Legislation, RBI policy & global cues key to GDP: Vaish

Government effort by way of legislation, an aggressive RBI policy of easing rates and strong global cues are all vital to create a scenario conducive for the inflow of FII and FDI and ultimately boost growth to 6-percent levels, says Pankaj Vaish, MD and head of markets- South Asia, Citi.

In an interview to CNBC-TV18’s Crystal Ball, Vaish adds that it is possible for the government to achieve the target if it the initiatives are consistent and implemented as quickly as possible. Below is the edited transcript of the interview on CNBC-TV18 Q: It has been a series of ups and downs this last quarter. But what is your estimate for the rest of the year? A: A lot will depend on how the Reserve Bank of India (RBI) acts because the slowdown in growth is serious, it is real and everybody is of the view that the economy has bottomed and will pickup. But what if it is not a meaningful pickup? But I think the risk-reward are skewed that way because the whole market seems to have believed that there will be will be a high-fives-low-sixes gross domestic product (GDP) growth trend for the next fiscal year. But just in case it doesn’t happen and that is not a scenario that a lot of people have planned on. So a lot will depend on if RBI acts aggressively enough to respond to that situation. On the inflation and fiscal deficit front, I think there is enough cover for the RBI to act. So a lot will depend on that. Ironically, there could be a year where the GDP is still quite weak but if the RBI has taken adequate policy action then the equity market may still be stable and may actually perform quite well. So it will seem somewhat counter-intuitive but that is the trend that has been witnessed from every recession in the US market —six-to-nine months before the end of a recession the market tends to bottom and rally very strongly. That situation can happen and we have seen a sample of that in April in the  way bank stocks came back very strongly and also when the wholesale price index (WPI) turned out to be slightly better than expected.. If RBI ends up easing rates by another 75 bps this year and gets down to 6.75 percent, the equity market may actually perform reasonably well on the expectation that RBI is now putting in a floor in the economy and all the interest rate-sensitives will do quite well. Q: Would it help the bond or the equity market if rates are eased by only another 50-75 bps? A: No, it will help both. You will have to risk-adjust the equity returns to be able to compare. I think the bond market, in some sense, will be obviously the more direct beneficiary but it could be similar to the quick rebound of the banking index. However a lot will depend on the body language and aggressive the RBI is. Add to this is the change in governorship in August-September of 2013. A lot will depend on who the new nominee is and his or her views are on interest rates and the overall monetary policy.. There can also be a scenario where the market gets very excited and both bond and stock markets rally strongly if it is a person with views that is deemed to be very growth-friendly. Q: What is your base case scenario on growth this year? Has the economy bottomed out? A: I think it is not a done deal. This is despite the herculean effort by the finance ministry in not just attracting investors but also think of increasing FDI caps and just doing everything in its power to push these proposals through. Economic growth was at 4.5 percent last quarter and for the full year it may be 5 percent. Our economists are looking at 5.7 percent for the next fiscal year. Q: That is below consensus, right? A: Yes, that is below consensus. So I think more needs to be done on the legislative front to create the conditions to start that virtuous circle. There has to be higher FII and FDI inflows and RBI’s help is vital. All these factors need to come together to touch the 6-percent GDP level. It is doable but requires a lot of work.
