Govt may have to sacrifice growth to reduce fiscal deficit: Jahangir Aziz, JPMorgan
- When CAD and fiscal deficit go up, bond yields go up and exchange rate depreciates.
- The market conditions will determine the quantum of rate rise.
- India should react to changing global financial conditions by changing fiscal and monetary policies.
What is your own assessment of the current macros? Is the rupee weakness more due to global factors or would you say the internal India factors are also at play at this juncture?
This is something that we have been flagging for quite some time. If you have an economy in which the fiscal deficit is very large -- central plus state -- running over 7% and could go up even further this year and you have a current account deficit that has moved from 1-2% range in 2016-2017 to 3% now. In a situation like that, two things happen – bond yields go up and exchange rate depreciates and that is how the economy adjusts. That is more or less what is happening in India. I wonder why people are surprised that this is happening because this is the standard way in which an economy would react when both fiscal deficit and current account deficit are widening.
Prime Minister Narendra Modi may hold an economic review this weekend and the government may announce measures on the currency and oil. What kind of measures can one expect to stem the rupee fall given the macros are not as bad as they were way back in 2013?
In 2013, basically orthodox steps were taken. Interest rates were raised 300 bps in one day and the government at that time squeezed in almost half a percentage points of fiscal consolidation in a six-month period in a pre-election year. You can search for clever ideas and clever schemes and if you search hard enough, you will find one that will stem the rupee slide, etc.
But at the end of the day if the government really wants to address the rupee slide, it needs to address not the symptoms which is the slide but the cause which is the rising fiscal deficit and rising current account deficit. That will require going back to doing what is orthodox which is raising interest rates and cutting fiscal deficit.
What is the quantum of monetary tightening that can be expected from the RBI to stem the currency weakness? On the fiscal deficit front, what according to you are the options in hand to get the fisc under control? Will the government have to cut capital spending?
At the end of the day, if you have the kind of problem that India faces which is like a broken record over rising fiscal and current account deficits, then the government necessarily has to bite the bullet and accept that it needs to sacrifice growth by cutting fiscal deficit through capital spending or current spending. This is something that the government needs to choose. But fiscal deficit needs to come down, monetary policy needs to be tightened and for all that growth needs to come down. You cannot reduce fiscal deficit without sacrificing any growth. That has never happened. The government has to make the choice.
It is difficult to say, how much RBI has to raise rates but I would have guessed that by now, if the RBI was planning to raise rates in October policy meeting, then for it to be more effective, it should have raised the rate by now. Raising it three weeks down the road is less effective than raising it at this point in time. The market conditions will determine the quatum of rate rise but as you have seen in case of Turkey, the rate rise has to be substantial.
Given that oil prices have been rising, what room do states and the Centre have for cutting the combined fiscal deficit or the central deficit? Is there a risk of cut in capital spending?
There is significant room. If the government believes in the growth numbers that the CSO is printing, then at 8.2%, there is almost no justification of having overall fiscal deficit above 7%. There is significant room for fiscal deficit to be brought down. This is something that at some point of time will have to be done. If you push it further down the road, then the amount of adjustment that will be needed will be even larger. But at 8% growth rate, it is very difficult to justify why any country is running a fiscal deficit of around 7%.
With the kind of pressure that we are seeing in emerging market currencies, do you see a risk of emerging market crisis emerging that could lead to a broad market contagion given the broad dollar strength?
We have seen the broad dollar strength from April to about July. It was more about reassessing developed market monetary policy and repricing how much US and ECB would be raising rates. The question was how will emerging markets react in a world in which the developed market monetary conditions have tightened much more than what people had expected.
That’s what happened between April and July. In August, it was very different. Investors actually started to reassess emerging market risks by itself and started looking at the current account deficit triggered by what was happening in Turkey and Argentina,
The investors figured out or assessed that the risk premium on current account deficit in emerging market countries is significantly higher than what we had thought previously and essentially the investors are demanding a much higher risk premium and emerging market countries so far has not delivered enough amount of assurance that the risk premium will come down.
Your firm recently released a report saying that the next crisis could begin very well in 2020. What does India need to do to be a safer haven?
The report that you are talking about is based on the probability of recession. We were talking about things beyond the US recession. In 2020, if you look at US recession probability, based on historical models, it is reasonably high. That was the point that was being made. What should India do to prepare for that? India should do what it should have done for the last 10 years which is to react to changing global financial conditions by changing both its fiscal and monetary policy.
If you look at India in 2008 and 2011, during the European sovereign debt crisis and in 2013 during taper tantrums, India’s policies never really reacted either pre-emptively or even concurrently with changes in global financial conditions. It has always been that global financial shocks or conditions have changed. These have shocked the Indian economy and then India has passively reacted to it. It is time for India to rethink the way it formulates its fiscal and monetary policy so that it is better able to respond to global financial conditions than it has in the past.
Should RBI defend the rupee or should policymakers just let the rupee depreciate? Would there be some implications on the Reserve Bank as well?
Jahangir Aziz: Over the last two, three weeks, the question in everyone’s mind has been whether India should react to the rupee slide, whether RBI should defend it? The question that they should be asking is whether or not India’s macro policies, both fiscal and monetary policy should react to changes in global financial conditions? The rupee adjustment or the rupee slide is just a symptom, it is not the cause. The cause remains elsewhere and the cause is that India domestically has a higher fiscal deficit, a higher current account deficit and global monetary conditions have tightened.
So the question that needs to be asked is whether or not India should be reacting to tighter monetary conditions and not let tighter monetary conditions shock the economy or create all the adjustments that happens when global monetary conditions hit the economy. Basically, the exchanges start depreciating and then reacting. That is the question that needs to be asked.
How happy are you with the current process for the NPA resolution? Does more need to be done or are they taking adequate steps and it is a slow and steady process?
The NPA resolution is working with some modest success. It has been a very long drawn process which should have been started and resolved much earlier. The fact that there is bankruptcy law and bankruptcy arrangement has been put into place and we are seeing firms and bankers getting together and restructuring loans is a very good sign. But that process is happening at a significantly slower pace than what the economy will benefit from. These are choices that the government has made. We had been flagging the problem of NPAs becoming a binding constraint to growth back in 2014. Many of the people had said the same thing but the government took its time and this is where we are.