India may get hit if US-China talks fail, says Morgan Stanley's Chetan Ahya

Indian economy was closely linked to the global one, and if US-China trade relations deteriorated, it would be difficult for the RBI to sort out domestic issues with liquidity, he said

India needs to address the issue of non-banking financial companies (NBFCs) on a priority before it hits the stability of the system, Chetan Ahya, chief economist and global head of economics, Morgan Stanley, told Anup Roy. He said the Indian economy was closely linked to the global one, and if US-China trade relations deteriorated, it would be difficult for the Reserve Bank of India (RBI) to sort out domestic issues with liquidity. Edited excerpts:


What are US-China trade tensions evolving into?

In our base case scenario, we are assuming there will be some kind of an agreement between the two on June 29. Global growth will still stagnate for two quarters at about the current level of 3.2 per cent, but there will be modest recovery after that. 

The second scenario we are assuming is that there would be no agreement, but no immediate escalation either. That would mean continued uncertainties for another three-four months.

The third scenario is where there is no deal at all, and the US imposes a 25 per cent tariff on Chinese goods worth $325 billion. In that case, the global economy may go into recession in three quarters. 

Do the trade tensions benefit India?

If you go back to a period when there was no trade tension, China was already seeing a rise in its per capita income and wages, where there was an opportunity for other countries to take a share in low value-added manufacturing. 

But you would have seen that this was going to — not India — but Vietnam and Bangladesh. India’s challenges are kind of independent of opportunities right now. When you have this kind of trade tensions, there is no absolute winner because when tensions are hitting global cycles, it’s going to hurt all Asian countries, including India.

Does India really need to be worried about its NBFC crisis? 

India is not as domestic as we may believe. It is very much linked to the global cycle. India needs to address this issue too as trade tensions can lead to non-linear outcomes. If there is a growth slowdown concern, there can be capital outflows from India, leading to currency depreciation pressures. It will be then difficult for the central bank to inject liquidity in an aggressive manner. 

The way the NBFC issue is being addressed right now might still be enough if you have a supportive global growth environment. But that may not be the case.  Remember, it is also coming at a time when India had a number of years of weakness in investments. The trailing cumulative drag to growth has been significant.

What should be done to address the issue? Bailout the NBFCs?

Not outright bailing out of NBFCs, but supporting the real estate sector will help.  A part of the problem of NBFCs sector is linked to real estate. We have reached a stage where there is risk-aversion among lenders, and credit is only flowing to select segments of the economy. 

The NBFC situation has created a broader ramification for the overall system. I am not saying that it is going to be a serious systemic risk, but it is constraining that pace of recovery. If credit flows to the broader economy is curtailed, then your growth will weaken and that will make the situation difficult for those companies. The risk is that this evolves into a negative feedback loop. 

What should be the immediate priority of the government now that it has come with such a majority? 

Reviving investments and addressing the NBFC issue should be top priorities. The government is aware of the need to revive investments and has formed a committee to address this. On the NBFC issue, the financial system is like the heart in the human body. If it is not fully functional, you cannot run at the right pace. The other element is recapitalisation of state-owned banks. So that overall financial system gets back to providing support to the economy.

The RBI has cut rates three times now; do you see any more scope?

The RBI has moved to an accommodative stance, which we view as appropriate, given the growth and inflation backdrop. There has been a significant weakness in the capex cycle. The growth problem can be addressed through easier monetary policy. We see the RBI having a scope of cutting rates by another 50 bps by December.

There has been some controversy about India’s data…

This issue has arisen since the last change in methodology. The simple workaround solution, which we tell our investors who are taking a decision on India, is to look at corporate revenue growth. It is not an accurate proxy for gross domestic product (GDP), but it is fairly relevant for the investors.

Which is decelerating…

Yes, the trends have been sluggish. If you look at Ebitda growth — and that tells you how things are for the corporate sector — that too has been sluggish in recent years. But it is somewhat improving now.

Does it mean that the growth slowdown this time is structural?

I could call it a deep cyclical problem. Structural would mean India has a huge problem like high debt or weak demographics. We don’t have that. So India’s problems are cyclical, not structural. 

The over-arching point that I am trying to make is that India is not going to be able to have a cycle independent of what is happening globally. If the global cycle doesn’t look very comfortable, and you have a domestic financial system issue such as NBFCs to fix, it becomes more challenging.