RBI decision to curb domestic liquidity to stem the fall in Rupee has led to fears of rising interest rates that could impact growth negatively. Further measures to support Rupee such a sovereign bond issue also continue to be on the table. VP, Sovereign Risk Group, Moody?s Investors Service Atsi Sheth tells Ira Dugal that a trade off between growth and financial stability may have been inevitable. Excerpts
Will RBI steps to support Rupee be growth negative?
Adjustment necessarily implies a trade-off has to be made somewhere. Stabilising the currency can either be via interest rate hikes, which could reduce growth or through other measures to stabilise the current account deficit and attract capital flows. However, measures to improve the current account deficit and attract capital inflows ? like narrowing the fiscal deficit, bringing down inflation, addressing infrastructure constraints, reviving investment ? are more long term in nature and are unlikely to achieve the immediate currency stabilisation that authorities seek. So, in short term, measures to stabilize the currency like interest rate and rupee liquidity adjustment require a trade-off between growth and financial stability. .
A number of experts have cut their growth forecasts for FY14. Are you likely to do the same?
We had earlier predicted about 5.7% GDP growth for FY14, which I believe is within the consensus range. We will continue to review that specific forecast in the light of ongoing developments and data. However, more than the specific number, what is important from the credit perspective is the overall growth trend and the magnitude of the slowdown. And the trend is clearly that India?s slowdown is likely to be significant and prolonged. This growth slowdown, in turn, exacerbates fiscal pressures, making it difficult to address some of the other macro imbalances related to the balance of payments and the exchange rate. So while we may adjust GDP growth number based on new data, that will not mean a change in the fundamental credit story ? which is that the prolonged growth slowdown is both exacerbating existing macro-economic imbalances and making it more challenging for policy-makers to address.
Is the funding of the current account going to be an issue this year? How would you view a possible sovereign bond issue which is being considered?
The government has so far not issued a foreign currency sovereign bond and we don?t have a specific view on the sovereign bonds. We do note that at this point, government foreign currency debt is relatively low as a proportion of total debt and this has meant that sovereign debt repayment costs have not increased significantly due to current depreciation. We also note the current account financing has come largely from foreign capital inflows into the banking or corporate sector and we anticipate this is likely to be the trend over the medium term. That is, the combination of NRI deposits, portfolio flows, external commercial borrowings and foreign direct investment will be the primary source of current account financing, rather than government foreign borrowing.
You have in the past raised concerns over external debt on corporate balancesheets. Has that problem worsened now?
Yes, firms that have unhedged exposures ? whether as importers or foreign borrowers ? are now exposed to a significant increase in import costs or debt repayment costs. And that certainly could lead to firm specific credit stress. However, from the sovereign perspective, total external debt is relatively low as a proportion of GDP and export receipts, so currency depreciation does not have the macro-economic impact it would in an economy that was more open, in terms of international trade and borrowing. We have seen that over the last couple of years, external debt has been growing more rapidly than GDP and export receipts. This is a trend we are monitoring.
Are you watching fall in reserves?
We do watch reserve levels quite closely. The fact that the balance of payments is in deficit would mean that reserves will decline in order to meet import needs or debt repayment needs. At this point and given anticipated trends, they are adequate to meet the country?s near term needs, and we expect authorities to be proactive in maintaining adequate reserve levels. We have noted that during periods of currency depreciation in the last few years, the Reserve Bank of India tends not to expend vast quantities of reserves to defend a specific currency level. They step in to intervene but mostly to stem volatility rather than to reverse the trend. We think it is credit supportive that authorities do not spend reserves to defend currency level higher than suggested by fundamentals.