Rupee did an encore against USD this year post Budget. Just like it had happened same time last year, Rupee reversed all of its pre-Budget weakness. Dollar/Rupee swooned as exporters and speculators joined in to hammer the USD lower. Pair closed the around 67.15 levels on spot in NDF. There was not much expectation surrounding the Union Budget. The best part Indian government did not announce anything to adversely affect the mood of the financial markets. In fact on a whole the Budget appeared more focused and prudent. Government proposed a 7% increase in overall expenditure, with an 11% increase in capital spending and 10% increase in spending in rural areas. Tax revenues are projected to grow 13% in FY18 as against a growth of 17% and 12% over FY16 and FY17. Government also made a beginning towards a simplified and low tax regime. They have reduced the tax rate for MSMEs from 30% to 25% and also offered a 500 basis point relief to folks earning below INR 5 lakh per annum. A lot of measures have been and also will be taken to augment the tax compliance in the nation.
GST in itself will give a boost towards a more a formal economy. However, it will come at a cost as GST should not be seen as merely a tax reform but a reset in the way business is conducted in India. There will be loss of business and also unemployment during the transition towards a more formal economy. However, the medium to long term path appears promising. A formal economy will be efficient as cost of capital will come down and government revenues will be augmented. India’s consolidated fiscal deficit is still one of the highest in the world at 6%. Over the past 9 years, it has been hovering between 6%-8%. Government has emphasised on a need for a more targeting of expenditure so that less of it is wasted. All in all, we expect the Union Budget to be received positively by financial markets. Over the month of January Indian Rupee has been a laggard in the EM basket. However, past couple of days of strength has been about a catch up to its peers. However, how far it will strengthen relative to its peers would depend on RBI. RBI has been accumulating USD since the New Year and we expect them to utilise the decline in US Dollar to shore up its reserves further. As a result, we expect Rupee to remain a below average performer in the EM basket for Q1.
Trading daily is like fishing. We survey the scene and the weather, fish where it’s best and catch them. Sometimes they’re large fish, sometimes they’re small fish and sometimes there are no fish at all. Since beginning of 2017, we are in such a lean season, where at best, an agile trader has gone home with small catches. However, things could change if Mr. Trump has his way. We could find ourselves a great profit making opportunity if that is the case. The theme I am talking about is the third phase in the global currency war. During the last two phases, US gained a lot of advantage but then lost some it.
During the first phase, US managed to weaken the US Dollar and help in repairing its economy and financial sector. During the second phase, divergent monetary policies between US and major economies in West and East, triggered a near 40% rise in US Dollar on a trade weighted basis. A stronger dollar not only knocked the wind out of the US shale industry and commodity producers as commodities collapsed but applied an additional strain on US economy as it ended up exporting more its domestic demand to world economy. We are probably standing at the cusp of the third phase of the bloodless war. President Trump is unlike any run of the mill politician, he is a true outsider. He understands how important it is for him to keep his core voter, white Americans, in good humour. These people make over half of the voting population in America and even parts of the African American community, who voted for Mr. Trump, did so because they wanted to reverse the globalising policies that they think stole their jobs away.
Mr. Trump is one such individual who in my opinion would not be closed about experimenting with policy options, which career politicians will abhor from considering. This week, Trump came within a stutter of saying he is going to weaken the dollar; or at least go to a currency war with others who have weakened their currencies. A weak dollar would be a panacea. It could mean higher stock markets, higher inflation, higher nominal growth, higher wages and more competitiveness. Jawboning alone would not be enough. Till date Mr. Trump and his team has tried to talk down the US Dollar. They will soon realise that is not enough. Currencies are driven by relative macro strength and weakness. Right now US economy and expectations surrounding the new administration makes it far more attractive place for investments than Europe or Japan or even China. Therefore, sooner, rather than later, once the frothy positioning dies, we will see US Dollar appreciate. It is a matter of when, and not if.
There comes the possibility that over the near future we see a growing risk that US government, through the US Treasury and US Fed, weaken the US Dollar. They can use a combination of dovish monetary policy and direct intervention in the foreign exchange market to achieve the end. A new type of “Plaza moment” can be seen in the currency market. On the face of it, a substantially weak Dollar could be a boon for emerging market assets. However, its impact on EM economies is not all positive. In a world saddled with excess savings and dwindling risk optimized real economic demand, “beggar thy neighbor” has been the policy of choice for most nations. Therefore, if US joins this war with an overt currency war, instead of a covert war (QE and rates to influence currencies indirectly), global economy and geo-politics could enter a very volatile phase. In such a scenario, on one hand though EM assets may rejoice but on the other, volatility regime would shift upward. Financial cycles will be become even more sharp and of a short duration.
Source: financialexpress.com