- 9/26/2023
With the U.S. Fed guiding ‘higher for longer’, what should emerging markets’ central banks do?
In conversation with #JPMorgan’s Jahangir Aziz. #BQLive #JPMorganIndiaInvestorSummit
In conversation with #JPMorgan’s Jahangir Aziz. #BQLive #JPMorganIndiaInvestorSummit
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00:00 Hello and welcome to the JPMorgan India Investors Summit.
00:03 We are here on the second day of the summit and to discuss the nature of emerging markets
00:10 as well as Indian fiscal consolidation as well as some of the other pointers that I
00:14 have listed out.
00:15 We have with us Mr. Jahangir Aziz, the head of Emerging Marketing Office at JPMorgan.
00:22 Welcome Jahangir.
00:23 I want to start off this conversation with the bond inclusion point because there is
00:30 a whole host of numbers out there in the market.
00:33 Some of it is emerging from the fact that some of the other indices may consider the
00:37 Indian bonds within their inclusion.
00:39 But to your mind, what does this signify?
00:44 So I think this is probably one of the big critical moves that India was supposed to
00:48 make.
00:49 We have been talking about it for many, many years.
00:54 And finally India has made that move.
00:56 I think that we need to look at the move from what it does to the efficiency of the market.
01:03 So most of Indian bonds used to be held very captive by domestic holders, whether they
01:11 are NIC or other pension funds or banks.
01:16 So their things that shocks and hit them were basically the same all the time.
01:24 By allowing foreigners to hold and particularly passive investors to hold it, you are now
01:31 creating another group of people with different kinds of liquidity shocks that will hit them.
01:37 As a result, you are diversifying your source of funding.
01:41 And that diversification of the source of funding is a very important step in terms
01:47 of price discovery of what is the true value, let's say, of the 10-year rate and not what
01:52 is being driven by regulatory restrictions that are imposed on NIC and on banks.
01:59 As you know, there are a significant amount of those things over there.
02:01 So it will finally, hopefully, over a period of time, by a period of time I mean two, three,
02:07 four years' time, Indian bonds will start reflecting the macroeconomic realities rather
02:12 than the regulations under which they are operating.
02:15 So that's the big step.
02:17 And the other step that it does is that because it was always held so captive, right, and
02:22 the ones who are holding those bonds did not have-- were under serious capital controls.
02:30 So they could not go somewhere else.
02:32 Finally, you will have a set of investors who can actually move out of Indian bonds
02:37 if, for example, fiscal discipline isn't maintained.
02:40 So the first time, I think, you are not only going to get price discovery, but you're also
02:45 going to get market discipline on the government, which we never had.
02:50 So I think the two together over a period of time is not an immediate-- you're not going
02:54 to feel it immediately.
02:55 But over a period of time, I think these two things are going to make it a much more resilient
03:01 and stronger bond market.
03:03 And hopefully-- and this is all from my point of view-- that with more foreign participation
03:09 and more familiarity with the government bond market, some of that slips into the corporate
03:16 bond market, where we desperately need both the price discovery as well as the diversification
03:22 of investors.
03:23 Fair enough.
03:24 I want to tackle some of these points a little later.
03:26 But let me first come to the global picture a little bit.
03:29 This high for longer narrative is now pretty much just established itself.
03:34 The Fed is also pointing out that a soft landing is not a baseline sort of scenario for them.
03:42 How are emerging market central banks supposed to read this?
03:46 Because most of them are on a pause, and they've been on a pause longer than the Fed has.
03:50 So I think here, the emerging market world breaks up into two parts.
03:55 So there are the Asian central banks, and then the non-Asian central banks made up of
03:59 the Central European and the Latin American.
04:00 If you look at the experience of the Latin American and the European central banks, but
04:05 particularly the Latin American central banks, they started moving rates back in 2021.
04:12 They moved rates significantly above the Fed funds rate.
04:16 For example, Brazil had increased rates by 1,100 basis points.
04:21 And therefore, they have created a significant amount of space between where their policy
04:26 rates are and where the Fed funds rate is.
