Investors will have to be patient and focus on the medium-term markers of growth than look for signs of a short-term turnaround, says Deutsche Bank's Asia chief economist
Singapore: The Indian markets are turning impatient with no sign of a quick fix to the economy, but this is likely because of a misunderstanding about the nature of the prevailing economic dynamic, Taimur Baig, Asia chief economist at Deutsche Bank AG, said.
Investors will have to be patient and focus on the medium-term markers of growth than look for signs of a short-term turnaround, Baig said, and added that it was unfair to judge Prime Minister Narendra Modi’s government on its one-year track record.
“Short-term market fluctuations are unavoidable, but that should not detract investors from the economy’s positive, medium-term outlook," Baig said in an interview.
What is your take on a year of the Modi government? The markets don’t appear to be giving the government a thumbs up.
It has been a reassuring year with respect to economic policy as the government has lived up to the expectations of improving executive decision-making, while at the same time maintaining policy continuity on a range of reforms—GST (goods and services tax), subsidy, financial inclusion and fiscal consolidation in particular—initiated earlier.
Measures towards improving the supply chain to reduce food price inflation, creating a more investor-friendly environment, and enhancing international cooperation on trade and finance are welcome. The government has had mixed success on the legislative front, but that was expected, given its lack of majority in the upper House.
We can sense the market is turning impatient with no sign of quick fixes to the economy, but this is likely due to a misunderstanding about the nature of the prevailing economic dynamic. Contrary to popular belief, India’s economic growth has slowed due to two major reasons outside of the political cycle:
First, the economy, just like any other economy in the world, was hit by a couple of major shocks in the second half of the last decade, recovering from which has turned out to be a very time-consuming process. A sharp rise in commodity prices hurt the balance of payments and caused a major fiscal slippage in 2007-08, while the global financial crisis of 2008-09 hurt corporate profitability and confidence immensely. These shocks created a boom-bust cycle that made many pre-bust projects turn unviable, and many corporates and banks are still dealing with the resulting underperforming assets.
The second factor behind slowing growth is a structural one. After enjoying the fruits of first-generation reforms in the last decade that pushed up growth towards 9%, second-generation (admittedly more difficult) reforms were not implemented that would have improved productivity.
The key drivers of sustained investment, namely costs of land, labour and capital, are unduly high due to regulatory bottleneck, poor quality infrastructure and human capital, and governance deficiencies. These are well-known and widely-discussed deficiencies, yet the investment and policy framework necessary to improve them have been left wanting.
Neither sources of drag can be ameliorated quickly. Hence, investors would have to be patient and focus on medium-term markers of growth—example, clean-up of bank and corporate sector balance sheets, pick-up in infrastructure investment, and a sizeable rise in foreign direct investment (FDI)—than look for signs of a short-term turnaround. This also means that it is unfair to judge the government on its one-year track record.
Has global investors’ perception of India changed in the last few months? There seems to be a lot of disappointment among global investors about the latest happenings in the country.
I disagree. Among the wide range of investors I meet around the world, there remains substantial interest in India. Of course, one notes a general nervousness about emerging-market economies as Fed policy normalization looms, and there is concern about economic growth potential worldwide, but India’s growth prospects are nevertheless seen favourably by investors. With economic outturn and outlook looking poor in Brazil, China and Russia, India’s growth potential looks particularly attractive on a relative basis.
How big a risk for India is the possibility of a weak monsoon? Weak rains are a tail-risk at this point, but could it end up derailing India’s disinflationary trend and still-nascent recovery?
Our study using long-term time series data shows that monsoon deficiency and inflation are not necessarily interlinked. There have been years in the past with deficient monsoon when food prices did not spike, and there have years with ample rains when they did spike. What explains this apparent disconnect is the role of public-sector policy in countering the impact of inclement weather and supply-side disruptions. If the government manages to stabilize grain prices by selling its food stocks, which are ample, in the market and keeps a close eye on supply-side disruption for non-grain food items, it should be able to limit food price inflation, in our view. Also, the global food price trend is benign, which should help.
The Reserve Bank of India (RBI) highlighted potentially weak rains as a risk to the inflation outlook, in its June review. With inflation-targeting being the new policy mandate, the central bank has committed to the 2-6% inflation target, come April 2016. Is it possible that weak rains could push inflation out of the 2-6% RBI’s Consumer Price Index (CPI) target?
We think RBI’s concerns are justified, but when the dust settles, inflation will turn out to be broadly under control.
In our view, the central bank will be happy to see CPI inflation stabilize around 5% over the next few years, and regardless of the monsoon dynamic, our forecasts suggest that this is achievable.
On food, as already discussed, weak monsoon is not a deal-breaker as far as inflation is concerned, with a key role for public policy to be played in this context.
On fuel, we don’t think there is much more upside remaining this year, given the ample global supply-side outlook and still-anaemic demand situation.
Inflation expectations should also be stable as wages remain muted and the labour market soft in India. In an environment of growth picking up only gradually, fiscal policy on a prudent path, and RBI pursuing monetary policy in a credible manner, inflation should not be a major source of concern.
Broader range of prices, including the WPI (Wholesale Price Index), GDP (gross domestic product) deflator, and the input price portion of the PMI (purchasing managers’ index) survey also provide room for comfort.
The Indian financial markets are under pressure and this is being blamed in part on the jitters over a weak monsoon. But is it all about the monsoon, or is there more to it? What do you make of the current market nervousness?
Markets worldwide have turned volatile and India has been no exception. Concerns about Greece, China and US Fed have combined with disappointment from stagnant trade and demand. In India’s specific case, these factors have combined with the increasing realization that there may be no quick fixes to the economy. Short-term market fluctuations are unavoidable, but that should not detract investors from the economy’s positive medium-term outlook.
The agrarian part of the economy appears to be a cause for concern. If it does not pick up in FY16, do you think the GDP estimates could be drastically different? Is the agrarian space going to be the problem sector for the economy?
We are still not sure about the new GDP series, given that it suggests a very different and stronger investment performance than what high-frequency indicators like industrial production, auto sales, import of capital goods, bank credit and corporate profitability suggest. Regardless of the GDP statistics, it is conceivable that a poor harvest can subtract from growth. But note that India is much less dependent on monsoon than before due to improvement in irrigation, diversification of crops, and a rise in production of winter crops. For these reasons and the fact that agriculture accounts for less 20% of GDP, the impact of monsoon on the economy is far less than it used to be a couple of decades ago.
Has inflation-targeting created an overvalued rupee which has hit ‘Make-in-India’ and export competitiveness?
Inflation-targeting has not led to overly tight monetary policy in India. We don’t think investors are bringing capital to India because of high real returns stemming from RBI’s interest rate policy—they are focusing on returns on investment from the real economy instead. Of course, exchange rate depreciation could help exporters on the margin, but it would also push up the price of imports, which are crucial for production.
Most emerging-market currencies have fallen much more than the Indian rupee, but most of these central bankers still want their currencies to remain weak. They are looking at it to kick-start exports. Will this strategy work?
We don’t think competitive depreciation would help in kick-starting exports. If all export-oriented economies are pursuing a weak currency, then at the end of the day, no one benefits. For India, major competitiveness gains can be achieved through productivity enhancement rather than some temporary benefit from FX weakness.
What are your expectations from the US Fed on an interest rate hike?
We think the Fed would make its first move in September. It will, however, be accompanied by a particularly dovish guidance, in our view. US economic data have begun to firm up after a disappointing first quarter, while both labour market and wage data indicate a trend recovery. But these indicators are still on arguably fragile grounds, which may warrant very cautious communication and guidance from the Fed.
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