Jan 28, 2013 12:12 PM IST | Source: CNBC-TV18

See 25 bps cut tomorrow; expect friendly budget: CLSA

As the street gears up to hear the Reserve Bank of India announce its first cut in prime lending rates in nine months, Rajeev Malik of CLSA said based on whole sale price index (WPI), a 25 bps cut can be expected tomorrow.

As the street gears up to hear the Reserve Bank of India announce its first cut in prime lending rates in nine months, Rajeev Malik, senior economist at  CLSA feels the RBI should approach a cautious stance ahead of the Union Budget.

The central bank had last reduced policy rates by 50 bps in April 2012. As the inflation rates stayed above the comfort zone of 5 percent, the subsequent five policy reviews saw the RBI maintain status quo on the rates front.

In an interview to CNBC-TV18, he reasoned that uncomfortably high CPI will prevent the apex bank aggressively ease rates, but based on whole sale price index (WPI), a 25 bps cut can be expected tomorrow. CLSA continues to expect a cumulative 100 bps rate cut for the year.

Malik firmly believes that a pick-up in real economy will be gradual and there is no reason to up FY14 GDP growth forecast yet.

Speaking about the impending Budget, Malik said the finance minister has already raised hopes and FY14 budget is likely to be investor friendly.

Below is the edited transcript of Rajeev Malik’s interview with CNBC-TV18

Q: What are you expecting tomorrow from Reserve Bank of India (RBI)? 25-50 bps rate cut or the outlier no change?

A: There really has not been any change in our thinking for the last several months. It is still a quarter percentage point. The justification is more in terms of the better than expected Wholesale Price Index (WPI) inflation number, which we have seen. What clearly argues against a more aggressive 50 bps is still uncomfortably high Consumer Price Index (CPI) inflation number. Bear in mind in India’s case there is always this which index you look at to decide how bad or good things are.

Here RBI should come clean and give a more direct answer, because when CPI inflation is at over 10.5 percent that is roughly almost twice the pace of real gross domestic product (GDP) growth there is really no reason for any central bank to actually cut rates. But because RBI follows a certain idiosyncratic preference for WPI that actually argues for a quarter percentage point rate cut, not to mention some of the long overdue measures we have seen from the government in trying to get the fiscal house in order, which remains work in progress.

Q: Any chance the RBI reins in the enthusiasm, sees what March delivers and then takes a stronger call on rates?

A: I would not rule it out, but I do not think that is perhaps the more likely outcome. Bear in mind what is far more important is what eventually happens on the implementation front not in what the budget actually shows in print. My own sense is the budget is going to be a paper tiger.

The Finance Minister has already talked up, the market has raised a lot of expectations and if he stays to the kind of guidance he has given, which is actually not that difficult the question is going to be can he implement it to ensure that there are no slippages.

Given the fact that it is going to be the last Budget before general elections the approach is going to be you present a budget that investors want to hear and then if the slippages are there so be it. The government can think about fixing it if it comes back, if it does not come back it is not its problem.

Q: Any change to what you expect to see on rate cuts through the course of the year though, either in terms of the inflation trajectory or what you have seen so far on policy moves like diesel etc.? Have you changed your entire year’s outlook at all?

A: No, we still continue to expect a total of 100 bps of repo rate cuts this year. Bear in mind, RBI has very little room in terms of moving fairly aggressively as far as cash reserve ratio (CRR) is concerned and that is to do with how the Liquidity Adjustment Facility (LAF) is managed. Its single policy rate at the repo level requires the system to be short. We can debate about the magnitude of course.

Also, our view remains globally that over the course of the year commodity prices are going to be a touch softer which then feeds through to the broader inflation metrics as far as India is concerned. What works in the reverse manner is really trying to address some of the suppressed inflation issues in India and that will clearly play role of a critical headwind, but is it going to necessarily step away from further rate cuts, I do not think so.

First the Budget, if the Finance Minister comes through and shows 4.8 percent for FY14 there will be fair amount of debate about how he gets there, but that opens up room for RBI to be a bit more aggressive. It is also important to bear in mind how one thinks about some of these moves on the fiscal front which have a near-term impact on inflation.

You really have to look at it in a more pragmatic positive like that once these one-off adjustments happen, over a period of time your medium-term fiscal outlook actually would be a touch better and hence inflation positive.

