*****RBI growth forecast for India too conservative: Neelkanth Mishra – The Economic Times

Clipped from: https://economictimes.indiatimes.com/markets/expert-view/rbi-and-consensus-growth-numbers-for-india-too-conservative-neelkanth-mishra/articleshow/92107279.cms


RBI growth forecast for India too conservative: Neelkanth Mishra


Nikunj Dalmia

,ET NowLast Updated: Jun 09, 2022, 05:38 PM IST


“The growth numbers that the RBI has put out are perhaps too conservative. I believe that the consensus growth forecast which is somewhat closer to the RBI’s forecast, is also very conservative. The growth momentum in the Indian economy is quite strong and those numbers can be beaten quite handsomely.”

“There is no reason for the RBI to say supremely accommodative and keep repo rates well below what they were pre-Covid but as we think about the economy, over the next year or so having rates meaningfully higher than what they were pre-Covid is also unwarranted at this stage,” says Neelkanth Mishra, Co-Head of Equity Strategy, Asia Pacific and India Equity Strategist, Securities Research, Credit Suisse.

We all saw how the market reacted to the monetary policy. The all-time low closing, for the rupee, the way the bond yields reacted as well and of course the equity markets. The inflation forecast is 6.7%, while the growth forecast is being retained. So, there is inflation and tightening, but growth stays intact?
The increase in the inflation forecasts to a large extent are backward looking. The year-on-year changes in inflation are a very slow-moving indicator. A more prudent approach when we are thinking about markets is to look at inflationary impulses and the best way to do that is to look at month on month and whether inflation is above seasonal or not and where the new inflationary impulses are coming.

Because of the Russia-Ukraine conflict, oil prices have gone up 50-60%, global food prices have gone up meaningfully, edible oil in particular and what that means is that there is a steep jump in prices which will keep inflating the year-on-year numbers. What matters is the incremental inflationary impulses and in our view at least at a local level, those impulses are not really that material and worrying yet.

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The growth numbers that RBI has put out are perhaps too conservative. I believe that the consensus growth forecast which is somewhat closer to the RBI’s forecast, is also very conservative. The growth momentum in the economy is quite strong and those numbers can be beaten quite handsomely. In fact, the 4% odd growth that consensus and RBI are projecting for the March quarter next year in particular looks too low to me.

What is one seeing when they look at the bond markets? From Mr Shiller to Mr. Bill Winters, the Global CEO at Standard Chartered, overnight commentary is coming in that recession is looking very possible, may be in the beginning of the next calendar year in 2023. The way the bond markets are indicating and the government has been saying is that these kinds of bond yields are not sustainable. Are you looking forward to any kind of jugalbandi between the RBI and North Block when it comes to the bond yields?
You have mentioned the US bond yields and the American economy and of course your question was on what is likely to happen or should happen in India. So let us take the US part first. The US policy post Covid, made it reasonably clear in hindsight that everything is very clear. It was excessive and so the stimulus that they give was far in excess of what was needed.

As a result, they have created global goods shortages because the demand just went 10 standard deviations above normal and that created pressures in the global shipping supply chains and a lot of other disruptions.

The good thing is that those disruptions are now reversing. We are already hearing of foundries. The chip supply shortages that everyone talks about imagine that some types of chips, some types of foundries are now seeing utilisation drop below 95% which is still very high but given the perception of chip shortages that is a remarkable statistic.

We are now seeing handset companies in Vietnam bringing down the number of days of operations from five-seven days to three days because there is so much surplus inventory. So, on the good side, the bullwhip is starting to invert very sharply, and that inflation will come off. But in the US, there is another problem that the Fed needs to address which is the wage price spiral and that hits services a lot more.

When the price goes up, wages need to go up and therefore as wages have gone up, the prices need to go up again. That spiral is something the Fed wants to break, and in order to do that, they may need to keep bond yields a lot higher than they would otherwise. In India, we do not have that problem coming to the Indian issue, US services inflation should not bother anyone.

Everyone took a hit from the goods inflation in the US. Goods are very freely traded and so if prices are high in the US, they will be higher everywhere in the world as well. If the prices of services in the US are high, it does not matter that much. Theoretically, it may be marred to a small extent but taxi rides or restaurant dining in New York is becoming more expensive. It does not really bother us here.

