See another 50 bps repo cut by FY13 end: Morgan Stanley

In an interview to CNBC-TV18, he said that the central bank is likely to cut repo rates by end of FY13.  Earlier, governor Duvvuri Subbarao also had said that RBI's monetary policy 'has to act' even if inflation is driven by food prices.

"They could potentially cut policy rates because growth has been weakening. But my view would be that we should look from an underlying cost of capital perspective, what is happening to market oriented interest rates. For example RBI cut policy rates by 50 bps on April 17 and if you look at the commercial paper rate that’s actually now higher than what it was on April 16 which is the day before the monetary policy," he explains.

Ahya sees inflation to inch up to 8% in the near-term. However, inflation may cool off to 7% if commodities don’t rise, he quickly added. India's inflation accelerated in April to 7.23% mostly on the back of food and fuel prices, while manufactured inflation was lower than expected.

Here is an edited transcript of his comments. Also watch the accompanying videos.

Q: How did you read the inflation number that came earlier this week?

A: It was definitely a surprise because both food inflation as well as core inflation were higher than expected. So it appears that the depreciation of the rupee seems to be coming through in commodity prices. Probably, that has pushed core inflation as well. Unfortunately, it’s not good news as we are not getting control on inflation; that’s what persistently the data has been indicating.

Q: Over the next few months, what kind of inflation trajectory do you see? Do you see it staying at such elevated levels through the next few months?

A: We think inflation will probably rise up to about 8% and then gradually start tapering off. But that’s again under the assumption that commodity prices support and don’t rise. Thankfully, that is helping the outlook on inflation, the commodity prices have softened. Both oil as well as CRB commodities excluding oil has gone down, which provides some support. But the rupee depreciation is off setting that to a large extent right now. So going upto 8% and then coming off, by March, we should still see inflation around 7%. 

Q: What do you expect RBI to say in its June communication? Do you think there will be a rate cut?

A: I would answer that question in two ways. Firstly, they could potentially cut policy rates because growth has been weakening. But we should look from an underlying cost of capital perspective, what is happening to market oriented interest rates. So for example, RBI cut policy rates by 50 bps on April 17. If you look at the commercial paper rate, it is now higher than what it was on April 16, which was the day before the monetary policy.

Similarly, if you look at the three-month inter-bank certificate of deposit rate that has also moved up higher. So market oriented short-term interest rates are unfortunately still rising. I think that will not come under control until the time we have achieved some control on balance of payments (BoP).

As long as the BoPs is in deficit, we have the impossible trinity. When we try to control the rupee, the cost of capital rises. If we cut cost of capital or interest rates, the rupee will depreciate. So I think we are in a difficult position here. The right question which you should ask is when will the actual short-term cost of capital go down. I think that is still sometime away; particularly the way the BoP trend is evolving.

Q: What about the current account deficit problem that people have begun worrying about and comparisons that were drawn to the 1991 year, would you agree with that?

A: If you look at the current account deficit, on a day to day basis, people look at it as imports versus exports. But from a macro driver perspective, it is effectively saving minus investment. And what has been happening on that front is that the government has been running down its savings. That is why the current account deficit is widening. So the solution could be the government recognizes the problem and says it is cutting revenue deficit and that will increase the overall savings rate in the country. Therefore, the current account balance improves.