Talking Point | #DBSResearch's MD & Chief Economist Taimur Baig on crude, bond yields, inflation and more, in conversation with BQ Prime's Tamanna Inamdar. #BQLive
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00:00 Welcome to Talking Point. I'm Tamanna Inandar and we're speaking today with Dr. Taimur Beg.
00:05 He is MD and Chief Economist at DBS. Dr. Beg, thank you so much for speaking with us. Absolute
00:10 pleasure to be talking with you, especially at a time when so much is going on in the global
00:17 economy. We're speaking on a day when crude is again reaching scary levels. So let's begin with
00:24 that. Let's begin with crude. There is a prediction of crude at 100. While we're speaking, it's
00:30 hovering around 97, 98. Brent, that is. Do you see crude pinching and implications for the Indian
00:38 economy? Okay. Yes. Given the supply demand makeup around the world in terms of refining capacity,
00:46 in terms of storage, looks like we're at a bullish part of the cycle as far as oil is concerned.
00:52 But I would make two important points. One is we shouldn't worry that much. And second is the
00:58 cycle itself may well be short-lived. So why we shouldn't worry about it? Well, we have lived with
01:04 100, 110, $140 oil in the past and not in recent past, going all the way back to 2008. So the world
01:13 in the last 15 years has seen $40 oil, $100 oil, $140 oil. That has not been the spoiler, if you
01:22 will, for the global economic cycle. There are many other things going on. Of course, energy-related
01:26 inflation is a concern. Of course, that leads to some pressure on the current account in the
01:31 currency. But that is not going to be the maker or the breaker of the economic cycle in India or
01:37 globally, in my view. In real terms, oil today is even at $100, substantially lower than anything we
01:44 saw during the previous bull runs of oil in the end of 2008, 2009, and as well as in recent years.
01:52 So first and foremost, I think it's important to understand that we have seen this before,
01:56 we've taken this in our strides. We have the absorptive capacity to deal with $100 oil. It's
02:01 okay. Now, even if that is still an uncomfortable dynamic for economic observers and market
02:09 participants, let's also keep in mind that in the last year and a half, global energy suppliers have
02:15 shown pretty heroic capability of ramping up production. A year ago at this time, when there
02:20 was peak panic around Ukraine, a lot of people said that the US production capacity was in its
02:26 last day. They were going to take a very long time to go back to pre-COVID levels of production.
02:31 Well, it turns out high oil prices have an amazing impact on galvanizing supply, and that's what we
02:37 saw in the US. The US ramped up supply by 10%, 15%, and they're on the verge of going back to
02:42 pre-COVID level of production. Same with gas. We felt that once the Russian gas toward Europe would
02:49 feel face some friction, that would cause huge amount of energy uncertainty. Looks like between
02:54 US gas producers and Qatari gas producers, Europe managed to secure substantial supply.
03:00 So I think that on the supply side, there is still capacity, temporary inventory, and refining
03:06 dislocation notwithstanding. Now, finally, let's talk about the demand side. We look at the US,
03:12 looks pretty good, but that's where the good story more or less ends. We look at Europe,
03:17 we look at China, we look at the export-oriented countries of Asia, demand is clearly not that
03:22 great. So demand not very good, supply-related issues kind of temporary. I wouldn't worry too
03:28 much about oil going toward 100. It will not be long-lived in my view. Is a larger worry the
03:35 stance coming in from the Fed last week and the impact it will have perhaps? And previous note,
03:42 or a recent note, DBS does talk about how Asian central bankers will respond. We have a MPC meet
03:48 in Mumbai next week. Do you expect that hawkish tone to filter through? Because we've been
03:55 waiting for the RBI to perhaps start cuts early next year. Has that timeline sort of gotten pushed
04:02 forward? I'm afraid so. And it's not just the Fed. We'll talk about the Fed in a second, but also I
04:07 think there are domestic factors, especially with respect to food inflation, that is turning out to
04:10 be a source of headache as far as the RBI is concerned. I don't think the RBI is going to be
04:16 very concerned if the rate cut cycle gets delayed by a little bit. I think overall the economy is
04:23 not dying for monetary easing, or it's not like liquidity is so tight that the market, the business
04:31 cycle requires substantial easing. It's nothing like that. So I think the RBI is in a good position
04:37 where they can convey some degree of inflation fighting credential and perhaps signal that it
04:43 will have to take a closer look at what's happening with the overall price dynamic before entertaining
04:48 easing measures at some point next year. So I think that unfortunately is a given, given the
04:53 domestic drivers. Now, the external drivers, whether it is oil or the Fed, the Fed is a very big
04:58 source of headache. I think the Fed tightening over the last year or so, we haven't felt it
05:05 entirely yet. It's about to come in terms of real interest rates being high, in terms of dollar
05:10 liquidity becoming tighter progressively, in terms of emerging market currencies, including the rupee
05:15 ceiling pressure of the mighty dollar sort of pulling itself up because of the high interest
05:20 rate differential between the US and the rest of the world. So I think that the Fed tightening and
05:25 the fact that they are very keen to give the signal that the rates will be high for a prolonged period
05:30 of time, that could be a source of destabilization for global markets, particularly the financial
05:36 system. We've seen a prelude to this already in the early part of this year when a couple of
05:42 regional banks in the US faced substantial duration risk and saw a liquidation risk and
05:48 that became a source of concern as far as contagion is concerned. It didn't spread too much. The Fed
05:55 banks came in and intervened quite vigorously. But is that it? Or could there be more accidents
06:01 lurking in the corner for companies, lenders or creditors who have big duration mismatch and is
06:08 not really prepared to deal with such high interest rates? So that certainly is my worry. I'm much
06:12 more worried about them than oil. Okay, so Fed is a bigger headache than oil at this point. Let's
06:17 just focus for a second on the China piece of the puzzle and bad news sort of piling up there.
