Inflation not to touch single digit before next yr: ML

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Ashish Agarwal , Asia Local Market Strategist, Merril Lynch does not see Indian inflation in single digits before next year and said that both the GDP and inflation would trend in-line with estimates. He added that money supply still remains high and feels it's too early to expect the RBI or Reserve Bank of India to react in the same way as China's Central Bank. He said the markets are moving into a phase of risk aversion and capital outflows. He believes the rupee could be in the last stages of weakness.

 

Excerpts from CNBC-TV18's exclusive interview with Ashish Agarwal:

 

Q: How concerned are the Foreign Institutional Investors (FIIs) right now about the level of depreciation that's happened on the rupee?

 

A: I wouldn't be able to comment on the level of FII concerns. But at a broader level what is happening is that markets are moving from reacting to a phase of generalized dollar strength to a phase of risk aversion. Also most equity markets in emerging markets are getting hit and currencies weaken more on account of sentiment and expectations of capital outflows.

 

Q: Yesterday, India watched with a great deal of interest as China slashed rates out there. Do you think the Indian Central Bank could follow given the kind of problems of growth that we are seeing globally? Is it likely?

 

A: The cases in both India and China are different. China has actually witnessed inflation moderate significantly from the highs in February this year. Moreover, non-food inflation in China has been about 2.1% and it is quite clear that export growth as well as some sectors in China are witnessing a sharp contraction.

 

In India this situation is slightly different even after factoring in a peak in inflation; the Wholesale Price Index (WPI) inflation will not move below double-digits till the first quarter of next year. The money supply growth remains pretty high and we have not seen the commodity-related adjustments getting reflected in Indian inflation.

 

So it is too early to expect the Reserve Bank of India to react the way the People's Bank of China (PBoC) has done; our economists are still expecting further tightening in terms of reserve ratio hikes and rate hikes.

 

Q: Having said that, do you see the benchmark bond yields languishing around that 8% mark, given the kind of expectations which are building up?

 

A: To some extent you have got to strip out the effect of Statutory Liquidity Ratio (SLR) shortage in the banking system. Also from what is happening to yields; one could say that the big picture is definitely getting positive in the sense the markets do anticipate some sort of relaxation in tight policy by the Reserve Bank of India.  But offlate we have seen a number of factors trigger extremely high demand for government bonds, you have got the Market Stabilisation Scheme (MSS) issuance which has slowed down, you have got RBI also buying government bonds reportedly for State Governments and with banking system deposits growing very quickly, bank demand for SLR paper has increased quite a lot.

 

So as more supply comes in and hits the market probably with the Pay Commission amounts getting released, we think the markets will lose some of the aggression that you are seeing offlate.  

 

Q: How are you reading some of the macro numbers; the general expectation is that inflation has probably peaked off right now and the market was enthused to see the Index of Industrial Production (IIP) numbers we had to report?

 

A: The macro numbers are largely in-line with the expectations, growth has been softening which is something that was expected but not too quickly. Inflation was something we expected to peak off and eventually trend lower. So the numbers are to an extent reinforcing our view. But money supply growth still remains high. Even with inflation dropping from the highs, you would still see double-digit inflation till early next year.

 

Q: Directionally speaking, do you see more depreciation in the rupee versus the dollar or do you think we are more or less done after the sharp spike down?

 

A: The big picture is definitely much more positive for the rupee. If one looks at the fact that oil prices have eased from about USD 145 per barrel to nearly USD 95 per barrel now, that's going to be having a big effect or positive influence on our trade numbers. India is still relatively a closed economy with global capital flows largely isolated or directed into the equity markets that selling doesn't seem to be too large for RBI not to be able to handle it.

 

The real effective exchange rate Index also probably is at the lows over the last one year which means that the Reserve Bank of India could get more aggressive in supporting the rupee and the RBI has enough ammunition to do so. So given these factors as a big picture, the rupee could to an extent be at last stages of weakness though I would like to qualify here that this does not assume significant selling by FIIs in Indian equities.