“Both the US downgrade and India’s political process have hurt investor sentiments”
Not just the downgrade of US sovereign debt by Standard & Poor’s, it is also the nature of government decision-making vis-à-vis business, especially the backtracking on commitments, that has hurt sentiments towards risky assets like equities, says Satish Ramanathan, head of equities, Sundaram Mutual Fund, in an interview to Sanjay Kumar Singh. He also believes that there may be more downside left for the Indian markets as they are still trading at a premium to Asian peers.
Is the US economy headed for a double-dip recession or do you see it as just having very weak growth?
I think it will have a prolonged period of weak growth. Double dip is not a scenario we are building into our assumptions. But should there be any spike in oil prices, or should inflation go up sharply, then a double dip is very much possible.
But is high inflation on the cards for the US economy?
Inflation could occur due to a couple of reasons: one because of the yuan appreciating vis-à-vis the dollar; and two, if commodity prices remain strong, something which is not built into our assumptions. The US being a large importer from China, a 5-7 per cent appreciation of the yuan will imply that it could face a problem of higher prices.
Has the yuan appreciated this year?
Yes, it has appreciated 5 per cent over the last two to three months.
What has been the real dampener for the Indian stock markets? Was it the debt ceiling imbroglio, the US downgrade of sovereign debt, or weak US GDP data?
The Indian markets have been impacted due to a couple of factors. Some of it is international and some of it is domestic. The international debt downgrade clearly impacted sentiments towards equities. There has been a shift away from equities and risky assets as people have become more risk averse.
Second, with growth expectations of advanced countries being lowered, a lot of investors felt worried about the prospects of Indian IT stocks, which got beaten down quite significantly.
And third, on the domestic front the political aspect is causing a bit of concern, with projects getting delayed and not getting commissioned on time. These are matters that are worrying investors.
Is the lack of movement on reforms-oriented policy-making by the government also an issue?
Not only reforms-oriented measures, I think business confidence has been affected by the fact that project approvals do not happen on time. Moreover, project approvals are given and then the government backtracks on them. While this may probably be good over the medium- to long-term horizon from the perspective of cleansing the political and business process, the short-term pain cannot be denied.
How do you see the European situation panning out? Is there a chance of bigger economies such as Italy and Spain defaulting on their debt obligations?
These are extremely slow growth and high fiscal deficit economies. So for them to pay off their debts is going to be very difficult. What may happen is that instead of a default, you could see debt getting rescheduled into longer-term debt papers.
At the same time, their risk spreads and cost of capital are likely to keep increasing, rather than decreasing. So, these economies will be under constant pressure. Their growth rates will contract to some extent, and this will slow down global GDP growth as well.
So this is not a problem which you foresee ending any time soon.
You will see this problem recede, start, and then recede periodically. The crisis that began with Lehman has now snowballed into a European crisis. The problem could go back to the US and then come back to Europe, and so on. Ultimately, what we have is three hugely indebted economies — US, Europe and Japan. All these economies will have to slowly pay down their debts. That will be a five- to 10-year process, not something that can be fixed in one year. So either people will have to pay higher taxes or receive lower grants. Government spending has to come down. At the end of the day, the outcome will not be very good because if government spending comes down then unemployment cannot come down, and so on.
What is your reading of the inflation situation in India? Is it expected to ease? Most economists are predicting that this will happen by October or November.
There are two or three aspects of inflation that we need to understand. A part of the inflation in our country is agri-commodity inflation. And a part of this inflation is linked to international prices. Some of it is also linked to oil: when oil prices go up, then ethanol prices go up, then corn prices go up, and then the prices of other substitute products go up. We have had a situation of rising agri-product prices impacting inflation.
The second aspect was crude prices remaining firm, which led to imported inflation. Crude and commodity prices had gone up very sharply. This component of inflation will probably begin to ease. It will take some time, but we will see it happen over the next 6-12 months.
The third aspect of inflation is India specific, which is that capacity creation has been stalled. Without capacity creation, pricing power remains in the hands of manufacturers. The authorities are trying to control inflation by controlling consumption through higher interest rates. That may put pressure on pricing and corporate margins, but the effect of these measures would be temporary. The longer-term solution is to create capacity and to ensure that corporate margins are eroded by competition, rather than by limiting demand. So, we could see a situation where demand comes back after 12 months, and even with higher interest rates, inflation will be back up.
So one should not expect long-term relief from inflation yet. What about rate hikes? Do you expect the Reserve Bank of India (RBI) to go slow on rate hikes, now that inflation is expected to ease slightly?
Regarding interest rates, we need to look at a couple of aspects. One is the direction that RBI will take vis-à-vis inflation, and the second thing that we need to bother about is the prevailing market rates. Market rates are likely to remain a little adverse. That’s primarily because if government borrowings exceed their stated levels, then you could see interest rates within the system go up even if rate hikes do not take place.
And even if RBI pauses after, say, one more rate hike or so, do you see any chances of rates actually being cut?
Going by the tone of both the central bank and the Finance Ministry, it seems that they would rather have inflation under check than have growth as their primary target. So rates are likely to have an upward bias rather than decline immediately. That said, India will be one of the few countries that will have such high interest rates. Consequently it gives the government and the central bank that much more room to manoeuvre a slowdown as and when it happens.