Market should be prepared for near-term pain: Montek

Despite a 380-point fall on the Sensex, deputy chairman of the Planning Commission, Montek Singh Ahluwalia, believes the market was not "surprised" by the short-term "necessary" measures taken by the Reserve Bank of India (RBI) to curb rupee volatility.

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"We have got an overall situation where the RBI did what was necessary to signal to market that the exchange rate is being pushed into an unreasonable range," he told CNBC-TV18 in an interview.
He says the market should be prepared for near-term pain, but adds, that growth is unlikely to be affected in the long run.
The RBI announced a slew of measures late on Monday to curb the rupee's decline by tightening liquidity and making it costlier for banks to access funds from the central bank.
The central bank said countries with large current account deficits such as India have been particularly hit by capital outflows triggered by market expectations that the US Federal Reserve could alter its loose monetary policy.
Ahluwalia feels the Fed chairman's statements have put a lot of pressure on our currency also and maybe in our case there was more worry because India has a large current account deficit (CAD).
"I would hope that when stability is restored, the RBI will be able to wind out this intervention," he says. Below is an edited transcript of Ahluwalia's exclusive interview on CNBC-TV18. Q: You would have noted since morning a lot of gross domestic product (GDP) downgrades have happened because of the signal for tightening or hardening or interest rates which came through yesterday. Do you think it is a vulnerable time to administer a dose like this, even with the currency in mind?
A: I think market analysts were not surprised at what the Reserve Bank of India (RBI) has done. The currency has been under pressure. It has been externally a very volatile situation, triggering a lot of outflows from emerging market (EM) countries as a result of some statements made by the chairman of Federal Reserve. The outflows, in my view, were a bit of an overreaction. I do not think that the chairman of the Federal Reserve said that he was about to wind down third phase of quantitative easing (QE3), but for whatever reasons there were outflows that put pressure on a lot of currencies. It put a lot of pressure on our currency also and maybe in our case there was more worry because we had a higher current account deficit (CAD).
In a situation like this, when markets begin to push the exchange rate, there comes a time when you think that the exchange rate has been put beyond what would be reasonable, given competitive conditions. I think that position was probably reached when the exchange rate was around 58-59.
As it went beyond that I think it was important for the RBI to signal: "We are not simply leaving the exchange rate to be buffeted about by whatever capital flows occur, because if you do that, then it is very likely that you will get massive overshooting. It will have a very negative effect on balance sheet. So, everywhere in the world, when you are trying to draw a line, you will indicate that by showing willingness by tightening short-term liquidity, which would discourage excess speculation at this point. I think the markets will read that signal, hopefully, correctly and that the rupee will then stabilise.
Obviously, over time markets also want to see the CAD go down. Over time one hopes that global financial markets will become more stable and flows will also resume. We have got an overall situation where the RBI did what was necessary to signal to market that the exchange rate is being pushed into an unreasonable range.
In parallel, they have taken steps using the exchange rate, sort of a willingness to take some pain in the short run. It is a short run measure. I do not expect it to make a significant difference to long run rates. I would hope that when stability is restored the RBI will be able to wind down this intervention.
That is really how one should look at what has been done. Of course, in the short run, there is going to be some pain and also some worry and that is understandable. Q: While the point about the currency has been well understood, the concern is on growth. Are policymakers aware of the risk that this year, and the next, growth may be well below the target they have set out, i.e., not 6 percent for FY14 and not 7 percent for FY15?
A: Let me say that we have not set out a target for the current year. The only target that was set out was at the time that the Budget was formulated. That was around 6.5 percent. It has been quite clear that the slowing down in the global economy, of all emerging markets, made it very unlikely that we would get to 6.5 percent. The government has not indicated what it expects the growth rate in the current year to be.
I sometimes hear figures like 6 percent, but that is not a formal statement. What has formally been said, and which I would endorse, is our objective in the current year should be to show a turnaround from last year.
Last year, we ended up with 5 percent but the last quarter was below 5 percent. We want to see the growth rate get back to something above 5 percent. Exactly what that would be? For now, no targets have been fixed. I know that many international observers have pitched the likely growth rate at somewhere around 5.7 percent. Personally, I think if we do 5.7 percent, it is less than what we hoped, but it will clearly indicate that the economy is now on the rebound.
What we do next year depends on what happens in the current year. I do not think the 7 percent is actually ruled out. If everything goes well, if many of the steps we have taken to get projects moving actually are effective and also if the global situation is much improved. Most global projection indicates that next year, i.e. 2014, you will see positive growth even in the Eurozone.
So taking all that into account, too early to say what the growth rate will be next year. It will be clearly below 6.5 percent; could even be below 6 percent but we haven’t given ourselves a target against, which to judge performance. Maybe when the finance ministry puts out its periodic review in Parliament, they will take a call on what the current year's growth rate is like and that will be the first official statement of what our expectations are.
_PAGEBREAK_ Q: The finance minister just had a press conference 15 minutes back where he mentioned 6 percent for this year and 7 percent next year as the targets. Let that be. The question is: whether after looking at the kind of Index of Industrial Production (IIP) numbers that you saw last weekend, where there clearly a lack of any kind of turnaround, at this time with sentiment being so low, can the system adjust to some kind of tightening of rates where the expectation was of getting some support from a reduction of rates from the RBI? Do you think at a juncture of such fragile sentiment and poor macro data point this kind of a move might actually hurt growth more than it helps the rupee?
