Trump’s trade wars could see a decisive result in 2019. In spite of all the rhetoric, the US trade deficit with China in 2018 would end higher than in 2017. The Trump-Xi truce would come to an end in the first couple of months of 2019. If China does move towards a conciliatory stance, Chinese imports from the US would shoot up and lead to a surge in US growth and CNY weakness. While markets might rejoice in the short term, large growth numbers in US is sure to rattle markets during the latter half of 2019 as the Fed could be forced to move from its dovish stance. If the tariff war escalates though, risk aversion would keep markets on edge and given the current vulnerable position, could cause large falls across all global markets. It is a matter of time before either of the two scenarios unfolds.
Both the scenarios will possibly take USDCNY above 7.00 during 2019 and will be negative for INR. If Chinese economy and shadow banking issues also come in the forefront, then we could see a sharper slide in CNY and larger slide in INR
2018 saw the damage that can be done by receiving FPI flows. With just 10 billion outflows, INR had to depreciate 12%-15%, indicating its vulnerability to global flow dynamics. We estimate that the current level of the Current Account Deficit (CAD) would result in a need for 35 billion FPI inflow into India to keep INR stable. Tariff war is one event which can decisively change the long term direction of global markets and INR. We believe that there would be a truce between China and the US in 2019, and the emergence of global risk sentiment briefly, only to lead to worries of a hawkish Fed and withdrawal of liquidity from EM.