Pranjul Bhandari, Chief India Economist, HSBC Securities
It seems inevitable that we will see a rise in rates. More than the quantum, there’s more concern about what the commentary is going to be because from the Fed to the BoE, that’s what the markets are reacting to today. What do you think the RBI Governor’s comment will look like tomorrow?
Mention will be made of the interior sector and the exterior sector of equal weight. Domestically, is the growth/inflation mix improving, getting worse, getting tougher, all of that will be discussed.
First quarter GDP, June quarter GDP was a bit below consensus and kind of a reflection on what’s going to happen to GDP going forward and then of course since the rupee weakened 3% following the previous political meeting, what could be its impact on inflation? What could be the impact of the poor rice harvest on inflation and, therefore, where does this put all of growth and inflation?
I think this will be a game that the governor will talk a lot about tomorrow. The other part, I think, will be about the external outlook – what’s happening to growth? What happens to some of the other uncertainties we have like China’s still sluggish growth? What does all this mean for the global economy and therefore indirectly for the US dollar and therefore also for financial stability in India.
So I think both will be discussed a lot. In terms of action, it must be a rate hike of 50 basis points at this point. Emerging markets are now trying to focus on big quantum rate hikes due to common issues with the composition of inflation.
My other concern is that we don’t realize now that growth is going to slow down a bit after Diwali and somehow we only have the leeway to raise rates for the September and December meetings because come on in 2023 and much of the discussion will be about growth. What to do to revive growth, what kind of budget we should have to revive growth and all that. The room for rate hikes will be much smaller. RBI will also focus on this latest boost at the September and December meetings.
“ Back to recommendation stories
When we spoke to the governor about six weeks ago, he indicated that liquidity in the systems is tight and credit growth is lagging deposit growth, which means they need to be aware of not not suck a lot of liquidity from the system. What would be the impact of this liquidity and credit growth factor?
Liquidity has tightened a lot over the past two weeks and there are reasons for that. The first is the forex intervention that the RBI is doing, selling a lot of dollars in the market and draining liquidity from the rupee and I think this problem is likely to remain.
Then there is the issue of tax cycles as in the GST tax cycle, the anticipated tax cycle that takes away cash but is usually temporary as hopefully the government will spend.
Then there is a third problem which is the most important at this stage, as the government is sitting on very high cash balances with the central bank – around 3 trillion rupees. In general, at this time of the year, the government sits with zero. He actually has an overdraft with the central bank, but what we’ve seen during the pandemic period is that the government doesn’t spend at the beginning, but rather towards the end of the fiscal year around March, and then throughout the year it sits on a lot of cash balances.
We hardly noticed it for the past couple of years because generally the liquidity in the system was good, but this year because there’s been so much forex intervention, it’s government has a habit of sitting on too much cash at this time of year and that’s really bad.
My feeling is that this will be a conversation that the RBI will have with the Ministry of Finance asking them to start spending more and start spending regularly rather than increasing spending at the end of the financial year as that may help to alleviate domestic liquidity stress at the time we do so many forex interventions. Hope this is a fruitful conversation and what we see closer to the Diwali period is some of the banking sector liquidity on the rise.
Global central bankers are ready to storm growth to manage inflation, but they are still looking at a lot of historical data and not looking at the recent drop 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 well below. Do you think there could be a deviation from what the global central bankers are doing versus RBI tomorrow?
We had this big commodity price shock in March and since then all the pressure has been on the inflation pipeline. He has progressed and hopefully will run out of steam at some point. But we still see inflationary pressures moving from WPI inflation to CPI inflation, from rural inflation to urban inflation, from goods inflation to services inflation. It advances but it is still in the system, it is not completely descended.
We have this new shock of a bad cereal harvest, the prices of rice and wheat are high and the problem with rice and wheat is that they are generally annual or biennial crops, it is not like the vegetables. It is very difficult to look very easily when it comes to food grains. My problem is that all of a sudden a shock fades away, but then another shock came along and it’s a tricky shock because inflation expectations react a lot to food grains and food prices. RBI still needs to remain cautious on the inflation front.
What about the outlook for strength and resilience that we see in the dollar index against other emerging market currencies? Yesterday, the rupee hit an all-time low. Do you think that compared to some of the other emerging market currencies, the rupee is a bit better off?
I will answer this in two parts – one the dollar and the other the rupee. In dollar terms, HSBC believes that dollar strength is likely to last and there are many reasons for this. The first is that when global growth slows, dollar strength increases; the other is high risk and risky volatility in global markets, that is, when the dollar remains strong. We still have sluggish growth in China which generally tends to keep the dollar strong. We have falling commodity prices, but they are still well above pre-pandemic or 2020 levels.
All of these factors are likely to keep the dollar strong. This is part of your question. The second part concerns the rupee. Over the past three months, India’s trade deficit has averaged $28 billion per month, which is very high. We think it will also stay quite high in September and October because we are importing a lot before Diwali and then in November-December the trade deficit might narrow a bit because oil prices have fallen and the impact of this will be favorable.
We could go 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, then 2023 and again the trade deficit will start to widen because exports will start to slow down.
We haven’t seen the whole export story unfold. It has just started. India’s low-tech and medium-tech export volumes have been slowing since June. High-tech export volumes have been a huge driver of growth and the balance of payments has started to slow since August. This is going to be a big problem.
Once exports start to slow, this could more than offset the benefits we derive from falling oil prices. In summary, trade, current account and balance of payments are expected to remain in deficit for the foreseeable future. All of this is pushing the rupee to weaken. Before saying how many or things like that, it is very clear that we are not in a crisis situation. We have a lot of foreign exchange reserves, we have about nine months of import cover; then we were in a situation close to the crisis which had fallen to six months and a half-seven months or coverage.
We have a lot of reserve with us, but it is important to note that the dollar has appreciated by 20% since the start of the year. The Asian region and the emerging market region in general depreciated by around 13-14%. During the same period, the rupee depreciated by about 9%. The Rupee has therefore performed better, but since this problem has been going on for so long and the RBI cannot continue to intervene indefinitely, some weakness in the Rupee is here to continue at this point.