In early stages of biz cycle turn; FY16 GDP at 6.8%: Nomura

Below is the verbatim transcript of Sonal Varma's interview to CNBC-TV18's Latha Venkatesh and Reema Tendulkar

Latha: You have been telling us that tracking inflation number is coming in lower than the inflation forecast that you had so far, that analysts had so far. What is the sense you got after looking at yesterday’s consumer price index (CPI) number that we look quite clearly way below 8 in January and way below 7 percent by March?

A: Yes absolutely. The underlying inflation which was tracking 6-6.5 percent in September actually has fallen to slightly under 6 percent in October. Next month we have another positive number because of base effect, post which we are expecting inflation to go up. But the disinflation actually continues still in the economy because of the lagged effects of growth slowdown. So it now appears that instead of the 7-7.5 percent range in which we were expecting inflation to rebound to in the first quarter of 2015, inflation is more likely to be in the 6-6.7 percent range in Q1 2015 - significantly below initial expectations.

Reema: So when does Nomura expect its first rate cut and based on what we have seen would you push forward your rate cut expectations by at least one policy?

A: We had highlighted in September that the inflation trajectory was undershooting and therefore there was a slightly higher probability of rate cut in the second half of 2015. But it is important to understand RBI’s new framework on monetary policy because clearly we are positive on inflation and inflation is tracking significantly below what we had expected and it is likely to continue to moderate in the first half of 2015 as well.

But when it comes to the view on monetary policy, I think RBI is taking a more medium term view on inflation and their objective is to keep inflation actually anchored around 4-5 percent in the next three years or so even as growth cycle picks up. Therefore, what we are seeing partly right now is actually the lagged effect of the past growth slowdown and the challenge for the RBI is that while inflation may undershoot in the short-term, in two years time when actually growth starts to pick up, will we still be able to stabilise inflation around 5 percent or whatever the medium target they set. Urjit Patel Committee actually set 4 percent. That is where the disconnect between inflation and the RBI stance comes through. Surely if inflation is coming down it does open up some room for rate cuts but if the objective is to stabilise inflation at 4-5 percent in a rising growth environment then that room is going to be quite limited.

Latha: So where would your informed guess be in terms of a rate cut timing?

A: Our base case is still for a cut in first half of 2016 and after the recent undershooting on inflation the probability of some cut in second half of 2015 is going up.

Like I said the scope for rate cuts in this framework is going to be quite limited and that is the more important message actually.

Reema: After three successive disappointments the IIP was a welcome relief at 2.5 percent. Do you think this momentum is sustainable?

A: On a trend basis, yes, we do think it is sustainable but in terms of sequential momentum, not yet. Part of the rebound we have seen in IIP in September in our view is increased production because of the festive season in October. As you know the working days in October this year were much lesser than working days last October because of Diwali falling in October versus November last year, we are going to see some moderation again in IIP growth in October.

But from a trend basis we are increasingly becoming confident that we are in the initial stages of the business cycle turning around. Whether you look at auto numbers which again were disappointing in October because of the lesser working days but the broad trajectory in things like medium and heavy commercial vehicles segment which is a good indicator of the transportation and industrial cycle, the kind of visitor arrivals we have seen in India which indicates the interest in the economy. The fall in commodity prices and inflation basically bodes very well for profit margins for companies and also for consumer’s disposable income and therefore discretionary consumer demand going up, the speed with which the government is clearing a lot of projects. Obviously there are some historical balance sheet issues and therefore it will take time for this to show up in real activity numbers. But the fundamental factors that drive the business cycle are now falling in place.

This business cycle of course is going to be much slower and gradual than in history because both fiscal and monetary policies are on the tighter side and also global growth outlook is quite muted. But in terms of the trend, India should see a gradual pickup in the growth cycle in the next 6-12 months.

Latha: Your gross domestic product (GDP) number for Q2, for Q4 of the current year and your guess for next year?

A: After the surprise rebound in IIP number in September, the September quarter GDP is tracking at around 5.5 percent which is about 20 bps below last quarters reading. But the tracking estimate a month back was actually closer to 5 percent so the tracking estimate for September quarter where GDP actually has moved up because of better IIP numbers and also because of higher government spending we have seen in September.

December quarter should be largely flat as compared to September because the impact of the below normal monsoons on kharif will be felt maximum in December quarter. So even if non agricultural GDP picks up which is what we expect, the headline GDP is unlikely to shift much. So for FY16 looking ahead India actually should be firing on all cylinders. Hopefully we have a normal monsoon which will push up agriculture GDP to above 3 percent. Industrial recovery will play out gradually and if industry does pick up then some of the sectors that are linked to industry whether it is transportation, credit disbursement should also start to see an improvement. So for FY16 we are building in growth rate of about 6.8 percent right now.

Latha: When does the turn actually come, first quarter of FY16? Will it be the April-June quarter?

A: I think the turn has already come, the quarterly readings have been very volatile but if you look at a moving average then the growth cycle is already starting to reverse. And this is not a V shaped recovery where suddenly in one quarter growth is going to go from 4 percent to 7 percent, it is going to be a gradual increase and we are already seeing initial signs of a gradual pickup in the growth cycle. More visible signs of growth picking up should be visible by the January-March quarter.