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Business News/ Politics / Policy/  Controlling inflation should be top priority
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Controlling inflation should be top priority

KKR's Sanjay Nayar and Morgan Stanley's Ridham Desai say at the Mint conclave that controlling inflation, restarting projects and improving inter-ministerial coordination should be priorities

Sanjay Nayar (left to right), Tamal Bandyopadhyay and Ridham Desai at the Mint conclave.Premium
Sanjay Nayar (left to right), Tamal Bandyopadhyay and Ridham Desai at the Mint conclave.

Mumbai: A clear mandate for the Bharatiya Janata Party-led National Democratic Alliance government has given hopes of quick policy decisions and clearances of stalled projects to reboot Asia’s third largest economy that has been growing at a slow pace in the last few years.

In a panel discussion, Sanjay Nayar, chief executive officer and country head, KKR India Advisors Pvt. Ltd and Ridham Desai, managing director, Morgan Stanley India, said controlling inflation, restarting projects and improving inter-ministerial coordination should be priorities for the government. The discussion was moderated by Mint’s deputy managing editor Tamal Bandyopadhyay. Edited excerpts:

What are the changes needed to revive the economy?

Desai: First, consumption must go down in the government balance sheet and investment must go up. That can be done as early as June or when the budget comes up. Second, we have to unclog the system. Enterprise is curtailed now because we have a lot of projects which are either incomplete or complete but unable to produce output. Those approvals have to come quickly. There is a longer list of things they need to do as they settle in.

We have a situation where the sentiment has gone way ahead of reality. The macroeconomic scenario is not as bad as it was nine months back. Both of you said inflation is a big problem. Tell us how to tackle these.

Nayar: Sentiment is so high because the election results were on an unexpected scale. It has been a tough year for companies. In the January-March quarter, they have struggled on the topline and demand has come off. The last leg to fall was consumption, that’s come off. There is inflation. I don’t think sentiments are misplaced. I think the quality of earnings have to change. We look at the numbers very closely, we have a sample in every sector.

At the government level, quality is a big issue. You can achieve fiscal numbers, but we are seeing payments not being made and a lot of bad loans. I have heard crazy stories of dues unpaid for 11-12 months. There are commitments on social schemes, redemption of bonds are to be made.

The quality of current account deficit (CAD) is another issue. You have a short supply side, you reduce the demand side and you settle at a GDP growth of 4-4.5%, which is not a great outcome. CAD comes down, imports are lower, exports are lower, life is good. Now, the challenge is to ramp up everything, without stoking inflation.

Desai: The stability indicators have got better, but growth indicators have become worse. Macro-stability is better because we took a knock on growth— which is essential for stability. The only bit I am not comfortable with is inflation, which is a threat to macro-stability. I think there are more animal spirits in the market, and therefore—it seems so—in the economy.

The second point, as Sanjay put it, is the quality of indicators. CAD has been reduced by rationalising gold demand. Demand is still high, declining, but still high, because real rates have turned positive only now. Again, I prefer to look at public savings, not the fiscal deficit. Because you can transfer expenditure from one side to the other side of the balance sheet and make one side look better than the other. The economic numbers come with a lag and I would be surprised if there is any improvement in savings.

I don’t believe a rate cut is a panacea for a growth recovery. Private sector leverage is at an all-time high and there is no capacity to borrow. Banks have maxed out on the loan-to-deposit ratio and there is no capacity to lend. By reducing the cost of money, I do not create capacity to either borrow or lend. In fact, I reduce capacity, because I am actually hurting deposit growth. We must deleverage the private sector, may be infuse capital into banks and revive deposit growth. All these require positive real rates. If you make real rates negative, you take two steps backward. I completely agree with the Reserve Bank of India governor that real rates must be positive and I am hoping the government agrees with that. I think it will. If you can supplement that with fiscal consolidation, the economy will probably turn around in a year from now.

What do you expect on the monetary policy front?

