In the back drop of a weakened rupee, lower wholesale price index inflation over past three months and decadal low economic growth of 5 percent, all eyes are on the Reserve Bank of India 's monetary policy on Monday. Most experts believe that, given the risk of further depreciation in rupee, the central bank would avoid cutting repo rate in June, but may provide a cash reserve ratio cut of 25 basis points to improve liquidity.
Experts believe that for the rest of year at least 50-75 bps repo cut would be definitely provided by RBI given the severe squeeze in both industrial and consumer demand. Experts argued that all economic indicators are pointing that the central bank now needs to shift its gear and sharpen its focus on growth rather than inflation. Most experts believe that RBI commentary will be more growth focused in upcoming policies.
Just a month back experts were of the opinion that RBI will surely provide the rate cut in June given the deceleration in both WPI and consumer price index inflation and sharp fall in GDP growth. However rupee's sharp decline against dollar has completely turned around the situation.
Hitendra Dave, Head of Global Markets and MD at HSBC believes that low levels seen in rupee past week are unlikely to be breached and it will move back to earlier levels. However Rajeev Malik, the Economist from CLSA believes that although rupee may appreciate in short term, there will not be any reversal in the currency depreciation trend. He sees rupee breaching 60 against dollar in beginning of next year. Citing key reason for this pessimistic view on Rupee Malik said that dollar would gain further strength over 12 months and US bond yield are also likely to go higher which will have a negative impact on emerging economies currencies.
As we had into the credit policy on June 17th, CNBC-TV18 poll has indicated that 70 percent of the respondents don't expect any action on repo rate or on Cash Reserve Ratio (CRR), but 30 percent expect either a CRR cut or a repo cut. What's more intriguing 80 percent don't expect banks to cut their lending or deposit rates even if the repo rate is cut and 60 percent don't expect the banks to pass on even if the CRR were cut.
To add more colour and perspective to where the economy is headed and what can policymakers do, CNBC-TV18's Latha Venkatesh had a discussion with an eminent panel consisting of Robert Wandesforde, Economist from Credit Suisse, Hitendra Dave, Head of Global Markets and MD at HSBC, Indranil Sengupta, Chief Economist from BofAML and Rajeev Malik, economist at CLSA.
Below is the verbatim transcript of the discussion
Q: The global risk-off suddenly took an ugly turn over the past two or three weeks. Are we going to see this continuously rear its head and therefore is the rupee going to be under pressure for the better part of FY14?
Wandesforde: The simple answer is probably yes. The good news is that I suspect we are at or very close to the end of this current phase of risk-off relating to concerns about US Quantitative Easing (QE) tapering. There are clearly a number of stages and hurdles to jump as time goes on and assuming of course the US data remains reasonably robust tapering is just one part of it. Obviously they will need to decide how to reinvest those profits, the coupon payments that they make on the bond holdings. Whether to stop that, whether to sell some of that bond holdings? When to raise the Fed funds target rate? All of those things have the potential to cause jitters in the market. Fundamentally, I would not be particularly optimistic about the rupee.
Q: We have seen the rupee fairly adjust to the pressure on Current Account Deficit (CAD). Some advantages will also start paying off with the fall in gold prices as well as the fiscal steps that have been taken. What do you see as the level for the rupee? How bad does it get and what maybe the fair range from now until end of 2013?
Dave: I am not very sure whether the recent phase of weakness in the rupee is directly attributable to the (current account deficit) CAD. Best I can put together is the reason for the weakness in the rupee is on account of the very bullish rupee views that were prevailing a month-month and half back or so. If you step back and look at the data, there has been enormous amount of capital flows which have come into the country both from debt and equity and given the strong rupee views expressed because commodity prices were stable, large ticket deals were announced, the government made some announcements regarding withholding tax, Tax Residency Certificate (TRC) etc.
