RBI may give dollars to OMCs if Re falls more: Barclays Cap

Even as most other emerging market currencies are weakening in the current global environment, Olivier Desbarres, director and head of FX strategy, Asia-Pacific ex Japan of Barclays Capital says the weakness seen in the rupee is largely due to global risk aversion. From current levels, he sees the dollar appreciating further.

As markets gear up for the EU summit to be held tomorrow, there are no big expectations from the European leaders.  Markets may be left disappointed by the EU summit outcome due to lack of concrete steps taken to tackle the euro zone financial debacle, he says. Below is an edited transcript of his interview. Watch the accompanying video for more. Q: What did you make of the measures that were announced by the RBI and the finance ministry and even over the medium-term? Would you expect it to provide some relief for the rupee?
A: I think the general consensus which we broadly share is that the measures perhaps fell slightly short of what analysts and the market were expecting. When you look at the measures at face value there are some good decisions which were made and decisions, which were necessary.
From the medium-term perspective, one could argue to the extent that it does take a step forward in encouraging capital inflows, this is a positive thing for the rupee but if you take a step back, again, we are trading in a market where expectations are high that policymakers will deliver on promises and will deliver the silver bullet. I think the market felt that the government and the central bank had perhaps fallen a little bit short.
If you look at how the market has traded beyond the rupee, we have to be careful in not attributing too much weight to domestic developments, what is happening at the global level is also key. The rupee has been one of the weakest EM performers in the past week but it hasn’t been the weakest performer.
If you look at the other high yielding emerging market currency such as the Brazilian real or South African rand, these currencies have done even worse than the rupee and currencies which are linked to the euro zone such as the Czech crown and the Polish Zloty have also underperformed the rupee. So it is not just about what is happening in India but what is happening more broadly to the US dollar and to global risk appetite. Q: Do you see trend continuing, the fact that many emerging markets including the rupee continue to be weak relative to the dollar and the dollar continues to pull higher?
A: We would argue that over the next three-six months the trend is going to be for moderate dollar appreciation which is based on the idea that US growth is holding up better than growth in other than G7 economies. As a result of that US yields will be under modest upward pressure. Combine that with the damage that has been done to global risk appetite in recent months and we think that safe haven currencies such as the US dollar and the yen will perform reasonably well.
In that environment, it is difficult for EM including Asian currencies to be appreciating versus the US dollar. I think at best they will be in broad ranges with the risk being that dollar Asia across pushes up higher, for example, the rupee weakening further versus the US dollar.
Of course this is very much subject to data event risks that we continue to see. In particular we have an important EU summit which ends on Friday. I think expectations going into that summit are still quite high and if the market is disappointed and EU leaders don’t deliver a comprehensive solution to the problems in Europe then we could see the dollar rebounding once again. Q: Are you hopeful of a large NRI bond scheme or something like that from the RBI which could lead to a much sharper pullback in the rupee?
A: Perhaps one mistake that we have made in the analysts community is to assume that the government and central bank had run out of measures to encourage capital inflows and what we have seen not just in the past few days but in the past few months is that the government and central bank still have a menu of measures it can pick from and bond issuance as you just ascribed is one of the possible items on that list.
If the rupee were to remain under pressure then it would encourage authorities in India to perhaps go further down this list of policy options. Again, there are other measures that they could undertake in particular providing dollar liquidity to petroleum exporters perhaps staggering imports over the course of the month.
The counter argument is that these measures don’t address the underlying problems to the current account and I would tend to agree with that. The market will ultimately want at some point, the authorities to deal with the underlying fiscal and the current account deficits but that is much harder to do in the near-term. It takes a number of measures which are sometimes politically difficult to introduce and even if you do introduce these measures they take time to work.
Where policymakers can have a greater impact in the near-term is on the capital account and I they have gone some way in addressing the concerns. When we look at the current account, I don’t think the improvement is necessarily going to be driven by policy but it is going to be driven by the fall in oil prices and that has been a substantial development and the one which is going to be positive for India as well as all other oil importing nations. Q: How detrimental will a failed EU summit be for currency markets because some influential global watchers have pointed out that a failed EU summit could be fatal for the euro and may even spell the end of the currency?
A: That is a rather dramatic view. We have had many of these summits before, we will have many more in the future and I don’t think the expectation is so high as to suggest that the market thinks that EU leaders will be able to provide broad sweeping measures that deal with everyone of the cyclical and structural problems that the euro zone is facing.
Where the disappointment may come into is that the EU summit may not deliver a large number of concrete measures. It may be more about delivering a roadmap, a blueprint for the EU and specifically euro zone countries to support growth and move towards greater fiscal and banking consolidation.
I don’t think this summit will be such a disappointment as to think that suddenly we are in the brink of the euro zone breaking up. We have been in far worse positions in the past three-four-five months and yet as we speak today the euro zone is still an entity. We can talk about the risks of one or more countries looking to exit but it is always important to go back to a cost benefit analysis of a country leaving and I have not yet seen overwhelming evidence that suggests that one or more countries will be leaving immediately because the cost benefit analysis is so clear that they need to leave.
I don’t think we are quite there yet. Things may need to get little bit worse, there may need to be a bit more tensions in Europe before the silver bullet gets fired by policymakers.