The world is not on the brink of a crisis: Nizam Idris

Interview with MD, head of fixed income and currency strategy, Macquarie

Currencies across the globe have given a lot of pain to the equity markets and sleepless nights to investors. Nizam Idris, managing director, head of fixed income and currency strategy at Macquarie tells Puneet Wadhwa in an interview that the market’s adjustments to the change in direction of policy bias in the US could see significant pain in the emerging markets. Draconian capital controls to manage the rupee should not be considered at this stage as it would have lasting negative implications on India as an investment destination, he warns. Edited excerpts:

Do you think the risk-off trade in the global equity markets is partly due to what is happening to currencies in the emerging markets, especially Asia? Do you expect more pressure on Asian currencies as we head further into CY13?

The causality of the recent market moves is actually the other way round; funds were being withdrawn from the global equity markets from a few weeks ago as fears the imminent move by the US Federal Reserve (Fed) to reduce its monthly bonds purchases, or quantitative easing, would presage an eventual unwind of easy monetary policy by the Fed. This led to broad dollar strength, not least against Emerging Markets currencies.

The fall in the INR against the USD worsened the case for buying emerging market (EM) assets and equities, setting off the vicious cycle of weak currency and weak stock markets.

The Fed’s quantitative easing policy since 2009 have been the main driver of strong EM currencies as liquidity flows towards high yielding currencies such as the INR. These inflows obscured some of India’s structural weaknesses, not least the widening current and fiscal account deficits. The threat of Fed’s liquidity withdrawal is now magnifying such structural weakness, hurting the INR.

This could be a multi-month trend, though not likely in a straight line. We expect the Fed to talk down the risk of an early and aggressive exit of monetary stimulus and that should slow the pace of fund outflows from EM equities in the months ahead.

What is your assessment of how things are panning out in the euro-zone, China and Japan? Can the withdrawal of the quantitative easing by the US Federal Reserve (US Fed) put more burden on the already strained emerging market currencies and equities?
Unlike the US, where a recovering economy has given the Fed a good reason to contemplate withdrawal of QE, economies in the euro-zone and China continue to struggle to reaccelerate, while Japan is showing early and nascent signs of a turn around. We are not anticipating a hard landing for Europe and China, but such risks are not totally eliminated.

Meanwhile, we expect Japan’s economy to continue to respond to ‘Abenomics’ and chalk up a decent two% growth this year.

Is the world economy on the brink of being pushed into a full-blown crisis?
We do not think the world is on a brink of a full-blown crisis but the market’s adjustments to the change in direction of policy bias in the US could see significant pain in the EMs with structural weakness in the months ahead.

In the Indian context, the central bank’s measures to stem the rupee’s fall have proved futile. Why do you think this is happening and what levels can one expect in the near-to-medium term?

The problem with the rupee is India’s weak balance sheets, given the twin fiscal and current account deficits which adds up to around 10% of GDP (gross domestic product). This large hole in the balance sheet has to be funded by capital inflows. Such flows have been easier to come by in the last few years when the Fed and other major central banks were pumping in cheap liquidity to resuscitate their respective economies. But with the Fed now looking likely to turn the spigot off, some funds are returning to the US.

The RBI cannot stem these flows but could utilise some of the foreign reserves accumulated in the last four years as funds flowed into India to cushion the impact on the INR now that those funds are exiting.

But this has to be done in moderation as the RBI needs to maintain adequate reserves. Other forms of measures to curb rupee weakness, such as draconian capital controls, should not be considered at this stage as it would have lasting negative implications on India’s lure as an investment destination going forward.

So, what does it mean for the current account deficit (CAD)? What are the key figures you are working with as regards the CAD? Do you think India’s sovereign rating downgrade can be a reality given all the macro-economic headwinds and policy inaction?
I still think the RBI could cut rates to support the ongoing reform push through encouraging growth and investment spending in India. This, though need to wait for a more stable global market conditions; the RBI do not want to further complicate matter given the already volatile markets currently.

But it is not just the external environment that matters for the RBI; the CAD has to narrow to leave the central bank with more room to cut rates. We are working on the assumption of a 4.6% CAD of GDP for FY13/14, a decent narrowing from 5.1% in FY12/13.

Equally important in our view is the fiscal deficit, where we think the asset sales progress has been less than satisfactory in our view. We are putting a low probability of a rating downgrade for India but this is predicated on a decent progress in narrowing the fiscal deficit.

What is your strategy at Macquarie given these developments and economic scenario? What are you advising your clients at the current juncture? Given this assessment, how do you see fund flows to the Indian equity markets panning out?

At Macquarie, we currently hold a positive view of the USD and continue to expect a structural upside bias for the USD-INR for now. We have advised clients to reduce their EM investment exposures for now. In the medium-term though, we would look for clearer signs of growth to make a decision whether to invest in high yielding bonds and credit markets again, in which case the INR could benefit, or to move to low dividend yielding cyclical stocks, in which case the INR may continue to see capital outflows.