Q: What is your sense of what lies ahead for global growth for the rest of the year because some of the portents from the commodity market etc seem to be suggesting that we might just be hitting a sluggish patch globally? A: I agree with you. Somehow a lot of people have written off - the commodity sell off is just everybody had piled into gold and big margin calls. All of that may be true but typically those are just the technical precursors. So, putting everything together so for a while we felt that the dollar could have a good year and that tends to go with the risk off scenario. Commodity prices falling and not just gold but oil and some metals, all of those falling also put that thing into the mix. The fact that bond yields are still low and bond market prices have rallied again that too is there. There are few things coming together to say that there may be a sluggish patch that may happen.   Sincerely, the strength that we saw in the US economy and the Q4 of last year was surprising, a lot of people didn't even believe the numbers and now you are seeing a softer patch come through in the first quarter of this year. So GDP in US was below expectations, China has clearly slowed down and is somewhat pleased about it’ if you hear some of the speeches that the new Chinese president made that this is what they are aiming for. They wanted a more sensible responsible growth and India has decelerated massively. So there are enough things out there to say, 'hang on there could be a patch of slowdown here'. So I worry about that and globally too not just in India. Q: Where would India or emerging markets generally fit in the context where the world suddenly wakes up and says hey we assume growth at a certain level but that is not panning out. How would emerging markets typically do vis-à-vis developed markets in such a scenario? A: This is where it gets somewhat interesting. If you get into the quadrant of massive risk-off then emerging markets would suffer too because people just say, I don't want to think about this right now. They say, may be Maruti Suzuki is a great stock but I really need to first take care of my global asset allocation. But if it is a step below that (bad but not terrible) then emerging markets with good stories can do well. We still have a massive growth problem, so we may not yet be in that bucket. On the Budget day we were talking at 4.5 percent GDP people don't necessary want to put up with all the stuff that they need to put up, all the political drama and everything. They can just go next door to Mexico which is a phenomenal country, it is part of The North American Free Trade Agreement (NAFTA) and it has got great labour force, they understand the culture better. So they could do that. At 4.5 percent, we don't earn the right to say, "Of course we are the place you should come to." At 6.5 percent yes we can try to make that argument, at 9 percent it is a slam dunk, then you know that in the bad but not terrible situation, we will be the beneficiaries. So, unfortunately there is a cascading effect of things here, I think in an extreme risk off which is not my central case, emerging market would sell off but in the bad but not terrible situation India should be a beneficiary but we still need to earn our stripes a little bit more to say that we have solidly got into the six handle GDP which may not be a done deal here. Q: Let me rephrase my question, do you see a global risk at all because right now when we talk to a lot of investors, they talk about India specific factors, elections, policy, RBI, nobody seems to be taking global risks very seriously as they did six-nine months back. Could that come back as a huge point of discussion on the table this year? A: Most people believe that risk has subsided immensely because the big central banks have so clearly demonstrated that they would throw everything, so that has given a lot of people comfort. I had met a lot of globally savvy investors in the US the week before last, so I would say that there are some very smart investors who feel that the European problem is not over. They feel that one of the large European countries could yet have a problem sticking in the currency block. These are the people I respect. I do not have any greater insight into the problem than they do and that is not again our central view but it is true that a lot of people have dismissed the global risks and I do not think they are totally gone. Now, there is a big academic debate going on, on austerity versus non-austerity among economists. So you have Paul Krugman and all talking about this is silly, it is clearly demolished the argument of austerity and they in fact point out to these papers that Kenneth Rogoff and Carmen Reinhart wrote where there were some data problems. So there is this debate going on, and if people start thinking that we do not need to go down the austerity path, I think you could have at least a bout, I do not know if it will be eventually successful but you could have another bout of attack saying that these countries are again getting into irresponsible zones and so you should dump their bonds and thus the currency may also be weaker. That possibility is probably higher than what market is implying right now.  _PAGEBREAK_ Q: Let me ask you about gold which was such a big talking point in April. Do you think gold will materially bring down the current account deficit (CAD) or will it be offset by huge amount of buying witnessed two weeks ago when the prices fell?
A: I heard there was a rush at jewellery stores. No, unfortunately I don’t think it will have a massive impact. According to the finance minister (FM), oil imports are at USD 170 billion and is clearly a more important factor in the current account deficit. Oil prices have fallen and have broadly stayed low. Lower oil prices, though they have bounced back a bit, will have a bigger impact on the CAD than gold.
Unless the government absolutely quashes the idea of gold as a lucrative investment, I think this demand will remain. Q: So where does that leave the rupee? Do you think there is really a possibility of the rupee going down to 57-58 by the time the year ends?
A: I think it will be difficult to diminish that risk. So during the later part of 2012 and the earlier part of 2013, it was widely that the finance ministry and other ministries were taking considerable effort to boost growth and the Reserve Bank of India (RBI) would enter and ease rates. Now my worry is that if government initiative is inadequate which will not allow the RBI to aggressively ease rates then there could be a problem on the rupee. So if growth stays very weak, it will result in weak inflows. If gold prices go back up again, the current account deficit (CAD) problem will rear its ugly head again.  If the government can get the investment excitement going, the situation can be salvaged. Q: What do you think is a higher probability outcome this year — will the market retest the 6,300-plus levels or test the 5,200-levels which seems quite unlikely at the end of 2012?
