To reignite growth, India needs structural reform and not monetary policy easing. The sense of policy paralysis has really hurt investment sentiment in India, foreign and domestic, said Mr Leif Eskesen, Chief Economist for India and Asean, HSBC, in an interview with Business Line .

The scope for the RBI to move to an easy monetary policy stance is low due to concerns such as inflation risks, absence of structural reforms and high fiscal deficit, he said.

Excerpts from the interview:

What do you expect in terms of rate action from the RBI's monetary policy?

It will be a close call. But I see no strong case for rate cuts. The broad reasons are: there is no significant change in either the global or domestic economic situation; inflation risks are on the rise due to high oil price; absence of structural reforms; and high fiscal deficit. So the scope to cut policy rates is low.

We feel there will be a 75 basis points cut in interest rates in the full fiscal. This will take monetary policy into neutral gear. If the RBI loosens the policy too much then there are chances of the economy growing faster than potential and inflation picking up.

Besides, the RBI is not getting enough support from other policy measures. The decline in fiscal deficit as projected in the Budget is moderate. The fear is that fiscal deficit will be closer to 5.5 per cent and not 5.1 per cent as projected. So the fiscal stance is not as tight as the RBI had hoped for.

In the absence of structural reform, growth potential has also slowed down. So, supply side is struggling to keep pace while demand is still growing. This is another reason for the lingering concerns on inflation.

What India needs to do to reignite growth is structural reform and not monetary policy easing. The sense of policy paralysis has really hurt investment sentiment — foreign and domestic — in India. So, it is important to support growth along the structural reform channel. Too much easing will result in inflation snapping back again.

Given that both Europe and the US are still not back on the growth path, what will be the impact on the Indian economy?

In a baseline scenario we expect a difficult first half in Europe and the US. We see some scope for a gradual recovery in growth in the second half. That's what we have built into our growth forecast.

If we have another situation where sovereign debt crisis flares back again in Europe and, lets say, there is much deeper recession in Europe than currently expected and slow growth in the US, then that will have implications for India.

Exports will weaken further and there will be less risk appetite for investors to invest in India. Risk aversion will build up. That environment could have implications from the demand side which could slow the economy. Those circumstances could necessitate further easing of the monetary policy to cushion the impact of the slowdown. But that's not what we are expecting in our baseline scenario.

Even if it were to materialise, there is still limited scope to ease monetary policy. You cannot cut monetary policy even in such an environment as much as you did in 2008 because of the lingering inflation pressures. But there is some scope if it happens. That is the downside scenario.

Inflation in India is still a risk due to oil price. What will be the impact of that?

The Government has to increase diesel and kerosene prices. That's the only way it would be able to maintain the Budget subsidies. In the case of oil prices, even if they come off, there is still under-recoveries that oil companies have to account for. So that will jack up kerosene and diesel prices.

That will add to inflation in the April-June quarter. So there is lot of pent up inflation. That is one of the reasons why the RBI is so concerned about oil prices.

Either you have to maintain the subsidy bill or jack up fuel prices. If you don't do that it means that subsidy bill will yet again increase substantially. The implication is that that the Budget deficit target will not be achieved.

What is your outlook for the rupee?

We have a target of 49 for the rupee by the end of 2012. It's a very moderate appreciation. Much less than many other Asian peers.

The reason is the high current account deficit and lingering inflation.

On the policy side, there are issues to be resolved for foreign investors to come into India — both FDI and FII. They are constrained to some extent by the lack of policy measures.

Therefore, we expect a relatively moderate appreciation in the rupee. If global conditions worsen and if it continues to impact domestic conditions, that could have a negative impact on the rupee in the short term.

> priyan@thehindu.co.in

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