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This document has been prepared for your information only and does not constitute any offer/commitment to transact. Such an offer would be subject to
contractual confirmations, satisfactory documentation and prevailing market conditions. Reasonable care has been taken to prepare this document.
Neither HDFC Bank Ltd. (including its group companies) nor any employees of HDFC Bank Ltd. (including those of group companies) accept any
responsibility for action taken on the basis of this document or liability arising from the use of this communication.
(1)
FX marketsThe HDFC Bank view
Main points:
The USD is poised to stage a comeback over 2015 as private demand picks up that allows the Fed to move ahead with its plans to tighten monetary policy.
We expect the next leg of USD strength to be concentrated more against EM currencies that could persist well into 2016 than the G-7 currency block.
The EUR might weaken in 2H2015 as the Fed tightens monetary policy but we see a strong case for a rebound over the medium term
While the JPY might fall victim to divergence in monetary stance between the Fed and the BoJ, we expect a more moderate pace of depreciation going forward.
We expect the INR to depreciate over 2015 on the back of US monetary tightening as well as apprehensions about the pace of the domestic recovery.
However, narrowing inflation differentials and improving growth differentials is likely to result in an improvement in INR performance over the longer-term.
(2)
Section 1•Review of recent developments
Beginning of the reflation trade?
Global bond yields: gradual upside?
China: asset bubble with limited economic momentum?
US: a new neutral rate?
Grexit: remains a risk but we are optimistic
(3)
The end of deflation– yes! But not the beginning of reflation
Increase in commodity prices + monetary easing in China & ECB + increases in bond yields = reflation????
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5-20
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9-20
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06-0
5-20
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Reuters CRB index (LHS)
Brent crude oil prices
USD
/bb
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03
-05
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5
UST 10 year German bund 10 year
In%
Commodity prices appear to be bottoming out that has put upside pressure on bond yields as investors have started to price-out the prospect of deflationary risks that had been a major concern in 2H2014.
Source: Reuters & HDFC Bank
(4)
However, sustained reflation is unlikely
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15F
Global growth (In YoY %)
Reflation—defined as a sustained pick-up in underlying inflation is unlikely.
Overall global growth still remains below potential level that suggests that upside risks to inflation are limited at this stage.
-2 0 2 4 6 8 10
US
Australia
Japan
UK
Canada
Euro-zone
Germany
France
India
Korea
Target Current CPI CPI year ago
In YoY %
Hence, for non-USD bonds price rallies could present selling opportunity. For US bonds gradual upside likely but sharp up moves unwarranted.
Source: IMF, economist & HDFC Bank
(5)
Global bond yields—gradual upside over the medium term led by Fed tightening
Global bond yields that were overbought in 2014 have risen sharply pricing out deflationary risks led by German bund yields
Since the Euro-zone was the epicenter of market concerns about deflation and growth, the unwinding of these concerns meant that Euro-zone sovereign yields led
the rally.
There could be a further uptrend in global bond yields over the remainder of the year as liquidity conditions could tighten if as we expect the Fed moves ahead with its
plans to hike policy rates.
However, QE in the Euro-zone and Japan will likely cap substantial uptrend in 2015.
(6)
China: reflation driven by policy not headline macro indicators
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15F
Shanghai stock exchange China GDP (RHS)
In Y
oY
%
The paradox : Weakening growth with record performance in equity markets
China’s growth momentum is slowing driven by:
Structural re-balancing from investments to consumption
Weakness in export performance
De-leveraging in the corporate sector
However, equity markets have rallied primarily because of measures taken by the government
and the PBOC to reflate the economy.
The increase in appetite for Chinese assets by foreign investors has meant a reduction in fund
flows into other major Asian markets such as India.
Source: IMF & Reuters
(7)
China equity markets– further upside will need evidence of improving growth prospects
What is driving Chinese equity markets higher?
Re-allocation of household portfolios from real-estate to equities supported by margin trading
Increase in foreign fund inflows after the government has allowed investors from Hong Kong and international hedge funds to invest in the equity markets.
Chinese policymakers have announced reforms ranging from streamlining administrative procedures to boosting the yuan's global role, adopting an anti-
corruption campaign and other financial sector reforms.
Will the trend persist?
We are not convinced that the rally in Chinese equity markets can continue without evidence of improving growth prospects.
