Hitendra Dave, MD, head of global markets, HSBC India, believes the central bank should go with a 25 bps hike now and then pause if need be. In an interview with FE?s Samie Modak, Dave says the market was surprised by the sharp fall in the rupee, but expects the currency to soon trade in its long term range.

What is your view on the rupee?

We are somewhat puzzled by the movements in the rupee because we haven?t seen much selling from the FIIs and the oil market hasn?t dramatically altered anything. It appears to be a combination of exporters pausing on the sell side and importers stepping up on the buy side. Perhaps risk aversion as a concept has crept in globally and so there is a flight to dollar across the world and that?s being reflected here. Longer term, over the next 12 months or so, if you draw the balance of payment (BoP) chart it still appears that India is going to have a net surplus. So for rupee to break its long term range appears quite tough. The only factor that can cause that is a significant reversal or increase in FII flows.

How do you read the implications of a QE3 for India?

If its a strong large dose of QE3 it?s not good for emerging markets since you will see inflation in commodities, leading to a weaker fisc and hot flows that are not necessarily supportive. Offshore investors need to see that the leadership is in control.

Are you seeing a hike in policy rates?

Clearly, if one gives greater weightage to domestic factors, I don?t think growth is derailing as much as is made out to be. We presume even if we have some industrial slowdown there will be some compensation on the agriculture side. On the other hand globally, the situation has reversed for the worse, there is a talk of double-dip even if it?s a one-third probability. We can?t ignore that. In 2008, we were hiking 10 days before Lehman Brothers. This time its a bit different but I would go still with a 25 basis points hike in this cycle. You can always take a longer pause if need be. If they pause now, it will be very difficult to review the rate hike cycle. It will be a judgment of what you give greater weightage to, domestic or global factors. If it?s 50:50, then it is a pause as the overseas factors are very negative. Also, lending rates in India are very high now. If you go by the fact that the last 50 basis points hike was accompanied by significant hawkish statement, I think the RBI should do another 25 basis points and get to wherever they believe is the required rate. Then you have scope to reverse.

How do you assess the liquidity situation at the moment?

The RBI has said that it wants liquidity in deficit mode and that?s how it?s been. Moreover, it hasn?t become so large that it disrupts transmission of monetary policy. The market is very comfortable with the deficit and most market participants have extra bond which can be refinanced at 8% should there be a need.

So, where are you seeing the yield on the benchmark bond?

Earlier, we had a sense that yields would stabilise at around 8.50% since inflation was out of hand, RBI was very hawkish and the borrowing programme was so large. But now deposit growth is exceeding the growth in credit and the surplus with banks is only increasing. Credit growth is a challenge for a variety of reasons like interest rates, credit concerns. As such, bond market conditions are lot more positive now than they were six months ago and we expects yields to be around 8.25% plus or minus 10 bps, till we get clarity on the growth. At about 8.35% and above there are more buyers than sellers while at 8.25% there are more sellers.

Do you seeing the government overshooting its borrowing target?

It would seem some of the budget assumptions are challenging given that fuel prices have risen beyond estimates as have prices of fertilisers. Also, the disinvestment target would appear to be relatively challenging in a weak market. However, tax revenues are turning out to be buoyant and, from whatever one picks up, we believe the intent not to cross the deficit appears to be quite strong. That said we?ll need a little bit of external help, we?ll need better oil prices.