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India a compelling medium-term story: JPMorgan Chase
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July 03, 2006

Rajeev Malik of Asia Economic Research at JPMorgan Chase expects the current account deficit to widen significantly in FY07.

Malik feels that inflation may breach forecast of 5-5.5 per cent. He sees the 10-year bond yield at 8.5 per cent by the end of this year.

Malik affirms that India is still a compelling medium-term story. He expects the rupee to weaken on current A/C deficit and the BoP situation. Malik has also noticed significant widening in oil and non-oil trade deficit.

Excerpts of CNBC-TV18's exclusive interview with Rajeev Malik:

What are your thoughts on the current A/c deficit numbers?

I think it is best to see the Q1 performance on current account more as an aberration rather than setting a trend. A lot of investors should recall that the same thing happened in the first quarter of last year.

I think this happens partly because of some seasonal effects, what happens is that the invisible surplus lands up which is substantially larger than the trade deficit for that particular quarter.

If you are right in this assessment, in the coming four quarters of the fiscal year, current account deficit will once again begin to widen substantially. So according to our forecast, we still see current account deficit widening substantially this year.

What would be a good number to work at for the end of the year? Do you hold to your earlier assessment of 3%, or can one be a bit more optimistic on that?

Since the starting point is much better than what was being anticipated earlier, the deterioration, even though if it is of similar magnitude, the end results still lands up being better.

Last year, the full year number came in roughly around 1.3-1.6 per cent of GDP; we will still see it doubling. Don't underestimate that just on the oil side and non-oil side, the trade deficit widening is going to be pretty substantial.

I don't think the trend of invisibles more than off-setting the trade deficit is likely to persist for the rest of the year.

What did you make of Fed's language and hike?  What do you expect Central Banks like ours to do now?

I think RBI is still in a tightening mode. I think the investors and people in general, tend to underestimate the underlying strength as far as India's growth is concerned. Governor Reddy has emphasized repeatedly that off-shore interest rates are an important bearing although it is not the sole impact. 

I think the difficulty that one has with India is that one keeps tracking what is really a faulty inflation indicator of WPI.

For all practical purposes, the underlying inflation is probably running higher than what the official indicator is stating. Even in the official indicator, it is likely to breach the RBI's comfort zone of 5. 5 per cent. So my own understanding is that by July 25, RBI is likely to do two things. It will revive up its inflation forecast marginally and it will deliver monetary tightening.

Where do you expect the rupee to move as well?

The currency moves really go through these cycles. I think there is nothing really happening that will force us to change our view in terms of further rupee depreciation and we still very much stick to that.

At the year-end, we are still looking at Rs 47.50. I think dollar weakness obviously remains a risk to that view, so would the quick turnaround, as far as equity inflows are concerned.

But purely going by the underlying developments on the balance of payments, increased risks in terms of sustainability of capital flows and still widening trade deficit, I think rupee has further weakness to pull through.

A lot of bond market experts seem to believe that the yield could harden in the next few months to about 8.50 per cent and not much more that. Would you be a bit more aggressive than that?

I think 8.50 per cent is what we are also talking about by the end of current calendar year. We have to remember where we have come from. Since the start of the year, long-term rates in India have risen quite substantially.

Apart from liquidity worries, the latest fiscal deficit numbers aren't heartening at all. It is the question of trying to gauge whether the RBI is ahead or behind the curve. One really can't, in all honesty, do a good job of assessment with a faulty indicator.

I would still give the benefit of doubt to the RBI that it has started off its rate tightening cycle early enough and have been giving fairly good indications. Hopefully going forward, we are unlikely to see much of a difference of opinion between the Ministry of Finance and RBI on the rate outlook. That would definitely undermine Central Bank's credibility and we could do without that.

If stock market investor were reading the entire macro signal on the balance, would you be worried looking at the macros into an equity perspective, or would you be comfortable?

For the investors it would depend on the time frame.  No two investors are necessarily alike. India still remains an extremely compelling and attractive medium-term story. If one is literally trying to take a punt getting in and getting out, I think it is extremely difficult to call bottoms and peaks as a lot of investors have already found out. I think from a medium-term perspective, it still remains to be a good story although not one without risks.

With an 8.5% yield target, would you look at shifting out of equity into the bond market or is it a bit early?

I think it is somewhat early. But over the long-term, the trend is fairly clear that equity investors are likely to be much better off. Again, one has to see risk-adjusted returns on that front.

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