Complex Made Simple

The bearish case for the Indian rupee and zombie shadow banking system!

Matein switches his position on the Indian Rupee. What changed his mind?

I expect at least another 50 basis points in repo rate cuts in 2019 There was a swift, brutal plunge in the Indian rupee exchange rate against the US dollar to 70.95 as of August 11, 2019 I am deeply concerned about the Indian central bank’s decision to allow regulated commercial banks to increase exposure to single non-bank financial company borrowers

By Matein Khalid: Chief Investment Officer and Partner at Asas Capital 

India’s Reserve Bank of India (RBI) has finally downgraded its GDP growth forecast to 6.9% (dream on!) and lowered its repo rate by 35 basis points to 5.4%, the lowest since 2010. After the de facto sackings of two successive central bank heads who refused to do the government’s bidding, (Dr. Raghuram Rajan, Dr. Urijit Patel), the BJP ended the myth of RBI monetary policy independence by appointing Shaktikanta Das, a Finance Ministry apparatchik, as governor. Das has pleased the BJP with his totally unrealistic growth projections and tolerant wink-wink attitude to its political allies among Indian corporate oligarchs who looted public sector banks (light touch regulation?), he has also delivered on monetary policy with increasingly accommodative rate cuts.

Since growth will unquestionably remain well below the RBI’s 6.9% forecast and inflation will continue to undershoot its target, I expect at least another 50 basis points in repo rate cuts in 2019. This was the subliminal message of the aggressive, uber-dovish 35 basis point rate cut to the financial markets. It is now prudent to position for a 25 basis point rate cut at the RBI’s October MPC review.

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Dalal Street’s reaction to the 35 basis point rate cut, the decline in the GDP growth forecast and the lack of any real initiative to increase the monetary transmission path of lower policy interest rates to India’s zombie shadow banks/corporates led to a predictably bearish reaction in the stock exchange indices. Not even the fourth successive RBI rate cut prevented steep falls in the Nifty and Sensex as Wall Street’s spasm of risk aversion after the escalation of the US-Chinese trade war has now triggered intercontinental contagion. The Indian stock market was not impressed by Governor Das’s shock and awe 35 basis point repo rate cut because it has priced in a far grimmer endgame for the current monetary/credit cycle.

The BJP’s decision to revoke the Article 370 “special status” of Jammu and Kashmir coincided with the escalation in US-China trade war tensions and geopolitical stress with Pakistan (goodbye UN plebiscite or Simla Accords) and China (India dare not defy Trump on Huawei, despite Beijing’s wrath). This led to a swift, brutal plunge in the Indian rupee exchange rate against the US dollar to 70.95 as of August 11, 2019. As the money markets price at least another 100 basis points repo rate cuts in the next twelve months, I expect the Indian rupee will depreciate to 73 – 74 by August 2020.

I was earlier bullish on the Indian rupee due to the fiscal deficit discipline signalled by the 2019 Union Budget (politically feasible since the BJP had just won by a landslide in the Indian general election and did not need to appease rural vote banks), the attractive inflation-adjusted yields in the government bond (G-Sec) markets and the capital markets talk of a potential $10 billion offshore Republic of India sovereign bond issue. Yet as facts change, I must change my opinion on the Indian rupee – as Mahatma Gandhi once observed: “consistency is the virtue of an idiot” – and I learnt the hard way a long time ago that an intellectually rigid prism trading Planet Forex was invariably fatal to my net worth and self-worth!

I had flagged a bearish strategy call on the Nifty at 11600 few months ago as I believed the systemic horror of the Indian shadow banking crisis (IF&LS, Dewan Housing, Yes Bank, India bulls etc.) and the property crash were simply not priced into the stratospheric valuations of Indian equities, the most expensive niche in the global emerging markets village.

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The Nifty index has fallen to 10850 as I write but I will remain short the Indian stock market exchange-traded fund (ETF) on the NYSE. When a liquidity crisis guts an emerging market, it is time to bail out. The first rule of Mattinomics, my philosophy of investing, has always been – when the going gets tough, the tough get going, bleed but do not haemorrhage (stop losses are mission-critical!). The ghost of J.P. Morgan whispers to me as I stare at the silhouette of half-empty office towers in Dubai’s Business Bay, “liquidity is like a cab on a rainy night. It disappears when you need it the most”.

