Why Nomura Fin thinks talk about a weaker rupee makes no sense

“There will be reserve money creation through dollar buying because macro situation is such,” she said.

Capital goods have contracted for the last 9-10 months. And Varma doesn’t see any positive signs on the capex side.

"We might see pick-up on the public capex front. On the private capex, we aren’t optimistic.”Below is the transcript of Sonal Varma’s interview to Sonia Shenoy and Latha Venkatesh on CNBC-TV18.Sonia: Hopes are high that there will be a rate cut by the RBI very soon. A lot of rate sensitives are moving, but what is your own expectation?A: October obviously is a bit of a close call. But our baseline is that the cut will come in December, not really in October primarily because yes, headline inflation has come down to 5 percent and is expected to be below 5 percent in the next few months. But even if you look at the last inflation print that we got, it was all driven by two items, vegetables and pulses and vegetables is basically not something that we really have a good handle on. What we focus on therefore is where the underlying inflation has been and the core measure of inflation was again at 5 percent. We look at a trimmed measure of inflation which is also a metric of underlying inflation and that was also around 5.1 percent. So, broadly, while food prices and the volatile components of food prices are causing lower headlines, underlying inflation is still around 5 percent. So, per se, the inflation dynamics have not really changed much to warrant a cut in October.Latha: I wanted to ask you about all this controversy surrounding the rupee. We just had Mr Shaktikanta Das vehemently deny it, but this story is refusing to die away. We had earlier in the week, one of the newspapers also reporting that the commerce ministry is pressing hard for a lower value of the currency so that exporters are benefitted. The political noise that jobs need to be created and some of the labour intensive exporters are suffering because of this stability of the rupee. That story is refusing to go away. Do you think that something might still come in terms of a lot of dollar buying by the RBI post this Foreign Currency Non-Resident (FCNR) B issue? And if it is going to happen, how are you going to approach this issue?A: To be fair, the commerce ministry, clearly given where exporters are coming from would want weaker rupee. So, it is not really surprising. But ultimately, it lies in the domain in the RBI. And the story talked about a devaluation which honestly, INR is not a pegged currency for it to devalue. There can be buyers towards depreciation and if you actually look back at the last three years, the RBI has been very aggressively buying all the dollars that have come in. And they have been leaning against INR appreciation despite the country having a balance of payments surplus for the last three years. So, the RBI, even so far has actually been tilting in favour of a gradual depreciation and that might as well be the strategy, they continue going forward as well. But this entire talk about a devaluation clearly does not make any sense, because there are huge macroeconomic costs that are involved with this. We are talking about imported inflation. The fact is that exports are not so sensitive to currency. They are more sensitive to global demand which continues to be very weak. And one thing we should not forget is that over the last decade or so, a lot of the exports actually now use imported content. So, the import content of exports is picking up, so if the currency depreciates, you think that exports will be get benefitted, actually they end up not getting so benefitted because the imported cost for them also starts to pick up. And finally, the challenge for the RBI, every time you buy too much dollars, you are releasing INR liquidity in the system and whether that is going to be consistent with your broad monetary policy objectives, whether that conflicts with your monetary policy objective, the entire macro considerations have to be taken into account. And clearly, the benefits that are perceived may not be as much. If that was the easy way out, all countries would be depreciating their way out of the current slowdown. It has not worked.Latha: It is not that they will be able to engender much of a depreciation, but I was just wondering if you think the RBI will change its gears from buying bonds to buying dollars probably after December. Will that be a way of keeping the market hydrated and therefore, what will be the consequences?A: The reserve money expansion is always a function of the amount of balance of payments surplus that you have which will determine the amount of dollar buying that the Reserve Bank does. And the balance of the monetary expansion takes place through the open market government bond purchases. So, this particular year, post the FCNR, in fact the balance of payment dynamics are looking extremely favourable, partly for the wrong reasons. Reports have collapsed, because investment demand is not picking up. The June quarter, we think we will get a current account surplus which will be the first surplus in nine years. And for the full fiscal year, FY17, the current run rate on the current account deficit is between 0.2-0.4 percent of gross domestic product (GDP) vis-à-vis about 1 percent in FY16. So, despite the FCNR B redemptions, the capital flow picture and the current account picture actually point to a situation where there will be a significant balance of payment surplus. So, to your question, yes, there will be a lot more reserve money creation through dollar buying and that is partly because the macro situation is such that you are getting such a large balance of payments surplus and to the extent that still there is a deficit to be filled in over market bond purchases will happen.Sonia: From a stock market point of view, a lot of people look to this data, generally the Index of Industrial Production (IIP) data, etc. to know when the capital expenditure (Capex) cycle recovery is coming through. And if you look at this month’s data in capital goods has contracted for 9-10 months now. There is no pick up in Capex cycle, even in the private investment pickup is quite weak. Do you see any signs, any green shoots and how long do you think this slippage could continue?A: As of now, we do not see any signs of pick up on the Capex side. And industrial production numbers are very volatile and one of the big culprits has been this category called rubber and insulated cables, very small weight, but can cause swings in industrial production growth by 3-4 percentage points every month. But even if you exclude that, the broader set of indicators, even things like import of capital goods, have actually been slowing down for the last six months, we do track a lot of leading indicators for the economy and the visibility that we have till about the first quarter, till March, 2017, actually are suggesting that there will be some moderation in non-agricultural GDP growth, not a pick up. So, to your question, as of now, there is no sign of a pickup. If anything, the signals are pointing to slight moderation in the growth numbers in the next six months. Beyond that, the expectation for private Capex to pick up in this global environment, with this balance sheet issues and with the current capacity utilisation, obviously is not feasible for private Capex to pick up. So, the focus therefore, shifts on the public Capex side. Now, like you said, it has not picked up so far. What we are seeing though is that project awarding activity in specific sectors has picked up on the railways side for the dedicated freight corridors on the roads for instance. Typically, this awarding activity does tend to be a leading indicator of actual execution, but there can be big gestation lags between when a project is awarded vis-à-vis when it is actually executed. So, if awarding activity is picking up now, the perhaps sometime in 2017, we might see a pickup on the public Capex front. Private Capex front we are not very optimistic at this stage.