India's macro fundamentals look absolutely solid: Anant Narayan

The fundamentals for India, the macro fundamentals look absolutely solid. The first huge fundamental positive which has sustained over the last 3-4 years is the fact that oil prices have come down to where they are which from a current account deficit perspective and from a country economy perspective is a huge boon given that we import 80 percent of our energy.

Second, there has been definite progress when it comes to reforms. Goods and services tax (GST) coming on board has been seen very positively by overseas investors. There has been political stability, which has come about since the February Uttar Pradesh (UP) elections.

So, all in all, clearly the market views India much more positively. Current account deficit seems to be under control. Flows are coming in, both in terms of portfolio investors as well as in terms of foreign direct investment (FDI), the country is soaking in FDI as we go in. So to that extent, the paradigm seems to have shifted. At the same time, I think it is also important we take into account the possible vulnerabilities as a result of what are seeing on the rupee markets.

First, with rupee having strengthened, it is probably not good news for domestic industry.

Q: Primarily, the oil prices, it seems to be a secular downtrend or at least capped at USD 55 per barrel. So this dollar weakness or rupee strength is perhaps not going away in a hurry. Is it already becoming a Dutch disease? The latest, May import numbers indicate that okay, if you took gold and the entire import basket, it went up by 34 percent year on year. Exports went up only by 8 percent. Even assuming we take out gold, still imports have risen by 25 percent, which means even project imports could be made and certainly machine tools were a good 30 percent higher. Do you think already Indian manufacturers are beginning to suffer because of this strong rupee?

Raman: I would like to believe that because we have a situation on hand. We have considerable capacity underutilisation. So, there is a case for Indian manufacturers to take a marginal costing approach to price their product and services, which I do believe they are doing currently. Despite that, if thanks to the currency strength, imports are coming in, we are creating a situation for the country, which for a long time to come, could impair its own growth in terms of manufacturing capability.

Today, one of the political resolutions is to get all-inclusive development, which means job creation, reskilling. Now, all of the traditional manufacturing is possibly giving way to automation robotics. So we need to figure out a way how to get more productive for either men, machine or money to rediscover our export competitiveness.

Now, this is in two parts. One is, we are fortunate that oil and we are very dependent on import of oil. It is soft and it looks as though it will remain soft for quite some time. So that is something that you can plan into your model for the near-term or medium-term. Unless the competitiveness of domestic manufacturing goes up, it is not going to be possible for us to breach through the export growth that we want to do.

Q: So, export growth is not there. My worry more is whether domestic industry is shrinking because imports are occupying larger terrain.

Raman: Most of the countries who have faced this earlier have got into protectionist policy which, in the short-term is okay, but in the long-term it will harm the productive capability of the country.

So my belief is that the policymakers could take some short-term view of this and raise anti-dumping duty, but it is not going to solve the problem. The Indian manufacturing industry is at a cross-road today. Technology is changing. The consumer behaviour and expectations are changing and you have this problem of cheaper and cheaper imports. So, it is in a situation where I would think that we might have to think out of the box, else we might miss the bus.

Q: I am wondering if there is a financial answer to this. Do you think the Reserve Bank of India (RBI) can be more aggressive in buying dollars? Their problem is that there is huge liquidity, but can it add a little more? Should the RBI be way more proactive in buying dollars than it is now?

Rangan: When the RBI must be deciding on buying dollars or selling dollars, they obviously are working on a certain premise that they want to either regulate a certain amount of volatility and I think it is a high volatility which they are more or less looking at rather than looking at the day-to-day movements.

Having said that, I think one of the so called fallouts of all this is that for example, as a domestic player, our balance sheets, both the sides, assets and liabilities, are domestic. We hardly have any foreign exchange implications of any of this. But the indirect fallout of that is, as Anant was saying that the flows have been very strong, both on the equity as well as on the debt markets.

The masala bonds for that matter, if you look at, which is a call on largely the rupee and if you look at, we did about Rs 8,500 crore of masala bonds and the rates at which they were done and today, the rates of the rupee, if the people have kept it open and all, it has actually led to a very real returns to the investors who have put in that.

So, it has opened up a liquidity window in some manner. More than the rupee appreciation, I think it is a stability and appreciation, both have enabled in terms of that type of a flow. Not only there, but if you look at the foreign institutional investment (FII) flows into the bond market which I understand that the limits of bond market is more or less trying to get filled up.

So there is a lot of rush, even into government securities and in the bond market, there is a lot of rush for the FIIs to come in and put. That is creating a further vulnerability in terms of rupee to appreciate. Whether it is fundamental or whether it is flow related, both have been very positive in terms of pushing it. So to what extent RBI would want to keep on controlling that, it is going to be quite tough.

