RBI may cut rate in Jun; see rupee 64-65/$ by Dec: Deutsche

Baig expects the rupee to settle between 64-65 to the dollar by December. He says the Fed will hike rates by December if not September, and that will make it difficult for emerging market currencies to rally against the dollar. A bigger factor deciding the trend in the rupee will be the current account deficit and crude oil prices, he says.

Below is the edited transcript of Taimur Baig's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: First up the consumer price index (CPI) numbers. Are the March and the April numbers running below the Reserve Bank of India’s (RBI) trajectory and below your trajectory, what should we expect from the bank therefore?

A: Roughly in line with trajectory, which would still keep RBI in place for a rate cut, I don’t think there is anything on the real economy side that is comforting the RBI or anything in the inflation side that is alarming the Central Bank.

So, we are in this juxtaposition of weak real economic data and fairly benign inflation and my rhetorical question is if not in June then when?

These are waning windows for emerging market economies to entertain easing monetary policy before the inevitable rate normalization comes in the US -- the last week’s market action itself is an ample warning that how volatile things can get in the second half of this year.

So yes, given that the window is narrowing given that inflation is benign and the real economy is struggling, RBI will cut.

Latha: How many rate cuts more even if June comes, are we done, the RBI’s math has been 5.8 percent inflation plus about 1.75 real return, that would give you 7.25 so is there space for more?

A: I think there is room for two rate cuts, 25 bps each but as you know very well, RBI’s frustration has not just been the magnitude of rate cuts that has taken place and will take place going forward, but alos the amount of transmission we see.

As per the Central Bank, it is struggling that what kind of enabling environment does it need to prepare so that the banks feel emboldened to pass on these 25-50 bps in rate hikes to the consumers, to the corporate borrowers.

So there are two issues here, one is how much more rate cut you want to do with real interest rate target in mind and an inflation target in mind and at the same time would that additional cut transmit to the bank system.

Therein lies the biggest question -- I think the answer is that only a fraction of what the RBI does is getting transmitted.

If you do 50, about 10-15 bps get transmitted then another 50 gets another 25-30 bps -- not a whole lot for the world economy. That is where the struggle of a Central Bank is right now.

Latha: So you think they will use the liquidity weapon at all, do more open market operations (OMOs) or cut cash reserve ratio (CRR)?

A: The CRR part is certainly on the agenda. I don’t think that structurally this Central Bank is particularly a big believer that the CRR acts as any prudential role in the economy and if there is going to be some prudential ratios, the statutory liquidity ratio (SLR) is always there.

So, the more CRR cut just from a structural point of views on the agenda and indeed if this issue of imperfect transmission is a problem the RBI might have to do that.

There is a gap between what the Central Bank thinks and what the banks think on this issue. Banks are perennially arguing that a lower CRR will put up cash and therefore there will be more stress.

I am not sure there is that much sympathy on this issue from the Central Bank side because they look at the overnight rate and they don’t see any stress there.

So their point would be if there was stress, we would see that manifest in the overnight market, if there isn’t, why they are not cutting.

Latha: The index of industrial production (IIP) is not the best of indicators, we had very good April sales data from some of the two-wheelers where the rural stress is high but even some of the two-wheelers like Bajaj reported good numbers and some of the four-wheelers definitely Maruti reported good numbers, where do you stand on growth, what numbers for FY16?

A: I am a big sceptic about the gross domestic product (GDP) data so we are forecasting 7.5 percent for the fiscal year that will end in 2016.

But if we look at the old GDP data which was about 5.5, I don’t think we have mutually changed our perspective as per the trajectory of the economy is concerned.

Meaning whatever was the case last year about 50 bps upside, not a whole lot more so very shallow cyclical recovery if you will.

Latha: The RBI’s ultimate goal is 4 percent by January 2018, they have not given an intermediate goal of January 2017 being 5 percent but nevertheless therefore what is the 18 month view of the RBI’s rate cut trajectory?

A: There is a lot of uncertainty and complications about the inflation forecasting horizon and there is so much uncertainty about where the output gap stands now.

I have great deal of sympathy for the Central Bank that whether it is the instruments available or the analytical tools available, they have to go month-to-month, it is very hard to be very confident about what is 18 months outcome from where we stand right now.

Latha: What is the in-house view in Deutsche Bank or even your own view, do you think the rise in yields that we have been seeing from April 20 whether it is German Bunds or whether it is US treasuries, is over for now or are we at the at least end of that volatility?

A: I don’t think we can call at the end of the volatility. What is happening in the market is it had overshot on the long side and then it is making some correction but it is revealing some aspects of the market in terms of liquidity, in terms of positioning, which is a bit troublesome which also means that going forward we should expect great deal of volatility as well.

All we are seeing right now is a correction from its overshot position to somewhat neutral and that itself is coming out with exceptional degree of volatility not just in the bond market, look at global equity markets, they have also been exceptionally volatile.

So, the second half of the year, regardless of whether the Fed normalises in September or December, volatility is here to stay with us.

Latha: What do you expect the rupee would do, we have seen this volatility itself give us about a percent in terms of depreciation, do we get to 65/USD by the year-end when I would assume one rate hike would have come?

A: I think that if we believe our base case which is a chance of a September hike by the Fed and perhaps if that gets delayed for whatever reason definitely in 2015 by December under that circumstances, it is very hard for EM Fx to rally against the dollar and the rupee which has bucked the trend rather strikingly in the last year or so would also capitulate to some extent because it is not just a question that dollar rally which itself didn’t seem to be hurting the rupee that much, it is the issue of what is happening with the current account, what is happening with oil and import bill and so on.

So I think that the rupee has moved away from its exceptionally comfortable zone to perhaps a little more even-handed risk, so 64-65/USD is certainly on the cards.