices, Credit Suisse is less optimistic about this: low oil prices also affect capital flows; and anecdotally consumers have already started “bottom-fishing” gold, offsetting at least some of the effect of lower gold prices on the currency.


The apprehension for several Indian investors is the potential impact on the currency ‘if’ capital flows slow down. The argument centres on the perceived circularity of capital flows and its impact on the Indian rupee. As the same argument can be spun from the positive side and given that any country with a CAD will have the same problem, this is a hypothetical concern: historically, in all but two years since 1991 portfolio flows have been healthy. In fact, across EMs FII equity flows have been quite stable, as there is a structural angle to them.


According to Credit Suisse, the bond market in India is maturing, with a growing and diversified pool of assets. However, allowing FIIs unfettered access to Indian rupee debt remained in the “no go” territory. Yet, in an overreaction, the government significantly relaxed these limits starting 1 April 2013. Over a period of time this should allow India to benefit from easy global liquidity: foreign holdings of Indian bonds on a relative basis are among the lowest globally. Yield-chasers who do not fear the rupee’s fall are likely to find Indian debt attractive: news reports suggest Japanese retail investors are now looking at Indian debt more constructively.


The rupee has been among the weakest globally over the past two years: the 36-country

REER is close to two-decade lows. The relative strength Year-to-date (YTD) is therefore not surprising, especially as it is part of a trend across EMs. Medium-term risks of over-reliance on foreign debt aside, a ‘crisis’ is certainly not imminent, according to the investment bank.


A potential stabilisation/minor appreciation in the rupee can drive inflation further downwards: global commodities in rupee terms are seeing the first decline in four years. While the Reserve Bank of India (RBI) is likely to stay concerned about elevated CPI (consumer price index) levels (around 80% is food and services), a sharp drop in the WPI (wholesale price index) and a falling CAD are likely to encourage the RBI to cut rates.


Rate cuts for most mean a risk-on rally: not surprisingly financials have performed the best over the past week. However, Credit Suisse disagrees on this, as rate cuts are driven by slowing growth, and particularly as the slowdown is not yet reflected in consensus estimates or valuations. 70% of the Nifty EPS growth in FY14 is expected from financials, materials and autos.


“We therefore flag companies with: (1) high interest costs but some stability in profits (Jaiprakash Associates and United Spirits), or (2) low P/E (high earnings yield) and defensive characteristics: NTPC, Coal India, HCL Technologies and NHPC,” said the investment bank.


For obvious and justified reasons most Indian observers are concerned about the pace of deterioration in India’s current account. As a result of nothing short of a dramatic deterioration in the trade deficit, the Current Account Deficit (CAD) in first nine months of FY13 has been at a record 5.4% of GDP. The increase in trade deficit has primarily been due to stagnating exports, whereas imports have continued to pick up.


While this is indeed of concern, Credit Suisse notes that since the global financial crisis, as consumption of the developed economies of the western world has slowed, that of EMs has been stepping up. Current accounts of most large emerging markets have deteriorated since then, and India is not the worst of the lot both in terms of absolute CAD as a percentage of GDP and the change since 2007.


One of the important reasons for the trade deficit expanding in the last three years was that India’s GDP growth remained strong and growth elsewhere slumped. While the slump globally seems to have stopped worsening, the dramatic slowdown in India’s GDP, and particularly that of consumption, puts downward pressure on trade deficit.


Much time and energy is spent on analysing India’s oil and gold imports. They are indeed an important part of India’s import basket. However, a meaningful part of the oil and gold imported by India is for re-export post value-addition. Once adjusted for petrochemical and jewellery exports, the contribution of oil and gold becomes less important. Further, with the economy slowing sharply and the increases in diesel prices finally transmitting the impact of high global crude prices, oil consumption growth has slowed to 0-1%. In fact, non-oil, non-gold imports have been falling YoY since July 2012.


