The growth data for the September quarter surprised expectations to the downside. Thus real GVA printed 6.9% versus consensus estimates of 7.3%. Whereas, real GDP came in at 7.1% versus 7.5% expected. As the graph below shows the so-called core GVA, which strips out agriculture and government sectors and is hence considered a proxy for the private sector, has slowed as well.
This slowdown is consistent with the core anchor for our fixed income view that peak growth is past us. To recall, this view is based largely around two pillars: 1> the world has exited the period of synchronized recovery that it saw over most of the past two years and is now marked by a slowing trade cycle; 2> the progressive tightening in financial conditions for most of the current year is bound to have a lagged impact on growth. That said, the slowdown already in official GVA is somewhat more pronounced than what one may have expected. This alongside substantial undershoots in CPI as well as a dramatic recent fall in oil prices reaffirms our view that there are no more repo rate hikes in the current cycle.
The weakest link in our macro in our view continues to be fiscal. In that regard, the recently released data for October doesn’t provide much comfort. Not only have we breached the 100% targeted fiscal deficit by October, but as the chart below shows, we are now tracking a higher run rate on fiscal deficit versus target, than we were at the same time last year. Thus year to date deficit till October is 104% of target versus 96% last year. This is particularly disconcerting since last year we ended up breaching the deficit target by 0.3% (which is why the bar for March below is shown at greater than 100%).
Against these numbers, however, are continued assurances from the highest levels of the finance ministry that the budget targets will be met. The commentary so far suggests this may be done through higher collections on direct taxes, possible overshoot on disinvestment, normal spending cuts as some ministries are unable to spend budgeted amounts, and rolling over of some excess subsidy items. There is no talk yet of voluntarily curbing discretionary (largely capital) spending. Should it come to this eventually, this may be an additional headwind to incremental growth. Conversely, as growth slows the temptation to show some small deficit breach may be higher. As of now the view remains that deficit targets will be met on paper. But this remains an area one has to watch carefully.
Finally, the RBI revealed its preference for continued Open Market Operations (OMO) purchases as its dominant liquidity infusion tool. Thus over and above the INR 1,26,000 crores done till late November, it announced another INR 50,000 crores till end of December (INR 10,000 crores done in last week of November and the balance scheduled for December). This is consistent with our view and given core liquidity calculations we fully expect more to happen over January – March as well.
Way Forward
There are certain offsets that need monitoring with respect to some of the trends mentioned above. The biggest one is a possible turn in the US dollar. Thus with tentative signs of some loss in economic data momentum as well as some turn in Fed commentary, there is already expectation building that the best of dollar bull run may be behind us. This may not show as much in the commonly tracked dollar index given that the Euro is suffering its own ills. However, what matters more is what dollar does versus other major pairs. In particular, the Indian rupee stands to gain both from this potential turn as well as from the dramatic fall in crude prices; just as it was suffering earlier in the year from the double whammy of stronger dollar as well as higher oil prices. Rupee has already appreciated around 6% from its October lows. Should this continue, this will constitute as a major source of incrementally easing the recently tight financial conditions. It will also constitute an additional source of liquidity creation and to that extent reduce reliance on OMOs alone.
Some observations on oil prices are also in order. At the time of writing, there has been some rebound in oil prices owing to US and China potentially de-escalating their mutual trade tension somewhat, and on news that Russia and Saudi have arrived at some tentative agreements to curb oil output. It is to be noted that after a spectacular 30% fall in a matter of less than two months, some rebound should be fully expected in crude prices. What matters more for our macros is that oil sustains in a lower range for longer. As an example if, alongside a stable rupee, Brent stabilizes even in the USD 65 – 70 per barrel mark, we will start seeing the macro benefits of this in current account and Consumer Price Index (CPI) down the line.
From a strategy standpoint, the view remains positive on AAA / sovereign. While rates have rallied meaningfully from the top, the macro situation is now much more positive. With no further hikes expected in the repo rate and assuming a stable currency and commodity outlook, we believe valuations on AAA / sovereign are still quite attractive.
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