Reforms must not stop; economy can bounce back:Chadha

The Forbes India Show introduces you to Gunit Chadha who recently moved from Mumbai to Singapore to take over as co-CEO of Deutsche Bank's Asia-Pacific division. He has also moved to the group executive Committee of Deutsche Bank.

Earlier, he was the CEO of Deutsche Bank in India, where in nine years the bank grew from a 550-man outfit to an over 9,000-employee organisation. Over the last five years,  Gunit increased profits at Deutsche Bank India at a compounded rate of 30 percent which made the Indian arm one of Deutsche Bank's fifth-largest. Below is an edited transcript of the interview on CNBC-TV18. Q: How does India look from Singapore, especially after what happened over the last two-three weeks?
A: It is interesting to note that Indians are more negative on India from within than from outside. Indian entrepreneurs were more negative on the country than multinational companies and that is why even through the last 12-18 months when policy reform did come through after some standstill, equity investors really didn’t leave the shores of this country.
They stopped putting new money to work, but that did not cause the market to collapse. The currency did lose value, but the value came back very quickly; by 5 percent in the last month and is probably one of the best-performing currencies. Though what the government has announced is a very welcome change, there is lot more to do. Q: Do you think the economy will improve?
A: Deutsche Bank holds the view that the GDP for FY12-13 will be 6 percent but there is potential for growth because it does take time for reforms to affect the GDP curve. So we think that the GDP will edge up to 6.5 percent in FY13-14. However, inflation is sticky. It will probably stay in the 7.5-percent range till March and have a bias on the upside because of two reasons.
One, the harvest could be a poor harvest and primary good inflation could edge up further. If for some reason, there is a crisis and the rupee loses value, it could cause a surge in manufactured-goods inflation. So, the government has got to be a little more cautious on inflation and that is the RBI is unlikely to reduce interest rates for now. Q: What could possibly be the cause of a crisis?
A: Certainly, what should worry India the most is what it can control. It is a combination of internal factors including the announcement of policy reforms, which must not stop. Q: Any concerns on the fear in some quarters that corporate India could go berserk on FCCBs and that could lead to a difficult situation?
A: No, I do not think so. I think corporate India has managed its risks reasonably well over the last several years. There have not seen any significant bankruptcies. A few companies have certainly had troubles, but it is not widespread. In fact I am pleasantly surprised that the SME and the midcap corporate sector have been relatively resilient, while the infrastructure segment has had some troubles from policy issues on fuel linkage.
So I think corporate India has managed itself reasonably well. I think RBI has managed the position very well and with the government stepping forward right now, it makes the recipe right for optimism in the quarters ahead.
_PAGEBREAK_ Q: Let us get back to the recent FDI initiatives. Do you see significant flows of money into retail and airlines or is it just the PE investment guys coming in, in anticipation of strategic investors following?
A: If you think how much FDI is going to follow as the result of the FDI in multi brand retail or in aviation etc, it is not going to be more than a few billion dollars in the next 2-3 years, that is not the point.
The point is that it reflects the conviction of the government, the government’s resolve to stay on course, it reflects that this government is intent on making the right moves and that confidence then brings a lot of the equity investors back into the markets and you have seen USD 15 billion come into India this year.
We think the Sensex will rally up to 20,000 before the end of this year. You have seen credit spreads in corporate India narrow which is very good. Even in a high inflation environment, our view is that the ten-year government bonds may just pierce 8 percent which has been sticky for a long time. I think it is the resolve of the government which stands up more than the actual dollars which come in through the FDI. Q: In a high inflation environment, where interest rates continue to remain sticky you think that if policy is certain corporate India won’t mind investing because the demand is going to be there?
A: Let us divide that into two halves. I think some time will lapse before corporate India's confidence is restored as it will wait and see that the government does not reverse its policies. Secondly, real interest rates need to come down. Q: If inflation is going to remain at 7.5 percent, what is the likelihood for real interest rates to come down?
A: It is our view, after Mach 2013, interest rates you could see 100 basis points repo cut over the next 9 months. Q: Will that largely be driven by the fact that the Reserve Bank gets confident that the government is getting its fiscal book in order?
A: Absolutely, and as the current account deficit starts to contract and the rupee stabilises, the RBI should get more confident in further injecting not just liquidity which they are doing right now, but also initiate rate-cuts. I think the capex cycle in India will build more in FY13 and FY114 than in the remainder of this year. But the next two quarters is the time to get the confidence back. Q: Is rating downgrade threat now over?
A: No, it is not. It is definitely not over. I think there is more than a fair probability that threat stays every much intact. It is what the government does in the next two quarters which will take that threat away. Q: What are the reforms that the government can do and keep that threat at bay?
A: For one, they announced today that second half-borrowing programme of the government is not going to expand. That is a very positive statement. It reflects the government’s intent to keep the fiscal deficit in check. Deutsche Bank feels that the fiscal deficit in FY12-FY13 will be 5.5 percent and we would like to see the government resolve to bring that in as much as possible.
