Radhika Rao, Assistant Vice President and Economist at DBS Bank
Radhika Rao, Assistant Vice President and Economist at DBS Bank, believes that focusing on growth is no more the
mandate of the Reserve Bank of India (RBI)
given the sharp slide in the rupee. The Singapore based banker believes that financial stability will be the primary goal of the central bank. Edited excerpts from an interview with Mahesh Nayak. Excerpts from the conversations:
Q. Are these testing times for the Indian economy and financial markets? When do you think the uncertainty will be out of our way?
A. This is a very challenging juncture for the economy as the authorities need to prioritise between growth and financial stability objectives. The marked currency depreciation has increased the need to tighten the screws on liquidity and monetary management, even at the expense of short-term growth. Two developments are required as a precursor to easing this period of uncertainty - US Fed needs to signal that the tapering (of quantitative easing) will be more gradual than markets are pricing in and on the domestic end, the external imbalances and structural reforms need to be seen through. It will be difficult to address the latter in the short-term, though the government can signal the intent and willingness to push through tough decisions to assure the markets and follow up with action. However, with elections fast closing in, reform machinery could hit speed bumps.
Q. Do you see any light at the end of the tunnel after meeting your clients? Or is the India growth story over and why?
A. The central bank's recent measures, while seen as a necessary step to
ensure financial and rupee stability , have toughened conditions for corporates and businesses. Funding costs in the short-term have risen substantially, along with increasing yields on corporate debt issuances, while the anticipated relief from reduction in lending rates has not materialised. Hedging costs have also risen accordingly. Looking ahead, damage to overall growth conditions along with the rupee trajectory is causing the most unease, with bottomline and margins of corporates likely to face renewed stress in the interim. Conditions are likely to remain tough at least for the next one to two years.
Q. What is your take on the RBI's monetary policy? Was it in line with expectations?
A. The policy decision was along expected lines though the consequent hit on the rupee was surprising. It does put the central bank in a spot and pressure could mount for more decisive action on the rupee.
Q. Do you think compromising on growth and focusing on interest rates and currency is the right way to go?
A. While the central banks might not be able to reverse the direction of the currency in an assertive fashion, this does not diminish the need to ensure that the unwinding happens in an orderly manner and not at the expense of the proper functioning of the financial markets. To that extent the central bank's focus on interest rates and currency is important. In the present environment, lowering rates will be insufficient as standalone in improving growth prospects, but on relative basis will be more detrimental to the currency and trigger fresh capital outflows. Thus, the need for the central bank to stick to its primary policy mandate of price and financial stability.
Q. Do you think the RBI will bite the bullet despite rising inflation and deficit to boost growth?
A. The path of least resistance for the central bank is to maintain status quo than to move in either direction on the policy benchmarks. The need to reinvigorate growth prospects will be left to the government, with a priority for long-lasting and structural reforms, though admittedly these will entail political costs as elections loom in the horizon.
Q. What is your view on liquidity in the system? What is your outlook for the Indian bond market?
A. Our in-house view on the longer end of the bond curve is for yields to stabilize between the 8-9 per cent mark. Normalization of the US yield curve over the medium term also implies higher rates in Asia including India.
Q. In the next six months to one year at what level do you see India's GDP and why?
A. The limited support from positive real rates and absence of revival in investment activity will keep the output gap negative for the year ahead. GDP growth will be closer to 5 per cent with downside risks.
Q. In the next six months to one year at what levels do you see inflation, current account and fiscal deficit and why?
A. Price pressures are likely to resurface from the scale of under-recoveries due to global crude movements and weak currency dynamics. The divergence in the WPI and retail inflation is also likely to stay, posing an additional headwind to policy direction. We have been flagging the risk of a reversal in the fiscal consolidation efforts and in the present environment the risks of higher spending and increased allotment to subsidies have risen. This could see the fiscal deficit exceed the target by at least 50 basis points. The unfavourable combination of negative rupee dynamics, demand for gold despite affirmative action and lack of sensitivity of exports to currency moves will keep the current account deficit around 4.5 per cent of GDP mark this year.
Q. Over the next one year what is your view on the emerging and developed markets?
A. Institutional investors are likely to prefer economies with sound external balances and favourable rate differentials. With much focus on the US Fed tapering exercise and resultant push up in the G3 yields and upward pressure on the Asian counterparts, investors will prioritise growth prospects, regulatory control and governance over purely returns. Volatility however is likely to remain high in the interim and might see a preference for holding cash until external uncertainties abate.
Special 
