With worst likely behind, when will GDP growth reach 6%?

Q: 5.3 percent is better than what the street expected so looks like the worst is behind for the Indian economy in terms of growth?

Virmani: I recall that when the 5.7 percent number came in, in Q1, I had said that the growth for the next quarter will be less than 5.5 percent. So, in that sense less than 5.5 percent, 5.4 percent, 5.3 percent I am not surprised. So, as far as I am concerned I am still on track, we are still on track to my forecast which I gave after the Budget which is of 5.7 percent growth; plus, minus usual 0.25 let us say. So, in that sense it is good news as far as I am concerned.

Q: Is there any specific disappointment? A large amount of growth has come from government, community social personal services has given 9.6 percent. Is that sustainable with the tax revenues being so poor, this will fall in the Q4, isn’t it? So, would you have to revise your overall number?

Virmani: Two concerns remain which were already in some sense flagged by the IIP data which came out recently. One is on manufacturing as you mentioned. The rate of recovery in manufacturing is not fast enough and we have to see this in the context of global excess capacity in manufacturing, the very slow and constant downward revisions of global growth. So, this is a big concern and this will link up to issues connected with reforms.

Second part is as you again pointed out, the investment recovery. There is no investment recovery and that links to this issue of the gap between the financial which we are seeing in the stock markets and the gross fixed real investments. So, that gap is getting wider and wider so it clearly remains a big concern for policy again.

Q: What have you made of the GDP numbers, does it indicate that the worst is over or are we going to get something pathetic for the third quarter, does it indicate that at least there is future growth sometime soon?

Gokarn: The one thing that I want to highlight is that this is a tale of two halves. The performance of economy in the first half I don’t think is going to be a very effective predictor of the performance of the economy in the second half and the main reason for that is the very dramatic decline in oil prices that we have seen in the last few months.

In the first half, we do see signs of some emergence from the bottom -- no question -- when we compare it to the last year, when it 4.7 and 5.2, in comparable quarters we are at 5.7 and 5.3. So, roughly 5.5 growth in the first half. When we look ahead we are really going to see a very different environment. For one thing the macro situation with inflation, with the current account deficit narrowing particularly because the pressure from oil is going to be substantially lower and the fiscal deficit. Everything else remains the same, the reduction in oil prices is going to have a bearing on the fiscal situation.

All of this creates a very different backdrop for anybody looking at expanding capacities. As Arvind just said, there is an excess capacity situation both in the country and globally in many sectors so I don’t think we should be expecting an investment revival any time soon but we need certain preconditions to be established for the investment to recover and one of them -- there is the other one which I will come to -- one of them is sustained margin expansions.

If we see margins going up, corporate margins, profit margins going up over the next two or three quarters which I expect will happen because commodity prices particularly energy prices will soften then we have the preconditions for an investment recovery some time during the course of next year.

The second one is obviously the monetary policy stance as and when we start to see interest rates coming off, that should add further stimulus. When that is going to happen and at what pace I am not going to speculate but the inflation scenario being what it is obviously as most people are expecting some time during the course of next few months we should see the cycle turn.

So this is really creating conditions for investment recovery perhaps in the second half of calendar 2015 and that is the story looking ahead, I don’t think we should be too concerned about the story looking back.

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Q: The capital formation number is pathetic. Even when you looked at the second quarter corporate earnings we hardly saw any upside surprises, many of the fast moving consumer goods (FMCG) companies, the monthly auto sales numbers are all indicating extremely anaemic consumption. So, is growth such a given in the forthcoming quarters or is it an if?

Gokarn: The outlook for the second half of the year is going to be somewhat better than the performance of the first half because of the margin expansion. The oil prices really have started to kick in around September-October and we are really looking at a clean quarter now from October 1st to end of December when we will see the impact of lower energy prices and lower commodity prices in general on margins. So, let’s wait for that information coming out in the early part of next year. So, that is really where we could see, if there is some resilience in the economy, that is how it is going to manifest.

