The Indian rupee on Tuesday hit a record low of 61.59 against the US dollar. According to Ray Farris of Credit Suisse, the rupee is likely to touch 61.50/USD in 3 months and 62/USD in 12 months. But after today’s drop, he sees risk of an overshoot of those numbers in the short-term.
He feels the RBI has gotten itself into a position where it is stuck between a rock and a hard place. “If it does not stabilise the currency the likelihood is that the currency will have a negative impact on inflation, which will be bad for equities and will mandate further hikes in interest rates and the longer it waits, the more it probably has to do which makes the outlook for equities even worse,” he told CNBC-TV18.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: We have seen dollar strength across some emerging market (EM) currencies, but the rupee has been singled out for severe punishment today. Are you seeing more downsides? What is going so damn wrong?
A: India has got a large Current Account Deficit (CAD) and it needs capital inflows to finance that deficit. The Reserve Bank of India (RBI) correctly raised interest rates and began to move real yields. Their approach has been positive, but then they called in a question how long they keep interest rates tight.
There is a lot of uncertainty in the market about the policy regime right now. So dollar-INR probably is going to continue to rise. We had forecast for sometime of 61.50 in 3 months and 62 in 12. Right now the risk is of an overshoot of those numbers in the short-term easily to 61.50 and probably above.
Q: As a market man what would you expect from RBI? Would you expect that they will now go ahead and hike the repo rate rather than just rates in the penumbra?
A: The specific inter-events are not what are important. Important thing is really the message and the credibility delivered into the market. They need to make clear that there is a level in the rupee that they are not willing to tolerate.
They build credibility by hiking rates further and sending the signal telling the market we will maintain this higher level of rates or increase rates further regardless of growth until the currency is stable and inflation has fallen meaningfully. In the meantime, some of your speakers have noted that structural reforms are also important and that is absolutely right.
The Ministry of Finance can help tremendously by announcing the realisations of the retail market assisting in liberalisations in some of the energy markets and making it easier for foreigners to buy onshore assets.
Q: You referred to the uncertainty with respect to tightness in the money markets. RBI in the policy used the word calibrated rollback. What is your opinion? How long will the measures that they had undertaken a few weeks back in the system? Will it be for the next two-three quarters? What is your sense about the longevity of these? Secondly, are rate cuts ruled out completely for FY13?
A: These are very good questions. They are questions that the RBI has itself created in the market. Our concern is by coming out, hiking rates and saying as soon as we possibly can we are going to roll this back.
We do not know what the real objective is. Is it to stabilise the currency for a week or two, is it to stabilise the currency on a more sustainable basis or on a more prolonged basis. So, there is a tremendous amount of uncertainty about how long rates will remain at these levels, whether they will rise further particularly going into a year to next year that is going to be dominated by politics.
Q: We did see a pullout of some amount of equity funds but it was not a great deal. Do you think that might just increase?
A: It could quite well increase. The RBI has gotten itself into a position where it is stuck between a rock and a hard place. If it does not stabilise the currency the likelihood is that the currency will have a negative impact on inflation, which will be bad for equities and will mandate further hikes in interest rates. The longer it waits, the more it probably has to do which makes the outlook for equities even worse.
So, you have reached a stage in the cycle where the likelihood is that what is required is monetary policy to focus on stabilisation of the currency and the government to announce some liberalisations, deregulations that improve structural capacity for growth in India and reduce some of the bottlenecks that contribute to inflation. But there is no easy way out at this stage given where inflation is and how currency weakness could add to inflation.
Q: Chances are they will still look for one easy way out which is trying to tap the Indian diaspora of something like an Non-Resident Indian (NRI) bond. Do you think some such announcement could come sooner rather than later and if that does what might be the impact on the currency?
A: It is a little surprising that it has not already come. Certainly some measures to raise funds to provide additional financing for the CAD would be considered to be positive in the market which would probably at least for a period of time help to stabilise the rupee.
It would help to buy them time. Our outlook has been for a while for inflation to come down because credit growth is slow. The economy is slowed. There are lots of good reasons to think that the domestic economy leans towards softer inflation.
The RBI simply needs time for that to happen to rebuild credibility and a bond issue might be able to buy some time. However, it is going to have to come with the interest rate environment and monetary environment remaining quite tight for sometime.
Q: You spoke about the possibility of the Indian Rupee (INR) overshooting your earlier estimate. It was 61.50 in 3-6 months and 62 plus in the next 12 months. Would you consider revising your target for the rupee?
A: We are always thinking about the validity of our forecast. We will consider them as market conditions change. We also have to be aware that sometimes the market can overshoot a forecast for a brief period of time and then come back.
So, right now we are just watching what the government does, what actions it takes to build credibility and how that affects the market.