So my own sense is that people outside India became so bullish on the currency that they acquired fairly sizable short positions for the dollar versus the rupee. If you look at the Reserve Bank of India (RBI) data for March and April, they bought about USD 1.3 billion odd in spot and their forward sales position is down about USD 4 billion. We do not know how much of that has been delivered and how much has been bought by them, but we can take a pick there, maybe a third of that. If you see during that time RBI bought a lot of dollars and when this whole talk of tapering off started, around third week of May, that is when all emerging market currencies positions started getting unwound. When you have a short squeeze of that nature the reaction tends to be quite sharp which is what we have experienced and at least over the last two days or so what you will notice is as those positions have got squared out the pressure or the panic in the market no longer exists.
There is no incessant source of demand which was coming entirely from short squaring. With that perspective I think one should look at the currencies. I think the low point that we saw in the rupee just in the middle of this week is unlikely to be breached barring severe shocks through the international system. So I think we are more likely to retrace some of the losses in the very immediate terms unless the Federal Open Market Committee (FOMC) minutes suggest that they are much more serious about tapering off than perhaps currently assumed, in which case you could have one more round. As I mentioned bulk of the pressure on the rupee is coming from financial market and not really on account of exporters or importers or FDI. Fortunately for us the financial market exposure that India has, especially to the debt side is fairly manageable and within that that part which tends to move in and out fairly quickly is even lesser. I think a large part of that fast money has already left if not entirely. My base case assumption is over the next few weeks rupee reverts back to where it started the fall.
Q: What is your global desk telling your about the risk-off are they telling you that it has just started and where can it take the rupee?
Malik: Rupee has depreciated by about 33 percent since end 2007 so this is not rupee’s problems and not something that started two weeks ago or one year ago. We are the second or the third worst performing EM currency. Globally, we can debate about the trajectory and the pace and the quantum of how the Fed’s tapering is going to work but I think the direction is pretty much set.
Two things are a lot more likely than not. A) That the dollar would be stronger over the next 12-24 months and two that US bonds yields would be higher- both those factors are going to be negative for EM currencies and India cannot be an exception. Government can try and do something to throw some sand to slow down the pace but when all EM currencies are adjusting to a stronger dollar and higher US bond yields, India cannot be standing aside as if nothing is happening.
Q: You have been one of the first to call the rupee at 60 what are your current levels on the rupee?
Malik: Our levels have not changed. At the beginning of the year, we were talking about 57-58, I think we are there now. We could see a bit of relief rally given the fact that currencies don’t fall 5-7 percent every month but I remain steadfast in my view that, we will break above 60 most likely by early next year and that would be in a sustained manner. There is this expectation that somehow rupee is going to go on an appreciation path. We can see some near-term movements but they are not going to be trend reversing.
My own assessment for what is happening with the rupee is really the broader cycle that we are going back to pre-2002 years when we will actually see annual depreciation. The biggest perhaps oversight policy makers have had is that here is a country that runs a large inflation differential and we are trying to keep the currency unchanged and even allowed it to appreciate for sometime. So, in a way it is pay back time and the fact that bond yields in US and US dollar is stronger, both of them will only add only more stress not less.
Q: How will the Reserve Bank of India act from hereon? Though for the moment the rupee is closing in on the central bank, how much elbow room does it have to cut rates on Monday?
Sengupta: The rupee is not the constraint in fundamental terms. It is a constraint in sentiment. In reality, if the Reserve Bank were to cut rates on Monday, the rupee would probably appreciate because in terms of equity flows one is looking at a portfolio of USD 250 billion, that response to growth. In bond market terms, one is looking at a portfolio of USD 35 billion — out of this USD 20 billion is probably the own portfolio of foreign banks.
However, there is this global all size-fits or perception that if rates are cut the rupee might depreciate so I think the RBI will not take the risk. So, maybe it will do a via media by cutting cash reserve ratio (CRR) and help the transmission of RBI rates to lending rates.
Going forward, every data point argues in favour of RBI easing — growth is low, inflation is coming down, the dollar has weakened, oil and gold prices are softer and the risks of a sovereign-rating downgrade recede. I think that monetary policy at this point in time should turn in support of growth.
We are looking at 50 bps cut in rates one in July and one in October. I think it is unfortunate that we are getting hemmed into a position now where the RBI perhaps will not cut rates, but hopefully that will pass.
