Over the past few weeks, geopolitical concerns held prominence over prevailing economic trends of synchronous global growth, tepid inflation and a gradual approach to policy normalisation by major central banks.

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The ongoing North Korean missile launches over Japan and a hydrogen bomb test brought back risk aversion to global markets. While global economic growth appears to be returning after almost 10 years of significant monetary stimulus, the weak inflation impulse in most of G-7 is delaying the urgency to reduce the stimulus. An exception in 2017 is the resource-rich Canada who has already hiked rates twice within eight weeks afraid of falling behind the curve.

In the USA, the hurricane devastation evoked a bipartisan response to pass a House Bill including $15.25 billion in disaster relief and a three month suspension of the debt limit out to mid-December 2017. This along with the surprise resignation of the hawkish US Federal Reserve vice chairman Stanley Fischer led to a rather complacent view of the US FOMC meeting on September 20. But the August CPI (+1.9%y/y) brought back a December rate-hike probability (50%) on the table.

European Central Bank (ECB) left its policy settings and forward guidance unchanged but foreshadowed a decision on QE taper at its October 26 meeting, which will follow more economic data, German Federal elections (September 24) and the Catalonia independence referendum (October 1).

The Bank of England, as it grappled with divergent data and stalled Brexit discussions, kept interest-rates unchanged by a 7-2 majority. The minutes displayed a hawkish rhetoric hinting at “some withdrawal in stimulus in the coming months” to bring the inflation overshoot (2.9%, August CPI) sustainably to its 2% target.

Domestically, inflation picked up in August with CPI (3.36%y/y, at a five-month high) and WPI (3.24y/y), on rising food/fuel prices, 7th CPC pay rise and the GST effect. This contrasted with subdued industrial growth (1.2%, July) coming on the back of the soft Q1 FY2018 GDP growth (5.7%y/y, a three-year low) making RBI’s monetary policy choices even tougher.

The rupee in 2017 has, however, benefited from the Indian asset market story about dollar weakness, a robust domestic macro outlook, low external financing and political risk. The US dollar index has now fallen by over 12% from its January 2017 peak helping the rupee gain around 7% over the same time. Considerable capital flows and significant corporate dollar sales have forced RBI intervention in both the spot market (11.82 billion till July) and even more in forward maturities (15.62 billion till July) - to avoid adding to the already buoyant rupee liquidity. This has resulted in a near U$ 400 billion RBI forex reserves (28 billion in FY2018).

But this rupee strength has slowed export growth (3.9%, July) raising the chorus for rupee depreciation. Near term though, we expect rupee to trade in 63.90-64.50% range with isolated surges on geo-political events.

GOING STRONG

  • Slowing exports have led to clamour for depreciation in the rupee  
  • Capital flows, corporate dollar sales have forced RBI intervention

The writer is president and chief operating officer, Kotak Mahindra Bank