Hence, we think that there could be some moderation in the foreign demand for Chinese assets. The policy measures taken so far have been priced in.
Monetary easing from the PBOC
(8)
US: What is the neutral rate?
What is the neutral rate? The level that would keep the economy growing in line with its potential level, sustain
full employment and keep inflation in line with the Fed’s target.
It is typically expressed as the policy rate (fed funds rate) in real terms and is used by the central bank to communicate whether policy is accommodative or restrictive. The level
was assumed to be around 2% prior to the crisis
However, recent statements from Yellen suggests that structural changes in the economy such as lower potential growth rate and demographic changes could have pushed the
neutral rate to ‘zero’.
(9)
US: A lower neutral rate will mean a more subdued rate hiking cycle
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
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10.00
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-01-
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1993
-03-
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1994
-10-
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2013
-10-
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Nominal Fed Funds rate Real Fed Funds rate
In%
In the pre-crisis period, as the business cycle picked up—the Fed would raise its nominal policy rate to at least 4% to ensure a core inflation target of 2%.
If the neutral real rate is indeed re-set to zero, the Fed in the current environment is unlikely to raise rates to above the 2.5% mark to account for its inflation target.
The upshot is that the rate hiking cycle could be shallower this time around then was the case in past tightening episodes.
Pre crisis neutral rate
(10)
Grexit: Remains a risk but we are optimistic
Greece’s debt levels still remain at unsustainable levels implying that Greece still needs funding for both the near and medium term.
Two areas need to be worked out: (a) Near-term financing to ensure that Greece does not default on its commitments that
are due over June such as loan repayments to the IMF worth EUR 3.0 billion.(b) A third bail-out program to ensure that Greece has adequate funding over 2015-16.
There has been limited progress in negotiations between the Greek policymakers and the Eurogroup about the type of reforms. eg: EU wants changes to VAT rates, pension
reforms. Greece wants softer options like reducing tax evasion.
Although we expect a deal to be in place, the worst-case scenario of a default and potential exit cannot be ruled out.
While a default does not imply an automatic expulsion from the Euro-zone, it could push Greece closer to the exit.
Please refer to Grexit: now a real possibility?, April 23,2015 for a detail review of developments in Greece
(11)
Section 2
•USD: A rebound with varying strength across currencies
The USD is poised to stage a comeback over 2015 as private demand picks up that allows the Fed to move ahead with its plans to tighten monetary policy.
Although the USD could stage a rally over the remainder of 2015, its strength could vary widely across currencies.
We expect the next leg of USD strength to be concentrated more against EM currencies that could persist well into 2016 than the G-7 currency block.
(12)
Uncertainty about US growth prospects has put the greenback under pressure in 1Q2015
A weak 1Q2015 GDP growth, muted retail spending and low inflation….
….reversed the uptrend in the USD
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105
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9-20
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02-1
1-20
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02-0
1-20
15
02-0
3-20
15
02-0
5-20
15
USD TWI index
Source: IIF & Reuters
(13)
In % 2Q2014 3Q2014 4Q2014 1Q2015
Developed economies 1.4 2.2 1.9 1.6
US 4.6 5 2.2 -0.7
Euro-zone 0.8 0.8 0.9 1.0
Japan -6.4 -2.6 1.5 1.5
Emerging economies 3.8 4.4 3.6 2.6
China 7.5 7.3 7.3 7.0
India 6.7 8.4 6.6 7.5
Global growth rates
The unexpected contraction in US growth in 1Q2015 especially after strong growth witnessed over 2014 has forced investors to question whether the US economy is entering a renewed soft patch.
A strong seasonal element in 1Q disappointment, the rest of the year could be much better
Average 1Q growth for previous years shows marked seasonal softness
Since 2010, 1Q growth has averaged a lot lower than growth over the remaining quarters.
It is possible that the severe winter weather in 1Q tends to restrain consumer spending and
residential investments
Government spending also exhibits a seasonal pattern particularly defence spending
Nevertheless, the seasonal moderation in growth coincided with other headwinds such as the sharp slump in mining investments and a ports dispute that hit export orders resulting in a contraction in
output.
We see strong possibility of a revival in US private consumer spending over the remainder of the year
as was the case last year. Source: Bureau of Economic Analysis & HDFC Bank
0.0
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1.0
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1Q 2Q 3Q 4Q
Average quarterly US growth over the last five years
q/q
SA
AR
in
%
(14)
Real income levels have increased over 2014-1Q2015 reflecting a fundamental improvement in the labourmarkets and a windfall from falling commodity prices.
