RBI measures only tactical, not game changers: JP Morgan

Neither the currency nor equity markets cheered the new RBI policy measures announced on Monday, but only hoped for more. To arrest the falling rupee, the central bank hiked the limit of external commercial borrowing (ECB) to USD 10 billion. Moreover, the regulator also increased the limit of overseas investment in government bonds by USD 5 billion to USD 20 billion.

However, Sajjid Z Chinoy, Asia Economics, JP Morgan explains that the measures are no game changers but only tactical in nature.

"These are very sensible tactical measures to improve capital flows in the medium-term. I think just because markets are disappointed we shouldn't discount to what these are. Broadening investor base into government securities to include real money investors, reducing frictions into the withhold tax is a good idea. But these are still tactical, they are incremental," he said in an interview to CNBC-TV18.

Blaming the government for inaction, Chinoy adds that domestic policy issues are not holding back investment inflow as current investment slowdown is not due to global factors. He also feels that diesel price hike will improve sentiment materially.

Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying video.

Q: Your snapshot view of what was announced yesterday and how material you think it will be for the money market including the bond market?

A: These are very sensible, tactical measures to improve capital flows in the medium-term. I think just because markets are disappointed, we shouldn't discount to what these are. Broadening investor base into government securities to include real money investors is always a good idea. Reducing frictions into the withhold tax is a good idea.

But, these are still tactical, they are incremental. I do not think they are the game changers that the market was let to believe what happened and what we need to see to fundamentally change the story around the currency and capital flows into the country.

Q: Is the market's verdict yesterday telling the government that it is not going to respond incrementally to these tactical fixes unless some of the core problems are fixed which are macro in nature?

A: The problem is not incremental. The problem with India's currency or with the capital flows in the economy is not because our capital account is not open enough to attract more capital flows. That was never the problem. The problem is much more fundamental.

There is now a question around some of India's macro economic fundamentals - can India grow at more than 8%, will inflation come back down to 5-6% levels that we like it to be, will we return to fiscal discipline etc. I think these are the core issues that have played markets over the last year.

What has happened in the foreign exchange market and the rupee is a symptom of all of these issues. I think what you really need is one or two announcements in the next few weeks or months which will answer these questions definitively. I think the fiscal question is the easiest.

We have benefited from a significant terms of trade advantage over the last month. Crude prices have come off. If you increase diesel prices now to demonstrate credible intent that this year's fiscal consolidation is well on track, I think that is a good starting point to begin to change sentiment.

Q: You think even the foreign exchange market might respond far more to a hike in the price of diesel than to any of the dollar enhancement measures?

A: If you look at the price action yesterday, you almost feel that people are itching to go long on the rupee. I mean there was just the expectation that you could get a sovereign bond of some sort. It is not clear what it would be, what would be its magnitude, how efficacious it would be and the rupee appreciated 1.5%.

There is now a realization that perhaps the currency, for all of India's problems and for the fact that inflation rates are very high, is undervalued and therefore, some mean reversion cannot be ruled out in times to come. That is what yesterday’s action showed. But for that to happen, you need one or two of these fundamental issues to be solved.

If you get two-three things not just ad hoc one measure, I am sure that would have a pretty significant impact on the foreign exchange market, more than the tactical manoeuvers to broaden or open the capital account incrementally. If you get a package over the next few months which is to say this is how we plan to address the fiscal deficit, this is our resolve to return to orthodoxy in central bank to keep inflation low and this is what we are doing to make India a more attractive investment climate, it would have a significant impact.

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Q: There was promise of some more; withholding tax for instance has come through and gets notified from the July 1. What else would you expect to see in this tone of things, not so much what is happening on the fiscal side but from the Reserve Bank of India?

A: I think the number of options now is quite limited. There was a lot of talk – withholding tax on corporate bonds would be a positive. Trying to attract money into infrastructure sector through corporate bonds has not been very attractive. So you want to reduce as many frictions as you can for people to take on that risk.

I think there was talk about a sovereign bond issuance or some kind of NRI bond issuance but, to do that before solving the fundamental problems is in a way putting the cart before the horse. What you want to do is convince investors that India is going to avoid ratings downgrade over the next year or so because we are now on high alert and it's only when you do that through this core fundamental measures will you get a very strong response to any kind of bond issuance.

We can still do few things incrementally over the next few weeks and the RBI can do that. We have done a number of these things since December and they haven't changed sentiment in the foreign exchange market. I would focus my energy on two-three big things that address India's macro economic imbalances.

Q: We were speaking to Nomura who was pointing out that they now have a sub-6% growth rate going up. Are you that cautious, have you marked down your growth estimates as well?

A: Two weeks ago, we had, but we are still around 6% mark. I think there is enough margin of error and at some level it doesn't matter. I think we have to be mindful that there are some positives here. The fact that the currency has depreciated so much in real terms will be a significant boost to the tradable sector, not just exports but to the import competing sector. That will be a positive for growth going forward.

People focus a lot on the actual export numbers, the year on year numbers which are deceptive given last year's high base. If you look at new export orders since August of last year in merchandise, those have gone up pretty significantly along with the rupee depreciation. So I do see the currency depreciation helping growth and ultimately, it will come down to what the government does on investment.

I think consumption will hold up within certain ranges but fundamentally, a sub-6% or higher than 6% growth number will come down to what we can do on the ground to clear some of these bottlenecks and get the capex cycle moving again.

Q: I do not know what the official global JPMorgan forecast is but a lot of big think tanks have started talking about near global recession conditions coming to the fore in the next four-five months. In such global conditions if you harp back to past experiences, how has the Indian investment cycle done in global recessionary conditions given that we have limited fiscal headroom this time to stimulate?

A: I think any kind of global recession or bordering on global recession will serve as the drag. But, if you go back to what the issues have been around investment, it's not been that global demand has been very soft. Despite global demand holding up very well, exports have grown twice as fast as GDP for the last two-three years.

Despite that we have seen no material investment. I think it will be a drag but, I do not think investment currently ails from a global drag. I think the problems are very well known that domestic demand is strong enough or has been strong enough. But, because there are all these implementation bottlenecks on the ground, the number of projects that have been stalled has doubled over the last year and quadrupled over the last three years.

Our completion rates on the ground have fallen by 2/3rd in the last few quarters and none of this has to do with global factors. If you can clear these bottlenecks on the ground, you will get some momentum in capex, irrespective of what happens globally.