04:28 So even if the Fed funds rate remained high for long, or even maybe even goes higher,
04:34 you will still have that cushion.
04:36 And because you have that cushion of 6%, 7%, 8% in real terms, which is obviously hurting
04:42 the economy, they still have a significant amount of space to bring down rates.
04:47 So I don't think that in the central banks of Latin America and in Central and Eastern
04:55 Europe, because of the space that they have created between their policy rates and the
05:01 Fed funds rate, that high for longer is going to be something that's going to stop them.
05:07 I think the Brazilian central bank is absolutely aware of the fact that the Fed is going to
05:13 remain on hold for a long time, and they're still cutting.
05:16 The same with the Chileans, and the one exception, of course, is Mexico, which is very closely
05:21 tied to the Fed.
05:22 And in Mexico, we don't expect the Banco Higo to cut rates any time before the Fed does.
05:27 Asia is a completely different ballgame.
05:30 In Asia, there was not that spike in inflation.
05:34 Asian central bank did not raise rates that much.
05:36 We have barely 150, 200 basis points of gap between where our policy rates are and where
05:44 the Fed funds rate is.
05:45 So there isn't that cushion that the Asian central banks have, is that even if the Fed
05:50 keeps high for long, they have space to cut.
05:55 Inflation is a problem, particularly driven by agricultural prices, driven by energy prices.
06:01 So I don't think you-- it's in Asian central banks, and I'm taking RBI and the BI and Bank
06:10 of Indonesia and BSP, everything taken together, there is that space to start a large easing
06:17 cycle.
06:18 You might get some symbolic rate cuts here and there, but probably in 2024.
06:23 But beyond that, there isn't any space for a large easing cycle till the Fed does.
06:28 And in all of this, the real 300-pound gorilla is what happens to the dollar.
06:35 The dollar has been strengthening, and in the face of strengthening dollar, continued
06:39 high inflation, not enough space, you've already seen Asian central banks-- and that again
06:46 cuts across RBI, Bank of Indonesia, BSP, Bank Negara-- is that they have already started
06:53 to tighten monetary conditions.
06:55 They haven't raised interest rates, but they have intervened in the interbank market.
06:59 Sure.
07:00 Good that you brought up the dollar strengthening.
07:03 Because I want to tackle that, because when you look at the Indian real rate scenario,
07:08 it's still pretty strong as compared to some of the other pure economies, not compared
07:13 to the dollar, of course.
07:15 But how does that affect, say, trade competitiveness?
07:19 So I think we make a very big deal out of lack of competitiveness because the rupee
07:26 is appreciating, let's say, against CNY.
07:29 That's basically the concern.
07:30 Rupees are appreciated on the CNY, and therefore, we are losing trade competitiveness.
07:34 Look, in today's world, just because your currency is more appreciated a little bit
07:39 or less appreciated a little bit for three months or six months, that doesn't mean people
07:45 that you have been selling or you're buying things from for the last 10 years through
07:49 six months, nine months, 10 months, one-year contracts are suddenly going to change.
07:56 That is the nature of the supply chain dynamics.
07:58 That is the nature of contractual agreements.
08:01 A significant portion of our trade is invoiced in dollars.
08:06 So as long as the dollar price doesn't move very much, there is not that amount of impact
08:11 on trade.
08:12 I know we make a big deal out of it, but there isn't.
08:15 Now, if this is sustained for one year, two years, then those contracts have to be rewritten.
08:21 Then there is an effect.
08:22 But none of us think that dollar strength is going to continue for the next two, three
08:25 years.
08:26 Or CNY will continue to depreciate at a point at which we are going to put for a sustained
08:32 basis we will lose competitiveness.
08:35 So I think that the bigger worry should be what has happened to global demand.
08:41 It far outweighs the impact on trade than a 5% appreciation of INR against CNY.
08:49 Sure.
08:50 But what has happened to the global trade scenario at this point?
08:53 Or for that matter, the demand scenario?
08:55 How is it looking?
08:56 So that's where the concern is.
