We need a 50 bps cut in interest rates, says DSP Merrill Lynch's Indranil Sen Gupta

Excerpts from an exclusive interview of Indranil Sen Gupta, Economist, Global Research, DSP Merrill Lynch with Business Line

On GDP growth

Our view is that we are unlikely to see any recovery in the GDP till the elections next year. If you break down the slowdown in growth of 300 basis points — 150 basis points was due to global factors, 75 basis points was due to the RBI’s tightening, 50 basis points was because of slowdown in investments and maybe 25 basis points was due to rains.

We did not expect the global factors to turn conducive or investment to turn around but we thought the RBI would be able to ease and rains would be better. But after the July measures (of the RBI), rate-cut hopes have receded.

We think the economy will get stuck at these levels and we are looking at 4.6 per cent growth in FY14. It is only in the September quarter of FY15 that we can talk about a recovery. GDP growth target for FY15 is 5.5 per cent.

The major trigger for the reversal will be decline in interest rates. Revival in investment alone cannot help the economy recover. If you look at history, no country has managed to come out of recession with just investment. In any slowdown, we need lending rates to come down. That revives demand which, in turn, leads to pick-up in investment. Further, the slowdown in investment cycle is global. In Brazil, investment growth rate is negative. In other countries too, growth in investments is down from double digits to lower single digits.

When investments grew, they grew in all the countries because there was a global up-cycle and now all over the world investment growth has declined. We at Merrill Lynch think that the next up-cycle will be in 2015. Till then, there is unlikely to be a turnaround in investment.

The good monsoon will ensure that growth rate does not decline significantly from here. But at a very fragile point in recovery, we have cut out the possibility of interest rates coming down. Before the July measures, all of us had growth expectation of 5.5 per cent; it has now come down to 4.5 per cent.

Rupee’s moves

The rupee appears to have bottomed at 68.8. We have said all along that a NRI bond issue will support the currency. It was a turning point in 1998 and in 2001. The current FCNR (B) swap facility should bring in some dollars, maybe $10 billion.

The main problem with the rupee now is that we do not have enough foreign exchange reserves. In the last five years we did not buy dollars though most other emerging market central banks bought foreign exchange to bolster their reserves. Our GDP kept growing and so did imports, so that now our import cover has halved from 15 months to seven months. We have to get back to 9 to 10 months of import cover for the rupee to stabilise.

It might not fall like recent times from 54 to 68 but settle down in the 60 to 65 range. Till we manage to add to our forex reserves, the medium term trend will be one of depreciation.

The current account deficit is a global problem. Due to weak global growth, exports are weak; global liquidity is high so oil bill is high. This is true in India, Brazil, Indonesia or any other country. Our problem got compounded by the fact that we did not build foreign exchange reserves like others. CAD should, however, be lower at 4 per cent in FY 14 versus 4.8 per cent last year.

Futile war on inflation

Inflation will go up. Rupee is depreciating, coal prices and diesel prices have moved up, power tariffs are rising. So growth in WPI will move up to 6.5 per cent level. It will all ultimately depend on the extent of rupee depreciation.

If oil prices settle at around $110, then at some stage, the growth in WPI will be done. Had the rupee not fallen the way it did recently, we were almost getting done. It is a strange cycle — because the rupee is falling there is inflation, because there is inflation, people say rupee must fall. Core inflation is coming down due to lack of demand. It is bottoming at a very low level, at 2.7 per cent. Demand is not likely to recover in the next five to six months unless lending rates come down.

Consumer price Inflation should come down to about 7 per cent in the second half of this fiscal. CPI went up due to the problems with logistics and so on but with rains being good, it should reduce.

Interest rates need to fall

When inflation is growing at 6.5 per cent, and economy at 4.5 per cent, there is no reason to keep interest rates at 7.50 per cent.

Because interest rates are high growth doesn’t happen, growth doesn’t happen so flows don’t come, flows don’t come so rupee depreciates, rupee depreciates so inflation is high — at some point we need to get out of this trap. We are hoping for a 50 basis points cut in policy rates by the end of this fiscal year.

The solution to controlling inflation is not interest rates. In January 1998 when Bimal Jalan hiked rates, the Fed rate was at 5.5 per cent, we were at 7 per cent. This time we are at 7.50 per cent, the Fed rate is zero. It is not right to keep interest rates high to control inflation. Inflation is high because of a) global liquidity and b) rupee depreciation. Rupee depreciation will only worsen if interest rates are hiked.

We took a simplistic view of inflation at 8 per cent. Inflation at 8 per cent was the highest in the world but growth at 7 to 8 per cent was also highest in the world. Are you better off with growth at 7 per cent and inflation of 8 per cent or with growth at 1 per cent and inflation at 6 per cent? It is questions such as these that are confronting us now.

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