The disconnect between income gains and personal spending has puzzled
With household balance sheets improving, there is limited need to use the extra funds for deleveraging
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Jul-
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-13
No
v-1
3
Jan
-14
Mar-
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May
-14
Jul-
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Sep
-14
No
v-1
4
Jan
-15
Mar-
15
Personal income Personal spending
In Y
oY
%
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
8.0
9.0
10.0
11.0
12.0
13.0
14.0
1Q19
90
4Q19
91
3Q19
93
2Q19
95
1Q19
97
4Q19
98
3Q20
00
2Q20
02
1Q20
04
4Q20
05
3Q20
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2Q20
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1Q20
11
4Q20
12
3Q20
14
Debt service ratio Financial obligation ratio (RHS)
Household debt ratios
In %
In %
US private consumption is likely to rebound as personal spending catches up with personal income…..
Source: Bureau of Economic Analysis, Federal Reserve & HDFC Bank
Hence, we assume that spending was held back in 1Q primarily reflecting seasonal factors
(15)
…..ensuring an improvement in US growth prospects
Source: Bureau of Economic Analysis, Capital economics & HDFC Bank
However, continued softness in mining investment is likely to remain a headwind for the
recovery
Why US growth prospects are likely to improve?
Increase in real income levels translates into pick-up in consumer spending
Some improvement in export performance
Pick-up in government spending particularly state government spending.
Some improvement in residential investments over 2015
An uptick in US growth is likely to push core inflation pressures higher over the medium term.
(16)
In % qoq SAAR 2013 2014 1Q2015 2015F 2016F
GDP 2.2 2.4 -0.7 2.5 2.8
Private consumption 2.4 2.5 1.8 2.6 2.5
Investments: 4.9 5.8 0.7 2.5 5
--Business investment 4.7 5.3 -1.3 0.5 5
--Residential investment 11.9 1.6 5 7.5 4.5
Exports 3 3.2 -7.6 2.0 3
Imports 1.1 4 5.6 5.3 4.5
Government spending -2.0 -0.2 -1.1 1.5 1.8
US GDP: growth forecasts
US inflation: should accelerate as private demand picks up
US inflation pressures are being driven by two sets of factors:
Lagged effect of currency appreciation and soft global commodity prices that has pushed headline
inflation rates low
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
200
250
300
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400
450
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600
Jan
-09
Jun
-09
No
v-0
9
Ap
r-10
Sep
-10
Feb
-11
Jul-
11
Dec-
11
May
-12
Oct
-12
Mar-
13
Au
g-1
3
Jan
-14
Jun
-14
No
v-1
4
Ap
r-15
Reuters CRB index (LHS) CPI inflation
In Y
oY
%
History suggests that diminishing slack should start pushing core inflation up
-6
-5
-4
-3
-2
-1
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2.4
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3.4
Mar-
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Oct
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May
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Dec-
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Jul-
06
Feb
-07
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-07
Ap
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No
v-0
8
Jun
-09
Jan
-10
Au
g-1
0
Mar-
11
Oct
-11
May
-12
Dec-
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Jul-
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Feb
-14
Sep
-14
Ap
r-15
Core CPI (LHS)
Unemployment gap
In Y
oY
%
To gauge the potential upside in inflation pressures, the Fed is likely to focus on the labour market in which rising wages constitute the first trigger for overall price increase
Source: US Bureau of Labour statistics & HDFC Bank
(17)
Wage inflation pressures are starting to pick-up gradually
Wage inflation pressures have lagged the improvement in the labour market and are picking up very gradually
4
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May
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No
v-1
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Jun
-12
Jan
-13
Au
g-1
3
Mar
-14
Oct
-14
May
-15
Average hourly earnings (LHS)
Unemployment rate (reverse scale)
In Y
oY% In
%
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.01.0
1.5
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2.5
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3.5
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
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1Q20
15
Employment cost index (LHS)
Unemployment rate (reverse scale)
In Y
oY %
In %
Why the muted rise in wages so far? An influx of low-paid workers into the labour force that could be holding back wages. However, wage inflation is likely to accelerate as labour market continues to show broad based
signs of improvement.
