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On how the economy is poised |
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Monsoons have no doubt been good this year unlike last year and industry is in a steady-holding pattern. Last year we had a 6 per cent growth despite bad monsoons. Though I do not see any major acceleration this year, there is definitely no slackening. |
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I expect a growth of around 6.5 to 7 per cent for this fiscal. The two drivers are construction-related sectors - housing and roads. The growth in these sectors is due to lower interest rates and more retail financing. |
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Besides, there has been a lot of money flowing into the rural sector for roads. Construction sector also has other linkages which have seen growth for transportation equipment such as truck sales. So overall the economy is looking good. |
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The enigma, however, is that investment is not happening. There are several reasons for this, too. Companies are still realising their full potential and improving efficiencies to utilise the spare capacities. |
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Investments are still flowing into areas where there is relatively high tariff protection like automobiles and related businesses. |
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There are three areas where we will see investments: Where tariffs are relatively high, where consolidation is happening (cement) and where there is less dependence on public infrastructure (textiles). |
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Investments will have to take place for the economy to see sustainable rise in growth rates. |
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On the missing link between the economy and the stock markets |
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The main reason here is that sectors that have grown are not a part of the market, except IT and automobile. Service sectors like entertainment have grown tremendously but there is not enough representation until recently. The dynamics of growing sectors are not reflected in the market. |
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The reason for the disconnect is that growth engines are not adequately represented. They come into the market after having reached a certain threshold and then exhibit some linkage. |
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The weak linkage between markets and economy has been, over the decade, the lack of representation of growth drivers (of the economy) in the stock markets. |
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We can take the example of coffee chains and other fast-food chains that have shown impressive growth but figure nowhere in the markets. |
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Some others sectors that have shown huge growth with immense potential and opportunities are security services (security personnel), private education (private tuitions and classes) and domestic power equipment manufacturers (inverters, etc.). |
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Another important aspect explaining the weak linkage is that growth in domestic appliances and automobiles has come from multi-national companies. |
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A majority of these companies are not listed. Many among the listed are going in for delisting. These patterns have a weak impact on the economy. |
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On the correlation between the Indian economy and global economy, and domestic markets and international markets |
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Indian economy is not entirely insulated. We now have a greater correlation with the global economy after our exports have moved up, which renders us vulnerable to global business cycles. |
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Our investments are dependent and interest rates have got integrated to the cycles. The markets, yes, are dependent on foreign inflows and we are a part of a global portfolio allocation process. |
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Capital flows into the country are largely in the portfolio domain and foreigners are interested in our equity markets. |
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So, naturally any shift in investment patterns will lead to portfolio re-alignment. |
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The other side of the story is that we are much less vulnerable than other smaller countries (South-East Asian nations) because of a large domestic market. Most capacities in these nations are designed keeping in mind their foreign markets, mainly the US. |
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So if US does not buy, their market dries up. This is not the case with India where you know with relative certainty that if there is excess production, the domestic market absorbs the excess. To that extent we experience less volatile cycles. |
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On the implications of a strengthening rupee |
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From the macro viewpoint it is over-insurance. The markets should feel safe because FIIs will have less itchy feet. They are now not worried about their exit cost with these kind of reserves. |
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Thus, it provides greater stability and assurance to the market. If the tendency is towards appreciation or stability, then the forward cover goes down and the required rate of return is lower which brings in more money into the system. |
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So, it looks positive from a short-term perspective. From a long-term point of view, the question is whether it is the right thing to do (strengthening of the rupee) since there are costs associated with over-insurance. |
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Two opportunities are missed here. The first is to lower tariffs and make imports cheaper. The reason the RBI is holding dollars is that there is excess supply relative to domestic demand. |
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So, when imports become cheaper the demand for dollar will rise. The second is to open capital-account convertibility (allow residents to hold dollar denominated assets). We do complain at times that our reserves are too big. |
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But if we look at South-East nations and the crisis they went through, we realise no reserve is too big for them. They have far larger reserves. |
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China, for instance, has around $300-400 billion. These countries look at their reserves as a stabilising force. |
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On how interest rates influence markets |
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The interest outlook is stable; we are reaching a bottom. I do not see any downward movement in interest rates but certainly do not see an upward movement either. Even with the recovery, I think there is enough cushion to keep the outlook stable. |
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Now, given this, we will clearly see a movement towards equity markets on a portfolio-adjustment basis; people will sell off their debt to enter equities. Interest rates by themselves will not stimulate investments. |
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If investment recovery were to happen because of other forces, interest rates definitely facilitate the process. Things are just waiting to happen and people should realise that there is opportunity in the market for raising money. And this, even from an earning-growth perspective, is quite positive. |
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Low interest rates signal that the earning-growth potential is not going to be hampered by monetary policy, which is very favorable. So, now both these factors are driving the markets. |
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On inflation expectations |
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I think what has killed inflation expectations is the food buffer. We can say that it is over-insurance, but there is no denying that it has an impact on inflation. |
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The second force on inflation is import tariffs. Third is the drive towards efficiency by companies amidst domestic competition (in response to the food buffer and lowering of import tariffs, making goods cheaper). |
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All these factors have put inflation in a pure unanticipated shock situation. An external shock will be the only source of inflation and the system seems to be well equipped to absorb even that. |
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So, all said and done, we have moved into a comfortable inflationary situation. This has given the RBI a great sense of comfort in managing interest rates. |
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By lowering average inflation, we have lowered the threshold for panic levels. Anything above 5 per cent sustained core inflation will invite panic. But the likelihood of the emergence of such a scenario is less unless there is a massive external shock. |
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On pension fund reforms |
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These reforms should happen. You will then be giving new players a choice to distribute their portfolio. But more than improving depth in the markets (the demand side), we need to look at the supply side. |
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This is where we need inclusion of market drivers in the markets. We should have newer growth engines to fuel the markets. This will then widen participation. It is important to have people who will hold for long. |
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It is equally important to churn the market portfolio by getting in three or four growth engines every two years. |
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Otherwise we will get into a diminishing returns pattern since earnings potential of existing companies in the market is not infinite. |
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