Q: We are probably in a lucky situation that at least the equity flows are not coming, it is coming more in debt, but does the RBI really have enough tools in its kitty? Should it go all out into intervention? What should the central bank's policies be?

Narayan: I think there is no shortage of tools should the RBI choose to intervene in a big way. I do think at some stage, over strength of the rupee might become a problem.

Q: But not yet so?

Narayan: Not yet so. I think the fundamentals look fine. I do not see a problem coming up but the vulnerabilities could be growing on two counts as Shankar Raman also alluded. The fact that for instance, the yuan has depreciated against the rupee by 7-8 percent in the last one year and we import USD 60 billion of manufactured goods from China, the fact that we are making importing from China even easier now is a problem for us given we are underemployed as a nation and we need employment for a whole host of issues.

The second thing is, the moment you have a trend of this kind coming through, complacency builds up. So a lot of the flows that Rangan also alluded to, investors bringing in money through the debt markets, exporters hedging, importers refraining from hedging, people borrowing in foreign currency and to the extent possible, not hedging. You are increasing unhedged exposures in the country and the analysis that we have done says that over the last three years, about USD 65 billion of additional unhedged exposures have been built up in this country.

Now, again it is not a problem. The country can easily manage this, but to the extent that you have rupee strength coming on the back of unhedged exposures being built up rather than current account surpluses or FDI alone. I think it is an unhealthy trend which needs to be managed.

Q: Where do you see a 12-month forward dollar-rupee?

Narayan: This is a full disclaimer. If you try and do something on the back of it, your problem. I do think that eventually rupee will start to depreciate again. I do think the current trend, given that interest rate differentials, consumer price index (CPI) differentials are there and given vulnerabilities and the fact that it is not great for the economy if rupee strengthens too much, I do think we will see a gentle depreciation going forward, maybe 66-66.50 to the dollar over the next 12 months. I could be completely wrong, we could see reverse, but I would bet for that at this point of time.

Q: What is your view?

Raman: I would tend to agree with Anant Narayan in terms of view. I think mid-66 to the dollar thereabout is what I see. But I do see the rupee somewhat give up the 6 percent gain that it has acquired over the last six months.

Q: That would be a big relief to domestic manufacturers for sure.

Raman: For a start.

Q: What would your guess be?

Rangan: My view is also that we are almost near the end of the strengthening part. If at all there is any move for whatever events or anything related, you would probably see a mild depreciation although not very high.

Q: We now discuss the cost of money. We have seen a fairly dramatic and unexpected fall in the cost of funds. If I take the 10-year from about 7 percent at the start of the year, we are now at 6.7 percent. If you take the old 10-year, if you take the new 10-year as well, it is a good 30 basis point, over a quarter percent fall in the cost of money. If you take probably or a one year or 1.5 year view, I think the cost of funds at even 200 basis points. So where are we headed to start with? Do you think there is more to go in terms of fall in the cost of money?

Narayan: Given the way the CPI surprised all of us and now we expect the next month's print to be even below 2 percent and given the fact that our monetary policy framework is reasonably straightforward, that is it is a lever of watch the inflation and react with interest rates. There is a high probability that the RBI will oblige with rate cuts in the August policy and maybe even beyond that. So 25-50 basis points of rate cut cannot be ruled out.

But I do like to go beyond just interest rates and inflation. I think the economy consists of lots more beyond that as well. There are lots of factors which support short end rates to be lower. Credit offtake still remains tepid despite the fact that debt capital markets are doing reasonably well. Rupee, as we discussed, is probably on the overvalued side which again calls for short end rates to be on the lower side.

CPI of course, inflation is a strong case as well and the fact is domestic industry on the micro level is not necessarily doing well. So maybe spurring some amount of consumption, some amount of banking health through short end rates can also be argued for.

At the same time, there are vulnerabilities on the longer end which we need to be cautious about. First is state government finances. The fact that we are discussing farm loan waivers, they have very strong social requirements and reasons for doing that but there are implications in terms of the fiscal health of the country, etc.

The second part which worries me a little bit is the fact that we are seeing so much of money move as savings into equity markets. Who am I to judge where equity markets are headed, but the fact that post tax returns on deposits have come down to particular level which encourages people to passively put money in systematic investments plans (SIP) and whether the capacity for the equity markets to hold that kind of money is there or not, is a bit of a vulnerability we have to worry about.

