Further weakness in rupee is here to stay: HSBC

The steep fall seen in the Indian currency is not about its levels but its timing says Andre de Silva of HSBC. In an interview to CNBC-TV18, Silva adds that the weakness is likely to continue in the rupee until fundamental weakness in the economy is addressed.

Despite various measures taken by the Finance Ministry to rein in fiscal consolidation, it is the currency that matters the most. “It is very difficult to resolve a lot of these policy problems without allowing the currency to go and allow the medicine to work. It is painful but it should necessarily be a key mechanism,” adds Silva. Below is the edited transcript of Silva's interview to CNBC-TV18. Q: Rupee has fallen considerably, 6 percent this month and by 16 percent since mid-May when the tapering talk started, do you think negatives are priced in, how much more downsides do you see? A: Unfortunately, it is not a question of level. It is more about timing and policy and it is not just specifically the India rupee, if one looks further within Asia, the Indonesian Rupiah is under pressure. So, the pressure will remain, further weakness is here to stay until the policies begin to address some of the fundamental weakness. Then there’s also the Fed tapering on horizon. So, it is very difficult to come up with specific levels as it was two weeks ago, three weeks ago or a month ago. The pressure is still remaining. Q: What do you expect to hear from the Federal Open Market Committee’s (FOMC) minutes on Wednesday, will a slightly dovish language from the Fed indicating that tapering starts later maybe in October or November mollify the current rout in emerging markets? A: I don’t think there will be much data from the FOMC. We don’t know and most communiqué is done at particular meetings and in terms of announcements, rather than annual testimonies from Bernanke. So, in my edge towards the prospects of tapering, it is as soon as September but I don’t think the issue is whether it is September or October. We are getting global liquidity being removed by the major central banks in terms of the US and that is exporting some of the emerging markets (EMs) including India. Q: Isn’t that tapering discounted at all, in the morning we had an expert telling us that maybe some markets have more than factored that in, right now it is only the nitty-gritties like the start date and the quantum of reduction per month whether it is USD 10-15 billion, so isn’t that discounted already? A: Yes, it sounds very peculiar, we already know the timetable when it is going to end. We are still trying to second-guess when it is going to begin and we are second-guessing it is as soon as September. If one looks at the survey evidence, it suggested it will be in September. But this is not about tapering per se. It is about whether this eventually leads to removal of the accommodative policy and interest rate rises. That is when it becomes much more concerned. So, even if one gets confirmation, it is just conformational part towards the next strategy and that is the concern we have for the likes of emerging markets including India. Q: FIIs have invested quite a bit in India, but we haven't yet seen too much of foreign fund selling. They invested even when the Sensex was 20,000, the currency was 55/USD, now with 16 percent dollar denominated fall, is there an argument that at current levels maybe it is too unattractive to sell? A: The problem with valuations is that one can subscribe to most asset classes within India and that will see repricing that is more attractive. In terms of bond markets, Indian government bond yields at more than 9 percent in 10 years look attractive, but the problem is it is not about valuations, it is about sentiment, it is about policy biting and showing evidence that it is beginning to work. It is too early. In terms of capital flows, yes we have seen some easing of pressure, but in the context of what we have seen, we have seen USD 11.5 billion outflows in the bond markets since May, we have had around USD 3 billion in the equity markets and if we get further pressure on the equity side we can see further outflows. So unfortunately, it is a little bit of a vicious circle. Yes, there maybe an easing currently, but if we get further slippage in the equity market, we can see more net outflows. Q: What does the market want to hear from an Indian government in terms of policy change that can stem the rupee slide? A: If one looks at in isolation, some of the policy announcements have been fairly conducive towards addressing some of the deficit problems. This includes fiscal consolidation measures going all the way back to September last year or more recently measures regarding reducing away from imports, but I think what matters is the currency. It is very difficult to resolve a lot of these policy problems without allowing the currency to go and allow the medicine to work. It is painful but it should necessarily be a key mechanism. So, at the moment, we have got this stop-gap measure where there is some defense of the currency, I do not understand why, but it should be allowed to free-float and weaken to address in particular the underlying current account deficit (CAD) problem. Q: The surge in yields is because of the RBI's liquidity tightening, what is your take on these steps? A: If RBI is trying to defend the currency then maybe there is some element of timing and mismanagement in terms of direction. Let’s take a step back. A lot of people are saying that this rout in the bond markets in India or otherwise has been triggered by Fed tapering. That is not the case when one looks at India, because the dramatic move seen in G-Sec yields occurred when we had those tightening liquidity measures mid-July and that is clearly having a dramatic impact. If the measures of tightening liquidity are just trying to stem the currency weakness, then maybe that is a little bit mistimed and it needs to allow the currency to free-float a little bit more, to allow the mechanism to work better in terms of policy response. In terms of the outlook of the bond market, it seems at the current juncture second-guessing policy tight liquidity is here to stay, but I would not rule out further tightening measures. So, it is still fairly negative for the bond market despite the significant back-up in bond yields and valuations.