Thursday, October 30, 2014

> Can Swiss bank money solve the FX problem? (MERRILL LYNCH)

■ Bottom line: No immediate impact; RBI to hold Rs58-62/USD
Can unearthing "black" money Indians have allegedly stashed away in Swiss banks help the Reserve Bank of India (RBI) raise FX reserves? We do not see any immediate FX impact given the legal issues involved, although the Supreme Court has yesterday asked the government to pass on information of Indians holding Swiss bank accounts to it today. Reports place Indians' deposits in Swiss accounts in an astonishingly wide range of US$2bn-2trn. In this report, we have worked with
an estimate of capital flight of about US$200bn based on a recent research study. If even half of this is unearthed, it could add US$30-35bn (three to four months of current import cover) to FX reserves over time, if taxed at, say, 30-35%. In the meanwhile, we calculate that the RBI will need to buy US$30-35bn to maintain eight-month import cover by March 2016. On balance, we continue to expect it to hold Rs58-62/USD assuming that the EURUSD remains around current levels. Our
Asia FX strategist, Adarsh Sinha, forecasts Rs61/USD in December.

■ Government passes Swiss a/c holder names to Supreme Court
The Supreme Court has yesterday ordered the government to pass on information of Indians holding Swiss bank accounts to it today. Finance minister Jaitley immediately told the media that the government will comply with the Supreme Court's directive. Attorney general Mukul Rohatgi also said that a list of 600-odd names in a sealed envelope will be handed over to the Supreme Court. This has just been done. The Supreme Court has asked the Special Investigation Team (SIT), headed by Justice (retd) Shah, to submit a report by November 30.

The story so far: The Supreme Court order is the culmination of a March 2009 public interest litigation filed by leading lawyer Ram Jethmalani seeking judicial intervention to bring back Rs700bn (US$11bn) of black money allegedly stashed away in foreign banks by Indians. It had ordered the institution of a SIT to probe black money in July 2011. The previous UPA government had submitted names of 26 Indians having accounts in in a Lichenstien, bank, of which eight were found legitimate. In May 2014, the just-elected Modi government paved the way for the SIT. In October, it committed to reveal all names against whom prosecution is launched but endorsed the previous UPA's stand that Swiss confidentiality clauses prevented it from making all names public. On Monday, the government disclosed names of three such account holders.

Estimates vary between US$2bn-2trn
Media reports place Indians' deposits in Swiss accounts in an astonishingly wide range of US$2bn-2trn. The Swiss National Bank has itself placed funds owned by Indians and entities at CHF1.95bn. This does not include the money Indians may hold in other names. In a recent study, Raghbendra Jha and Duc Nguyen Truong, of Australian National University, estimated total capital flight at US$186+bn during 1998-2012.

Unearthing capital flight can add US$30bn to FX reserves
We estimate that the government can add US$30-35bn to FX reserves, over time, if it is able to unearth some of Indians' "black money" abroad. In this report, we have worked with an estimate of US$200bn based on Prof Jha's estimate of capital flight. If even half of this is unearthed and taxed at 30-35%, this could add three to four months of current import cover to FX reserves, over time, when import cover is running low at 8.3 months

■ Tax amnesty scheme unlikely for Swiss bank funds
The Modi government is unlikely to announce a tax amnesty scheme to bring back Indians' "black" money stashed in Swiss banks based on a statement by Nirmala Sitharaman, minister of state for finance, in Parliament. In our view, VDIS schemes discriminate against the honest tax payer, although they allow the government to quickly raise revenue. At the same time, the government proposes to re-launch the Kisan Vikas Patra, which has had relatively relaxed know-your-customer norms but no fiscal incentives in the past.

We fully agree with Nirmala Sitharaman, when she tells Parliament that "...the experience shows when you bring in VDIS (Voluntary Disclosure of Income Scheme), it discriminates against genuine taxpayers. Those of you who pay taxes are goes against honest taxpayers... It may not be a conducive path for recovering more taxes..."

India has announced several amnesty schemes to allow citizens to disclose their "black" money after paying the prevailing income tax. The 1997 VDIS scheme taxed this “black” money at 30% for individuals and 35% for corporates.


>INR: An exciting range (MERRILL LYNCH)

  USD/INR: A range trade with opportunities
We continue to expect USD/INR to maintain a 58-62 range but believe there will be  opportunities to accumulate carry despite the risks from a stronger USD. Our analysis suggests positioning is less extreme, hedging activity is INR-supportive and carry remains extremely attractive, particularly for short EUR/INR. We expect  USD/INR to end the year at 61 (previously 60) despite a strong USD, and revise our end-2015 forecast to 60 (from 64) to factor in a stronger balance of payments (BoP) outlook.

  RBI’s range of tolerance: Rs58-62/USD
The Reserve Bank of India’s (RBI) range of tolerance for USD/INR and its intention to build reserves will be the single-biggest driver of the exchange rate over the forecast horizon, in our view. We expect it to buy US$35-40bn by March 2016 to maintain 8-month import cover. We see the 58-62 range breaking sustainably under  two scenarios: 1) sufficient FX reserves, (> 10 months import cover) which looks unlikely until 2016; or, 2) a much stronger USD than even we (as USD bulls) expect.

 ► Two medium-term positives
We expect the BoP to be INR-supportive, albeit highly dependent upon oil and gold prices. Our estimates place India’s current account deficit at 1.7% of GDP in FY15 and basic BoP deficit at roughly 1% of GDP by FY16, consistent with a stronger level of the INR. We also believe the RBI will maintain its inflation credibility with a 
likely peak in inflation reducing the need for a nominal depreciation ofthe INR. This should allow the RBI to cut rates 75bp in 2015 and encourage portfolio inflows.

 ► Risks from the stronger US Dollar
A stronger USD is a clear downside risk for the INR but our estimates suggest the sensitivity to the DXY index has fallen. While the RBI is unlikely to fight a much stronger USD, it would take sizeable appreciation to move USD/INR sustainably above 62. Moreover, FII portfolio inflows – that are more skewed towards equity than bonds – should react favorably to any RBI rate cuts and thereby be less vulnerable to a narrowing rate differential if the Fed begins hiking in June 2015 (asour US economists expect).