Experts believe that for the rest of year at least 50-75 bps repo cut would be definitely provided by RBI given the severe squeeze in both industrial and consumer demand. Experts argued that all economic indicators are pointing that the central bank now needs to shift its gear and sharpen its focus on growth rather than inflation. Most experts believe that RBI commentary will be more growth focused in upcoming policies.
Just a month back experts were of the opinion that RBI will surely provide the rate cut in June given the deceleration in both WPI and consumer price index inflation and sharp fall in GDP growth. However rupee's sharp decline against dollar has completely turned around the situation.
Hitendra Dave, Head of Global Markets and MD at HSBC believes that low levels seen in rupee past week are unlikely to be breached and it will move back to earlier levels. However Rajeev Malik, the Economist from CLSA believes that although rupee may appreciate in short term, there will not be any reversal in the currency depreciation trend. He sees rupee breaching 60 against dollar in beginning of next year. Citing key reason for this pessimistic view on Rupee Malik said that dollar would gain further strength over 12 months and US bond yield are also likely to go higher which will have a negative impact on emerging economies currencies.
As we had into the credit policy on June 17th, CNBC-TV18 poll has indicated that 70 percent of the respondents don't expect any action on repo rate or on Cash Reserve Ratio (CRR), but 30 percent expect either a CRR cut or a repo cut. What's more intriguing 80 percent don't expect banks to cut their lending or deposit rates even if the repo rate is cut and 60 percent don't expect the banks to pass on even if the CRR were cut.
To add more colour and perspective to where the economy is headed and what can policymakers do, CNBC-TV18's Latha Venkatesh had a discussion with an eminent panel consisting of Robert Wandesforde, Economist from Credit Suisse, Hitendra Dave, Head of Global Markets and MD at HSBC, Indranil Sengupta, Chief Economist from BofAML and Rajeev Malik, economist at CLSA.
Below is the verbatim transcript of the discussion
Q: The global risk-off suddenly took an ugly turn over the past two or three weeks. Are we going to see this continuously rear its head and therefore is the rupee going to be under pressure for the better part of FY14?
Wandesforde: The simple answer is probably yes. The good news is that I suspect we are at or very close to the end of this current phase of risk-off relating to concerns about US Quantitative Easing (QE) tapering. There are clearly a number of stages and hurdles to jump as time goes on and assuming of course the US data remains reasonably robust tapering is just one part of it. Obviously they will need to decide how to reinvest those profits, the coupon payments that they make on the bond holdings. Whether to stop that, whether to sell some of that bond holdings? When to raise the Fed funds target rate? All of those things have the potential to cause jitters in the market. Fundamentally, I would not be particularly optimistic about the rupee.
Q: We have seen the rupee fairly adjust to the pressure on Current Account Deficit (CAD). Some advantages will also start paying off with the fall in gold prices as well as the fiscal steps that have been taken. What do you see as the level for the rupee? How bad does it get and what maybe the fair range from now until end of 2013?
Dave: I am not very sure whether the recent phase of weakness in the rupee is directly attributable to the (current account deficit) CAD. Best I can put together is the reason for the weakness in the rupee is on account of the very bullish rupee views that were prevailing a month-month and half back or so. If you step back and look at the data, there has been enormous amount of capital flows which have come into the country both from debt and equity and given the strong rupee views expressed because commodity prices were stable, large ticket deals were announced, the government made some announcements regarding withholding tax, Tax Residency Certificate (TRC) etc.
So my own sense is that people outside India became so bullish on the currency that they acquired fairly sizable short positions for the dollar versus the rupee. If you look at the Reserve Bank of India (RBI) data for March and April, they bought about USD 1.3 billion odd in spot and their forward sales position is down about USD 4 billion. We do not know how much of that has been delivered and how much has been bought by them, but we can take a pick there, maybe a third of that. If you see during that time RBI bought a lot of dollars and when this whole talk of tapering off started, around third week of May, that is when all emerging market currencies positions started getting unwound. When you have a short squeeze of that nature the reaction tends to be quite sharp which is what we have experienced and at least over the last two days or so what you will notice is as those positions have got squared out the pressure or the panic in the market no longer exists.
