Fiscal policy is now dissociated from electoral cycles: RBS

Finance Minister P Chidambaram today assured that there will no further squeezing of expenditure like last year to contain fiscal deficit. However, many believe that with elections and the Food Bill hanging on the government's head, it may find it difficult to meet its target.

However, Sanjay Mathur, Head of Economics Research, Asia Pacific ex-Japan, RBS believes that fiscal policy has now dissociated from electoral cycles. "I actually think that if one looks at the last few elections, fiscal policy has become much dissociated from electoral cycles and that has been a good thing. Right now, the order of the day, particularly having achieved 4.9 percent last year- that you spend the money, get the economy going otherwise this is going to become a very serious long-term problem," he observed.
Commenting on the rupee depreciation Mathur said that Reserve Bank of India needs to intervene as it is likely to hurt severely in a time when economy is struggling with lowest growth.
"Corporate India carries of lot more foreign exchange debt than it ever did before. That debt servicing cost is going up and these are the times we need a central bank to lean against the wind," he noted. Below is the verbatim transcript of his interview. Q: Your key takeaways from what the finance minister said – does it improve your attitude or your mood over the economy, the rupee anything at all?
A: I thought that the one thing which he said which is quite positive was that we are not in this to compress expenditure any further. We know what happened in the Q4 of last year. The kind of constrain it put on growth and one could see that in the gross domestic product (GDP) numbers. I do think that as you just said, the NRI bonds or even liberalizing the debt capital markets to foreign investors are not really the solutions for the day.
It is imperative now that the Reserve Bank of India (RBI) actually intervenes, maybe it is a global issue but it is hurting. The finance minister spoke of two things. One, imported inflation and the other was subsidies. There is a third dimension. Corporate India carries of lot more foreign exchange debt than it ever did before. That debt servicing cost is going up and these are the times we need a central bank to lean against the wind. Q: More on the issue of the finance ministers statements on expenditure – would you worry and if we went ahead with the expenditure and there was food security ordinance or bill that is hanging on our heads – this year to repeat could be more difficult? After all it is last few months, the whole stretch before the elections?
A: No. I actually think that if one looks at the last few elections, fiscal policy has become very dissociated from electoral cycles and that has been a good thing. Right now, the order of the day, particularly having achieved 4.9 percent last year- that you spend the money, get the economy going otherwise this is going to become a very serious long-term problem, that one keeps compressing expenditures, your growth suffers because of that you have to exercise even more austerity to meet your fiscal targets. Q: What is your expectation in June? Some talk about cash reserve ratio (CRR) cut and not so much a repo given better transmission is possible with the CRR? Secondly, apart from June what is your total expectation of what is the rate cut that the RBI perhaps will do in the coming fiscal?
A: We do think that rates could go another 50 basis points; had it not been for the weakness in the rupee, I would have felt that a rate cut is there in the June meeting. We have now become a lot more skeptical on that.
As far as CRR cut is concerned, I do think that, I want to be cautious on that. I don’t think that the problem of liquidity right now is a structural one. It is really a mismatch between government cash surpluses and what the system is demanding today. I think there has to be a more technical resolution of these two issues to resolve this liquidity problem. Q: With respect to the data that has come out this week, let me start with inflation, the consumer price index (CPI) number coming in almost at the same level as the April inflation number, coming in as a disappointment as well now with the rupee appreciating with a lag the inflation indices I assume will start showing the impact - does this change your forecast on the inflation trajectory as well what does that mean for RBI. How many cuts were you expecting and now do you abandon those hopes?
A: Yes, the CPI number was somewhat disappointing I would think. We had expected a bigger change but even then if we actually strip out the food component, the CPI is coming down. From what we are hearing, just looking at or reading the media in terms of what is happening to food prices, that the subsequent print would be generally quite a positive one.
There is one more thing that needs to be recognised in terms of inflation, the economy is very weak and one can see that. That corporate do not have pricing power. We are in a situation where fuel prices have gone up and yet one sees aggregate inflation come down. That is very symptomatic of a very weak economy. Q: Staying with the weakness in growth that you have highlighted, yesterday’s index of industrial production (IIP) figure as well was disappointing although it is known to be volatile still on seasonally adjusted basis things appear to be slowing down. Are you more worried or perhaps the street was penciling in an improvement in growth in FY14 – are we getting a little too optimistic about the extent of improvement that we could see?
A: We didn’t see scope for much of an improvement at all. We have built in a growth of 5.3 percent for this year but still it is very contingent on the government delivering at least a few reforms and the monsoon panning out alright. I actually did not have any hopes that we are going to break out of this weak streak and the economy is weak. Q: What is your quarterly trajectory of the GDP growth – one number will come by August. What is your Q1 number and your full year numbers?
A: If I recollect, we are looking at the first half to be under 5 percent and then we get to an exit rate that is the Q4 of FY14 to around 5.6-5.7 percent. So, that should give an aggregate 5.3 percent for the full year. Q: Another point with respect to from where you come from RBS you would have fixed income research and you have a global understanding of emerging market bonds. This appears to be a sell-off of movement of hot money away from the first place where they can take profit if indeed we are getting into a tighter monetary situation starting from United States? Do you think the amount of money that is gone out of Indian bonds will taper out – is the worst over there, as well from the rupee, at some point it becomes attractive, everything has a price so do you see too much depreciation in the rupee from current levels?
A: Let me answer that in two parts. I do think that at some stage we will see some degree of stability in terms of portfolio flows, in terms of how or at least a slow down in the rate of outflows. There are two problems. The first is by itself, I don’t think that the direction of US bond yields is very clear so that is one dynamic. Second, one would want them to stabilize, whatever levels they are, stabilize and find an equilibrium. The problem is we are very confused at this point in time that the US economy is not red hot. It is not technically signaling that the quantitative easing (QE) exit is obvious at this point in time. It almost seems that the Fed is getting worried that there is another bubble building up. Now we are dealing with two different issues over here. That is the first thing. Q: Bubble where- asset markets?
A: In the bond market etc. The Fed is trying to tell people that please do not get complacent over here. That is one thing. So, one does need bond yields to stabilize.
The second, the rupee is actually reflecting all the weaknesses etc but there are times like this and 1995-1996 is also a case in point that unless you get a central bank that is leaning against the wind is by intervening in a very significant way but I do think that the FX reserves position is a lot more constrain. The problem we have right now is that whatever statement one gets is - well this is in line with the world and that does not suffice.