Imports of capital equipment are down in the first 10 months of FY13 Credit Suisse expects them to stay weak for several years, somewhat similar to the trend seen in the last cycle. Similarly, while the much reviled electronics imports have indeed risen quite sharply, the investment bank does not expect them to be immune to the slowdown in discretionary consumption currently underway in India. Cell phones are almost a third of electronics imports, and in value terms high- /mid-end phones form almost a third of this. It is also noteworthy that cell phones globally are seeing ASP compression—a trend that should apply to India as well. Similarly, PC/notebook sales, a sixth of electronics imports, should also see price compression with steady volumes.


Slowing exports have also helped exacerbate the trade deficit, especially once we remove petrochemical and jewellery exports. Of this reduced set, engineering goods, agriculture and pharmaceuticals are 63% of exports—the share of textiles has been falling steadily.

While engineering goods exports have fallen so far, the unconvincing part of the rise in engineering goods exports two years back seems to have already corrected, obviating further correction: both exports of non-ferrous metals ($2 billion in FY10 to $9 billion in FY11, has corrected back to $3 billion), and of non-transport capital goods ($10 billion in FY10 to $20 billion in FY12, now $15 billion). Within engineering goods, exports of transport equipment (cars, two-wheelers, trucks, tyres and other auto components) continue to rise. Similarly, chemicals exports are likely to improve further.


According to Credit Suisse, exports of agricultural commodities have continued to rise, and are expected to hold up: this is a diversified basket, improving sustainability. The sharp fall in the rupee in the last one and half to two years has improved competitiveness (there is usually a lag in the economy reacting to it), and increasing awareness among farmers has improved surpluses that can be exported.


While trade deficits have indeed disappointed, lack of acceleration in ‘invisibles’ (trade related items that affect flow of currency but cannot be seen physically crossing the border—software exports, remittances, etc) has been as big a concern. On a four-quarter rolling basis growth has been tepid since the financial crisis.


There are three major moving parts to ‘invisibles’: software exports, remittances and business income—the first two are positive, as in they are inflows, whereas the third is an outflow—income repatriated from India by multinational companies (MNCs) in the form of royalties or dividends.


As the base of software exports has risen, and in particular as the BPO industry has slowed due to competition from other emerging markets such as the Philippines, growth of service exports has slowed. Credit Suisse believes that the rise of captive units, which effectively price their services in rupee terms, has also hurt growth.


According to the investment bank, remittances have also slowed of late, but over the past two decades their growth has rarely been in the negative territory for a long time. On the third element of invisibles, i.e. income repatriation, as multinational (MNC) companies have increased their presence in India, there has been a sharp surge: this trend is unlikely to reverse anytime soon, especially as there is a rapid increase in MNC activity, and in the royalties charged by them from their Indian subsidiaries.


The three parts put together imply a flattish trajectory for ‘invisibles’ in the coming quarters.

With trade deficit starting to narrow at the margin, this implies the CAD should start to shrink. Looking at data for 30 EM countries over the past 30 years, it is clear that the CAD does not deteriorate by more than 200 basis points for sustained periods (in 87% of the cases, in fact such a deterioration was limited to one year only) after increasing by more than two percentage points of GDP, India’s CAD is expected to narrow as well.


The market is very positive on the fall in prices of crude oil and gold. Given the frequent commentary on the country’s over-reliance on the two this is not surprising. The decline does help bring down CAD all else being the same. But the net effect on the currency is likely to be limited, as “all else” is unlikely to remain the same, according to the Credit Suisse report.


In particular, a fall in oil prices is likely to reduce the surplus generation in oil supplying countries, and that could affect some of the capital flows. The enthusiasm on the fall in gold price helping India is already being dented by the anecdotal surge in gold buying as consumers try to “bottom-fish”—so much so that some stores are running out of inventory.

This may not continue, and is likely happening because of the coming marriage season,

but does minimise the impact of the decline in gold prices.

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