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At the start of the year, we saw three global risks lurking the market; oil, trade war and global monetary tightening. These risks did play out for most part of 2018 and kept both debt and equity markets volatile. However, as we come to the close of 2018, some of the concerns appear to be ebbing at the margin or at least temporarily suspended.
Crude oil price has fallen sharply from US$ 85/bbl (during mid-October) to US$ 60/bbl in the span of a month. The US had successfully persuaded Saudi Arabia into increasing the supply, exempted eight countries (including India) from Iran oil sanctions (up until May), while there is a parallel improvement in output from the Russia, US and few other economies. In that regard, the upcoming OPEC meeting holds the potential for retaliatory supply cut and will be closely watched. Thus, agreeably, the current price fall is driven more by event specific developments than the underlying fundamentals and hence remains vulnerable to some reversal.
After nearly a year of trade spat, US and China held cordial talks at their recent summit meeting following the G-20 leaders’. They agreed upon temporary suspension of additional harmful trade actions and continue negotiations over the next 90 days with a view to deliver more tangible results. While the latest agreement cannot be considered a full de-escalation of trade tensions between the US and China, it pushes off the potential economic disruption that might have stemmed from the previously scheduled increase in tariffs at the beginning of 2019.
Finally, the macro data from the US as well as the recent commentaries from the US Fed officials signaled more gradual rate hikes than was initially perceived by the market. This in turn has also toned down the market expectations of the extent of US rate hikes.
Since 2009, the developed markets, particularly US, have largely outperformed the emerging markets. It has also been a narrow rally with technology companies as the main gainers. Since the financial crisis, US companies (as gauged by S&P 500) have given nearly US$ 8 trillion in buybacks and dividends, against the present market cap of US$ 25 trillion. Corporate profits as a percentage of GDP there are already at elevated levels. With a significant under-performance in equity market and currencies, emerging market valuations look more attractive. As flows turn positive for emerging markets, India, with its structural appeal may receive its fair share. However, it will have to compete against some of the other beaten down markets in Latin America, China, Turkey and South Africa that are witnessing positive political/economic changes. Particularly for India, politically heavy calendar for the next six months and prospects of large supply of equity owing to government disinvestment plans would have an impact.
The recent crude oil price led to some improvement in macro-economic prospects for India. Indian macro is deeply intertwined with crude prices. The current fall in crude price would lead to US$ 10 billion of savings in import bill in FY19 and hence a parallel reduction in CAD. On an average, retail petrol and diesel prices have fallen by Rs. 5 and 3 per liter respectively. It can fall by another Rs. 2-3 per liter from here on. This is positive for inflation both directly and indirectly (reduced pressures on core inflation). While headline CPI readings continue to surprise on downside, we must keep in mind that core CPI still remain sticky around the 6% mark and unusually low food prices strengthens the case for mean reversion. However, if the current dip in crude oil prices sustain, RBI could well scale back its policy stance to neutral from that of ‘calibrated tightening’.
From an external point of view, we believe that the Rupee/US$ is fairly valued at 70-72 and the recent appreciation captures further upside. Sentimentally, falling crude oil prices is beneficial given the presence of a large downstream eco-system, especially for the consumption driven sectors like paints, packaging, etc. FIIs have invested $ 1.5 billion in Indian markets (debt and equity), the highest pace of inflow since Jan 2018.
On the fiscal, there is unlikely to be a material impact due to fall in crude oil prices. At the time when FY19 Union budget was drafted, the government had penciled crude price expectation at US$ 65/barrel for the full year. On the contrary, Indian crude oil basket had averaged at US$ 75/bbl for first seven months of FY19. Assuming that it averages at US$ 65/bbl for remainder of the fiscal, it still entails a cost over-run of Rs. 100-150 billion.
While the crude price fall led to some alleviation in inflation, external and currency risks, the recent growth prints (Q2 FY19 GDP softened to 7.1% vs. 8.2% in Q1) coupled with challenges in the NBFC sector underscores some headwinds to Indian growth. Equity markets may have already priced in moderation in the growth momentum. In the near term, they will gyrate to the tune of political news flow.
On a more structural and long-term basis, one needs to be watchful of the adverse developments in the Indian domestic savings. Indian domestic savings rate at ~29% (of GDP) is one of the lowest amongst its Asian peers. Barring Philippines and Sri Lanka, all the Asian economies saved more than India when their per-capita income was around US$ 2000 levels. Even Vietnam and Bangladesh, with incomes lower than India, are saving more than India.
India’s overall domestic savings has fallen since FY11 (from 37.2% to 28.8% of GDP in FY18) owing to sharp fall in household savings (FY10: 26.1% of GDP FY17: 16.3% of GDP). The fall in household savings were being partly offset by the rise in private corporate savings that were deleveraging rather than coming out to borrow.
Over the past six successive years between FY13 and FY18 (estimated), personal consumption expenditure has outgrown household income. Not surprisingly, household savings have fallen from 34% of disposable income in FY10 to as low as 22% in FY17 and estimated at 21% in FY18. And the share of private consumption expenditure has increased from 56.2% of GDP in FY12 to 59.1% in FY18. Consumption can grow faster than income if a) households utilize their past stock of wealth, b) start saving less (thus gross savings fall) or c) resort to loans thereby reducing the net savings. Presently, it is the reduction in gross savings (both physical and financial) that is prime contributor to the overall fall in household savings.
Overall Net household financial savings at 7.2% (of GDP) is below the desired level of at least 8% level. With combined gross fiscal deficit at 6.5% (as of FY18), it leaves very less for private sector to borrow. Bank deposits are gradually losing its sheen as a channel for financial savings which is partly helping the demand for other products such as mutual fund, pension fund and insurance fund rise. Penetration of long-term financial products has been improving since last seven years, though it has still to attain the historic high. Investment in equity market saw a whopping rise to 8% of overall gross financial savings (vs. 2-3% seen in this decade).
Hence, the fall in financial savings as is primarily due to reduced traction of the bank deposits. Consequently, we are seeing the bank deposit growth moderate to ~9% vs. yester years trend of 15-16%. This is worrisome. The challenges in the NBFC sector have shifted the credit baton back to the banks. Banks’ Credit to Deposit ratio is already stretched at 77%. Further rise in bank credit would require banks to incentivize deposits (perhaps by raising rates). We may also see banks with excess SLR running down their government securities holdings.
Crude price fall and large OMO purchases by RBI this fiscal (Rs. 1,760 billion anticipated till December) have led to a 50-bps rally in bond yields since September. Looking ahead, market remain concerned about the shortfall in GST collections which is likely to be around Rs. 1 trillion. This keeps the fiscal risks alive even though given that it is mostly cash-flow accounting, the government may meet the stated 3.3% target. However, markets will be cognizant of this risk and G-Sec movement is likely to remain range-bound.
CIO – SBI Funds Management Private Limited
(Mutual funds investments are subject to market risks, read all scheme related documents carefully.)