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Apr 27, 2013, 03.55 PM IST | Source: CNBC-TV18

Will RBI agree with Rangarajan' s portrayal of economy?

All eyes, whether corporate, industries or foreign investors are on Reserve Bank of India’s next move, with hopes that the central bank will oblige this time to pull out the economy out of its slumber by providing much needed rate cut in its next monetary policy on May 3.

With the Prime Minster's Economic Advisory Council (PMEAC) expecting the economy to grow at 6.4 percent this financial year and headline inflation falling to 5.96 percent in March (first time in 40 months), speculations are rife that the Reserve Bank will chip in with its bit by announcing a rate cut.

However, many experts do not think the growth projections of PMEAC chairman C Rangarajan reflect the real picture of the economy. In a CNBC-TV18 discussion, most experts find Rangarajan to be overtly optimistic. They also maintain that RBI will ease rates by 100 bps over this financial year and the quantum of rate cut may vary.

A CNBC-TV18 poll on possible RBI action on May 3 shows  majority of the respondents expecting a 25 basis repo rate cut and another 20 percent seeing a cash reserve ratio (CRR) cut.

Also read: Policy inertia, not low investments, stalled economy: PMEAC

Advisor to the government Dr Parthasarthi Shome, Bank of Baroda Chariman Mundra, Larsen & Toubro CFO Shankar Raman and the Bank of America Merrill Lynch Economist Indranil Sengupta discuss the implications of Rangarajan's optimism and what the RBI can do under the current scenario.

Below is the verbatim transcript of the discussion

Q: What’s your sense? Rangarajan committee puts GDP at 6.4 percent, the Budget had also forecasted similar number. Do you think the economy will be 1.5 percentage points better in FY14 than in FY13?

Sengupta: We are less optimistic. My view is that we can do around six percent growth if we get a normal rain. We are looking at about 60 basis points of growth from a normal rain. Our view is that the economy is has slowed 300 basis points, 150 basis points was global, it won’t come back, 75 basis points was because of RBI tightening that can reverse, 50 basis point was because of slower capex, I don’t expect that to come back either till the elections, and 25 basis points was bad rains which seems to be reversing. So maybe something close to six percent seems more doable.

Q: Do you think that we can really do 1.5 percentage points more, 6.4 percent in the current year?

Shome: I do feel that it is achievable. Why do I feel that? Firstly, last year’s growth was slightly lower than we had expected. So the base is lower, so you have to adjust for that. Secondly, if you look at the Budget, there are some real incentive oriented measures there. If you look at the plant and machinery incentive - Rs 100 crore to be written off over two years, you are getting a tremendous amount of incentive. In construction, any house that is costing Rs 40 lakh, full interest on Rs 25 lakh loan being written off for one year. So there are some incentive elements. While corporate income tax has been given a slightly higher surcharge, over as two points, the incentives of the major multiplier generating sectors should have an impetus. I don’t think prior to the Budget, these kinds of elements were fed in and now they are being fed in. Plus, we will get some more foreign direct investment that had been occurring. So all of these things put together, plus the inflation control, leads to some policy space through the year. So I am quite confident that it should be okay.

Q: At the moment what is the feeling on the ground? Are things moving at all? Is more business getting done not necessarily for Larsen and Toubro (L&T), what is the sense you are getting, will we do more in terms of output, 6.5 percent more in terms of output in the current year?

Raman: The growth that is being projected seems on the optimistic side as far as we are concerned. These are observations based on the ground development. The reason why I am saying this, is we are currently running at about 4.5 percent and historically if you look at the statistics, the first two quarters of the year and one of them being a monsoon quarter are not very high growth prone quarters. So, if the economy has to reach 6.5 percent by the end of the year, it has to clip closer to 7 percent in Q3 and Q4, granted that those are closer to the election periods, so there would be some government expenditure but for the investments to take shape in terms of financial closures for capex ordering, job creation, I think all of that to happen between now and Q3 and Q4 looks a bit optimistic. My guess is it could be anywhere between 5.5 and 6 percent as we see things on the ground today.

