India remains an attractive investment destination: Lambregts and Erken

After a 25 bps hike in December, we expect the US Fed to hike one more time in the first quarter of the calendar year 2019

Jan Lambregts, managing director and global head of financial markets research at Rabobank International, and Hugo Erken, senior economist and country analyst for North America, Mexico and India, share their views with Puneet Wadhwa on the outlook for the global economy and markets. Edited excerpts:

What is your interpretation of the G20 meeting outcome? Is the worst as regards ‘trade war’ behind us now?

Erken: This is not what we expect. In many ways, the deal currently in place does not differ much from the ‘Mnuchin deal’ dating back from May, when China also promised to buy more US agricultural and energy products and lower the trade deficit with the US. Although we can expect China to step up US imports, the current deal also implies that China on many front will have to accept structural reforms and open up its economy. 

The question is if this China can adopt the proper policy measures within 90 days. If the US feels that China progress on that front is too limited within that period of time, the US will press ahead with the implementation of the tariffs of 25 per cent on #200 billion. If China does follow up on its promises to announce structural reforms during their Economic Work Conference in December, this will be a victory for the US administration, but China will probably frame this as a planned domestic reform strategy. 

Further down the road, any final deal will most likely include US dictated terms that will protect intellectual property rights of Western firms operating in China and expose Chinese state-owned enterprises to foreign competition. This would undermine China’s ‘Made in China 2025 strategy’ that aims at global technological dominance in high-tech industries, such as the aerospace industry, ICT, robotics and clean-energy cars. China would certainly not be keen to abandon that strategy, and we can therefore expect the trade war to flare up again.

What are the key risks for the global financial markets from here on?

Lambregts: There is never a shortage of risks to worry about. If I had to limit myself to three, the risks would include ongoing and further escalating trade war between the US-China; hard Brexit; and the US Federal Reserve (US Fed) too aggressively, triggering a recession down the road in 2020-2021.

How troublesome could be Brexit for the stability in global financial markets?

Lambregts: Only a hard Brexit would potentially have enough impact to affect global financial markets. Like with all things Brexit, the difficulty lies in definitions used. A hard Brexit can be tremendously damaging if it is a cliff-style Brexit where not a single mitigation is applied. But this is extremely unlikely. In the case of “no deal”, the far more likely variant would be for various mini-deals to help mitigate the immediate fall-out and generated extra time for negotiation of a more comprehensive deal eventually. So while a Hard Brexit has the potential to disrupt at a global level, it is actually unlikely to do so when taking these mitigations into account.

How many rate hikes do you expect from the US Federal Reserve in 2019 and are global equity and bond markets factoring this in at the current levels?

Lambregts: After one 25bps hike in December, we expect the US Fed to hike one more time in the first quarter of calendar year 2019 to bring the fed funds rate to 2.75 per cent. At that point, we think the yield curve will be inverted, or very close to it, which is traditionally a good signal of a rising risk of recession. Combined with a slower economy we think this will see the US Fed pause for the remainder of 2019. However, this is not a consensus view. The market things US Fed is getting a bit too aggressive with their dot plot of forecasted tightening, but still thinks they will do a bit more than our forecasted path.

How are you viewing developments in India in terms of key economic data, especially ahead of the state and general elections? 

Erken: Although the Indian economy starts to fray at the edges, we still believe growth will be in line with potential growth in the next couple of quarters. The recent decline in oil prices, high government consumption and accommodative monetary policy will support growth in the run-up to the general elections. Growth forecasts for the third and the fourth quarter are pegged at 7.3 per cent and 6.9 per cent, respectively.

Moreover, we expect infrastructural stimulus to provide an additional impulse to the economy in the second half of calendar 2019, which will reverse the downward growth trajectory of the Indian economy in 2019. What could throw the Indian economy off its potential growth track further down the road is an expected slowdown in the US economy, which will affect world trade. India also is not immune to global economic developments. 

We also expect a somewhat lower trajectory for potential output due to difficulties for the Bharaiya Janata Party (BJP) to remain its robust majority in India’s Lower House (Lok Sabha) after the general election in April/May 2019. As a result, the BJP will have to resort to coalition-based policymaking with other members of the NDA (National Democratic Alliance) or even non-NDA parties. That will hamper the business-friendly reform agenda of the BJP, which would result in levelling off of potential growth as well.

How do you view the recent turn of events between the government and the RBI?

Erken: The RBI has not been over-caution on inflation in our opinion, as the inflationary risks were absolutely present. In retrospective, inflation has been surprising to the downside, as food inflation was much milder than expected and import inflation on the back of the heavy rupee depreciation earlier this year seems to have materialised partially at best. 

The recent spat between the government and RBI has been resolved in a pragmatic manner, which has been promising from a market-point of perspective. Further down the road, however, the NPL (non-performing loan) problem India is real and significant. So, in the end the pain of loan restructuring has to be taken at some point, and this impact could be exacerbated if the economy slows down. 

What is worrying in our opinion is the re-assessment of the capital framework by a panel of RBI and government members. If this panel decided that the government can tap to a larger extent into the RBI’s reserves, this might have foreign investors question the independence of the RBI and put a leash on FDI and portfolio investments, which are absolutely necessary to plug India’s current account deficit. 

How does India look as an investment destination? What are the key risks to the 'Indian equity story' from here on over the next one year?

Erken: India remains an attractive investment destination. The improvement on the ease of doing business index, low external and household debt, reform-friendly government and the enormous market make India an attractive proposition. However, there are risks that make India vulnerability to external shocks and may weigh on portfolio inflows, such as the high dependency on oil and the high twin deficit. From a policy perspective, decreasing India’s vulnerability will be an important challenge for the next government.