See rupee at 59.50/$, Sebi move to hurt in long run: Nomura

Neeraj Gambhir, managing director and Co-head, Fixed Income India, Nomura India believes the measures taken by the Reserve Bank and Sebi will help the rupee recover in the short run. However,  in the long run, it will make currency trading illiquid while increasing the impact cost and volatility.

In an interview to CNBC-TV18, he says the currency can appreciate at around 59.50 levels and after that the market will revert back to looking at how fundamentally things are and what happens to dollar and rest of the emerging market (EM) currency space.

With regards to RBI's July policy, Gambhir does not see the central bank cutting rates. "The focus has shifted from worrying about growth to management of the currency and the macroeconomic stability. In such circumstances, it is highly unlikely that the central bank will be keen to do any kind of rate reduction," he adds.

Below is the verbatim transcript of Neeraj Gambhir's interview on CNBC-TV18

Q: What have you made of the moves that were announced by the Reserve Bank of India (RBI) and Securities and Exchange Board of India (Sebi) on Monday? Do you think they are going to move the needle significantly for the rupee?

A: Some of these administrative moves were expected given the kind of trading that was seen in the rupee and the kind of panicky action seen on the currency. It is along the lines that we have seen in the past which is to reduce the overall liquidity in the market and to try and reduce the size of the speculative positions that anyone can take. It is a pretty large action.

The total size of the position taking that can happen has been completely curtailed with this move. So I am not sure how liquid the Futures market will be as a result of this entire move and that is going to bring further illiquidity into the currency trading per se.

In the past, we have seen that these kind of actions where the regulators have brought illiquidity into the market and the impact cost became higher and higher. So, the bottom-line will help rupee for a while. In line with how dollar has been trading against other Asian currencies, we tend to appreciate a little bit. We can go down to 59.50/USD, but over a longer period of time this is not a very great move from a market liquidity standpoint. It reduces the liquidity and increases the impact cost. It effectively increases the volatility in the currency.

Q: Do you think this will end up causing distortions in the market that may work against the currency if there were some lumpy outflows from the Indian bond market from global investors?

A: The currency Futures market was getting quite liquid and large place for people to come to. Foreign investors were not permitted to participate in the currency Futures market. For a lot of domestic players, especially domestic corporates, this was a significant place to be hedging your risk. Once this market liquidity goes away, there will be a significant impact on these positions. People will have to come back to the Over-The-Counter (OTC) market and that again has lot of restrictions. So, we are regressing in terms of the overall openness of the market that we use to have earlier.

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Q: According to estimates, open interest (OI) in currency Futures should be around USD 5 billion right now and in the next two days it has to scale down to about USD 2 billion, is that accurate? How much impact can the market see if so much compressed movement happens within two trading sessions?

A: I have not done the numbers myself, but that seems like a fairly decent estimate of the size of the reduction of the market that needs to happen. At a trading member level, you could have about USD 700 million open position now which has to come down to USD 50 million, so it is a sharp contraction that needs to happen. The squaring off of the position in the Futures market will cause its own distortion in the Futures prices.

We are already seeing some kind of a deviation from where the Futures would have traded had this not been introduced. So it is going to have an impact, but it has to be done over the next two days and therefore, it will have a short-term impact on the market. But net-net, we need to then start looking at what happens to the market after this Futures market liquidity goes away and how people readjust their positions in the forward space once they are forced to take out their positions in the Futures market space.

We could appreciate at around 59.50 levels and after that we will revert back to looking at how fundamentally things are and what happens to dollar and rest of the emerging market (EM) currency space.

Q: Usually, there is a movement in the opposite direction, but it is just a matter of days before the asset class comes back below the level where it was trading till the measures took place. Do you expect that to happen with the rupee as well, a temporary move to 59.50 and then fundamentals driving it back to 61 again?

A: It is possible. We need to watch out two things. One, what happens to the US treasuries market and hence to the US dollar versus EM currencies, secondly, the impact of some of these measures on current account deficit (CAD), especially gold. There has been some talk about gold imports coming down and hence some kind of tightening or reduction in the CAD.

If we see a meaningful reduction in CAD and a sustainable trend there, then you could have a fundamental deviation in the path of the currency. As long as it stays in about 4 percent range, the pressure on the currency over a long period will continue. It will not be helpful that such measures will reduce the liquidity in the market and hence would increase the volatility. So it is quite likely that once the positions get readjusted, we come back and start trading to the levels that we have seen earlier.

Q: What is the outflow situation both in the bond market and in equities? Are outflows continuing from both markets?

A: The outflows have somewhat stabilised. A lot of people especially in the fixed income space have adjusted their positions. We have seen a sharp move in the bond market yields. Bond market yields have also reached a stage where they should stabilise now, especially if the US Treasury Yields stabilise at these levels. It is quite likely that we may see some people coming back and looking at attractiveness of the market. So I do not expect the flows per se to be a big driver of the market especially from the fixed income side from here on. The directionality will be more provided by the sentiment.
 
Q: Where has this huge plunge in the rupee left the RBI in terms of how it approaches the next policy? Is it now a very low probability that we get a rate cut either cash reserve ratio (CRR) or repo in July?

A: It is very unlikely that we get any monetary policy easing in the next policy. The focus has clearly shifted from worrying about growth to management of the currency and the macroeconomic stability. In such circumstances, it is highly unlikely that the central bank will be keen to do any kind of rate reduction.

The focus will be a lot more on driving the point around improvement in fundamentals. They will point towards the government to say that there needs to be a lot more structural reforms that can encourage growth and may bring in more sustainable long-term flows into the economy. Any rate reduction at this point in time is completely ruled out. We need to see how this whole QE related tapering and its impact on EMs plays out over a longer period before we can start revisiting any rate reduction thesis.

Q: If this measure from Sebi in terms of position limit tweaking does not help the rupee beyond the next couple of days, what does market expect from government in the next couple of days that can fundamentally change the course of the rupee a bit?

A: With regards to short-term measures, some more administrative measures around gold and trying to compress the gold demand further should be possible, as that is one variable that can be played in short-term. Also, if you look at the larger and bigger import items it is very hard to play with them. In terms of fundamental and structural reforms, further opening up of the foreign direct investment (FDI) announcements, it is highly unlikely that any of this will have a short-term impact, but from a longer term standpoint, from evidencing the commitment to reform standpoint, those announcements will be important.