The Rupee has strengthened in the recent past and this trend is expected to continue with fresh debt investment limits to be opened up for foreign investors early next year. Sonal Varma, managing director and Chief India Economist at Nomura tells Bhavik Nair that the currency could firm up to Rs 63 against the dollar. Varma also points out that CPI inflation could remain close to 4.6% in 2018, led by higher oil prices and domestic growth recovery. Excerpts:
What is your view on the Rupee?
Broadly, we are constructive on the Rupee. With oil prices rising, there will be some widening of the current account deficit (CAD), but that is not a big concern. Over the last two-three years, India has been attracting higher FDI inflows, which to a large extent has funded the CAD. Rising growth should be positive for equity flows. The foreign portfolio investor (FPI) limits will also steadily go up on the debt side. From a domestic perspective, these are positives. From a global perspective, our expectation is that the current environment of synchronised global recovery with low inflation will continue, which in general should be supportive of capital inflows in the emerging markets at least in the next six months. By mid-2018, we are expecting the dollar-rupee at 63 levels.
Bond yields have hardened in the recent past. Do you see this trend continuing?
There are a few factors pushing up the yields. One is the upward rise in oil prices. Then we have seen concerns surrounding the fiscal slippage for this financial year, because of which there are fears of increased bond supply in the January-March quarter. The market which was expecting a rate cut from the Reserve Bank in mid-2017 has now completely priced out the rate cut and some probability of a rate hike is priced in. In general, we are constructive on bonds. The average inflation forecast for the next twelve months is between 4.5-5% and with yields on the 10-year bonds in excess of 7%, our view is it offers sufficient real rate cushion. We believe that the RBI will be on hold because some of the inflation rise is driven by base effect, house rental allowance increase and vegetable price increase, which need to be looked through. Our view is that 10 year government bond yields should stay at around 7% in 2018.
On one side you have the OPEC production cuts and on the other US shale oil production is picking up. What is your view on oil?
The factors that will primarily drive up oil prices would be the OPEC production cuts and the synchronised recovery that we are seeing globally. The factors that could offset the prices globally could be the US shale oil supply and a slowdown in China growth in 2018. We expect the Brent oil prices to average around $65/barrel in the first half of 2018.
We have seen the CPI rising since June this year. Where do you see the CPI in December?
We have the first fortnight data and that is pointing to higher inflation. The typical decline that we see in vegetable prices in winter months has not played out so far. So, year-over-year vegetable prices inflation will shoot up substantially higher in December. Because of that food inflation will pick up even further and headline inflation could be in excess of 5%. Of course, we need to wait for the next 15 days to see how things pan out. The other thing is that the spike we have seen is because of the vegetable prices. One should not extrapolate from these prices because it is possible that the decline in prices, which typically plays out starting November and December, will play out a little later this year, maybe between January to March. There should be some moderation in vegetable prices after the recent spike.
What would be the effect of HRA on the December CPI?
The house rent allowance (HRA) increase actually has been showing up in the headline and core inflation starting July, when for the central government employees the HRA increase became effective. The peak effect would be in the month of December, post which it should start tapering off and should completely vanish starting July 2018 onwards. The state HRA is bit of a puzzle. It is difficult to judge both the quantum and the timing.
What is your outlook on inflation for 2018?
On an average, we are expecting about 4.6% on CPI inflation versus 3-3.5% in 2017. Higher oil prices, domestic growth recovery and a mean reversion in food prices should lead to a pickup.
Any worries for 2018?
The one thing we will be closely watching is the many elections lined up in 2018, and what these could mean for government policy. After the Gujarat election, the expectation is that there will be increased spending on rural areas. The economic implications of the political cycle is something we think would be important to keep a close eye on.