Jahangir Aziz believes the Indian economy today is far more dependent on the global economy and points out that a delayed global recovery could hurt India?s growth momentum. In a conversation with Shobhana Subramanian, the chief economist at JP Morgan says that sluggish private sector investment at home is worrying because consumption alone cannot drive the economy.
Were the recent hikes in the repo and the reverse repo necessary?
Yes, they were necessary and my sense is that they will do another moderate hike in November and get it over with. Whether we?re looking at the old WPI index or the new one, the worrisome part is that there are massive capacity constraints and that?s been driving up prices since February. After the new government came to power there has been a push for infrastructure spending but if you look at the private sector, where real industrial capacity gets created, there has been almost no capacity expansion since the third quarter of 2008 or nearly 18 months.
When do you see inflation coming off?
The IIP in the last 7-8 months has been growing in double digits so there has been a massive strain on capacity as reflected in the strong rise in non-food inflation, I don?t see this problem being resolved soon. You do see some private investment but, for another 12 -18 months, you?re looking at a situation where capacity constraints remain and therefore I don?t see how core inflation comes off. Sure, global commodity prices might ease if the global economy slows down but then I don?t see investment happening. So, either we?re going to have pretty decent global growth or the recovery will be slower than expected but not a disaster, in which case India will grow strongly but we?ll see pretty strong core inflation. Or there?s a double dip, in which case both growth and inflation come off. Also, the high food inflation isn?t the result of one drought. Even last June it was at 11%.The last time food inflation was 5% was in early 2007 and the demand for food has consistently outstripped supply.
Will consumption come off given the high inflation and rising interest rates?
I don?t think consumption demand is coming off; in fact, that?s what?s pushing up prices. After 4-5 years of 9% growth, people have come to believe in that growth rate; they feel incomes will keep rising and so are happy to walk into a bank and take a car loan, even if other expenses have gone up. They feel the 9% growth will happen for the next five or six years?the lifetime of the loan?and they can pay it back. People are almost surely borrowing more these days but they?re also saving probably the same amount; they?re using their mutual funds as collateral to buy consumer durables. This is a big change because previously only people in the upper income groups would do something like that.
So what are your concerns?
Without announcing it, we have become far more dependent on the global economy than we were in 2002.There has been a sharp rise in investment in the last five years, which has gone into creating capacity. But this has been absorbed more by overseas markets. If you look at the share of consumption to GDP, it has fallen consistently every year since 2002 while the share of exports has consistently risen, though it?s still small compared with other Asian countries, China for example. We?re at 25-26%, so consumption, which is in the 60s, is way higher. But, at the margin, for every rupee worth of capacity being created, an increasingly large portion is being consumed by foreigners. RBI recently noted that almost 60-70% of manufacturing is now directly linked to exports and that?s a very large number. This is confirmed by empirical analysis we?ve done.
With the global economy slowing down, is 9% a question mark?
I think if the global economy goes into a double dip, then even 8% will be a question mark. That clearly is the risk. We have become far more dependent on global recovery though we acknowledge it much less both in our market dialogue as well as in our policy dialogue. We still think that we are very non-Asian, that it?s the rest of Asia that?s dependent on global growth. But the ultimate absorber of investment have been, to a large extent, foreigners, both for manufacturing and services. The export mix has changed and so growth does significantly depend on what happens overseas, so the 8% can be questioned.
What about concerns in the home market?
India Inc has to start expanding capacity very, very soon because in its absence, inflation is moving up. While engineering companies may have large order books, what?s happening is that companies are utilising existing capacities; they?re running three shifts instead of two shifts rather than putting in a $1-2 billion into a new facility. Where are the headlines announcing big projects? Some of it is happening but that?s not enough to get to an 8-9% growth rate. Let?s say approximately 60% of GDP is consumption and roughly 40% is investment. Consumption hasn?t grown more than 4-5%, which is pretty strong. That gives you about 3% growth rate so we need another five percentage points, which means the remaining 40% has to grow in double digits at the minimum. So investment needs to happen by a very large order of magnitude. Infrastructure is doing its bit but it?s limited; it?s about a quarter of India?s investment or even less than that, maybe about 6% of GDP.
So, do we have a chicken and egg kind of situation?
Exactly. That?s what has happened over the last 18 months. Entrepreneurs have looked at the global economy and said I don?t have any conviction that this is going to last for the next five years and therefore, I?m scared about putting in a billion dollars.
Instead, let me move from one shift to two or from two shifts to three. So, there is also a domestic risk and we?ve waited quite some time for private investment to turn around. We?ve used up most of the bullets that we have, namely, government spending through loan waivers, higher salaries and so on. When the global economy went into a shock and then recovered, we used that recovery to get a large impetus from exports. And consumption isn?t really going to grow more than 4-5%; it has never really done that. So we?re back to that one engine and that has to fire very soon.
There?s a lot of money coming into the market?
There is a significant amount of liquidity sitting outside and that liquidity will probably be expanded in the next few months if the US goes into another round of quantitative easing. The Europeans or Japanese aren?t tightening money any time soon either. And if 10-year US Treasury yields are at near 2%, then where are you going to invest? That?s one thing that?s driving inflows.
We also forget the order of magnitude; to move the Indian market by 10 or 20%, you need probably less than 1% of global liquidity. These are not large numbers from the investors? point of view and I think flows will sustain because I don?t see the Kansas City Teachers? Retirement or Pension Fund having much of an option but to invest in emerging markets and to continue to invest if they?re to have even a remote possibility of meeting their obligations. You will see ebbs and flows like with everything else.
Where does the strong rupee leave exports?
The problem is that we may have moved from 10% exports to 25% exports with little or no help from the exchange rate. It happened because there was a massive increase in productivity in the manufacturing sector. If you look at the impact of global demand versus prices for any category of imports, the impact of demand has been much larger than the impact of price. A 1% increase in the price of the commodity has a much smaller impact than a 1% decline in demand for that commodity.
So, we are not really there because we had a price advantage but because the global economy was expanding at that time and our industry managed to break through. We haven?t come even close to a point where we should be worried about the exchange rate. We were at Rs 40 not so long back in July 2008. The rupee cannot be out of line with the level of growth and inflation in the economy; if we keep the rupee undervalued we will see more speculative flows. Who is going to pay for that?