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See CY08 inflation at 10%: Lehman Bros

Published on Thu, Jun 26, 2008 at 10:48 | Source : CNBC-TV18

Updated at Fri, Jun 27, 2008 at 15:38

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Rob Subbaraman of Lehman Brothers expects the ECB to raise rates in July. Inflation hasn't peaked out yet, he feels. He expects inflation to remain higher in India. Rob also expects the Reserve Bank of India, or RBI to hike the Cash Reserve Ratio or CRR by another 50 bps in July. He sees the inflation close to 10% this year and the FY09 growth at 7.3%. However, Rob expects growth to pick up in FY10.

Excerpts from CNBC-TV18's exclusive interview with Rob Subbaraman:

Q: What's your view on the very big global growth question - after four years of higher than trend growth, do you fear that the next couple of years could be lower than the trend growth for most global economies?

A: If you look back at what's happened to the global economy, we have had what initially was a housing crisis in the US, which spilled over into a global credit squeeze. And this is a pretty major demand shock to the global economy and that's affected the US and Europe. And then and now we have a commodity price shock and particularly the oil prices - you combine them together and it's very hard to imagine the global economy is going to remain above trend. We think it is going to slow below trend where it is slowing already below trend and it's going to slow further and it's going to mean that in the major economies, the central banks will be cutting rates further or starting to cut rates next year.

Q: The consensus view that is emerging right now, is that before rates get cut responding to lower growth, first rates might actually harden to tackle the inflation beast, you don't belong to that camp, do you?

A: It depends on the country. For the Euro area, we do think the ECB will raise rates in July. But we think that later this year we are going to see growing evidence of the Euro area economies weakening and it is going to force in the reverse though and the ECB will cut by 125 bps next year. When it comes to the US and the Fed, the case is that the Fed is going to stay on hold this year. We have growth slowing probably more than the consensus - after the tax repay sway off, we think the consumer in the US is under a lot of strain and we expect oil prices to start coming down later this year. So for the Fed, it is a close call in August-September but we think that we will probably stay on hold and start cutting by 25 bps January and another cuts of 25 bps in March next year

Q: What about India - what kind of rate action are you factoring in here?

A: India is a centre of attention right now with 11% of inflation and the measures introduced by the RBI early this week. Our view is that inflation is going to remain elevated and the risk is it will probably go a bit higher; it probably hasn't peaked yet and with the RBI very concerned about it feeding into inflation expectations and becoming more entrenched, we do think there would be more hikes and we expect another 25 bps hike by the RBI in the late July meeting and 50 bps more of a CRR hikes. The risk is they actually have to do more than that - fiscal policy can't be eased much more to combat inflation because the deficit is widening pretty rapidly.

Q: That's the key concern, from the start of the year up until now - there has been a consistent scale down in GDP targets for most people and a scale up with what's happening in the deficit, what are you working with now on both those counts?

A: We have scaled up inflation a bit more and inflation is going to come close to 10% this year on average and we will probably go higher in the coming weeks. The growth was at 7.3% for this financial year, and we are assessing the possibility of potentially lowering that a bit further following inflation going up more by the rate hikes that we are seeing by the RBI.

Q: The conventional wisdom has been that following these rate hikes which work into the system with a lag, maybe the real impact will be felt 2-3 or 3-4 quarters down the line, while the focus has been on growth numbers in 2009, what's your estimate of growth in 2010 if we are going to be surprised on the way up with more interest rate hikes?

A: It's a very good point that the monetary policy has long and variable lags and so the RBI needs to be conscious of that and at the same time inflation expectations can rise quickly so it needs to react now. So clearly what it is doing now to keep inflation in check is going to hurt growth and that too at the weakest point. We will start to see growth picking up in FY10, and it's largely predicated at oil prices coming down and if we have oil prices coming down at around USD 90 per barrel, by January-March 2009, and if we are right with the oil prices, then the growth will start to come back. And the biggest thing to watch right now for India's out look is oil prices.

Q: You said that the upside risks remain for interest rates, what could be the nature of surprise that you are expecting with interest rates in India over the second half in 2008?

A: One of the obvious upside risks is oil prices that keep going up and another one is the kind of feed-through effects of more producers passing on their higher input costs, wage prices starting to develop, that's the risk . At the moment the Wholesale Price Index or, WPI will probably peak at somewhere around 12%-13%, but the risk is on the upside to that at the moment.

Q: You don't see too much room for either fiscal or even rupee action, do you think most analysts might be surprised with the pace of interest rate hikes, we might have to see if indeed that will be the only tool to fire fight?

A: That's part of the reason why this upside risk to rates is, because the other kind of policy tools - there is not much room left to ease them. Earlier this year there were a lot of fiscal measures, whether it was subsidies or reductions in import duties or measures like this to try to bring inflation down. With the budget deficit widening, the room for that now has really gone and then we have the rupee. And because of the rising import bill also we expect export growth to slow because of the weaker global economy. The current account deficit will widened to about 3% of GDP in the coming year and so the room to use rupee appreciation to fight inflation is also diminishing because that's going to further exasperate the current account deficit, so lot comes down to monetary policy, it's in the firing line.

Q: From a global investor who is looking at India, his point of view, what's the biggest problem for India?Is it the bad fiscal deficit situation, the run away inflation or is it growth slowing down to be lower than what people expected earlier, which of these three do you think is the headline problem for India for a global investor?

A: They are all relevant but immediately, the biggest concern is inflation and the uncertainty of just how high its going to go. The markets and global investors are probably very encouraged and we are encouraged by the RBI's proactive response this week in wanting to take inflation by the throat to really show that its on top of inflation, so this is a big and positive move. There are other Asian countries, Indonesia, Thailand, the Philippines where the risk is that the markets might perceive that they are starting to fall behind the curve and India now is looking less like that following the proactive measures the RBI is taking to deal with inflation.