We expect global growth to witness a moderate rebound in 2020. The uptick is expected on the back of cyclical rebound in global manufacturing, easier monetary policy conditions creating easier financial conditions and easing of global trade tensions. We are also positive on India’s growth revival and a near term cyclical upturn looks quite likely, aided by substantial policy easing, positive global growth tailwind and potential easing of credit stress.
The risks to our outlook are mostly geo-political in nature. With phase one of US-China trade deal done, our base case is that temperature will begin to cool down. While this is not the last time two of these major powers will have tussle, at least a truce is in sight in the near term. However, the recent US-Iran tension is a key emerging risk, which has potential to majorly impact global and Indian macro. For financial markets, another big risk is US elections.
USD is counter-cyclical and it tends to be highly correlated with policy uncertainty both economic and geo-political. As global growth improves and economic and policy uncertainty fade due to low rate signalling by central bankers and phase one deal, both these trades may reverse. Though most of the depreciation in USD will be borne by other OECD currencies, primarily Euro, the second order effect could be felt by EM currencies as well.
After the sharp depreciation of 2018, INR has been range-bound through 2019 which is typical in a year of strong BoP surplus amidst continued RBI intervention. Yet, given how weak our growth has been, INR’ tendency to depreciate remains. We believe INR will depreciate to 75 to a dollar. Our view on BOP is surplus of close to 20-25bn dollars and CAD of 1.75% (for 2020). Though higher oil price is the key risk to this view on BOP & CAD.
We expect rally in commodities, notably crude, as both USD depreciation and global reflation help aid their prices. We expect higher crude price in 2020 not only due to the recent US-Iran tension but also production restraints by OPEC+ and higher demand from Indian & China (expecting 1-1.5mm b/d increase in Demand in 2020). That will be a bad news for India for both rates and currency. Most of the other industrial metals too will go up as they tend to respond well to improved EM demand conditions. Sino US trade deal is a big news for industrial metals.
We are bearish on United States Treasury and rest of the world’s bond yields. Improved growth and higher commodities will drive global inflation somewhat higher. Energy prices which have been puling inflation lower will also begin to contribute to inflation as the base effect of the high oil price begin to fade in next few months (oil prices collapsed in Q4 last year). On the positive side, at least in US, the upward pressure due to tariff hike will begin to fade and in fact, if the talks are successful, they will begin to reverse. The same can’t be said for EMs which are likely to see upturn in food inflation feeding into generalised inflation over next 12m.
EMs across the board are experiencing high food inflation due to supply shocks. In India, term of trade adjustment in favour of food economy will continue to take food inflation higher. Since we are constructive on cyclical rebound of India growth, MPC’s commitment to low rates will start to waver in the middle of 2020 and accommodation may get withdrawn at some point then. However, while most of the rate easing is behind us, RBI will stand committed to ease financial conditions. The latest operation twist (OT) adds another tool to their arsenal and their willingness to drive rates lower, even though unorthodox policies. OT also creates space for fiscal support to growth. Loose financial conditions, fiscal activism and weak currency will aid the cause of growth and will start to reduce the stress in the credit markets.
Fiscal stress in India is large and the supply of GOI, State and PSU paper is very large, taking fiscal deficit to 7.5%-8% of GDP (including PSUs). While OT (operation twist) will support Govt bonds in near term, no such support will be available for other bonds. So our base case is that spreads begin to inch higher in the first quarter of the year. Eventually, high inflation, proximity to terminal repo rate, improving growth conditions and fiscal stress will mean that even Govt bond yields move higher in 2020.
The credit stress for the financial system may have peaked in 2019 and we should begin to see steady descent of it over next few years. The chief risks in India are some special situation credits. Some large balance sheets continue to struggle and significant intervention may be needed by RBI & Govt to avoid major accidents there.
All said, we think 2020 will be a year of moderation in India. The stress in financial system will climb-down. Loan growth will begin to rise. Real estate will reflate, long bond rate will rise, and credit spreads will decline. INR will depreciate. Policy uncertainty will go down. Steady ascend in our growth will begin. The investment growth may still remain elusive though at some point in 2020, if no major accident happens, the long awaited investment cycle may take some shape in India.
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