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One has to see how the combination of fiscal deficit and the monetary policy plays together. Europe has taken steps like gradual austerity and easy monetary policy . India is finally moving towards fiscal tightening. But this has to be done gradually because if it happens too fast, it can affect growth. At the same time, one has to watch how the monetary policy pans out, because unlike Europe, India also lives with high inflation. Therefore, the challenge is how to ease monetary policy when the fisc is correcting gradually and handling inflation. How markets will behave depends on how the policy responds to these challenges.
Will fiscal adjustment come at a heavy price of seeing tepid growth?
When you tighten the fisc, it obviously has an implication on short-term growth, while the long- term economy gets healthier. So that's a tricky one, specially when you are one year away from elections. The key issue is how do we handle monetary policy when you have a large current account deficit and high inflation.
If you were in the shoes of the policy makers, how would you play it?
The policy makers may have to take a risk on at least one parameter -- either inflation or growth. I think fisc containment has to be gradual. What I would like to see is a more moderated improvement in the fiscal deficit.
Has global investor perception on India improved dramatically from the pre-September period, as you begin your annual conference today?
We have got a very good response, as around 500 participants from various institutions in India as well as overseas are attending the conference . There is an air of expectation that India is finally moving on a more positive track on the policy front. Corporate interest in meeting investors is at a record high. Over three days, 4,000-5,000 meetings will take place.
In 2012, India got $24 billion foreign inflows which surprised many people. This year has started on an even better note. Do you expect 2013 to be a bigger year in terms of liquidity flows?
Global liquidity is easy. The sense from Davos is that there is relief and no imminent worry of a crisis. Interest rates around the world are low, so liquidity will flow where it sees opportunity. The issue from an Indian point of view is how do you balance fisc tightening, handling inflation therefore monetary policy while at the same time give growth to investors. It’s a very tough combination to handle. But if we can make a reasonable progress on this, money will come. India's current account is an issue and trade deficit numbers indicate that we have a run rate of $240-250 billion of trade deficit in a year. Therefore, portfolio flows are no longer just welcome, they are necessary.
How much of these flows will get into the secondary market like it did in 2012, and how much of it will get soaked by issuance of fresh paper. We have seen a lot of this already at the start of the year.
Divide the issue of paper into three parts. First, government companies – they will have a reasonable flow of that paper even next year, if we have a handle on our fiscal deficit. Second, real sector companies, particularly those in the infrastructure sector. Due to high level of debt, the equity values at which many of these companies are trading are very thin; so most of the promoters will find it difficult to issue equity at this valuation and keep reasonable ownership of their companies. Third, the banking and financial institutions from where we recently saw a lot of paper coming in and more will come in. I think currently investors are more comfortable with this paper and there will be a reasonable supply of such paper in 2013.
Do you think banks and other financial intermediaries will be able to profitably deploy the funds they are raising? So far, loan growth is quite tepid and investment plans have not yet started picking up. Will we see a turnaround in the investment climate?
Right now, some of the banks may need to raise capital which will give a lifeline to many leveraged companies. So, some banks may raise capital to provide a breather for the real sector which is under pressure.
What is the sense you are getting when you talk to companies? While the stock market is just 8% short of an all-time high, somehow CEOs don’t seem to be exuding that confidence.
First of all, stock market is nominal value and we are talking about five years later; so you got to discount it for inflation and look at the present value. I would be cautious to see the stock market at an all-time high in nominal terms to see what is happening in the real economy. I think in the real economy, corporate India is certainly moving slow. We need to keep the market in good shape to aid the real economy. We have made progress to keep the market in reasonable shape, but still translation of that to the real economy is not happening.
Are you surprised by the reluctance of the entire retail and HNI fraternity to participate in the equity market?
India is going through a paradox. We are importing foreign savings into Indian equities and exporting Indian savings into foreign gold. It is an amazing paradox. I think there is a sense of disillusionment in terms of the performance of companies. Though the market is close to its nominal high, many companies are above their five-year highs. But there are even more companies which are between 60-80 per cent lower than what they were five years ago. That is a problem.
Do you see this trend changing, or do you see this story of two halves continuing -- foreigners being bullish on India and locals continuing to be bearish?
I think the local investor has a much higher hurdle rate for his or her return versus what the equity markets are promising to give. If you can get 8.5-9 per cent post-tax returns though various instruments that are available in the market today, you’re talking about 12-13 per cent pre-tax hurdle rate for a domestic investor. Compare that with a foreign investor who is getting very little on his dollar money. Yes, there is a currency issue but let’s keep that aside for the moment. Therefore for a local investor, the hurdle rate of return he is getting on his debt instrument is a significant barrier to make a choice in equities. Second, a lot of informal money is now out of equity market and is moving o other markets -- real estate, gold and commodities.
Currency is a big factor for global investors and in the last three years, it has taken away a lot of equity market from India. How do you map the rupee?
The rupee is linked to what we do on the macro, particularly on the fiscal side and the current account side. The current account is showing some signs of pressure and if I had to take a call on the currency for 2013, I don’t see either 50 or 60.
Are you expecting a slew of banking licences this year?
The FM mentioned a possibility of four or five new bank licences. The process will take one-and-a half to two years before the new banks are in the business.
How do you see this year for banking? It’s a tale of two halves -- the way private sector banks have performed and the way PSU banks have performed. Do you expect this divergence to continue?
I think the banking business is pretty simple. When you are a significantly leveraged player, equity can be very virtuous or vicious because leverage can change the game for any highly-leveraged institution. Therefore with respect to banks, I think the balance sheets are far more critical than short-term P&Ls. Investors will differentiate where they believe that balance sheets are robust, believe in the book values, believe in quarterly numbers and on relative basis see softer stress levels on the balance sheet. I think investors wants to see this comfort through 2013.
How much of a reduction in interest rates do you expect in 2013? Where would your greater comfort lie this year, fixed income or equity?
Policy rates by the end of 2013 should be about 7 per cent. That will fuel decent returns on bonds in the short term, but finally once you come down the curve, it will help investors to take a call on equities. I think the equity markets will also see a very sharp divergence between what investors perceive as quality and what investors are cautious about. And the quality part of the market is relatively a small segment, and it is choosing those companies which have a bottom-up approach, as distinct from buying India top-down which is a big difference I see in the marketplace.
