 "Paul Cashin")
India will have to maintain tighter fiscal and monetary stance in the foreseeable future with food inflation and revenue collections being the Achilles heel, says Paul Cashin, assistant director in the International Monetary Fund’s Asia & Pacific Department, and mission chief of India. He tells Dilasha Seth and Indivjal Dhasmana that the recapitalisation requirement for Indian banks to meet Basel-III requirement by 2018 is a moderate one. Although convinced with Indian gross domestic product numbers, Cashin says it is time India introduced a producers’ price index to better capture prices. Edited excerpts:
Are you convinced with India’s gross domestic product (GDP) numbers?
These figures are carefully produced by the Central Statistics Office (CSO). We are supportive of their efforts. Broadly, those numbers give a credible picture of the economy. It has been quite difficult for the press and ministries to get a hang of what is happening as we have only three or four observations available to us. Basically, we are comparing apples to oranges. CSO is going to release back-casting of numbers. So, we will have a line of apples to compare. The broad pattern of what we see still remains the same even after change in the GDP measurement method. India is accelerating with a smaller output gap. We are also studying some of the price sides of the figures. We are very pleased that India is moving away from its fascination with the WPI (wholesale price index) and GDP at factor cost. But, India has to do a bit more work on its price indices. We would like to see a proper producer’s price index. They are working on it and may introduce it in a year or so. That will be a welcome addition. With a PPI, it will be a long step forward.
With retail inflation within the Reserve Bank of India’s (RBI) comfort zone and wholesale inflation in the negative, do you think inflation is still a worry?
We have been surprised by how fast inflation has come down in the recent past. Although six per cent (Consumer Price Index) inflation target has been achieved and we believe it would come down to five per cent by next year, the challenge will be to attain four per cent medium-term target considering food price volatility. We see upside risks to inflation led by a faster-than-expected rebound in oil prices. But, food is your Achilles heel in terms of inflation. India is always susceptible to bad monsoon or rainfall creating upside pressure on inflation. RBI will need support from Delhi to address supply-side challenge, especially related to food. We have already seen very low increases in minimum support prices and better utilisation of buffer stocks. However, more initiatives will be required on the agriculture side to deal with inflation. We also need to see how the seventh pay commission outgo impacts inflation.
You have partially attributed the relatively low inflation to tight monetary policy. But, there has been a clamour for a rate cut with the government sticking to the fiscal consolidation path. Would you recommend monetary easing by RBI?
We would still see India maintain a relatively tight monetary stance to get inside the comfortable inflation band. The RBI Governor took advantage of the collapse in oil and commodity prices and pushed through some cuts in the policy rate. But, yes, further fiscal consolidation is also going to put up room for that, though we’ll have to wait and see. There are upward pressures to inflation with food and other dimensions, which may override the benefits you are getting from resuming fiscal consolidation. But there is no doubt that had fiscal consolidation not resumed, there would have been less of a window for the RBI to cut rates.
What are you views on the initiatives announced in the Budget? Are you convinced with the fiscal math?
We are very pleased to see the government back on the fiscal consolidation path. We think it is based on fairly credible assumptions. We have seen positive reaction in equity and bond markets through this. I would congratulate the government for a lot of work on the expenditure side. Although a lot more is required on better allocation of subsidies. There is not much done on the revenue raising side, so it is again an Achilles heel of the fiscal set up on the revenue side. Obviously, GST will be a big part and we are trying to look at that. I think fiscal consolidation will help the economy.
India’s fiscal deficit and inflation remain on the higher side. However, wholesale price deflation has magnified India’s debt and fiscal ratios. Does India still need to lower inflation?
In India’s context, you have a general fiscal deficit in the orbit of seven per cent of GDP and that is very high. Your debt-to-GDP ratio is, however, moderate at about 65 per cent of GDP. But, one reason you could continue to run seven per cent deficit year after year and not end up like Japan with 250 per cent debt-to-GDP is partly because of inflation. When inflation was very high, you would tend to inflate away some of the debt carrying capacity. But now, governor Rajan has been very successful at reducing inflation, therefore that engine is running down and is not as accommodative to you anymore. So we recommended in our staff report that SLR or the compulsory holding of government paper by banks ratio should come down at the same time as the deficit comes down. And the governor has been doing that. But there is no doubt that the inflation engine was a big part of why you could keep debt-GDP so low. But in the report we have said that India’s debt is completely sustainable. No problems there.
The government is also considering reviewing the FRBM targets going forward in view of the current global economic uncertainty. Is it a good idea?
I believe that the general proposition is to allow for counter cyclical window in events rather than stick rigidly to the target. That will be up for discussion. There are many countries that allow this.
Do you see a counter cyclical window existing for India in the foreseeable future?
There is not much of a window on the monetary side. You will have to have tighter fiscal and monetary stance in the foreseeable future. We don’t see much room. Don’t forget that you are in a current fiscal situation with oil at $30 a barrel and it is a big bonanza for India, but what if the oil goes to $50, $60 or $70? What are you going to do then? That’s why the GST is so important for revenue raising. We are very pleased at the fuel subsidy situation has been more or less squared away, but we still have food subsidies. This is a very benign period for India. India has had 2.5% GDP bonus due to low oil and commodity prices as it is an importing country. So real earning of all Indians has increased leading to a little spurt in the consumption. We are still waiting to see private sector investment pick up some more, but no doubt India’s fairly robust growth path is mostly driven by India itself. It is all happening domestically. It is not relying on exports like China or Asean.
The IMF report raised concerns over the rising NPAs in the Indian banking system. Government has come up with a strategy to support public sector banks through recapitalization and consolidation. How far will this help?
In terms of recapitalization, there are big numbers being thrown around in the Indian newspapers. But that’s because your banking system is big. So any number is going to look big, running into lakhs and crore. When you step back and look, the cost will be about 1%, of the GDP spread over four years to achieve Basel III capitalization standards by 2018 for state banks. It appears big when you look at it as a nominal number but if we put it into proportion with the rest of the economy it is a pretty moderate number and it something the government could accommodate without much trouble. Under pretty severe scenario of the banking sector where restructured loans cascade back into non-performing loans, it is 2-3% of the GDP. That’s not cheap but that’s not cataclysmic either.
