7th Pay Commission to weigh on RBI policy? Experts discuss

Ahya believes the Pay Commission won't threaten the government's fiscal deficit target as the 12-months trailing number is right now at 3.4 percent.

He says: "So, they are doing pretty well and they have just an additional hike in excise for petrol and diesel. So they have got protected and created enough buffers on fiscal deficit. So, we don’t think it will be a big slippage from what we had expected earlier for March 2017 only because March 2016 is going to be much better than what we have projected earlier."

On the impact of wages, Ahya says the 7th Pay Commission will create demand and lead to some inflationary pressure but given the "very low aggregate demand,"  it will infact not pose to be an issue.

Below is the verbatim transcript of A Prasanna, Chetan Ahya and VG Kannan's interview with Latha Venkatesh on CNBC-TV18.Q: The 7th Pay Commission -- will that be big thing that you will watch out for in the forthcoming policy? The fact that it might alter the RBI's dovishness, which was very prominent in the previous policy?Prasanna: Definitely, it is an important development but we have to remember that it was not completely unexpected, right? Pay commission has been set up quite some time back and the reporters expected any time at the end of this calendar year and if you look back at the last policy itself RBI had mentioned explicitly in that statement and also said that they expect the government stick to the fiscal roadmap. I would assume that RBI had factored in some of this impact in terms of higher pain, therefore higher spending, higher consumption and some growth boost in their calculations when they projected inflation a year ahead. Maybe you can argue that some of the numbers might be different from what one would have assumed earlier. So to that extent there will be some minor adjustments, but I don’t think this would call for a complete change in our base language or the projections from previous policy to this policy.Q: What is your own expectation in terms of the load on the deficit itself? What percentage, is it 0.7 percentage of the gross domestic product (GDP) that it will add in terms of expenses and more importantly, the house rent component, which goes up by 138 percent, what will that do to the RBI's consumer price index (CPI) trajectory for FY17?Prasanna: So it is 0.7 percent. If you add one rank one pension (OROP), it can go upto 0.85 percent also but you need to remember that this is not just a standalone thing. The economy is also growing so revenues will also grow and one would assume that there is a service tax hike again which is going to be in the offing because as you go towards the GST, service tax has to keep going up. So if you put altogether, what we estimate is that it can go to 3.9 percent or in other words government has to still find 0.4 percent extra compared to this year in terms of additional revenues or some savings and spending to come back to 3.5 percent, which is part of their roadmap. So essentially 0.4 percent is what we should focus on. As far as the CPI impact or housing impact, which you mentioned, it is not 138 percent, there is an increase in coverage of HRA also. So if you strip that out, it is 109 percent but what we have found out is that if the government owned housing or housing occupied with government employees in the CPI housing basket, it amounts to only around 3 percent or slightly less than 3 percent. Initially we estimated 50 bps but now we have drilled it down and we think it is only 30 bps increment in the overall inflation because of this HRA.Q: Let me get Chetan Ahya's lowdown on next year's both fiscal deficit and inflation trajectory. What would you make both goods and services tax (GST) and more importantly 7th Pay Commission?Ahya: We are projecting fiscal deficit for next year for the Central Government at 3.9 percent. The reason why we are not showing much slippage because of 7th Pay Commission is we think that this financial year itself the government will be able to show for March 2016 a lower deficit than what they were projecting. The 12-months trailing number is right now at 3.4 percent. So they are doing pretty well and they have just an additional hike in excise for petrol and diesel. So they have got protected and created enough buffers on fiscal deficit. So we don’t think it will be a big slippage from what we had expected earlier for March 2017 only because March 2016 is going to be much better than what we have projected earlier.To add to the point on inflationary impact of wages -- that is what is important for RBI when we are mentioning this in the context of RBI's action, you can weigh it in two contexts. One is whether this will create too much demand and therefore inflationary pressures but right now the economy is running at a very low aggregate demand so we don’t think that will be a problem. From the cost side, it will be a problem if it is seen to be in terms of weighing on wage expectations of even just the public sector. They know this is one of. From next year onwards, wages to GDP will begin to normalise for Central Government employees and more importantly, we don’t think it is going to have a pass through into private sector wages because private corporate sector is not making money and they are not going to be responding to these wage pressures from public sector, which is also one of. So no cost side pressure, no big demand side pressure, we don’t think this is a big issue as far as inflation outlook is concerned.Q: So you expect the RBI to stick with its inflation trajectory, its forecast between 6 percent and 5.5 percent up until mid-calendar FY16 and then going down between 5 percent and 5.5 percent and an inflation of 4.8 percent for the first quarter of 2017 that is January 2017. You think that will be pretty much what they will stick with, of course it was in the monetary policy report it was not in their policy statement, the FY17 trajectory but will they stick with it or will they indicate that January 2017 could be higher?Ahya: Ideally, they should stick with it because it seems to have got the buffers of maybe the pay commission effect already or whatever the other concern the RBI has from potentially oil prices going up. Just to contrast that forecast, we are not expecting inflation to go much above 5 percent. So for the bulk of that period, the forecast range that you mentioned, we are sticking on with around 4.75-5 percent range for inflation. Our confidence comes from the fact that all the sources of inflation are supportive. The only concern we have is in food prices and food prices as we can see it is only in tur dal and tomato. It is not transmitting, generalised to other food items so that is comforting and so therefore we are still sticking on to our rangebound forecast of around 5 percent. Q: I am raising the entire fiscal and inflation argument only to check whether the governor will continue with that other big Santa Clause gift he gave us last time and he said that I am still in accommodation mode. Both of you are expecting that the fiscal deficit will not be 3.5 percent in FY17 but 3.9 percent. Can the governor persist with accommodation in this policy as well?Prasanna: Just to clarify what we said is that it can go up to 3.9 percent but what we expect is government will try and take steps whether in terms