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Aziz also says “the interest rate differential has to start narrowing. Once that happens, we do expect emerging market countries, including India, to see a significant amount of portfolio flows.”
The Budget has been described as judicious, where prudence has trumped populism and how the government has really done the right thing. How would you describe the budget?
Jahangir Aziz: On the headline numbers, we expected the budget deficit to be about 5.2% in a pre-budget preview of it. It surprised even us and delivered 5.1%. So obviously, we have to laud the government in delivering a very strong consolidation. In our view, given where India’s growth is, FY24 and FY25, you are going to see these 6%, 7% growth numbers. The disinflation is on track. It is not really where the RBI wants it to be, but it is getting there largely because most of the disinflation is being driven by a normalization of the supply chain and because there is a significant amount of export price deflation coming out of China. So we will get there.
If the Fed cuts somewhere between now and June, that gives the RBI ample space to start cutting rates and support the economy. So there was never really any need to provide macroeconomic support at this point in time. Instead, what was really needed was that they focus back on fiscal consolidation just to get India’s debt stock stabilizing around the 83-84%, which we think is going to happen because even if you compare it to pre-pandemic levels, which was 70%, we are about 15% higher stock of debt. So it was needed to start consolidating and consolidating early.
Do you think from what the finance ministry has done, the action is going to move more towards RBI? We already saw what the Fed indicated. Do you think now that pivot and the cycle turn off, when the rate easing is going to begin will act as the next big trigger for both equity markets as well as bonds?
Jahangir Aziz: Yes, the government has done its job right. This was a 0.7% consolidation. And given the track record of this particular team in North Block, they have actually delivered year after year. It is not that they have missed their target. So we can be pretty much sure that unless something happens in the global economy, we will get the 5.4% fiscal deficit done.
It has actually brought down total gross borrowing. You add on to it that with some persuasion, if you can get the state governments to start bearing back from the 3.1%, 3.2% to let’s say closer to 2.7%, 2.8%, both of them together now creates the kind of fiscal space that the RBI would have needed if it was to go on a significant easing cycle.
I think what is holding the RBI back is simply that the interest rate differentials with the Fed is still too low for them to do that without raising concerns about financial stability. So my guess is the RBI will do a Fed. They are going to say that enough amount of progress has been done on inflation, but there is still need to see more data and there still need to be some more convinced that we are on the right track and that the government has provided them with this fiscal consolidation, a very credible policy, a framework within which they can start cutting rates. I do not think they are going to cut rates till the Fed actually does cut rates. But after that, yes, you could see some reasonable cuts in RBI’s policy.Also, what is happening within India equity markets? While we are rip-roaring and are already looking at a fresh all-time high, the fact is foreign money has completely eluded India, all through 2023 and we are seeing that play out this year so far as well. Do you think, purely because of our positioning vis-à-vis the rest of the world, 2024 makes a stronger case for more flows and concentrated ones at that towards emerging markets and thereby India also benefiting?
Jahangir Aziz: Yes. So that is what we are hoping to see. Obviously, in January, we did not get the kind of flows that we were expecting and part of the reason was you had this exuberance in December where you did see a significant amount of flows coming into emerging markets though not in Indian equities. But with the March rate cut being pushed back, I think that also pushes back this rate cut. You really need the Fed to start cutting rates. You really need the 10-year rate and the 2-year rate in the U.S. to start sliding down to more normal levels. It is very, very hard to see people putting money in risk assets outside of their comfort zone, i.e. getting over their home bias when this cash was paying you about 4.5%, 5% not too long back and your own equity market was giving you a significant amount of upside.
So you really require this interest rate differential to start narrowing. Once that happens, we do expect emerging market countries, including India, to see a significant amount of portfolio flows. We should keep in mind that even if you look at the post-pandemic period, if you add up all the flows that have come into emerging markets, there have not been very much and so people do not own emerging market assets very much. Ownership is very low, positioning is very low. Once that trigger starts, you should not be surprised with significant flows coming in.
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