The Hindu Business Line : ‘Rupee could touch 47 to a dollar by March’

The stimulus package is likely to provide some relief to the most stressed sectors on which it is focussed. — Dr Dharmakirti Joshi, Director and Principal Economist, Crisil.

Vinson Kurian

Thiruvananthapuram, Dec. 22 The rupee is more likely to appreciate over the medium run and could touch 47 to a dollar by March 2009, according to Dr Dharmakirti Joshi, Director and Principal Economist, at rating agency Crisil.

Giving his insight into the state of the economy and the banking sector in particular, Dr Joshi told Business Line that the resumption of special market operations for oil companies by the Reserve Bank should alleviate depreciating pressures, going forward.

With some normalisation of the pattern of capital flows, the rupee should move back towards its fundamental trend, which is to appreciate.

The financial markets are currently extremely volatile and a number of short-term factors could drive a wedge between fundamentals and market outcomes. Thus the margin of error for the short-term forecast is high given the economic uncertainty. Excerpts from the interview.

Do you think the obsession with fiscal deficit has given rise to excessive reliance on the banking system as a ‘mover’ of the economy? Is the latter worse for it?

The ability of a country to use countercyclical fiscal policy to ‘move’ the economy depends on the available fiscal leeway and varies from country to country. Some countries like China have enough room for heavy fiscal doses as their debt and deficits are not excessive. India on the other hand has much higher levels of fiscal stress. No doubt these are extraordinary times and fiscal targets need to be relaxed to pump prime the economy. This year, the Indian government has already given a significant fiscal stimulus through implementation sixth pay commission, farm debt waiver, and subsidies. The supplementary demand for grants for 2008-09 is Rs 1,05,000 crore which inflates the budgeted fiscal deficit by almost 80 per cent. On top of this, Rs 20,000-crore fiscal stimulus was announced recently. Thus, from the fiscal side there is little room for additional stimulus.

While high fiscal deficits do not allow for a heavy dose of fiscal stimulus to revive the economy, sliding inflation has created room for an aggressive monetary policy. Thus, we have higher dependence on monetary policy/banking system to revive the economy.

Lenders are facing mounting capital pressures prompting them to even propose interest on CRR as an alternative to capital support from the Government. Have they been driven that far to the wall already?

Despite rate cuts and lowering of reserve requirements, banks have not been able to cut lending rates. This is due to general disruptions in financial conditions which have increased risk aversion and tightened credit standards. Also there is pressure on the banking system to service the additional credit requirements due to drying up of alternate sources of finance such equity, external commercial borrowings etc. Despite higher deposit mobilisation though deposits, banks are not able to service the quantum of funds required in the system. That is why even with the slowing economy, overall credit growth of the banking system appears strong. Yet the borrowers’ demand is not fully met. So steps like recapitalisation of the banks and interest on CRR may be needed to help the banking system cope up with the situation.

Infrastructure sector has become more capital-intensive than labour-intensive. In this context, do you think higher spending will essentially translate into more money in the hands of people?

Well it is true that infrastructure activity in general is becoming more capital/technology intensive. But by and large infrastructure activity in India generally remains labour oriented. In addition, infrastructure spending also has multiplier effects on rest of the economy.

‘Public works” type of infrastructure activities such as highways/roads, irrigation and urban infrastructure (drainage, sewerage) generates employment and creates purchasing power. Thus infrastructure spending needs to be well targeted for it to be effective as a countercyclical tool when the demand is sluggish. The need of the hour is to ensure sustained financing for such infrastructure activities to shore up growth in the economy.

Interest rate and indirect tax cuts have immediate impact on the economy. Increased spending is fraught with interest rate and inflation risks. Can the Government be faulted for going for the easy option?

Interest rate cuts have a lagged impact on the economy. At present the monetary policy transmission is weak. Consequently, despite RBI’s aggressive rate cuts, the general lending rates are still sticky. What this implies is that monetary easing by RBI will take more than “normal’ time to stimulate demand in the system.

As pointed out earlier, despite the need for a greater dependence on fiscal stimulus we are constrained by high deficits in pushing the pedal hard on this option. Too much monetary easing can also create inflationary pressures. It would not do that right now as the demand is slipping. Similarly increased spending is fraught with interest rate and inflation risks- but none of these risks will materialize in today’s economic scenario. Every option to revive the economy comes with a cost.

The challenge is to optimise on the available options. We have so far used the mix of monetary and fiscal measures. What the stimulus package is likely to achieve is to provide some relief to the most stressed sectors on which it is focused (exports, small enterprises, infrastructure and housing). The reduction in indirect taxes will allow companies to reduce prices while cushioning their margins and hence further bring down inflation.

Are we facing a recession as defined in classic terms already?

Unlike the advanced economies where recession implies contraction of GDP, in developing economies like India the recession is limited to slippage in growth rates or in other worlds – a growth recession. The first two quarters of this year have recorded 7.5 per cent growth – a climb down from blistering nine per cent in the previous four years but nevertheless a decent growth rate in the current context. We are set to witness a sharper slippage in growth in the remaining two quarters of this year. Thus we will witness a sharp growth slowdown but not a recession as the advanced economies are facing.

Why is it that the stimulus package has not been able to elicit the desired response from credit-starved markets and the larger economy?

The recent stimulus package is well-targeted but it does not carry enough punch to quickly revive the economy. The market response reflects that.

There’s a view that in emerging economies, revenue-based stimulus measures are more effective at boosting output than expenditure-based measures. Should this necessarily apply in India’s case?

Revenue-based stimulus measures (like direct tax cuts) are generally more effective as they increase the purchasing power and boost demand quickly. The expenditure-based measures on the other hand could be sluggish as it can take time to implement the spending program and they are generally fraught with inefficiencies in implementation. Having said that to be effective revenue based stimulus has to be rightly targeted. It will be effective only if more money is in the hands of the people with higher propensity to consume- which is in the lower and middle income categories. In a country like India, direct tax cut/revenue based measures may not suffice as these will only benefit the tax payers. We need a mix of well targeted revenue and expenditure based measures. The expenditure based measures focused on lower income groups like the NREGS also stimulate demand. We need a mix of both.

Kindly give us your updated estimates and the logic thereof on (i) inflation (ii) lending and (iii) GDP growth rates for the short-to-medium term (up to March 31, 2009).

Inflation: Both demand and supply side pressures on inflation have eased significantly leading to a faster than anticipated decline in inflation. The recent cuts in petrol and diesel price along with CENVAT reduction will further reduce inflation rate in the current fiscal. We expect inflation to be below 5 per cent by March, 2009.

GDP Growth: The impact of past monetary tightening was already moderating growth in India. The sharp deterioration in global scenario has further dampened the growth prospects. Consequently, the Indian economy is slowing at a much faster rate than anticipated earlier. We expect the Indian economy to grow at grow at 6.5-7.0 per cent in 2008-09. Since the economy has expanded at 7.5 per cent in the first half, a sharper slide is expected in the second half of this year. Some of the services which drove growth in the first half of this year such as construction, transport services, real estate and business services are set to moderate in the coming quarters.