In the first part of this three part interview; Nandkumar Surti, CIO, J.P. Morgan Asset Management shares his views on rising interest rates, inflation and the impact of fiscal deficit
The views are diverse of whether interest rates have peaked or will further creep up. What is your take on that?
I am personally of the opinion that rates will go up. The inflation outlook is once again rather grim. The December 2010 inflation reading was expected to be much lower at around 6+ per cent. By the time it gets declared around mid-January 2011, I am expecting it to be around 8 per cent. That means the March level is also unlikely to be 6-6.5 per cent. So at least a 50-75 bps hike is on the anvil over the next 6-12 months.
What is fuelling inflation?
Commodity prices have inched upward in the recent past. Commodity prices have been rising on the back of expectation of US GDP growth of 3.50-4 per cent in 2012 and also because of strong growth in Asia. Crude oil is quoting at around $94/barrel. The unseasonal rains have disturbed the already high food inflation scenario. So, high commodity prices and food inflation are the main culprits. Sustained food inflation may also lead to wage price inflation. When that happens, the result is that manufacturing inflation could be around the corner. Till now, the saving grace was that manufacturing inflation was between 4.5 and 5 per cent. So from the market perspective, it was not a big threat. Now if this trend continues, manufacturing inflation will be something to contend with.
When inflation skyrocketed last year, the cause was put down to the bad monsoon of 2009 and to some extent the Minimum Support Price (MSP). Is it purely a supply side issue?
It has been the unseasonal rains of 2010 that have caused the current bout of food price inflation. The rains have not only disturbed the existing crops but also affected the sowing for winter crops. However, it is actually predominantly one segment in the food basket that is the main factor. This is something that economists have been saying for a while. As disposal incomes of the Indian population rise, the protein content in the diet has risen. So consumption of high protein products like egg, poultry, milk and pulses has risen. The supply of these products cannot be increased at the rate that demand has risen. All these factors are keeping food inflation high.
In such a scenario, how will monetary policy help curb inflation?
Monetary policy may not control food price inflation. However, monetary policy will have to contend with the secondary impact of food price inflation on general inflation. Food price inflation, commodity inflation and the price of crude oil are all likely to creep into general inflation. And it is due to these issues that monetary tightening will continue.
Moreover, it is high inflationary expectations that have to be dealt with. Hence, anchoring inflationary expectations is an issue to look into.
How do you see the price of crude panning out?
In fact, I have a different perspective on the price of oil. Looking at the intense cold wave that has hit Europe and the U.S, I would say it is a good sign that oil has stabilised at around $90/barrel and not shot higher.
What will be the impact on our fiscal deficit?
There will be a definite impact. For every $10 hike in oil prices, it affects the fiscal deficit by around 0.2 per cent and inflation by around 2 per cent. So that is a huge burden. Despite petroleum prices being liberalised, the government has not been able to fully pass it on, primarily due to the already high level of inflation. The government has been putting on a brave face and saying it’s just a matter of time before it is passed on, but it’s still an issue. Even if they pass it on to the consumer, they will not be able to do so entirely.
Do you see the fiscal deficit hindering the India growth story?
Not as of now. Global liquidity continues to be strong. So funding of growth for the economy is not a problem. So a high current account deficit can be viewed as a problem but it also means that a lot investment is taking place. As long as it is non-oil related, we don’t have to worry because it means good capital investment and the economy is on a growth path. So capital flows will keep coming in.
The key issue is whether commodity prices will threaten the already high current account deficit. Till now portfolio flows have been good. They have been slightly on the lower side in the recent past due to the political turmoil. There are doubts whether the government can push for more reforms and attract greater FDI. So it’s bit of a pause at this point in time.
Per se, fiscal deficit is not an issue. The current account deficit at these levels of 3.5 per cent is also not an issue. But if things go bad, the political set up gets disturbed and growth becomes a question mark, the issue will arise on how to finance the deficit since exports are still stagnant and oil prices are high. Having said that, the exports scenario will improve now that the growth prospects in the US are improving.
You don’t think it’s a problem achieving the growth target?
No. I think India will meet its GDP target. We will continue to be in the 8.5 per cent range. The government has had a great year in terms of disinvestment and the 3G auction.
Read Second part of this interview on February 18, 2011