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Re may cross 55; RBI can't do much unless govt acts: CLSA

As the rupee slide continues, Rajeev Malik of CLSA feels that it is pure risk-off dollar strength that is playing out.

Excerpts from Bazaar on CNBC-TV18 Watch the full show » ALSO READ See what other FIIs are saying about the markets See what other experts are saying about markets See what Udayan Mukherjee is saying about the markets

As the rupee slide continues, Rajeev Malik of CLSA feels that it is pure risk-off dollar strength that is playing out. The global risk off angle may force the rupee to see further downside despite RBI measures coming through, he said.

He however believes the rupee problem is not the underlying problem. "We haven’t seen any meaningful corrective action from the government to address any of this. I think it is equally important to think about India and its imbalances away from just a typical growth inflation kind of a trade off," he said.

He goes on to say that the RBI will not have much room to ease unless the government can actually deliver meaningfully on the fiscal front.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.

Q: Everyone has been watching the rupee more than anything else this week. Would you say we are getting the same bark that other Asian currencies are or do you think there is something different in the way people are approaching the Indian rupee?

A: We are pretty much getting the same shafting that other Asian currencies are getting. This means it’s, to a large extent, a pure global risk off dollar strength playing out. Don’t forget currencies are relative priced. So if the dollar will strengthen everything relative to the dollar has to adjust. The best indication of that is to track the Singapore dollar. This is one of the best managed currencies in the region of a country that runs roughly 16% of GDP current account surplus.

It is a huge financial centre and faces none of the problems that India has for example. Despite that, the Singapore dollar has actually depreciated about 3% this month alone. So it is nothing compared to what the Indian rupee has gone through. I think much of the move on the rupee earlier on was fundamental. In the sense, the rupee had to correct whether it was inflation differential or lack of policy coherence etc. Much of that is over but we still have to play out the global risk off angle, which is why further downside can't be ruled out despite RBI measures coming through.

Q: When you put that report out on 55 to the dollar, you were suggesting it would be the year end target. It happened in two months, what are the chances of an overshoot from here?

A: Absolutely, currency is a moving game; it’s a momentum build up. A little did we know that the government rather than taking any constructive action will actually be scoring self goals. The 55 target was a hugely non consensus call. Despite that, we are almost within kissing distance of that. So you will see a certain response coming through. But a lot of the responses that RBI has will be timed buying tactics.

Weaker rupee or the pressure on the rupee is not really the underlying problem; it is just a symptom of the underlying problem. We haven’t seen any meaningful corrective action from the government to address any of this. I think it is equally important to think about India and its imbalances away from just a typical growth inflation kind of a trade off.

I don’t think RBI will have much room to ease unless the government can actually deliver meaningfully on the fiscal front. I think people are just looking at certain individual items and trying to draw conclusions, they are missing the wood for the trees.

Q: What is your view on crude, which has come off to a USD 107 per barrel this morning. Do you think that can fix our macro issues or do you think there are other parts of the piece which still make you cautious about Indian macro respite one key parameter moving in our favor?

A: It is an important adjustment, which can be favorable to us both in terms of the current account deficit and from an inflation metric. What people overlook is what's driving that crude correction is very important. If it is risk off then we will still suffer as far as capital flows are concerned. So it is not a coincidence that the kind of correction you have seen in crude despite that rupee is actually weaker whereas everyone only focuses on just the current account side.

You have to look at what it means for capital flows as well. There is a reason why I label India as a global risk on-off fire ball. If tomorrow all of a sudden risk is on, I don’t think anybody would be worried about the rupee or about any of the other problems but that will just give us a bit of time. But is the government going to fix anything during that time? We haven’t seen much so far.

Q: You have been talking about the threat of inflation rearing its head again. But people are split over the last inflation tick we got in the sense that it didn’t really hit core, it was food inflation. What is your sense of where that part of the puzzle could be headed over the course of the next few months?

A: A lot of it is going to be a function of two different dynamics. One is in terms of what's happening to commodities, which will clearly offer a positive tone as far as inflation is concerned. Some of it will get compromised by a weaker rupee but demand is also softening. The other part is really how the headline is going to behave and we come back to food inflation.

Don’t forget households don’t necessarily dig into core inflation. The core is at 4.95%. If you try and tell somebody that that’s really what you should be looking at, you would be just requested to leave the room kind of thing. You look at one year forward, consumer household expectations, they are sitting at 12.5%.

So there is a lot more adjustment that needs to happen. I think a very rough metric one can use is look if your headline WPI (Wholesale Price Index) inflation will be anything between 7-8% for the next several months and your repo rate is already at 8%. I don’t think RBI has much room to cut it from that level.

All the ones who are arguing about weaker growth etc, will soon start focusing about that issues like interest rates have been cut, deposits are not growing up, we will come back to a broader another offshoot of a liquidity problem. So piece meal measures are not going to work.

Q: Where does that leave the RBI because one thought when one looked at the global situation that perhaps they could move more easily on rates? You think they can or it’s going to be a tough call for the next 6 months and how much they can ease?

A: I think what's happening on the balance of payment side just makes it a lot more difficult. Don’t forget if the rupee was sitting at 50-52 the arguments could be very different which is where we come back that we are essentially going through a structural adjustment that is needed and this is the orthodox approach. Below trend growth, try and compress aggregate demand, keep monetary policy tight. Will there be costs and consequences? Absolutely but when the government is not doing anything on the fiscal front, the monetary still has to continue keep on adjusting it and when I say something on the fiscal front I don’t mean just a token nominal move as far as petrol prices are concerned.

Q: So what are your observations on how the RBI has approached the rupee’s depreciation so far? We have hit new lows over the last 3 sessions, the RBI has come in periodically, intervened and then stepped back and not quite pulled the rupee back from the brink of a new low. Do you think it is doing the right thing?

