Here’s why Indian rupee is resilient to global shocks
The slump in GDP is not surprising, writes Matein Khalid
Despite the geopolitical tensions provoked by the North Korean nuclear test, the shock fall in the Indian GDP growth data, a rise in G-Sec’s government bond yield and foreign selling of equities on Dalal Street, the Indian rupee has been resilient at 64.10 to the US dollar as I write. This resilience is also due to the paradoxical fact that the Japanese yen, not the US dollar, is the safe haven from North Korean risk even though the Empire of the Rising Sun is within range of Pyongyang’s ballistic missiles. Japanese, with its $1 trillion in US Treasuries, its current account surplus, its trillion-dollar pension hoard, its negative interest rates and its role as a carry trade funding currency becomes a Pavlovian, if temporary safe haven currency in time of financial or geopolitical stress. This fact alone explains the resilience of the Indian rupee to North Korea as long as the crisis does not escalate into a catastrophic war.
Planet Forex has concluded that combination of the $100 billion damages from Hurricane Harvey and North Korea’s nuclear brinkmanship will tilt the balance of power in the Yellen FOMC to the doves, particularly since August payrolls data and even inflation was well below consensus. The calculus reinforces the soft US dollar scenario and assures the appreciation trend of high yield emerging markets currencies like the Indian rupee will continue.
The slump in the Indian GDP is not surprising, given that demonetisation and the introduction of the Goods and Services Tax (GST) triggered destocking and production bottlenecks. Unlike the claims of Congress netajis, this is not an end of the Indian economic growth story or an inditement of the BJP’s reformist agenda. India will continue to attract the world’s highest FDI among emerging markets. Foreign debt funds have been consistent buyers of Indian government debt securities. Even though I doubt if there will be another repo rate cut in 2017, the dramatic fall in July consumer price inflation to 2.3 per cent means a repo rate cut in early 2018 is inevitable since inflation is well below the Reserve Bank of India’s four per cent inflation target. This means the Indian central bank will no longer build foreign exchange reserves. It also means India offers the highest inflation adjusted yields in Asia, given that the yield on the ten year Indian G-Sec debt is 6.5 per cent.
The protracted bear market in crude oil benefits the Indian current account and the rupee, as does the metrics of India’s remittance economy. Remittances are now $70 billion or 3.5 per cent of the Indian GDP, a secular pro-rupee ballast. My target remains 61-62 on the Indian rupee in six months.
The US dollar ignored the sight of a Trump-Schumer handshake in the Oval Office and sank to 1.2070 against the euro. The plunge in the ten year US Treasury note to 2.03 per cent led to a surge in the yen to 107.60 as financial markets brace for fresh North Korean missile launch provocations and the impact of the Category 5 Hurricane Irma on coastal Florida, Georgia and contributions of remittances to India’s GDp South Carolina. It is now obvious that the US dollar is not viewed as a safe haven currency in the North Korean crisis. The two year US Treasury note, the security most sensitive to a shift in Federal Reserve monetary policy, trades at a mere 1.25 per cent. This means Wall Street has priced out any rate hike in September and December. This means any uptick in growth or inflation, traders could trigger massive short covering in the overcrowded short dollar position. After all, the yield on the two-year Treasury note equals the upper end of the central bank’s Fed Funds rate. This is insane. The bond market is the world’s most overvalued leveraged time bomb. Get real. Get out!
I believe the financial markets have misinterpreted Mario Draghi since he upgraded the ECB growth forecast but did not protest the rapid rise of the euro from 1.05 to 1.2070. However, the free fall in the US dollar will lead to a rise in inflation that is simply not priced in the US Treasury bond market. Note that Dr Draghi pointedly noted eurozone inflation is well below his targets, an explicit hint that the ECB balance sheet will continue to expand. This could spell disaster for the euro bulls.