I am not too worried about 5.7, 5.8. It does indicate that we have hit the bottom, we are emerging from the bottom but I do see a significant amount of upside coming from the commodity price situation because it really changes the macro around and three-six months ago we were worried about the macro. I don’t think we should be anywhere close to being as worried about it now because of this one dramatic change.

Q: I would still be a little sceptical simply because a large part of the fuel price passing on is perhaps over. Last time around the government actually increased the excise duty. So, it kept the money with itself, it did not really come to the citizen. Even going forward CPI itself has subsidised power and subsidised LPG as its fuel elements. If anything, those will have to go up. Transportation cost which actually reflects diesel and petrol prices perhaps will not show this because we are not going to see ST bus tickets or train tickets coming down. So, are you really confident of growth? 5.3 is better than what the street expected but are you going to revise any of your numbers upwards for growth this year or the next?

Varma: We are quite confident that growth cycle has already hit the bottom. Growth never moves up linearly. So, we have to focus more on the trend rather than the quarter on quarter numbers. What I would say is that when we are looking at the growth outlook we need to segregate the trend or the potential growth and the business cycle.

We have discussed this multiple times that because of lower capital formation and the productivity loss that has happened India's potential growth has come down from 7.5-8 percent to about 6 percent. However the fact is that we have been growing almost a percentage point below even this potential for the last two years. Therefore there are enough low hanging fruits for us to actually get back to potential quite quickly. Some of this is already starting to be visible in the data.

Therefore going back to a growth rate of 6 percent on a sustained basis I don’t think is too much of a problem. We are actually doing the right things in terms of improving productivity in the economy. The big question is whether India's potential growth itself is going to pickup in an environment where global growth is quite anaemic and that would require significant amount of policy efforts domestically on the infrastructure front to basically take potential higher. However going to 6 percent I don’t think is a problem.

Q: When you say 6 percent quite easily what are your own Q3 and Q4 estimates?

Varma: Agriculture is again going to be relatively weak in Q3 although this quarter has been a positive surprise. For Q3 we are expecting higher than this 5.3 percent number, closer to 5.5 percent and a number closer to 5.9 - 6 percent for the final quarter. So, we are quite positive on the growth outlook looking ahead.

Q: But where will that growth come from? As you pointed out agriculture is the bigger, it gives almost 20 percent to Q3 GDP and that we know is not going to be as good as the previous Q3. It suffers from a base and it suffers from sub par monsoon. So, what is going to be the big contributor to Q3 GDP of 5.5 percent that you are talking about?

Varma: There are enough fundamental reasons to actually drive a private sector driven pickup. So, the government may cut its fiscal finances but that is having a positive effect on interest rates for instance the bond market actually coming down. So, financial conditions are actually getting much more easier.

Commodity prices have fallen so profit margins are going to go up. Oil is not just about petrol and diesel, the entire derivative complex of oil is going to see a big drop and that means that companies are going to see higher profit margins. Sentiment has already picked up. If you look at some of the initial surveys on job market indicators they are also starting to move higher. A lot of the decisions that have been taken by the government in the first six months are yet to show any impact. So, most of the leading indicators actually of the growth cycle are suggesting that the business cycle is likely to move higher. So, there enough conditions and factors in place.

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Q: 6 percent comes when according to you?

Varma: 6 percent will come closer to first half of calendar year 2015.

Virmani: You said where is the growth coming from? If you look at the IIP numbers, I haven’t had a chance to examine the consumption numbers from this GDP but the IIP numbers suggested that both consumer durables and consumer non durables were negative. So, where this growth is going to come from is recovery of consumption. I don’t think the oil price decline has really fed into the pockets of the consumers yet and that is going to happen during this quarter and you will see that recovery of consumption is going to drive the growth faster.

Latha: Where is the economy poised as far as the Reserve Bank of India's policy is concerned? Our poll of economists suggest RBI will hold rates on December 2 but they pointed out that the governor’s tone will be the more important thing to watch out for.

Virmani: I really cannot comment on monetary policy till December 3 (Dr Virmani is an advisor to the RBI). So, let me say a little bit about inflation.

For the last two months or so I have been saying both inside outside that inflation is now on a clear downtrend, that is one point and this was well before the big oil decline and the 5.5 number and basically one of the factors was the sharp decline in WPI and my analysis showed that the gap between CPI and WPI generally closes.

