Need to put an end to ratings debate, says KV Kamath

The first quarter GDP numbers have come in at 5.5%, may be a little better than what many people feared. However, in the details are a lot of devilish facts. For one, private final consumption has grown by only 3.9%. That is the lowest since the new series of GDP started -- 2004-2005 -- therefore, the lowest in 8-9 years.

Likewise, capital expansion, gross fixed capital formation is up just 0.6%. Quite a bad number considering that in the last year also we were averaging about 4-4.5% every quarter so a bad number again.

But what will this mean in terms of how long slowdown will last, if both consumption and investments are down? Interestingly, according to Kamath, people still want to invest but there are constraints holding them up. “We are seeing it quantified for the first time this quarter. Despite that, 5.5% is not too bad a number because there were expectations that number would be even lower. I guess unless we get consumption and demand up, and as I said investment up, we will find it challenging to keep the momentum of growth going,” he told CNBC-TV18 in an interview.

But the bigger fear among economy watchers is the possible rating downgrade of the country, owing to the slow pace of reform. However, Kamath believes the rating agencies are not being fair towards India. He says we need to put an end to the ratings debate with a strong answer.

“In China's history, 10 years back, they had the same GDP, the same per capita income. The assets, which were under stress/non-performing, were 50% of the economy and we are talking of 4-5%. Let us put things in context and at that point of time they had a rating which was significantly higher than our rating today,” he explained.

Below is an edited transcript of his interview with Latha Venkatesh.

Q: Consumption has begun slipping and capex has been a non-starter for several quarters now. At this point in time, how far do you think is the slowdown, because it doesn’t look like a two quarter thing?

A: I have been always an optimist, but for the last couple of quarters my fear was that we will have a twin impact of consumption and investment slowing down. Very interestingly, this is not to say that aspirations have gone down. People do not want to purchase, it is that they can’t afford. It is not that people don’t want to invest; they want to invest, there are projects, but there are constraints holding them up.

Despite that 5.5%, is not too bad a number because there were expectations that number would be even lower. I guess unless we get consumption and demand up, and as I said investment up, we will find it challenging to keep the momentum of growth going.

Q: My fear is more with investment because a great deal of money is locked-in. The date of commencement for a lot of power projects come in by FY13 or FY14, and because fuel is not in place, do you think the worst of non-performing loans and the worst of half finished power projects is still in front of us?

A: Most of the power projects are in a way reckoned. They are reckoned because we already have 20,000 megawatts on coal and 5,000 megawatts on gas which is ready to be fired and largely not fired because of lack of fuel. So these have been already factored in. I don’t think this will make that much of a difference to the book of the banks. The number may go up, the restructured amount may go up, but that is already being talked about by the rating agencies. That is not my worry because given the growth opportunity in the economy, this capacity is going to be absorbed in no time. In fact, almost in every infrastructure area, whatever we throw at this economy is going to be absorbed.

My worry is that incremental assets are not there in the pipeline. There is nothing that the banking system has done in the last one and half years that warrants to say that in the next three years there are enough projects which will come and provide the momentum for growth, and I think we are reaching that critical point. It's like takeoff speed; if you don't takeoff now, you have applied the brakes, then you need to take corrective action and I think that worries me.

On the consumption side, because that's the other side which could push things, we are seeing the numbers indicate a slowdown. There again, if you look at any proxies, the interest in consuming has not gone down, but affordability has gone down. I think we need to address now the twin issues of consumption and investment.

Q: I agree with you that this economy can take as much of power as you can throw at it. You know that once the SEBs have the power to pay and once the coal is found, there will be consumption. But from here to there, if you have Rs 3.5 lakh crore of restructured assets coming in, you could see some serious decimation in terms of investors running away, rating downgrades. Could that be very serious next four-five years?

A: Let's take the number that you have said, Rs 300,000 - Rs 350,000 crore. We are talking of USD 50 billion. If you look at it in the context of our economy, that's less than 3-3.5%.

Let me put in context. At this point in China's history 10 years back, they had the same GDP, the same per capita income. The assets which were under stress, non-performing were 50% of the economy and we are only talking of 4-5%. At that point of time they had a rating which was significantly higher than our rating today. I think we have to put an end to this rating debate and actually give an answer to the rating agencies to say that you are not being fair to us. Look at what was the situation elsewhere and then tell us how far off are we.

I don't think that it's a challenge; to me it's a worry in a different context. This is signaling slowdown, and slowdown shouldn't go back to a level where things appear broken, where it takes time to fix and get it back on. Otherwise, I would think that yes, we need to watch this carefully. We need to see how to put that back into productive use, but the system can absorb this.

Q: Do you think that we have to contend with a rating downgrade sometime soon? The fisc is not moving and it has been warned. I agree there are other sovereigns with much bigger debt. Do you expect a rating downgrade? How serious is it for the economy?

A: I think that a rating downgrade is really shocking because there is enough evidence which the government has to present to these rating agencies..

I don't think that we are a profligate country in any context. Yes, we have run high deficits but they were created with a purpose of driving an inclusive agenda and has shown results. What is being witnessed is the impact of the high deficit on growth which has slowed down to the Prime Minister’s advisory council rate of  6.5%.

This is not the negative growth that we have seen in other countries that warrants a downgrade. And it is not as if our rating is at such high levels that they need to be downgraded. I don't expect it to happen.

Q: I am sure these arguments will be made by the Indian government as well but in the event it happens do you foresee the amount of stress? The last time such a threat was made by rating and other international agencies was in 1991 and India was forced to implement reforms.