A: I think it is doing the right thing. The last thing I would want to see is RBI draw a line in the sand at any particular level and keep on wasting its reserves because we don’t know how the global situation will develop. When those reserves keep falling even though India has a fairly comfortable starting point from here on that will actually spook or make people a lot more nervous.

Whatever RBI has up its sleeve; whether it is trying to open up a special window for oil companies for dollars etc, these are all messing around with the broader market mechanism. They are not fixing the underlying problem which is where we come back. The solution for lot of what is going on is really with New Delhi. RBI’s approach, measures can buy some time but since August of last year when the rupee really started to turn in a big way, what meaningful action have we seen from the government really.

India’s rupee fell to a record low as investors sought the perceived safety of the dollar over emerging-market assets on concern Europe’s debt crisis is worsening.

The local currency headed for the biggest weekly drop in almost six months after Greece’s credit rating was cut by Fitch Ratings yesterday amid concern the country will leave the euro. The Dollar Index, which tracks the currency against those of six major trading partners, rose 1.7 percent this week, the biggest advance since December, as Moody’s Investors Service downgraded 16 Spanish banks and 26 Italian lenders. Funds based abroad cut holdings of Indian shares by $114 million over May 15 and May 16, exchange data show.

“Strong market forces in favor of the dollar have created panic,” said J. Moses Harding, executive vice president at IndusInd Bank Ltd. (IIB) in Mumbai. “The Reserve Bank of India does not have enough ammunition to fight against the tsunami-like ferocious headwinds the rupee is facing.”

The rupee declined 2 percent this week to 54.7500 per dollar as of 9:28 a.m. in Mumbai, the biggest drop since the five days to Nov. 18, according to data compiled by Bloomberg. It slid 0.5 percent today and touched an all-time low of 54.7650 earlier. The currency has slumped 7.1 percent this quarter in Asia’s worst performance.

The rupee’s one-month implied volatility, a measure of exchange-rate swings used to price options, rose 92 basis points, or 0.92 percentage point, to this year’s high of 13.27 percent.

RBI May Act

The Reserve Bank is closely monitoring the rupee’s movement and will act if needed, Deputy Governor H.R. Khan told reporters at Pokhara in Nepal on May 16, without elaborating. The monetary authority is considering selling dollars directly to oil importers to ease demand for the greenback, a central bank official said, asking not to be identified, citing policy.

The RBI may offer dollars to oil companies at its daily reference rate for the local currency, B. Mukherjee, director of finance at Hindustan Petroleum Corp., India’s third-largest state-run oil refiner, said yesterday.

The central bank cut last week the amount of overseas income companies can hold in foreign currency to 50 percent from 100 percent, forcing them to convert earnings. On May 4, policy makers raised interest rates on non-rupee deposits by as much as 300 basis points and freed up borrowing costs on foreign- exchange loans to exporters.

‘Out of Bound’

“The pace and trajectory of the depreciation has resulted in the perception of a currency out of bound and beyond control,” Arvind Chari, senior fund manager in Mumbai at Quantum Mutual, wrote in a research report yesterday. “This we believe is not the case and the RBI can turn around the situation by initiating a few more policy steps.”

Six-month onshore currency forwards traded at 56.36 a dollar, compared with 56.21 yesterday, and offshore non- deliverable contracts were at 56.71 from 56.43. Forwards are agreements to buy or sell assets at a set price and date. Non- deliverable contracts are settled in dollars.

To contact the reporter on this story: Jeanette Rodrigues in Mumbai at jrodrigues26@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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Maha plans exit option for SEZs, use land for local parks

Maharashtra is in the process of preparing an exit policy for SEZ developers and then convert the surrendered land-banks into local industrial parks.

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Maharashtra is in the process of preparing an exit policy for SEZ developers and then convert the surrendered land-banks into local industrial parks, as the Centre is unlikely to rollback its decision to tax such clusters, chief minister Prithviraj Chavan said.

"I had a discussion with the Union finance and commerce ministers, and I am not very hopeful whether they will go back to a tax-free regime for SEZs as was promised initially," Chavan said told Ficci meet.

Chavan said promoters of special economic zones (SEZs), particularly those in the manufacturing sector, are increasingly shying away from going ahead with plans due to tax burdens they foresee due to certain provisions in the proposed Direct Tax Code (DTC) and the move to bring SEZs under the dividend distribution tax and minimum alternate tax.

The SEZs, inspired by the Chinese experience to promote exports and enjoying a slew of tax immunities, suffered a jolt last year when the Centre decided to bring them under the purview of DDT and MAT. Certain conditions in the DTC, which will be in force from next fiscal, are also making the SEZ promoters uncomfortable, Chavan said.

Maharashtra has so far acquired 27,000 hectares for SEZs and is increasingly coming across cases where promoters are turning away from developing the land.

In the face of this, the chief minister said, his government is contemplating a policy to turn this land into local industrial parks and join the league of specially notified Maharashtra Industrial Development Corporation (MIDC) parks.

The exit option given to promoters will free up a lot of land for investments, especially around Mumbai and Pune where there is otherwise an acute shortage of land, the chief minister said. "Those who want to continue, let them continue; those who want to opt out, the land which is procured for SEZs will have to become local industrial parks, just like MIDCs," he said, adding the forthcoming new industrial policy will address this issue.

Conceding that MIDC townships--built in the latter part of the last century--are not planned well and lack being modern townships, Chavan said the same policy will also have provisions under which land will be acquired in contiguity and used for social purposes.

To transform MIDCs into modern industrial townships, the newly acquired land will be used for housing, schools, colleges, medical facilities, recreational facilities, something which they are lacking at present, he said.