08:58 The concern is that given the resilience of emerging markets in the US, we seem to start
09:05 believing that Goldilocks will run for the rest of our lives.
09:11 Goldilocks is going to run for the foreseeable future, maybe even well into 2024.
09:20 But beyond that, there will be a slowdown.
09:23 It is not that there isn't a slowdown taking place.
09:26 It is just that the slowdown isn't as fast, as deep as required to bring core inflation
09:35 down to the tolerance level of central banks.
09:39 So if you look at across the world, there is a massive disinflation taking place.
09:43 But no country has their core inflation anywhere close to the comfort level or the target levels
09:50 of the central banks.
09:53 You need the global economy to slow to do that.
09:58 And look, you can't have your cake and eat it too.
10:03 You can't tell me that I don't want the economy to slow, but magically core inflation is going
10:09 to come down to the inflation targets of central banks.
10:12 If core inflation does not come down to the inflation targets of central banks, then the
10:16 central banks are still in play.
10:18 Do you really want the central banks to remain in play at this point in time?
10:22 So I think that's the problem.
10:24 I think we will get the slowdown.
10:27 It will be a slowdown, which is probably going to surprise you on the upside, because you'll
10:31 be surprised by the slowness of the slowdown, if there is any such word like that.
10:36 And we're going to continue doing that.
10:39 But we need to have that happen.
10:41 Because if we don't have that happen, then the central banks are still in play.
10:44 And you don't really want the central banks to come back into a rehacking cycle.
10:50 Policy makers will probably ask you, if I can't eat the cake, why the hell should I
10:53 have it?
10:54 There are certain times in the framework of policy makers that hunkering down, accepting
11:02 low growth for the sake of ensuring that you get inflation down, particularly if you're
11:08 an emerging market economy.
11:10 Everything is as pernicious, even politically, which we very well know in the case of India
11:15 as high inflation.
11:18 You may not be able to deliver growth.
11:21 You might get away with not being able to deliver growth.
11:23 But if you deliver high inflation, most emerging market governments do get punished.
11:29 So even from a political standpoint, that trade-off that we keep thinking about, let's
11:34 give them a little bit with growth by tolerating a little bit more inflation, every policy
11:40 maker knows in emerging market doesn't really work.
11:43 And emerging markets are far more susceptible and open to changes in inflation than they
11:50 are to growth.
11:51 So you know.
11:52 You brought up the CNY a bit.
11:54 So I just want to ask you about the China plus one sort of approach that a lot of India,
11:59 as well as some of the peer companies, are.
12:01 How competitive is India versus some of the others who are trying for the same spot?
12:05 Right.
12:06 So I think there are three different kinds of relocation that is taking place, all in
12:09 the name of China plus one strategy.
12:11 So the first relocation that has been taking place has been taking place for quite some
12:15 time is the relocation out of China, because China has become more costly, whether you're
12:20 looking at business transaction costs or wages, et cetera.
12:24 So low value added manufacturing has been moving out of China for a long time.
12:31 And you can see that in Vietnam and Bangladesh and places like that.
12:35 India hadn't benefited from that.
12:37 There is another relocation that started post the pandemic, which is what we call China
12:43 plus one policy, where because of the pandemic related shocks to the supply chain, the people
12:51 on the other end of the supply chain want to have some insurance that if that event
12:55 again happens, I don't want to be caught with no supply chain completely in one country.
13:00 That's the China plus one supply chain.
13:02 The China plus one supply chain is not that I'm going to take away that supply chain completely
13:08 from China and relocate it to some other country.
13:10 It is that I'm going to keep the main supply chain in China, but I'm going to add another
13:15 supply chain just for the case of insurance in some other country.
13:19 And clearly, India and Mexico are big players over there.
13:24 And it is not a question of being competitive in the sense of exchange rate or wages.
13:28 It's a question of whether or not they have a manufacturing ecosystem.
13:32 If you look around the world, the manufacturing ecosystem in Korea is far more expensive than
13:37 in China.
13:38 It is only in countries like India and Mexico, et cetera, where there is a manufacturing
13:43 ecosystem which can benefit from it.