A: These are separate issues. Though a rating downgrade would have serious consequences, I am not factoring that it into a base case at all. But moving on, the government has to assure the people and the world that it is taking action and I have articulated the areas that need attention.

Land, environment, mineral rights and natural resources are at top of the mind. The government needs to ensure that Coal India is able to supply power projects which will go on stream and don’t stall. Next comes tax and other related issues which I think will be resolved by the finance minister. But there are critical issues that need to be addressed.

The consumption index is a good signal and an improvement in the interest rate environment should get confidence back to push things through.

Q: How can you be so positive on interest rates?

A: My question to the economist is very simple - What is causing inflation? I have not heard anyone articulate that question. Once you know what is causing inflation you can then implement the appropriate solution. Till date, the interest rate has been the only tool that has been used and for almost 18-24 months it hasn’t worked and is causing other problems instead. So it is time for us examine other options and investigate the cause of inflation

Q: Can we afford more trouble due to inflation that will ensue with the demand for lower interest rates which will increase consumption at a time when the current account deficit is already 4.25%?

A: I don’t know. Despite your logical arguments, high tax collections have been a big surprise and over a 10-year horizon the country almost ran on a balanced budget. Till two years ago, we were on track. So, what has happened to derail the situation? But clearly, we need to get tax collections up. Tax collections are higher when the economy is booming. So, a cycle has been disturbed and has complicated the fiscal.

The current account deficit is driven by oil which is triggered by the exchange rate. The trigger for the exchange rate in India is the capital market which is determined by the state of the overall economy and the growth rate. The economic context has changed significantly and there are a whole set of new drivers at work and impacting the country.

Q: A lot of people may not agree with that argument.

A: The problem is that nobody agrees with my arguments which are proved right over a longer period of time. We need to understand the changed context.

Q: I concur that if growth was initiated, it will solve a lot - fiscal problems, the issue of investments and the yawning current account deficit.

A: I have a lot of sympathy for the policy makers. But, if the conventional approach doesn’t work, what do we do?

Q: You listed out a whole host of projects which are stuck for want of land, mining bans decisions by the lokayuktas, by the judicial system, and for not being able to resolve the distribution of coal to the power companies. Interest rate is not even at the centre of all these problems. What should the government do?  What do you advise?

A: There is clearly the impact of unresolved problems. But if you analyse the situation, there can be growth even with a lot of unresolved problems. Luckily, we have created enough capacity to give us breathing room.

Over the last three-to-four years in every infrastructure segment we have created adequate capacity to give us breathing room for only another two-and-a-half years. The government has to start taking action over the next six-to-twelve months by getting Parliament to carry on with the task of making laws and running the country.

Q: You mentioned that there will there be concrete policy takeaways. Comparing the 1997, 2003 slowdown to the current slowdown are we better placed, or are we worse off?

A: We are significantly better placed. We had an Indian economy which was leveraged at 4:1 to 4.5:1 total debt, both long-term debt and short-term debt at that point in time against the Indian economy which is leveraged maximum at 1.5:1 or 2:1, it is slightly higher for infrastructure projects.

Q: It is only 15 if you only take the top 10 infrastructure groups?

A: Infrastructure sector is on a different premise and we need to look at it differently. Historically, we were looking at that point in time, 10 years back only.

Q: You mean it’s not an endemic problem?

A: It’s not an endemic problem. Indian companies have scale, they are globally competitive, today they have good quality and can compete anywhere in the world; it’s completely different. The consumer today had affordability, so he was able to had aspirations and affordability, today there is a distortion in the affordability equation but that will come back. So, today’s situation is far better than what it was 10 years back.

Q: What about the government, fiscal deficit we have not moved an inch on it. Do you think we are in for something very severe, some big disaster in terms of investors quitting the country if we didn’t move at all? Would February of 2013, bring in some really serious consequences because we have not even moved an inch on what everyone is watching, fiscal deficit?

A: It’s as a chicken and egg problem in the sense what will drive investors away, will the fiscal deficit or lack of growth drive them away.

Q: At the moment the focus is quite clearly on fiscal deficit, I hear that the growth has been accepted?

A: It’s not driving them away, it’s getting the investor in because if the investor is in then there will be no corrections that is needed on a whole range of items starting with the exchange rate, you are not going to get that. Getting the growth momentum up is an issue today. Today, we have an outstanding finance minister to manage the fiscal deficit; previously he did a balancing act which nobody thought was possible. I am sure that we will see best efforts on this but growth is something we cannot afford.

Q: The Reserve Bank put out a number and if we don’t move on subsidies as of today, given the current crude price then fiscal is quite clearly 5.6%, which is assuming we will get the tax revenues. So if we don’t even get that then we are heading towards 6%. Do you see any movement at all and if it doesn’t happen?

A: I would leave it to the finance minister because he has done this in the past; let us see what the ministry comes out with.

Q: Post Lehman crisis, you said that when growth falls below 6%, it could be a start of unemployment and now you are heading two big industries, which are big employers banking and IT. Do you fear that if we have a sustained sub-6% growth it will mean unemployment then there is a lot of social unrest?

A: This would worry me and this is one of the reasons I am in a exhorting that let us not get growth to dip below 6% because then pressing the accelerator, changing gears will become harder. Again, it is not just banking and IT services industries. It is also significantly in infrastructure building where employment is provided, particularly at the bottom of the pyramid. Now, that is already impaired to some extent that employment generation capacity. I don’t think we can afford to impair it any more.