Indianomics – Page 21

Indianomics: Have India’s macros reached a tipping point?

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Summary

Crude prices are now threatening to remain well over USD 70 per barrel. Separately, the trade deficit even at lower crude prices have shot up. In March, it was nearly USD 14 billion. Thus, even in FY18, when crude prices averaged between USD 50-60 per barrel, the current account deficit (CAD) has likely been 2% of GDP.

With crude likely to average over USD 70 per barrel in FY19, will the CAD move closer to 3%, which is the danger mark? Separately the fiscal deficit could also rise partly due to crude prices and partly due to election year largesse, especially on the MSP front.

Bond yields have already surged and the rupee has fallen reflecting the worsening of these macros. CNBC-TV18’s Latha Venkatesh caught up with Ashima Goyal, Member of the Prime Minister’s Economic Advisory Council, Sajjid Chinoy Economist at JPMorgan and Neeraj Gambhir Managing Director – Fixed Income unit at Nomura to find whether our macros have reached a tipping point.

Q: You have just put out a note indicating that trade deficit for March if seasonally adjusted would actually have been well over USD 15 billion. Now your current account deficit (CAD) even when crude prices were lower you say would be 2%. So, are we in danger of getting to probably 3% current account deficit in the current year?

Chinoy: We should start to recognise that when oil prices move up as rapidly as they had in the last six months, it creates a trade shock for India as a large oil importer, which in further makes the growth inflation trade-off much worse. So that is the fundamental problem.

On the external front, we had a view that India’s exports underperformed as compared to the world. So, despite the GDP growth slowing in 2017-2018, the current account deficit is on course to tripling from USD 15 billion last year to almost USD 50 billion 2017-2018.

On that base, you overlay crude estimate at about USD 70 per barrel for 2018-2019, the current account deficit is about USD 75 billon or about 2.7% of GDP. For the last three months, we had a view that slightly above the 2.5% is considered sustainable. In the last four months we have already seen that on a seasonally adjusted basis the monthly trade deficit is averaged USD 15.50 billion a month since December, which is an annualised current account of USD 75 billion.

The area of concern for me slightly is that if you look at the mix of capital flows they have become a little less stable. We get carried away by large balance of payment surpluses, but in the first three quarters of this fiscal year foreign direct investment (FDI) has been below 25% last year and a lot of the current account is being financed by interest sensitive flows. With global rates expected to go up in the next year, and Indian rates going already at peak level, the interest rate differential goes against India.

There is no reason to panic. We need to be in a state of vigilance because these things can move very quickly. It is different from 2013 as the RBI is sitting on a war chest of foreign exchange reserve for USD 50 billion.

Q: Sajjid thinks that there are two major dangers that trade deficit is widening and it could widen even further because of crude and two the quality of our capital flows is a bit questionable, yet not time to panic. What would your take be? If crude were to go to USD 70 it is not just a current account deficit problem, it will also reflect as a fiscal deficit problem, but first let me take current account deficit? Do you think we are likely to hit 2.7% or even worse in the current year?

Goyal: We should not extrapolate from the current situation because there are possibilities of correction. One reason for slow export growth has been the good and service tax (GST). GST council has shown very fast response. They need to figure out the constraints specifically and find out a quick solution. For oil, most analysts still think that the long run oil prices between USD 60-70 will not sustain for very long above because of the supply response or loss of market share and longer term substitution for non-oil sources of energy. So Sajjid Chinoy’s projections are leaner there as they are assuming on the past records. That need not necessarily be the case.

Even for fiscal deficit, we were expected to gain from the fallen oil prices but we could not as growth continued to be slow. There are sources of demand when oil prices are high. That raises revenue and the number of self-correcting features in all markets remittances into India rise, which helps the current account to adjust somewhat.

Q: Let me not get into fiscal deficit immediately, we will come to fiscal deficit in a minute. But we have waited for the last year for this GST supply disruption to subside, but as Sajjid Chinoy points out for the last 5-6 months our trade deficit has risen to USD 15-16 billion, one month I think February even almost USD 17 billion-16.5 billion, it doesn’t look like exports are firing although the world is growing. Something has gone seriously broken here what is your confidence that it will get fixed soon. What is your confidence that we will not get to well over to 2.7% in terms of current account deficit?