Q: This estimate of 6.5 percent growth, we must put this 1.5 percentage point increase in perspective. If FY13 growth was 5 percent we are actually looking at a 30 percent more output in terms of pace of growth incremental growth. Is the banking system giving you that kind of demand for credit at all?

Mundra: While I agree that as of today there are not many discussions about the new projects coming on ground, but there is one clear perception that compared to what was the situation few months back, today obviously in the concerned circle the level of optimism is certainly more. People are still little on watch mode looking at the various developments. Having said that what is more important is that we have a large amount which is under different stages of implementation. There are a large number of stalled projects where the capex itself is quite substantial. According to some estimates Rs 7 lakh crore worth of projects are in various stages of commencement. This is one area that has received quite a focused attention from the government in past few months; finance minister himself was assessing the situation. My point is that even if good percentages of these projects, if they get going that will also bring a capex cycle and that will create that kind of demand of the capital goods and all that which can certainly add to the growth in economy.

Q: We have not yet been able to solve coal linkages for instance, coal price pooling, how many times we get these false starts and then nothing happens. Discoms being able to buy more power, have we resolved any discoms problems? Some electricity distribution companies have raised their tariffs by 30 percent, but that after sleeping for 10 years. We are nowhere near getting to even the cost of the power that they have to pay if you look at the actual costing of power in the country now. The point is at the moment there is an intention to disentangle, but there is no result on the ground. So, are you really sure that bank credit can grow or new projects will really knock at the door?

Mundra: I agree, you made quite a few points and I can’t just simply brisk aside that all these are very pessimistic kind of notes, but having said that let me tell you that at least in last few months or even in the recent past there had been couple of developments like some of the Central Electricity Regulatory Commission (CERC) award’s which are given in respect of the power projects or the mining issues they have been sorted out to some extent. Issues are numerous, I wont say that all of them can be sorted out in one go but what I am trying to say that there had been couple of definite measures which have already been taken and a very hard stock taking had been done of the various individual projects and issues surrounding them.

It will need lot of discussion at government level also, it will need inter-minister coordination to be brought in. Being in a federal state there will be certain issues which are at the state government level, there may be issues which may be even at the level of local bodies but a fair stock taking has been done. Some action has started, that is why I am making an assumption that even a part of these projects if they get going, that can put the economic activities in a right mode. That is the point I am trying to make.

Q: Let’s come to the rate cut. Do you think the Reserve Bank of India (RBI) has too much elbowroom? Do you think consumer price index (CPI) at 10 percent and CAD even at a benign 4.5 percent gives the RBI too much room to cut rates?

Sengupta: We are not living in an ideal world where you will have everything so packed, so beyond a point you have to take your chances and hope that you get growth.

Q: They took chances earlier….

Sengupta: If you see, we are expecting about 75 basis point (bps) rate cut this calendar year, a 100 bps over the fiscal. If you see India today has become the only country in the world where lending rates are still at their 2008 peak.

Q: And where inflation for three years is at double digit?

Sengupta: But then if you see India’s growth is 5 percent inflation is 8, in Russia growth is closer to 3, inflation is 6, in Brazil growth is 1 and inflation is 6. So all over the world every country has the problem of stagflation, because you have global liquidity and low growth and so money goes to commodities. So, I am not saying that you ease very aggressively, but clearly a growth will not come back till you ease interest rates and while inflation expectations are important, growth expectations are also important because ultimately India is a growth story. So from that point we do expect that the RBI will cut at least 75 bps this year.

Q: Let me come on this point of inflation to Dr. Shome. Fiscal deficit has been fueling inflation. Although the government kept its word in FY13, do you think in FY14, this 4.8 percent will be achieved? Simply because you are now 14 months from election, by the time you come to June and December you will be six months, four months away from election and even now every month we are not sure whether that promised diesel hike will come. April’s 45 paisa diesel hike hasn’t yet come. Do you think the Finance Minister will stay the course on the fiscal consolidation?

Shome: I have worked with this finance minister for sometime and he sticks to the extent feasible to a strict and narrow path, he has indicated his intentions and he will achieve 4.8 percent. He had said 5.3, he achieved 5.2, but to some extent it was also because GDP growth was lower. So, I think that it will be achieved.