In India, the indicator of sticky inflation is for example, wages. Wages are rising outside of a few pockets which are a very small part of the labour market like the IT services. I do not think there is any evidence for sustained wage pressures. In fact, the demand for NREGA work is higher than it was pre-Covid. Thankfully it has come down a lot in terms of it only being about 20 lakh ahead of pre-Covid levels. But rural wage growth is still under control. I do not think that there is any evidence of sticky inflation in India.

The bigger challenge for India is the balance of payments deficit. Now at May trade deficit which on a seasonally adjusted annualised level was as high as $330 billion, the balance of payment deficit is unsustainable, and we need to address that. The RBI so far has chosen to raise rates whereas perhaps a better outcome may emerge from the weaker rupee and because, when we raise rates, we slow down the whole economy in an attempt to bring down imports by a bit.

It is a much more direct and efficient approach in my view. If we let the rupee weaken and then raise import prices and then imported goods start slowing down, in the next three to four months, we may see the rupee weakening a lot more because our import basket has been hurt very badly because of the higher energy prices, not just oil but coal, edible oil, fertilisers, and gas are expensive, and that adjustment is the more important one.

To do that, the rupee weakness is perhaps more important. It will boost or increase headline inflation for a while. It will be another step because imported goods will become more expensive, but monetary policy can seek to look through that.

There is some concern around inflation expectations becoming sticky at a higher level. An impulse which comes from necessary weakening of the rupee can be looked through, when we are thinking about monetary policy. So, from a rates perspective, I see less of a justification or increases beyond what I would call rate normalisation. Now that Covid restrictions are mostly eased, the recent wave is a bit of a concern but the restrictions have mostly eased as the economy has normalised.

There is no reason for the RBI to say supremely accommodative and keep repo rates well below what they were pre-Covid but as we think about the economy, over the next year or so having rates meaningfully higher than what they were pre-Covid is also unwarranted at this stage because a lot of the impulses in inflation are global and will keep the year on year numbers inflated for much longer than we may be comfortable with. But we need to understand sequential inflation impulses and look at local impulses as we think about local rates.

You made a couple of interesting points there. How does the BOP deficit issue get resolved then?
There are three ways of addressing a BOP deficit, the first is to increase exports which is happening to some extent but as you can imagine, we cannot. If our BOP deficit is $60 billion, we suddenly cannot raise exports by $60 billion. It will happen over three-four years, but it is very hard to adjust to it very quickly.

The second is to get more capital. So, we can get inclusion in the bond indices like in other global bond indices and that would bring in $30-40 billion in one year. We perhaps can decide to step that process up.

Third, even though it is given that what has happened to global markets and what is likely to happen to global markets, in our view the Asia-Pacific earnings will see downgrades and they may be led by hardware technology, materials and metals, but as that happens, I think it will create more disruption. So, the portfolio flows to emerging markets – and we are anchored to it as a large part of the flows that come to India are through the emerging market funds or Asian funds. So if there is concern, it is very unlikely that capital flows will pick up by themselves and even the FDI flows, which is a private equity venture capital type of flows, that were dominating flows in the last three-four years, are likely to slow down for various reasons that have been well publicised.

So, getting more capital in is going to be a challenge other than that inclusion in global bond indices which brings us to the issue of reducing imports.

Now when we reduce imports, we can choose to reduce only the imports of what has seen higher increases in prices. The problem is that if we bring down energy import volumes, that will badly hurt domestic GDP because we cannot grow GDP without using a dense form of energy. If we want to move faster, we would want to automate, use computers, have better climate control in our house or in our cars or in our trains, we would need more energy. There is no good option. People have questions; oh! why are you saying that imported goods should all become expensive, the poor man’s household will be hurt! But that is the sad reality.

The problem is we are dependent on imported energy. It has become substantially more expensive than it used to be and it is important to change our import basket. If we should not be bringing down our imported energy by that volume, then we need to bring down the imported avocados and blueberries. I know they are small numbers but wherever we are dependent on imports which are to a slight extent discretionary, we need to bring down those imports.

And how do we do that? We cannot tell someone to stop having imported avocados or apples. We need to let prices go up and those prices then become the signal that forces down consumption and people switch to domestic avocados. Now that they are available, we can question their quality. But the point is that the transition and then a weaker currency will also support exports over a period and that is a much healthier correction.

