See FY14 GDP at 6.5%; RBI may be cautious in Jan: Deutsche

As experts are mulling the possibility of a rate cut in the January monetary policy, the RBI governor has been cautious in his stance. Taimur Baig of Deutsche Bank feels the governor’s worries about inflation are consistent and he does not expect large galloping moves from the central bank during its upcoming meet. Although, he is hopeful of a rate cut in January, according to Baig, the inflationary pressures in India continue to be volatile and it might make the central bank cautious.

“I think there is still room to argue that he will go ahead and the Central Bank will cut rates in the January 29 meeting. My basic call is that we should not expect large galloping moves by the RBI. It will be incremental, it would be hedged by the past experience that inflation in India tends to be volatile,” he explained. Don't Miss: See 75bps cut ahead; banks to outperform in FY14: Kotak MF Baig expects the union budget to be an assertive one and believes the current account deficit could be around 4.2 percent. Moreover, he believes the current account drag on the economy is going to be substantial in FY13 and FY14. Going forward, Baig feels GDP growth could touch 6.5 percent in FY14. However, he is not very hopeful about the European economy and feels it might bottom out. Here is the edited transcript of the interview on CNBC-TV18 Q: The governor has sounded cautious. We had a runaway rally in the bond markets on expectations of a 50 basis points (bps) cut after the inflation numbers came in lower than expected. But he said that inflation is still high even if it is declining, what do you make of this in the first place, what are you expecting in January and what are you expecting thereafter, at least in the first six months? A: I think the governor has been consistent. Yes, he did allude to chances of monetary easing in Q1 of this calendar year. However, at the same time, I do not think that in the October or the December monetary policy statements we are that sanguine about the outlook that we could have just guaranteed succession of a rate cut in the first quarter of 2013. From that point of view, for the governor to recognize that the inflation trend is favourable and at the same time, one has to be cognizant of the underlying pressure. I think it is absolutely consistent with what the Reserve Bank of India (RBI) has been saying. I think the market went a little ahead of itself and the couple of these low 7 percent print on the inflation side buoy those expectations. So the Central Bank governor did what he should be doing. I think there is still room to argue that he will go ahead and the Central Bank will cut rates in the January 29 meeting. My basic call is that we should not expect large galloping moves by the RBI. It will be incremental, it would be hedged by the past experience that inflation in India tends to be volatile. Just because it is down now does not mean it is going to be down with a great deal of certainty for the next three months. That should make the Central Bank a little more cautious. Q: I just want to add two things. The governor said in an interview to me when I spoke about the fact that you are guiding for a rate cut in January, he said it is corrective on two things, “I am speaking of easing and I am speaking of the Q4 just by way of correction,” he said. So, technically he has not promised a rate cut in January, he has promised monetary easing in Q1, not even promised, he has guided. So would you think there is scope for a cash reserve ratio (CRR) instead of a repo? A: That game has been played before, from April of last year onwards the Reserve Bank of India (RBI) has conspicuously refrained from cutting the repo rate. But at the same time, as far as the monetary conditions are concerned there has been substantial easing. CRR has been cut, liquidity has been added and overall guidance from the central bank has not been towards inflation fighting only as the primary objective. The shift has moved towards supporting growth. From that point of view yes, every meeting will probably come with something. If the RBI actually acts tough and decides not to cut repo, I think it will still come up with some move towards easing monetary conditions and one of them would be to allow the CRR to go down a little bit. Q: There is a view in the market that if the RBI starts easing now that will start taking effect a year later and they have already eased significantly by way of CRR, which is more potent as compared to the repo. So, why not start incrementally reducing repo by 25 basis point (bps) over 2 to 3 quarters and reduce it by 75 to 100 basis points. What should prevent the RBI from not doing that and holding repo? A: The general argument is that the central bank has been easing monetary condition in any case as we just discussed and secondly, can the central bank be that confident about the trajectory of inflation, given in the past we have been repeatedly wrong in calling the bottom of inflation, calling the top of inflation and it is not just one central bank that is to be blamed, but the analyst community is equally to be blamed. From that point of view, can one confidently start a significant interest rate cycle and guide the market that there will be 25 basis points of cut in every meeting from now till October. It would be nice if they could have done that and it would certainly have created what Mario Draghi calls “positive contagion” for expectations to improve, business sentiments to improve and beyond the actual mechanics of rate cut the condition seems to become amenable towards investment and growth. But, I don’t think India is in that position