Desai: I don’t think the governor will touch interest rates. Core CPI (Consumer Price Index) has stabilised. There is a threat of El Nino and a return of food inflation. The governor needs to see how much support he gets from the government. If it can support him with lower consumption, he can come back in three or four quarters and cut interest rates. But generally speaking, I don’t see an interest rate cut in the next few quarters.

What about a hike?

Desai: That’s a possibility if inflation picks up, or if the government does not help with fiscal consolidation.

Tell us how fiscal consolidation can be done.

Nayar: All industries cry about (high interest) rates, but that should be the last thing to worry about. We have an upward bias on the rupee and I fear much of this is volatility related to the inflows. I think rates will be able to become firm, rather than become easy. The government spends 33% of its expenditure on debt servicing. Think of a company that spends 33% in servicing its debt.

To the credit of the outgoing finance minister, he has brought about a fairly high stability into the economy.

Desai: The new government inherits a few good things. It is not as bad as last year. On diesel, we are now just 5 away from market pricing and are close to decontrol. There has been some rationalisation in rail freight. The CAD is under control.

Fixing the headline fisc will require at least two three years. But the government needs to see things from a public savings viewpoint. Corporate savings are depressed and household savings are down about 100 basis points. First, you need to urge public sector units to become more profitable, and second, curtail subsidies. I would push for a 5 diesel price hike now and just close out the oil subsidy. It may have a small implication for inflation for the next three months, but six months out, it will decline. I wouldn’t fall prey to the Food Security Bill right now. The organisation to implement it is not in place and therefore, you end up spending more than you thought you would.

The UK experimented with small businesses by cutting taxes, which boosted employment and generated huge revenues. I think there is a case for a counter-cyclical tax cut. I know it sounds odd when your fiscal situation is so precarious, but if you do that like you did in 1997-98, it will actually set the stage for more government revenue. You are setting up a recovery in corporate profit, which can then be reinvested and you get the cycle going.

How will we restart stalled investment projects and revive the animal spirit in the economy? Chidambaram tried doing that.

Desai: I think we have the right leader (in Prime Minister Narendra Modi). The electorate has delivered a clear mandate for growth. But no sweeping reforms can be expected. It needs to be done sector by sector.

Chidambaram tried doing that, by holding meeting in every zones with industrialists and bankers.

Nayar: The difference is, now there is a strong leader at the Centre and better inter-ministerial coordination. Projects are stuck for months for various reasons. Everyone must work towards the same direction.

Secondly, you cannot have projects run by Delhi. You need states on your side. The new PM’s view of treating the cabinet on a more enlarged basis including chief ministers of states is a great idea. Finally, people need foreign investments to come in, because there is going to be a shortage of local capital. But that will come later when the demand for capital picks up. You come to that last. First, growth has to pick up.

Desai: I completely agree with Nayar. Let’s look at what the National Highways Authority of India (NHAI) did recently. (NHAI has allowed premium restructuring for nine road projects). This was in the pipeline for several months. They couldn’t decide on the premium extension, and these projects were sick. All of a sudden, nine road projects have become viable. There are expectations that others too will be cleared soon. It has opened the door for NHAI to issue orders for more projects. That’s because people are confident the road sector has become viable. In the last two years, you couldn’t do that. Such decision-making is needed to put projects back on track.

Will the government be able to address the issue of banks’ bad loans and capital requirements?

Nayar: Even if you unclog the system, you are not going to get loans unless banks have the capability to fund. About 70% of the banking system is in the hands of public sector banks and they are quite strapped for capital. The combined amount of bad loans and restructured loans will be about 10%. That’s a huge amount. If you want GDP back to 7-7.5%, that is not going to come without investment picking up, which needs financing. I think the government must be innovative on how they inject this capital—privatise, bring down its stake to 51% or even take a bigger knock. I’m not sure how they will do it. That is a big question mark.

