RBI measures here to stay; rate cut likely after Sept: HSBC

The Reserve Bank of India had embarked on a spate of measures after the rupee tumbled to a record low of 61.20 to the US dollar on July 8. RBI raised short-term interest rates on bonds and commercial papers by 300 basis points and capped the amount available under LAF or liquidity adjustment facility to 0.5% of total liabilities. It was earlier 1% of total liabilities. Leif Eskesen, chief economist - India & ASEAN, HSBC, expects RBI to hold key rates unchanged today.

He told CNBC-TV18, the growth backdrop is not very encouraging, global as well as domestic. The monetary policy will have to address the pressure on the rupee. On the inflationary front, though the WPI has come down in the last few weeks, CPI remains a concern and sticky at double digit levels. This is turn implies broader inflationary expectations. The weakness in the currency too adds to the mix.

Also Read: RBI Macroeconomic Review: Hints at more curbs on fund flows, GDP seen at 5.7% in FY14

He feels despite marginal reduction in CAD in June, it still remains unsustainably high and chances of it narrowing significantly are less in this year or even the next.

Monetary policy will have to cater more to the currency, he says. He feels RBI will highlight the lingering risks when it comes to the external side and the potential pressure on the currency in today’s policy. He does not believe the RBI moves over the last 10 days to be short-term measures.

Eskesen says there is not much room for the RBI to ease policies in the near-term. If some of the pressures on the currency were to dissipate and if inflationary pressures ease a bit, then there might be a rate cut in September or October.

Below is the verbatim transcript of Leif Eskesen’s interview on CNBC-TV18

Q: What are your expectations today and what do you expect the bond market to do in response to that, because yields have been holding above that 8 percent handle?

A: We believe the Reserve Bank of India (RBI) will basically remain on hold keeping both policy rates and Cash Reserve Ratio (CRR) unchanged. Of course the growth backdrop is not very encouraging either on the global side or the domestic side where things have actually softened in recent months. There are two key concerns. On the inflation front, yes Wholesale Price Index (WPI) has come off, but Consumer Price Index (CPI) remains quite high and sticky at around double digit levels and that of course has implications for future broader inflation expectations which have also held up.

More recently the weakness of the currency adds to the mix, the adjustment in administered prices is also something that adds to underlying inflation pressures. What is in the focus by now is the external position, the Current Account Deficit (CAD). It had come down to some extent in June when you look at the measures that were taken to curb gold import, but overall CAD remains unsustainably high and it is not going to narrow very significantly either this year or next year for that matter.

So there would still be pressures on the currency, especially in the context now where there are more concerns about the repricing of developed markets (DM) versus emerging markets (EM) in light of potential recalibration of US monetary policy. Monetary policy as we have also seen more recently will have to cater somewhat more to the currency, so that also in a sense keeps them where they are, especially, with the latest measures also having to remain in place for while still.

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So it would be quite dovish on growth, but it would be quite a hawkish statement on the inflation picture and also the external risks that you have with wide CAD and therefore need to keep monetary and fiscal policy relatively tight, focus a lot on basically structural policies to help alleviate some of these imbalances in the economy.

Q: A lot of the focus is about what the RBI may say on winding down some of the measures that they have taken in the last 10 days. Do you think one should be expecting any clarity or guidance on that front in today's policy?

A: I do not think there would be a lot of clarity. I think they would highlight the lingering risks when it comes to the external side, the potential pressures on the currency front and therefore signal a need to remain quite vigilant when it comes to stabilising currency markets there. So I would not expect a signal that these measures will potentially only be in place for a relatively short period of time.

RBI will have to manage expectations in that sense and say that these measures may have to be in place for potentially a bit longer than expected, because the pressures that are bringing them about whether it is the external pressures related to Quantitative Easing (QE) tapering or whether it is some of the domestic pressures related to the fact that the CAD remains very high in this current environment, but it will still continue to be with us for a while still. So it would be in a sense a little bit premature to begin to signal that these measures are just going to be with us for a very short period of time.

Q: Some of your peers have suggested that they maybe around for maybe 2-3 months and that is unlikely to have any significant impact on growth. If they were to last for longer would you say you would need to start relooking your growth targets which are already quite low for India?

A: Yes, I would also suspect that 2-3 months is what we are looking at in minimum in terms of these measures having to remain in place. If they are extended to another 6 months overall, of course it starts to have implications for growth directly because of the impact it has on funding costs, also to the extent it is necessary to keep them in place for longer.

The other side of that is because macro stability remains an issue that has negative implications for growth in terms of investment incentives, in terms of appetite for consumption and things like that. That could certainly have more impact on growth in that particular environment, but then you also start to come into a situation where you need to make some harder choices, on the one hand between catering to the currency, stabilising the currency and then also on the other hand allowing the exchange rate to potentially adjust to a changing fundamental economic backdrop.

Q: Do you think at the end of today's policy communication market participants might give up on expectation of any rate cut for the course of this calendar year?

A: I think there would probably be somewhat scaled back expectations on that front. It is hard for RBI really to signal much room to ease policies in the nearer term. I do not think it is quite off the table yet. So to the extent some of these pressures on the currency begin to dissipate in September-October then we are back to a situation where the growth backdrop is quite weak and if the exchange rate has been holding up at that point in time, the inflationary risks may also to some extent have receded at that point in time, so then they could potentially ease policy.

But clearly the way things stand now with the risk that this global backdrop is not going to improve anytime soon as I mentioned earlier some of the imbalances in the economy when it comes to external side of things not necessarily improving dramatically either, that clearly is a risk that these measures will have to potentially stay in place for longer.