See better inflation nos early next year: Macquarie Cap

Q: Once the dust settles on this bailout package in the financial sector, what do you think it will do to the real sector for the next 2-3 quarters? Are we now going to see numbers which will start flagging a recession?

A: Economic numbers come out with a bit of a lag. So, given the almost freezing credit availability, numbers would look bad for the next couple of quarters for all practical purposes. The US is probably in a technical recession now. But the important things, in a forward looking manner, are the speed, implementation and the design that would then begin to impact all the issues. Hence, the whole bailout package is a necessary but not the sufficient condition overall. The implementation and the speed with which is it is implemented would be very critical.

Q: Are there any fears of this spilling over into other economies, because now there has been talk about recession or recession-like situation for the entire euro zone as well? How many economies would you be worried about?

A: The domino effect is playing out. If one notices, the whole decoupling theory for emerging Asia was pretty much a first half story and very few people necessarily talk about it anymore. We have already seen the impact getting felt in the money markets around the world. Global capital flows have been impacted and real sector data which comes out with a bit of lag will still show that. With respect to Asia, particularly for emerging Asia, it is going to be a bit of double whammy in that not only has the capital flow cycle reversed, which is not necessarily looking to change course anytime soon, but also the broader weakness on some of the industries that lot of Asian economies depend on is also showing some worrying signs. So, in lot of these countries the downshift on growth front will be fairly severe for the second half. We reckon they would bottom out sometime in the first quarter of the next year; however, there again the differentiation would come in what the policy response lands up being. Some countries have already responded, for example, yesterday the central bank in Taiwan cut interest rates. China has already moved. A number of central banks have already tried to play around with liquidity injection but bigger policy moves are still some time away, but that is exactly the way they will go.

Q: I notice you expect to see an unchanged status from the RBI this time around and then significant cuts, what is it that you are pencilling in from the RBI?

A: There are two aspects to it--one, is Governor Subba Rao's first policy meeting at the time inflation is elevated, and there are a lot of global cross currents that one would have to take into account. But, while the wholesale price index (WPI) is still at 12% and one can debate whether or not it is the right measure and it is accurately measuring things, the underlying impression still remains that inflation is elevated. Although, by the end of this year, and then, into the first quarter of next year the numbers would look far better. Given what's happening in the global front and the fact that the inflation numbers are not worsening should be two important parameters as a result of which the governor would keep the policy rates unchanged. The issue will be that will he do anything else, purely, in terms of liquidity management, and I wouldn't rule out the RBI easing on the SLR requirement again. By the early next year, inflation would be looking better and given the broader growth concerns, RBI would step in with a fairly aggressive easing. Over the next year, we could easily see cuts in repo rate and CRR to the tune of around 200 basis points.

Q: What is your own assessment of global growth--economic growth in calendar 2009? Do you think we can predict, with some degree of accuracy, what the extent of the slowdown could be, or is the window open for surprises on that front on the extent of the slowdown next year?

A: I think the window is still open. What will happen is for the next four quarters numbers would look bad. However, the down side surprise to a certain extent is going to be concentrated in the first two quarters. For those interested in letter-shaped recoveries, 'V' or under root, etc., this is going to be more like a prolonged 'U' for sometime.

However, India stands out simply because the drivers are more concentrated on the domestic side. The capital flow cycle will clearly impact some element of growth. Then, the issue becomes how aggressively policy can be shifted to try and cushion the capital flow and that is the part of thinking behind when I say a very aggressive easing by the RBI is going to kick off from early next year onwards. Before the end of this year, we do see potential moves on SLR, purely as a liquidity management issue.

One thing worth emphasizing is that RBI in a way is reverse buying compared to the last two to three years. At that time the issue was strong capital inflows; it was hiking cash reserve ratio and inflation was an issue. Over the next six to eight months the flow is going to change. Capital inflows may or may not pick up. For the time being, they are still very much on the outflow side. Rupee is under pressure to weaken and RBI can try and come in and prevent it. For the time being, 47 seems to be line in the sand, but as it does that it would be drying up rupee liquidity further. So it has to counter balance that by some measure. Improving capital inflows, liberalizing policy, something that is already going on, but it is not sufficient and they need to do more.

Q: What about global liquidity? What's your assessment not just from an FII perspective but what we can look forward to in 2009, because to some extent, our growth is dependent on some global inflows of capital?

A: Foreign direct investment would be far better insulated. However, the overall magnitude of capital flows coming out of a multi year expansionary cycle will clearly reverse and be far more subdued. So, we are not necessarily going back to a Hunky Dory straight off the race kind of a global capital scenario to the extent that there is pressure on the dollar to the extent that oil prices remain more or less depressed or not necessarily scaling new highs. All those are also factors that would indicate that global capital flows aren't going to be all that impressive. Finally, there is the broader issue of cyclical slowdown that a lot of these countries will have to run their course on.

Q: Where do you see the bond market headed? Yields have cooled down significantly in the past couple of months; will it impact life materially for the entire banking space?

A: Yes, it would and therein one will have a couple of different cross-currents--a big one is the anticipation of as and when RBI would signal a turn in policy. The other is purely in terms of money market liquidity related plays. Again, to the extent that they try and do anything to prevent excessive rupee depreciation, liquidity tightens, there has to be a counter balance adjustment measure. But, one of the aspects of trying to counterbalance any moves on SLR, potentially, could be an increase in foreign investment limit as far as local debt markets are concerned. Also, these are things the government has been talking about for some time. now and one is in a situation where capital flows are quite weak and there is pressure on the rupee to depreciate. So, they will try and make a stronger case, and I am not sure the current governor would necessarily resist from many of these measures; the broad direction is pretty much set.