However the second point I would make is that if you look at the GDP deflator and I was the one who introduced this consumption deflator to use as a measure at that time because we did not have a good measure and that is showing 4.5 percent.

Q: Will there be too much leeway for interest rates to fall simply because if growth picks up then that will use up the excess capacity isn’t it? If the intention of the monetary authority is to take us towards 6 percent and then 4 percent is there so much leeway? How much can rates fall say over a 12 months period?

Virmani: I have to answer generally. If you look at the real repo rate about 2 months ago it was negative 2 percent. Now it is up to if you take even the last number 5.5 percent, it is 2.5 percent positive. So, this trend in my view is going to continue not exactly at that same pace. So, that issue is there.

Q: Are really all the risks out. Can stray onion inflation or a vegetable inflation still really yank up inflation expectations and the RBIs inflation expectation numbers are not really softening. So has the battle against inflation been really won, the crude price fall notwithstanding?

Gokarn: The two aspects that your question raises, one is what is actually shaping inflationary expectations and why have they been so stubborn in not responding to what are clearly softening trends on many fronts including petroleum products which have a very important bearing on inflation expenses. Particularly in a situation where food prices which were expected to surge after an indifferent monsoon have actually been relatively been comfortable, have softened. We have seen a negative price decline in vegetables which is something we haven’t seen for a long time.

So we have to get a little closer to the explanation as to what is driving inflation expectations in this economy. We really are in a situation where if you take expectations as the basis for policy and obviously that is the framework, that is the theory then we are in a situation where unless we continue with an extremely tight monetary stance we are not going to get expectations down but if you take the headline numbers and both CPI and WPI then you are saying well, the business cycle is playing itself out. Supply shocks that we have had with oil and food have been positive. So there is room to cut.

So there is an analytical issue that we have got to resolve but let me just talk about the food inflation risk particularly. We have seen some relatively positive actions particularly in terms of how the government have sold down from its cereal stocks; rice and wheat and that has had a dramatic impact on rice prices. before the middle of 2014 we had two years of 16-17 percent rice price increases after the sales began we have seen it come down to six and seven percent.

This has actually offset all of the monsoon impact on other prices and considering that the monsoon actually recovered on the second half that has had a positive impact on vegetable prices. So there are some long lived factors, there are some temporary factors. I don’t think we have dealt with food inflation, structurally the risks are still very much there but we have seen some actions that have helped it come down. We will see some benefits on this for some time.

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Q: Therefore can monetary authorities be terribly bold about rate cuts for the next 12 months. How early should they start cutting and how much may they be able to cut?

Gokarn: I really don’t make predictions about monetary policy nor do I give advice in public. So I am going to pass on that question.

Q: What is your sense, how quickly can the governor cut, and how much leeway will he have to cut over the next 12 months?

Varma: The point that expectations are still high is relevant and we know that expectations in India are adaptive. Now things are falling in place both in terms of some sort of demand compression because of the tight macro policies and also because of the impact these have had on supply side in the sense that cost pressures particularly wages are growing at a slow pace. So, conditions are now there for actually inflation to undershoot even the six percent target in the next 12 months.

So what we need to see therefore is for all of this to play out in terms of lower inflation, lower food inflation and gradually inflation expectations coming down. So, in this scenario I don’t think RBI should be ahead of the curve in terms of trying to cut rates. Our prediction is that there is going to be some space but probably to the extent of maybe about 50 basis points or so.

So we are pencilling in 25 basis point cut actually in the second and third quarter of calendar year 2015, but unlike the past many cycles in India policy stands in India is likely to be either neutral or tight because if the RBI is moving towards a flexible inflation targeting framework where we are targeting inflation to remain in the four to six percent range even as the growth cycle starts to pick up then actually there is no scope for monetary policy stance to become accommodative in this regime.

Q: At the most 50 bps cut all of 2015 starting perhaps April?

Varma: Yes our base case is for June. There is obviously some probability to April but we are pencilling in broadly in Q2 and Q3.