Jahangir Aziz, chief economist at JPMorgan India, believes the rupee will remain range-bound in the near term and expects another round of rate increases from the Reserve Bank of India. In a conversation with Ram Prasad Sahu and Sheetal Agarwal, he talks on GDP growth and exports, among other issues. Edited excerpts:
What is your call on the rupee?
vOur view is that it will hover around 44-44.5 in the near term.
How will its appreciation impact services and exports?
Since 2002, investment has been driving India’s growth story. Domestic consumption as a share of GDP has fallen every year from 2002 till now. Exports have skyrocketed from 10 per cent to 25 per cent of GDP. The export performance in India is driven by demand from foreign countries. BPO (business process outsourcing) alone will be significantly impacted by changes in the rupee, because it’s a homogeneous product and very price-sensitive. While a one per cent dip in demand in foreign countries reduces export volumes by five per cent, an equivalent appreciation in the exchange rate, except for the BPO sector, has very little impact.
Do you think RBI will look at sterilising forex inflows?
RBI shouldn’t sterilise unless these inflows become very, very large. The rupee liquidity is tight right now, short by '50,000 crore almost every day. RBI can take intervention without sterilising it up to '50,000 crore. But the moment it breaches this mark, sterilising will take place. It would not be very large, if it happens.
Your take on the cost of intervention.
In 2006-07, RBI intervened to the tune of '1.8 lakh crore via market stabilisation scheme (MSS) bonds. Assuming a 10 per cent interest rate on it, interest outgo is around '18,000 crore. That’s a significant portion of fiscal deficit. If we issue a similar size of MSS bonds now, we will add at least 50-100 basis points to interest rates, so there is a direct fiscal cost and indirect cost via high interest burden.
Do you think FII inflows will continue? What impact will it have on Indian markets?
This is not a speculative flow as yet; rebalancing is still taking place. These are small funds rebalancing a very small portion of the portfolio away from US treasuries to maybe half a percentage point towards emerging markets. Unfortunately, given the size of our financial markets, this creates tidal waves. Only 10 per cent of the market cap is actually traded. Of these, FIIs invest in the top 25 companies (by market cap). We expect this rebalancing to continue in the near term. For FY11, these inflows will continue to be strong.
Your view on the interest rate scenario.
We believe India, Brazil and Chile will have one more rate rise, while Israel may do a couple. We don’t foresee any rate hikes after October-November. The US GDP growth in the December 2010 quarter and the March 2011 quarter will be a key variable to watch, as then their interest rates will start hardening and then BRIC nations will start tightening the cycle again.
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How much will the Indian economy grow in FY11?
Growth in FY11 is seen at eight per cent, as the investment cycle has not yet turned around. India Inc needs 20 per cent growth in capacity expansion to achieve eight per cent growth.
Your take on the rally in commodity prices.
Except gold, metals usually rally when global economies recover. Gold is the only hedge against inflation, bad growth, etc. Commodity prices are rising due to increase in global demand and not due to supply shortage. Hence, I think the impact of higher prices will be offset by the positive impact of a better growth trajectory in the global economy. So, fears that high commodity prices are bad for India’s growth are untrue. It is bad for India’s inflation, but not bad for India’s growth. Individual companies, though, may get impacted.