06:25 Growth estimates for China were already lowered. Does the Evergrande implosion make things worse?
06:31 News coming in that the stock has been suspended, the founder is under some sort of police control.
06:37 Is that real estate piece going to unravel at an even faster pace? None of these news items help,
06:46 no question about it. There's no way to sugarcoat any of these developments. I do think that the
06:51 chance of an outright crisis stemming from housing to banks to households, the way we saw it happen
06:57 in 2008, 2009 in the US, I think that's pretty unlikely in China. I think the authorities have
07:02 far more levers in place to intervene than the US had. For example, a Lehman moment in my view
07:09 is sort of unthinkable as far as China is concerned. They've seen how those things
07:13 unravel and they will not let that happen. Similarly, as far as banks are concerned,
07:17 I don't think a bank run or for that matter, the RMB facing huge amount of shorting by Chinese
07:23 individuals, I think those things are unlikely. Those are typical things that happen during a
07:27 financial crisis. People take the money out of banks, people try to convert to a foreign currency.
07:31 Those things I think are unlikely in the context of China. There is significant greater degree of
07:37 control as well as confidence in the authorities' ability to backstop the system. So I don't think
07:42 people will panic like that. Having said all that, huge burden of debt, dysfunctionality
07:48 among the various players in the property system, whether it's the local government financing
07:52 vehicles or the property developers or the banks that are in the middle of all these,
07:56 everybody has to deal with some degree of reckoning, some haircut, some loss recognition,
08:02 some equity write down, I think is very, very likely. And how can that help? Eventually,
08:08 things will be cleansed, the system will move on. But the transition to that period
08:12 would be rather painful. And this is true for every country that has dealt with a housing crisis
08:17 in modern financial history. China cannot be any exception.
08:19 Yeah, but the interesting take is that you're saying this is not China's Lehman moment.
08:24 They have enough at their disposal and speed to rein things in.
08:29 So if you just think about the Lehman moment, that the money markets were unwilling to fund
08:36 the day to day operations of Lehman Brothers, I think something like that is very unlikely in
08:39 the case of China. Because if indeed there is a liquidity call, let's say on a bank or a non-bank
08:44 financial company, I think the authorities have enough strength and lever available to make sure
08:51 that the liquidity issue does not morph into a solvency issue. And also, it was a decision made
08:58 by US regulators to let Lehman go, they could have come up with ways to sell it, they decided
09:02 not to. I don't think that is likely in the case of China. Secondly, is that the deep layers of
09:08 securitization where CDOs built up on CDO squares and so on. I had some worries about that in the
09:13 context of China five years ago, when there are a lot of shadow banks that were issuing all sorts
09:18 of structured products. That risk is behind us. Those products have two, three year tenors,
09:23 they're all matured and taken care of. So again, so that sort of parallel, I will struggle to draw
09:31 between the Lehman movement and China right now. All right, let's turn our attention to India and
09:35 what's happening here. After, I think, positively surprising 7.8% GDP growth in Q1, expectations
09:45 have been moving up for the financial year. Your own expectations are between 6 and 5.8. Is that
09:54 a more conservative view? What are the sort of headwinds you see going forward? Is consumption
10:00 slower, capex because of an election cycle, some of those moving parts? So, we run what we call a
10:07 real-time now casting of India. So even before the quarterly data comes out, we take all the
10:12 monthly data and we put into our model to get a very good sense of what would be the ultimate
10:18 GDP outcome long before GDP comes out. So the number that you just cited is based on the now
10:21 casting exercise. It turns out to have a pretty decent track record in recent quarters in terms
10:26 of calling what the number would be for India for that quarter. Now, why are we seeing a somewhat
10:32 lower number now for the second quarter of the financial year than the first quarter? Not in
10:37 history that there's major sequential slowdown. There's a bit of a base effect in place. And also,
10:42 in terms of capex, in terms of sort of the net exports contribution to growth, we're seeing some
10:49 degree of softening. But I would say these are marginal issues. It's not something that is
10:53 making us worried about India or compelling us to start sort of taking a double take in our overall
11:00 financial year forecast. So I think it's a year-on-year slowdown as opposed to a
11:06 major substantive sequential slowdown. All right. But let's just focus on India and the
11:12 growth outlook a little more. Still pegged to be one of the fastest growing economies
11:16 in the world, this year at least. What is the picture emerging like for you? And what are
11:23 the challenges you see down the road? I think the challenges are obvious. If you have high interest