Goyal: There should be some correction in the oil prices. There can be some restrictions based on imports and so on. There will be measures to tackle the unresponsive policies.

Q: What if it remains above USD 70. It is a very good chance as several experts say that it remains between USD 70-75.

Goyal: I have heard the finance ministry saying that they are comfortable with rates up to USD 80 and in terms of managing the fiscal and current account deficit they have done their maths. So, it is not going above that at present.

Q: Are you convinced that there is a likelihood of things getting a little wobbly in the external sector? Right now we are saved by the fact that the dollar itself is weak, but if for some reason the dollar strengthens can we have an unnatural adjustment or a quantum leap in the dollar-rupee?

Gambhir: If you see the rupee’s performance over the last four months or so and if you look at the broad dollar Index, we effectively have underperformed by approximately 6% or so. Dollar should have been weak than rupee but in reality rupee is weak by about 3%. On a trade weighted basis, rupee is approximately 6% weaker versus some of the other trading partner currencies.

At the margin, this kind of underperformance by rupee should actually help exports even though exports may not be that currency sensitive, but at the margin, the 6% underperformance versus one of the major currency is something which should help. Going forward, we should see some benefit coming into the current account numbers. Though, the reaction time can be a bit longer than the volatility in the market.

I am particularly concerned about the new reports about the Saudi’s intent to have the crude oil between USD 80-100. I don’t know how much confirm those news items are, but if that is the case then we need to be. Sajjid Chinoy advised us not to panic, but we need to be very vigilant. We need to make sure that the markets are allowed to adjust, along with the currency and that should help in terms of balancing trade deficit that is sorting of accruing over a period of time.

Q: What would you place the current account deficit at, do you think it goes closer to 3% at all?

Gambhir: Our estimate is that every USD 10 of increase in crude oil prices adds to about 40 basis points of CAD. So we were averaging at 2% of CAD at an average price of about USD 67 per barrel. So from USD 67 per barrel, we go to USD 77 per barrel. We should see about 2.5% current account, 2% is a safe zone, but 2.5% is somewhat concerning. So I think we can absorb that additional USD 10 but at the same time we need to be vigilant.

Q: Now for the fiscal deficit. What is your estimate, do you think that the fiscal deficit stops at the budgeted estimate or do you think, it can worsen to 3.7 or more considering the fact that there is an MSP as well as a crude impact?

Chinoy: Unlike the current account deficit at some level, fiscal deficit is a much more direct policy variable. It is under control and given the stress in the bond market, the government is very sensitive to market signals and I think because it is a variable that you can control, despite the pressures from oil, I am very hopeful that the government will limit the fiscal deficit to 3.3%. one thing that is going to help both the fiscal and the current account is that oil price increases should be allowed to be passed on at least for another USD 10-15 because it reduces the fiscal pressure and Ashima Goyal spoke about some of the natural correctives, this is one of those things. If oil prices go up and pump prices go up then hopefully volumes will reduce or not grow as fast in response. So I do think, if you think of the CAD more fundamentally, it is ultimately nothing but the investment savings gap in India.

We want investment to pick up, we hope investment picks up this year so if investment is picking up and you don’t want the CAD widen, savings has to pick up in tandem as well which means public dissaving should not get worse. We have seen state fiscal deficits get worse this year, which is why it is very important that the government stick to its deficit. I increasingly believe they will this year.

One last thing I will say just for the clarification, our forecast for next year’s current account is not a linear projection as Ashima Goyal says, we have built in exports recovering but because growth is expected to recover, import should also grow in tandem. So taking into that account, we end up with a number of 2.7%.

No need for panic. The issue is if policy is prudent, the GST works in fixing exports and we allow oil prices to pick up, there will be auto correcting mechanisms both for the fiscal and the current account.

