The Reserve Bank of India’s inflation target has a built-in bias and it would take another three-four data prints or the central bank to start recognising that, Hitendra Dave, MD and head of global banking & markets – HSBC India, believes. He tells Shobhana Subramanian and Shamik Paul that the India story is a good one and one has to struggle to answer the question what can go wrong. Edited Excerpts:
What was your understanding of the MPC meeting minutes? Do you think the latest inflation print warrants such caution?
The inflation projection of the RBI has always attributed too much to one-off factors such as demonetisation in explaining low inflation and it has been worried too much about the unknown while predicting inflation. If you see wheat, oilseeds, cereals, pulses, or even onion and potato, the production last year and even in this season is expected to be the highest ever, or the highest in the last few years. The fact that it is the supply side which is causing prices to remain soft was completely ignored in its analysis.
It has said the average inflation for the first half of this financial year will be 4.5%. It difficult to see how it can be anything above 3.25% or so. This is the extent of the variation. As each successive data point comes, we will have to see how the RBI reacts to it in terms of its inflation forecast and stance. My sense is that inflation is going to be 100-150 basis points lower than what it has predicted.
Is the bond market positioning itself for this kind of benign inflation? Will you second guess RBI?
The fixed-income market is stuck between the inflation it sees and feels, which is much lower than what the MPC sees and feels, and the RBI’s projection. Unfortunately, the market does not get to choose the rates, it is the MPC which gets to choose the rates.
The first thing that the market will look for is signs of the MPC beginning to realign towards it. The market is unlikely to realign towards the RBI at this point of time. It is a question of when MPC realigns. Having changed their stance only fairly recently, I would think it would take a few more data prints for it to start recognising that its
projections for inflation appear to have a built-in bias.
Do you see the excess liquidity in the banking system as a problem?
Liquidity per se is not a problem at all. What is does is. Typically, excess liquidity lowers the credit standard, which results in credit bubbles, bursting of those bubbles and instability. At this juncture, it is difficult to see risk related to excess liquidity building up in our system. Excess credit growth, etc are not there.
The RBI was concerned that some of the money market rates – the overnight repo and the short-term T-bill – had gone below the policy rate. It has fixed that through a large amount of MSS, CMB, reverse repo and T-bill operations. This level of liquidity may be the new normal.
The RBI has said they want to bring the liquidity conditions back to being neutral in the longer-term. But the amount of work needed to achieve that – possibly, the financial market is not in a position to absorb that.
If it wants to remove it permanently, then the only tools are OMOs and CRRs. Given the banking sector profitability issues, they are not likely to touch CRR. As far as OMOs are concerned, it is an option on the table, but I would really question why. Unless you are saying I want to do it because I want to do it, because it is taking away from my committed stance of neutrality. The monetary authority will have to manage at the short-end by making sure that the money market rates don’t start drifting below the policy rates. There is no evidence to suggest in my mind that liquidity is causing either inflation or credit bubbles.
Is there room for a rate cut?
A lot of us feel that policy rates have space to go down. But we have been wacked for having that view twice in the last four months. So, even the most optimistic guy expresses optimism very privately. A point will come when I guess the data will force the RBI’s hands. But I think that point is not now because we have only one inflation print. We need 3-4 data points, then there will be a little more acceptance at the MPC.
What is your view on the rupee?
The whole world is looking at India’s trade deficit, they are looking at the current account deficit and those numbers are just incredibly good. The country effectively needs between $18 billion and $25 billion to fund its current account. With the kind of growth prospects we have, our fiscal and current account position, the kind of political stability that we have, it is reasonably safe to assume that that level of capital flow either through the FDI route or through the portfolio route is certainly likely to come.
So once you put the numbers together, you can understand why the rupee by and large is getting stronger. And this is when the RBI is aggressively mopping up dollars. In March, it bought almost $11 billion. Just imagine where the rupee would be if the central bank would not have been present in the market. And then it feeds on itself. When everybody sees the numbers, exporters come in to sell, importers hold back. And that itself becomes a self-fulfilling situation for the currency. Overall, you have to be bullish on the currency.
What is your estimate for the rupee?
Of course, global factors will have an impact – the dollar index will reflect in the rupee. But in the longer term, all depends on what the RBI wants to do. If your question is where will the rupee be during the course of this year, then you are effectively asking me how much will the RBI intervene.
Intervention is a costly proposition. You are issuing a currency where you pay 6.25% and you are buying a currency where you are getting 1%. So intervention has its costs. It also has its benefits. When you are in trouble, a lot of your reserve help you. But If your current account is heading in a direction where it will be 1% of the GDP, how much of reserves do you need? Reserve are not going to be used in the next 12 months. Left to itself, the currency would be strengthening. Because it is not being left to itself, we will have to see the extent to which is is controlled.
The fiscal deficit at the Centre is in control, but the states’ deficits are rising. Won’t that be a problem?
I think the India story outside India is great. You have to struggle to answer the question what can go wrong. It is as if you are looking at the world through a rose-tinted glass. There is a time to do everything, and this is not the time to start sounding out the states. The banks hold these bonds. There are already under stress. We don’t want a massive loss on their bond portfolio. I agree that in the next round of fiscal consolidation, the focus has to move away from the Centre to the states. The overall debt to GDP, the consolidated fiscal deficit is high.
However, because it is broadly unchanged over the last four-five years, because the Centre has come down and the states have gone up, the overall deficit has remained more or less unchanged. From a risk perspective, it is a worry that it has not improved. But it has not worsened at a consolidated level.
Will demand for Indian assets by overseas investors continue?
The money that comes into India is largely seeking growth. The world wants to acquire more Indian assets, be it through the FDI channel, the FPI channel, offshore bond or the masala bond channel. Supply from India is not very large, relative to the size of the economy, relative to where we are placed vis-a-vis global growth rates and relative to where we are placed vis-a-vis global vulnerability indicators.
We are in the midst of a MPC whose bias appears to be that rates would go up. The reason why we are all cautious is the reason why international investors are also cautious. Except that they have the cushion of an appreciating currency, which we don’t have. If we buy a bond and it is unchanged after a month, we would not have not made any money. If an international investor has bought a bond one month back, and it is unchanged, he has made money from rupee appreciation. So what is currently attracting foreign investors is as much the inflation growth dynamics as the currency dynamics.
Will the coupon on offshore issuance go down?
On a steady state it is reasonable to expect that all repeat issuers will find that fresh issuance is either at the same level or tighter than where they had done before. The range is a function of the timing. It is difficult to put a number to that.
–Shobhana Subramanian and Shamik Paul