Source: US Bureau of Labour & HDFC Bank
(18)
The Fed needs more evidence before it can act
The Fed has made its actions data dependent because the traditional relationships that should suggest that consumption and inflation could
accelerate are not yet fully visible
The Fed has given itself some time to re-examine the recovery and the temporary factors that derailed the economy in 1Q has forced a re-think on counter-cyclical
action
Nevertheless, if we are correct in expecting a revival in private demand, the Fed could begin its rate hiking cycle by September-2015 or December-2015.
Subsequent action is likely to be cautious, muted and heavily influenced by the flow of data.
(19)
We had expected USD gains since 2014 on the back of two factors:
A.) Weaker growth, disinflationary pressures and monetary easing outside the US would result in global sovereign yields
converging towards US yields
B.) Improving US growth prospects that will allow the Fed to tighten monetary
policy pushing US sovereign yields higher and creating strong demand for the
greenback in the process
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-1
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15F
20
16F
Global US economy
GDP growth rates
In Y
oY
%
Source: IMF
(20)
USD strength can only come on the back of a stronger US economy that could lift US yields. Past yield advantage already priced in
-1.60
-1.40
-1.20
-1.00
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-0.40
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105
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-09
-201
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02
-02
-201
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02
-07
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1
02
-12
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02
-05
-201
2
02
-10
-201
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02
-03
-201
3
02
-08
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02
-01
-201
4
02
-06
-201
4
02
-11
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4
02
-04
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5
USD TWI (LHS) US- G7 2 year yield differentials
0
0.5
1
1.5
2
2.5
02-0
1-20
09
02-0
6-20
09
02-1
1-20
09
02-0
4-20
10
02-0
9-20
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02-0
2-20
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02-0
7-20
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02-1
2-20
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02-0
5-20
12
02-1
0-20
12
02-0
3-20
13
02-0
8-20
13
02-0
1-20
14
02-0
6-20
14
02-1
1-20
14
02-0
4-20
15
UST 2 year G7 sov 2 year
In%
From 2014, G-7 yields started dropping to the exceptional low US yield levels that three rounds of QE had fostered. This happened as the G-7 economies themselves adopted accommodative monetary policies.
The yield story has played out! The next leg up for the USD will have to come from a stronger US economy.
Source: Reuters & HDFC Bank
(21)
In b
ps
AXJ currencies overvalued while EUR looks weak. This is likely to drive the USD’s differential movement patterns in the medium term
60.0
70.0
80.0
90.0
100.0
110.0
120.0
01
-20
09
07
-20
09
01
-20
10
07
-20
10
01
-20
11
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-20
11
01
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07
-20
12
01
-20
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07
-20
13
01
-20
14
07
-20
14
01
-20
15
AXJ Euro-area Japan
REERs
Undervalued
Overvalued
Greenback strength since 2014 has been more concentrated against the free-floating G-7 currency
block…..
….that has pushed both the EUR and JPY to highly undervalued territory
Hence, the brunt of the next move higher in the USD is likely to come against fundamentally
weaker EM currencies such as the AXJ currency block.
AXJ = India, Singapore, Malaysia, Indonesia, South Korea, Thailand, Hong Kong and Philippines. Source: Bank for International Settlements & RBI
The accommodative monetary policies of the ECB and BoJ has played a role in the undervaluation.
(22)
Scope for a rally in the G-7 currency block
-20
-18
-16
-14
-12
-10
-8
-6
-4
-2
0
EU
R
JPY
CA
D
AU
D
MY
R
IDR
GB
P
SG
D
KR
W
INR
TH
B
PH
P
Performance against the USD since 2014
In %
After a period of weakness over 2H2015 driven by Fed tightening monetary policy, we see strong case of a rebound in G-7 currency pairs especially in those currencies that belong to regions whose economic outlook is
likely to improve over the medium term.
Fair values are the fundamental equilibrium exchange rates (FEER) that calculates the exchange rate that equates the current accountat full—employment level with sustainable net capital inflows. Thesevalues have been calculated by the Peterson Institute for International Economics.
Source: Reuters & HDFC Bank.
(23)
Current spot rate Fair value
EUR/USD 1.126 1.20
GBP/USD 1.56 1.63
USD/JPY 123.50 107.00
USD/CAD 1.2334 1.19
AUD/USD 0.7740 0.85
EM Asia currencies likely to remain under pressure
0
2
4
6
8
10
12
2010 2011 2012 2013 2014 2015F 2016F
GDP growth rates
Avanced economies EM EM Asia
In Y
oY
%
EM Asia growth has slowed because:
Export-led growth model has taken a hit because of overvalued exchange rates and
subdued growth particularly in China.
