Can't predict sharp recovery, situation is difficult: MS

Reema: One bad Purchasing Managers' Index (PMI) reading seems too small a reason to trigger such a huge market reaction, what is the real worry?

A: It is very difficult for me at least to opine on how quickly or how fast markets unravel. However, a lot of this also has to do with global sentiment and also to do with the fact that there is a lot of easing expected from different parts of the world possibly a reaction expected from the Federal Reserve, reaction expected from the People's Bank of China (PBOC), emerging markets are under pressure and we haven't seen that much of a policy response from all these policy makers.

Something that people have taken for granted over the last few years, there may also be an element in here that we have to wait on many occasions even in the past for that policy response to come through. I do agree that it feels like a difficult situation when all we are getting is news flow and market reactions but we are not seeing anything decisive on any front in terms of a policy reaction.

Mangalam: Are the markets then crying to the Central Bankers for more help like don’t hike rates or are they telling the Central Bankers for all your rounds of quantitative easing (QE) nothing has improved. We are selling off because Central Bankers are out of tricks?

A: You can look at it quite a few ways. The problem is the situation is so difficult that it is very hard to come out aggressively in either direction because there is a lot of policy support. On the other hand, as you are saying even after many years of policy support it is not like we are at a decisive path of growth. So, we have been in this grey area many times.

It is hard for me in fact, if I tell you anything about my opinions of what happened in the last seven days you should probably disregard them completely. Being an economist we look at much slower moving parts of the economy. What is happening over here is if you look at where the macro adjustment has taken place, it has taken place in developed market economies, policy makers have thrown kitchen sink at those problems. Developed market (DM) growth is not really where these problems are ascertaining themselves. In the past we have pointed out that there is a feedback loop because emerging markets (EM) are bigger that goes back in to developed markets. There is some concern about that here.

However, this problem is firmly an emerging markets' backyard right now. It is the emerging market policy makers -- very few of which have responded in the past to the warnings they had received from markets which now need to take that warning on board now and respond in the way we would like them to.

What we have done is we have thought of emerging markets in two blocks. On the one hand we have got the emerging markets that have extremely funding issues that have high inflation. The policy choice over there is to think about should we protect growth or should be carry on with the macro rebalancing. Those are your traditional emerging market economies, India is in that group, Brazil is part of that story, Russia, Indonesia, Turkey, South Africa, Mexico these are all part of the EM like economies.

Then there is a sort of DM like economies and the DM like economies are the North Asian ones where they have high leverage, they have got deflation and the policy choice over there is look if I cut interest rates, will I get a higher leverage which I don’t want. But if I cut interest rates then I will be able to deal with deflation a little bit more and that is their trade off.

What we have been suggesting is that as circuit breakers what you need is the EM like economies that have a problem that have not adjusted need to raise interest rates. India has already done that for a while but the DM like EM economies in North Asia also need to ease monetary policy and direct credit hopefully in a way that doesn't create more leverage but does deal with the deflation problem at home.

Reema: What is the dealing desk now saying. Will the markets find their feet soon enough?

A: I will answer this in an usual economist roundabout way. If you look at the backdrop we are facing, we faced a situation in China where growth has gone down significantly over the last six months. We are looking at a situation in the US where the US consumer did not spend the commodity windfall. Typically speaking that takes a long time before the commodity story can assert itself among the US consumer and we have got the other developed market economies not showing very strong robust growth performance, there is a kind of a trend but no one is booming. So it is not surprising that global trade has taken a turn for the worse over the last few months and that doesn't help either.

Therefore, you need to see some normalisation take place somewhere; you need to see the US consumer start to use some of the windfall that they have received from the commodity price decline, you need to start seeing some measures in emerging markets trying to stabilise that growth front particularly in the DM like economies and you need to see further consolidation of growth in Europe and in Japan and that by itself should possibly give a little bit of support for the export part of the story.

However, it is hard to tell at this point in time whether this recovery is going to be a sharp one. No one expects a massive amount of monetary easing to be on the cards, no one expects anything dramatic to happen from the advanced economies. We have already flagged that policymakers in Asia need to do more on the easing side but we are still waiting for that. So almost everywhere that you look at, you have got this little bit of tension between growth and policymakers that has not been resolved yet and we are waiting for a resolution of that.

Mangalam: Since you see the problem with the emerging markets and as we understand China is the biggest of them, what do you want or expect the PBOC to do immediately like do you think them to cut reserve requirements or whatever or what do you expect from the PBOC from the rest of 2015 then? A: I wouldn't say that the biggest story here lies with the PBOC and what they have to do. They way I would put it is these are complimentary parts of the problem. You have got parts of EM that need to solve their own domestic fundamentals. Brazil is a large enough economy that spillovers from Brazilian problems can spread very quickly across EM. China is another large economy which is dealing with its adjustment process which is saying that we want to try and keep ourselves from being importers of deflation. In that sense what is happening is the PBOC probably will come out with reserve requirement ratio (RRR) cuts as we have argued. They should come out and develop some kind of monetary easing, a path over a period of time to give sustained help to the economy to get over its deflationary problems. We have a rate cut that is also penciled in for the remainder of the year. However, overall the way it needs to do this is it needs to do this in a way that does not just add to the stock of credit that they have, emerging markets all over the EM space have never been shy to direct credit. They have never been shy to say that look this part of the economy is an unproductive part, let us not allow the credit to flow there.In the Chinese economy you do have a situation in which the services sector is not indebted. It is productive, it is growing and if the credit could be channeled towards that side then you might not get an intensification of the leverage worries that people have looked at when viewing China.Reema: Can anything the Reserve Bank of India (RBI) does, make a difference, like say an out of turn rate cut or something?A: I don't think this is a situation where India has to do anything proactive. I have voiced in the past that one of the advantages of having a banking sector where the state owned banks have a significant amount of capital or re-capitalisation to do and having real interest rates high is that you tend to be much more selective. The process of capital accumulation and growth becomes a slower and hence a longer term process which can build momentum later on. Real interest rates are high; the Governor of the RBI has been concerned about the Federal Reserve's actions and the impact on India. Very few central banks have done that also in the past. Mexico, the South African Reserve Bank, the Central Bank of Chile, and more recently the Central Bank of Turkey have all begun to talk more actively about what they should be doing if reserve starts hiking interest rates. So, I don't think this is something that India needs to do on its own to break impasse. Obviously if things get worst globally speaking then just like other parts of EM, the risk of rate hikes come in but this is not a problem for India. It is a problem for many other economies that have not adjusted. We are not that concerned on the Indian front right now.