13:45 But again, it is no one is saying I'm going to move the entire supply chain out of China.
13:49 It is China plus one.
13:51 It is not I'm going to-- there is no China.
13:53 The China is still there.
13:55 Exactly.
13:56 Absolutely.
13:57 So the third relocation, which is mostly location rather than relocation, which is based on
14:03 this national security, French-shoring, on-shoring concern.
14:07 And that is to locate emergent technologies, whether you're talking about advanced semiconductors
14:13 or robotics or biotech or hypersonic travel, whatever you want to talk about, right?
14:19 That emergent technology in countries where you are much more-- I mean, politically, you're
14:28 much closer to that.
14:30 I think Janet Yellen called it the circle of trust, right?
14:35 I don't think any emerging market was supposed to benefit from that location of new emergent
14:41 technologies, right?
14:42 So I don't think any emerging market is going to even get anything of that sort, right?
14:48 Any bits and pieces of NATO countries might get it, right?
14:51 It is going to remain in developed market.
14:54 You've already seen that on-shoring taking place in the US.
14:57 It's a massive on-shoring that's taking place, at least in the semiconductor industry.
15:02 And that was that because of the nature of it, right?
15:06 You're trying to insure against national security concerns.
15:09 It will remain in developed markets and the NATO countries and NATO allies.
15:14 So-- Fair enough.
15:16 Coming to India now, this approach of looking at your forex reserves as some kind of sign
15:24 of national strength, right?
15:28 Is that absolutely essential?
15:30 So a long time back, in the 2005s and '06s, if you go back to that period of time, you'll
15:39 find there's a massive amount of debate taking place.
15:42 What's the optimal level of reserves?
15:44 Sure.
15:45 And it was driven by the concern that PBOC, the Chinese Central Bank, was continuing to
15:50 accumulate reserves, which was many, many years of import cover, right?
15:57 I think in 2014, not just the 2013 paper tantrum, but in the 2014 CNY weakness event, it was
16:07 sort of demonstrated that there is no such thing as optimal level of reserves.
16:14 So in 2014 over '15, China started that period with about 4.2, 4.3 trillion RMB dollars of
16:23 reserves.
16:24 Don't exactly remember the numbers, so don't hold me to it.
16:27 In that eight-month period, they lost 1.2 trillion.
16:32 So this was an economy with 4.2 trillion, in eight, nine months' time, end up with 3
16:37 trillion.
16:38 And from that experience onwards, countries like India, Indonesia, the Asian countries,
16:46 the lesson that they have drawn is that there isn't any-- more reserves is always better
16:53 than less reserves.
16:54 And to be fair, last year, when the dollar strength skyrocketed, India spent a significant
17:01 amount of reserves, right?
17:02 Now, you can argue that, what's the point of doing that?
17:06 There's a very high cost that the Indian economy pays for accumulating the reserves.
17:10 We don't count that cost.
17:13 All of that is true.
17:14 I'm not saying that you can't make the argument, well, India should not have, whatever, 625
17:20 free reserves right now.
17:22 But as any of these policymakers will tell you, that there are times, and we have seen
17:28 times when the outflows have been so strong that not stepping in and stabilizing the economy
17:36 would have probably been much more costly.
17:39 So I really don't think that you can, in today's world, especially after the 2014-15 China
17:47 experience, you can turn around and say, I have too much reserves, and therefore I need
17:52 to diversify.
17:53 I don't think that question was raised in the 2005-2006.
17:59 I don't think anyone raised that question anymore, at least in the Asian context.
18:02 Last couple of questions from my end, but with respect to the domestic inflation scenario
18:07 in India, you've seen this headline rate being consistently outside the tolerance.
18:14 And you've seen poor inflation, however, in the recent years, has been coming down below
18:19 6%.
18:20 Is the MPC to be credited, or is there other factors at play?
18:23 Look, I think clearly-- and again, people are raising questions about inflation targeting,
18:28 et cetera, and changing all of these things.
18:31 Look, inflation targeting was probably one of the biggest reforms that were done.