A: No. Quite frankly that judgement has to be left to the RBI and the finance ministry. The notion that freefall of the rupee does not hurt growth is completely wrong. It is a judgemental question. It is quite clear in my view that some of the rupee depreciation that has occurred was a restoration of competitiveness. When it goes beyond 58-59, it goes beyond that. Some of that may even be justifiable, because after all we are running a much larger CAD than in the base year where the real effective exchange rate (REER) is computed.
Taking it above 60 you have to give some signal, otherwise there is a serious danger of overshooting. An overshooting does involve very negative effects on growth, because it impacts the balance sheet of a lot of companies that are going to do investments and it makes investors also hold back from coming in. Will this move hurt growth in this current year? In my view, a temporary short-term tightening of liquidity is less important for growth than doing all the things that we said we will do and we are doing in order to get rid of implementation bottlenecks in projects.
You mentioned that the finance minister in his press conference said 6 percent for the current year. That is a scaling down from the Budget; a little higher than what a lot of international observers have said. Whether we can do 6 percent does not in my view depend on the short-term interest rate which could well be reversed when the situation stabilises. It depends critically on getting projects moving and government has put in place a number of mechanisms that are supposed to address that problem and which I know are addressing the problem in some dimensions, a lot of this will become clearer when all these measures finally take effect on the ground. That is what is going to cause the recovery.
Basically you want a recovery of investment and that investment is actually being held up by projects which are held up, not so much by what happens to the short-term interest rates. Obviously, a rise in the short-term interest rate makes some people wonder what the future is going to be like. That depends very much on whether the global economy stabilises, financial flows come back in play and so on. I would not have said that failing to act would have been better given the pressure that could have come suddenly on the rupee. Q: While the concerns about the CAD are well documented would you say part of what has been done overnight is with an eye on the capital account where there was a heightened risk emanating and this is probably done with an eye to the kind of outflows we have seen from the bond market with the hope that this kind of stemming of the rout on the currency may actually pullback flows into the bond market?
A: Let us put it in the following way. Obviously, the CAD doesn't put any pressure on the rupee if the international markets finance that current account deficit without any problems. You have to ask yourself how bigger CAD you want, but last year that is 2012-2013, the CAD was 4.7 percent of GDP and there was a lot of liquidity in the international market. The situation has changed. My expectation is the CAD in the current year is going to be significantly lower. I don't know if the finance minister mentioned a particular figure, but I would hope is well below four percent, that is my personal expectation. Now the question is even that we have to have net inflows, which can finance the CAD of that size.
Of course the net inflows will be much less than last year. But in a world of capital mobility in the short-run money that is already there can easily flow out and that puts pressure on the rupee and this becomes a judgement call. Is this merely a daily variation in which case you let the market have its play, is it something that goes well beyond what is the reasonable degree of depreciation, does the market think that you are not going to take all the actions that are available to you in your armoury and I think what the RBI has done after a week when they were intervening according to newspapers they felt that the pressure is continuing and some signal was necessary and I can assure you by the way that financial analysts would almost universally say that this is an understandable move.
This is not a long-term raising of the interest rate, it is short-term initiative in the discouraging people who want to make short-term profits by betting against rupee and the assumption is that as stability gets restored, as people see that the underlying economy, the basic improvements that I have been talking about on the underlying economy are taking place and the global situation also stabilises these steps can be reversed. Q: It is just that it is taking longer than you thought it would show up in. We spoke many months back when the Cabinet Committee on Infrastructure had met. It was your view—if I am not mistaken—that in the month of May and June some of these issues would start to show up but as the current IIP numbers are showing, these improvements are still not manifesting themselves. Therefore, the question is: even if you are successful in getting some money into the bond market because of yields going up and this temporary hardening could we lose that money from the equity market where people start to get scared about growth in India again?
A: What I said in May and June, I would say that what I was talking about there were decisions of the Cabinet Committee on Investment actually taking effect in a number of areas. I think that has happened. It is not widely realized and maybe we should be publicising it more. For example, I forget the exact number, but almost 25 oil exploration projects that were held up because security clearances etc, were not being given have been cleared. That does not mean that they are immediately investing but you have got a large number of projects that are now cleared and we hope that they will get on to start investing.
A number of changes have been made regarding environmental regulations that will make it a lot easier for road projects to get implemented. This has also been done in the sense that the notification is out. Fuel supply agreements in providing coal whether domestic or imported – this was a big issue. We had sorted out the problem of about 68,000 megawatt (MW) of older plants but for 78,000 MW of plants after 2009 or something like that it was not clear what the nature of the coal supply would be.
That has been decided, communicated and the only issue that now remains is the plant have to get the state electricity regulatory commissions to approve the higher cost of imports for which the central government is communicating that look this must be allowed. So that is a done deal. Everybody who has a power project knows how much domestic coal which is low price they are going to get and how much imported coal which is higher price they have to count on. Now they have to get on making their arrangements. That is a big change in a very important sector.
They have also set out another group in the cabinet secretariat, which is going to look at a number of projects that are held up and see where we can take some quick action. I haven't seen a list of those projects but my expectation is that maybe by the end of July, they will identify these projects and then in another couple of weeks hopefully we will be able to resolve those problems. It is true that these things take a certain amount of time to get implemented. However, the first half of the year therefore is a year in which many changes have been made but the impact on the ground in terms of getting projects going again maybe is somewhat weak.
So it is in the second half of the year that this should have full effect. How effective it will be we will have to see. But I think this is the critical thing that government needs to focus on. I agree with you that the IIP numbers were disappointing but they refer to an earlier month. We do not have the IIP numbers for June, July, August which is perhaps when some of these things might begin to show up.