Analysts have cut India's FY13 GDP forecast on concerns of a tough economy riding on weak market, sliding rupee and widening of fiscal deficit. Jahangir Aziz of JPMorgan explains that India's monetary and fiscal policies are extremely loose.
In an interview to CNBC-TV18, he said, "The reason why India has high inflation is because growth is running far ahead of India’s capacity. This is largely because monetary policy and fiscal policy both are extremely loose." He also warns that analysts will be forced to lower growth rates, if euro crisis worsens.
Recently, Goldman Sachs too cut its FY13 gross domestic product forecast to 6.6% from 7.2%, citing a weaker investment outlook due to domestic policy uncertainties.
However, the big concern is about the second half of FY13 as inflation is likely to start spiking in April itself at the end of the base effect. "Inflation rate could go to 9% by July," Aziz adds. Rupee may even sink to 57-58 per dollar in the absence of a policy change, he points out.
Batting on diesel price hike and strong policy reforms, Aziz stresses that there are lot of politically insensitive measure that the RBI and government can implement but not willing to.
"If we get a 10% increase in diesel prices, I think you might see quite a bit of support coming, atleast in the short run to the rupee. That will actually convince people that the government is willing to bite the bullet and take the tough measures," he elaborates
Below is the edited transcript of his interview with CNBC-TV18's Sonia Shenoy and Ekta Batra. Also watch the accompanying videos.
Q: Goldman Sachs lowered its GDP growth target to 6.6%. What are your thoughts on this? Would you be scaling down GDP targets for the year or would you wait for Q1 GDP numbers that come out next week to make that assessment?
A: I am going to wait for next week’s GDP numbers for Q1 to come out. Our sense is that however bad the situation looks, Q1 of this year will actually be better than Q4 of last year.
There is some momentum going through. We have seen new export orders and the PMI shoot up. If I do scale down GDP, it won’t be by much. I might just go below 7%. We are just above 7% now.
I think the bigger concern is what happens in the second half of the year, how Europe pans out. If European growth is brought down much more then the support one expects from exports won’t be forthcoming to the same degree, and then we would be forced to reduce the growth rate a lot more.
But we need to get over this next one-two months hump that we are witnessing and get to a point where the rupee stabilises and we get some sense of which direction policies are going to go to. That will be key.
There are a lot of things that is being held back because of political sensitivity. But there are a whole lot of things that the government can do that is politically insensitive, which the government or the RBI is still not willing to do.
Q: What does that really do to inflation? A lot of people have now scaled up their inflation targets as well. We are expecting to hear about some sort of diesel price hike anytime soon. How much pressure this will put on inflation? Do you think the next number will look uglier before the June policy comes out?
A: We have had extreme view on inflation, since March of 2010. Our view hasn’t changed. Our view has always been that the reason why India has high inflation is because growth is running far ahead of India’s capacity. This is largely because monetary policy and fiscal policy both are extremely loose.
We expected inflation to start spiking in April itself at the end of the base effect. That’s exactly what the inflation has started to do. We have two diesel price hikes for the rest of the year, amounting to about 10%. That could happen either in two parts or it could happen in one part, if the government is brave. But based on that, we already had an inflation rate going to about 9% by July. We are still sticking to that trajectory.
We think that the 7.2% April print will likely be revised up to 7.5-7.6% after the usual revisions are done. The inflation is on track to reach about 9% by July. So, we are really not changing our inflation view. We are sticking to 9% peak of inflation, somewhere around July.
Q: The other thing, which has been spoken about, is the subsidy burden and what exactly might happen to the fiscal deficit situation. Hypothetically, say we do get a diesel price hike anywhere to the tune of around Rs 3-4 per liter. What do you think is the relief that we could see on the subsidy burden then?
A: The Budget has about Rs 43,600 crore as the amount of subsidy. If you assume that oil averages about USD 100 a barrel, not even USD 120 a barrel, for the rest of the year and the rupee averages around let’s say 54-55 for the rest of the year, the amount of diesel price increase that is required in order to just keep to the subsidy of Rs 43,000 crore is about 10%. So, at the minimum, you require 10% increase in diesel prices just to keep to the subsidy. In order for the government to reduce the subsidy, it means more than that.
If we get a 10% increase in diesel prices, I think you might see quite a bit of support coming, atleast in the short run to the rupee. That will actually convince people that the government is willing to bite the bullet and take the tough measures.
Q: The other point is that you along with a lot of economists have written in reports that there is some hope to see some support on the rupee. In case we do get some policy action from the government, we did get a petrol price hike and we could be expecting a diesel hike. We are hopeful about that. How much do you think it could actually support the local currency, if incase these things do culminate?
A: If the government actually goes through the petroleum price hike, we still don’t know whether or not in response to the opposition the government might not rollback the petrol price hike. I think that would be the first step. I think the diesel price hike is key because that really is something that will test whether the government is willing to bite the bullet and go through with difficult politically controversial reforms in order to make sure that the fiscal is in order and that more reforms will be forth coming. So, I think it’s an important signaling device. So, I think all eyes are on that.
But beyond that, I think there are lot of things that the government can do to support the rupee, that are non controversial in a political sense, it might be controversial in economic sense, but is non controversial in political sense.
Q: What about the RBI? What more do you think the RBI can do at this juncture to defend the rupee? Every option that they have used, be it curtailing the arbitrage trades, EEFC accounts etc, doesn’t seem to be working.
A: The RBI is going around in circles trying to do things that are associated with defending the rupee without defending the rupee. Even if it doesn’t want to use up its reserves, I think that the manner in which it has used reserves as a way of defending the rupee that really hasn’t helped. It has already used about USD 25 billion odd in September. It’s always happens in little dribs and drabs rather than as a strategic coordinated effort.
Even if you leave that aside, if you look at the playbook, that almost everyone follows, when the currency is under pressure, it’s basically raising interest rates. RBI hasn’t actually done that, isn’t even talking about it. Just about a month and half back, we actually saw a 50 bps rate cut taking place.
If you look at the two countries in the EM world who actually has suffered the most in the last one month is the Brazilian real and the Indian rupee. The two of them are vying to who will reach to the bottom first. Both of them are based on policy weakness and in both cases we have seen actual rate cuts being the trigger with this very large move. Until and unless RBI decides to defend the currency with what is conventional, what is step one, I don’t really think that other things can be done to support it. But ultimately they have to do an intrinsic defense.
Q: Realistically, where do you think the dollar/rupee could be at by December 2012?
A: The government could very easily raise the FII limits on government securities from the 10-15 billion, we have now to let’s say a very large number 50 billion. It could cut down withholding taxes and do things like that which are important to bring back capital flows back and if you add to that reforms etc, let’s say after the presidential elections, the rupee could get supported.
But my sense is that in Q3 and Q4 of this year the rupee will again slowdown. We do expect the rupee to somewhere be around 57-58 thereabouts, I am not sure whether its going to be exactly end of December. But on current policies, it looks as if the rupee will be at 57-58. Otherwise, if the government does bring about policy changes then we could see some significant support to the rupee and the rupee could be much more appreciated than that. So, everything depends on what the government does in the next one to one-and-a-half months.