The rupee, in fact the real effective exchange rate, has strengthened marginally, and it has not changed much over the last year or so. In fact, against that US dollar, the rupee over the last three months is one of the strongest currencies and the only currencies that are stronger are that of commodity exporters. I do not think that is a very prudent level to maintain and letting the rupee drift down a bit is going to be very helpful for making those adjustments.

Let us talk about capital flows and let us address our equity market watchers as well. I was reading a very interesting note from you wherein you said that you are recommending using the pause in the global selloff. I like the fact that you are admitting that India is not alone in this, this is very much a global selloff. Having said that, the entire definition of traditional defensives which are IT, pharma is something completely different. Here you are recommending telecom, utilities etc?
Yes, the traditional approach. Most investors get surprised that we are calling for a weaker rupee and then why we are underweight IT services. Fundamentally, it is a great sector to be in when there is global macro uncertainty. For example, if a global tech selloff happens, then the sectors which deal with inventory would be the worst affected. That is where the supply chain is. When it lashes downwards, it makes things very panicky but there are no inventories in services.

The downgrade would be from around 10-12% growth to 8-10% growth or maybe 6-8% growth in terms of dollar revenues and they have great balance sheets, cash flows, supreme quality management and corporate governance. Everything is very attractive. The problem is, it is a very expensive sector.

The second problem is that it is also seeing a challenge which it has never seen.

It had claims on the best quality IT talent that India produces. There were large global software companies and some very tech focussed start-ups, well-funded, which used to get better quality engineers early on and they paid a hefty sum, but as software saw a boom, which is fantastic for the country as we are now starting to move from plain vanilla services and not owning the IP to starting to own the IP and as the software world shifts to software as a service, it is a great opportunity and it is a great thing for India.

The challenge is that if the offshore IT engineer delivers $35,000-40,000 annually in revenue, about $17-18 per hour and about 2000 hours a year, the SAS company is generating $80,000-100,000 per software engineer and therefore their ability to pay is much more. This is an issue we have been flagging over the last year and a half.

The business structure, the business model of whatever IT service companies pay and therefore what revenues they generate is going to come under pressure. As these two adjustments happen and we see this downgrade of growth and margins downgrade, it used to be 5-6% which went up to 12-15%. It is now 10-12% and maybe it will need to fall to 6-8% to see a necessary downgrade in PE multiples. That is why we are underweight IT services.

In healthcare, we started to add weights because it has become cheaper. It has underperformed for many years now and the challenge is that it is a very stock specific sector but again, a very defensive characteristic and therefore we have gone overweight.

In telecom, that is one of the few sectors where the cycle is asynchronous to the GDP cycle or has been so since 2016 onwards. Brutal price cuts and complete shakeout in the industry have been happening in the sector. Around 2 years ago, a decision to let three private players sustain brought price stability and provided some stability in earnings.

We wish we had added utilities earlier. They have done very well. The fear was that thermal power capacity will just become obsolete in four, five or seven years. What has happened though the earnings may not go up much for sustenance, is how long India will need thermal power. Those timelines have extended and which is why coal miners and thermal power generators may be a slightly safer place to be. We have added in the note in which you mentioned beneficiaries of the shortage of rail capacity.

During Covid when passenger trains were shut, freight was moving at 2.5 times the speed it used to move pre-Covid and that allowed the railways to gain share. Even on 150-200 km stretches, it was gaining share and what has happened once the passenger trains have restarted is that the freight speed has gone down again. We need more rakes as now there is a shortage of rakes. Therefore, road freight is now being ceded again and it is great for truck manufacturers.

We are also observing that a lot of trains are getting cancelled. This maybe a May or June phenomenon because that is when the heat is at maximum and power demand is the strongest. There is near to little hydel power. Hopefully, July onwards, that will ease out but while that happens, it is great for pricing power for airlines.

Again, it is very counterintuitive to have higher oil prices, a weaker rupee or potentially weaker rupee and why going overweight on airlines. We have been overweight airlines because they have the pricing power.

Even if 1% of rail passenger’s trains are getting cancelled or becoming more unpredictable, the shift to airlines gives them tremendous pricing power. Look at the difference in passengers by air and by rail. All of those are places where you can reasonably hide as we go through what I think will be a turbulent phase for global markets.

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