EM Asia likely to slow further over 2015-16
Enormous spare capacity is constraining an investment revival
High levels of debt have crimped the private sector
The onus is likely to be on reviving growth via public infrastructure investments and consumer
demand.
Currencies of AXJ nations that are likely to undertake structural reforms to revive domestic
growth prospects could to an extent buck the trend.
Source: IMF & HDFC Bank
(24)
High quantum of USD denominated debt likely to add to EM currency vulnerability
0
200
400
600
800
1000
1200
1400
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
in U
SD b
n
EME private international debt issuance and
cross-border bank borrowings
Cross-border bank borrowing
International debt securities
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
100.0
RU TU IN BZ ID CNa
s %
of
tota
l ex
tern
al
deb
t
EM external debt by country: USD denominated
liabilties
(25)
Source: World Bank
Section 3•G-3 currencies: How much more downside?
The EUR might weaken in 2H2015 as the Fed tightens monetary policy but we see a strong case for a rebound over the medium term
The GBP might fall victim to the pro-USD trade in 2015 but it is likely to move gradually higher over 2016.
While the JPY might fall victim to divergence in monetary stance between the Fed and the BoJ, we expect a more moderate pace of depreciation going forward.
(26)
Euro-zone: growth prospects have improved
-1
-0.5
0
0.5
1
1.5
2
2.5
May
-14
Jun-
14
Jul-
14
Au
g-14
Sep
-14
Oct
-14
Nov
-14
Dec
-14
Jan-
15
Feb-
15
Mar
-15
Ap
r-15
Retail sales Industrial production
InY
oY %
Euro-zone growth is showing more broad-based signs of picking up driven by a rise in exports and low commodity prices that has stimulated consumer spending.
In QoQ SAAR % 2Q2014 3Q2014 4Q2014 1Q2015
GDP growth 0.8 0.8 0.9 1.0
Household consumption 0.8 1.0 1.5 1.7
Government spending 0.6 0.6 0.7 1.1
Investments 1.2 0.6 0.5 0.8
Exports 3.2 4.1 4.1 4.2
Imports 3.8 3.9 4.6 5.1
GDP: Main components
While household consumption has led to recovery, it has been driven primarily by the sharp slump in commodity prices. With commodity prices showing signs of bottoming out around current levels, it could mean
some moderation in consumer spending going forward.
Source: Eurostat, ECB & HDFC Bank
(27)
The ECB will need to stick to its QE schedule of September-2016
-4
-3
-2
-1
0
1
2
3
4
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
20
11
20
13
20
15
F
Deviation from potential output
In %
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
Mar
-09
Jul-
09
No
v-0
9
Mar
-10
Jul-
10
No
v-1
0
Mar
-11
Jul-
11
Nov
-11
Mar
-12
Jul-
12
No
v-1
2
Mar
-13
Jul-
13
No
v-1
3
Mar
-14
Jul-
14
No
v-1
4
Mar
-15
Exports growth
In Y
oY %
The high quantum of slack in the economy implies that deflationary forces still persist
The ECB embarked on QE to import prices pressures and export stronger growth from the global economy. However, its job is only half done as:
The ECB will need to ensure that the export revival sustains and improves
Hence, we suspect that the ECB via its QE program or via verbal intervention will step in to reduce the onset of a substantial uptrend in the EUR at least in the near term.
Source: IMF, ECB & HDFC Bank
(28)
The EUR could rally over the medium term because:
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
2012 2013 2014 2015F 2016F
GDP growth rates (In YoY %)
France Germany Italy Netherlands Spain
-3 -2 -1 0 1 2 3
2012
2013
2014
2015F
2016F
Current account deficits % of GDP
Spain Netherlands Italy Germany France Euro-zone
Improvement in export performance likely to ensure current account remains in a comfortable
surplus position
Improving growth prospects on the back increase in exports and pick-up in private
demand likely to result in increase in capital flows into the region
Hence, a favourable balance of payments position likely to drive a reversal in the currency in the medium term.
