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See inflation at 6.5% in coming weeks: Morgan Stanley

2008-03-24 10:56:37 Source : Bazaar/CNBC-TV18
(Interview Transcript)

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Chetan Ahya, Managing Director of Morgan Stanley said inflation may head up to 6.5% in the coming weeks due to the lag effect of higher commodity prices previously. He added that headline inflation could be seen between 5-7%, topping at 6.5% & settling at 5.5. According to him, the cost of borrowing is already high and hence, the RBI may not tighten rates further. However, he expects the RBI to cut repo and reverse repo rates by 25 bps in July.

Speaking to CNBC-TV18, Ahya said that if oil touches USD 120 per barrel, the currency may appreciate. �But the concern is that we don�t have capital inflow support,� he added. Ahya expects to see a slowdown in capital inflows to USD 30-40 billion from over USD 100 billion on the last 12 months. He also expects to see some pressure on capital goods.

According to Ahya, the demand for real estate will be subdued untill interest rates ease off. He also predicts a pressure on the housing sector till policy rates decline. He added the GDP growth could come down to 7% versus the earlier 8.3%.

Excerpts of CNBC-TV18�s exclusive interview with Chetan Ahya:

Q: How worried would you be about the inflation number which came in at 5.92 and what kind of a band do you see it in, over the next four-eight weeks?

A: The headline inflation is a concern as it�s moved up to 5.9%. A lot of this was driven by base metal prices in this week. So there is going to be some pressure going forward. We think the numbers could head up to 6.5 over the next few weeks. But to the extent to which, I think the good news came from the fall in commodity prices, that is the real leading indicator and that has come off over the last two-days. It will be worth watching that if prices do come off by another 20% or so, that will give some comfort to the Central Bank and look towards a possible cut in the monetary policy rate.

Otherwise, I think in the near-term, I don�t think the Central Bank is going to react looking at this and tighten the monetary policy. But it will definitely takeaway the possibility of a policy rate cut in the April monetary policy, which we are all looking for.

Q: Over the next quarter or so, what is the band that you are seeing headline inflation being at?

A: I think in the next few weeks itself, it could go up to about 6.5% and this is primarily the lag effect of the previous rise in commodity prices. Then we expect it to come back down to the extent to which commodity prices have already come off. But it will remain above the Central Bank�s comfort zone of 5%. So, we could expect it to trade between 5% to maybe 7% but most likely topping off at 6.5% and then settling around 5.5%.

Q: You�re saying that the Central Bank will not do any kind of tightening if inflation remains in that 5.5% plus kind of zone, whether it�s through a direct rate hike or any kind of tightening instrument?

A: I would be very surprised if they did that because the existing level of interest rates are very high. What we are looking at is like the benchmark mortgage-lending rate, which is at close to about 11%. Our view is that a neutral level on that is somewhere around 9.5% or so. So we are in somewhat restrictive zone on that front.

At the same time, we are seeing some kind of risk aversion in the Indian banking system as well, where the consumer loans spreads have tightened significantly. Also, the corporate, if you look, the Triple A, A and B spreads over government security has also widened. So the actual cost of borrowing is already fairly high. I would be very surprised if Central Bank tries to tighten further and slowdown the demand further, which is already under pressure.

Q: The rupee has depreciated quite a bit. Do you think it�s an option for them to let it appreciate a little bit to take the edge of inflation?

A: I think that�s definitely a policy tool. We were looking for basically three responses from the Central Bank or rather the government. First one was some kind of control on prices through import tariff cuts. I think that is already underway.

The second one is rupee appreciation, which is likely if you have an environment of capital flows which is very supportive. At the same time, if commodity prices had gone up, I would say a benchmark of oil at USD 120/bbl would have triggered the policy of appreciation by the Central Bank. But since oil has come off, I think at this point of time that is the second best option, not necessary as long as commodity prices continue to weaken. So if oil goes to USD 120/bbl the currency will be looked at by the Central Bank as an option. But it�s not a very easy option as it was last year because we don�t necessarily have capital flows support like we had in March and February 2007.

