At a time when interest rate cuts are termed as the panacea for propping up growth, the more fundamental imbalance of a huge fiscal deficit needs to be addressed, says Hitendra Dave, head of global markets India, HSBC Bank. Speaking with FE?s Aparna Iyer, Dave says the size of the overall budget needs to be stable for the next 2-3 years which would solve issues on the inflation, fiscal and current account front.
There is tremendous pressure on the government for reforms and on the health of its finances. What should we expect?
Sovereign fiscal deficit is a pain. But the reality is that we actually need 2-3 years of a reasonable budget size and we will have a fiscal deficit correction. The GDP growth will help. 6-6.5% of real growth means nominal GDP growth is 12-14%. If you dovetail that with faster services growth then much of the tax revenue gets taken care of.
Unfortunately, over the last 5 years, we have taken the size of the budget from R7 lakh crore to R15 lakh crore, which is a staggering growth. The growth is even faster than the nominal GDP growth. I think over the next 2-3 years, they should not hike the budget size. And doing that will fix everything. You will find term yields going down, fiscal deficit as a percentage of GDP going down, which will give tremendous space for RBI to do things.
So fiscal deficit must be addressed for policy transmission?
Right now transmission is not happening. The sovereign borrows so much that term yields are very high. And people are not putting money in bank deposits despite deposit rates being high around 9%. Principal reason for that is people think 9% deposit rate does not give positive return. This cycle of expectation has to be broken. You fix fiscal deficit, term yields will get fixed, deposit rates will get fixed, current account and inflation will also get fixed. Monetary policy transmission will be faster. It is clearly the number one issue.
But growth and industrial output have been falling over the past several quarters. Can this be brushed aside?
I am not saying we turn a blind eye. Within the GDP we need to see what sectors are slowing down. Instead of quarterly, let?s look at seasonally adjusted number. Seasonally adjusted, the fourth quarter is when the trend actually reversed.
The capital formation was higher than previous quarters. Look at corporate results for Jan-Mar. If we are really having that big a slowdown why is every FMCG company posting a topline growth. I think it is soon to come to the conclusion that 6.5% is a disaster. We weren?t as good as we made ourselves to be in 2007 and we clearly are not going to be a basket case now.
Are rate cuts critical at the upcoming policy?
I think their dovishness has to go up for the simple reason that circumstances merit so. Oil is lower, growth is turning out to be lower than their expectations. In April policy, they had said that growth of 6.1% is significantly below trend and they had taken only a quarter figure into account. Given that assessment 5.3% for January-March would appear to be disastrous. The case for a cut is well laid out. I expect a 25 basis points cut in the repo rate. The case not to do so hinges on inflation,fiscal situation and lack of clarity on monsoon.
Is the oil price fall a great help?
Things are a lot better today than they were a few months back. Oil price fall is a great relief. Oil has fallen 25-30% and is looking weak. It is not threatening to go up. Oil price fall has come down contrary to everybody?s expectations. Rupee weakness, for me, is a good thing as it props up growth, especially when the RBI doesn?t seem to have much room.
We have seen tremendous volatility in rupee. What is the outlook?
As far as the rupee weakness is concerned, it is one of the better things that have happened. Currency weakness is a boost to growth. It is great for import substitution.
I feel with the 25% movement which has happened now, it would be ideal for us to have some exchange rate stability. So even if the world starts loving us tomorrow or oil comes down more, or we do reduce the fiscal deficit and suddenly if lot of dollars come in, I hope we don?t let the rupee appreciate too much. We need some much needed exchange rate stability.