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Weekly Economic Review - UAE, India & Global Macro

Week ending August 9, 2014


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UAE bellwether stock Emaar reported Q2 results where it showed a dip in sales for the real-estate business of 5.2% as compared to the same quarter last year. This was offset by strong growth from its malls, retail & hospitality business of 12%. The drop in real-estate sales reflects the slowdown in volumes in its key market of Dubai where the sharp rise in prices has dampened some of the enthusiasm that was prevalent in the market last year.

Interbank EIBOR fixings in UAE have been sticky with the 3 months EIBOR rate fixings not falling below the 0.70 level. Three-months EIBOR had started the year around 0.81286 and trended lower through the year to trade a low of 0.70714 during the middle of July and has inched higher to 0.72143 since then. As per UAE Central Bank data available upto end of May deposits in the banking system have increased by 7.94% (Dhs 101.50 billion) and Loans have increased by 5.89%(Dhs 69.30 billion). With ample liquidity it was expected that the spread between the USD 3 months Libor and the UAE Dirham 3 months EIBOR could revert back to its long term range of 10-20 bps. The spread currently is just under 50 bps with the 3 month Libor quoting at 0.2489%. What has hampered this move lower is that there is very little trading in the interbank Dirham market for beyond a month & as most and banks price significant amounts of their loans based on a spread over EIBOR and a significant lower EIBOR rate could impact banks when marginal deposit rates are still quoting at levels around 0.60% for 3 months. As long as customer deposits rates remain at these levels in Dirhams we may not see EIBOR levels trend further lower.

Equity markets took a hit this week catching up with the sell-off of the global markets on Thursday and Friday of the previous week when the UAE markets had already closed for the week. Trading volumes are expected to be low due to summer vacations coinciding with the end of the fasting month of Ramadan.

India's central bank the Reserve bank of India maintained the Repo Rate at 8% but cut the Statutory Reserve Ratio (SLR) by 50 bps. As per law banks have to maintain government bonds in their portfolio to the extent of the SLR rate, which results in easy funding for Government borrowings. This has been the second cut in the SLR rate since RBI Governor Raghuram Rajan assumed office in September last year. There have been growing calls to bring down the SLR rate significantly to free up the banking sector to fund the private sector more effectively. The SLR rate was introduced at 20% in 1949 and peaked at 38.5% in the early 1990's when India was facing economic stress. Currently at 22% it is close to the lowest level since Independence and there are expectations that we could see lower levels going forward.

A cut in the SLR results in two fold impact, firstly from the banks point of view it frees up funds which are invested in low yielding government assets and this can be channeled into higher yield corporate or personal loans. Banking sector profits could increase if banks can manage the lending risks effectively. Secondly from a Macro point of view it increases funding available to the private sector which could result in lower rates due to competition among banks and at the same time it puts pressure on the government to cut its fiscal deficit as banks will not be obliged to purchase these bonds. This cut of 50 bps releases about INR 40,000 crores ($6.5 billion) of funding that could be made available to the private sector. The immediate impact of this cut could be negligible as the overall SLR ratio for all banks is about 28%, which means that banks are holding substantial excess than what they are required to. The sharp slowdown in the economy with sub 5% growth over the last 2 years has resulted in the private sector struggling to maintain robust balance sheets which had resulted in banks preferring to park funds in risk free government bonds rather than lending to the private sector. It also means that banks will not push private sector loan rates lower as yet, but with the revival in confidence in the economy post the forming of the new government in India, combined with a cut in the Repo rate in Q4 2014 or Q1 2015 we are certainly headed for lower rates.

The cut in the SLR rate also indicates that the RBI is keen to aid growth from its earlier hawkish stance towards curbing inflation at the cost of growth. This bodes well and is well aligned with the new governments agenda to push economic growth back into the 7-8% range from sub 5% currently while keeping a lid on inflation. RBI Governor Raghuram Rajan warned that risks to inflation exits from uncertain monsoons which could impact food prices and from higher oil prices due to geopolitical concerns.

Geo-political concerns impacted both the Indian Rupee & Equity markets this week. The Indian Rupee posted one of its biggest falls this year on Wednesday and traded at low of 61.7375 which is the lowest level since March 5 earlier this year. Indian equities traded lower for the second consecutive week amid profit booking. Foreign Institutional Investor turned net sellers this week amid a bout of risk aversion as Russia beefed up its troops on the Ukrainian border and rumors swirling of an imminent invasion by Russia. Keep an eye out for any significant fall in the Indian Rupee and levels of 63-64.00 if reached over the next few weeks, should be used for building of long INR positions. As far as Indian Equities are concerned we may not see a very large correction as investors would pounce on opportunities at lower levels to add to long positions in the wake of improving macroeconomic fundamentals with the government targeting growth rates of 7-8% and the policy paralysis in government decision making is a thing of the past with the current government enjoying a comfortable majority in the lower house of parliament.

Geo-political risk dominated events this week with rumors of a Russian intervention in East Ukraine, start and stop ceasefires in Gaza & escalation in Iraq where the rebels threatened to capture the oil rich areas in the Kurdistan province. Risk Aversion sent gold prices higher and the 10-year US treasury yield touched its lowest level for the year even as US economic data was upbeat. German 2 year yields traded in negative territory for the first time since May this year.

In US, data was upbeat with weekly jobless claims slipping further lower below the crucial 300k mark at 289k, the 4-moving average fell to 293.5k its lowest level since Feb 2006. The trade deficit for June came in at the lower end of forecasts at $41.5 billion with exports up 0.1% and imports down by 1.2%. These numbers bode well for Q2 GDP.

In Europe as we had warned earlier in the year the issues with the core are getting more concerning. Eurozone's third largest economy Italy slipped into recession with GDP contracting for the second consecutive quarter. Italy's second quarter GDP fell 0.2% and since 2012 Italian economy has only posted one quarter of positive GDP growth and is in a state of secular stagnation showing no signs of growth or of bottoming out. With the sanctions imposed on Russia and counter sanctions Italian exports of fashion and luxury goods will be impacted. In the largest economy Germany, Industrial orders fell 3.2% in June which shocked the market which was looking for growth. France the second largest economy in Eurozone has been a laggard and manufacturing activity has contracted in July & unemployment increased. Portugal Banco Espiroto Santo fiasco has raised concerns of potential similar issues with other banks in Europe. Overall the impact of spiraling over of tensions in Ukraine could derail the Eurozone economy further. The Euro has steadily lost ground after trading a high to 1.3993 in early May and traded its 2014 low of 1.3333 this week. The Euro could ease to levels below 1.30 in Q4 and the current trend and broad macro-economic weakness could take it down to as low as 1.2500

US equities managed to close higher thanks to reports of Russia withdrawing troops from its border with Russia and Ukrainian rebel leaders agreeing to talks. US treasury yields touched 2014 lows on a massive flight to quality as the 10-year yield dipped as low as 1.3468 before spiking higher on Friday after de-escalation in Ukraine. It managed to eke out enough gains to close above the Fibonacci support level at 2.41% which is the 61.8% retracement from its all time low of 1.3790% on July 25, 2012 to its high of 3.0516% traded on Jan 2, 2014. Geo-political events in 2014 which have resulted in risk aversion have helped cushion the process of QE withdrawal in US, without which US yields could have spiked higher with economic data also largely upbeat. The next support lines below are the 50% & 38.2% retracement levels at 2.21 and 2.02 respectively which could be tested in Q4 2015.

Compiled & Researched by: Shailesh N. Mulki

Disclaimer: This is not a research report as the views and information contained herein are the personal views of the author. These should not be taken to constitute advice or recommendation.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.