FY14 budget to be heavily populist: CLSA

Despite series of measures taken to counter inflation, the upcoming reading is unlikely to be comfortable. Speaking to CNBC-TV18 Rajiv Malik from CLSA said headline inflation level would head higher. He rubbished claims that the UPA government has made sweeping reforms. He said the government is focused on reflating the capital market, but sentiment needs to improve for its divestment programme to take off. He expects the government to present a very populist budget in FY14, which will weigh on deficit.

Also read: India can recover faster than China, says RBI

Here is the edited transcript of the interview on CNBC-TV18.

Q: Let's start with that strong policy expectation from you. What will the RBI do on October 13?

A: I think there are two parts to arrive at the ultimate conclusion. Inflation numbers are not going to be comforting. Inflation headline level would be heading higher. Core inflation sequential momentum is already moving up. Looking at some kind of positive news on inflation, it is not going to push RBI. What can tilt the hand is if we see at least one or two big moves that have a meaningful impact on the fiscal.

I find it amazing that reform is the most abused word in Indian media and if you read some of the stuff that people are falling head over heels calling about sweeping reforms, big bang reforms, it seems like a different planet. What we have seen is a set of bold decisions long overdue with couple of them having certain reformist angle surely. But, if this is what big bang reforms mean for this government, then I am Santa Claus.

But, what is more important is we still have a month to go and if the government does come through with a couple of measures that have a meaningful impact on the fiscal both qualitatively and quantitatively, it will allow RBI more flexibility. Just saying that we can overdue divestment and therefore, fiscal deficit will come into play, you are not really solving the underlying problem at all.

Q: If you had to line up for us what these reforms are that you think the government can execute? Politically we know how tough it is and we are also getting into the budget. There are expectations of a populist budget this time around. How much do you think the government can really do this time, incrementally?

A: An honest answer is I don't know. What is more relevant is this trade-off has increasingly found the government relying much more on reflating capital markets rather than necessarily doing what needs to be done. Subsidy related decisions are populist in nature, but you cannot wish them away when one of the biggest underlining factors for the problem that India has is a very inflexible fiscal. Due to this rush towards legal entitlements or certain social works programs etc. that really doesn't leave much flexibility.

You can keep kicking the can down the road and maybe the strategy is over the next six months, into the next budget which is going to be populist, you try and reflate the markets and sentiment will improve and things will happen. Don't forget you need sentiment improving for divestment to take off as well.

But, you need a concerted effort. What we have seen is a good start. I find it somewhat disturbing when everyone gives it too much of a twist of the best thing and that seems to be happening in India.

Q: Where do you see rupee headed since the capital market reflating moves have had a very positive capital flows impact? First, your comment on how the rupee might itself move and secondly, on how you see current account deficit moving from hereon?

A: Rupee is going to really be a story of two bets. For now possibly into year end, maybe early part of next year we will continue to see it more perky. This will partly be because of capital flows, partly because of the broader risk on which is complemented by some positive long overdue moves locally.

Again, I find assessment on the rupee by just about everyone rather unidimensional because flows will come in and therefore, the rupee will appreciate. What people overlook is that inflation differentials matter for exchange rates. We can have a strong inflow of capital flows and that could push rupee to 50-51, but what happens thereafter? India still runs a large inflation differential.

Don't forget inflation erodes the value of your currency and central banks typically have to weaken the nominal exchange rate to get the real effective back on track. So my sense is positive on the rupee for the next few months. By middle of next year, rupee is going to be back towards 55-56, both because of the inflation differential and a factor that almost nobody talks about, that is what happens to the dollar.

We are a lot more constructive on the US dollar for 2013. Although, we do think over the next few months the weakening bias will still play out for the US dollar.

Q: What did you make of the current account deficit relief that we have seen? Do you think it has peaked out in FY12 and what are your estimates for FY13?

A: I think the current account deficit at 4.2 percent was pretty much the high end. I would however caution just because the current account deficit is narrowing does not mean that everything is hunky-dory. What matters for the rupee market is really what is happening on a net basis, both in terms of current account and in terms of flows. If next year is going to be a strong dollar year that clearly is going to have an impact as far as global capital flows are also concerned.

To me, the fiscal side is actually a lot more worrying. But, in all of this I see fewer efforts to actually fix the underlying issues. A lot more measures which are also welcome is not really addressing the underlying thing. It is really kicking the can down the road.

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Q: We have two more data points before the RBI policy at the end of the month. There is the IIP number on October 12 and inflation on October 15. What are your specific expectations from these two data points? Do you think we are still going to deal with high inflation-slow growth sort of situation?

A: Absolutely and I think neither of those two will really have an impact as far as RBI's own thinking is concerned. Like I mentioned, if in the next month we see one or two more sensible actions from the government that have a meaningful impact on the budget, it is a foregone conclusion that RBI will ease.

Inflation is not going to be the reason that will allow them that flexibility. I think people overlook that RBI's walk is rather different from its talk. Its talk is very hawkish. It must be the only central bank in the world which is worried about inflation and then undertakes efforts, for example CRR cut that results in lower lending rates.

I personally don't know of any other central bank which does this. So there is clearly a dichotomy between what it is saying and guiding versus what it is doing.

Q: Where do you see the inflation trajectory? Where will the fiscal deficit finally end? Will it really be much south of 6 percent?

A: I would be surprised. Our working assumption since early part of the year has been at 6 percent. How much of a difference it makes is going to be what all the government can do and that is really anybody’s guess.

I would love to see the government taking more action to fix the issue. My own sense is even if they are able to do something for this year’s budget, next year’s budget is likely to be fiction. It will be heavily populist in its action and tone even if the numbers are meant to say something else. I think that is going to be an issue for quite sometime.

Q: What about growth? All this is not really adding up to growth which if anything will take some time perhaps to start showing a positive hue. Have you changed your GDP numbers at all? What are you working with for this year and more importantly for next year?

A: This year's number is unchanged at 5.5 percent. We did recently revise down FY14 forecast to 6 percent from 6.5 percent. Once again I think it is important to point out that for the next couple of quarters we will remain down in the dumps in a relative sense. To the extent that we see more constructive action, a slight improvement can take place. It is very important to underscore what we are living through now. The kind of a run we saw between 2003 and 2007 is very, very unlikely.