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Indian Economic Update
PM, Mr. Modi on last Saturday promised more measures to ease problems faced by small businesses due to GST. The PM added that council of state ministers have already accepted most of these suggestions and the announcement is likely to happen post the GST council meet.
The GST Council meeting started on Thursday, proposed measures that included reducing taxes from 28% for items of mass consumption and allowing business to file returns once in a quarter rather than on a monthly basis as prescribed earlier.
US: Employment undershoots expectations in October
- US Non-Farm Payrolls (NFP) increased by 261K in October compared to 18K in September.
- Unemployment rate declined further to 4.1% in October from 4.2% in the previous month, lowest since 2001.
- Average hourly earnings printed at 2.4% YoY lower than market expectation of 2.7% YoY.
Fed is likely to stick to its rate hike path
The latest FOMC statement termed the growth as solid and employment addition affirms the trend in economic activity. However, the fall in average hourly earnings might concern the Fed. It is probably that the impact of hurricanes still lingering and the data has still some noise to it. Considering the recent data, we believe it is likely that the wages will raise in the next month. We continue to expect that the Fed will raise rates in its December meeting.
Other important developments during the week:
- Reserve Bank of Australia (RBA) kept the policy rate unchanged at 1.50% in its monetary policy.
- In line with expectations, Bank of Thailand has kept its key policy rates unchanged at 1.5% in their policy meet.
- Reserve Bank of New Zealand also kept its official cash rate unchanged at 1.75% in its monetary policy. The accompanying statement however, raised the Bank’s inflation forecast, signalling that interest rates may need to rise slightly earlier than previously expected.
- The US Senate tax reform bill was introduced on Thursday. Much to the disappointment of markets, the Senate bill proposed that the corporate tax cuts will be effective from 2019 (House bill proposed it will be effective from 2018).
Indian equities started this week on a flat note. Market players failed to have any firm direction, mixed cues from Asian equity peers and profit booking in some sectors after last week’s steep price rise weighed on the indices.
Sentiments were subdued in the pharmaceutical, the stocks of banks also suffered as investors weighed the losses in Banks’s treasury books post the fall in bond prices. Further, shares of Oil Marketing Companies were dragged down by rising crude prices.
Indices inched up towards end of the week, most of the market movement remained stock-specific amid the ongoing Jul-Sep earnings season.
During the week Sensex lost 1.10% to close at 33314.56 while Nifty declined 1.27% to close at 10321.75.
Indian Government bonds started the week sharply lower. Bond prices were down as surge in global crude oil prices sparked concerns of upward pressure on inflation. Further, traders refrained from taking fresh position in lieu of heavy supply lined up this week. The overall market sentiment continues to remain weak, as rate cut hopes reduce significantly.
The moderation in global crude oil prices offered some support to bond prices towards the end of the week.
The 10Y benchmark yield ended at 6.96% as compared to the previous week’s close of 6.86%.
Oil hits two-year high as market rebalances
Since touching a yearly low around USD 42/ barrel (WTI) and 45/ barrel (Brent) in June, crude prices have been steadily increasing, touching 59/ barrel on end September and more recently crude crossed its highest levels in more than two years as Brent and WTI traded above 64/ barrel and 57/ barrel respectively, roughly marking gains of over 40%.
Why has it happened?
Crude markets have been increasingly shifting towards a rebalance in last few months, with efforts from OPEC and non-OPEC member to curb the global oil glut. The compliance levels of OPEC members (excluding Nigeria and Libya) have largely moved prices as they rose from 75% in July to more than 90% expected in October. Moreover, members have focused on curbing exports in addition to production levels, which is seen as a more important metric in driving investor sentiments. On the demand side, market sentiments were boosted after IEA and OPEC revised their crude demand growth upwards to 1.6 million bpd for 2017 and 1.4 million bpd for 2018 on account of global economic expansion. Furthermore, geopolitical risks majorly due to the Iraqi-Kurds conflict have led to supply disruptions amounting to almost 500,000 barrel per day and have supported prices further.
