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India has a very serious medium-term inflation issue

India has a very serious medium-term inflation issue
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First Published: Thu, Mar 18 2010. 10 49 PM IST

Warning note: Bhanu Baweja.
Warning note: Bhanu Baweja.
Updated: Thu, Mar 18 2010. 10 49 PM IST
London: Bhanu Baweja, head of research and EM (emerging markets) strategy at Swiss bank UBS AG said in an interview that India has a serious inflation issue over the medium-term. Edited excerpts:
Warning note: Bhanu Baweja.
What is the trajectory for the dollar index?
Over the next quarter, we think that the euro sell trade is likely to come back. We do think that the problems in Europe will dictate trends in currency markets rather than monetary policy by the (US) Fed. So we do think that the euro-dollar should head lower towards the 1.33-mark over a three-month period, which basically means that the DXY (dollar index) should strengthen the broad trade rated dollar from out here. I want to be clear that this is not because we are huge fans of the US economy. We think the US economy will do well for a while and then will in fact plateau out. This really is a euro sell trade rather than a dollar buy trade. Almost exactly the opposite of what happened last year, where the market was selling the dollar against pretty much everything.
There may not be value in the US dollar but it is rising because liquidity is chasing it. We have seen record equity inflows. Where is smart money headed in the next three months or so?
The dollar will do well not because of the merits of the US economy but because of the demerits of the euro zone. First, I would not be funding out the dollar; I would be funding out European currencies. Second, there is still value in the emerging markets in the front-end of the bond curve. So I would move into front-end in the bond market in the emerging markets. I would maintain a very small long position in equities but would be taking profit as the market moves higher from out here and I do think equities can stay relatively well.
We have seen a near double-digit inflation in India. What do you expect the Reserve Bank of India (RBI) to do and its impact on bond yields?
We do think that as liquidity does tighten in the very near term, you will find yields rising with the 10-year (bond) probably approaching 8.25% or 8.30% mark. But it’s difficult to call for much further weakness in the Indian bond market despite high inflation because this is a captive bond market. It is a bond market where banks are meant to hold government bonds; it’s not a completely freely traded bond market. So from those levels in fact we might actually tactically buy the bonds.
As far as inflation is concerned, we think in the next three-six months inflation is going to come lower because the food price inflation is going to be coming off. But make no mistake, India has a very serious inflation issue over the medium-term.
What is your call on the Indian rupee for 2010?
At this point, although the market is fairly short in the euro and fairly long on the INR, which could lead to a squeeze the other way—euro-INR and sterling-INR going higher—I quite like that as a secular trend in the medium term.
Moving forward we still expect the rupee to do well and the preferred currency of the short side being either the euro or the sterling. But even against the dollar we think that the rupee will hold its own and we are expecting a modest appreciation towards 43 over the next several months.
cnbctv18@livemint.com
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First Published: Thu, Mar 18 2010. 10 49 PM IST