50 bps CRR hike before year-end: HSBC

ANALYST'S VIEW

The fall in the rupee proved to be a short-lived one, as the currency bounced back with a vengeance over the past couple of weeks, breaking the 40-level against the dollar for the first time since May 1998.

As we argued on August 3, the RBI has proved unable to protect its proverbial line in the sand, given the strength of the inflows (FDI, portfolio and remittance). Our currency team also argues that the rupee will strengthen further, hitting 39 by the year-end.

The appreciation in currency usually hits exports. But, we in HSBC have different views in this regard for India. In our report "India's export downturn: Don't blame the rupee", HSBC had argued that while currency changes have some impact on exports, local companies often leave the foreign currency prices of their product unchanged, with profit margins and ultimately investments and jobs taking the hit.

We believe the world trade and the interest rate on export credit are much more important determinants of export growth.

Meanwhile, we can find strong statistical evidence that the rupee has big effects on the manufacturing wholesale price index (WPI) "" a 1 per cent rise in the trade-weighted rupee cutting 0.7 percentage points from the inflation rate over the following 12 months.

This is a key reason why we believe the manufacturing component will drop below 4 per cent in the near future. But this needn't necessarily mean that the headline rate will continue to drop.

We will be very surprised if the recent big drop in primary articles (mainly food) inflation to 7.5 per cent in the week of September 8 or fuel price inflation (to -2.9 per cent) can be sustained for much longer.

Nevertheless, all the recent news, including the poor July industrial production numbers and the US rate cut, seem to present a dovish picture. We, however, doubt if it is dovish enough to trigger a near-term rate cut from the Reserve Bank of India (RBI). With inflows driving the currency higher, the RBI is back in the familiar position of trying to mop up excess liquidity.

Therefore, we continue to expect a further 50 basis points CRR (cash reserve ratio) hike before year-end. It is also important to note that while WPI inflation is dropping, CPI inflation is rising again.