Q: How strong is the case for a 50 bps rate cut tomorrow? It is an expectation that not many people have, but some people do. Do you think what the Finance Minister has been saying and doing on diesel etc. may even prompt the RBI to go out and move 50 bps or would you rule out that possibility?

A: I personally would rule it out for the simple reason one has learned the hard way and this includes the RBI as well that you always want to see the money. Talk is cheap. Show the action. So the Budget is going to be the big elephant in the room. There is really no reason why RBI should pre-empt that kind of a setting.

Recall what happened last year. It is fairly justified if they move in a smaller dose now and then wait and see what the Budget etc. shows they can always come back with a more aggressive move later on. The chances of a 50 bps rate cut are actually a lot smaller than RBI not cutting rates at all.


Q: Do you see relaxation of Foreign Institutional Investors (FIIs) ceiling on government bonds having significant impact on the rupee or the bond market in days ahead?

A: Incremental impact, yes. Do not forget this is not the first time this limit has been increased and despite the increase rupee has remained in the doghouse and that essentially should tell you along with the fact that in 2012 we had a pretty chunky FII inflow total both debt and equity in excess of USD 30 billion and rupee has still continued to suffer.

So our trajectory for rupee really was by the end of the first quarter closer to around 53/USD, but over the course of the year it begins to slide again and will end closer to 57/USD. I do not see any reason to change that at all. While the government is moving a bit on the fiscal front, its thinking about the rupee still remains a bit of an enigma to me.

Q: On the policy parameter scale though would you rate the last few months as higher in terms of delivering something and have you at all had reason to relook your GDP targets or fiscal deficit targets or even to give the GDP growth an upward bias now?

A: On the growth front, no. The way I would summarize while giving the government and the Finance Minister in particular a fair amount of credit for some of the overdue actions that have been put through, mood locally was much worse than on the ground reality up to September last year. Thereafter mood is actually a lot better than on the ground reality. The critical difference is really how the equity markets have been rerated.

The very fact that earnings growth expectations have not really altered tells you that the real economy is going to take a bit more time to change gears. I do not think what the government has announced really can be used as a reason to upgrade GDP growth forecast. I know industry lobby groups have a different way of thinking always, but it does minimize both what the fiscal slippage potentially could be and the fact that rating agencies are not necessarily going to pull the trigger.

My own sense is even if the Finance Minister presents a 4.8 percent of GDP fiscal deficit for FY14, rating agencies should wait a few months to see how it is actually playing out. Putting something on paper and not necessarily following it is an old art form in India.

Q: What are your own channel checks showing up both in terms of industrial growth and infrastructural growth? A lot of companies have been suffering on that accord - either there is not enough project clearance or some other problem.

A: I think that is very correct assessment. It is a fair assessment. One of the most disappointing aspect and I am surprised there has not been much talk or analysis of it is that what we have eventually see of National Investment Board (NIB) in its avatar as Cabinet Committee on Investments (CCI) in the process it has lost a few teeth. It is not really what the original intent was.

It remains to be seen how effective it can be with getting things done as far as on the ground momentum is concerned. The second aspect and I must say it boggles my mind why not more assessment is put into it - while everyone is happy that the government is finally addressing some of the fiscal slippage issues what people overlook is what the fallout of this is going to be and consumption at some level has to be one of the areas which will suffer.
Do not forget India has two lopsided macro balances it needs to fix.

One is consumption is a lot stronger than investment and the second is fiscal is a lot looser while monetary is a lot tighter. These shifts are not going to be smooth by any stretch of the imagination and all this is happening in a global environment which can literally flip on a dime. So while encouraging moves by the government some of the underlying adjustment fallout is something that continues to be ignored and I must say I find it rather surprising.

Q: There have been some recent moves on import duty on gold etc. as well. Do you still worry about where the Current Account Deficit (CAD) will be next year?

A: I worry more about capital flows. Since 2002-2003 while the current account has continued to widen what made really the difference whether that was a stress point or not was the magnitude of capital inflows. We are really like a moving comet with many different issues that are not in our control.

Rather than focusing on raising import duties on gold, what is more essential is why there is such a high surge in demand for gold by Indians after the global financial crisis. It is not just a cultural factor; there is something more fundamental at play. I

t has a lot to do with India, because other countries do not show this and there is really nothing getting done to fix it. There is a very mechanistic approach of raise import duties and hopefully that will be solved, I would be surprised. More importantly, if for whatever reason globally capital flows slow down they do not even need to reverse, even if they slowdown the knock on impact on the currency is going to be quite substantial.

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