A lot of the rise in reserves, which we are seeing right now, is largely because of the non-dollar currencies appreciating. So yen and the euro holdings of the Central Bank are converted into dollars and they appear to be high. But that�s not actually high capital flow which is represented there.

Q: You are saying that in April, the Reserve Bank of India may not do anything to do ease monetary policy. What about the next meeting, do you think it�s conceivable that they will ease by then or this sticky inflation figure will keep us with the pretty much statusquo monetary policy situation for more then six months from here?

A: We are still expecting a cut in July. Of course we are assuming that the commodity prices take a breather further from where they are today. If commodity prices don�t come off, that will be a risk. But at this point of time I would take my base case for a cut in the repo rate and reverse repo rate by 25 bps in July.

Q: What about the credit growth situation. The numbers which are come in are not very comforting, overall 17% odd non food credit growth, 16-17% for the last 11 months. Is it softer than you would have imagined or the RBI would have liked?

A: You are looking at April to February number. If you look at YoY, there is no change in this week, so I don�t know why this press story is now. But even 21.8% YoY, which is steady over the last fortnight, is definitely a weaker number than 33% at the peak that we had seen.

I wouldn�t say that the RBI would be unduly worried about these levels. It�s kind of around the level they are looking at which is about 23-25% range. So it�s little bit lower than that. I am sure that they do sense that the growth is slowing but the circumstances are very different, they cannot take the risk on inflation and respond to it by cutting interest rates right now.

Q: I believe that you think capital inflows could slowdown quite significantly for the rest of the year. Of course, portfolio flows and other equity market flows have diminished visibly over the last three-months. You expect this year to be a sticky year in terms of flows?

A: Yes, primarily because of what is happening in the US and of course, when it went up close to USD 110 billion last 12-months, also because there was a very exuberant environment in the global capital market place. Now to the extent to which the US financial system, which generates the liquidity for risky assets has been kind of affected badly, there will be an impact.

Just to look at the math, 55% of the US financial system works on securitized paper and that market has completely been frozen in the last few weeks as we have seen. There�s bound to be an impact of that on our capital inflow. So we think that the capital inflows could slowdown to USD 30-40 billion from over USD 100 billion that we had seen in the last 12-months.

Q: What impact could it have on us and which sectors do you think you would turn cautious on, given your capital inflow scenario?

A: From a macro economic perspective, what we will see is that the one sector which has helped up pretty well, in terms of spending, is the capital goods sector. So what we have seen a tightening monetary policy first playing on consumption then the US export slowdown resulting in our exports weakening. The strong driver of growth was capital goods sector.

I suspect that now, with this capital flows slowdown, we could see some pressure on the capital goods sector as well, so the overall capex will be affected. Just looking at the math, a USD 110 billion capital inflows would mean 11% of GDP if it comes down to 3-4%. That will be a significant loss of capital availability for the capex in the country.

Q: Would you worry about either real estate companies or banks now?

A: Banks are okay from a macro perspective. About property companies, I am not an expert on the stock market, but I do definitely think that the overall household spending on property is definitely coming off. If you look at the fresh mortgage disbursements for the top companies, it has already come down to about 3% and it is unlikely to revive quickly considering that the Central bank is still pursuing a tighter monetary policy.

So real estate demand per se, particularly from the housing sector, is under pressure and will remain that way for the next few months, until we a decline in the policy rates.

Q: People in the market are already quite worried about what kind of economic situation we are heading into in 2008. The inflation and IIP numbers and making them slightly uncomfortable, or more then slightly uncomfortable. What kind of an economic scenario do you envisage Q2-Q3 of 2008 on all fronts?

A: Basically, we are expecting GDP growth which is at 8.3% in the last quarter of 2007, to come down to 7% in the last quarter of 2008. While it is, on an aggregate basis, weaker and slower than what we were looking at, I would say that in the end, the outcome of growth settling at around 7% is not really a very bad outcome considering what we are seeing elsewhere in the world. So yes, it is slower and weaker than before, but I would not say that all hell is breaking with that number of growth of 7%.