Jun 05, 2012 02:23 PM IST | Source: CNBC-TV18

Q4 GDP: Derailed economy has economists worried about FY13

Economists worry after India's economic growth grew at its weakest pace, slipping to 5.3% for the fourth quarter of FY12. The lowest growth in nearly nine years has them debating on what the factors are which led to this slowdown.

Moneycontrol Bureau

India's economic growth grew at its weakest pace, slipping to 5.3% for the fourth quarter of FY12. This is the lowest in nearly nine years due to poor performance of the manufacturing and farm sectors.

Samiran Chakrabarty, head-research, Standard Chartered Bank sees bond yields likely heading lower from current levels. The 10-year bond yields fell 3 basis points to 8.49% as concerns over global risk aversion lured investors towards safe-haven government debt.

India's economic landscape malaise is heavily intertwined due to the lack of positive global newsflow as well as clarity from Indian policy makers. Reeling under the blow of the twin deficits – current account deficit and fiscal deficit, we also have headline inflation to deal with.

Manish Wadhwan of HSBC says if India is able to rein in its current account deficit, we could stabilise the fall in the rupee. This limits the flexibility of central bankers to ease liquidity, lower the cost of borrowing and make greenfield investments attractive.

The growth outlook for fiscal 2012-13 is now much lower, says Sonal Varma, India economist, Nomura Financial Advisory & Securities. "FY13 GDP expectations will have to be revised downwards," she says, adding that India needs sustainable non-inflationary growth but this current lag between growth and inflation could range from three to six quarters.

Rohini Malkani, the managing director and chief economist of Citi India expects the average inflation for FY13 at 7.4% but also sees the number heading higher in the second half of FY13. The India growth story has clearly been de-rated and the only way to get it back on track is for the government to place more emphasis on reforms, says Malkani.

According to Varma, the crisis in Europe has a huge role on how our economy fares. If the Euro crisis is resolved, she sees our FY13 GDP growth to hover around 7% but if the situation worsens then we may see our it at 6.5%.

Recent policy changes, tardy reforms and governance deficit have deeply dented investor confidence. The biggest bane for the market since last week has been the depreciating rupee. It reached another all-time low today at Rs 56.50 against the dollar in early trade on increased capital outflows and strong demand from importers for the greenback.

But Wadhwan says the rupee tumbling is in-line with other currencies from the Asian basket. He sees the INR depreciation as more to do with the situation in Europe. "The rupee depreciation is a global adjustment to the strengthening of the dollar," he says.

Malkani expects the rupee to trade in the 54-56 to the dollar range for the next 6-12 months.

Below is an edited transcript of their interview on CNBC-TV18. Watch the accompanying videos for more.

Q: This has come as a shocker. Were you expecting anything close to this 5.3% figure?

Varma: Not all, 5 was possible but not 5.3%. But the breakup suggests that the disappointment is mainly in services. Now it's possible that the slowdown is in the industry is in the private services side of retail trading, wholesale trading and the financial services side.

But the other factor could also be maybe they have seen some slowdown in the government component of services this quarter. Nevertheless services have been the strong part of India's growth rate. If that is also starting to collapse then there is a risk of India’s potential having already fallen below 7% now.

Q: Are you surprised with the GDP numbers; what could have led to this?

Malkani: While one was expecting that the growth in Q4 would be around 6%, it was primarily due to the fact that Q1 industrial production numbers were around 0.6%. This probably dragged these numbers down.

We do believe that it would be one of the factors that the RBI would have to keep in mind, not in its immediate policy but a few months down the road. This would have to be again taken into account with what's happening globally regarding oil prices, and all awarded goal posts that the RBI has been focusing on such as suppressed inflation, fiscal situation, food prices, etc.

Q: How do you expect the bond market and the foreign exchange market to react? We have already seen some sharp reactions with the yield cooling down quite substantially.

Wadhwan: It’s one of the ugliest numbers we could have expected. It’s a real shocker. It’s quite negative and it has surpassed all kinds of expectations on the negative what we have thought. The market has already reacted to this.

On a big picture basis, I would suggest that though there is still some kind of hawkishness left that interest rates may not come down, from the market side you can expect the reactions and they are factoring in these rate cuts to happen sooner than later.

They have already been on that side but even if RBI doesn't cut in June, the probability of a next 50 bps cut becomes very sharp in the July policy though I would not rule out some kind of a RBI action in June itself. It's far below the number what the policymakers would have expected to.

Q: You have been hearing all the details of these numbers, the worry is how much of a spillover happens for Q1 itself. How would you rework estimates or expectations now for Q1?