11:28 rates in the US, if you have some degree of stubborn domestic inflation, these things get
11:33 in the way of orderly management of the macroeconomic environment. And that can lead to
11:38 some dissipation of animal spirits, some dissipation of momentum in the capital markets,
11:43 and so on. So that, I think, is consensus unsurprising as far as risks associated with
11:50 India are concerned. I'm not going to put the election as a major source of risk. We have run
11:55 even studies looking at elections in the last 20, 25 years in India. There have been times when the
12:00 government was in a precarious state. There have been times when the government was in a very
12:03 commanding state. In any of those cases, we don't see what we call a political business cycle in the
12:09 context of India, meaning you don't see major slippage leading into the election. You don't see
12:13 major slippage after the election because some things were kept under rugs. It doesn't quite
12:18 happen that way. And one of the reasons for that is that public sector expenditure as a share of
12:23 GDP is actually not that large, especially if you compare to OECD countries or even a country like
12:27 Brazil. India's government is relatively small. So even if there are a certain amount of pre-election,
12:34 post-election volatility, it doesn't affect the entire multi-trillion GDP that meaningfully. It
12:40 might affect some localities, some municipalities where there is some big election and around that
12:45 some spending is done. But system-wide, we don't see major impact. In the past, we used to see some
12:50 macroeconomic impact on the external variables, the rupee, FII flows. I don't think in this cycle,
12:56 again, we don't need to worry that much about it. And most importantly, and I think this is
13:01 critical because this sort of varnishes India's democratic credentials tremendously, which is
13:04 even the parts of the business cycle where we have seen substantial swings in seats or substantial
13:12 tenuousness in terms of leadership. We haven't seen any major shift in policy. And I think that's
13:17 the critical one, both for domestic and foreign investors that, of course, we will spend a lot
13:22 of time between now and the election, you know, who's going to win and how many seats they're
13:26 going to get. What does it mean? But the fact of the matter is, as far as the markets are concerned,
13:30 as far as the economy is concerned, it doesn't mean that the outcome would then start affecting
13:34 policy. I don't see that happening. And that, I think, should be a source of assurance for the
13:39 markets. Absolutely. And you see that spilling over to all segments of the markets, equity,
13:45 fixed income, and of course, the economy, as you're speaking. Well, I think the domestic
13:52 investors' interest in the financial markets, we're seeing a sea change. So think about the
13:56 last couple of years when foreign investors have actually been rather shy about investing in India,
14:01 during which time we've seen a surge in domestic flows, going into mutual funds,
14:05 going into domestic bonds, and so on. So this tells me something healthy occurring, that you
14:11 don't want too much reliance on hot flows to maintain your day-to-day expenditure and day-to-day
14:17 bills. If domestic savings is now percolating from sitting idly in banks to more productive
14:22 parts of the economy, then even if we are going to see in 2024, let's say, around the Fed high
14:27 cycle, some degree of global volatility, it doesn't necessarily spell doom for Indian markets.
14:32 So that's the good takeaway, that domestic investor sentiment is strong. It has withstood the last
14:38 couple of years of global market volatility. So we would need much more than $100 oil to
14:42 win that party. Let me come to the big sort of wow moment, as far as the Indian economy is
14:50 concerned, and at least was celebrated that way, is the inclusion of Indian government bonds in the
14:56 JP Morgan index. Do you see that having a substantial impact on flows?
15:02 I'm reminded of that quote from Spiderman, "With great power comes great responsibility."
15:07 So yes, great to be part of a big global index, that by definition brings in some flows,
15:13 but that also brings in additional scrutiny. So the way the fiscal accounting is done,
15:18 the way fiscal reporting is done, would be under far greater scrutiny now by global investors
15:22 than ever before. So flows, yes, scrutiny, yes. So you take your pick which one you want. I think
15:30 it's good to actually have greater scrutiny and greater market discipline on the Indian
15:34 government's financing issuance and so on. I think it is good to have investors globally or
15:39 domestically coming to the Ministry of Finance, to the debt management people, to get a sense of
15:44 the duration of the debt, the issuance calendar, and then trade around that. I think that's a
15:49 very good disciplining mechanism. So yes, scrutiny will come. There will be any free lunch, but I
15:54 think it's a good thing for the long term. We should welcome it. Absolutely, we should,
15:59 because like you said, with great power comes greater responsibility. Thank you so much,
16:03 Dr. Baig. Always a pleasure to speak with you. Pleasure is mine. Thank you.
16:07 Thank you.
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