'Pressure on Asian currencies will continue'

The rupee’s slide against the dollar has sent the markets in a tizzy.

Sanjay Mathur, managing director and head of economics research for Asia Pacific (ex-Japan), Royal Bank of Scotland, tells Business Standard that in the emerging market pack, India needs to learn lessons from Korea and Taiwan, which have managed their economic situations well.

The case for buying into emerging markets equities, especially those in India, is getting weaker by the day, he adds.

Edited excerpts:

The risk-off trade in the global equity markets is partly due to what is happening to currencies, especially in Asia. Do you expect more pressure on Asian currencies over the next few months?

I think the pressure on Asian currencies will continue.

The fundamental issue we have in the markets right now is there is a shift in the way the US Federal Reserve (US Fed) is behaving.

There is a change in its philosophy.

There is growing fear that at some stage, the withdrawal of quantitative easing by the US Fed is on the cards. QE withdrawal is not that negative per se.

A rise in rates in the US is not new for us.

But what used to happen in the past was risk assets in Asia were positively co-related with rising US rates; the reason was higher US rates meant the US economy was strong and it would give other economies tailwinds in terms of exports from Asia.

Unfortunately, at this point in time, the US economy hasn’t quite reached the velocity by which these tailwinds could come through.

On the domestic front, we have, by and large, exhausted fiscal and monetary policy measures through which we can expand.

Real interest rates have been low and credit growth has expanded sharply. In terms of fiscal policy, we seem to have hit the edge in India and Malaysia.

The QE withdrawal is happening at a time when there is a question mark over growth in Asian economies.

The earnings momentum is decelerating and the cost of capital is rising, which has put us in a very tight spot.

So, where and when does all this stop?

Well, it will stop when because of the US economy, there would be an improvement in Asian economies and exports.

That would be a turning point for Asian currencies.

However, it is difficult to put a time frame to this.

Is the world economy on the brink of being pushed into a full-blown crisis? Is the ‘India story’ over for foreign institutional investors?

I don’t think the world economy is on the brink of a disaster.

It is true emerging markets now account for a larger part of global output and demand.

However, we cannot arrive at this conclusion. I don’t think EMs would grow at the pace they used to earlier.

The case of India is more of a man-made story.

The domestic policy agenda hasn’t been advanced.

So, one can expect some chinks in the armour.

The last 18 months have been strange, given the widening current account deficit and the lower industrial output, amid rising inflation.

I think going ahead, the CAD would be milder, but that would only bring the economy into balance.

The next challenge would be recording higher growth that would entice foreign investors.

Do you believe the case for buying into emerging markets equities, especially in India, is getting weaker by the day?

Yes, it is getting weaker by the day.

For a long time, there was a degree of disbelief that things could go wrong in India.

There was a belief that even if the policies went wrong, Indian companies were very versatile.

This particular hypothesis, never questioned earlier, is now being challenged.

India Inc’s leverage levels have gone up, amid sagging sales and weakening pricing power.

So, we need a fundamental shift, both at the policy level and at the corporate level.

What levels can one expect the rupee to be at in the near-to-medium term?

Though the measures have so far proved futile, these haven’t been completely ineffective.

We need to understand this is a dynamic strategy.

Until now, I felt there was an effort that somehow, there would be enough steps to ensure the stability of the currency and protect growth.

Now, it is getting clearer and clearer that one cannot allow the currency to weaken without impacting growth.

There has been a shift in the thinking to stabilise the currency first and then look at growth.

As a result, the policy response from the Reserve Bank of India and the government has been a three-pronged attack.

The first was to deal with gold; the second to increase the carry-adjusted return of investing in the rupee and the third to improve the demand-supply balance for foreign exchange in India.

But the real question is how forceful are these measures?

I don’t think RBI would have known how much the rupee could slide.

I think RBI is learning by the day, and would need to fortify the same measures.

Is there a solution to the problem? Where does the fall stop?

It is a dynamic situation and it is very hard to predict where all this would end. Fundamentally and based on the current and expected CAD level, it does appear the rupee is at a fair value now.

It should mildly recoup some of its losses.

I don’t think there would be an appreciating trend that would fall in place, as we need better growth conditions for that.

But certainly, there is a case for being more positive on the rupee’s trajectory.

