Emerging Market: Unfavourable environment for EMs like India: Rob Subbaraman, Nomura

“Emerging markets are going to struggle. It is a pretty unfavorable environment for emerging markets such as India, which is dependent on energy and some food imports”


Rob Subbaraman, Head of Global Macro Research, Nomura, in an interview with Anand JC explains why emerging markets are in trouble, how the ban on food exports can lead to a global crisis, and why India needs a lot more than just a PLI scheme to catch up with China in manufacturing and FDI. Edited excerpts:

Are emerging markets like India still the best option for investors after very visibly losing some steam over the past few months?

EMs are going to struggle in the coming months. The US Federal Reserve is currently hiking rates & will possibly hike quite aggressively in the coming months. We have slowing global growth and high commodity prices. Right now, it is a pretty unfavourable environment for EMs including India, which is dependent on energy and some food imports.

Now that the Fed has turned hawkish, some are worried that we may see a repeat of the taper tantrum even though the authorities argue that we are much better placed today than we were in 2013. Are the naysayers right in being worried?

The chances of a large exchange rate depreciation of the Rupee are reasonably low at this stage; India has built a fortress in terms of forex reserves. It is also starting from a position where the current account didn’t have a large deficit to start with. I don’t foresee a forex crisis.

But that said India, like other EMs, is going through a challenging period. There is high public debt, monetary policy is being tightened, and there isn’t much fiscal space either. Ultimately, that environment of the rising cost of living, tighter monetary policy, and not much room for fiscal easing are going to lead to slower growth.

EMs have seen heavy outflows in the recent months, as Fed has turned hawkish. Retail investors have shown some resilience for now but in the medium-to-long term, is India still among the preferable destinations for FIIs?

Absolutely. India is still in the mode of economic development. We are seeing growing geopolitical risks around the world and it is possible that the strange relationship between China and many advanced economies could be beneficial to India in the medium term. Still, I don’t think it will happen that easily. India will need to show that its eco fundamentals are strong and that it continues to work on becoming more competitive and take advantage of that.

Since the pandemic hit, the Indian government has actively promoted its Aatmanirbhar scheme and has introduced the likes of PLI schemes, to showcase its intent. India intends to be a viable alternative to China and Taiwan. Are the current measures good enough to pose India as a legitimate alternative to China?
It is too early to tell. China’s success over the last two decades didn’t happen overnight, it put a lot of effort into creating the right foundations. Just having cheap labour is not enough, there is a need to lower the overall cost of doing business, deregulate labour markets, and have sound infrastructure, and a decent health system. If they do come in place and you start to attract more FDI, it can feed on itself and lead to more investments.

Touching base on the current rise in protectionism as a result of the war in Ukraine. Be it India, Indonesia, or Malaysia, some prominent players are indulging in food protectionism citing domestic priorities even as food security is becoming a problem worldwide. Do you see this exacerbating the global macroeconomic situation?
Absolutely, this is a very dangerous development. From a country’s perspective, it can make sense. But if every country starts to do that, it will only lead to more food shortages and exacerbate the problem at a global level. Right now, we have a coordination failure across the world, particularly the EMs. There are 30 countries that have imposed trade restrictions on food. This is a very bad sign and is increasing the risk that food prices keep going higher.

Coming back to the fiscal situation of India, the government recently announced a slew of measures that are estimated to cost $26 billion, including lower fuel taxes and import levies. How far will these measures go in addressing the issue at hand and how do you think they will affect India’s fiscal situation?
I think India, like many other countries, is trying to coordinate monetary and fiscal policy to address high commodity prices and inflation. The measures you talked about, including the subsidies which the government provides to help the poor, will weigh on the fiscal position. The risk as we see it is the government’s budget deficit target for this year is overshot as a result. The government can try to increase its privatisation or divestment measures and cut expenditures, but in this environment, we are going to start growth slowing down.

Currently, the reopening of the economy is helping the growth but that burst of pent-up demand growth will soon fade and in the coming quarters it will be hard for India to meet its fiscal deficit target.

Despite the rising inflationary pressures, the RBI took its hawkish turn only recently, even as economists and experts have been calling for action for months now. Has it really been behind the curve or was the RBI right in prioritising growth for as long as it did?
It is always easy to assess things in hindsight, if we were to go back 3-4 months, it wasn’t clear how quickly the economy would recover from the pandemic and how high and sustained the commodity prices would be. Now, I would say it is behind the curve and needs to catch up. It has moved a bit more aggressively now and we think it’ll need to continue to move aggressively on rate hikes to get back ahead of the curve.

One of the challenges for the RBI is the second-round effects from the high inflation. Inflation expectations in India are in double-digits. High inflation is bad for growth in the longer run. It can be painful to get it down but in the long run, it is better to do that.

Does the RBI need to opt for aggressive rate hikes in the coming meets?
I think it would be something that is very much on the mind of RBI Governor Shaktikanta Das and it is a hard policy trade-off. The reality is that a lot of inflation in India is imported inflation which is coming from commodity prices, energy prices in particular. Monetary policy cannot lower the energy prices, it affects relative prices. To bring inflation down would be growth-negative, it is as simple as that. The RBI and other central banks are thinking about how aggressive they should be, because the more aggressive they are, the bigger the risk of a sharp growth slowdown.

We think inflation is going to go over 7% in India in Q3 & Q4, possibly over 8% for some months. Real rates are still deeply negative so we expect RBI to hike by 35 bps in the next meeting and 50 bps in the one after that.

Some indicators like bond yields are pointing towards an imminent recession in the US. How is that likely to impact EM currencies, especially the Rupee?

I don’t think that the US is heading towards an imminent recession. The recession risk, in our view, is more for next year, rather than this year. The market tends to focus on the US treasury 10Y-2Y gap, that is not a very reliable measure of recession and typically when that yield gap goes negative you don’t get a recession for about a year after. There are better measures, like the gap between the 3-month treasury bill and the 10y bond yield and that is nowhere near negative at this point.

Households in the US are sitting on a lot of excess savings, the labour market is very strong and even though there has been tightetning of financial conditions, it has happened at a very loose level. Even now, the level of conditions is not overly tight.

We expect three 50 bps rate hikes in June, July, and September and that could put more pressure on EMs through capital outflows and currency pressure.

Among the EMs, which countries are better placed to deal with some of the uncertainties that the ongoing war is likely to pose
At first

, you feel it’s all negative and bad in EMs. But as you dig deeper, there is variation, particularly in the next 1-2 years. The most negative right now is Eastern Europe EMs that are exposed to the war. The net importers of commodities look vulnerable, like Turkey, Pakistan, Sri Lanka, and Egypt. India, Indonesia & Philippines figure in this group as well. Net commodity-exporting countries in the Middle East should do reasonably well, some in Latin America as well. Malaysia could do well, in Asia.

The current situation for India’s neighbours isn’t exactly pretty with Sri Lanka facing some economic uncertainties and some political volatility in Pakistan. Are these developments likely to feed into India’s growth story?
They are right on India’s doorstep, so their being in a crisis isn’t good for India. Other than the trade channel, there are the financial aspects. Indian companies with operations in these countries may face challenges, as could Indian investments in these countries. The third potential channel is more on the social side, if the governments are not able to stabilise the situation, there could be increased social unrest on India’s doorstep. At this point, it is not a major negative for India but it is definitely something to watch.