India May Escape Brunt Of A Taper Tantrum, Says IDFC AMC's Suyash Choudhury
The U.S. Federal Reserve Chair Jerome Powell's signal that a tapering of asset purchases could begin this year left global markets undisturbed. Adequate telegraphing of the reversal in emergency policies and a clear distinction between slowing asset purchases and a lift-off in interest rates helped keep market sentiment undisturbed, according to Suyash Choudhary, head of fixed income at IDFC Asset Management.
The focus in the coming months, Choudhary said, will not just be on the timing and quantum of taper but also on what peak interest rates in this cycle will look like. For now, given the nature of stimulus being given to the U.S. economy, the market believes that peak rates will be lower than in earlier cycles, he explained.
Should there be taper-induced-volatility, India may be relatively protected. This, as the Indian economy is not "over-stimulated" and policy support has been nuanced during the Covid-19 crisis, said Choudhary. Weak foreign inflows into the Indian debt markets over the past few years, too, may prevent any sharp reversal. In addition, micro factors at play may continue to draw global debt and equity capital into Indian firms.
Watch the full conversation here and read edited excerpts below:
Markets believe Fed chief Powell's comments signaled a 'dovish taper'. Is that how you saw it as well?
What matters ultimately for global markets is whether their expectations with respect to the future of policy normalisation are getting met or not. There, to the Fed's credit, this time around the messaging is adequately planned well in advance.
The Fed has been preparing the market for some sort of taper to begin, although there has been a divergence in expectations on when it will begin. The Fed Chair's speech did not throw any adverse light on this expectation.
The other aspect which will probably soon gain more prominence is the current market expectation of peak policy rates in this cycle and when the actual lift-off begins from the Federal Reserve. The big dovish message from the Jackson Hole speech was in fact that there is very large difference between this and the taper actually happening, which is linked to substantial further progress on employment and inflation goals.
The chair noted that progress has been made on inflation goals and the actual lift-off is linked to the Fed's assessment of full employment and inflation being at 2% and well on course to modestly exceed 2%.
So, as of now that expectation remains intact, that the Fed lifts gradually, and that the peak policy rates in this cycle will be somewhat lower than that in the last cycle.
In subsequent Fed meetings, both these points will be of relevance. One is the taper schedule which probably is more a near term phenomenon. But, as let's say 2024 dot plots start to reveal themselves in Fed meetings, the market will also get some sense on Feds thinking on more medium-term policy rates in this cycle. Like I said, we think that will gain more prominence as far as market reaction function is concerned in the days ahead.
What is your thinking on how the taper period plays out for emerging markets and India in terms of capital flows.
EMs (emerging markets) as we all understand are no longer a homogeneous basket. So, previous attempts to keep them in some sort of a parameterised constant have actually not worked out.
To India's benefit this time around, there are quite a few factors that are noteworthy.
One, this time around India is not hyper-stimulated from policy. Broadly, people believe that the last year's and this year's fiscal stimuli have been nuanced. Neither has the RBI's balance sheet expansion been extremely aggressive, nor has it lost touch with convention to a very large degree. For example, most of the balance sheet expansion over the last 12 months has been via forex reserves growth, which is obviously good as far as any EM is concerned.
So, policy has not been overly stimulative. That is reflected in the fact that we are taking time to achieve pre-pandemic growth. Second, the current account is largely well behaved, which is the number one vulnerability in a global volatile environment.
Another aspect to also remember is that, unlike previously, FPI inflows into debt have actually been quite agnostic of India for the last three, four years. So it's not as if they have recently been building a very large position that could be subject to some sort of miss-footing.
The third aspect is that both at a micro and macro level there are a lot of levers that India is currently exercising to draw global capital, some of which are fructifying at micro levels. So, if you look at the company level, there has been debt, equity as well as FDI kind of money flowing in. At a macro level, hopefully with the disinvestment program now gaining speed and the asset monetisation or temporary leasing of assets program getting underway, there may be a capital draw in play. Although that doesn't take away the primary mandate that the current account deficit should be well behaved.
Fourthly, the starting point on forex reserves is quite decent although this is the weakest point in this argument because, for emerging markets, it's the flow of forex that would count more, not so much as where you started from. So, to clarify you're starting at $615 billion but suppose you start losing $50-$60 billion in a short period of time that would be of concern. Not that it is likely to happen, but that's the weakest point in this four-part argument. Primarily it has to do with the fact that we are not overstimulated, we are gradually getting round back to pre-pandemic levels and FPIs in debt have anyways been agnostic for some time.
In the immediate post-pandemic period, growth in advanced economies will be strong while emerging economies may take longer to recover. Will the growth-differential argument, which typically works in favor of EMs, be weakened?
One way this cycle has been quite notable is that economic realities at major blocks around the world are actually very different. In a normal boom-bust cycle, you would see a bust being followed by a revival and typically emerging markets reverting to trend more quickly. That is how the process runs in a largely synchronised fashion.
Obviously, there is some amount of synchronisation in this cycle as well but, for example, take the case of U.S., which is where the fiscal exceptionalism has been the highest. They've gone ahead and given 25% of GDP as a fiscal stimulus spread over around one-and-a-half, two years, which has led to a scenario where over 2021, their growth rate is probably four times their long-term trend rate of growth. Over 2022, it will be roughly two-to-three times their long-term trend rate of growth which is quite unprecedented. Which is why it has, if you want to call it that, upset the global analytical thinking apple cart in some way.
If you examine, and this is now quite speculative, but if you examine the U.S. fiscal stimulus in greater detail, a bulk of it is very short-term expansion aimed at revenue spending. So, it is basically some sort of fiscal transfers to households which, by definition, has very weak multiplier effects on growth down the line.