Desai: We have given our solution to the RBI and the Union finance ministry. They have estimated a loss of 3% of GDP. We have done the exact opposite of what the US has done. They transferred private debt to public debt, while we transferred public debt to private debt. So, public debt to GDP is at a 30-year low—65% of GDP—while private debt to GDP is at an all-time high. Now, you have to re-engineer a transfer. One way of doing this is to disinflate the economy. Then, in four-five years, fresh equity will be created, public debt will rise and private debt will decline. I don’t think the government has the luxury of that much time. So, you want to fast-track the process, through state-owned banks. You can easily raise off-balance sheet capital with the government issuing bonds. I don’t think credit rating agencies will frown upon it. It can be done overnight.

All PSU banks can raise capital at reasonable valuations. Three months ago, those valuations didn’t look good enough for them to sell shares. Today, there are takers, because people have become optimistic about the change that has come to the country.

Nayar: I don’t think they can raise capital from the market now. Markets can come off the way they have come up and people will suspect the quality of books. State Bank of India is in a different class from the rest. For others, it is not easy to raise capital. Stressed assets are high. You can bring in lot of long-term capital to distressed assets and take these off the balance sheets. But banks have to take a hit in this process, which is difficult. I’m not sure how much stock market capital is available but there is a lot of long-term, stressed asset capital and restructuring capital are available.

What are the four priority items for the government? And where do you see the GDP growth in the current fiscal year?

Desai: In the short term, inflation should be top priority, followed by projects. In the longer term, the first issue is natural resources. India has gone through reforms on industrial licences, but has not followed up adequately on the natural resources side. So, we need to come up with solutions on how to get them out of ground most efficiently, price them and get it into the market place. The second is urbanisation. Small villages of 20 or 30 years ago have become small cities or towns, and we must take them to the next level. Urbanisation is the most powerful drive to make people richer. Thankfully, it is recognised by the government and was in the Bharatiya Janata Party’s election manifesto as well.

The third thing is regarding business environment. If you get savings up, investments will follow. We have the demographics to generate savings for our next 10-15-year growth. We have 450 million children who will join the work force in the 10-15 years. We need to ensure is that they are skilled and healthy, which unfortunately they are not. That should be the third part of the government focus. We will have better growth figures this year because of last year’s low base. Most of the improvement will come in 2015-16 when we expect growth to go back to 6%. We see our potential growth rate at 7%, not 8% or 9%. When we go to 8% or 9%, we overshoot our potential, unless we lift our productivity level sufficiently.

What is your house’s take on the Sensex?

Desai: The markets are a bit over-exuberant, but I keep reminding myself of 2009 when United Progressive Alliance returned to power. The market was then trading at about 19 times earnings—very similar to today— but by October 2010, it was at 24 times. We got a little bit of earnings growth, but the multiples went through the roof and after that, the market went down. Short-term price changes are about the expectation of change; in the long run, equities reflect actual change. The expectation of change is very hard to judge. So, if I were to forecast—and I know I can go totally wrong on this—I expect modest returns on the Sensex in the next 12 months—more like 10%, but I can be totally wrong on this, because the expectation of change can go further up from here and the multiple will rise further. A far more reasonable forecast for the long run would be 12-14% returns. It is unlikely that returns exceed nominal GDP growth in the long run, but given the fact that our starting point is a bit depressed, and that we have had a few years of accumulated growth, in the next five-seven years, equity returns could exceed nominal growth.

Nayar: In the short term, I want to see better coordination between ministries; so, a really functional Prime Minister’s Office will be a great positive. I think they got to fix the power issues. An integrated power and coal ministry helps a lot because there are so many near-complete power projects that are mothballed without fuel supplies. It’s critical for growth, manufacturing and job growth. The third is getting some of the pending Bills passed. Capital productivity has gone down, and it’s a good time to unclog projects and infrastructure. In the long term, you have to address capital market reforms where savings do come into the real sector. We have a non-existent bond market.

My growth forecast is slightly more optimistic than Ridham’s, because of our low base. Indian companies do perform at a high return on equity (RoE), and I think RoEs are pretty low because we have had low asset turns, lowest margins ever. But those can pick up quickly because the demographics and consumption are all intact; so, better sentiment can help. So, I would say a shade over 5% in 2014-15.

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Published: 15 Jun 2014, 11:40 PM IST
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