We expect liquidity to be tight till December, at least.

- J P Morgan

Expecting 8-8.5% GDP for March 2011, if the investment cycle picks up.

The leading investment bank voiced concerns about how sticky inflation continues to be. The
remarkable GDP growth over the last few years is at the heart of the India story. However, inflation
has been high for several months, and hurts all. To contain inflationary expectations, RBI hiked repo
and reverse repo rate on 16 September 2010. At this juncture when the RBI is worried about the
volatility of Industrial production and the recovery in global economy, it is quite interesting to
understand what the experts are thinking. 

Sajjid Chinoy, India economist, J P Morgan spoke with Capital Market's Yogesh kulkarni on various
issues associated with global and domestic economy. 

Double-digit inflation. How big a worry is for the economy? 

Inflation is a concern for everyone, especially those who live on fixed incomes (e.g. non-indexed
pensions) but we are particularly worried about growing non-food inflation. We expect to see a
moderation in food inflation (even though food inflation has accelerated for 5 weeks in a row!) on
account of a normal monsoon and the base effect as the year progresses. The real concern is non-
food manufacturing inflation and core inflation. We think this is likely to be sticky, and we expect
inflation to fall to only about 7-8% by March 2011. 

On 16 September, RBI hiked repo and reverse repo rate. What you are expecting in November
policy meet? Do you think the hike in rates at this stage is an aggressive reaction form the
apex bank of India? 

The RBI's language in the last policy review was justifiably hawkish. If inflation continues to be sticky,
we expect another 25 bps rate hike on November 2. 

Higher inflation adds stress on interest rates and therefore on investment. What is your view
on long-term interest rates and how it is associated with growth? 

Real interest rates in India are at an all time low and have been negative for almost two years now. So
we do not think that a small rise in rates will impede private investment. Private investment remains
the key for Indian economy in achieving 8% + growth this fiscal. Consumption is expected to grow at
about 5-6%, the fiscal stimulus is being withdrawn, and the outlook for exports is sobering. 

Is there any major risk for domestic growth? 

The key risks to India are from the developed markets going into a double dip. This will impact our
exports, capital flows into India, and impede our investment cycle. 

Is USA set for a double dip? There is one school of thought arguing that Fed should hike
interest rate now. The 0% credit for long duration may give birth to another crisis. What is your
comment? 

The US economy is caught in a vicious circle. It is a consumption-driven economy, but consumers are
low in confidence because of high unemployment and depressed homes prices. This lack of
spending, however, causes firms not to hire, which keeps unemployment high and reinforces the
cycle. The Fed is caught in a tough situation. Raising rates when unemployment is at 10% is not
politically possible. At the same time, so much cheap credit could well fuel the next bubble. 

An unstable global economy and a promising Indian growth story could result in higher capital
flows. Will it be fuel inflation? What is your reading of the liquidity scenario over the next few
months? 
Capital flows are expected to be strong for the foreseeable future: a rising interest rate differential will
induce more ECBs, the government has lifted govt and corporate debt limits, and equity flows should
continue in light of the pipeline of IPOs on the navil over the next 3 months. 

We expect liquidity to be tight till December, at least, since currency-in-circulation should rise sharply
as the festival season starts. 

Hike in CRR will have adverse impact on bank credit growth rate, which is actually not that
strong. Don't you think aCRR hike will impede credit growth? 
.
CRR is a very blunt instrument and the RBI will not raise the CRR when liquidity is so tight. Banks are
currently holding 30% of their NDTL in government bonds – more than they need to. So there is a
buffer they can use if credit demand picks up. 

Recent data shows, China is on track to overtake Japan as the world's second-largest
economy after the United States. What is the SWOT analysis for India and China? 

India's potential strengths and weaknesses are two sides of the same coin. We will reap a
demographic dividend in the coming years, but to take advantage of this we have to increase the
education, healthcare and skill-development of our youngsters. In addition, we have to make massive
investments in physical infrastructure to increase our potential growth rate.

People keep talking about how the Chinese model is coming apart, but the fact is that they keep
growing in double-digits decade after decade. I think, though, that India's growth is more organic, and
China's biggest challenge will be to reduce its reliance on external demand, and increase
consumption demand at home. 

Is India decoupled? 

I don't believe so. When the global financial crisis struck, India needed a large fiscal and monetary
stimulus to avoid a sharper slowdown. Our exports declined sharply, and global capital dried up.
Almost 70% of manufacturing output is exported, so we are more globally interlinked than we think. 

Your growth projection for current financial year

On the assumption that the private investment cycle picks up in earnest the second half of the year,
we are expecting 8-8.5% GDP growth for this fiscal. 

Recently, RBI has released discussion paper on Entry of new banks in the private sector. How
you look in to the matter. Especially when Indian banks including Private Indian, public banks
have not able to capture 50% of the Indian population as a bank customer.

Increased competition in the banking sector is very desirable. It will result in the cost of financial
intermediation coming down, an improvement in service levels, and help achieve greater financial
inclusion, which is a critical prerequisite for India to keep investment rates high.
Q1 2009-10 developments..