In the last few days, investors have been more bullish on crude pushing gains in Brent by more than 6% and in WTI by 5.5%, as geo-political uncertainty escalated in the middle-east over the weekend. The Saudi Arabian crown prince cracked down on dozens of princes and business tycoons raising concerns about stability and policymaking in the world’s largest crude exporter, which has also been experiencing tensions with neighbouring nations of Iraq and Iran. Additionally, last Friday saw a very bullish fall of 8 in the US oil rigs which is considered an early indicator for future output.
Markets seem to be reading too much into the geo-political risk premium and we see the current level to be a temporary surge, largely expected to come back down closer to where the fundamentals suggest at around USD 60/ barrel. A downside to current prices is the rising US production, nearing record levels at 9.5 million bpd while exports have crossed the 2 million bpd mark, which could be the trigger for a sharp correction ahead as geo-political risks subside. With a growing spread between Brent and WTI of almost USD 7/ barrel, US has been spiking its exports given the premium prices on the global benchmark (despite covering for shipping costs), which should cap prices on Brent and narrow the gap.
Crude hike Impact on India
The surging crude prices spurred a selloff in the Indian equity market as investors were distressed by the impact rising oil prices would have on the macroeconomic factors of the economy. The rupee fell the most in seven weeks and the 10Y government bond yields surged to a fresh six months high as excessive oil prices worried investors of a possible fiscal slippage, inflationary pressures and lower chances of the RBI cutting interest rates. Every USD 1/ barrel rise in crude prices leads to an increase in India’s current account deficit by approximately USD 0.8 billion. On the inflation front, a 10% increase in average crude oil prices would shave off 10-30 bps from GDP growth, with full pass through to consumers. It would directly impact approximately 3.6% of the CPI basket and also indirectly through increased transportation and production costs. The total effect on headline CPI inflation would be to the tune of 40 bps increase.
However, as per the RBI, assuming that crude oil prices reach USD 65/ barrel in the second half of 2017-18 in this scenario, inflation could be higher by about 30 bps in 2017-18. Real GVA growth could weaken by around 15 bps in 2017-18 due to the direct impact of higher input costs as well as spill overs from lower world demand. Meanwhile, the center has asked the states to reduce their VAT in lieu of rising oil prices and dismal fiscal position.
Medium term Outlook
The world oil market seems to have broadly returned to balance this year, as the market turned from a surplus to a deficit largely on account of a strong draw in stocks in the second quarter. As global demand exceeds supply, the last quarter of the year is expected to remain in deficit. This is assuming OPEC production remains at current levels, around 32.7 million bpd.
In the year ahead, we expect the crude market to be in a deficit initially in line with the current demand and supply levels, but broadly move towards a slight surplus (ruling out natural disasters and temporary geo-political risks disrupting supply), which translates to prices being around the USD 59-62/ barrel range. In this respect, the November 30th meeting among global producers is very crucial in shaping the crude market balance ahead.
Gold edged higher during beginning of the week. The yellow metal steadied as investors looked past Friday’s non-farm payroll data, while a sharp retracement in the US treasury bond yields, helped the non-yielding precious metal. Physical demand from China and India were lackluster, however Indian demand is expected to be stronger as the peak wedding season sets in the coming weeks.
The demand for the yellow metal was boosted as the dollar dipped, following media reports that suggested a delay in the implementation of a major corporate tax cut. Investors are staying close to the safe haven amid rising geo-political risks in the Middle East.
Meanwhile, World Gold council released a bearish Q3 report on Gold. According to the report, demand for the bullion slumped to an eight-year low in the third quarter as it fell to 915 tons in three months to September, down 9% from the same period a year ago.
Indian Rupee started the week marginally weaker. Dollar purchases by public sector banks, on behalf of importers weighed on the domestic currency. However, some quantum of dollar sales by foreign banks capped rupee’s further depreciation.
The fall in gilt and equity markets weighed on the domestic currency. Further, persistent dollar purchases by banks, on behalf of importers weighed on the domestic currency. The increasing oil prices also triggered oil importers dollar demand.
Meanwhile, rupee strengthened towards the end of the week as some foreign banks sold dollars. Exporters’ dollar sales and positive equities also supported the rupee. The marginal weakness in the dollar index also aided other currencies.
Source: ICICI Bank Research, Bloomberg and CRISIL.