It is a pre-election year, so we are living in the real world. But when I look at all the measures plus if the economic growth thus takes place, you will see that more revenue will come from that growth as well. If you really look at a tax-gross domestic product (GDP) ratio which we already achieved last year it has come back at the central level to over 10 percent, so another one percent of GDP has been garnered without any windfall gain from 2G, 3G and all that. So, I think that we are on a good path and to the extent feasible to project at this point I would say that the conservative fiscal path will be adhered to.

Q: What’s your inflation target for the current year?

Sengupta: It is somewhere between 6-6.5 by March.

Q: If inflation is going to continue to trend at wholesale price index (WPI) level at 6-6.5 percent and CPI at current levels of close to 10 percent do you think you can really pass on much by way of a rate cuts even if Reserve Bank were to give you a rate cut on May 3, do you think the banking sector will be able to pass it on?

Mundra: I think we are talking about passing on even without discussing whether there would be a rate cut or not.

Q: Do you think you have too much elbowroom to cut rates if you don’t see the CPI ticking lower?

Mundra: Firstly, I have a slightly different take on this. What I feel is that not only there would be a rate cut, I would rather feel there maybe a reasonable case that it could be a rate cut of 50 basis points on the repo side and there might not be any action on the CRR side. That is what I would tend to believe. That being the case, I think a transmission would certainly be possible post March. You must remember that whenever earlier there was a talk about a rate cut and the transmission, the banking industry had a dilemma till March about the high cost of deposits and liquidity issues. Post March, the scenario has substantially changed.

Liquidity in the system overall continues to be good. Of course, there is still a borrowing from the Liquidity adjustment facility (LAF) window. So, deposit rates have already softened. So, with that background already there and if there is a repo rate cut, as I say, I would expect that probably RBI may decide this time frontload looking at some of the economic indicators which have emerged, then probably transmission would happen and then there would be a long pause before RBI may decide to have another small rate cut during the year. That is how the trajectory could be. Why I am particularly mentioning it? If you look at the core inflation, it has last come at 3.58 percent which might be even indicative of a stagflation kind of condition. So, that is the situation on the inflation front and there had been some positive improvement on the current account deficit (CAD) with the prices of both - oil and gold coming down by more than 15 percent.

Q: That is the macro economic argument. I am asking you a plain banker question. When CPI runs at close to 10 percent, will depositors bite if you offer them something like 6.5-7 percent?

Mundra: As I said, it has already happened to a large extent post March. I think that should be possible.

Q: Will cheaper money make a difference? Do you think that will provide even a little bit of trigger for people to come and announce capex plans or even incrementally produce more?

Raman: In all our consultative discussions with Reserve Bank of India, we have been maintaining one point that cheaper money by half percentage point or one percentage point is not going to make huge economic difference when it comes to committing new projects. But let’s take the case of stuck projects. Today, most of the projects, particularly in the infrastructure area are stuck with 80:20 debt equity and these projects were bid when the growth rate was about 8.5-9 percent. We have growth rate coming to 5 percent so there is a revenue compression with over leverage position. So, given the fact that the inflation in the country is structural and hence cannot be resolved by just moderation of the interest rates. Interest rate reduction whether it is half percent or 75 basis points would make those stuck infrastructure projects that much more viable and as these projects become little more viable, then it could attract investments both from equity as well as debt. That gives the headroom for a logjam of a situation that we are in where traffic is slow, the leverage is high, and equity has dried up. So my sense is more than for the new projects, interest rate reduction could enable the existing projects to breathe a little more easy and sort of regal its way out of a very tight corner it finds itself today.

From the discussion with these experts we can conclude that an interest rate cut is possible and the banker will pass it on and industry does seem scope to use it at least to create some space for itself, some consumption, some demand and some elbowroom for projects that are stuck with very high leverage. So even if not 6.5, perhaps something close to a six percent growth is at least what the economist believe is possible. The man who runs the wheels of the economy is a little more skeptical about it, so captains of industry are not really very confident that they are going to run much faster than last year but yes, the economist thinks that a little better is possible.

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