Source: IMF & HDFC Bank
(29)
Thoughts on how to trade the EUR:
The prospect of the Fed tightening monetary policy and ECB maintaining its divergent stance could push the EUR lower over 2H2015.
As the economic outlook improves that is accompanied by an improvement in the balance of payments position—the EUR is likely to rebound over the medium
term.
The ECB could continue to verbally intervene to cap any major uptrend at least until it is confident that it is close to meeting its objectives.
However, the EUR is significantly undervalued—we do not see a sustainable move below 1.05
(30)
GBP: Ranged trading in 2015 followed by strength in 2016
-6.0
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14
20
16F
UK current account deficit
%o
f G
DP
We see some downside in GBP/USD in 2015:
(a) Prospect of the Fed normalizingmonetary policy
(b) The pricing in of fiscal consolidationover 2016-2017 by the newly electedgovernment
(c) BoE maintains status quo
Given that the UK economy has a sizeable current account deficit, risk aversion and enhanced volatility is likely to limit the
magnitude of upside in 2015.
However, we still expect UK growth to remain relatively strong driven by pick-up in
consumption and strong labour markets….
…that force BoE to normalize monetary policy in 2016 and result in currency appreciation.
Source: IMF
High current account deficit will likely restrict any major uptrend in the GBP:
(31)
JPY: Depreciation potential limited
0
50
100
150
200
250
300
350
400
70
80
90
100
110
120
130
17-0
6-20
05
17-0
6-20
06
17-0
6-20
07
17-0
6-20
08
17-0
6-20
09
17-0
6-20
10
17-0
6-20
11
17-0
6-20
12
17-0
6-20
13
17-0
6-20
14
USD/JPY (LHS) USD-JPY 10 year yield differential
In b
ps
USD –JPY yield differential more than priced in based on yield gap JPY appears oversold
Economy mending a little. Accelerated monetary expansion unlikely
Hence, we expect the USD/JPY uptrend to persist as the Fed tightens policy but the pace could moderate going into 2016.
-8
-6
-4
-2
0
2
4
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14
20
16F
Japan: Deviation from potential output
In %
Only when the BoJ terminates its QE program that is likely in 1H2017 will the USD/JPY pair top out.
Source: Reuters, IMF & HDFC Bank
(32)
Section 4•Can the INR buck the bearish AXJ trend?
We expect the INR to depreciate over 2015 on the back of US monetary tightening as well as apprehensions about the pace of the domestic recovery.
(33)
However, narrowing inflation differentials and improving growth differentials is likely to result in an improvement in INR performance over the longer-term.
INR: Pace of depreciation has subsided, although it has not bucked the EM trend
In % 1H2014 2H2014 2015YTD
INR 3.4 -6.4 -1.2
SGD 1.4 -6.3 -1.0
MYR 2.3 -9.6 -6.9
IDR 1.4 -5.0 -6.3
KRW 4.0 -8.9 -0.5
THB 1.7 -1.6 -2.1
PHP 2.2 -2.7 -1.0
BRL 7.7 -20.5 -15.7
TRY 2.5 -8.7 -15.7
ZAR 0.6 -7.8 -5.8
Performance against the USD
The INR has depreciated by a lesser quantum in 2015 than its peer EM group on the expectations that the pro-reform government will be able to transform the economy’s macroeconomic landscape.
90.0
100.0
110.0
120.0
130.0
140.0
150.0
90.0
95.0
100.0
105.0
110.0
115.0
120.0
01-0
6-20
12
01-0
9-20
12
01-1
2-20
12
01-0
3-20
13
01-0
6-20
13
01-0
9-20
13
01-1
2-20
13
01-0
3-20
14
01-0
6-20
14
01-0
9-20
14
01-1
2-20
14
01-0
3-20
15
01-0
6-20
15
USD/INR USD/AXJ USD/EM CAD (RHS)
However, we still believe that the INR will depreciate over the remainder of 2015.
Source: Reuters, IMF & HDFC Bank
(34)
Note: USD/AXJ = Average (SGD + MYR + IDR + KRW +THB + PHP)USD/EM CAD = Average (BRL + IDR + TRY +ZAR)
Re-based to 100
2015: Depreciation is on the cards!
