Pranjul Bhandari, Chief India Economist, HSBC Securities
It seems inevitable that we are going to see a rate hike. More than the quantum, one is more worried about what the commentary is going to be because from the Fed to BoE, that’s what the markets nowadays have been reacting to. What do you think the commentary from the RBI Governor is going to be like tomorrow?
There will be a mention of both the domestic and the external sectors in equal weight. On the domestic front, is the growth inflation mix improving, is it worsening, is it getting more challenging, all that will be discussed.
The first quarter GDP, the June quarter GDP was a bit below consensus and some sort of thoughts on what is going to happen to GDP going ahead and then of course since the rupee has weakened 3% following the previous policy meeting, what could be its impact on inflation? What could the impact of the weak rice crop be on inflation and therefore where does that put the whole growth inflation mix?
I think that is going to be one part which the governor will talk a lot about tomorrow. The other part, my sense is, will be on the external outlook – what is happening to growth? What is happening to some of the other uncertainties we have like the still sluggish Chinese growth? What does all of that mean for the global economy and therefore indirectly for the US dollar and therefore also for financial stability in India.
So I think both these will be discussed a lot. In terms of action, it has to be a 50 bps rate hike at this point. Emerging markets are now trying to focus on large quantum rate hikes because of the common problems around inflation mix.
My other worry is that we do not realise now that growth is going to slow quite a bit after Diwali and in a way we only have the space to hike rates for September and December meetings, because come 2023 and a lot of the discussion will be on growth. What to do to revive growth, what kind of budget we should have to revive growth and all of that. The room for rate hikes will be much less. RBI is also going to focus on giving this last push over the September and December meetings.
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When we spoke to the governor about six weeks ago, he did indicate that liquidity in the systems is tight and the credit growth is lagging the deposit growth which means that they need to be cognisant of not sucking out a lot of liquidity from the system. What would be the impact of this liquidity and credit growth factor?
The liquidity has tightened a lot in the last couple of weeks and there are reasons for it. Number one is the forex intervention that the RBI is doing, selling a lot of dollars in the market and draining out rupee liquidity and I think that problem is likely to stay.
Then there is the problem of tax cycles as in the GST tax cycle, the advance tax cycle which takes away liquidity but that generally is temporary because hopefully the government will spend.
Then there is a third problem which is most important at this point as the government is sitting on very high cash balances with the central bank – about 3 trillion rupees. Generally during this time of the year, the government sits with zero. It actually has an overdraft with the central bank but what we have seen through the pandemic period is that the government is not spending early on, rather it is spending towards the end of the fiscal year around March and then through the year it sits on a lot of cash balances.
We practically did not notice this for the last two years because generally speaking system liquidity was good but this year because there has been so much forex intervention, this government has a habit of sitting on too much cash at this point of the year and that is really hurting.
My sense is that this will be a conversation the RBI has with the ministry of finance asking them to start spending more and start spending regularly rather than lump up spending at the end of the fiscal year because that can help ease domestic liquidity stress at a time we are doing so much of forex intervention. I am hoping that it is a fruitful conversation and what we see closer to the Diwali period is some of the banking sector liquidity rising.
Global central bankers are ready to storm growth to manage inflation but they are still looking at a lot of backward data and not looking at the recent decline in commodity prices. Do you think RBI could do it differently because the numbers the governor gave us last time are based on crude prices at $105. Crude prices are way below that. Do you think there could be departure from what global central bankers are doing versus RBI tomorrow?
We got this big commodity price shock in March and since then, the whole pressure has been on the inflation pipeline. It has been advancing and hopefully will peter off at some point. But we are still seeing inflation pressures move from WPI to CPI inflation from rural to urban inflation, from goods to services inflation. It is advancing but it is still in the system, it has not completely gotten off.
We have this new shock of a bad cereal crop, rice and wheat prices are high and the problem with rice and wheat is that they are generally annual or biannual crops, they are not like vegetables. It is very hard to look through very easily when it comes to food grains. My problem is that suddenly one shock is petering off but another shock has come and this is a tricky shock because inflation expectations react quite a lot to food grains and food prices. RBI still has to remain careful on the inflation front.
What about the outlook in terms of the strength and resilience that we are seeing in the dollar index versus other emerging market currencies? Yesterday the rupee hit an all-time low. Do you believe that in comparison to some of the other emerging market currencies, the rupee is a little better off?
I am going to answer this in two parts — one the dollar and other the rupee. In terms of the dollar, HSBC believes that the dollar strength is likely to last and there are many reasons for that. One is that when global growth slows, then dollar strength increases; the other is a lot of risk-on, risk-off volatility in global markets that is also when the dollar remains strong. We have still sluggish growth in China that generally tends to keep the dollar strong. We have falling commodity prices but still these are well above pre-pandemic or 2020 levels.
All of these factors are likely to keep the dollar strong. That is one part of your question. The second part is about the rupee. In the last three months, India’s trade deficit has averaged about $28 billion a month, which is very high. We think it is also going to remain pretty high in September and October because we do a lot of pre-Diwali imports and then, come November-December, the trade deficit may narrow a little bit because oil prices have fallen and the impact of that will be favourable.
We could go up from about $28 billion a month to about $22-23 billion a month. But my problem is that $22-23 billion is also a very high number and then come 2023 and again the trade deficit will start widening because exports will begin to slow.
We have not seen the whole export story unfold. It has just about started. India’s low tech and medium tech export volumes are slowing since June. High tech export volumes have been a huge driver of growth and BOP have started to slow down since August. That is going to be a big problem.
Once export starts slowing, that could more than offset the benefits we are getting from falling oil prices. Cutting a long story short, the trade, the current account and the balance of payment is likely to remain in deficit for the foreseeable future. All of that puts pressure on the rupee to weaken. Before I say about how much or things like that, it is very clear that we are not in a crisis situation. We have a lot of forex reserves, we have about nine months of import cover; then we were in a close to crisis situation that had fallen to six-and-a-half month-seven months or cover.
We have a lot of buffer with us yet it is important to note that the dollar has appreciated 20% since the start of the year. The Asian region and the emerging markets region in general has depreciated about 13-14%. In the same period, the rupee has depreciated about 9%. So the rupee has been outperformer but because this problem is for so long and the RBI cannot keep intervening indefinitely, some rupee weakness is here to continue at this point.