Budget 2013: Flat GDP cuts FII eye on Re; fiscal discipline key: Chinoy

Sajjid Z Chinoy of JPMorgan explains that flat GDP growth is preventing any appreciation in the rupee despite significant FII inflows. Chinoy explains, on CNBC-TV18, that the government needs to usher in fiscal discipline to offer the RBI enough room to cut rates and boost growth.

Below is an edited transcript of the analysis on CNBC-TV18 Q: In a recent report, you touched upon the reasons behind why the rupee has been stuck in a 54-56 range despite flows and portfolios being quite strong? Can you explain the reason for this and whether these factors will continue to haunt the rupee in 2013?
A: The current account deficit data for Q3 of 2012 was an unprecedented shocker of a almost 5.5 percent of gross domestic product (GDP). It is worrying that the drivers of the large current account deficit are now becoming structural in nature. Exports have slowed very sharply and unless there is a meaningful pick-up in 2013, export growth is not going to gallop.
More worrying is the invisibles component where net investment outflows, such as interest payments on existing debt, FDI and profit repatriations have structurally gone up. So every quarter begins with a current account of 1-1.5 percent outflows of net investment income.
The concern is that if the current account deficit is going to be 3.5 - 4.5 percent of GDP, then despite all the inflows of capital in a benign global environment, the rupee is running to stay in the same place. The month of December is case in point.
While the inflows were over USD 5 billion, the rupee was essentially flat as compared to currencies in other emerging markets which saw a meaningful appreciation. So I think having a large current account deficit will be a significant drag on the currency for most of 2013. Q: What do you think the government can do to limit the current account deficit (CAD) for the rest of this year?
A: Another aspect of concern is that the problem is not gold this year. In 2011, there was the obvious explanation that inflation was brought down or gold imports were disincentivised, the current account problem could be solved.
This year gold imports, though large, are on track to be 25 percent lower than last year. And the prospect of the overall deficit this year perhaps being larger than last year’s - 4.2 percent of GDP - looms large. The government could ease supply constraints to bring imports down.
Another measure to reduce imports is to ensure that domestic supply constraints are not binding and therefore induce import substitution and begin to produce at home what was previously being imported. Outside of these measures it is very hard to see what the government can do. There is very little one can do on the export front if the global economy does not recover. Q: The bond markets reacted with optimism a couple of days back when some comments were made about the government being able to limit the fiscal-deficit situation. On that front, how concerned would you be on how this year shapes up and what we may hear in the Union Budget?
A: The twin deficits go hand-in-hand. The progress made on the fiscal deficit is going to show up in the current account deficit as well. To be fair, the government over the last three-to-four months has shown a new found urgency to try and correct the deficit.
But the data is very sobering. If the economy is going to grow at 5.5 percent this year then direct tax collections will suffer. There is only so much one can do to compensate by slashing spending. The worry is even if spending is slashed this year, it will simply be postponed it to next year and then next year's fiscal target becomes even harder to obtain.
So I think there is a whole bunch of open questions that the government needs to address. I think the Budget will be perhaps the most significant event in the first six months as far as the macro-economic outlook is concerned.
If meaningful and credible fiscal discipline is ensured that will boost sentiment and open offer more space for the Reserve Bank of India (RBI) to cut rates. So I would look very closely at what the Budget accomplishes. Q: The ten-year bond yields have come down below 8 percent after a long time. Do you see it staying there or is it just a temporary fall which is predicated on the move the RBI will make on January 29?
A: I think one has to consider both short-term and medium-term factors. The short-term factors are the large tax surpluses that the government is sitting on boosted by auction-funds, and bonds have rallied as a result.
There is also the prospect of a rate cut in January.
So if there is a rate cut in January and the prospect of more cuts later in the year, the market usually does well. But I think all of this is building up to the Budget. What it offers will determine the outlook for bond yields for the rest of the year.