Transcription
It's the economy. This is a very special edition coming to you from the sidelines of the Morgan Stanley Investor Conference and my guest today is Chetan Aya, one of the best known faces of Morgan Stanley and by my estimate one of the best economists tracking India and now Asia as well. Chaitan, thank you very much for your time on what must be I'm sure a very busy morning.
Thank you very much L for having me and thank you very much for coming at our conference site. It is u it's a lot of buzz around here. So it's great to have you here.
I came to enjoy the buzz and even relate relay it to our viewers. Okay. I for us and and for you I suppose the big event is on June 5th when the Reserve Bank will be uh announcing its next monetary policy. Now one of the debates during the rounds is yes fit flexible inflation targeting is very good but have we reached a time when interest rates are needed to be hiked to defend the exchange rate where are you in that debate?
So we don't think that the RBI should hike uh India doesn't have an inflation problem India doesn't have a current account deficit problem so if you're going to hike interest rates what purpose is it going to serve if the purpose is to provide higher yield on your currency then 25 basis points is not going to do it. How we did it in 2013 is by lifting the upper end of the policy rate ban and effectively letting the liquidity tighten when capital outflows are happening and you have to do something like you know 150 200 basis points of overnight interest rate hike.
Too expensive.
It's too expensive. It's just not what the economy needs right now. So I think it will it'll be counterproductive.
Okay. No, I'm asking you this because as you know and you cover all of Asia, Philippines has ra raised rates in April and Indonesia did it in uh May. So there may be an expectation from the hedge funds from the fund varieties that uh you know there rise in interest rates. Will a lack of a rise in lack of a rate hike disturb the currency at all?
Um I think it's not in fact it could backfire because a lot of the investors in India are the equity investors and if you're going to take up interest rate hike which will affect growth it'll actually lead to more equity outflow. So I think from a flow perspective and even from currency management perspective interest rate hike is not the best tool. The best tool is to augment capital flows if you need to be on a short-term basis but more importantly also work on the long-term solution for stabilization of balance of payments.
Okay then let us start with the short one uh the short term what can what are the options available to reserve bank on June 5th itself uh to augment capital flows as you say?
So for the RBI um probably to operate in conjunction with the government they could provide some hedge protection attracts some external commercial borrowings. It it could be open to the private sector. I'm pretty sure you're going to get a lot of inflows, but if you just open it up to the banks and state-owned enterprises, uh government-owned companies, uh we can get something like 4050 billion and that will definitely be uh an immediate stop cap arrangement addressing the balance of payment deficit issue.
Yeah, those ideas have been doing the rounds and uh everyone is expecting something like that. But this doesn't endanger external debt to GDP types, right? 50 billion is far for the cause.
It doesn't. It doesn't. And and look, I mean the the issue is that you want to ensure that the currency is not having a self-fulfilling problem which it is going through right now because the trading returns have been bad for FX investors or you know the rupee has depreciated. It has led to some kind of a self-fulfilling dynamic and mind you it's the corporate sector in India where this self-fulfilling expectations affects the most. As you as you know from the data foreign portfolio investment in debt is not really that negative.
It's quite sticky.
Exactly. So it's the domestic corporate sector which goes through this challenge. Um and you know you uh we don't have the published data uh from the government on what is the hedging ratio where the other countries do do that provide that information. It would be good if the government actually compiles it but in our estimate corporate sector in India is now overhinging or hedging more than what they used to in the past. So that has been a big issue. Imagine the trade is $1.5 trillion. So if ex one months export remittances are delayed and one months of import payments are brought forward that's you know 100 plus billion dollars of demand supply gap that has to be filled. Um so I think you have to think about uh the stabilization of currency and checking that self-fulfilling problem that.
No fair enough actually over the last one year 526 we don't still have the last quarter's bop deficit but even assuming you know if you take the first 9 months it was about $30 billion and if you add say another 20 billion the RBI's intervention should have been 50 billion their intervention was 190 billion in FI26 so clearly it's because of this hedging and uh yeah that.
And the other solution is uh lat to uh take out you know the interest tax that you're deducting from uh for the for the investors from outside and at the same time get rid of the capital gains tax. India is one of the very few economies in the world which is putting tax on that interest income for foreign investors and putting capital gains tax. Uh and by the way, non-resident Indians, I'm included in one of those, can put money into domestic banking system and not have to pay tax on the deposits or interest income on the deposits. So we have created such cowouts and we should create similar cow outs for foreign investors. It's just like what you want to be in a relative space versus other investment destinations.
Yeah. not deliberately make ourselves look difficult. Okay, let me come to the broader economy itself. I mean uh see we are still the fastest growing largest economy. Then why is it that our corporate growth is not as high? Earnings growth as you point out in that article in economic times is not keeping pace with rival countries. Why is corporate earnings growth not as good as GDP growth?