In the Indian context the RBI has put out studies in the past basically saying that revenue spending has very short multipliers of less than one year, while capital spending has stronger multipliers and more persistent multipliers. If you apply a similar framework to the U.S. economy, most of this spending would probably have very weak growth multipliers and also a significant portion as we know now is getting saved or used for de-leveraging.
So, you wonder, although this year and next year the growth profile is going to be quite robust, whether the debt being taken is commensurate in adding to the long-term potential growth rate of the system. This, in other words, and more simply, means that at least to us, there is a reasonable probability that by late 2022 or 2023, the U.S. system would have probably run out of a substantial portion of this fiscal field.
Obviously, on the other side, you may argue that fresh stimulus has been talked about, which is now aimed at infrastructure and therefore will have stronger growth multipliers. To be fair, those are being planned over longer periods of time and the net stimulus spending is weaker because a lot of that will be financed by the budget through some other measures.
Hence, although today, the growth rates of the developed world seem overwhelming, we are cognisant that a lot of it comes through a short burst of very large fiscal spending which probably has lower growth multipliers and the situation, let's say in 2023, may look quite different.
What we worry about, if at all, is in the short run, can the market expectation get dislocated, with respect to where the medium term rate hike cycle is going to peak? Although we don't think it's very likely but that's a tail risk. But we are more confident that as you step into late 2022, you will probably realise that most of the multiplier effect of this spending has faded out.
Therefore, the growth differential related EM flow, probably, is a short-term headwind. Like I noted before, India has some micro stories playing for them which are good draws for capital for India but over the medium term, I don't think that growth differentials have been meaningfully resent. At least that's our current hypothesis.
A few months back, there was real worry about rising U.S. bond yields and the implied tightening for other markets. That seems to have turned around. What's your thinking on how U.S. yields move from here?
We always get to appreciate that in hindsight, but markets are very forward looking. In fact, the peak policy rate expectations in the U.S. peaked out somewhere in March and April. Since then, if you see how much in rate hike expectations people are building-in by let’s say in 2023, that has stagnated.
If you see bond yields, they seem to have peaked out over there. One, this has to do with the forward discounting mechanism of the market. Two, data itself has started to turn slightly more mixed compared to the elevated expectations of the market. It's always about the actual versus expectation and the market had very lofty expectations with respect to U.S. data. Recent data has been patchier and more mixed.
That is not to say that we cannot have another reset shock. Like I said before, if there is one tail risk that we worry about it is that a mix of data reopening or inflation persistence for a period of time, leads the market to believe that the peak rates in this cycle are probably going to be higher than what is being discounted currently. If at all there is potential for chaos, it is from there.
Again, this is not a base case, it is a tail risk that we continue to think about from time to time. So, one hopes that the next three-or-four-months progress in a direction where market expectations don't get significantly nudged upwards with respect to peak policy rates in the cycle.
In this period, what are the policy mistakes for India to avoid?
The base case remains that there is no taper tantrum, but just to kind of examine the tail risk scenario.
In the case of India, obviously monetary policy has done a remarkable job. They have been analytically very clear through this phase; they have dispensed with data interpretation issues that have cropped up for the market from time to time and so far they have been proven right.
Now, if at all, the way we would think about this is that the overnight rate is at an emergency level and, analytically, even if there are further growth risks on the anvil, is it fair to continue to keep overnight rates at an emergency level that typically corresponds with un-modellable, huge downside tail risks to growth?
Today, most things are becoming more modellable and probably, in the realm of statistical significance, we can dispense with very large tail risks to growth. So, whether the 3.35% overnight rate is threatening to overstay it’s welcome is one thing that one has to seriously think about.
Probably, the next leg of RBI's framework development has to be around how the reversal will progress. For example, in his last available interview, the Governor has refused to speak about it because he says—why do you assume that we are on the brink of reversal?
But if you want to keep market expectations anchored when you take the next step you need to be able to communicate before that next step, what your reversal schedule is going to look like. Otherwise, the risk is that the market over reads into your relatively benign next step.
For example, what happened when the VRRRs (variable rate reverse repo auctions) were first announced this year. The governor was very clear in the policy statement that don't mistake VRRR as any attempt to normalise policy, which is a very welcome clarification for the market. But there are a number of steps that will need to get taken before you actually are in the realm of repo rate hikes. You have already started to basically de-facto step away from yield curve control and you are back to orderly evolution of yield curve control which is being seen in the gradual bond yield rises. And you have expanded the amount of VRRR.
One question on the markets’ mind is with core liquidity in the vicinity of Rs 11 lakh crore, how will your normalisation run? Will it be just an expansion of VRRR (quantum as well as tenure)? And then you can, at some juncture, start to hike the reverse repo rate? Or are you going to take durable steps to remove liquidity? Obviously, nobody expects OMO (open market operation) bond sales to the market, but MSS (market stabilisation scheme) bonds or something like that?
So, the question really is that when the next step is taken, whether there is a risk that market over-reads that. Therefore one has to lay out that framework well in advance.
The other point is, 3.35% is overstaying its welcome in some sense. Remember a bank is raising money at 3.85-3.90% for one year today. Housing finance and non-bank finance companies are raising at 4.25-4.30%. Now, reasonably whether that amount of accommodation for such balance sheets is required or not is something that one can always argue on.
So, we are in the realm of nuance. Obviously policy needs to continue to be accommodative, obviously we need to gently flatten the yield curve as the overnight rate starts to rise and, for those things to happen, a schedule or an analytical framework of how normalisation would proceed, is probably something that the RBI should now start to think about to manage the signaling effect of whenever the next step is taken.