Rupee will see a depreciating trend in 2013-14 because of the high current account deficit and could weaken to 60-level by the end of the year, says Neeraj Gambhir, MD & head, fixed income India, Nomura Fixed Income Securities. In an interview with Aparna Iyer, Gambhir says CAD can be financed comfortably this year, but the risk of foreign flows receding remains. Excerpts:

We saw a highly volatile rupee last year. What is the outlook for this year?

Given the fact that we are running a large CAD, we feel the broad direction of the rupee is to depreciate. The question is how much does the currency depreciates and whether the depreciation is orderly or jerky. I think in case of rupee, we would see the volatility play out depending upon the global risk sentiment. Last year, there were lot of positivity created mid-year and we saw a new finance minister, and a lot of talk of reforms. This year we are heading into an election year. I feel the rupee should trend towards the level of 60/$. A 10% depreciation during the course of the year is not that difficult to imagine. This number will depend on how strong the flows are and how big is CAD.

The CAD is the biggest factor hampering rate cuts. How big is the risk in FY14?

If we look at CAD mathematics, our imports have grown quite a lot. It is not just capital goods, but commodities such as oil, coal and gold. Given our CAD, we need about $70-90 billion of capital flows every year. Our dependence on capital flows is, thus, very large. Whether these flows can sustain will depend upon what risk environment is prevalent.

Also, there is a lot of money being printed globally because of the lose monetary policy of the US Federal Reserve and the Bank of Japan’s asset buying plan. This liquidity will find its way into emerging markets.

This year we may not face as much of a challenge in getting capital flows, but a necessary precondition is that we need to follow the path to structural reforms.

What expectations do you have with the RBI policy in May?

Both IIP and inflation will be supportive of a 25 basis points rate cut. We feel inflation would be lower at 6.6% and core inflation would be probably lower than 4%. IIP could potentially signal muted growth. That would basically re-emphasise the fact that even though food and fuel inflation is keeping the headline inflation high, core inflation momentum is not there and growth has weakened substantially.

Also, liquidity needs to be in a comfortable position for banks to transmit the rate cut to the borrowers. If liquidity continues to be tight going towards the monetary policy, we would expect a CRR cut.

We have seen heavy OMO bond purchases in last two years? Will FY14 be similar?

The amount of primary liquidity required to be infused by RBI every year to sustain the money supply growth rate of 13-14% is quite high. There are only two ways for RBI to create long lasting primary liquidity, either by purchases of forex or by buying government debt.

In current scenario where CAD is absorbing all the flows, RBI will have to buy government debt to infuse primary liquidity.

We feel OMOs of a particular size would be required in 2013-14. They would need to be timed as per liquidity situation. If CRR is not cut, OMOs will have to begin by May.

FIIs? interest in bonds has increased. Will this sustain and are long-term players buying Indian bonds?

I think the investment interest by long-term players such as sovereign wealth funds and insurance companies is a function of our rating and the view on the currency. Our rating is just investment grade. From interest rate perspective, we have perhaps a very high interest rate in the region, so it looks good. We have typically seen good inflows and interest from FIIs as long as the currency has been stable. The simplification of the limits recently is a big positive step. This was a long-standing request from FIIs. As we make the FII regime simpler, there will be more and more interest from them.