See FY09 growth at 7.1%: Morgan Stanley

Chetan Ahya, MD of Morgan Stanley expects the Reserve Bank of India or RBI to tighten policy rates by another 50 bps, but believes that the tightening effect will come slowly.

On the other hand, he doesn't see RBI hiking Cash Reserve Ratio or CRR going ahead.

He sees FY09 GDP at 7.1%. According to him, commodity price movements will impact GDP growth.

He expects inflation to remain above 10% till November-December. He also believes that most of the central banks are not taking the inflation problem seriously.

Excerpts from CNBC-TV18’s exclusive interview with Chetan Ahya:

Q: What do you make of the Reserve Bank if India’s (RBI) move and what more do you expect the Central Bank to do in the remaining six months of this year?

A: RBI did the right thing; essentially we are at a time where the Central Bank had to buy insurance from second rough effect of higher commodity prices though the headline inflation was not necessarily driven by strong domestic demand. But the fact that the commodity prices are continuing to rise they had to buy insurance by acting and they have done the right thing. We expect the Central Bank to tighten by about another 50 bps over the next six months assuming that the commodity prices are not going to come off quickly.

Q: Have you scaled down your Gross Domestic Product (GDP) forecast because of rising interest rates now for 2009 and 2010?

A: For financial Year 2009, we are at 7.1% versus consensus of 7.6%. So, we are already lower than consensus and we expect the consensus to catch-up with our numbers. A lot of the momentum is not going to immediately slowdown because of the rate hike effect. It takes some time for monetary tightening to filter down in domestic demand. So, the real risk is more for FY2010 outlook; for FY2010 we are at 7.6%, again significantly lower than consensus but that’s where we are evaluating the risk further and it will depend upon how commodity prices go from here.     

Q: To get couple of other numbers out of the way as well - what are you working in terms of estimates for the repo rate and the Cash Reserve Ratio (CRR) because I have been reading numbers of about 9% for repo and 9.25% for CRR?

A: We are looking at 50 bps hike in policy rate and no hike in CRR at this point of time. The liquidity is going to tighten automatically even without the CRR hike as the foreign inflows slowdown. Last week, forex reserves declined by USD 4.9 billion. So, in that environment of automatic tightening continuing, there is no need to do further CRR hike. The policy rate hikes will have to be done to continue to maintain the message from the Central Bank to ensure that the pass through effect is limited and to maintain the inflationary expectations.

Q: There has been a lot of talk about scale down in global growth not just for us and the other offshoot of that is that the expected decoupling of emerging economies did not happen. Do you see that playing out over the next few months that the most global economies will be more coupled in the way they move?

A: Decoupling has already happened - maybe not in financial markets as much. In financial market as well, we have to watch alpha, not beta and alpha is continuing to be there. But in terms of the real economy what matters is the trend in GDP growth and if one looks at the Asian GDP growth; in the Q1 it grew at 8.8% same as India’s number even while the US has continued to slow. So, the real economy decoupling actually did happen and that’s why we have the inflation problem. If the real economies had coupled with the US we would not have had the inflation problem globally.

We will just give a perspective on the global growth; last 40 years average is at 3.8% and in 2008 Morgan Stanley estimate for global growth is 4.1% which means that we will still be above the global 40 year trend average and not because the commodity prices are not coming down significantly. So, for the coupling-decoupling outlook what has happened already is that the economies have decoupled.

In terms of going forward, a momentum is still pretty much there in emerging market growth rate. There are only few Central Banks which are taking the inflation threat seriously; one of them being India but the more important ones and the larger emerging markets are yet not buckling under the pressure and tightening. So, we still have some amount of real economic decoupling trend continuing as far as another six months is concerned. Until the inflation threat really forces a more Central Banks to tighten, this challenge particularly is more in countries like China and Middle-East which have foreign exchange policies slightly different from India and their monetary polices that’s why relatively lose. So one is going to see domestic demand in a lot of other emerging markets continuing and that’s why in the next six months real economies will still continue to stay in soft decoupling form.       

Q: Just want to ask you about your growth forecast again, you are at 7.1% this year many of your peers, global brokerages are at 7.5%-7.6%-7.3% while most of the domestic guys from the Reserve Bank of India (RBI) to the Finance Ministry to some of the local think tanks like Centre for Monitoring Indian Economy (CMIE) are still holding 8.5% kind of targets, where is a disconnect there?

A: Q1 numbers have probably given much more hope to people and in Q1 a few things were probably there, which are not likely to continue in our view. Firstly there was a very strong government spending. Real contribution of government spending growth was 9.2% and on average it tends to be 6%, so there will be downside in that in the coming quarters.

Secondly, the non-government services sector continues to grow well. There is always a lag we all know what happened to industrial production in the March quarter. So going forward, we think that the non-government services sector will also slow down. There is a significant component of that, which is linked to industrial activity and it does not move on its own. So the combine effect of that is going to show up.

For example in financials, RBI is targeting credit growth and aggregate demand to come down by tightening they have themselves said that. So the financial services will also see a slowdown in growth going forward.

We cannot have both the factors; we are tightening to slow aggregate demand and cannot have aggregate demand and growth still at 8.5%. That seems to be on balance, a very contrary to what they are trying to achieve.

Q: Would you go so far as to say that we as well might be hitting a period of stagflation as has been talked about for some developed economies?

A: In Indian or emerging market context, we are still in inflation era which is you have higher growth and high inflation. Even in India, if you take just our numbers at 7.1%, you cannot really use stagflation word for that context. We do have a challenging environment in the sense that inflation is still accelerating while growth is decelerating. So, it is a whiff of a stagflationary tight environment rather than being exactly in stagflation.

That challenge remains for all the emerging markets. The attended challenge now for a lot of emerging market is that we all benefit from lower inflation and it gives the confidence to the Central Banks that they have played a role in doing this. But there was a global backdrop to this, which was very constructive. Now unfortunately this global backdrop has turned against us.

The Central Banks, which would say that they are going to control this inflation, will really have a challenging environment because this is not local inflation this is global inflation. So, this tug-of-war between Central Banks effort to control inflation and actually bringing down inflation will keep markets in a very uncertain phase all across emerging markets and we are already seeing that. Currencies in emerging markets are depreciating and the assets are under performing. This environment will not go away from us soon because the Fed has not tightened yesterday. In this environment where the monetary policy from the developed world particularly Fed is loose; at the same time you are seeing a situation where a lot of the other emerging markets are pegged to the US monetary policy and you have aggregate demand continuing to be strong. So, commodity prices could still remain strong and that is why the emerging market and Indian inflation outlook looks concerning to us.