Panic in currency market; see more FII outflows: StanChart

Ananth Narayan of Standard Chartered Bank is worried that the panic-like situation in the currency markets for the last two days may impact the fundamentals of the economy in the short-term.

The rupee dropped to a record low in early trade on Monday tracking gains in the US dollar after disappointing data from China and slightly better-than-expected US jobs data. Traders are on watch of any intervention from the RBI. There has been little indication the Reserve Bank of India (RBI) has intervened to prevent rupee weakness in recent sessions, according to traders. The recent problem seems to be not so much withdrawal from the equity market, but from the bond market in India. Narayan says it is the focal point of this negative spiral. "The market senses that, just as it was in second half of 2011, we could be reaching a situation where it is easier for dollar to move and rupee to move down than the other way around," he told CNBC-TV18 in an interview.  The need is to control the asymmetric depreciation of the rupee, says Narayan. "We are seeing close to a billion dollars out of outflow in the debt (markets) from FII this month. There could be more on the anvil given the sharpness of the move and the turn in the negative sentiment," he warns. Also read: Worst behind us; not worried about rupee: Samir Arora Below is the verbatim transcript of his interview on CNBC-TV18 Q: It has been panic situation in the currency market for the last couple of sessions, what is your view on that? A: Yes, it has been panic for the last few days now and it is getting into a spiral of negativity. It is reaching a stage where people are reminiscing about the move in August 2011, and the move last year after the Budget when there was a secular steep fall. So, it has got into a big of negativity and unfortunately, it can reach levels where it can impact the fundamentals of the country in the medium-term as well. Q: The recent problem seems to be not so much withdrawal from the equity market, but from the bond market in India - are you worried that that is a trend which might get aggravated in days to come if the rupee continues to be this weak? A: It would be a focal point of this negative spiral. The fact is that at the moment the market gets the sense that just as it was in second half of 2011, we could be reaching a situation where it is easier for dollar to move and rupee to move down than the other way around. It does look like an asymmetric move at the moment. If the rupee was to strengthen, there is Reserve Bank of India (RBI) to mop up dollars and shore up reserves and authorities seem to be a lot more reticent when rupee starts to weaken. So, it is being seen asymmetric at the moment and that is clearly bad news for both fresh inflows into the country, especially the discretionary debt type, and of course for existing investments in the country as well. We are seeing close to a billion dollars out of outflow in the debt FII this month. There could be more on the anvil given the sharpness of the move and the turn in the negative sentiment. Q: Through Friday there were sharp cries for RBI intervention or some kind of support for the market. Anecdotally have you heard about that - are they getting worried about what is happening beyond this 57 level? Do they want to get it back to some kind of stable ground before attacking the issues around it? A: They should but it is a call that the RBI has to take and we have heard the Governor speak the last few days. The reality is that this particular move has less to do with the rest of the world, as it does with the sentiment in India itself. If you look at the fundamentals of the country they have not changed too much. Things are still looking okay. The fiscal situation has improved, inflation is coming off and the data this week should be good as well. Commodity prices have been behaving themselves. The monsoon seems to be on a good track. There is anecdotal Foreign Direct Investment (FDI) due this particular month as well. You have Hindustan Unilever (HUL) coming in Bharti Retail coming in. So it is not really as if the bottom has collapsed out of the fundamental story as such. This is clearly an issue of sentiment. It is an issue where people are going into that spiral of fear, where they expect that things could go from bad to worse and we could have 50-60 paise moves everyday. To break this sentiment you need some kind of decisive action to come through. I guess the best people to deliver it at the moment are the RBI and the ministry. Once that comes in and once some kind sanity returns to the market then we can go back into looking at the fundamentals. At the moment though if this continues for a few more days, you could have a situation where the fundamentals do get questioned and the debt-FII flows etc. start to get questioned in the medium-term. Fundamentals of the country have not changed too much. The fiscal situation has improved, inflation is coming off, commodity prices have been behaving themselves and the monsoon seems to be on track. _PAGEBREAK_ Q: What kind of moves would you be looking for? In the past they have tried things like tinkering with duties on gold etc. and even direct