Of course, I do not need J.P. Morgan to remind me that, at least in the Dubai property markets, Greater Fool Theory is the investment formula used by crooked property developers to fleece untold millions of dollars from the life savings of the countless leveraged lambs (aka homeowners) they have so mercilessly slaughtered in the past decade. What a pity, what a world!

I am deeply concerned about the Indian central bank’s decision to allow regulated commercial banks to increase exposure to single non-bank financial company (NBFC) borrowers – obviously the RBI knows that the shadow banking crisis is now systemic and could lead to a mass extinction event for hundreds of busted zombie banks, corporate and property developers (Crooks R Us), much as a mega asteroid collision 65 million years ago took out brontosaurus and his (her?) dinosaur buddies. Thanks to the greed of India’s political/financial elite, Indian housing, agriculture and small merchants will face the mother of all protracted credit crunches as hundreds of shadow banks go belly up as the business cycle morphs into recession. After all, shadow banks goosed consumer borrowing binges in everything from status symbol Marutis for Indian farmers to South Bombay luxury penthouses for the suited-booted corporate Maharajahs of Black Money – and now the music has stopped with a vengeance.

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Indian investors and banks are disgusted by the fraud and deceit that is endemic in the shadow banking constellation, as Deloitte’s belated resignation as Dewan Housing’s auditor attests. I wonder if RBI Governor Das has ever heard of Sir Thomas Gresham, whose three centuries-old Gresham’s Law argued that investors will not throw good money into crooked deals. It is idiotic to increase counterparty exposure to an NBFC borrower as the shadow banking crisis escalates. This is not a liquidity, but a solvency crisis, an ugly existential fact that the BJP and the RBI have not grasped. But then I guess consistency is really the virtue of an idiot.

The $14 billion Dewan Housing Finance debt moratorium ensured that the “cockroach” theory will cause the death rattle of dozens of Indian shadow banking dominoes. It is insane for the RBI to pressure Indian bank, hardly the paragons of corporate governance, as the Chanda Kochar scandal at ICICI and the Yes Bank (run by Dr. No?) debacle proves, to increase exposure to shadow banks. As I predicted the day Dr. Raghuram Rajan resigned, the people of India will pay a heavy price for a yes sir, no sir, three bags full sir BJP babuji at the helm of its central bank.

India’s growth malaise in 2019 is structural/sectoral, not just cyclical. The BJP’s rupee demonetization, increased tax collection vigilance and NBFC funding freeze has led to four successive quarters of slowing GDP growth. Higher tax rates, stressed corporate balance sheets, the funding crisis in the shadow baking system, a collapse in luxury property values, slower exports, decelerating credit financed private consumption have all contributed to the Indian economic growth slump in 2019. India’s auto, banking/finance, telecom, construction, FMCG, real estate and construction industries are all hit by structural shocks. These shocks are not amenable to RBI short term monetary stimulus. As I scan the inventory data of vacant units in India’s largest eight cities, I guesstimate a 25 – 40% hit to prices from current levels is inevitable. Modi’s pledge to morph India into a $5 trillion economy in his second term? A cruel joke!

The 30% YTD fall in Maruti’s shares amid a near decade low in auto sales, a sharp slowdown in volume growth at Hindustan Lever, ITC and Godrej, the NPL scandals in Indian banking and the exodus of 14000 Indian dollar millionaires to greener (sandier?) pastures abroad tells me Bharat Inc’s economic malaise will be protracted. In retrospect, Modi 2.0’s tough love 2019 Union Budget, rich-tax surcharges, Bankruptcy Code and tax raid vigilantes will only accelerate the slump in domestic demand, the reason the IMF slashed its forecast GDP growth. Modi’s RSS zealots obviously do not subscribe to Deng Xiao Ping’s “to get rich is glorious” doctrine in their distrust of Indian business elites (ex laadla BJP oligarchs) – a major Achilles heel of India Inc. in the months ahead.