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
May
-13
Jul-
13
Sep
-13
No
v-1
3
Jan
-14
Mar
-14
May
-14
Jul-
14
Sep
-14
No
v-1
4
Jan
-15
Mar
-15
May
-15
Equity Debt
Portfolio flows
In U
SD b
illi
on
The INR is likely to remain vulnerable primarily to capital outflows:
Concerns about the pace of the recovery and prospect of lower debt flows until FII debt limits
are raised ……
…along with a tighter US monetary regime that could result in capital outflows and further
depreciation pressures
35
40
45
50
55
60
65
70
85
90
95
100
105
110
115
120
17
-06
-200
5
17
-06
-200
6
17
-06
-200
7
17
-06
-200
8
17
-06
-200
9
17
-06
-201
0
17
-06
-201
1
17
-06
-201
2
17
-06
-201
3
17
-06
-201
4
USD Broad TWI (LHS) USD/INR
Source: SEBI, Reuters & HDFC Bank
The prospect of a reduction in capital flows is likely to mean a possible upside of 66.50 for the USD/INR pair in 2015.
(35)
RBI likely to intervene to curtail extreme depreciation pressures and volatility
The RBI has both purchased and sold the greenback responding to intra-monthly flows to
maintain a stable currency
Given that RBI via its USD purchases has added to the total quantum of reserves, it has built-up adequate firepower to intervene aggressively.
The upshot is that the RBI could intervene fairly aggressively were depreciation pressures set to intensify that could to an extent limit the magnitude of depreciation going forward.
Source: RBI & HDFC Bank
(36)
250000
270000
290000
310000
330000
350000
370000
04-0
6-20
10
04-1
0-20
10
04-0
2-20
11
04-0
6-20
11
04-1
0-20
11
04-0
2-20
12
04-0
6-20
12
04-1
0-20
12
04-0
2-20
13
04-0
6-20
13
04-1
0-20
13
04-0
2-20
14
04-0
6-20
14
04-1
0-20
14
04-0
2-20
15
04-0
6-20
15
Foreign exchange reserves
In U
SD m
illi
on
0
5000
10000
15000
20000
25000
30000
35000
Jan
-12
Ap
r-12
Jul-
12
Oct
-12
Jan
-13
Ap
r-13
Jul-
13
Oct
-13
Jan
-14
Ap
r-14
Jul-
14
Oct
-14
Jan
-15
Ap
r-15
Purchases Sales
Purchases/sale of USDs by the RBI
US
Dm
illi
on
Improvement in external vulnerability indicators likely to mean reduced deprecation pressures
in % FY91 FY12 FY13 FY14 FY15
CAD/GDP -3 -4.2 -4.8 -1.7 -1.2
External debt/GDP 28.7 17.8 20 23.7 23.2
Import cover (In months) 2.5 7.1 7 7.8 8.9
Short-term debt/forex reserves 146.5 26.6 33.1 30.1 26.7
Short-term debt/total debt 10.2 21.7 23.6 20.5 18.5
Debt service ratio 35.3 6 5.9 5.9 --
Forex reserves/total debt 7 81.6 71.3 68.1 69.4
Fiscal deficit to GDP 7.6 5.8 5.2 4.4 4.1
Source: RBI & Ministry of Finance Note: External debt , ST Ext. debt and Debt service ratio updated till Dec,2014
India: Solvency and liquidity indicators
(37)
With the current account deficit and external debt ratios moderating, the INR is likely to be less vulnerable than the past to the Fed tightening monetary policy.