In case a currency depreciates, the realised depreciation is more than what one always thinks it is.

Do you think policymakers have failed to deliver on economic reform policies, as most of the measures adopted so far have been ineffective? What could have been done differently?

I think the response could have been more forceful.

We have reacted with a delay.

Particularly, inflation management could have been done better.

On the gold front, for example, I don’t think we are trying to cap jewellery demand.

Gold jewellery is a natural cultural thing for us.

What has changed over the last few years is gold has also taken on the additional role of an investible asset class.

This, in turn, added another $20 billion to our import bill.

The real deposit rates, too, were negative.

Had we taken care of that, we would not have had such a situation.

Now, we need a more forceful measure to overcome all this. I think over the last few days, there have been such measures.

We also need growth and confidence of India Inc.

We cannot have a situation where Indian companies are always actively scouting abroad for opportunities.

The growth of the Indian MNC (multinational company) is a landmark achievement.

We should have carried out reforms, not on foreign direct investment, but simple things such as policies on land acquisition, mining and overall governance that need to change.

Which markets/economies could do better going ahead and why?

I think there are countries that are likely to do well in the EM pack.

In north Asia, Korea and Taiwan are certainly good stories.

The countries with the least imbalances are the ones that holding up reasonably well.

It is also true if the US recovers, Korea and Taiwan, at an aggregate economic level, will feel the benefits first.

China, too, would gain, but it is a large economy, with a significant domestic demand component as well.

Are there any lessons to be learnt for India on how Korea and Taiwan have managed their overall economic situations?

Yes, I think there is something to be learnt. First is fiscal prudence.

We all have to learn when to put in policy stimulus and when to withdraw it, not on the monetary side but on the fiscal side.

Second, when the crisis was over, we should have retracted to stabilise the fiscal position.

However, we did not do that.

On the contrary, we continued with excise duty cuts, expanded the scope of Mahatma Gandhi National Rural Employment Guarantee Act, etc.

We should have known what to do.

Third, in terms of improving overall productivity, not much effort has been made.

One cannot have infrastructure-related issues lingering as a bottleneck.

Do you think India’s sovereign rating downgrade could be a reality?

I think the downgrade could be a reality not because of the currency, but the falling growth.

Currency fluctuations come and go; I don’t think it would impact the sovereign rating. The CAD, in my opinion, would improve.

On the fiscal side, I am a little more hopeful. I think the government recognises the situation we are in.

The government did a good job in January-March, in terms of a complete crackdown on expenditure.

I think it would be forced into that if its wants to maintain fiscal stability.

Where the situation has become dire over the past few weeks is people are talking of India going to the International Monetary Fund.

This, I feel, is too far-fetched an idea right now. Just because the currency has taken a beating does not mean one becomes an IMF candidate.

What are the implications of a downgrade?

Well, there would be a second round impact on the currency.

That said, our assets are already trading as if a downgrade has happened.

So, I don’t think the impact would incrementally be much worse.

FOMC (Federal Open Market Committee)’s minutes have not given us any guidance on the tapering-off plan. What is your expectation from the US central bank?

I think they (US Fed) would wait for a signal that the labour market has strengthened further.

They might want to assess the impact of rising mortgage rates on housing demand.

Of course, the housing numbers announced recently were very strong.

So, while there is a commitment to end the bond-buying programme or gradually start tapering it, it should start by the end of this year or next year. I don’t think it would be a radical shift.

How bumpy has the road to recovery become for India Inc? By when do you think a recovery would start being reflected in the financial performance and stock prices?

I think the road has become extremely bumpy now.

It requires a very strong and concerted effort and response, in terms of policy; and, it is not the monetary policy, but the real reforms.

Given all that and assuming everything falls into place, the earliest you are looking at is the second half of 2014-15, when it would be reflected in the performance of companies. Profitability parameters of companies have deteriorated.

So now, the corporate sector, coupled with policy underpinnings, has made the overall situation more demanding.

Are there any pockets of strength or opportunity for investors in the equity markets or would investors be able to buy stocks cheaper in the next three months?

Avoid resources, banks, building materials and the automobile pack. Look at safe bets such as pharmaceuticals and information technology where some benefit has already accrued.

Image: Sanjay Mathur ' Photograph, courtesy: Business Standard