The Hindu Business Line : Forward premiums should move right

Almost all the markets felt the heat of a populist election mandate. Dr Manmohan Singh's appointment as the new Prime Minister allayed some fears, as he was the initiator of reforms in 1991. But it looks unlikely that things will be the same as before, at least for some time.

There is no doubt that Dr Singh shall provide able governance and may actually continue with some of the reforms taken up by the earlier Government. But one thing is absolutely clear, second generation reforms will take the back seat. One cannot ignore the fact that Congress by itself is in the minority and will require the support of the Left parties and its allies on all major economic issues for it to be able to enjoy the confidence of the House.

Dr Singh and some of his Cabinet colleagues may be liberals but it will be impossible for them to ignore the mandate of the people. The economic policies of the earlier Government may not have been the only reason for its poor showing in the elections, but the defeat has ensured that the new Government will think twice before treading on the reformist path.

Privatisation, labour reforms, subsidy rationalisation, fiscal consolidation - - all these will clearly be on the back burner at least for some time. As Dr Singh has himself said that he will pursue economic reforms but with a human face, which means that only soft reforms will be taken up. Any tough measure will have to wait.

And even if Dr Singh decided to take some tough measures, the Left and other allies will brand them as anti-people and ensure that they never see the light of the day.

In this environment, I think the foreign investors (both direct and portfolio) will want to wait and watch for sometime before they decide to significantly increase their India exposure. For all you know, eventually India might see a similar surge in foreign investments as we saw over the last year, but it is not going to take place tomorrow.

We should see a slowdown in capital flows over the next six months and a significant one in portfolio investments. Investors will want to put the new Government under the microscope before making any large commitments into India.

We have quite recently seen the resurgence of the dollar against all major currencies. The dollar has strengthened or has at least stopped falling against major currencies on account of the strong economic data coming out of the US and hence the expectation of a hike in the Fed funds rate.

In fact, it has actually rallied by almost Rs 2 from its lows of 43.25 that we saw about a month and a half back.

Crude oil prices have almost doubled over the past year, which is surely going to eat into a significant part of our current account surplus. A shrinking current account surplus, uncertain political and economic environment and the global resurgence of the dollar - - all point towards a less strong rupee. Mind you, I did not say a weaker rupee.

All I am trying to say that for factors mentioned above, the dollar is no more a mindless sell at all levels as it was sometime back. Especially not so when you know that there are already significantly large short dollar positions in the market.

I have not looked at the numbers lately but my last recollection of the RBI's BoP numbers suggested a short dollar position of more than $6 billion in the market.

We have actually seen very little fresh dollar selling over the last week, at best there has been two-way customer interest. The earlier urgency to sell dollars at all levels in the fear that the level might not be seen again at all is clearly missing.

Whether one likes it or not, the overall sentiment on the rupee has changed. In this environment, it is unlikely that the dollar shortage will be as acute as it was before. Hence the premiums should not be negative for long. The market was sitting paid and that is why every time it went closer to par, it bounced back from there. But this time around I think it will go into the positive territory and stay there for sometime, if not longer.

The Mifor curve should also adjust accordingly. It is already at a much higher level than before so the adjustment to the right should not be as severe.

(The author is a senior trader, interest rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)