yet. Yes, in the last couple of months the trajectory of inflation has been favourable. Going forward, we should reasonably expect commodity prices to remain flat, which on a year-on-year basis should be starting to go down and that should help inflation. But, how confident are we in making those pronouncements and can a central bank really build a major monetary policy decision based on those expectations? _PAGEBREAK_ Q: Breaking the back of inflation may also mean that you are hurting long-term growth. In that sense, how do you think the RBI should balance? Do you think it is good to start easing incrementally from hereon, should the bias be towards easing or is it necessary that we break the back of inflation even if growth were to suffer in the medium-term? A: I think to some extent, it should be the latter. As we have seen in the case of US in the early 80s, when Paul Volcker’s aggressive interest rate increases and tight monetary policy stance pushed the US towards recession temporarily but, then ushered in a long era of macroeconomic stability as inflation expectations were acted lower. From that point of view, the Central Bank’s primary objective should be to achieve something like that and I would argue that some of the growth responsibility lies with the centre and not necessarily with the central bank. Q: What kind of fiscal deficit number are you working with? A: As we were discussing, the finance minister is certainly sounding very committed towards impressing the market. Revenue side measures, expenditure side measures and a lot seem to be in the pipeline. Expectations are certainly rising for an assertive budget. I am expecting the budget to be targeting something in the range of 4.8 percent. So something below 5 percent seems to be the absolute minimum the market would require to be impressed. I think what is far more important than the number is the credibility of the number. Can we believe the government if it says that they will carry out substantial subsidiary reduction? Can you believe the government if it says that tax administration would improve so much that just without any tax policy measures, yield can go up by 0.5 or 0.7 percent of gross domestic product (GDP)? It is the language and the content of the budget more than just the topline numbers that are absolutely critical. Q: You have just been saying that you have come up with a Deutsche Bank meeting in 10 countries in the emerging markets (EMs) and you are having 6 percent Current Account Deficit (CAD). We did 5.4 percent in the September quarter and then we had two ugly trade deficit numbers for October and November. So, a lot of economists I met are working with 6 to 6.1 percent for Q3. What are you working with in terms of CAD quarterly as well as yearly for FY13 and FY14 and do you think over there we are getting into a seriously unbalanced terrain? A: Without any doubt we are getting into an unbalanced terrain. I am right now working with something in that range for the whole financial year, about 4.2 percent of gross domestic product (GDP). It is very hard to figure out how that comes down substantially in FY13-14 unless there has been a huge pick up in exports. There will be some pick up in exports, but a huge pick up in export is probably asking for a lot. So, the question is then what does India do on the import side? What happens with gold imports, which admittedly is on the way down? What happens with oil imports where one can argue that if there are a couple of more administrative hikes in diesel prices, maybe there will some demand response and there will be some cut back in wasteful import and that sort of a bill. But, even then I think the CAD drag on the Indian economy will remain substantial either this year or next year. India is still growing. After all the slowdown we are still talking of a 5 to 6 percent economy. There is a substantial import demand and exports are lagging substantially and then the rupee is a casualty. Q: What did you make of the rupee before 2013 ends? Do you have any growth forecast for FY14 now? A: Given that India has become more correlated with the global economic dynamics and since we do expect bottoming out in Europe, if there is a pick up in the US and China, India should do better this year than last year, just on the back of that external pull. We are expecting about 6.5 percent growth for FY13-14. Would that mean that the exchange rate stabilises? Perhaps, sentiments are also a very big part if exports pick up and flows do improve. But, I think there are significant roles to be played by both the central authority in terms of dealing with excessive import demand as well as on the monetary authority in terms of having a macroeconomic stable situation that then brings in more flows and stabilises external account. Q: There is one theory that is doing the rounds. It says, in the budget itself the Finance Minister will not be very profligate, but he will save the fire power for later in the year when we come closer to the elections and that is the time when he actually does some profligate spending. Do you think something like that is possible? Are you getting confident that the Finance Minister will not do something at this point? A: I don’t think it is zero sum. I think it could be both where you could have a relatively responsible top-line number within which you make sure that the various vote sensitive spending items have generous allocation. For example, in case of the Unique Identification (UID)scheme, you could argue that UID scheme could allow the government to not necessarily ramp up spending, but let it go to the people who get the cash and therefore, become favourably amenable towards the government.