Tamiur Baig of Deutsche Bank tells CNBC-TV18 that the dangerous combination of low growth and high inflation will not last past 2012. “Either low growth will bring down inflation or we will see growth begin to pick up and that would somehow be precipitated by supply side response and inflation will become manageable,” he explained in an interview to CNBC-TV18.
Inflation for April came in at a shocking 7.2%, much higher than analysts’ expectations. Baig believes that supply side factors have started to weigh on inflation again, however, he is more worried if shocks materialise. “If you don’t have any shocks and yet we see food prices jump up, what would happen when actually shocks materialise,” he questioned.
Given what happened with inflation, Baig says that he doesn’t expect easing from the RBI in June. “I really cannot see what local factors can precipitate the RBI to make a move now given what has happened with inflation,” he elucidated.
While domestic factors aren’t encouraging enough for a rate cut, Baig says a big slowdown in global growth or a big decline in oil prices could lead to a response from the RBI. “Short of an extreme scenario like that, it is very hard for me to see under which circumstances RBI will be able to cut rates in June,” he said.
He further adds that the central bank is not too worried about credit growth at this point, but will use all tools available to ensure that liquidity in the system is at comfortable levels.
Q: What have you read into the inflation figures yesterday and do you think this is a start of a big snap back on inflation ticks that we may see?
A: It may not be return of a snap back, but it is certainly worrisome. It is not just the WPI inflation as you have seen but also the CPI that is showing high pick up in prices. We have also seen purchasing managers index (PMI) showing renewed pressure on their raw material costs as well as their upward costs. This is again demonstrating that even if demand is weak, the supply constraint nature of India is so severe that we can have low growth and high inflation for the next few quarters.
Q: What worries you more – manufactured inflation, which ticked up a bit, or food inflation which is consistently higher and is showing alarming signs again?
A: We don’t have any poor indicators for monsoon, we don’t have any news about supply side disruption and despite that we have seen very big pick up in a host of food product prices. This is indeed worrisome, because if you don’t have any shocks and yet we see food prices jump up, what would happen when actually shocks materialise. What if rains end up this year being lower than the long-term average? So definitely inflation will remain a source of concern for years to come, not just in this particular cycle or this particular quarter.
We were hoping that we will see some respite this year because growth was going to be significantly below trend. I am afraid we are beginning to see that that is not going to happen. There are two additional worrying factors for inflation. One is this incomplete pass through of fuel price. If we see diesel and kerosene forced up later this month or next month, that is another source of inflation. The 20% year on year decline on the rupee will push up the rupee costs of imported materials.
Q: There will be some more data points before the RBI speaks in June. Do you think it will be able to move again or given what it is seeing on inflation it is very unlikely that they will move on rates in the June meeting at least?
A: It is very unlikely; I really cannot see what local factors can precipitate the RBI to make a move now given what has happened with inflation. It has to be something external. A big slowdown in global growth or a big decline in oil prices because of some pick up in risk aversion that could lead to a global response from the interest rate side and RBI might be a part of that. But short of an extreme scenario like that, it is very hard for me to see under which circumstances RBI will be able to cut rates in June.
Q: So what looks like the more likely outcome that they do in terms of easing up liquidity that is keep attacking the CRR but hold on rates?
A: Open market operations (OMOs), CRR whatever is necessary to ensure that transactions in the economy are taking place in an orderly manner, that there is no credit crunch.
I don’t think the RBI is particularly worried about credit growth per se, I think that is a function of how much demand there is in the economy. Real interest rates are not particularly high, they are zero or slightly positive in India, so what really matters is liquidity. For example, whether the government spending is being matched by the system’s demand for liquidity. If there is some imbalance there, then surely RBI has the tools and ability to inject additional liquidity.
Q: Will growth decelerate further and push the RBI into acting more on rates, or do you think it is inflation which we should get worried about in the second half?
A: What sort of data points would RBI have at its disposal when it meets in mid June? It will have the January-March growth data, which will be lackluster but not particularly horrible. It will be in range of 6.25-6.5%. It will have little more indication on core infrastructure and what is going to be IIP for the month of April, but those are not going to be make or break in either direction.
So for the second half of calendar year 2012, it will have to be external developments for the RBI to be motivated towards doing anything on the rate side. Short of that, it will try to keep rupee stability, it will try to keep liquidity ample and beyond that not a whole lot more than RBI can do at this point.
Q: From an India watchers point of view, can you recall instances in the past where we have had this dangerous combination of low growth but high inflation, how the economy panned out then and what kind of approach you saw from RBI?
A: We had a temporary manifestation of this during the 2008 global crisis when we had growth coming down in the latter part of 2008. At that time, inflation had not fully come down yet, but that lasted for just a quarter or so. By early 2009, we saw inflation collapse.
Nothing can exist in a vacuum; you cannot have quarter after quarter of weak growth and high inflation, something has got to give. Either low growth will bring down inflation or we will see growth begin to pick up and that would somehow be precipitated by supply side response and inflation will become manageable.
I see this very toxic combination that we have right now, below 7% growth and higher than 7% inflation, lasting perhaps in 2012 but not beyond that.
Q: Do you have a view on the rupee; do you think RBI will be successful in reigning in this depreciation around 54 kind of levels?
A: I think it depends on the resolve of the central bank. If the central bank is firmly of the opinion that they don’t want to allow the market to overshoot and don’t believe that rupee beyond 55 to the dollar is something that is helpful to the Indian economy, I think any monetary authority or financial authority has enough tools in its arsenal to ensure it happens.
The question is, is it really worth it? At what cost do we shut the capital account down? Do we create sundry requirement for all of export earnings? There are tools that can bring in rupee stability, but the question is whether the RBI is prepared to go to that extreme.
Right now the RBI is trying to have it both ways, which is allow the exchanges to move on day-to-day basis to some extent and then come up with capital account measures that allow for one-off improvement in the capital flow situation. I think what matters now is also something that has to help India from the external side. If we don’t see oil prices come down further, it is hard to constructive on the rupee.
On the other hand, if the problems that we are seeing in Greece spread all over Europe, it is hard for me to see how oil prices remain high. Under a low oil price environment India gets bailed out; fiscal get helped, balance of payment get helped and that would net-net help the rupee.
Q: There was a bit flutter over here after the S&P announced they were putting India’s rating under watch. Given what you are plotting for the next 6-8 months, would you say the risk some kind of rating downgrade has increased or remained static?
A: I don’t think growth going from 7.5% to 6.5% changes India’s ratings outlook. The debt sustainability of India remains extremely favourable given the gap between real economy growth rate and real interest rate. We would need to see growth go below 6% and normal interest rate go in double-digit territory before debt sustainability becomes an issue.
I cannot read S&P’s mind, but I would think that a ratings agency would look at factors like that before becoming particularly negative on India’s debt sustainability.