RBI should be cautious on exit policy: Uday Kotak

Q: Starting out of the monetary policy were you at all surprised that they chose to keep rates steady - at Fed, the Indian Central Bank, the European Central Bank as well as the Bank of England, all keep rates steady but all indicate towards the inflation worry and rates going up. So what did you make of that and where do you think we are in terms of the curve of interest rates turning?

A: I will go back to what happened in 2008. People were worried in 2008 - "Are we going to see a repeat of 1930s?" The good news is policymakers knew what medicine should have been used in 1930s and used that medicine around the world in 2008 and 2009, which is based on historical experience and knowledge. The problem now is after having applied the medicine and saved the world from a crisis, we have no historical model about what to do next. The constant concern is if we act too soon, will we fall back again? And if we act too late, will there be inflation? Therefore, in the absence of models, we are literally driving in the dark without lights on and therefore there is an element of caution not wanting to rush in and do things which will create a crisis or run the risk of a crisis again. At the same time it is a completely dark night in terms of the way forward and you have got to do it feeling and sensing your way rather than trying to be too courageous about how to do it.

Q: I understand that there is no historical context to what we should do next instinctively what do you think regulators should do next?

A: They should move slowly. There has to be a gradual exit, it should not be disruptive and I would be more on the side of caution in terms of moving towards exit slower rather than faster.

Q: Are you not worried then about - sure, they applied all the solutions that we knew of historically to last year's crisis and have managed to get us out of it in some fashion but all of that has also contributed to its reflating of asset values - a cause of deep concern right now across the world because a lot of that money has gotten channelised into stocks, bonds across the world and it is also leading to countries like Brazil looking at ways of stemming that sudden inflow of dollar that is happening, so what do you think the repercussions of this reflation are likely to be?

A: I think the answer to that is the policymakers feel more comfortable handling an inflationary or reflationary situation. They have seen that, been there in the past. It is the deflationary side, which is more difficult for the policymakers to handle and therefore the caution is in terms of making sure that we don't have another bout of potential deflation. Does it run the risk of a potential asset bubble? The answer is yes.

But is that risk worthwhile compared to the risk of going back into the pit? That is really the issue. I would say that prick the bubble slowly and carefully - don't disrupt the recovery process.

Q: How do you do it slowly and carefully because the moment you indicate that you are going to start for instance, what Nouriel Roubini calls "the mother of all carry trades" - the dollar carry trade, which is meant markets in India have seen more than 50% appreciation in the last few months - what do you do? The moment the Fed starts talking the language of higher rates - that money is going to start rushing out like hot money.

A: My view is that the Fed is unlikely to do anything before the second half of 2010. So you have at least 6-9 months to go before you see the fed doing anything.

Q: For that six-nine months then you mean that this flush of dollar will continue?

A: I think there will clearly be a move towards returns but that is where I am saying we don't know how this whole thing will work out. And the single most important point is dollar as a currency. If there is one point I would look at amongst all, it is the value of the dollar and it is inter-linkages across everything else. Therefore forget equity markets, forget asset markets, forget commodity markets - focus on the dollar because that is the single most important signal about how the world will react over the next six-nine months.

Q: So right now it is a declining dollar with the exception of a few upticks whenever you get good gross domestic product (GDP) data or good economic data from the US. What is your outlook on the dollar for the next six months? How does India need to be prepared?

A: On a fundamental basis, the dollar has to get weaker. But on a technical basis, the dollar is clearly getting more and more oversold. In a carry trade as you get more oversold, whenever a technical correction happens, it will be sharp. So this is the classic game - the music is on, everyone is dancing - you do not know when it will stop and where you will be caught.

So it is all about when you are going to see that shock but that shock will come at some point of time when dollar shorts will have a challenge. But at this point of time, on a fundamental basis, the dollar is looking weaker.