Inflation to keep RBI hawkish; see no rate hike: Ahya

In its second quarter monetary policy review, the Reserve Bank of India (RBI) had raised policy interest rate for the second time and warned that inflation was likely to remain elevated for the rest of the fiscal year. Chetan Ahya of Morgan Stanley says inflation risk is very much alive which will compel the apex bank to sound hawkish in its next policy announcement but rules out rate hikes in the near term.

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A latest RBI survey indicates inflation expectation it is still rising.
The RBI's inflation control measures in an economy beset by sluggish growth has left the capex cycle on a standstill. Ahya says the rupee, which has recovered from its record lows after RBI measures, may fall again. Below is the verbatim transcript of Chetan Ahya's interview on CNBC-TV18 Q: What are you going for gross domestic product (GDP) number and would the number at least indicate that 4.4 percent we saw in the first quarter is the bottom?
A: We are forecasting 4.6 percent GDP growth for the quarter, so in that sense it would be probably indicating that 4.4 percent was the worst quarter that we have seen but I think that risks are pretty much there in terms of possibility of growth dipping again and the key to watch there will be what happens to the US monetary policy, the US 10-year and its implication on Indian interest rates. So, at this point of time, it looks like probably the instability which was generating out of the US monetary policy is behind us but the jury is still out, we will have to watch what happens to the currency market when the Fed tapers. Q: You said that even 4.6 will not be perhaps good news, it could get worse. What is your full year forecast?
A: We do expect growth to be ranging in 4.5 to 5 percent going forward but risks are still there that it may not have bottomed considering what is still pending for us from the US monetary policy side. Q: Talking about inflation, which has been haunting the market. Do you continue to see Raghuram Rajan deliver a hawkish tone in his monetary policies ahead to scare away the inflation ghost?
A: We do think that the inflation risk is not completely behind us; in fact the inflation expectation is the key to watch. The latest survey from Reserve Bank of India (RBI) which indicates that inflation expectations have gone to a new high, does concern us so from that perspective we think that the RBI will have to still maintain a hawkish tone until the time they can see that they have got some kind of control on inflation expectations. So, even if we do get some kind of a rate cut, the market will force on keeping interest rates quite tight. Q: Where does the cycle end. One more rate hike in December 18 or you would think that another as well cannot be ruled out?
A: We think at this point of time the way the RBI communication has been probably they will not take up any more rate hikes. I remember you were asking the central bank Governor as to what are they watching as far as transitioning from marginal standing facility (MSF) to repo rate is concerned and the Governor mentioned its Fx stability rather than inflation. So, from that perspective it looks like there is more bias to ease rather than to increase short-term interest rates. So, I would say that probably not any more explicit lifting of short-term rates.
What you could see is a hike in repo rate but then you open the repo window so that you transition to repo rate. That kind of a rate hike is possible but that is all getting too much into semantics. What we care for is short-term interest rates and those will remain around 8.75 percent to 9 percent. Q: The other thing that the RBI Governor said was that if growth is bad, I remember asking him that would he also look at growth numbers to decide rate hike policy. He said if growth is weak then that it will set in disinflationary forces and accordingly it will impact our monetary policy. If on Friday the number comes closer to 4 percent then do you think the rate hike is - how would you react if it comes closer to 5 then he is emboldened to take that rate hike, if it comes closer to 4. How will the market read it?
A: The market may read the growth is below consensus, the market may read that there will probably be no rate hike but the key to watch could be inflation because all said and done growth has been decelerating for a while. This story of negative output gap has been there with us for a very long time and it has not reflected in inflation. So, there are other factors which are driving inflation and our view has been for a long time that once inflation is there even if it is because of factors which is not initially due to lose monetary policy, it may be due to rural wages, it may be due to government spending. It is RBI's responsibility to ensure that real rates are not negative for four years. However, they waited too long for negative output to show in disinflationary impact and it has not yet shown. So, to keep hoping for that is a little bit of we think a risky strategy. Q: You track a lot of the internals closely, the capital goods numbers etc. The market has been little sanguine on this sector in the last couple of days expecting that maybe there are some green shoots visible as far as the capex cycle goes and maybe we could have seen the worst. What sense you are getting. Is the capex cycle turning or is there still time to go for that?
A: We do not see any indicator that is showing that capex cycle is recovery. The indicator that you would want to watch is Centre for Monitoring Indian Economy (CMIE) data on projects under implementation which has still tick down both for private as well as public sector in the September quarter. If you look at capital goods imports that have also continued to be very weak or if you look at engineering and construction companies orders for domestic business. That also continues to be very weak. So, we do not see any sign of a pick up in capex or what we have seen is improvement in external demand. So, that is what is lending stability to the growth trend. Q: Coming back to the policy that you said in the credit policy and thereafter the Governor saying that the MSF rate and in fact the rate cycle itself is dependent on the rupee. Actually rupee has been an outperformer; a performer compared to the fragile five, compared to other emerging market peers. What is your sense, when tapering comes and when perhaps US rates go towards 3 percent. Will there be a major impact on the rupee, after all a fairly big arsenal has been built-up in the form of 26-27 billion, in the form of foreign currency non-resident (FCNR) and banking capital swaps. Is it likely that the RBI will not have to use the monetary instrument yet again to defend the rupee?
A: If it is 3 percent, it’s fine. It’s the pace at which the US 10-year bond goes up, US dollar goes up and the magnitude. If the magnitude is not going to be too high which seems to be likely because the Fed is not going to absorb those high interest rates considering the state of the economy. So, I would personally think that we will not probably see the days that we had seen when there was no transaction in the Fx market and the currency was going through aggressive fall of 2-3 percent a day.
So, those days are behind us but we may see depreciation pressures because currency is a relative price. We do think that the US economy is doing better, the dollar is going to come back, in fact it is already retrieving back the fall that it had seen in the last two months. So, some depreciation is inevitable but it is not likely to be a panic situation as we had seen in that period of August-September. Q: What is your view on fiscal deficit, a number that will come perhaps in the vote on account? Will 4.8 be maintained and if it is maintained, will there be a major cut in plan expenses, will that colour your FY15 growth estimates?
A: The numbers look difficult to be achieved. Twelve month trailing number is at 5.3 percent and if you look at the trajectory of tax revenue growth, it looks almost impossible to achieve the 4.8 percent deficit unless the government gets going quickly on expenditure growth. So, tax revenues, divestments, shortfall and some telecom receipt shortfall turns out to be 1 percent of GDP on the revenue side then our math shows that the government will have to cut the expenditure growth to 3.5 percent in the balanced part of the financial year, which considering that they are heading into elections will be very difficult to achieve. So, it will be probably some accounting changes which will help to show that number but as such the math looks difficult to be achieved.