Now this is a very serious long-term issue. I think the that we have been relatively slow in moving up the value chain. If you think about rest of the Asian economies, they have been doing all lot of basic stuffs like electronics manufacturing years back right and then now they are evolving into semiconductors. Different countries are involved in the region in different parts of the semiconductor supply chain. Japan is into equipments. Uh South Korea is into memory chips. Taiwan is into logic chips. So every country in the region has figured out something to be playing in this higher valuated part of the supply chain. Uh unfortunately we have been uh slow in moving up this supply chain and that's what is affecting our relative position.
But the numbers are even uh stocking versus developed world. So US compared ours is what 12%.
Uh yeah first quarter earnings expectation for India is about 12%, South Korea is 150%. Taiwan is 48%. Japan is 33%. And US is 27%. So I think from investors perspective it is just very simple math of relative earnings growth differentials between India and the other markets and that's actually at the heart of these FBI equity outflows.
Okay. And at the same time I think that this is also indirectly affecting the outflows from the private equity investors.
Okay. So let me therefore ask you the rupee has fallen and you know the ater levels or measures we are like 91 or 92. We normally the uh at real effective exchange rate is a little over 100 you know at 105. Has it fallen enough and earnings turn enough for us to expect that sometime soon uh foreign investors will be you know attracted?
Yeah. So we we are thinking about uh two aspects here. One is the valuation of the rupee on a real effective exchange bid as you mentioned it's about 3.7 standard deviation below 10ear trailing mean.
Yes.
Um so you know 10 year trailing mean is supposedly like the fair value. uh if you didn't have any long period of wide current account deficit in that period and which is the case in India so it is uh it is fair to assume that to be the fair value and now we are like 3.7 standard deviation below mean so it's no problem of currency competitiveness it's just the fact of balance of payments dynamic that is affecting the the rupee so we are expecting the rupee to appreciate modestly uh and two reasons for that uh number one is that we are expecting that the growth trend in India is improving. So that should at least help some investors to think about the upside in some of the sectors and at the same time we're expecting that there will be some resolution to this Middle East uh tensions and so if oil prices go down further from where they are that will also help and parallelly we are also calling for uh a bit of weakening of the dollar as you know the dollar has also been relatively strong in this environment and so as the dollar weakens India's own earnings growth trajectory improves and oil goes down that will give some modest rupe appreciation.
Okay. Well, the other interesting report that you published recently was the very strong capex cycle in Asia powered by power, defense, uh electronics will India benefit from that if the ecosystem grows does that make India's growth a little safer and anyway your forecast for Indian growth as well?
Yeah. So we are expecting this capex super cycle. It's it's driven by uh four drivers. Number one AI and AI related infrastructure capex. Number two is uh energy. Energy is in turn for energy security for powering AI and also for energy transition. Uh number three is defense and number four is um industrial capex.
Okay. every economy in the world is trying to onshore industrial supply chain and that's triggering a big round of uh investments. So these four drivers we think will mean that there will be a significant rise in capex across the region. In fact it's happening across the world and one favorite indicator of mine to look at this would be to look at capital goods imports. it tends to be very well correlated with GDP component of capex and that in Asia is growing at 27% in dollar terms on a year-on-year basis. So this capex cycle is already booming. Um as far as India is concerned, it will also see the investments in all these poor areas. So it's uh inevitable that India will also see a pickup in capex cycle. The only difference between India and rest of Asia is that they are actually also exporters. So when the US and Europe is spending in these areas, they are able to get the benefit of exports, India will be just the benefit of domestic investments that happens in these areas.
Fair point. Okay. Actually uh yesterday the Mosby released the first new IIP series and actually capital uh spending has been very good or capital goods is like I think 12% growth in there's some encourage encouraging signs but manufacturing some 6.4% is looking encouraging. But a final question to you on inflation. I mean we just had our commodities editors saying that you know aluminium etc are also at four year highs and crude uh some of it has gotten passed on. The Indian government may be forced to pass on a little more. So will we be uh what kind of inflation do you see in India and will that require rate hikes?
So we do expect inflation to head towards more like uh little over 5%. Um but at the same time you know the drivers to inflation are you know energy prices. Uh we don't expect that core inflation will go significantly above RBI's 4% target and if that is not the case we don't think this inflation should be a worry and hopefully the situation in Middle East improves and that you know oil prices inflation will also sort of be ebbing. uh but underlying there is no big uh demand pressure in the economy which is taking the core inflation at a level that RBI needs to respond to this.
Okay, that's good to hear. Thank you very much Tithan here. Pleasure speaking with you and I think some very important takeaways for us. We should hope that uh Reserve Bank and government will encourage some ECB offerings from Indian corporates with some hedging support as well. You know the longerterm solution of getting into investments in electronics and skilling R&D. Well, those longerterm solutions are always there. Thank you very much. My pleasure to be with you.