Michael Sneyd, global head of foreign exchange strategy and cross-asset strategist at BNP Paribas, the Paris-based financial group, tells Indivjal Dhasmana the rupee has depreciated three per cent in 2018 and the 10-year bond in value by four per cent. This has wiped out one year’s yield of the bond. Even then, he says, foreign investors have more favourable views of bonds than equities in India. Edited excerpts:
The US has put India on its currency watchlist. How do you see this impacting the dollar-rupee and investment in India's bond markets? Is there is a chance of the US administration branding India a currency manipulator?
The rupee has weakened recently, and 10-year Indian bond prices have also declined. However, our view is that this is due to other factors and not because of India being added to the watchlist in the US Treasury’s report. The report monitors factors such as the size of current account surplus, bilateral trade deficit with the US, currency moves and growth in RBI’s foreign exchange (forex) reserves. India has been added to the watchlist due to the recent growth of the Reserve Bank of India’s (RBI’s) forex reserves. But, India’s current account balance remains in deficit and the rupee is not considered undervalued. In this context, India is unlikely to be named a currency manipulator in forthcoming reports.
In this context, how do you see the external risk from the trade war the US has engaged in with China and to a lesser extent with India? How will that impact the rupee-dollar? What about India?
India is not one of the targets of the recent protectionist rhetoric by the US. This is due to India’s bilateral trade balance with the US being relatively small at $20 billion in 2017, as against a trade deficit of $300 bn that the US has with China. In our view, the main channel in which trade wars could impact Indian markets is via the risk appetite of global investors. If global trade wars were to escalate dramatically, a decline in the risk appetite of investors would be negative for the rupee, Indian bonds and India’s stock market. There is a 20 per cent probability of this negative scenario.
From the perspective of the rupee and Indian assets, the impact of geopolitical tensions is very similar to that of trade wars. The main impact would be if global investors’ risk appetite declines due to rising likelihood of conflict. This is not a base case scenario but is certainly another potential downside risk for Indian assets.
The rupee has been depreciating against the dollar. Do you see any particular level for the rupee in the near future against the dollar?
The rupee has depreciated over 3 per cent since the beginning of 2018. If you look at the range of dollar-rupee (exchange value) in recent years, this move does not look excessive as yet. The macro fundamentals of the Indian economy continue to appear very positive, in our view.
But we are concerned about the impact of the weakness of the rupee and Indian bonds on foreign investors holding Indian assets. Since the start of the year, Indian 10-year bonds have fallen in value by almost 4 per cent. This, with the decline of the rupee, means almost one year’s worth of yield (i.e 7 per cent) has been wiped out in the past four months. This could lead to repatriation of funds by foreign investors and further weakness in the rupee. We have been forecasting the dollar-rupee to reach 66 this year but the market has already quickly converged on this level.
What do you expect from the central bank this year?
We think it will raise the policy rate this year to 6.5 per cent, with two hikes of 25 basis points each, most likely in the second half of this year. In our view, there are upside risks to inflation in 2018. Higher oil prices, a weaker rupee and rising core inflation suggest RBI might need to be more hawkish. But, many are expecting the central bank to cut rates.
In our view, the market has not fully assessed the upside risks to inflation in India and how RBI will respond to these. In 2017, the dissenter on the RBI Monetary Policy Committee was a dove but now the dissenter is a hawk, reflecting quite a dramatic shift of stance.
When RBI raises the policy rate to bring down inflation, how would investors react to it in terms of their investment in bonds?
A higher RBI policy rate would likely cause bond yields to rise a bit further but tighter monetary policy is also likely to provide stability to the rupee. This stability will provide foreign investors with the confidence to remain invested in Indian bonds, given the attractive level of yields, in both real and nominal terms, compared with other countries.
How do you see the attractiveness of Indian bonds vis-a-vis stocks?
We have a more favourable view on Indian bonds than equities. An Indian 10-year bond provides a yield of 7.6 per cent (yearly). In comparison, Indian equities are trading on a trailing price to earnings (P/E) ratio of 22, equivalent to an earnings yield of only 4.5 per cent. Usually, investors require higher yields from equities than bonds. This suggests Indian bonds appear to be very good value.
How do you see foreign investors’ confidence on India, with the bad-debt issues of banks yet to be resolved and India Inc still over-leveraged?
Four years ago, when Prime Minister Modi was first elected, foreign investors’ sentiment towards India increased dramatically, resulting in an increase in allocations to the rupee, Indian bonds and Indian equities. Many of these allocations continue to be held, due to their strong performance in recent years. We see that foreign investors’ continue to have a positive outlook on India’s macro outlook but bad-debt issues and high leverage are viewed as potential downside risks and are starting to reduce investor confidence. We have observed that the amount of foreign direct investment into India has declined in recent quarters, which we think makes the rupee more sensitive to foreign investor portfolio flows and, therefore, more vulnerable to these downside risks.
How do you see the movement of India's competitive trade partners' currencies against the dollar vis-a-vis the dollar-rupee?
We expect low yielding Asian currencies such as South Korea’s won, Taiwan’s dollar and the Singapore dollar to strengthen in 2018 vis-à-vis the (US) dollar. We also expect the Chinese renminbi to appreciate.
Will it help India's export?
Underperformance of the rupee versus other Asian currencies would, technically, increase India’s competitiveness. However, we think the impact from currency movements on competitiveness is likely to be small. Many other factors will make a more dramatic impact on India’s productivity and competitiveness over the years ahead. Such as continued investment into infrastructure (e.g roads, rail, power and internet access), education and increasing the ease of doing business.