Rob Subbaraman, Head of Global Macro Research, Nomura, in an interview with Anand JC, discusses why emerging markets are struggling, how the food export ban can lead to a global crisis and why India needs so much more than a simple PLI program to catch up with China in manufacturing and FDI. Edited excerpts:
Are emerging markets like India still the best option for investors after having very visibly run out of steam in recent months?
Emerging markets will experience difficulties in the coming months. The US Federal Reserve is currently raising rates and may increase quite aggressively in the months ahead. We have slowing global growth and high commodity prices. Right now, it’s quite an unfavorable environment for emerging markets, including India, which is dependent on energy and some food imports.
Now that the Fed has turned hawkish, some fear we are seeing a repeat of the taper tantrum even though the authorities say we are much better off today than in 2013. Are the naysayers right to worry?
The chances of a sharp depreciation of the rupee’s exchange rate are reasonably low at this stage; India has built a fortress in terms of foreign exchange reserves. It also starts from a position where the current account did not have a large deficit at the start. I do not foresee a forex crisis.
But that said, India, like other emerging markets, is going through a tough time. Public debt is high, monetary policy is tight and there is not much fiscal space either. Ultimately, this environment of rising costs of living, tighter monetary policy and little room for fiscal easing will lead to slower growth.
Emerging markets have seen strong capital outflows in recent months as the Fed has turned hawkish. Retail investors have shown some resilience so far, but in the medium to long term, is India still a favorite destination for FIIs?
Absolutely. India is still in economic development mode. We are witnessing growing geopolitical risks around the world and it is possible that the strange relationship between China and many advanced economies will benefit India in the medium term. Still, I don’t think it will happen that easily. India will have to show that its ecological fundamentals are solid and that it continues to work to become more competitive and benefit from it.
Since the pandemic hit, the Indian government has actively promoted its Aatmanirbhar program and introduced programs like the PLIs, to show its intent. India intends to be a viable alternative to China and Taiwan. Are the current measures good enough to make India a legitimate alternative to China?
It is too early to tell. China’s success over the past two decades has not happened overnight, it has put a lot of effort into creating the right foundations. It is not enough to have cheap labor, one must reduce the overall cost of doing business, deregulate labor markets, have solid infrastructure and a decent health system. If they get in place and you start attracting more FDI, that can feed on itself and lead to more investment.
Touching the base of the current rise in protectionism in the wake of the war in Ukraine. Whether in India, Indonesia or Malaysia, some prominent players are engaging in food protectionism by invoking national priorities even as food security becomes an issue around the world. Do you see this exacerbating the global macroeconomic situation?
Absolutely, this is a very dangerous development. From a country’s perspective, this may make sense. But if every country starts doing this, it will only worsen food shortages and exacerbate the problem globally. Right now we have a coordination failure across the world, especially MS. There are 30 countries that have imposed trade restrictions on food. This is a very bad sign and increases the risk that food prices will continue to rise.
Returning to India’s fiscal situation, the government recently announced a series of measures estimated to cost $26 billion, including lower fuel taxes and import duties. How far will these measures go to solve the problem in question and how do you think they will affect India’s fiscal situation?
I think India, like many other countries, is trying to coordinate monetary and fiscal policy to deal with high commodity prices and inflation. The measures you mentioned, including the subsidies that the government provides to help the poor, will weigh on the budgetary situation. The risk as we see it is that the government’s budget deficit target for this year will be exceeded as a result. The government may try to increase its privatization or divestment measures and reduce spending, but in this environment we will start to slow growth.
Currently, the re-opening of the economy is supporting growth, but this pent-up demand growth spurt will soon fade, and in the coming quarters, it will be difficult for India to meet its fiscal deficit target.
Despite growing inflationary pressures, the RBI has only recently taken its belligerent turn, even as economists and pundits have been calling for action for months now. Has it really been behind the curve or was the RBI right to prioritize growth for as long as it has?
It’s always easy to assess things in hindsight, if we were to go back 3-4 months it was unclear how quickly the economy would recover from the pandemic and how badly commodity prices would be nurtured and supported. Now I would say he is late and needs to catch up. It has moved a bit more aggressively now and we believe it will need to continue to act aggressively on rate hikes to regain a leg up on the curve.
One of the challenges for the RBI is the second-round effects of high inflation. Inflation expectations in India are in double digits. High inflation is bad for long-term growth. It can be painful to get it down but in the long run it’s better to do it.
Should RBI opt for aggressive rate hikes in upcoming meetings?
I think that would be something of great concern to RBI Governor Shaktikanta Das and it is a difficult political compromise. The reality is that much of the inflation in India is imported inflation that comes from commodity prices, energy prices in particular. Monetary policy cannot lower energy prices, it affects relative prices. Reducing inflation would be negative for growth, it’s as simple as that. The RBI and other central banks are considering their aggressiveness, as the more aggressive they are, the greater the risk of a sharp slowdown in growth.
We think inflation will exceed 7% in India in Q3 and Q4, maybe above 8% for a few months. Real rates are still deeply negative, so we expect the RBI to rise 35 basis points at the next meeting and 50 basis points at the next.
Some indicators like bond yields point to an impending recession in the United States. What impact is this likely to have on emerging market currencies, particularly the rupee?
I don’t think the United States is heading for an imminent recession. The risk of recession, in our view, is more for next year, rather than this year. The market tends to focus on the 10-year to 2-year US Treasury spread which is not a very reliable measure of recession and generally when that yield spread goes negative you don’t get a recession for about a year afterwards. There are better measures, like the spread between the 3-month Treasury bill and the 10-year bond yield, which is far from negative at this point.
In the United States, households are sitting on a large savings surplus, the labor market is very strong and even though there has been a tightening in financial conditions, it has happened at a very loose level. Even now, the level of conditions is not too tight.
We expect three rate hikes of 50 basis points in June, July and September, which could put further pressure on emerging markets through capital outflows and currency pressures.
Among emerging markets, which countries are best positioned to weather some of the uncertainties the ongoing war is likely to pose
, you feel that everything is negative and bad in emerging markets. But as you dig deeper, there are variations, especially over the next 1-2 years. The most negative at the moment are the emerging markets of Eastern Europe which are exposed to the war. Net commodity importers look vulnerable, such as Turkey, Pakistan, Sri Lanka and Egypt. India, Indonesia and the Philippines are also in this group. Net commodity exporters in the Middle East should do reasonably well, some in Latin America as well. Malaysia could do well in Asia.
The current situation for India’s neighbors is not exactly pretty, with Sri Lanka facing economic uncertainties and some political volatility in Pakistan. Are these developments likely to fuel India’s growth story?
They are right on the doorstep of India so the fact that they are in crisis is not good for India. Besides the commercial channel, there are the financial aspects. Indian companies with operations in these countries may face challenges, as may Indian investments in these countries. The third potential channel is more on the social side, if governments are unable to stabilize the situation, there could be an increase in social unrest on India’s doorstep. At this point, it’s not a major downside for India, but it’s definitely something to watch out for.