The government also needs to initiate further administrative reforms especially on core infrastructure. I understand that is politically not easy, but that is whar investors and rating agencies will be closely watching. Q: The government has moved to improve the solvency of SEBs largely because banks have refused to lend to SEBs anymore. So do you take that as a positive because the government responded to pressure?
A: Absolutely. I think the SEB reform was yet another initiative which was in the right direction. The government needs to be complimented for accelerating what lay in hibernation over the last 12 to 18 months.
_PAGEBREAK_ Q: What can go wrong externally? I know it is beyond India's control, but how tricky is the situation outside?
A: The situation outside is tricky. I don’t think we can count that risk off. Things could go wrong if there was a crisis in the Middle East and oil price spiked. Our view forecasts Brent to actually come down to USD 100 from USD 110. Though that’s a positive view, it could easily go in the other direction if there was a crisis.
Another risk is the political crisis in Europe. I think there is much debate around the eurozone. The ECB and the German Chancellor have calmed the markets and sent 10-year Spanish yields down from 7.5 percent to below-6 percent. Though nerves have been calmed, the certainly remains. Q: What are the chances of all of these events happening?
A: The chances have receded in the last few quarters, but you just cannot extrapolate the most recent past. So anything could happen. Q: Let's come back to India. You bet big on retail. Is that focus still strong? Was your sale of your credit card business to IndusInd a strategic move or was it because of loss of interest in retail?
A: Actually, retail was never a very significant part of our business. Of Deutsche Bank India's business, retail is probably one or two percent. But our retail presence made us visible, embedded us in the country's psyche and allowed us to plant the flags via branches. We are committed to our retail business in the country. I think it is a very important source of liquidity which feeds our corporate and investment banking business.
We got out of the credit card business because we couldn’t answer the simple question- Do you build a profitabile business by raising or contracting scale? We could'nt answer that question and that is why we decided not to be in the business. Q: You will soon be increasing the number your branches to 17 in India. That's very close to that threshold of 20 where the definition of priority sector lending will change, not to include export lending. Would you be comfortable getting out at over-20 and then getting into the priority sector or would you be content at below-20?
A: I think the more demanding question on that will be what happens when subsidiarisation comes into India for foreign banks. So it is more likely that we will wait and see the contours of the subsidiarisation policy for foreign banks and then take a decision. Q: At the moment what does subsidiarisation look like? Will allow you free entry into tier-2 and tier-3 cities? Is that be attractive enough for a foreign bank? Would you want to get into the tier-1 cities as easily as an Indian bank?
A: The demo will be in the detail. I think regulators at various parts are looking at subsidiarisation as one way of putting arms around banks leading to governance within the boundaries. But I think there are other ways to address the same issue. So we will have to see what the final construct of subsidiarisation. Q: What will make it attractive for a foreign bank to consider India as a big market to get into? How would you like the subsidisation rules to pan out?
A: I think it is very important that while we all build inclusivity, it is important that the larger foreign banks in the country have a level playing field to at least address both the corporate as well as the retail needs in the top 50 cities of the country. That should be given to the foreign banks once subsidization comes and then thereafter allow the building of the inclusivity on the back of that.
Though it is also important that foreign banks pay the charge for inclusivity, let the most competitive bank build that and the other banks could actually pay a toll for that. There are different models on how to build inclusivity - what we have right now is a model which says that any bank which wants to extend its geographic footprint must build it right from scratch on its own. Maybe that could change. Q: Let me just back to the global economy. We spoke about Europe and the kinds of threat that could come from the political situation. But how does the rest of the world look?
A: Deutsche Bank research has forecast that the global economy should grow this year at about 2.9 percent which is probably a tad less than where our view was a few quarters ago. Q; Where and what would the engines be?
A: We think the US will grow at about 2 percent both in this year and into next year. We think the euro zone will contract this year. We think that it will bottom out by the fourth quarter of 2012. We also forecast that Japan will slow down as the post-tsunami reconstruction is now coming to an end. China started to slowdown and so is India.
So we think the global economy will grow at about 2.9 percent. Next year, it will grow at 3.2 percent and thereafter in 2014 at 3.8 percent. This is on the assumption that there is no global crisis. So the forecast is about slow growth with the liquidity provided by QE3, Bank of Japan and the ECB.
As long as global growth is slow-to-modest, the liquidity continues to come in, I think India could benefit the most if it follows up on its policy reforms. What could be worse than a  global crisis, is the strengthening of global growth because then all the money will go back to US and Europe. Q: What were the pockets of surprise for you last year?
A: I think the resilience and the resolve of the various countries in eurozone led by Germany and the fact that every crisis in-the-making was very well handled as recently by the ECB's Draghi as well as by Chancellor Merkel, I think was a positive surprise.
Many had written off the eurozone and had projected that Greece would be out of the EU. Actual events over the past few quarters have demonstrated the strenghth of political resolve. Q: So, the politicians and bureaucrats in Europe have surprised on the upside?
A: I think it is also fair to say that globally all came together with Europe to make sure that the world stays calm.