Rupee may end FY14 at 61.5/USD, GDP growth to be hurt: HSBC

Leif Eskesen, chief economist -India & Asean, HSBC believes there is a downside risk to gross domestic product (GDP) growth due to the liquidity tightening measures by the Reserve Bank of India which will lead to high interest rates. He believes the Indian currency will not be easily tamed and there could be more tightening measures in the offing.

“There might be need for even more tightening to stabilise the currency, indicating that macro uncertainty will linger for a longer period of time,” he says in an interview to CNBC-TV18.

According to Eskesen, rupee may be looking at 61.5 level against the dollar by the end of this fiscal year and then around 63 by the end of next fiscal year, indicating a gradual depreciation of the currency. Below is the verbatim transcript of Leif Eskesen's interview on CNBC-TV18 Q: The Reserve Bank of India (RBI) measures may no longer be just temporary in nature. If that is the case, would you be concerned in terms of growth outlook going forward?
A: From RBI’s perspective, the key priority in the short-term is to really anchor up expectations about the currency. So they both have to be quite forceful in terms of their communication that it is indeed their primary objective.
Also, they have to put action behind their words as we have seen today when they essentially mopped more liquidity from the system and that could potentially be necessary in coming months. So, these liquidity tightening measures would have to be in place for a while and that would have implications on growth going forward.
The longer these measures would have to be in place, it would be symptomatic of the fact that macro economic uncertainty will linger for longer that has implications for sentiment among consumers, sentiment among businesses in terms of investment. So, that effect could have implications on growth because of what it implicitly assumes.

Q: Are we actually likely to strike a sub 5 percent GDP this year?
A: We still have 5.5 percent growth forecast in place for India but it increasing looks like the downside risk to that forecast are beginning to dominate. So we could see low but we haven't actually officially revised our forecast yet. But there clearly are downside risks to the growth outlook both because you are going to see this liquidity tightening measures and therefore, high interest rates being placed for longer.
There might be need for even more tightening on that front for that matter to stabilise the currency. It also implies that macro uncertainty will linger for longer and that also has implications for growth. So the arrow is pointing down from that point.

_PAGEBREAK_ Q: The expectation from many economists was that FY15 could see fructifying of some of the steps being taken now. We have one major round of state elections and then general election as well and from the early polls that our sister channel threw up it looks like a fractured mandate. How is FY15 looking to you in terms of growth?
A: It looks better from the following perspective. There has been traction on reforms since September last year, but it takes a while before these reforms kick in and have an impact on growth.
Also, when it comes to expedition of some investment projects with Cabinet Committee on Investment (CCI) even those projects will only take a while before they kick in and have an impact on growth. So, the lagged effect of some of the measures that have been taken so far this year will begin to have an impact.
Hopefully, by that point we will have some more stabilisation when it comes to the currency at that point in time. So you will start to see macroeconomic uncertainty beginning to recede to some degree, that would also be supportive for growth and then from global perspective we are also looking at recovery next year in United States, more stable conditions in Europe and in China for that matter. That would also add some impetus to growth.
The growth outlook for next year certainly looks better than growth outlook for this year.

Q: Currency is the key variable. We have seen big moves from the RBI. It looks like they want to defend the recent lows of 61/62 against the dollar. Where do you see stability for the currency?
A: According to our latest forecast, we are looking at 61.5 by the end of this fiscal year and then we are looking at about 63 by the end of next fiscal year. So, we are looking at a gradual depreciation of the currency.
We also have to realise that term stabilisation does not mean a fixed level, to a large extent it means lowering the degree of volatility in the currency. So, that is a bit where we are coming from.

Q: What will you expect from the government now and how seminal will they be? Do you expect them to announce something in the nature of a bond or are you only anticipating more current account deficit (CAD) correcting steps?
A: Some of the steps that have been discussed are specifically addressing the CAD. Some steps have been taken so far when it comes to curbing gold imports. Some of the steps that have been discussed more recently in terms of curbing non-essential imports, luxury good, it seems highly likely we get something on that front.
On the financing front, further increase in external commercial borrowing (ECB) limits would appear to be on the table. We will have to see whether there will be steps taken to allow government companies to increasingly tap external sources of funding to also bring in more capital and then when it comes to the sovereign bond issuance there is some resistance on that front including from the RBI.
When it comes to NRI deposits, the question remains are we going to substitute one inflow for another by doing that and therefore, how effective it is essentially going to be. So, when it comes to NRI and sovereign bond issuance maybe a bit more doubtful on front, but I would not rule it out.
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Q: Tax-free bonds are allocated to some infrastructure financing companies like Rural Electrification Corporation (REC) and National Highways Authority of India (NHAI). Do sovereign wealth funds take an interest in this? A lot of interest is in the domestic market because it assures you some 10 percent tax-free for the next 10 years, a very attractive return even by Indian inflation standards. Will sovereign wealth funds bite?
A: They are interested on that front and there is still pretty decent yield pick up as it is. What is important for sovereign wealth funds as well as foreign investors more generally speaking is that we get some macroeconomic stability on the table in the short-term.
We have addressed some issues related to the currency which is a key concern at the moment. Although these measures will help, more needs to be done both from the perspective of RBI anchoring expectations about the currency.
The government is taking the measures in terms of addressing the current account more directly and then more importantly from a more sustained basis structural reform is continued to be rolled out to bring about a more sustained improvement in macroeconomic conditions including the CAD.

Q: We have seen huge rupee depreciation and the corporate earnings are clearly reflecting that the export part of almost every company's sales has done much better. When will this start paying off, the rupee depreciation combined with the decent pick up in Organisation for Economic Co-operation and Development (OECD) countries? Won't that be a seminal advantage for trade deficit for the rupee and more generally for the economy?
A: It will begin to kick in, but more so next year. In the US right now with exception of the Institute of Supply Management (ISM) now, growth is still relatively moderate.
We are not looking for a more rapid recovery until we head into the tail end of this year and into next year as well. So, from the beginning of next year we could see the combined effect from firmer demand abroad and also some support because of the competitiveness gain when it comes to the currency. The weaker currency in India's case also implies higher imported inflation. So net-net the impact on competitiveness is not necessarily as dramatic as you think.