Expect rupee to hit 70 by mid to end 2017: Indranil Sengupta, BofA-ML

In an exclusive chat with ET Now's Consulting Editor Mythili Bhusnurmath, Indranil Sengupta, Economist & Co-Head of India Research, BofA-ML, says looking at the dollar hitting 102 a euro and the rupee hitting 70 by the mid to end of this year.

Edited excerpts...

It is a countdown to the monetary policy decision. This time around, can one really believe that beside fiscal policy support that came in during the budget, you will have the RBI extending out monetary policy support also, especially at a time when there is a lot of uncertainty with regards to rates globally?

Mythili Bhusnurmath: Not only is opinion divided, you could actually argue both ways because if the fiscal stimulus is as minimal as it appears to be from the budget, then it seems to suggest the economy is doing quite well and the government does not really believe there is need for a stimulus in which case it might make sense for the RBI to hold its hands and wait to see what the Fed does in March and then react. But on the other hand, you could argue that the fiscal stimulus may not be sufficient and this is an opportunity for the RBI to lend its support. Mind you. it is no longer the RBI, it is the members od MPC who have shown themselves to be fairly conservative going by the past track record . Of course, it is a pretty short track record but they have been fairly conservative and one could argue both ways but the bigger question really is will that interest cut really make a difference because banks have already cut their rates by much more than the RBI has cut its own repo rate.

As of now, the jury is out. My personal view frankly is that the RBI does not do anything by waiting because the impact of demonetisation which really is the biggest medium term impact that we are going to see domestically, has not yet played out. So there is no urgency really in the RBI cutting interest rates because all over the world if you look at the numbers both in the US as well as the EU and also Japan, inflation is edging up.


At a time like this, monetary policy acts as a much greater lag than fiscal policy. So I would tell the Monetary Policy Committee that there might be a case to buy out your time for now and then react because after all there is no urgency as such. But I do not know whether Indranil shares this view. Indranil, am I being excessively conservative or would you think this is a time to really grab the bull by the horns and cut rates?

Indranil Sengupta: We are certainly looking for a rate cut on Wednesday. My simple question is if not now, when? Demonetisation has clearly hurt growth. We cut GDP growth to 6.9%, the Eco Survey is talking of 6.75 to 6.5%. That means almost a 100 bps lower than where it was forecast a year ago. If you look at the old GDP series then we estimate growth at 4% to 4.5%. Second. inflation is likely to hover around 4% at least till June and the Southern Oscillation Index it is pointing to a La Nina condition this year. Inflation is going up in the rest of the world but here inflation is driven by rains and not by demand. By demand. I mean who can argue that there is no excess capacity? Three, if you look at the budget, the fiscal deficit has actually come down to 3.25% from 3.5% which means that in effect the budget is contractionary because it has brought down the fiscal deficit. So unless monetary policy picks up the slack, then you end up with the contractionary effect on the economy. And this at a time when the global recession is over 8 years old.

Finally, if you see a relatively dovish FOMC has steadied the dollar, in any case our view is that if you cut rates you attract FPI equity flows and that supports the dollar. By not cutting rates last time, all we achieved is outflow. It is only when the Fed turned that you saw a bit of inflows. So it is not correct to think that if the RBI keeps rates high that supports the rupee. The converse is actually true. Any which way you look at it, the safest thing to do is for the RBI to cut now and when you talk of banks cutting lending rates -- they have cut MCLR -- what you need is a cut in the average lending rate. So with liquidity, with rate cuts hopefully the banks in April to September, will start to cut their average lending rates. It will take another six months for that to show up in recovery. So if the RBI cuts now, the effect on growth will be felt almost nine months from now.

Mythili Bhusnurmath: Two questions based on what you have said; a) do you not think that the markets --and I am not just talking about the bank I am also talking about bond yields, -- have actually pre-empted the RBI and rates are way below what they would have been regardless of whether RBI cuts or not. That is number one. Number two is , since when have interest rates been the main factor in determining investment? Today we have a situation of excess capacity. So even if interest rates are cut, it is not going to really make a difference,. We are not going see corporates invest. So what purpose does this serve? On the contrary, your debt flows might accentuate and outward debt flows might increase. Is that really a case or do we lose anything really by waiting till April and then cutting rates?

Indranil Sengupta: Number one, bond markets have pre-empted the RBI hoping the RBI will cut which also means that if the RBI does not cut then bond markets will sell off. If bond markets sell off, why will FIIs come and buy G-secs to make further losses? So the point is that everyone- has been expecting rate cuts by the RBI, that is number one. Number two, nowhere in the world can you have investment in a recession, first lending rates have to come down, then there will be demand, after demand there will be exhaustion of existing capacity and then only will investment come. To say that you know rate cuts will not bring investment therefore let us not cut rates means that you will never be able to exhaust capacity and year after year we will go on thinking investment will come and it would not. It is very important to understand that talking of investment without rate cuts is like putting the cart before the horse. First you have to have lending rate cuts, let demand revive, capacity will get exhausted and then capex will happen.

