Rupee fall has no full stop; may see 65/$ in FY14: CLSA

The choice of WPI in calculating inflation creates an anomaly in determining the real effective exchange rate (REER), points out a day-old CLSA note.  At 9.3% YoY in May, India's CPI inflation was nearly double WPI inflation of 4.7%. Since the Reserve Bank will consider WPI inflation, there is a scope for an easy monetary policy, Rajiv Malik of CLSA told CNBC-TV18.

Also read: Rupee opens strong at 59.32/dollar on Bernanke's comments The report also mentions that RBI is not wedded to managing the rupee on the basis of REER. It has a hands-off approach, which means that global liquidity headwinds will cause INR to weaken. Speaking on the subject of rupee depreciation, Malik said the the currency can fall to 65/$ by the end of FY14 and even then it cannot be called a bottom. He expects the currency depreciation factor to dominate Reserve Bank of India's policy moves. Below is the edited transcript of Malik’s interview to CNBC-TV18. Q: What have you made on the recent moves on the currency and whether you think it is enough to stem the kind of losses we have seen so far? A: What one will see is really given what has happened overnight in terms of the Federal Open Market Committee (FOMC) minutes and Bernanke's clarification is a bit of a break in the clouds. Enjoy the ride, because it will not last long. Just do not go to sleep. I think the rupee will get a bit of a respite. We may possibly move up to 58 against the dollar sometime this quarter, but there is no change in my underlying theme that this currency has much more to weaken. We certainly do see it going to 65 by the end of 2014 and that would not necessarily be the end of the story. The fundamental story on the rupee remains underappreciated that this is a currency which partly because of rebalancing of global liquidity cycle is going to go back to the pre-2002 pattern of annual depreciation. Q: Are you sure that global liquidity is tightening and that trend will be in place for the next couple of years? A: Part of the reason there is a break in the clouds is simply in terms of the kind of concerns the markets had. Whatever Bernanke has indicated overnight does not change our assessment that September is still going to be the most likely meeting when the process of tapering begins. It is important not to confuse tapering with tightening. It is going to be a gradual pace of unwinding and similar to what we have seen in recent weeks. After every week, there will be an assessment in terms of what is happening to the real economic data, how markets are reacting and whether or not the Fed needs to fine-tuned. So, this volatility is something we will have to get used to, but directionally, over the next one-two years, it is pretty clear which way the US dollar, US yields and broader global liquidity is going to go. Q: What about the internals? The optimists believe that starting May, the Indian Current Account Deficit (CAD) problem will begin to self-correct and that will give some respite to the rupee. On that you are not convinced? A: Respite for the rupee does not necessarily mean it begins to appreciate. Currencies do not fall out of bed 10 percent every two months. One can see a bit of respite. But once again there is far too much fixation on just the current account dynamics in India which was perhaps the key reason to the commodities’ correction in April. I think while the CAD will narrow the bigger issue is going to be that our non-FDI (Foreign Direct Investment) related financing requirement will still be significantly large in an environment when broader global liquidity conditions are going to be far less helpful than what they have been. One must not forget that India's inflation differential too has not disappeared. Q: There is also the other problem that has cropped up which is with regards to the Food Security Bill and in order to finance something of that size the fear is that planned expenditure will actually start coming down going into the next year. Are you getting worried that we are probably getting into a deeper mess with regards to some of these macros rather than seeing some improvement which was the hope for FY14-15? A: The irony with the Food Security Bill is twofold. The government is actually landing up exercising an emergency option such as an ordinance for getting the Food Security Bill off the ground, when there are 101 economic issues one could think of where a similar emergency like action could easily be warranted. Secondly, the hit from Food Security Bill really does not come through from next year onwards in full measure and more importantly, it is the medium-term fiscal dynamics that it actually has a far greater impact on. So, over and above that, it is perhaps the wrong approach to solve the problem they are trying to solve. The medium-term fiscal problems or challenges that it will create continue to be underappreciated. Q: How does this all tie-in with monetary policy where the growing opinion is that for most emerging markets (EM) including us, we are probably getting into a phase where rates will have to start moving up rather than staying static or moving down? A: There are two important things to bear in mind. Firstly, RBI's own currency approach. Unlike many other Asian economies, RBI has more of a hands-off approach. This means that it is willing to live with greater rupee movement than necessarily stem the pressure by jacking up interest rates. _PAGEBREAK_ Since end of 2007, rupee has depreciated by about 35 percent and during this period, RBI did not launch a defense of the currency by jacking up interest rates. So, I think that important difference should not be ignored, for example, a place like Indonesia which has used increase in interest rates to defend the currency. What this means for India's is that the pre-rupee move, the bond market was feeling that Diwali arrived early and one is going to see a series of rate cuts but that should be just completely thrown out of the window. I would be happy if we managed to get just one rate cut and I do not necessarily rule it out as long as the rupee stabilises. Over the last year and a half or so, the RBI has cut interest rates despite the fact that the rupee has weakened. Ultimately, it is going to be a play really with financial stability and rupee stability which will be the key factor. Numbers from inflation and IIP will still suggest there is scope for easing, but I think it is going to be really the pushback coming in from the currency market and the global dynamics. Q: Just looking ahead a few months not just a few weeks how strong is the possibility or probability in your eyes that in 2014 inflation stages some kind of a comeback, something that many people probably are not discounting today given that we have got used to gradually falling inflation over the last many months? A: That is certainly part of our central case and it is nothing new. The reason why we did not think a series of rate cuts was likely in India is because by the time one gets into next year, atleast India's growth would be improving, globally the broader commodity combination along with weaker currency will all be adding to pressure points. For an economy where there has actually not been much capacity addition, even an incremental improvement in demand has the potential to upset the inflation calculations. Q: We will also be getting Index of Industrial Production (IIP) numbers. Anything that you are seeing in the ground over the last few weeks which is suggesting a pick up in the economy or you still remain quite circumspect about growth for the next couple of quarters? A: There is as much momentum in the Indian economy as in a garden snail. So yes, we are trading the bottom, but any kind of meaningful pick up is really going to be back-ended this year and more relevant after the elections only. Not that elections have historically had a big impact in terms of economic cycles, but I think this time around it is somewhat of a unique combination just given the kind of a policy response environment and how the private sector is feeling generally. Q: There are some anecdotal notes about how credit off take to sectors within infrastructure has picked up and that is balancing out this Non-Banking Financial Companies (NBFC) problem. Do you think that is a function of the economy recovering or a gentle push and shove from the Finance Ministry? A: I think it could be a combination. But the main question really is, is it signalling a relevant convincing turnaround and if it is, one should be questioning how come most of the order books from lot of the companies have not necessarily shown. If one looks at Purchasing Managers' Index (PMI) data which is a fairly reliable set of sequential data, that is actually been worsening. So, if all this credit off take is taking place that is actually very good, but in terms of its overall impact it is not necessarily moving the needle all that much yet. Q: Debate is raging in global markets on how EM asset classes will do in a context of tightening liquidity through the next couple of years. How do you think that whole trade will pan out? A: Volatility is going to be a friend or foe depending on how one takes it. As we come out of some of these unconventional policy responses, it is literally flying in the dark. Broadly speaking EMs still have to digest this rebalancing as far as global liquidity is concerned and once that is out of the way, then one gets a much clearer positive session as far as EMs growth and lot of other parameters come into play. Until that time, and that is not going to be different from prior liquidity reversal cycles, there will be a bit of a payback after having enjoyed the ride for quite a few years.