While reiterating the view that there was “very, very little chance” of inflation being stoked, CEA Arvind Subramanian in an interview with Banikinkar Pattanayak dwelt on the impact of the carry trade, on the RBI’s fears that large-scale loan waivers could cause inflation to reignite, on the benefits from GST with even the current high rates and complex structure and on the likelihood of the NPA resolution mechanism working. Edited excerpts:
Instead of the finance ministry calling MPC members to Delhi, why didn’t you go to Mumbai?
What we had said was we would like to see MPC members for technical inputs and then we want to present the inputs to the entire MPC. We said the MPC members should come here because it’s easy for them to come here, and then we would present the inputs in Mumbai to the entire MPC. But both the proposals were rejected.
Has RBI fuelled the carry trade?
Ever since the December MPC meeting, G-Secs yields hardened, the rupee moved from 68 to 64 against the dollar — that’s a manifestation of carry trade. It has an impact on both inflation and growth outlook. If all the monies come in, the normal exchange rate appreciates. The rule of thumb is that for every 1 percentage point appreciation of the exchange rate, there is a downward impact on CPI of roughly 0.1 percentage point. But appreciating real exchange rate affects the growth outlook. A stronger currency could help reduce inflation but it would also affect growth. Therefore, the policy response has to be calibrated accordingly.
You may also like to watch:
One view in political circles is that a strong rupee keeps import costs under check, and we import more than we export.
The view that we should have a stronger rupee because we import more than we export is not right — when the currency appreciates, it hurts both the exporting industries and import-competing industries. When people say a weaker rupee will lead to a rise in input costs, we have to remember that imported input costs account for, say, just 10% of total input costs.
But small exchange rate changes don’t affect export competitiveness much.
Larger exchange rate changes have bigger impact and smaller exchange rate changes have proportionately smaller impact. But if you talk to the clothing sector, for example, they say their margins are so small that even a 2% exchange rate change makes a huge difference.
The MPC fears large farm loan waivers can cause fiscal slippages which will fuel inflation — a BofAML estimate is this could be as much as $40 billion or 2% of GDP. If this is funded through bonds, the deficit will rise by 0.2%. Is the fear legitimate?
In the run-up to the 2013 crisis, there was some evidence that a number of factors, including rising MSPs and fiscal deficit, contributed to inflation. However, the fact is in 2017-18, both the Centre and the states are targeting reducing the deficit to 5.8% against 6.2% in 2016-17. So, in even a worst-case scenario, the loan waivers will reduce the consolidation. Traditionally, the central bank says if you can’t behave responsibly, we can’t cut rates. But here, we are being responsible.
With such a complex GST and such high rates, will we get the benefits we want? Or will they come in only after the GST Council reduces rates?
My assessment is the GST will have at least two benefits: First, relative to today, there is a huge reduction in complexities; second, there is a decline in tax rates. While the impact of GST on inflation depends on how much pass-through happens, headline CPI inflation could still drop. But the point is we have not got as much base expansion and as much reduction in complexities as we would have liked. But even with these rates, I expect a 10% expansion in the base due to just invoice-matching.
How do you explain the 11.1% growth in private consumption in Q3, the demonetisation quarter? While you had said in the Economic Survey that the uncertainties would dissipate and spending might rebound towards the end of the year, Q4 turned out to be worse, with private consumption growth slowing to just 7.4%.
The supply side data are more accurate. On the demand side, government investments and net exports are relatively (more accurate), but one has to be cautious about reading too much into consumption data (for 2016-17) at this stage.
Gross fixed capital formation contracted 2.1% and private consumption slowed down in Q4FY17. Going forward, what will be the driver of growth? Obviously, government spending alone can’t boost growth to the desired level, especially when, as you said, there could be a fiscal tightening.
Hopefully, there could be a bounce-back in consumption after demonetisation. Exports are rising, but investment, for sure, remains a concern. As I have said, growth in real economy has also decelerated from last July. So whatever is your (RBI’s) growth outlook, there is absolutely a very very little chance of closing output gaps and, therefore, stoking inflation structurally, given the twin-balance sheet problem. Personal loan growth, a gauge for consumption, has also been decelerating recently.
As far as stressed assets with the banks are concerned, how do you see the recent government move to encourage resolution through insolvency law? And while banks need huge capital infusion, the government suggests consolidation — merging a weak and a strong bank doesn’t give you a strong bank. Will this boomerang, and will this mean stealth privatisation?
The ordinance was a great step both optically and substantively. I think we have to give it a chance to work out. My own view is if we can have one-two resolutions of big cases in the next three to six months, it would be great. As for mergers, let’s look at the performance of SBI after the merger and then talk.