Chakraborty: The important thing to note here is that as we know in FY12, the investment engine was not working and it now seems that the consumption engine, which was supporting growth even that has started faltering. If you look at the breakup of numbers, the segment which we take as a proxy for consumption in the services sector, the retail wholesale trade has grown just about 7% from more than 10% which it was clocking before.

This sharp drop in the retail trade segment gives us an indication along with some anecdotal evidence that probably the consumption story is not as strong as it was in the first three quarters. We will have to now filter in terms of getting into our FY13 forecast. So we obviously will be reviewing our numbers after this but the big story seems to be that consumption is not safe anymore.

Q: Most of your peers have slashed FY13 expectations ahead of this number on an average to about a 6.5%-6.8% kind of take. Would you say everyone will probably have to rework these numbers with a downward bias?

Varma: Yes definitely, I think we are starting from a very weak position. Things have actually become worse in the April-June quarter with the global crisis. So there could be some spill over because of that in this quarter. And we are yet to see some policy response from Reserve Bank’s side, so there would be some downside risk.


One thing to mention is that while rupee depreciation is negative on a lot of counts, it is option mechanism. When you do not have the fiscal monetary space, you have to let your currency depreciate because it will help you gain some market share on the export side.

It will help reduce your imports; it will probably boost some domestic production as it helps more of reverse substitution. So I think rupee depreciation is a big positive which we should not overlook, so that is one positive that I see right now.

Secondly, I think there is some movement on the coal and roads front on the infrastructure side. Perhaps, we should still see a pick up in the second half of the year. But the coming quarter or two, still look like they will be a fairly difficult one.

Q: You were making the point about consumption slowing down. If we do get in the Q1 and Q2 of FY13 5-5.5% kind of GDP reading, could we even struggle to make it to 6% in FY13 given the kind of slide that we have seen in the services number this time around retail trade that you pointed out?

Chakraborty: We need to look at the way negotiations in March-April have not been as much as one could have anticipated. Given the high inflation, the real wages are probably now falling especially in urban areas probably the fiscal stimulus that was going to the rural areas is not going as much. Overall, that is pushing down assumption growth.

Our best hope, at this point of time, seems to be the base effect of last year since industry. Investment was so low last year, possibly nothing can be worse than that. If you live on that hope then base effect can give you some kicker in the industrial side in the second half of the year. But that is about it. I do not see any autonomous improvement in the economy other than that I would want a strong policy action to kick start growth. All our macro challenges get much more exacerbated when growth rates are low.

So we now need to focus more on growth and worry a bit less on inflation, let’s be sure that with 5%growth core inflation is bound to come down and let’s not worry too much about food and fuel which are more supply side issues to be dealt with by other measures.

Q: Do you think the market will start pricing in rate cuts in June or July from the Reserve Bank now. Do you see the yield coming off to around 8.25%; that did not look like a possibility even a week back?

Wadhwan: I think it’s a mix of two fundamentals. One, RBI has been buying back bonds in the OMOs for the last three weeks. That’s very specific to the bond market. So the positioning of the bond market was such that they had not supplied any paper, net supply was 0. So on that account, I think you have seen a reaction. But on a big picture basis, I would tend to agree that now the market would start factoring in rate cuts in the fiscal. Though there can be arguments that they may not cut in June but the possibility becomes very high in July.

We should see some reaction from RBI on this sooner than later. If you go beyond the 10-year bond yields, there is a lot of demand and supply issues around the government bond market. But the derivatives curve, the swap curve is already pointing out to some kind of rate cuts. That had been sticky for last 6-6.5 months. We are already seeing some reaction on that front and markets will give already a hint of a rate cut.

Q: What would you set the cap at for the yield because the counter argument as you said is that it is a pretty heavy borrowing year itself. Do you think 8.5% would be the top?

Wadhwan: I think I can put in a range of 8.35%-8.60% even with this kind of number. But the more the time passes and the supply is taken away by the market, you should see yields on the lower side rather than on the higher side. At the moment, policy rates are at 8% and bond yields are hovering around 8.5%. But the next push towards 8.25% could happen only with the actual rate cut happening.

Q: Do you think expectations for the whole bulk of the rest of the year should be opened up now in terms of the quantum of expectations for the rest of this year from the Reserve Bank’s side?

Varma: I think so, at 5.3% a lot of things change and it is not an easy call. Our expectation is that headline inflation that will come out in June, will be higher and core inflation maybe lower. So you have different economic variables tugging at different directions. RBI can either justify not doing anything or justify doing something. So it really depends on what their priority is. If they are still looking at headline inflation readings then that will not support a rate cut this time. But given the growth weakness, fall in crude oil prices and the global outlook, I think those cases would support a rate cut. I think it’s a very close call right now.