BOP forecasts:
Note: Oil imports have been calculated on the assumption that Brent curde oil averages around USD 65/bbl in FY16Source: RBI & HDFC Bank
(38)
In USD billion FY13 FY14 YoY % FY15 YoY % FY16F YoY %
Exports 306.6 318.6 3.9 316.8 -0.6 318.3 0.5
Imports: 502.3 466.1 -7.2 461.0 -1.1 475.6 3.2
Oil 168.8 172.5 2.2 141.5 -18.0 121.7 -14.0
Gold imports 53.5 29.4 35.9 45.0
Non-oil excluding gold 280 264.2 -5.6 283.4 7.3 308.9 9.0
Merchandise balance -195.7 -147.5 -144.2 -155.7
Software exports 63.5 66.9 5.3 70.3 5.1 74.2 5.5
Private transfers 64.5 65.5 1.6 66.0 0.8 65.0 -1.5
Other invisible categories -21 -17.6 -20.0 -22.0
Net Invisibles 107.6 114.8 6.7 116.3 1.3 117.2 0.7
Current account: -88.1 -32.7 -27.9 -38.5
% of GDP -4.8 -1.7 -1.3 -1.7
FDI 19.8 21.6 32.6 35.0
Portfolio flows 26.9 4.9 41.0 18.0
External loans 31.2 7.7 3.4 8.0
--External assistance 0.8 1.0 1.8
--ECB 8.5 11.8 2.8
--Short-term trade credit 21.7 -5.1 -1.0
Banking capital 16.5 25.5 11.7 8.0
--NR Deposits 14.9 38.8 14.1 7.0
Other capital flows -5.1 -10.7 1.4 -5.5
Total capital account 89.3 49.0 90.1 63.5
Errors & Omission 2.6 -0.8 -0.6 -2.0
Overall BOP 3.8 15.5 61.5 21.4
INR: Historically driven by both inflation and growth differentials
INR influenced by both inflation and growth differentials
Our equation: Change in INR = -1.76 + 1.02*(India-US) growth differential – 1.30 *(India – US) inflation differential
Inflation differential represents competitiveness and the CAD impact. Growth differentials could capture either productivity differences (the Rajan view) or simply the capital account impact.
Assumptions:
We assume gradual moderation in domestic CPI inflation driven by lower food
inflation trajectory and improvement in growth prospects on the back of an initial
revival in the public investment cycle
US growth likely to peak in 2016 followed by a moderation in inflation rates over the
period.
In % India growth US Growth India inflation US inflation Predicted USD/INR
2015F 7.5 2.5 5.4 0.1 65.86
2016F 8.0 2.8 5.7 1.5 67.18
2017F 8.4 2.6 5.6 2.2 67.38
2018F 8.2 2.4 5.2 2.1 67.14
2019F 7.8 2.2 5.1 2.1 67.11
2020F 7.7 2.1 4.8 2.0 66.90
Source: IMF & HDFC Bank
(39)
The upshot is that narrowing inflation differentials and improving growth differentials could lower pace of depreciation and result in an improvement in INR performance over the longer-term.
Extreme depreciation is unlikely over the longer-term
-100000
-80000
-60000
-40000
-20000
0
20000
40000
60000
80000
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY
09
FY
10
FY
11
FY
12
FY
13
FY
14
FY
15F
FY
16F
Current account FDI Loans Basic balance of payments
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
20
11
20
13
20
15F
20
17F
India-US growth differential (In %) India-US inflation differentials (In %)
Improving current account cover + falling inflation differentials + rising growth differentials = INR supportive over the medium term
Note: Basic balance of payments = Current account deficit – (FDI + External loans).Figures are in USD million. Source: RBI & HDFC Bank
Source: IMF& HDFC Bank
(40)
35.0
40.0
45.0
50.0
55.0
60.0
65.0
70.0
75.0
Jan
-09
Jun
-09
No
v-0
9
Ap
r-10
Sep
-10
Feb
-11
Jul-
11
Dec
-11
May
-12
Oct
-12
Mar
-13
Au
g-1
3
Jan
-14
Jun
-14
No
v-1
4
Ap
r-15
USD/INR spot
Implied rate from 1 year forward
Implied USD/INR spot from current forward rates is 68.60 that is above our forecasts.
Forwards both over and under estimate future spot INR.
We see case for a downward correction in forwards
The forward future spot link explained
(41)
Source: Reuters & HDFC Bank
Our forecasts:
3Q2015 4Q2015 1H2016 2H2016
USD/INR 63.50-65.00 65.00-66.50 65.50-66.50 66.00-67.00
EUR/USD 1.10-1.13 1.05-1.08 1.13-1.14 1.18-1.19
GBP/USD 1.54-1.56 1.52-1.54 1.53-1.55 1.57-1.59
USD/JPY 122.00-124.00 124.00-126.00 126.00-128.00 125.00-126.00
(42)
HDFC Bank Treasury economics research team
Abheek Barua
Chief Economist
Phone number: +91 (0) 124-4664305
Email ID: [email protected]
Jyotinder Kaur,
Principal Economist
Phone number: +91 (0) 124-4664338
Email ID: [email protected]
Shivom Chakravarti,
Senior Economist
Phone number: +91 (0) 124-4664356
Email ID: [email protected]
Tanvi Garg,
Economist
Phone number: +91 (0) 124-4664372
Email ID: [email protected]
(43)