A: Yes, in fact even on Budget Day I opined that this level will come down a little bit. But the bourses have posted a massive and very impressive turnaround. If the RBI can come and deliver a nice cut both in the repo rate and in the CRR and does not announce too many negative forecasts, I think the markets ou will get the excited and return to the old highs may be on the cards. Q: So you are ruling out 5,200 or do you think it is a low probability?
A: The probability is low . Q: In your visits overseas and the discussions with large investors, did Indian elections feature prominently?
A: We have traveled with the finance minister and his delegation and Indian elections came up in a lot of discussions. But they were in the context of the ability of the government to ensure fiscal discipline. The finance minister assured all parties concerned that the government was committed to economic reform Q: You don't see it as a major risk for the market in the next 8-to-10 months?
A: The uncertainty about election results is kind of a given. I don’t think anybody is forecasting a slam-dunk kind of a victory by any alliance, atleast right now. So then the question is if there are early elections, there are worries of a knee-jerk sell-off. So, I don’t know if it is necessarily a big negative. So I don't think there is any reason for gloom if early elections were announced.
_PAGEBREAK_ Q: What is the probability that as we get into Q3, Q4 of this year we see growth numbers which are slightly better than the last couple of quarters as we get the rebound from some more fiscal spending, but we do not get to 6 percent. We get to the numbers your economist is talking about - 5.6-5.7 percent. Earnings growth is 9-10 percent, but not much more than that. It is not an outlandish scenario. If that happens, how would markets take it?
A: That is not a good scenario. What will happen is you could have equities doing okay. I do not think they will have a massive selloff or anything, but you could have a problem on the currency and that is what I worry about. If you do not get into the 6 percent handle, a lot of FII investors will be reluctant. This visit that we did it was very exciting. We had 150 people in New York, a 100 in Boston.
In Boston it was the day after the unfortunate marathon incident. People turned out in big numbers. They really liked listening to the finance minister. He speaks well and he had very smart people in his delegation - Dr Rajan, Dr Urjit Patel, Dr Mayaram. So they were very excited and asked some very good questions. I spoke to a lot of them later, the CIOs of very large funds. Some of them had increased their allocation quite a bit. These are great names that you want to see coming into India. But a lot of them were just short of writing in a cheque. They just want to see the reality on the ground change also. We have had follow-up conversations on FII limits.
What I need to do to set up a custody account, all of that stuff. People are close, but they are still watching the political development particularly on the legislative fund, because a lot of the premise of this rebound is also on things like regulator for coal and pricing continuing to readjust, and power and FDI caps getting changed and all of these things which if there is a legislative logjam that could be a problem. The FM even talked about how he has reached out to the opposition leaders and has gotten some agreement with them which was very heartening to hear.
Again, if in the light of all these recent political developments, if the parliament cannot meet and they cannot put bills out there, then people will be discouraged again. So I would worry in that scenario about the rupee. It would be a good scenario for the bond market, because then RBI needs to probably go down even more. Interest-rate sensitives in the stock market will do okay because of their interest rate tailwind, but certain other sectors will suffer.  So equities will be sort of ho-hum but bonds will do really well and I would be a bit concerned about the rupee. Q: None of us are talking about a global bear market. US has done well, the mother market, Japan has started doing well. But we get stuck with 7 percent growth in China, 5 percent in India, 1.5-2 percent in the US and suddenly we have a global equity bear market creeping in silently. Do you think it is zero probability or there is a case for it?
A: We are just totally crystal balling here now. My view is because there has been sufficient scepticism of the equity market rally, especially in the US. It is unlikely that it will time very soon with a collapse in the equity market. There is some chance. Our lead futures guy in New York follows several parameters for the S&P, and he has been pointing out that the AIA Survey of the investors.
The sentiment is actually close to a bearish maximum, so a lot of people are very negative on the equity market. His view is that there could be another blow off top for us and people will kind of throw in their towel. Most people have been just chasing this rally. So that scenario makes a little more sense to me then an immediate collapse given what the positioning in the marketplace is and the sentiment is. So, in terms of that global scenario that you are laying out, some of that is possible, because there has not been an euphoria even in the European market or the Asian market. People have been very negative.
People have given a whole range of reasons why they do not want to be invested. Japan has been an outlier because of the very dramatic steps the Bank of Japan (BoJ) has done, but the rest of Asia is actually not that expensive. From that point of view, first there is a chance that it frustrates the skeptics, and then down the road when everybody is aboard there is that slowdown for you.