But in general, the expectation both from RBI and the finance ministry has been growth of 7.3% to 7.6% range. Clearly, those expectations are now going to get revised down. So the growth outlook for FY13 is now much weaker. The growth outlook is much weaker; crude oil prices are much lower. Expectations for the full year also will need to be relooked at.

Q: What does precedence or history suggest because the observation seems to be that when a number falls with this much moment, the next couple of quarters also see an equal amount of momentum in terms of a fall or an impact? Would you expect to see a much rougher next six months and how do you think something like the bond market would tide through that and something like the currency market would tide through that?

Chakraborty: That’s typically the case. I was anyway expecting the bottom of the growth cycle to be much flatter and now it seems that it could be even further negative than I initially thought. I think now there will be an expectation that will start getting built-up on rate cuts but the effect of rate cuts on currency is something, which is still pretty uncertain.

While there could be argument that this will prompt capital flows into the country, which are growth sensitive, at the same time, we lose the carry part and that can take rupee down further. So it remains to be seen which way rupee will be dragged because of rate cuts. That is still an open question. But I am sure that bond yields will try to head lower with expectation of more action from RBI.

Q: Have you started doing some mental calculations about how much you will scale down your FY13 GDP number now?

Varma: Honestly, there is a lot of uncertainty. I think there is a lot of global uncertainty right now; if the European issue gets sorted out then we will perhaps still grow at around more on the minus side but around 7%. But if the euro crisis does accelerate further then I think growth can be closer to 6% then we cannot even do 6.5% or 7%.

But I like I said, one should not overlook the effects of INR depreciation. When everything is going bad that is the absorption tool that will lead to some benefits to the economy over the next six-twelve months.

Q: It is early to start working numbers but what kind of contribution would you expect to see from these three parties in order to get anywhere near Dr Rangarajan's ambitious target of 6.5-7%?

Chakraborty: Arithmetic wise, it will now become very difficult to project 6.5-7%. Possibly we will be looking at numbers even lower than that range. But still, the details have to be worked out because clearly none of us factored in such a sharp fall in GDP for this quarter. It will filter into our forecast for next year as well.

Q: What are you expecting from the Reserve Bank of India now because that seems to be the hope that with such an ugly number maybe the RBI starts getting more dovish and cuts more aggressively?
Malkani: As far as rate expectations are concerned, our base case is of the RBI easing rates by 25bps. This takes into account what the RBI has been guiding over the last couple of policies, wherein it has expressed concern on 1) levels of suppressed inflation wherein the latest calculations indicate it’s at 4.2% level, 2) what's happening to food prices, 3) what's happening to pressures regarding wages as well as retail and 4) what's happening to the rupee.

Taking into account these goalposts, we expect that, at best, you could see one more rate cut. Now, where could we be wrong? We could be wrong if a) growth continues to surprise on the downside, b) oil prices come off further and c) if RBI again switches back to its focus on non-food manufacture products inflation where the latest prints are clearly heading towards its medium-term targets of 4%.


Q: On the core part of that puzzle though on inflation figures what is Citi penciling in, in terms of what we may likely see on inflation tick over the next couple of months?

Malkani: As far as inflation is concerned, our views remain unchanged from the start of this fiscal. We do expect that average inflation for FY13 would be close to 7.4% level and on the immediate near term, the print might be slight benign. We do expect post August-September, we could see the numbers inching up little bit.

This is again largely due to the fact that we are factoring in some price hike regarding fuel. Secondly, we need to take into account what is happening on the exchange rate front, thirdly, the impact of tax hikes. Food inflation remains to be a big problem for India. So taking into account all this, we expect the inflation to average around 7.4% for FY13.

Q: A lot of other details that have come through, one of the gross fixed capital formation which is at about 5.4% for FY12 and private consumption as well at 5.5%. Specific to the gross fixed capital formation, are you disappointed with that kind of reading? What did you have in mind?

Varma: 5.4% is actually alright. We were expecting close to 0% or slightly negative reading on the gross fixed capital formation side. What has happened in this particular quarter is if you are referring to the full year numbers, there has been at least in this particular quarter some narrowing in the consumption investment gap.

In the last four quarters, we have continued to see consumption picking up and investments slowing down. While the growth numbers are disappointing, what we need is a sustainable growth and a sustainable non-inflationary growth that cannot come about unless consumption falls.

While there will be a pain on the growth side because the investment slowdown is finally trickling into consumption, this is exactly what the economy needs. We are still seeing double digit CPI inflation, 7-7.5% WPI inflation despite the economy having slowed so much.

