Mumbai: Michael Spencer, chief economist (Asia-Pacific) for Deutsche Bank AG, is a rare optimist who thinks the worst is over for the global economy. He predicts that as the world economy gradually starts recovering six months from now, the Reserve Bank of India (RBI) may take cues from global central banks and hike rates again starting 2013. Spencer said in an interview that a fuel price increase is inevitable and this will spike inflation, pushing RBI into a firefighting mode once again. There will be rate cuts in 2012, but these may be short-lived. However, this will not have a major impact as India is poised to grow 8-8.5% in the coming years. Edited excerpts:

You believe that things will only improve from here?

Policy forecast: Spencer says India may see rate cuts in April, but it will be a temporary phenomenon. Photo by Saanskrut Kumar/Mint.

What will be the implications for India?

Certainly India will come under pressure to raise interest rates as well. I think in terms of rate hikes, next year it would make sense. For RBI, the dilemma is clear. Growth has, by all measures, been very weak. But core inflation has not declined. Now we get a drop in core inflation in January, but I think that was partly because there was a base effect from year ago.

The feedback we get from industry is that the economy is too weak and we need to cut interest rates, but the feedback we get looking at core inflation is that the economy is not that weak.

How do you see RBI’s role playing out in such a situation?

I think RBI will find, like any central bank all over the world, clearly by the middle of next year, that interest rates are going up. Now, whether they cut interest rates in the next few months, as we believe, or whether they keep interest rates on hold because core inflation is quite high, remains to be seen. I am inclined to the view that we will see some rate cuts in the next few months, but I think everybody will be raising interest rates in 2013.

So whatever rate cuts we may see will be short-lived?

Our view is that we may get a rate cut in April. But it would be a temporary phenomenon. We are currently forecasting a 100 basis points rate cut between now and July-August (one basis point is one-hundredth of a percentage point.)

I think 7.5% is the bottom before rates start rising again. That will be appropriate for an economy which is structurally growing at 8-8.5% in a couple of years time with inflation at 5-6%, so yes, 9% interest rates absolutely make perfect sense.

But how do you expect the growth rate to be 8-8.5% after such interest rate hikes?

Yes, if I look at 2014, I can see them rising back to 8% by the end of next year possibly. And in 2014, I can see growth of 8%-plus. It will be clear that growth is improving within the next six months.

What is the role of crude here, particularly in the case of India?

If you look at crude, up till now, we haven’t really built in political risk premium in the price of crude. The price has risen because over the last few weeks, we have progressively better news of the state of the global economy. Where it is a problem for India is the pressure on the government to raise local prices. You have these irregular adjustments. Diesel prices in the last seven years have risen 30%, but global prices for crude have more than doubled. I am fairly confident that in the budget, or soon after the budget, we will get a decent fuel price increase—could be 10-20%.

What will be the impact of this fuel price increase on overall inflation?

We don’t know how much the increase will be, but the calibration will be—a 10% increase in fuel prices will increase inflation by 1% over the next 12 months. The danger here is that RBI is seeing a significant decline in headline inflation, seeing very weak GDP growth and is responding to that by being prepared to ease interest rates, just at the point where inflation is going to turn up. It gets a little bit complicated. Growth has been well below potential for the last three quarters. You would sort of expect over the next few months it would show up in low core inflation as it tends to lag (behind) the economic cycle. So it is reasonable to take the view that over the next three-six months, core inflation will decline a little bit. But what worries me is that just when that happens, you kick up the fuel prices.

And, of course, we have to always worry about the monsoon and what that (means) to food prices. Food price inflation is about as low as it ever gets. I do worry that if I think forward over nine months, it is quite likely that the main source of disinflation—food and fuel price inflation—will both start to rise again and I am worried that this would impact business and consumer sentiment.

What are your expectations from the forthcoming budget?

The strategy is to start to rein in the deficit again. We are not looking for new measures, but it is important to continue with some tax reform measures and in proportional terms, less growth in government spending. We think India is going to run a fiscal deficit of 5.5% of GDP in 2011-12 and 4.8% of deficit for the next fiscal. We are looking at a GDP growth of 7.5% for the next fiscal.

anup.r@livemint.com

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