intervention with some tweaks in the forex market, but those moves do not help the currency beyond a day or two and usually the market goes back and retests those lows. What is a durable fix in your eyes? A: It has to be in stages. To start with we should stop talking about gold. The more we talk about gold, the more we probably drive investors to buying up more gold expecting something to happen tomorrow. Either we take action or we stop talking about gold. There has to be some round of intervention as well. The problem today is that a lot of us believe that the reserves will not be used in toto because the RBI is not happy about letting go of reserves. Letting go of reserves is a bad thing and it can be short-term and stopgap, but the reality is if you have that entire reserves not being used at all, that sends a very negative signal to the market. We have got to understand that the powers of the RBI and the authorities are near infinite. There is Foreign Exchange Management Act (FEMA) after all. If you remember in the 90s and the early 2000s every single item that we had to import had to go through the RBI. Nobody is suggesting that we have to go back there and the fundamentals are reasonably strong at the moment. However, worst comes to worst there are nuclear options available if we absolutely reach those panic situations. So there is enough reason for the regulators and the authorities to come in and bring in some sanity into the market. Seeing 5-7 percent moves in a month is not good. There is no point comparing ourselves with South African rand and other currencies. It is not that. This is about us and what is happening domestically. Bringing sentiment to an even keel is extremely important right now. Q: This happened in 2011 and then in 2012 as well. Why is it that when there is weakness in the region the rupee is an outlier, it is more vulnerable than any other currency? A: There is a sense of asymmetry right now and it is unfortunate. The problem also is the same kind of negatives that we had when rupee was 45, then at 50 and then at 55 can be repeated at 60 and 65 as well. The point is at what point do we say that the rupee has now reached a level where things ought to settle down and give it sometime? - Close to 30 percent move since August of 2011 is extremely sharp. I am not sure if the country can withhold that kind of one directional kind of move on an ongoing basis. It can have a scarring effect on investors and on all kind of investments in the country. Therefore, the starting point has to be kind of a recognition that we need to let the market settle down here. We have always heard that the regulators and authorities want to limit volatility in the markets. It is a good time for them to start now. By the way they will be helped by other inflows coming in. There are large ticket FDIs due this particular month and the month after, so that could help in that sentiment as well. In any case we have got to let the market settle down here and not go into a spiral. At the moment, the risk is though that the sentiment will be one of buying dollars on dips. Even if you have a correction by 20-30 paise, importers will rush into buy. Investors will think three times before they bring in the dollars and there is a negative spiral of sentiment right now. Q: In terms of relief what kind of levels do you expect the rupee to pullback to because of how sharp the fall has been? Are people reworking bands that they hope to see in the second half? A: Firstly, the asymmetry which exists right now, the feeling that the rupee can depreciate a lot faster than it appreciates - that that sentiment needs to be brought under control. Nobody is saying the rupee should not depreciate. Rupee has an inflation problem, we have an interest rate differential problem and we should depreciate over time, but not in an asymmetric fashion. Second, absolutely there is an emerging market crisis across various currencies. Reality is if you look at it in the last 4-5 years, the rupee has depreciated between 30-60 percent against most of the Asian peers, against the other emerging market currencies as well. Yes, we have some of it which is obviously justified because of inflation, because of our own peculiar growth problems etc. At the same time what we are saying is a certain level of sentiment modulation is required. On the part about FEMA that was an extreme point. All I am saying is that the actual steps that one can take between interventions, between moderation to the final nuclear option there are plenty of steps we can go through. Nobody is suggesting we go and use the FEMA arsenal right now. All we are saying is we got to be a lot more confident about modulating moves in the local currency. Going forward, in the short run the sentiment will dominate. The negativity will remain for a while. We will need something to break that spiral. One thing which could come as a matter of course is the FDI flow, which is due right now and maybe rupee finds its own level. At the moment, most technical analysts, most fundamental analysts are looking at any pullback in the rupee as an opportunity to buy. That is a sentiment prevailing right now. A kind of reflexivity can seep into the market which we have to be careful about.