Mar 06, 2013 10:38 PM IST | Source: CNBC-TV18

Budget Analysis: Ratings agencies will track CAD, says Deutsche Bank

Taimur Baig, chief economist, Deutsche Bank, says that the country‘s current account deficit is a much larger problem than the fiscal deficit itself.

Taimur Baig, chief economist, Deutsche Bank, says that the country’s current account deficit is a much larger problem than fiscal deficit itself. Talking to CNBC-TV18, he added that rating agencies are worried more about India’s external sustainability, not necessarily its public debt sustainability

Here is an edited transcript of the interview

Q: Comments from the finance minister (FM) clearly indicated that there is a large danger from the current account deficit (CAD). It’s likely to breach 5 percent for entire FY13, but what have you penciled in for FY13 and FY14?

A: There better be some improvement. I agree with the FM, I think the current account deficit is a much bigger concern than the fiscal deficit itself, which seems to be on a gradual path towards consolidation. But we have major factors to drive the current account deficit to a more manageable level. For the whole of FY12-FY13, we are looking at about 4.6 percent of gross domestic product (GDP) in current account deficit.

Going into FY13-FY14, there is a reasonable argument to be made for a second lower current account deficit, assuming gold prices and oil prices remain flat or declining and exports pick up. So we are looking at about 4.1 percent of GDP current account deficit in FY13-FY14, and given the sort of measures that the authorities are implementing with regard to foreign investments, we think financing of that deficit should be relatively orderly. Therefore we expect some stable outlook in the exchange rate, not expecting major deposition risk for the time being.

Q: What do you think the rating agencies will make of the India rating, given this kind of current account deficit?

A: Absolutely, that has been our view all along that the rating agencies are worried about India’s external sustainability, not necessarily its public debt sustainability. India’s external debt has gone from low USD 200 billion to mid USD 300 billion just in the span of the last five years.

On a residual maturity basis, short term debt, as the share of reserves has been declining and the total debt has been rising. So, these are very uncomfortable developments for a country that is running a CAD and need orderly supply of dollars. So from that perspective, I think the ratings agencies will look at rupee stability and the current account stability and that’s where I think the ratings decision will hinge.

Q: Coming to the fiscal deficit. There is scepticism that even the 4.8 percent mark for FY14 might slip due to multiple factors, say like populism seeping into the second half. Hence, high expenditure and possibly the divestment targets could be a tad too steep. Do you think the 4.8 percent mark is achievable?

A: The 4.8 percent mark is probably subject to about 0.25 percent of GDP risk, which is not a lot. Looking at even a 5 percent of GDP outturn for 2013-14 was unthinkable six months ago, and now we think that is possible.  So, India has come a long way in terms of fiscal consolidation in recent months. But you are right. On the disinvestment side, the targets do look ambitious. But if is indeed going to be a year for equities worldwide and there will be major rise in investor sentiment, maybe this is a good year for India to have an ambitious disinvestment target.

On the expenditure side, as you know, there is not much scope for spending beyond Budget appropriation, unless there is an overshoot of the subsidy side. There, we don’t think there is much risk. We expect flat prices as well as local liberalisation measures continuing unabated.
There might be other risks that are coming from the planned spending side. But I think that the risk is downside, not an upside risk, in meeting which the authorities will not be spending 30 percent year on year. If indeed some revenue items were to be weak, they would use that buffer as a savings measure.

Q: What about the borrowing target for FY14 of Rs 6.3 lakh crore? How exactly do you expect the 10-year to move?

A: We are relatively constructive on the 10-year, in the sense that we do see bond yields heading towards 7.5 percent at some point in the second half of this fiscal year. We think that the overall gross borrowing target is not necessarily what we should be looking at. On the net side, the numbers are not that unfavourable. The authorities have clarified some of those figures even subsequent to the Budget. Generally speaking, we remain comfortable with the supply of bonds as well as the various pockets of demand in the economy as far as the bonds are concerned. So we are relatively constructive on fixed income outlook.

Q: Q3 GDP came in at 4.5 percent. Chances are that this quarter is not going to look very good. What are you expecting by way of GDP growth in Q4, the headline for FY13 and whether FY14 will be helped at all by the Budget and other policy measures?

A: I think that for the January-March quarter, the chances are it will be quite a bit higher than what we saw in October-December. When you look at what the Purchasing Managers' Indexes (PMI) have suggested, how the core infra numbers have come up for January and what we are seeing in terms of global demand for exports, we ought to see some decent numbers when the February-March trade data comes out.

Based on that premise and expecting agriculture not to be a source of drag any further, we should see a high-5 growth for the January-March quarter, which will take the entire year’s average to around 5 percent, or maybe a little higher than that. Going to FY13-14, you are absolutely right. The big question is, where the growth will come from. There is a consolidation strategy in place. Consumption is already fairly resilient. You have to see how that picks up further. It has got to be investment. It has got to be exports. 

On exports, we are hoping for a turnaround in global demand. On investment, we do think that the authorities will be announcing some major implementation of the Delhi-Bombay corridor and some other landmark projects like that ought to have some favourable impact on private investment sentiment. So, we are mildly optimistic as far as growth is concerned. We see it going towards 6 percent, if not a little higher in FY13-14, but we do recognise that there are a lot of risks. The risk of this growth being lower than what we are expecting is not small. There is sizeable risk there.

Q: Now that the government has been aggressively slashing fiscal deficit, will the fall in aggregate demand as a consequence reign in inflation? What’s your inflation trajectory?

A: We don’t see a very strong link between efforts to consolidate fiscally, and inflation impulse coming down substantially. Maybe that happens with a lag over time but if the government is cutting back on spending in the January-March quarter, I don’t think that immediately translates into significant decrease in demand for goods and services in a large economy like India.

Mind you, the public spending is only 15 percent of GDP and we are talking about a USD 1.8 trillion economy. I don’t think inflation gets addressed so easily. But in terms of the inflation trajectory for the year 2013, I think the first six months of this year were in decent territory.
There aren’t many upside risks to commodity prices. Output gap is large, pricing power is low and agriculture prices are not also expected to strike any further, and we have a fairly favourable base effect. 

So we could go toward a low of 6 percent, perhaps even come down slightly below that in the first half of this year if things fall in place for India. Challenges in the second half of the year when the base effect would not be that favourable, and perhaps there may not be that much respite coming from food and commodity prices. So we don’t see India becoming a 5 percent inflation economy in 2013 nor in 2014. Inflation will probably be in the 6 percent range in the best of circumstances.

Q: Since we have addressed growth and inflation, where do you think the RBI is placed in the scheme of things? Will they take cognisance of growth slowing, hence cut rates and if so, by how much?

A: I have been a big hawk as far as the monetary policy is concerned. I have been resisting cuts call all through last year, and then in January we did say that the RBI will change it tack and it indeed did it. We expect that tack to continue. Incremental 25 bps cut in March, perhaps even in the end of April, early May meeting. Output gap is wide. Growth is slow. Inflation momentum for the time has come sharply down. There is plenty of room for the central bank to act now.

Q: What is your level that you are working with on the rupee and do you think that 57 could possibly be back on the table?

A: I think that 57 can certainly be entertained, but my view for the whole year, independent of the ongoing instability of exchange rate is one of a constructive one. As I said earlier, I do expect the current account in the next fiscal year to come down a bit and I do expect orderly financing of the CAD. So going beyond the current unsteadiness I see the rupee appreciating towards Rs 53-52 by the end of this year.


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