RBI policy to remain vigilant, don’t expect further rate hikes in near term: Suyash Choudhary, IDFC

In an interview with ET Now, Suyash Choudhary, Head-Fixed Income, IDFC, shares his outlook on treasury. Excerpts:

Just an initial comment on what the IMF is saying. The principal risk facing India spillover from tightening of global liquidity merging with the domestic concerns. Yes, nothing new, but formal comments are coming in from the IMF. Your reaction?

Yes, like you said there is nothing new here, but what the comments underscore for us is that even though we have seen tremendous macroeconomic progress since July of last year, predominately on account of the current account deficit as well as a bit more proactivism with regard to the RBI policy, the battle is by no means done.

If the global liquidity environment were to continue to be progressively tighter, then we need to continue to get our macroeconomic house in order. So, both on the rates as well as the need to continue to buffer the rupee, there needs to be to continue vigilance.

The IMF has expressed doubts on three major things – on inflation coming down, on the fiscal deficit as well as current account deficit. On the current account deficit, do you think they are being a little harsh because all said and done, the government has had pretty good success on that front. Of course, it might have been artificially contrived because of the import duty on gold and the general slowing down of the economy, but as far as CAD is concerned, will you like to give the government the benefit of doubt?

Absolutely. I do not think anyone can take away from the efforts made on the current account deficit and the staggeringly large compression that the government and the RBI have managed to do. So to put that a number from $88 billion the year before, this year’s current account deficit will be in the vicinity of $45 billion dollars, which is half of the current account deficit compressed. But that said, one has to keep an eye on the future with regard to two aspects, in our view. One is that if we were to see some sort of growth rebound, that again can put some pressure incrementally on the current account deficit.

So, from the $45 odd billion that we will print this year, there is a likelihood that it expands if ceteris paribus everything else remaining the same, there is incremental growth because by definition current account deficit is the difference between the investment rate and the savings rate. So if savings is constant and investment goes up, by that identity current account deficit will widen.

Second has to do with gold and there are figures coming through from agencies like the World Gold Council that with the gold curbs in place, the unofficial market has picked up. Now obviously, the need of the hour was to plug the current account deficit. So the curbs were put in place, but this cannot be a sustainable solution. So at some juncture some of the curbs will need to get relaxed and we will have to see how gold imports shape up in the light of those relaxations.

And would you agree with the IMF that most of the fault actually lies within domestic factors? Almost two-thirds of the mess that we are in is because of domestic factors, not because of external factors. And, for you which are the domestic factors that to your mind played particularly a large role in actually resulting in this kind of slowdown?

It is not really some slowdown in investment to GDP because, like I said earlier, if savings to GDP have fallen as well, investments to GDP had to fall for the current account deficit to get controlled. In my view, the bigger report card which we need to judge India’s progress by is the trends in capital efficiency and there if we look at it, we have much to answer.

From historic averages, the capital efficiency levels have eroded quite significantly. The incremental capital to output ratio, which basically measures the number of units of additional capital required to produce one additional unit of output, has gone to quite remarkable level.

So there are studies done from government quarters as well which say that if incremental capital output ratio had persisted at historic levels, our GDP growth today would have been much higher, maybe even as high as in the 7% vicinity band, even given the current investment to GDP. So I would tend to agree that a large part of the rebalancing or the policy rebalancing needs to happen domestically.

In terms of the direction that we have got from the US Federal Reserve in the light of the QE tapering as well that could be taking place, how do you see the Reserve Bank of India really acting on the interest rates in India and what could they be doing on the currency end as well to support the Indian rupee?

The Reserve Bank of India has actually done a phenomenal job over the last few months not just to shore up the current account deficit and plug the need for capital. So, the $34-billion FCNR exercise was truly unprecedented, but almost equally importantly in restoring the international communities’ faith in RBI’s ability to control inflation to a very large extent. So not that the previous governor had not done a good job around it.

But simply by refining communication in favour of one nominal policy anchor, which is headline CPI, the Reserve Bank has done a remarkable job in refocusing international and domestic attention that the RBI will have truly a very low threshold of tolerance for inflation.

So, having said that, we think the RBI policy will remain very vigilant, although as a base case we would not expect further rate hikes in the near term, should inflation turn out to be persistent at around 8% levels on the CPI. We don’t rule out one or two more rate hikes later in the year, but I also would like to add that the threshold for those rate hikes will also be high given the underlying fragility in the economy.