‘You can’t run a marathon with a fractured leg’

Lokeshwarri S K | Updated on January 12, 2018 Published on May 28, 2017

INDRANIL SEN GUPTA, Co-Head & Economist, India Research, Bank of America Merrill Lynch



Only when banks are adequately capitalised by the government can they lend

With demonetisation behind us and the country all set to welcome GST, the economy appears to be on relatively firmer footing. But stronger credit growth and private capex spending will happen only if the RBI moves policy rates lower, says Indranil Sen Gupta, Co-Head & Economist, India Research, Bank of America Merrill Lynch, in a chat with BusinessLine.

Now that inflation is moving lower, do you think the RBI will cut rates in August, as you have been writing in your reports?

That is our call on interest rates (a rate cut in August). The reasons are — one, inflation has gone down; core inflation is 4.1 per cent now against 4.8 per cent in October. Two, we don’t see the output gap closing any time soon, even if we take the new IIP number into account.

And finally, it is hard to see any material second-round impact of the hike in HRA due to the Seventh Pay Commission. That’s because even the first-round impact is all statistical.

The repo rate has moved down by 175 basis points since 2016 but credit growth is at multi-year lows. When do you think the inflexion point will come when credit starts picking up and private capex starts happening?

It’s true that the RBI cut 175 basis points but most of those cuts did not translate into lending rate cuts because they did not provide liquidity. It was only once the RBI started providing liquidity from the end of 2015 that lending rate cuts started.

We think the RBI has room to cut a max of another 25 to 50 basis points since long-run CPI inflation is 6.5 per cent and policy rate is already 6.25. But now if you cut, given that liquidity is good with open market operation (OMO) already done, there should be much faster transmission than before.

Finally, coming to capex, I think that is one-and-a-half to two years away. First, lending rates have to come down, then demand will pick-up, capacity will be exhausted and then capex will happen.

If you see the RBI’s output capacity indicator, that was 80 per cent in 2011, right now it is sub-75 per cent. How can there be capex when capacity utilisation is this low?

May be, if you cut rates now, in one-and-a-half to two years, the output gap could begin to close and capex could start turning.

Isn’t the slack demand also due to banks being in a shell and unable to lend due to the growing non-performing loans (NPLs)?

There are two parts to the story. One, why did the NPLs form and two, what do we do with the stock of NPLs. Giving the RBI more powers to supervise banks, following Acharya’s recommendation to form NAMC, etc, is a part of stressed assets management.

But these stressed assets were formed due to the weak growth environment with high interest rates. NPLs are forming because lending rates are high. Once you have provided sufficient liquidity, interest rates move down and economy turns, NPL formation will come down because these are largely cyclical.

Our analysis shows that the money pumped in to recapitalise banks is being used to bring down bad loans and is not resulting in credit growth. What’s your take on this?

Banks can lend only when you raise their effective capital. If you don’t give the money, banks will not be able to lend and economy will not recover.

You can give money with strings attached, say that banks have to become more efficient etc, that is a separate issue.

In the past you had a history when global growth was crashing and interest rate was high and that’s why NPLs were formed. Now you have to ensure that you take those NPLs out in whatever way, whether by recapitalising banks, by making private companies bid for those assets, by forming a National Asset Management Company funded by the fisc.

Any which way, government will have to provide capital to banks now. Once the cycle turns, there will be enough takers for bank stocks. But at the bottom of the cycle, no one will buy them. When a person has fractured a leg, you can’t ask him to run a marathon. First you have to nurse the fracture and then he can run.

What’s your view on the GST rate-fitment? Do you think the government has got it right?

We see GST rates as non-inflationary, although we need to wait for the rate on textiles which is expected on June 3. This supports our view of a RBI rate cut in August.

Now that six months have passed since the demonetisation in November, what is your assessment of the impact of this on economic growth? What is the growth you are projecting for FY18?

The impact of demonetisation was fairly temporary. If we go by media reports, the income declaration scheme has not really succeeded. So the economic impact has also not been too substantial.

We did see a dip in December quarter and that carried over to January and February, but most of the channel checks suggest that the economy is back to normal now. We are looking at growth going back to 7.2 per cent in FY18 versus 6.9 per cent in FY17.

Have you pegged back your estimates of the money that can be raised from IDS II?

Well, we were expecting about ₹1 lakh crore. But media reports suggest that it could be lower, around ₹13,000-14,000 crore. This means that the government’s ability to take up social welfare or infrastructure programmes is going to be limited.

The Budget had factored in almost about ₹50,000 crore of income tax from this scheme, so there will be that much pressure on the fiscal deficit as well.

So you don’t think there will be any additional dividend from the RBI because of demonetisation?

We do expect additional RBI dividend of about ₹60,000 crore by cancelling old notes that were not surrendered. We have to, of course, wait for the official number. But our view has always been that it is better to reduce Open Market Operation rather than pay the special dividend to the government.

What is your estimate of the size of the black economy in India? Do you have any numbers on that?

We have been working with an estimate of about 25 to 30 per cent of the GDP being the black economy of which 10 per cent could be in cash.

What’s your view on the rupee, will it continue to strengthen against the dollar?

We think the rupee will weaken to 66.75 against the dollar by December and that the dollar will not weaken much from here. We also think that the RBI will buy dollars to recoup forex reserves. So the net effect will be that the rupee might not strengthen much from here.

Given the fact that the Federal Reserve is hiking rates, will a rate cut not impact fund flows into the country? The spread between US and Indian rates is already narrowing…

I have heard the same argument when the interest rate was 8.5 per cent also. The point is, we are still 500 plus basis points away from the Fed fund rate. There is no point in keeping lending rates higher than the 2011-level when capacity utilisation is lower than 2011. It’s important that we nurse our economy just as the US is taking care of its economy. The best defence for the rupee is a strong economy that attracts flows, not interest rate differential that hurts growth at home.

Published on May 28, 2017

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