18:36 And we did manage to bring down both expectations and inflation to a 4% handle.
18:43 You can't look at quarter and quarter or month by month.
18:45 You have to look at over the entire period of time.
18:49 And clearly, RBI and MPC deserve some credit for it.
18:54 But the current episode of disinflation that we're seeing, I would think that much of that
19:00 has to do with China.
19:01 So Chinese export prices in dollar terms is now running at minus 15%.
19:08 And this is in dollar terms.
19:09 I'm not adding the 10% depreciation of dollar CNY into it, or the 7%, 8% appreciation of
19:15 INR against CNY.
19:18 That's in dollar terms.
19:19 It is running at minus 15% at this point in time.
19:22 And that is running because Chinese macro policies, particularly fiscal policy, is so
19:27 biased towards the supply side and so little biased towards the demand side.
19:33 If you look at Chinese fiscal policy, there's almost no support for consumers.
19:38 So retail sales have been languishing.
19:41 Industrial production has been rising.
19:44 The result of that, too, is a massive buildup, we suspect, of Finnish gold inventories.
19:50 That is putting on the pricing pressure, both domestically, where China is facing a disinflation
19:55 problem, and externally, where China is basically reducing export prices.
20:00 And I think that this phenomenon still has legs to carry on.
20:04 And I would think that not just India, but anyone who has a major importer from China,
20:10 has benefited, including the US, has benefited significantly from this decline in global
20:16 disinflation.
20:17 And I think this is going to carry on.
20:19 So yes, I mean, clearly, the MPC has to be credited for it.
20:26 They could have easily said, OK, fine, we are going to change inflation target because
20:30 of this, that, and the other.
20:31 Didn't do that.
20:32 They stick to their guns.
20:33 And sticking to their guns does pay out.
20:36 And this is the payout that we're getting, is that even in a world in which we have seen
20:42 serious supply-side shocks, serious demand-side shocks globally post the pandemic, we did
20:48 not get the spike inflation in India or in Asia that we got elsewhere.
20:54 Lastly, the question of Indian financial discipline.
20:58 I know that it's one of your pet peeves, but you said that this inbound inclusion could
21:04 sort of spur that at some point in the future.
21:08 We are approaching an election year very soon.
21:12 Highly unlikely you wouldn't see a government cut spending during that kind of a time.
21:18 But this puts at risk the 2026 target of 4.5% on the fiscal deficit.
21:23 I just want to get a sense as to what can the government do.
21:25 Look, I think that not just this government, I would even go back to the 2014 budget when
21:34 two months before the election, there was a budget and the UPA government at that point
21:41 in time didn't do anything on trying to spend its way out of trouble.
21:48 We did that a long time back.
21:49 We paid the price for it during the taper tantrum.
21:52 But since that point onwards, I think fiscally we have been reasonably disciplined.
21:59 I think we will remain reasonably disciplined.
22:01 Look, in election year, you will all get all sorts of announcements of all sorts of things.
22:09 Market will react to these announcements, et cetera.
22:12 I would say to the market, to the investors, I think they need to look beyond the announcements.
22:19 I think last three years, the budgetary outcome has been better than what has been budgeted
22:27 consistently.
22:29 Maybe this year you may not get that kind of outcome being better than this thing.
22:34 Maybe it will be much closer.
22:35 Maybe next year it will be closer.
22:37 But I don't really think that any government is going to leave behind that abiding, today
22:44 the very abiding influence that we drew from 2013 taper tantrum.
22:51 The fiscal is something that you play around with without paying a price for it.
22:55 I don't think any government.
22:56 Look, you'll get a little bit of here and there, et cetera, et cetera, et cetera.
23:00 We will wait and see how that is implemented.
23:04 My point being that don't get taken up by the announcements.
23:07 All right.
23:08 Thank you so much, Mr. Aziz, for joining us on this conversation.
23:10 Pleasure talking to you, sir.
23:11 Pleasure.
23:12 Thanks.
23:12 Thanks.
23:20 [BLANK_AUDIO]
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