Interview with Executive Director, UBS Investment Bank
Edward Teather, executive director and senior economist, UBS Investment Bank, tells Puneet Wadhwa that if agencies do downgrade India's rating, it will be a reflection of the adjustment in macro factors that has happened, rather than a precursor to a further movement. Excerpts:
As we approach the US Federal Reserve meet later this week, what do you think the outcome will be and what are the likely repercussions on developed and emerging markets (EMs)?
We are expecting the Fed to announce a tapering of its quantitative easing programme and expect this to start from October and run through until the middle of 2014. Any clarity the Fed gives investors should calm the markets.
What is the amount of tapering you expect?
About $10 billion a month. Since the current bond buying is around $85 bn a month, the entire taper could easily take eight or nine months to wind down.
How much have the markets discounted these events?
The expectations we have for bond yields coming to the end of this year in the US is around 2.5 per cent. As the US 10-year treasury yields are a tad above that, the markets have more or less priced in the taper. The question mark, of course, in the medium term is the degree of uncertainty around that event and whether or not the US Fed allows the market greater certainty after its meeting. If there is an element of uncertainty, the risk premium could remain elevated.
Is there a silver lining in terms of how Europe, China and Japan's economies are shaping? Could they be the next growth engines for the global economy over the next two-three years?
We can't be certain for the next two-three years but the incremental news flow we have is significant in terms of Europe. Leading economic indicators there are positive. We are not talking about booming growth indicators but a shift from negative outcomes to positive outcomes. This is important for Asia's export market.
Is there more pain in store, especially for India, grappling with its own set of macro economic and political issues?
Most of India's issues revolve around the current account deficit, which means the combination of consumption and investment spending is outstripping the funding available domestically. Thus, India has to borrow abroad. This deficit is not going to go away completely in a hurry.
Is the worst behind us as regards the rupee?
Though it is difficult to forecast, a level of 65-66 to the dollar is our standing projection. One way to forecast a currency is to take into account the rate of inflation in the country, relative to its trading partners.
When we do this for India, we find the real effective exchange rate has moved close to multi-decade lows. That means Indian exports have become more competitive on the one hand, while imports have become more expensive. This also makes Indian assets cheaper for foreign investors.
Thus, all this put together, implies India might need less financing and, hence, foreign investors will be more willing to invest. We are comfortable with the currency at the current levels but this has to be taken into context, with the Reserve Bank of India keeping interest rates high and the government doing more to raise fuel prices.
Within the EMs, can you highlight which markets/economies could do better and why?
Within Asia, UBS' Asian equity strategy and economics teams believe with an improvement in Europe and slowing of the credit cycle, which has supported Asian growth, especially Southeast Asian and South Asian growth in recent years, the exporting economies and plays will do relatively well;. Whereas, more domestic plays and economies will not perform quite as well. That would leave us more optimistic on North Asia in the immediate future and a bit less optimistic on Southeast Asian economies.
Do you think EMs are on the brink of a currency crisis, given the recent trend and failure to stem the rout? Or, is the worst behind us?
One thing that stops us from arguing there is going to be a currency crisis is when we look at the foreign exchange (FX) reserves and, particularly, these reserves relative to short-term external debt i.e payments to be made within the next year or so. The good news here is that FX reserves are higher in almost every country as compared to the short-term external debt.
This gives us some comfort, that while currencies might fall further in the Asian, Southeast Asian or Indian context, policymakers are in a position to provide liquidity such that the decline in currencies does not get out of hand or reach an extreme level. So, we argue against the currency crisis theory, on the basis that there are still some favourable FX reserve stocks in Asia.
Most rating agencies have been warning India time and again regarding a rating downgrade. How close are we to a sovereign bond issue, sovereign rating downgrade and approaching the IMF (International Monetary Fund) for assistance?
Because of the FX reserves, we don't think there is any need to approach the IMF now or in the near future. We also don't think India will be rushing to do a sovereign bond issue. On the ratings, it is clear that India's macro economic position has deteriorated in recent years and the CAD has become wider. The government has had to work hard to manage the fiscal deficit close to its targets, amid slowing growth. All these things will typically make a rating agency concerned.
On the other hand, what would make rating agencies more comfortable would be the central bank raising or facilitating a rise in interest rates and the government continuing to work hard in keeping the fiscal deficit in check. So, a rating downgrade is by no means guaranteed as of now.
But it's also the case that rating downgrades tend to trail market price movements. So, even if India does get a rating downgrade, it will be pretty much a reflection of an adjustment in market prices/macros that has already happened, rather than a precursor to further movements. So, once rating agencies do make that decision, it is likely the markets would have already discounted it.
What are your forecasts for CAD and GDP (gross domestic product) growth for India?
We currently have a forecast of 4.7 per cent for GDP growth. I think the economy will be a tad better next year. The standing forecast we have is 5.7 per cent (GDP growth). As regards the CAD, I have some sympathy for the government's target of $70 bn or 3.7 per cent of GDP. I think the degree to which interest rates have been raised and the degree to which the government is likely to work on meeting its fiscal target and the degree to which you can see domestic demand growth has already slowed will all help that target to be met.
Of late, there have been policy decisions on removing some bottlenecks in infrastructure projects and perhaps a kneejerk reaction to stem the rupee's fall. Where has India gone wrong and what more could have been done?
I think the point here is the administrative bottlenecks clearly grew in recent years and the government has moved within the current administrative framework to remove some of those bottlenecks. From the economist's perspective, the answer would be to streamline the number of permissions required or the regulations that need to be adhered to. This is beside some effort to limit the contradictions within those regulations as well. This is not to say that one should go light on the standards one applies to projects but the amount of red tape and regulation must be brought down.
Are there any pockets of strength or opportunity for investors in the equity markets, as things stand? Or will investors be able to buy stocks cheaper in the next three months?
One of the important characteristics is that domestic growth has to be on the slow side to get the CAD down. As the CAD comes down, the downward pressures on Indian asset prices should diminish. So, it is not necessarily domestic growth you want to invest in. Given where the currency is now, it is export-exposed plays that will be more interesting for investors in the near term.
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