Mythili Bhusnurmath: I thought the government is going to ensure demand revival through OROP as well as the pay commission recommendations but you clearly seem to think that interest rate cuts are very important for that. Another question that I wanted to ask you really is that whether the RBI would cut rates in just a matter of less than 48 hours maybe but what are you expecting to see as far as growth projections are concerned, will the RBI tow the economic survey quote, unquote, “government line” of 6.5-6.75 in that range or will it kind of not given any voice or say anything at all, not given any comment at all or will it give a very different projection because after all the entire budget projections are based on the economic survey’s estimates and we really do not know what GDP is going to be either for this fiscal or the next fiscal?

Indranil Sengupta: Well you know the official forecaster for growth is the CSO, just as RBI is the forecaster for inflation. So I mean, I would expect that the RBI will at least put a risk around its 7%, I think growth forecast. I think the issue is not whether you cut growth further, the issue is that you know because of demonetisation we have seen the turn in consumption that we expected from the pay commission OROP etc stubbed out or at least postponed and GDP growth forecasts have come down over 70-100 bps at the least, for this year. And then again you look at next year. So whether you cut further or not further, you are almost 60-100 bps down from where we began around this year. And there was talk of 8% growth, now the talk is down to 7% growth.

Mythili Bhusnurmath: Another point which I wanted to ask you in the context of monetary policy. There is lot of discussion and debate and speculation on whether the monetary policy committee is really targeting the midpoint of 4% or is it looking at this fiscal’s target of 5%. What should be the monetary policy committee really look at? Should they keep that 4% as sacrosanct or should they look it as 5% which is what you have in the short term for this fiscal?

Indranil Sengupta: My understanding is that you look at 5% for this fiscal and there after you look at 2% to 6% band that is 4 plus/minus 2 which is now part of the statute and that is what I found the budget also talking of.

Mythili Bhusnurmath: If I can move back to the budget, a number in the budget documents a projections that they have given which is seemed to be a little bit on the high side and a little difficult to really take entirely at face value was the investment target of 72,500 and we just had a report on ET Now saying that the government is very hopeful of achieving that target this year purely because you are going to resort to CPSE ETFs. Now the problem with CPSE ETFs is that even though they might raise money, the fundamental purpose of any kind of disinvestment which is to bring in better management into these public sector undertakings will not be achieved. B) They are also thinking of including public sector banks in this. Your views on both, how wise is it to take the CPSE ETF route, number one and how wise it is to bring NPAs into this or is it better to care take PSBs separately, public sector banks separately, and there reduce government stake ideally to less than 50%?

Indranil Sengupta: I think the latter is political decision which we have to wait and see. I have nothing against ETFs if that is the way of raising money so be it. I think that yes the divestment targets are steep. Maybe the allocation for oil subsidies is not sufficient and so on but in the net one must also remember that the government is going to get a dividend from the RBI although we would have preferred lower OMO and maybe the VDI scheme will net a bit more than what the government has budgeted. So I think that will help to reconcile numbers as we head into this year.

Mythili Bhusnurmath: What is your view on the future projection of the dollar? Do you expect the dollar to weaken or to strengthen because remember Trump was initially very much in favour of a strong dollar and he wanted to have a strong fiscal stimulus which normally would have resulted in a stronger dollar, but we are seeing the dollar weaken a little bit, so what is your prognosis for the dollar going forward because that has important bearing for us?

Indranil Sengupta: We are looking at the dollar hitting 102 a euro and the rupee hitting 70 by the mid to end of this year. Right now, of course, the rupee has seasonal support. Of course, the dollar rally has stalled for now but we think that as the year progresses it goes to 102 a euro.

Mythili Bhusnurmath: So despite the fact that you think the rupee is going to hit 70 to a dollar, oil prices are going up, you still think there is a case for a monetary stimulus because normally both these factors would have resulted in pushing up inflation because we are heavily dependent on oil imports and a weaker rupee does push up our oil bill. So despite this, should the RBI really cut interest rates?

Indranil Sengupta: Two things here, number one is that if the dollar strengthens, the impact on the rupee is that on the cross currency basis so that is number one. The second is that what this will do is make capital flows especially equity flows that much scares for the emerging world for now. So the country which cut rates to support growth will be the country which will attract flows. So given that our FX reserves are already under pressure, there is every need to cut rates, revive growth, attract flows because at the end of the day India is a story of growth, it is a growth story not one of interest rate differentials. We are not into the business of attracting bond market flows.