Consequences of a Multi Speed Recovery: Currency and Capital Conflicts : Citi

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India Macroscope
Consequences of a Multi Speed Recovery: Currency and Capital Conflicts


 Renewed Quantitative Easing – Managing Expectations and Inflows — Further use of
unconventional monetary tools in the developed world coupled with rising growth/
interest rate differentials with emerging markets has once again brought the issue of
management of capital flows to the forefront. While high expectations of QE run the
risk of disappointment, we believe flows to EM and India should fundamentally
remain strong.
 Capital Inflows – Back to Fore; What Could One Expect in India — Given the rise in
absorptive capacity of flows, the RBI has so far been the least interventionist central
bank in EM Asia. However, as Governor Subbarao has emphasized, ‘If inflows are
lumpy and volatile or if they disrupt the macroeconomic situation, we will do so’.
Revisiting this theme, while the cost of sterilization is key, we expect authorities to
focus on indirect measures – allow some INR appreciation, rebuild reserves, tighten
prudential norms and encourage outflows. Punitive controls are unlikely.
 Macro: Going Remains Mostly Good — 1) Growth: Estimates remained at 8.4% for
FY11, with possible upside due to positive trends in the summer crop 2) Fiscal:
Higher spending and rising oil under-recoveries pose a slight risk, but progress on
divestments is encouraging and could offset this. 3) Monetary: Credit off-take
remains buoyant; Food price inflation remains sticky 4) External: Current account
deficit to be met by rising capital flows, though composition is deteriorating.
 Financial Markets: Combination of Global and Local Factors at Play: FX — Growth
outperformance and capital inflows searching for high rates of return will lead to
INR strength. Factoring in imminent QE our Mar 11 and Mar 12 INR estimates
stand revised at Rs43.5/US$ and Rs42/US$ from Rs45.5/US$ and Rs43.5/US$.
Rates: Given trends in growth, credit and inflation, we maintain our view of the RBI
hiking once or possibly twice by fiscal year end.