of additional resources or trying to trim the expenditure. So it will try and bring it as close to 3.5 percent at least in February when they present the budget, I think that will be their effort.So, 3.9 percent is upper end of where it could go. At this point of time, RBI will also point to government fiscal roadmap. So that is all they have to go by. So clearly it is not logical for the Central Bank to assume that the government will exceed the fiscal deficit. So they will still point to the fact that the government is expected to stick to 0.5 percent and therefore I expect them to retain that accommodative word. Accommodative word mean or lead to immediate action in the near-term. That is something which RBI had also clarified in the last statement. So they are still waiting for more transmission and definitely I don’t think prior to budget, RBI will have any bias towards rate action even they may retain the word accommodative.Q: You think they will retain the word accommodation?Ahya: We think they will maintain the word accommodation in the monetary policy and we think they will cut policy rates by 25 bps in February when they meet.Q: They meet in February before the Budget, you expect that rate cut even before the Budget?Ahya: Yes because I think they would get the comfort of inflation maintaining at around 5. As you know, their trajectory of inflation is showing an uptick and I don’t think that for the Budget per se they will know something new. You know the fact that they have been maintaining fiscal deficit quite better for this financial year itself. So unlike the last time when they wanted to know what the new government's policies are, now it is all very clear what their policies are and actual trailing data is probably going to give them the comfort that these guys are managing fiscal deficit quite well.Q: Our poll indicated that there is nothing coming in the credit policy by way of a rate action, what are your expectations? Kannan: This time around I would say that they would like to look what is going to be the Fed action and once the Fed action goes through, they will probably take the call as to what to do. I expect that before March, we expect a cut. Q: If the credit policy indeed does not announce anything by way of rate action, even then do you think banks have the scope to cut deposit rates and lending rates, deposit rates or base rates? Kannan: My own reading of the deposit rates is that deposits have been growing but not to the extent like in the past when the rates were high. Therefore going forward immediately cutting the rates would hurt us in the form of flows by way of deposits. Unless the government of India reduces the rates on the post office deposits and other schemes, the chances of further cutting could be quite suicidal to all the banks. I feel that if there is a move there also even without RBI cut there could be possibility of a deposit cut but without that as of now, there may not be much of a scope. Q: What kind of a loan growth are you expecting in the second half of FY16? Kannan: The end of the year, we are looking at around 12-13.5-14 percent so having been around 10 percent we expect the growth to be around 14-15 percent in the next four months, mostly by way of retail as also by way of takeover advances. Q: The answer from the bankers doesn’t seem to be that they are expecting too much by way of deposit cuts or lending rate cuts. Therefore what is your sense on economic growth itself, we should not be factoring interest rates as an input into expecting better demand at all in 2016? Prasanna: Obviously there have been some cuts already; there have been some lending rate cuts. So you would expect the lag effect to flow through in the next year. So definitely that should be part of any growth estimate. Also, I think that this is a busy season. So liquidity has definitely tightened. Therefore there shouldn’t be any immediate expectations but there is a request by the banks for the government to look into small savings rates and suppose the government does something on that saying the run up to the budget or in the Budget, then maybe that could be a trigger for some rate cuts for lending rate cuts. So then that would mean that going into FY17, definitively there is more in the pipeline in terms of lower interest rates. Q: What therefore are you looking at in terms of economic growth next year? Is there an economic upturn that you are penciling in 2016 or in FY17? Prasanna: In terms of gross value added (GVA) estimate for FY16, it is 7-7.5 percent. It is 7.3 percent in the middle of that range and into FY17, our estimate is 7.5-8 percent at this point of time. Of course the Pay Commission what you are talking about that stimulus matters only if the government allows the deficit to expand but otherwise if they are sticking to 3.5 percent, it essentially means that they are paying out higher salary but somewhere else they are trimming. So in that case maybe it is not much of a stimulus. Q: How are you looking at the cost of money in the economy, are you expecting a seminal fall in interest rates? Ahya: I think we should get more lending rate cuts. As you know there are challenges that the deposit structure is such that you have the liability period of about one year. So the transmission of that just by very nature gets delayed and we have not got enough of that deposit rate cuts that banks have done, transmitted through the lending rates. Yes, they have to fund their credit cost because non-performing loans (NPLs) have been high. However, if you take a six-nine months outlook, we should see at least another 50 bps cut in the lending rates as banks begin to pass more and more of this deposit cuts into the lending rates. Q: What are you expecting by way of growth in FY17? Ahya: I would give you both -- the delta as well as the number. So the delta for financial year 2016 will be 20 bps and we are looking at 7.5 percent and March 2017 we are at 8.1 percent. Q: What else you may expect from the credit policy? Kanna: Other than the rate cut, I don’t see much of a change. There could be some discussions on the liquidity coverage ratio because the banks have been making reference to the RBI. Having statutory lending rate (SLR), cash reserve ratio (CRR) and the liquidity coverage ratio is a double whammy. So we do expect that there could be some relaxation there. Q: What will this credit policy be important for for you? Prasanna: Essentially it will be interesting to see whether there is any change in view in terms of the balance sheet growth because the kind of balance of payment (BOP) surplus -- no one was expecting at the beginning of the year hasn’t materialised clearly and going into next year also again the outlook is uncertain. So in that case, is there a change in the kind of balance sheet growth which RBI has estimated and therefore does it lead to any change in that open market operations. Q: What will you look forward to on December 1? Ahya: What I would be wanting to see personally rather than what I would expect is that they should probably raise the issue of recapitalisation of public sector banks. RBI has not been so aggressive mentioning that this is an issue but soon it will become an issue if we are going to get growth recovery. So the government has been delaying that decision for too long and I would wish that RBI raises it in a monetary policy.