RBI should be cautious on exit policy: Uday Kotak

Q: Mr Raghuram Rajan, last week, said, "We are nowhere close to any situation. I only see the rupee recovery as a rebalancing of the rupee so to speak, I don't think we should get concerned." Where are you in this debate on whether India needs to start moving towards even talking about not imposing any but talking about some sort of capital control if at all? What should the nature of that capital control be?

A: India's absorptive capacity on foreign exchange has improved over the last two-three years. Therefore, India can absorb more foreign exchange in 2010 than it did in 2007. Up to USD 50 billion of inflows, both in foreign direct investment (FDI) and foreign institutional investment (FII), can be absorbed by India. We need to think about absorption issues post that number. If we reach that situation, then I would have an market stabilisation scheme (MSS) kind of an approach rather than a tax approach, which may be more appropriate for India.

Q: What repercussions does it have on interest rates?

A: It again puts pressure on the fiscal deficit because the government is funding that interest, which is something we should be more ready for rather than taxing flows.

Q: Why do you think our absorptive power has increased?

A: It is because a lot of infrastructure projects are underway. The size of the economy is larger than what it was three years ago. We have not borrowed that much money from the global markets over the last twenty-four months. Therefore, to that extent we have greater ability to absorb. Corporate India is in much better shape in terms of its leverage ratios due to equity markets giving them funding. So I believe India can take more money today than it did three years ago.

Q: When is the music going to stop?

A: India will actually see a wonderful tug of war between flow of money into Indian equities and supply of paper by Indian companies wanting to raise capital. It is this tug of war that is good for India. If companies can raise this money, they use it productively for building capacity and if the game plays out, the markets will not run away. We probably won't see an asset bubble. At the same time, we will have a lot of capital raised for productive use. Therefore, encourage supply of paper when supply of money is going to be good. This is the best way for India to go forward.

Q: If the disinvestment indications are coming from the government, does it mean a diversification in that kind of paper? That money is not then channelised only towards 10-20 hot stocks. Is it actually spreading itself across various companies and different asset classes?

A: Our internal working shows that in the next twelve months the government and the companies want to raise capital of USD 40 billion.

Q: Can we absorb that much money safely?

A: Absolutely, USD 40 billion is a tough number to raise. Therefore, if there is a good flow of money into equities and a good supply of quality paper, you have a perfect landing for India.

Q: What does that mean for the way the markets have increased in the last few months? On the kind of companies money is going to go to, does it mean a slower rise in the markets over the next six months? What will be your anticipation over the course of next six months?

A: Quality companies must take this opportunity to raise money. At the same time, from the government point of view, as this flow comes in, I would not advise a tax but an MSS down the road. However, let the flows happen, let India get greater ability to absorb capital flows, let companies raise capital and put up capacity. India will go to 9-10% GDP growth in the next two-three years.

Q: Don't you think where an asset bubble situation is right now?

A: No. I have great confidence in Indian companies' ability to supply paper as markets move up.

Q: Where are we going to use the capital which they raise? We are in a situation of oversupply and overcapacity in many industries. We haven't seen the demand come back to that level. Are you expecting demand to come back to that level in the next year or two?

A: Right now, the need for capital is really infrastructure and high capital investment sectors because consumption is moving well ahead of the investment cycle, for example sale of cars. Therefore, we need to create the backlog capacity which can make and support higher levels of consumption. If we do that, supply will in fact also address the question of inflation, because you need to create capacity ahead of the demand. You will take care of the inflation issue, which is essentially in India supply driven issue.

Q: Are you seeing real demand kick-in? Till now many people thought that it was just inventory restocking that was going on. However, real demand is seen not just in auto which has had a spectacular quarter but in other consumer goods, infrastructure and all of that.

A: Absolutely. The other day I told a global institution that car sales in India have gone up in October more than 30%. However, he looked at me and asked, "Where are the roads?" So we need to have the roads.

Q: It means that at least Uday Kotak believes that the next six months we are not going to see any prolonged disruption in the equity markets. Do you believe we have enough paper coming into the markets to be able to absorb the supply of money?

A: Absolutely.

Q: We definitely don't need to look at any kind of capital controls or anything right now to keep the paper supply going?

A: That is my view and if there is excessive capital flow, use the MSS route, as we did a few years ago, rather than a tax route.

Q: The Fed, in your assessment, will start reacting to the situation two months from now or the second half of next year?

A: I believe in the second half of the next year.

Q: When do you think the Indian Central Bank will have to start moving? Will it be in January, February, March or maybe later than that?

A: I believe that it could even be December or January for some early signals in terms of making sure that inflationary expectations get under control. However, as long as they are small steps and non-disruptive, Indian markets will absorb them and take them in their course.