There is no incessant source of demand which was coming entirely from short squaring. With that perspective I think one should look at the currencies. I think the low point that we saw in the rupee just in the middle of this week is unlikely to be breached barring severe shocks through the international system. So I think we are more likely to retrace some of the losses in the very immediate terms unless the Federal Open Market Committee (FOMC) minutes suggest that they are much more serious about tapering off than perhaps currently assumed, in which case you could have one more round. As I mentioned bulk of the pressure on the rupee is coming from financial market and not really on account of exporters or importers or FDI. Fortunately for us the financial market exposure that India has, especially to the debt side is fairly manageable and within that that part which tends to move in and out fairly quickly is even lesser. I think a large part of that fast money has already left if not entirely. My base case assumption is over the next few weeks rupee reverts back to where it started the fall.
Q: What is your global desk telling your about the risk-off are they telling you that it has just started and where can it take the rupee?
Malik: Rupee has depreciated by about 33 percent since end 2007 so this is not rupee’s problems and not something that started two weeks ago or one year ago. We are the second or the third worst performing EM currency. Globally, we can debate about the trajectory and the pace and the quantum of how the Fed’s tapering is going to work but I think the direction is pretty much set.
Two things are a lot more likely than not. A) That the dollar would be stronger over the next 12-24 months and two that US bonds yields would be higher- both those factors are going to be negative for EM currencies and India cannot be an exception. Government can try and do something to throw some sand to slow down the pace but when all EM currencies are adjusting to a stronger dollar and higher US bond yields, India cannot be standing aside as if nothing is happening.
Q: You have been one of the first to call the rupee at 60 what are your current levels on the rupee?
Malik: Our levels have not changed. At the beginning of the year, we were talking about 57-58, I think we are there now. We could see a bit of relief rally given the fact that currencies don’t fall 5-7 percent every month but I remain steadfast in my view that, we will break above 60 most likely by early next year and that would be in a sustained manner. There is this expectation that somehow rupee is going to go on an appreciation path. We can see some near-term movements but they are not going to be trend reversing.
My own assessment for what is happening with the rupee is really the broader cycle that we are going back to pre-2002 years when we will actually see annual depreciation. The biggest perhaps oversight policy makers have had is that here is a country that runs a large inflation differential and we are trying to keep the currency unchanged and even allowed it to appreciate for sometime. So, in a way it is pay back time and the fact that bond yields in US and US dollar is stronger, both of them will only add only more stress not less.
Q: How will the Reserve Bank of India act from hereon? Though for the moment the rupee is closing in on the central bank, how much elbow room does it have to cut rates on Monday?
Sengupta: The rupee is not the constraint in fundamental terms. It is a constraint in sentiment. In reality, if the Reserve Bank were to cut rates on Monday, the rupee would probably appreciate because in terms of equity flows one is looking at a portfolio of USD 250 billion, that response to growth. In bond market terms, one is looking at a portfolio of USD 35 billion — out of this USD 20 billion is probably the own portfolio of foreign banks.
However, there is this global all size-fits or perception that if rates are cut the rupee might depreciate so I think the RBI will not take the risk. So, maybe it will do a via media by cutting cash reserve ratio (CRR) and help the transmission of RBI rates to lending rates.
Going forward, every data point argues in favour of RBI easing — growth is low, inflation is coming down, the dollar has weakened, oil and gold prices are softer and the risks of a sovereign-rating downgrade recede. I think that monetary policy at this point in time should turn in support of growth.
We are looking at 50 bps cut in rates one in July and one in October. I think it is unfortunate that we are getting hemmed into a position now where the RBI perhaps will not cut rates, but hopefully that will pass.
Q: Do you think the RBI really can go ahead and cut rates even if it had the courage in June?
Wandesforde: I think under normal circumstances, if the RBI were to cut interest rates then the currency would appreciate for precisely the reasons mentioned — that FII equity-related and bond flows would receive a boost. But, I think the environment now is slightly different right. I don’t think the market, in its current mood, would take to a rate cut kindly. I think there is a substantial risk that the rupee could depreciate shortly on the back of that. For that reason alone, the RBI will be reluctant to move this time. Though this does not mean that the RBI will not cut rates going forward, but for that to happen consumer price index (CPI) inflation has to come down and the needs to be improvement in trade deficit numbers as well.
