Interview: RBI needs to ease off forex intervention, says Standard Chartered’s Sahay

Sahay expects the services sector to power GDP growth this year while exports could be a drag, owing to global growth concerns. She expects the RBI to take the repo rate to 6 percent by December through two rate hikes. Edited excerpts of the interview:

Do you see the RBI’s approach changing towards the exchange rate?

In our view, we think we are now closer to the point where the pace of intervention has to slow and give way to a weaker rupee. If you look at the import cover, from double digits we are now down to nine months of import cover.

Commodity prices are off the peak, but they are still elevated. Oil at 90 (dollars per barrel) is not a comfort for India. Hence, in our view we are now closer to the point where the RBI may moderate its pace of intervention and you may see the rupee trading above $80. So our forecast is by September, the rupee could be at 81 per dollar and if the dollar shows weakness, this could be around 80 by December. The other point is that when it comes to forex policy, reserve management has to be done from an economic cycle point.

Historically, India received $20-25 billion of balance of payments surplus on average for every decade. The reserve accumulation we did in 2020 and 2021 has been exhausted partially—effective reserves are now down to levels last seen in late December 2020.

The current account deficit is likely to remain wide in FY24 too. Hence there is a need to be more prudent in terms of spending reserves in defending the rupee very aggressively. The world outlook on inflation, growth and capital inflow remains uncertain. So it becomes important for a more prudent intervention strategy.

Also read: Moody's cuts India CY22 GDP growth forecast to 7.7% from 8.8%

What do you make of the Q1 GDP data?

It is lower than our expectation of 14 percent and the RBI’s expectation of 16 percent. Having said that, there is a clear story of an ongoing recovery. My sense is that there are some sectors which still have a lot of catching up to do.

For instance, within the services sector, trade, hotels, transport and communications (sectors) is now growing consistently back at the rate we used to see in pre-pandemic times.

Going forward, this can be an important driver of growth because if you look around, the hospitality sector is doing well, transport is doing well and wholesale trade is holding up.

If I talk about H2 of FY23, probably the drag from net exports will also ease off. Net exports in this quarter chopped off 600 basis points (6 percentage points) from headline GDP. This may not even change in the second quarter but hopefully, in the second half, we may see a relatively smaller drag from here. In all, it is a mixed story on growth, especially if you look at the underlying components.

Also read: GDP growth surges to 13.5% in April-June on favourable base, but misses estimates

So, you expect services to do the heavy lifting to power growth?

Absolutely. I think services will do the heavy lifting. If we focus on the year-on-year numbers, growth in services is outperforming the industrial sector.

If you compare the absolute level with that of 2019, the trade, transport and communications (sector) stands out and this can be a potential driver of growth going forward. Even if it does not drive growth incrementally, it has enough room to absorb any moderation in growth in other segments of services.

A related point here is that public, admin and other services grew by about 20 percent. But if you see the expenditure side, the government consumption expenditure has grown by just close to 1 percent.

Now in public, admin and other services, the other services reflect small business activities involving tailors, beauty parlours, etc. It shows that this segment is coming back, driven by the private sector.

Since headline GDP growth is lower than RBI projection, do you think it would change the speed or course of monetary tightening?

There is a clear possibility of some marginal downward revision on GDP growth.

For monetary policy, the focus is very clearly on inflation. While the inflation trajectory seems to be moderating and upside risks to the inflation trajectory seem to be contained, it is still above 6 percent.

The other important point is that given the hawkishness major central banks are showing, RBI will have to go and hike rates to contain the indirect impact on inflation and at the same time, ensure that the adverse impact through the external sector is contained.

The growth outlook in our view has not changed significantly post the data release. We expect the repo rate to go all the way up to 6 percent by December. In September, we see a hike of 35 bps and in December, another 25 bps hike.

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How do you see the rate hikes after December? Will the RBI pause?

It is possible but it is an evolving situation. Whether the monetary policy committee will pause before they start hiking again or before they start cutting, we don’t know.

If the Fed takes its rate to over 4 percent, then there is an upside risk to our repo rate forecast of 6 percent. But if recession fears grip the world at large, you may see MPC (Monetary Policy Committee) hitting the pause button and take stock of whatever they have done in terms of transmission of rate hikes to the economy.

To take a call on this so much in advance is a challenge. This is what the RBI Governor, too, said in his interaction. Currently, based on our global and domestic growth/ inflation outlook, we expect the December hike to be the last one in this cycle.

In the past, India’s exports have played a big part in lifting the overall growth. Would this continue?

When we talk about exports, especially since the outbreak of the pandemic, we have to take two factors into account.

One is the role of global growth and trade and the second, is the supply-chain disruptions, which created an opportunity for Indian exporters. This opportunity was created both by the outbreak of the pandemic and the recent geopolitical tensions.

Now, it is clear that Indian export growth is dependent on global growth, especially the demand coming from the US and Europe. Hence, a downward move or moderation in exports, in our view, is inevitable.

There is another reason why exports may moderate. In 2020 and 2021, the export volume change in India was exceptional compared with the past. We have had extreme strong performance on export volume. That will lead to some plateauing out now.

But some of the export items, for instance, we are exporting fuel related products to US, Europe in a way which we were not doing before. That won’t change because these countries are moving away from their traditional sourcing countries.

There will be some moderation for sure but some support can come from the changing mix of exports. Some demand channels may stay intact despite geopolitical tensions.

In all respects of growth indicators, have we finally recouped all pandemic-related loss? Where do we go from here?

If we look at FY23 Q1, it was in double digits primarily because of base effect. This would not be replicated in the remainder quarters.

Secondly, as we move further into FY23, the pent-up demand factor will fade away and lastly, we will see the impact of slower global growth on India’s demand too. Hence, we will see growth slowing as we move into the last quarter of this year.

In the fourth quarter, we see GDP growth at 4.2 percent and for FY24, we see it as 5.5 percent. At the headline level, optically this can be seen as a big moderation but we know it is not the case. There is a normalisation here. Getting a growth rate of 5.0-5.5 percent in the current challenging environment, in my view, should not be underplayed.