So all in all, there is a strong case for short end rates to come down, give a fillip to domestic industry. I am not so sure though that this should be complacency in the longer end given the external situation, given the vulnerabilities building up in the economy, maybe there is a case for longer ended rates to be on the higher side. A steeper curve would be perfect.

Q: That is not a very happy situation for the non-banking finance companies (NBFCs) and the manufacturing company. What is your estimate? Do you think that there is a case for longer term rates to fall, there is necessity for long-term money to fall, cost of money to fall, will it fall?

Rangan: Two questions you have asked. Basically, you are saying whether the long end rates will fall.

Q: Should the 10-year go to 6 percent?

Rangan: The simple answer to that is obviously the macros. If you trace all the macros whether it is CPI or whether it is flows and other, there is enough reason to believe that the G-sec has further room to fall whether it is 6 percent or 6.25 percent, most of the bankers who you ask they probably would be talking on a 6.25 percent type of a rate, somewhere in the near future.

But if you had to talk about whether interest rates are going to make a difference, whether it is 25 or 50 basis points from here on for the type of projects and others which you are talking about. I would think that the investment into new projects is going to come in only when we are going to see the existing capacities being utilised. Today, the capacity utilisation is on average between 50 and 60 percent in most of the industries. As you also mentioned about the banks, they have a lot of infrastructure assets already and they have to solve a lot of the old problems.

So given that the credit offtake will probably start happening when we see some of the reversals in these capacity utilisations largely, the requirement even to have a long-term funding for some of these projects, I do not think the market is -- you do not see many people coming into the market and asking to raise long-term money for putting up a new project. It is either refinancing largely or it is largely the consumer driven businesses, whether it is housing loans or those types of businesses which are continuously in the longer end to pick up money as and when it is opportunistic.

Q: Everyone is looking at your sector probably break that logjam that enough houses are demanded and built, then probably that will lead to a consumption and therefore an investment cycle kick off, but you are actually looking at the investor, the capital goods guy.

Rangan: Even if you look at our sector for example, to be very honest about it, if you look at the housing finance which is sort of a benchmark for the real estate activity.

Q: You do not see the cost of money falling?

Rangan: Cost of money is coming down and obviously it is a financing business so as the rates come down, you pass on the benefit.

Q: But can it not be a kick off for further demand housing finance?

Rangan: To some extent, yes.

Q: If it came down to 7 percent? That is what happened in the previous cycle.

Rangan: Today if you had to look at the current interest rates and put all these Credit Linked Subsidy Scheme (CLSS) subsidies and tax benefits and whatever it is, you are almost at the 4 percent type of real effective interest cost to you, to anybody. It is quite that way, very attractive, at this point in time also. But having said that, whether it can go down further, probably yes. But if you look at even at the current juncture, the average growth of most of the housing finance companies (HFCs) have been around 18-20 percent on a book basis, particularly the larger ones.

So there is a real activity which is happening there which is obviously keeping the balance sheets to grow, the assets have remained broadly well in terms of collections and all that stuff. But the capex segment and others is where the large part of capacity underutilisation is lying.

Q: That is a larger question, but I want to ask you whether you see masala bonds and domestic interest rates, altogether, making cost of money easier for India Inc in general. Will FY18 be the year where that will be the positive side of profit and losses (P&L)?

Raman: I somehow believe that we are almost at the bottom of the cost of money debate. I do not believe that there is going to be a big downside to interest rates from where we are today. Two reasons. One is I think, we have caught the tiger by the tail in terms of farm loan waivers and several states are coming up for election and even those which do not have election will have the farmer agitation coming up. The government possibly, in the run up to the FY19 election will have to deal with it in a very sensitive manner. I do believe that that is going to create some unexpected holes in the government's balance sheet.

And secondly, the banks which are sitting with money, are also sitting with huge amount of non-performing assets (NPAs) and these were the very accounts where the banks were happy to lend, let us say five or six years ago. So there is a structural issue here about banks having money but not wanting to lend to people whom they lent earlier. So who are the new guys who are going to put their hand up and claim money?

Q: Consumption? No?

Raman: The consumption cycle is what possibly will pick the investment. Hopefully, this festival season on the back of maybe reasonable monsoon, should be able to see the consumption pick up and that could lead to some capacity utilisation improvement. And if the government does go forward with the infrastructure build that they are talking about, I expect steel and cement to also lead the way along with construction.

Q: Basically coming back to my fundamental question of cost of money, you are not expecting more than perhaps a few basis points?

Raman: There would be some marginal correction perhaps depending on the demand-supply situation, but I do not expect that to be significant for corporate India to change or refashion any of their current plans.