Q & A on Indian Economy

Q&A with Business Standard

Q1. The last few years has seen a shift in the composition of household savings away from financial assets. However in light of a fall in inflation which essentially translates to higher real interest rates/deposit rates, and a buoyant stock market, will we see a shift away from physical assets? if so, will this lead to an increase in bank deposits and thus impact deposit and credit rates?

A1: The Inflation expectations, sampled by the RBI still unbelievably(to me) high. If these reflect actual consumer expectations, then the shift to financial savings will only occur when they come down. On the on other hand, actual inflation is declining and if expectations follow these as has normally happened in the past, financial savings should increase with a decline in inflation. This will impact bank deposits and deposit and credit rates in the expected direction.

Q2. With the US Fed likely to phase out quantitative easing and expected to raise interest rates next year, in light of strong GDP and employment numbers, will we see any impact on capital flows to India? how will this impact the proposed disinvestment that will be unveiled over the coming months?

A2: very time there is a change in forecasts of US growth, it is accompanied by speculation about tapering of easy monetary policy by the US Federal Reserve Board and volatility in financial markets. Higher US growth combined with further tapering will lead to higher international interest rates and volatility in capital flows to emerging markets. But I believe this will be a short term phenomenon as far as its affect on India. Over any period longer than a month or so, flows to India will be determined by the soundness of our macro-economic policy and the growth enhancing (policy & institutional) reforms.

Q3. On the framework of monetary policy, we have seen how central banks in other countries are looking multiple indicators such as employment numbers, nominal gdp growth, rather than focusing solely on inflation. Do you think an inflation targeting regime will restrict RBI's room to maneuver?

A3: When the Raghu Ram Rajan Committee first raised the issue of "inflation targeting" in 2006-2007 I opposed it on the grounds that (1) Indian financial markets were highly segmented, underdeveloped & far from efficiency of US, UK markets. (2) That economic growth was still too dependent on government policy and governance actions that affected the supply side, to be treated as totally  independent of policies for inflation control and (3) We didnt have adequate predictive models for linking monetary policy instruments with future inflation, partly for the reasons 1 & 2. Since then it has been clarified by Dr. Rajan that "inflation targetting" doesn't mean that other elements such as actual and potential economic growth will be totally ignored. This "soft" version of inflation targetting can take care of the concerns that I had raised. 

Q4. The IIP data for the last few months has seen an uptick on the back of an incipient revival in manufacturing. What are your expectations going forward? do you think that the recovery in manufacturing is getting more broad based?

A4: This has been the longest bottom in the IIP in the last two decades i.e. the IIP has been at the bottom of a stretched out U. Given the unprecedented nature of this bottom, it is hazardous to make predictions with a few months of positive data. Nevertheless I believe the recovery in IIP has finally started.  However I still have doubts that the recovery will be very rapid, given the uncertainties in the global situation and the natural learning/taking charge process that a new government inevitably has.

Q5: While we are seeing an uptick in various indicators such as auto sales, why are sales of commercial vehicles lagging?

A5: The former is an indicator of reviving consumption, while the latter is linked to investment. The revival of the investment cycle was expected by informed analysts to lag that of the consumption one.

Q6: On inflation, do you think the fall is temporary or permanent, especially in light of firming up of fruits and vegetable prices? how do you think inflation will trend in the coming months?

A6: Because of the importance of seasonality in vegetables, fruits and many other agricultural commodity it is very important to look either at de-seasonalised data when talking about month to month changes (eg June 2014 to July 2014) or to look at the annual change (July 2014 over July 2013 & June 2014 over June 2013). Overall I believe that Inflation is on downward trend at this point. However the uncertainty arising from poor monsoon in certain regions and oil price spikes cannot be ignored.

Other Questions

Q1:  What is the likely effect of the anticipated taper in US Feds Monetary policy

A1: This will lead to a rise in US and global interest rates with the expected increase in Asset price adjustments. Consequently, capital flows into and out of Indian stock market and debt instruments will also be affected. However, in my judgement these effects will be short term. Medium term capital flow will be driven by expectations about the speed of recovery of Indian growth, speed of decline of inflation and economic reforms to bring these two about. Capital inflows will resume quickly if there is confidence that Indian reforms will ensure growth recovery and inflation decline.