HSBC roots for rate cut; StanChart sees no change to growth

Ahead of the Reserve Bank of India’s (RBI) quarterly monetary policy review, investors and market analysts are wondering which way the pendulum will swing on July 31. The RBI is grappling as it tries to increase its foreign capital inflows and build up its reserves that have fallen substantially in the recent period due to market intervention.

As the debates continues as to whether or not it must loosen interest rates, CNBC-TV18 spoke to two experts - Manish Wadhawan, HSBC and Samiran Chakrabarty of Standard Chartered Bank, if they were expecting a non-event policy or if they felt the RBI may choose to surprise.
While Wadhawan finds the probability of a rate cut high and is expecting the central bank to surprise the market with a 25 basis points rate cut, Chakrabarty isn’t holding out for a move as he doesn’t see an interest rate cut getting the economy back on the fast track to growth.
RBI had opted to hold rates in the mid-quarter policy review in June, citing upside risks to inflation. Our economic environment meanwhile continues to take a whack due to a lacklustre monsoon so far this year. Inflationary pressures as well as a crumbling rupee continue to pose a threat.
The RBI has projected inflation to be around 6.5% by March 2013, with a caution that it will remain sticky and that there was a need to arrest the decline in economic growth. Below is an edited transcript of their interview. Q: Would you go with the extraordinary majority of people who are expecting a non-event policy or do you think the Reserve Bank could well choose to surprise? It’s the best chance they have to surprise. Wadhawan: I would be in the minority camp. I would say given the push which is being talked about by the government and the way things are panning out, I expect that RBI might surprise us with a 25 bps cut this time. If you see the market levels also we have already seen the market started factoring in some kind of policy easing. If you see the CD rates three months back and today where we are, they are down by something like 50-75 bps.
The Government of India’s bond yields 10-year paper is down by something like 30-40 bps from the peak it achieved in Jan-Feb. The market is already to some extent factoring in that, though I appreciate what the governor said that inflation is still high. But on balance I would say with the way the numbers are coming and I am also putting in one more factor which is the drought situation which is still uncertain, putting all the pieces together there is a probability of a rate cut and the RBI might surprise on that. Q: What is your expectation on Tuesday? Do you think inflation will be on top of mind? What exactly would your inflation trajectory be, considering the situation on the monsoon at this point? Chakrabarty: This is a classic case where your mind tells you there should not be a cut but there is always a fear at the back of your mind whether there will be a surprise from the RBI. Now we just did a quick analysis of the last 12 policies. In the last 12 policies – in four out of 12 cases, the RBI sprang a surprise on market expectations and in the last two it surprised and that is probably driving this fear in the market that there could be another surprise around the corner.
But really, we should not be forecasting on the basis of surprises. In our view, we should be forecasting on the basis of what the RBI has been telling us because I would like to believe that their guidance is what they will follow and if I follow their guidance then it looks to me there should not be any rate cut on Tuesday.
It is a different story that we can argue against the RBI logic of saying whether interest rate cut at this juncture is going to help growth or not. But it seems that the RBI has taken a stance that interest rate is not the reason why growth is slowing down. So an interest rate cut is also not going to revive growth. At the same time, it might reunite the fears of inflation.
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In our view inflation trajectory can go up to 8% back again in couple of months time, especially if the monsoon situation does not improve. We are already seeing signs of food prices going up, even the core inflation might moderate and headline inflation still can inch up to 8%. Q: But look at their position in the next big policy. Definitely in mid-September when they have the inter-quarter policy, their position is going to look even more awkward. Inflation will probably be 8% and we will by then have got the first quarter GDP number which would probably be lower than 5.3% we don’t know, it could be higher. So you would be in the awkward position that inflation and growth would have gotten worse and probably the fisc would not have moved. How long can the RBI keep to this position? Chakrabarty: We have taken a call that this is going to be a pretty long haul for the central bank where if they really want to get into a situation where inflation comes down to their comfort level of 5-6% then they will have to be patient. You cannot possibly flip-flop on policy every three months changing your target, changing your assumptions.
There is an assumption here that the central bank has made that given the current supply side situation, a demand boost through interest rate cuts is only going to fuel consumption and not going to improve investment. So the demand-supply balance is actually going to worsen because of an interest rate cut. If this is their stated position or if this assumption does not change then I don’t see how they will be in a position to cut rates even in September.
Only in a situation of a drought impacting demand very, very severely or a global collapse leading to demand destruction in a big way can there be a reason for a demand stimulus. Otherwise, I can’t expect a rate cut coming anytime soon. There is some logic in how markets have reacted off late, because if you look at historical patterns, five year OIS had stayed above 7% only in severe tightening cycles. We are clearly not in a tightening cycle anymore. We are in a moderate mid-course kind of a situation.
