Forex reserves provide an eight-month import cover, which is a critical level for exchange-rate stability, says Indranil Sen Gupta, the director, Global Research, Bank of America-Merrill Lynch. In an interview with Aparna Iyer, Sen Gupta says that in the event of large dollar outflows, the Reserve Bank of India can afford to sell $15 billion and still safeguard this import cover. Sen Gupta expects RBI to cut the repo rate in February. Excerpts:
Given the risk-off sentiment, are dollar outflows imminent? How much of an outflow can India handle?
We think the US will recover, but problems would come from Europe, Japan and some emerging markets. If there is a broad sell-off, it would surely affect us. But at the end of the day, our GDP grows at around 5%, which is better than others. RBI has been shoring up reserves. We believe RBI can sell up to $15 billion and still have 8-month import cover in terms of reserves.
Is 8-month import cover ideal for us?
Historically, the rupee has been stable when the import cover has been around eight months or more. Before 1998, we had a low import cover and the rupee was continiously depreciating. Till 2010-11, we had a higher cover and the rupee appreciated. Then again it depreciated sharply when the import cover slipped. Now, we are back at around 8-plus levels and the rupee is somewhat stable. The perception is that eight months of import cover is critical.
How much have we gained from the oil price crash?
Every $10 per barrel fall in oil brings down the current account deficit by $8 billion. But the dollar has appreciated 10% against global currencies, this is putting pressure on rupee.
At what level do you see the rupee trading at in next two months?
Our call is that RBI will not spend much forex on 63-level, it would do that at 65-level. If you see the dollar strenghthening, the pressure would be more. But more or less, the rupee would remain at current levels.
How does the external debt situation look in FY15?
The external debt has gone up because FIIs have bought bonds. Now, most of these inflows have been absorbed by the forex reserves. The other factor is external commercial borrowings. On this, we have been crying wolf. I don’t think any big firm has defaulted and most have been able to refinance. Much of the funds have been raised by the bluechip companies and banks.
What will prompt RBI to cut rates in February?
Inflation will be around 6%, so RBI would be comfortably-placed to achieve 8% target. If we see the rabi output as of now, barring pulses, the output seems to be at the last year levels. The fact that oil has gone down much more than the expected level gives comfort to RBI on imported inflation, which is really the driving force of inflation. Based on these three factors, we will see a cut in February.
Have inflation expectations come down finally?
Inflation expectations are very hard to measure and the RBI governor had pointed out the limitations. Inflation-indexed bonds show a completely different picture. My view is that inflation expectations don’t change in a year, they change once in 10 years. I am not convinced about inflation expectations argument.
You have forecasted 6.3% GDP growth for FY16? What factors will contribute to this?
We are expecting 50-75 basis points cut in the lending rate and this should stimulate the demand and production. There is an argument that capital expenditure will happen irrespective of the rate cuts. But that is seldom the case. The lag between lending rate cut and the impact on demand is around six months.