It will take some time for these slowdown in the economy to translate into lower inflation. But we need inflation to come down because RBI rate cuts will only lead to a temporary growth surge unless inflation comes down sustainably you will not see private investments pick up and unless private investments don't pick up you will not see potential growth actually move higher.

Consumption coming down is a good sign because it should ideally be a precursor to inflation also coming down. It should help us get a more sustainable long-term non-inflationary rate of growth which is what India needs.

Q: Typically how long does it take for the structural adjustment of consumption growth falling and thereby pulling down inflation? That is the period of pain that all financial markets will have to go through before inflation comes down and then eventually the cycle of restocking growth again happens.

Varma: I think typically the lag between growth and inflation could be anywhere from three to six quarters before you see the adjustment happen. The adjustment would have happened quicker if government consumption had slowed down.

We could have seen a better non-inflationary rate of growth. Unfortunately, you are not seeing that component adjusting at all, which is forcing the Reserve Bank to contract investment much more.

Earlier, you had mentioned that the Reserve Bank is the only institution that can actually get us out. At the same time, we need the government part of the puzzle to work because that is one of the main reasons why we are here in the first place.

Q: What is the experience on this inflation consumption growth connection, in a sense, when you do start seeing consumption growth falling off, how fast and how sharp is the cool off in inflation?
Varma: It depends. At this stage, I think there are still some reasons why inflation may not fall to 5-5.5%. The consumption fall we are seeing right now still seems to be the more rate sensitive consumption items. The non durable side may have moderated a bit but the rural side of consumption and the government part of consumption is not really that interest rate sensitive.

I think the slow down we will see in inflation will be more because of weaker investments which translates into lesser wage income growth as well as higher interest rates which bring down demand for consumer durables, maybe partly on the non-durable side.

But at this stage, the demand side management will prevent inflation from picking up back above 8% and it will help bring the core inflation down. I think to get back to 5% inflation level, we need a supply side response. I don’t think just pure demand management will get us down to 5% inflation.
Q: Do you think you will need to revise the GDP  target further down today?

Malkani: As far as growth is concerned, I would say that - how does India get out of this whole dilemma? Firstly, there needs to be some aggressive thrust on the reform front both in terms of fiscal consolidation as well as execution that needs to be done.

Secondly, India clearly needs a bit of luck in terms of lower oil prices as well as capital flows. The key message is that a combination of both will help India regain its past luster. But India clearly needs at least one of the above to even sustain its current growth momentum.

Q: What do the currency markets now focus on and how do you think that rating agencies might read such growth numbers? Do you expect any further news pressure on the markets or do you think that most of the pain has already been priced in the rupee?

Wadhwan: On the currency front, I think very important thing to look at is that in comparison to the Asian basket, we are more or less depreciating at nearly similar pace since 1 January across the other Asian currencies.

I think it is more to do with what is happening in euro and how the dollar is strengthening against euro versus and how the dollar is strengthening against other Asian currencies.

If that kind of a trend goes on, then you might see some more pressure on the INR. But if you see some kind of early resolve to the euro issue by June or July, you might see some kind of stability. I think the most important thing is that the rupee has not extraordinarily depreciated versus the Asian peers. So it’s more of a global adjustment.

The dollar has started strengthening for the last six or eight months and we are seeing the impact here. So from a basket point of view, it is not that bad. But the future course will depend on some of the points which have been raised. If we are lucky and oil is pushed down a bit more, it really helps us. Overall the way things are getting set, we are seeing such a low GDP number.

I think the focus of RBI would also move towards growth more after looking at these kind of things. Let's just hope rupee should stabilize, but I think it depends more on international events than on domestic things. On the domestic side, the important thing would be how our current account deficit gets reduced.

We have already seen some kind of a hint or some kind of numbers in the Q1 itself wherein the gold demand has gone down. If things fall into place and if we are able to manage our current account deficit for this fiscal between USD 150-175 billion, it could start helping stabilize rupee.

Q: Where do you stand on the rupee? What’s your target there?

Malkani: As far as the exchange rate is concerned, it’s a clear reflection of what’s happening at the macro level. We've clearly seen that the India growth story has de-rated.

This is a combination I would say of the various four deficits that are inflicting the economy. We feel India's current account deficit will come close to around 4% levels.

India's fiscal deficit, the combined state centers at around 8-8.5% of GDP. Thirdly, we have a big trust deficit and fourthly, what we have seen over the last 15-16 months or so is also a big liquidity deficit. As a result of all these deficits, we feel that it’s taken its toll on GDP growth, which is now likely to be in the 6-7% range.

Secondly, we feel it has taken its toll on the currency, which is down basically 25%. Thirdly, we've seen that on bond yields. Taking into account all this, we do expect it to trade in the 54-56 range in the next 6-12 months.

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