Q: I take your point that policy can always be self-correcting but the big difference between 2013 and now is that we now have growth on our side or so it seems but can that also go for a toss. Given the fact that the National Company Law Tribunal (NCLT) process is not working so fast and banks are likely to find themselves seriously strapped because of non-performing asset (NPA) recognition, even this very good micro-growth number that we get, do you think that can get mired or somehow reined in because of higher prices, because of probably a rupee fall and the banks being in a broken condition?

Gambhir: On growth, we are fairly optimistic that the estimates that Reserve Bank of India (RBI) has put out are achievable. I think if you look at the MPC minutes today, consistently across all MPC members, there is a recognition that there is a pick-up in the growth and at the micro level, there is a pick-up in the credit offtake in general despite the situation that the banking system is in and also the fact that there is higher capacity utilisation and if you look at some of the micro level data, the high frequency data, you still get the confidence that across the board, growth seems to be in a cyclical recovery path. How long that path sustains is anybody’s guess.

I am not that worried about growth at this point in time. I also feel that the NCLT process that you talked about is taking its time. I think it was expected that this process will take its time. It is a new process, these are big cases that are expected to be resolved. So some sort of back and forth in these cases, some amount of litigation was to be expected. I am quite heartened by the fact that we had our first resolution, which is the Vedanta’s acquisition of Electrosteel and we have three cases, which are likely to go towards liquidation. So to me, out of the 12 cases, we have a clear path on four cases within a span of less than a year. I think it is a pretty good outcome.

So I am fairly positive on the NCLT process, yes, there is likely to be going forward more impact on bank balance sheets as the recognition is brought forward, the recognition standards are tightened but the reality is that incrementally for a lot of banks, the growth is coming from the retail portfolios and not necessarily from their corporate portfolios. That is likely to continue and the fact of the matter is that credit growth is continuing.

Q: I am not saying that we are in panic mode at all, I am only asking if macros have reached – all macros have shown deterioration, once you have a current account deficit that is widening, if there is a very good possibility that the dollar becomes a little north of 66, that has its own impact on inflation, crude could have a direct impact on inflation if the prices are passed on and then there is a possible MSP impact on inflation, so inflation could be higher than we are now sitting at, growth could be lower than we are now sitting at, fiscal deficit could be higher than what we are now estimating, CAD could be higher than what it was in FY18, is it fair to say that all four macros are likely to worsen than what we are now estimating?

Goyal: These are negative shocks for India especially oil prices but we are in an inflation targeting regime and the RBI will respond quickly and it is true that once you have inflation targeting these sort of cost shocks need not necessarily show up in inflation. To that extent, inflation expectations are anchored and two other points, I would like to make is that our growth is largely driven by domestic consumption, exports are net negative for demand. So our export is robust to that extent to global shocks.

Second point is about MSP, there is a widespread fear that this will be inflationary but it is rising out of problem of plenty. Prices have crashed below variable cost performance. If you give them variable cost, not the comprehensive cost, that is not inflationary and the need to increase farmers’ income should come from other types of rural activity. There is a large growth in horticulture and other kind of changes taking place, non-rural farm employment is increasing. So it should not be taken to mean that prices are going to be raised to raise their incomes. Prices are only going to give them minimum variable cost and for the major crops, this is actually ruling below market prices at present.

So it is not necessarily that MSP will add to inflationary pressure. There is a general fear in India that because we went through an episodes since 2007 of high food prices triggering inflation that second round effect takes place but that second round effect takes place only if food inflation is sustained and it is above 10%, which happened in that case, it is not going to happen now.

One feature of robust markets and India has strengthened its institutions and markets is that volatility is reduced, you need not see very large spikes, our market by itself can create large spikes but then regulation comes in. Since you have good regulation and good market, some volatility is healthy for hedging and for markets to work well, we should not be afraid of volatility, allow some volatility and allow markets to self-correct as well as prevent overshooting. Regulator should prevent overshooting then I think we are fine, we are just learning to navigate the international ocean, which is a bit choppy. We should go ahead and enjoy the ride even if it is a bit up and down.

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