Q: What is your estimate? Will the pressures of lack of growth begin to tell on CPI inflation?
Wandesforde: I think the impact of growth on the CPI is fairly limited. Though food, beverages and tobacco constitute nearly 50 percent of the index which in turn is largely dependent on the monsoon. The monsoon and not demand is key to food prices. The CPI will follow the fall in the WPI down, but it is not really a consistent relationship. It does not always work like that, but I think this time it will.
WPI will probably bottom before CPI does. The chances are WPI will bottom perhaps 3.5 percent in September. The CPI could continue to fall for quite a longer time as food prices dominate.
Q: What is your estimate of the WPI and the CPI’s trajectory given that the rupee is now a big factor?
Malik: There will be an improvement in the WPI partly because it reflects tradables. The most recent depreciation in the rupee will always have a negative impact. But there is normal fashionable interpretation that somehow core WPI coming off reflects demand destruction. That view is heavily overstated and over emphasised.
Core CPI data reveals a completely different picture. There are obviously pockets within the economy which matter to the consumer where the pressures are totally different. And here I reiterate my earlier comment that there is a fixation with WPI and core WPI and therefore, it is reflecting something about demand dynamics is actually somewhat incorrect or stretched to an extent. WPI reflects tradables in a heavy way so commodity prices are lower and hence one is seeing that. But really the big problem in India has been the neglect as far as high CPI is concerned.
Q: CPI is a very relevant factor when it comes to inflation expectation- bankers are simply not able to reduce deposit rates without affecting the volume of deposits.. Do you think that inflation expectation will be impacted by the seminal fall in WPI and a hopeful fall in CPI so that banks will have the leeway to cut deposit rates sometime down the year?
Sengupta: There are two issues here. I agree that CPI inflation is a key determinant of inflation expectation. However, that does not mean that monetary policy can affect CPI inflation. CPI inflation will depend on rains. Rate cuts or rate hikes are not going to sow or destroy harvests. But the main target for the RBI has to remain WPI.
Secondly, if one looks at what is happening on the liquidity side, the first and foremost reason why deposit growth is slow is because liquidity injection by the RBI needs to pick up- whether by open market operations (OMO) or by CRR cuts. If one has reserve money growth that is around 10-11 percent, one is not going to get money supply growth or a deposit growth that is higher. So, the first and foremost need is to inject more liquidity by the RBI.
Once that happens deposit growth will grow. Yes, if CPI inflation comes down one needs less money in your pockets to some extent one goes back and put more money in the bank. But that is not the reason that will drive up deposit growth. That is one of the aids to boost higher deposit growth, but the key to higher deposit growth is more liquidity from the RBI.
Q: Do you think a situation will arise for the RBI to increase liquidity? The central bank has maintained that it will always keep a deficit liquidity of one percent of the total net deposits. Do you think the RBI will reverse that decision?
Wandesforde: I doubt it. I don’t fully understand why the RBI is so intent on keeping such a relatively large deficit position. But right now, as long as the deficit position is within USD 700 billion, the central bank seems reasonably content. So, there probably is not a massive amount of pressure on that basis for a CRR reduction. But there should be cut in CRR for the reasons just explained.
Q: What do you expect from the RBI on Monday and for the rest of 2013?
Malik: I think on Monday the RBI will certainly have to stay on hold. I think its guidance will reflect concerns as far as the global backdrop is concerned and India’s own balance of payments issues. I would not rule out possibility of a rate cut in the July meeting if the monsoon ends up being good one but I still think that is pretty much going to be it. The RBI cannot be in an aggressive easing mode as perhaps the local bond market has been wedded to for sometime.
Sengupta: A CRR cut of 25 bps on Monday and 50 bps of rate cuts for the rest of the calendar year.
Wandesforde: Nothing on Monday. A 50 bps of repo rate cut during the rest of the calendar year.
Dave: I am looking at a 50 or 75 bps of cut in the rest of this financial year or maybe within this calendar year also. For Monday, I am not sure whether rupee will get the kind of weightage. I think it is a close call for Monday between a cut or no cut.
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