So that’s why the market’s anticipation is that now we are going to head lower in policy. It may not be now, but maybe three months, six months down the line and that’s why market is trying to price it in by trying to push five year Overnight Index Swaps (OIS) down that 7% threshold. Q: What sort of importance do you think the RBI is going to place on the global situation? How exactly do you expect them to tie in the precarious situation in Europe at this point? Wadhwan: The RBI has been saying they are focused more on internal factors than on the international factors and we have seen the evidence in the policy which they have been following. But since the last June policy, a lot of things have changed for worse in world markets. One important thing is that China has cut its rate twice and we have seen rate cuts in Korea. Things are still not improving in the euro zone area.
But the most important thing what I have perceived is oil prices have started to show some kind of stability; whether its band of USD 90-110 per barrel. And we hope the way things are panning out in the US and developed world where they have started producing oil to the extent of 20% of their own consumption. It gives some kind of comfort that on oil might start stabilising. One factor which market has been putting across domestically is that if India raises diesel prices and adjusts those things and we see some kind of hope on fiscal side in India things might start stabilising.
On the international front again the same thing; if things really go bad from here at that time you might see the RBI reacting. So there can be some kind of a leeway that the RBI might not come now and keep it as insurance when it is required. Overall, the way things have panned out in the last six weeks, the way things are on liquidity, the way things are on what is happening on the international front, there will be bias as is evident and getting manifested in the markets, which are traded at the moment; whether it is a five year OIS or one year OIS. You see the lending rates have also started nudging a bit down.
So putting altogether markets are already on one side whether RBI obliges on Tuesday or it obliges six weeks down the line. I take the point domestic inflation is important but we will have some kind of trade-off because 8% is still on the higher side on the repo rate. I think the way things are, I would still go for a rate cut. Timing definitely is a bit uncertain whether its six weeks down the line or day after tomorrow. Q: What is your sense - will not the RBI have to come to terms with a new reality of a 5% number coming in for most quarters in terms of GDP growth? Chakrabarty: I have some doubts on the last quarter 5.3% GDP print. In my view, this number can be revised upwards to about 6% or so and if that is correct then possibly the FY13 GDP growth could be in the 6-6.5% range. I don’t know whether a similar thought process the RBI has or not.
But at least at this juncture taking down growth drastically from 7.3% to 6-6.5% handle might be slightly tricky because then the clamour for rate cuts will go up even more and the RBI might just try to do a balance by revising growth down in two stages - first bringing it down to the 6.5-7% handle and then looking at the monsoon probably bringing it down even further.
_PAGEBREAK_ Q: What happens to the market if there is a cut? Assuming nothing happens we should be going into the credit policy with something between 8.08 and 8.1. If that is the tenure, what happens if there is a cut and if there isn’t a cut? Wadhawan: If the RBI obliges and cuts rates, you could see a rally of at least 10 bps and the bigger picture would be that the market would start factoring another 25 bps. Somewhere in the heart there is a clamour for a rate cut, 7.5% seems to be one of those targets on repo rate, the timing looks a bit uncertain but the market has a tendency to discount all these things in advance. Q: When you say 10 bps you mean we could go sub 8 if there is a cut? Wadhawan: Yes, it is possible to see around end September these kind of levels the way things are going on. But it is a very tight range. If you see what I am talking about is 10 bps down and may be 5-7 bps higher. So it is on either side market is at a cusp at the moment. The big picture is that market is looking at lower and lower rates.
Whether it is evident in five year OIS (Overnight Index Swap) levels, one-year OIS levels, bond market and surprisingly you would see till the time OMOs were continuing the yields were higher. RBI has stopped doing OMOs for last 1 month and we have seen yields coming down. So it is giving you some kind of hint somewhere the way situation is. Q: Just to confirm, there is no possibility of a CRR cut you assume at all. If you could just add to that the liquidity scenario possibly in the next couple of weeks which you expect to pan out because we do understand it’s comfortable at this point? Wadhawan: The core liquidity shortfall at the moment is around between Rs 40,000-50,000 crore. It is happening on account of the WMA which is drawn and the government spending which has happened in the last few months. A lot of subsidy payments have gone to oil companies and the food and fertilizer companies. So we are already seeing liquidity quite comfortable.
But liquidity will start getting a bit tighter, tighter in the sense the repo numbers could go up to around Rs 65,000-75,000 by mid-September on account of advance tax. We have seen in the last six months that liquidity has actually started easing so I do not see a probability of a CRR cut now. That is something which will be held back for October if required. There is no need for a CRR cut at this moment. Q: Finally it quite clearly looks like it will be a non-event policy at least as far as the bond markets are concerned, because if there is a cut, then it’s 8%, if there is no cut then at the most 8.15%. You are not looking at a very, very big change from what Manish confirms. So what really will you look for on July 31? Chakrabarty: The RBI has made a few assumptions in its June policy. I want to see whether it continues with these same set of assumptions - that interest rate cuts at this juncture, they are not going to help growth. I want to see whether the RBI is still putting its bias in favour of fighting headline inflation rather than core inflation.
These are critical assumptions which will determine where we are going to get a 25-50 bps rate cut or maybe a 100 bps rate cut over the next 6-12 months, because market will try to price that in depending upon the kind of comments that we get along with the decision.