Positive Signs- Slow and Steady

The rate of contraction in economic activities and the extent of pressures on financial
systems eased in the first quarter of 2009-10. There is an expectation of beginning of
recovery towards the later part of the year, which may get extended into the next year i.e.
2010. Appetite for risk seems to have improved modestly in the global financial system.
Credit spreads have moderated and the market volatility also has gradually waned. Credit
Default Swap spreads, reflecting the cost of insurance against credit risk, have improved.
Spreads on emerging market bonds have flattened, suggesting improving access to the
international markets for EMEs. The volatility in the exchange rate of the EMEs has
generally declined. In the first quarter of 2009-10, the core infrastructure sector exhibited
higher growth in relation to the growth recorded during the corresponding period of the
previous year; the Index of Industrial Production (IIP) with mining registered the highest
growth of 7.3% over the corresponding period of 2008-09, registered positive growth at
3.7% over the corresponding period of the previous year. The leading indicators for the
services sector such as new cellphone connections (up to May 2009) and cement
production (up to June 2009) indicate signs of improvement.

Advance Economies Still Showing Negative Trends

Reflecting the persistence of the global recession, unemployment rates in advanced

countries continue to rise and trade activities remain depressed, affecting the export
performance of most of the countries. Growth impulses remained subdued in India, which
was evident from the growth deceleration in the second half of 2008-09. At 6.7 per cent,
GDP growth for 2008-09, however, was better than what most had expected, though it
reflected a deceleration in relation to the average 8.8 per cent rate recorded during the
high growth phase of 2003-04 to 2007-08. The impact of the contraction in global demand
was evident in the decline in Indian exports, which also accelerated the rate of
deceleration in manufacturing output growth. Services, which account for 64.5 per cent of
the GDP, also experienced a modest slowdown. The slow progress of monsoon up to end-
June 2009 has affected the kharif sowing, which could have implications for the
agricultural production. The progress of monsoon in July 2009, however, has improved
considerably.

Fiscal Consolidation, a big challenge ahead!

The Union Budget for 2009-10 has placed the fiscal deficit at 6.8 per cent of GDP in 2009-
10. While the fiscal stimulus raised aggregate demand, there is a need to address the
challenges for fiscal consolidation with a view to returning to the high growth path at the
earliest. The fiscal response of the Government came in the form of a large stimulus,
which though led to an increase in the fiscal deficit from 2.5 per cent of GDP in 2007-08 to
6.2 per cent in 2008-09 (Provisional Accounts).

Net capital inflows down by 90% in 2008-09!

For the year as a whole, the current account deficit widened to 2.6 per cent of GDP from
1.5 per cent of GDP in the previous year. Reflecting the impact of the contagion operating
through capital flow channel, net capital inflows fell to US$ 9.1 billion in 2008-09 as
compared with net capital inflows of US$ 108.0 billion in 2007-08. The challenge of dealing
with one of the severest external shocks was managed by the Reserve Bank with reserve
loss of only US$ 20.1 billion (net of valuation).

Stable financial market ahead

The Indian financial markets continued to function normally and exhibited stability with
lower volatility and higher volume in the first quarter of 2009-10. The call rates hovered
around the reverse repo rate. The commercial paper market exhibited greater activity,
reflecting revival in demand for funds by the NBFCs and the working capital needs of
corporates. The government securities market witnessed increase in volume in the
primary segment reflecting the large borrowing programme of the Government. The yield
curve at the end of June 2009 had steepened at the shortend due to ample liquidity.

Credit Market showing signs of improvement

Both deposit and lending rates showed signs of moderation in the first quarter of 2009-10.
With the return of capital flows, the foreign exchange market showed appreciation of the
rupee. The equity market recovered a large part of its earlier losses.

WPI still heading south-wards!

The decline in year-on-year inflation in the first quarter of 2009-10 essentially reflects the
statistical factor of high base that emanated from sharp increases in commodity prices
during the first half of 2008-09. Inflation as per Consumer Price Indices (CPIs) continues
to remain at elevated levels.

The growth outlook for 2009-10 needs to be assessed in the context of lead indications.
While indicators such as growth in IIP, the core infrastructure sector, gradual revival in
demand for non-food credit, improved business expectations could be viewed as signs of
recovery from the slowdown, there are other factors which may dampen the growth
outlook such as the delayed progress of monsoon, decline in exports due to the
persistence of global recession, lagged impact of the negative growth in manufacturing in
the last quarter of 2008-09 on services demand, negative growth in capital goods, decline
in the production of commercial vehicles, and an accelerated fall in import growth
suggesting dampened demand conditions. On the inflation front, there are indications of
inflation firming up by the end of the year due to the waning base effect of last year,
increase in commodity prices, delayed progress of monsoon potentially driving up food
prices, expansionary fiscal policy, accommodative monetary policy. India’s structural
growth impulses continue to remain strong, given the high domestic saving rate, sound
financial system, and growth supportive macroeconomic policy environment. Domestic
deceleration in demand and persistent uncertainty in the global conditions, however,
operate as the major drag on a faster recovery

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