Inflation likely to hit double digits soon: Morgan Stanley

2008-06-02 11:04:00 Source :-CNBC-TV18

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Chetan Ahya, MD of Morgan Stanley said the GDP numbers are backward looking and the services sector lags industrial data. He thinks the GDP growth rate is likely to come off from the next quarter and sees Q1FY09 GDP at 7.5-8%, while FY09 at 7.1%.
On inflation, he said it will hit double-digits soon. The oil price hike will trigger inflation spike, he said. He believes RBI will hike rates if oil goes to USD 150 and stays there.

He sees FY09 headline fiscal deficit at 5.1% and it may cross 10% if oil stays at USD 120 per barrel.

Excerpts from CNBC-TV18�s exclusive interview with Chetan Ahya:

Q: What let to that GDP surprise you think and is it backward looking or do you think you can carry some of that momentum forward into the 2009 outlook?

A: I think it is backward looking. I think the sector which has really done well and the data if one looks at is services sector and that tends to lag the industrial production data and in fact there is a bit of divergence this time but we think next time it should come off.

Q: Do you expect this quarter to start showing slower numbers on the GDP?

A: Yes and I think the way to look at will be corporate revenue growth and if one looks at the corporate revenue growth that hasn�t moved back again to significantly higher levels. The last quarter number was for 1,500 companies that we looked at, at about 13% nominal growth from the peak of 29% in September �06 quarter and from the data which has come out so far, it doesn�t look like its going to be significantly better than that. So no matter what the GDP data shows, I think the underlying trend for growth is that of deceleration.

Q: To get down to the numbers: are you expecting Q1 sub 8% number?

A: We are expecting 7.5 - 8% for Q1 and for the full year we are expecting 7.1%

Q: You had no reason to scale up your GDP numbers for 2009 after looking at the Q4 numbers for 2008?

A: Not really.

Q: What about inflation already at 8.1% and we haven�t even had the fuel price hike. Do you need to now revise upwards the inflation projections because by this time a lot of analysts were hoping to see the first signs of moderation?

A: We are out with a note in the morning generally in the context of interest rate outlook - we are making a point that inflation will go to double digit soon; we are already at 8.1%. Typically the government has been revising previous week�s data by about 80-150 bps assuming that there is 100 bps revision; we are probably already at 9.1% and then we are going to see oil price hike of about 10-15%. So the moment we do the oil price hike, we will basically cross double digits.

Q: By when do you expect inflation to touch, Wholesale Price Index (WPI) to touch 10%?

A: I think the trigger will be the oil price hike and hopefully it is done in the next one week or so; then in other four weeks time we should see inflation at double digits.

Q: What do you think will be the RBI response to that? So far it�s managed or dealt with it through the Cash Reserve Ratio (CRR) route. Do you think more dire measures will be in place if we see that psychologically important 10% mark?

A: It is going to be complex task; the growth is slowing and we think growth will probably slow further. So ideally RBI should not tighten. But we are seeing two other added challenges - (1) fiscal policy is running extremely loose; we are continuing to run higher and higher deficit as oil keeps going up which makes RBI�s task more difficult. (2) If oil goes to USD 150 and stays there for four-five months, that will cause a lot of pressure on the currency which will basically then make RBI to consider the decision to hike the policy rates. So our view is base case right now - no policy rate hikes. But if oil goes to USD 150 and stays there considering that fiscal policy will still continue to be loose, the RBI will have to take the burden of tightening the monetary policy to reduce the pressure on currency.

Q: How do you see the RBI approaching the rupee now, which went to almost 43 to a dollar and is now cooled down a bit closer to 42 to a dollar; in the light of what is going around how do you see the Central Bank approaching that?

A: I think at this point of time, there seems to be active intervention from the Central Bank to hold the rupee below 43 to a dollar, but it is all predicated on what happens to global market place - particularly what happens to oil and what happens to the dollar.

The expectations in the US for the Fed rate cut is moving closer to the date; we were earlier expecting it to happen in the Q1 but the market is now beginning to discount it - probably happening even as soon as October still not fully priced in but if the Fed Futures expectation gradually turns, moves forward and the Fed does hike earlier then we will see the dollar strengthening and that will cause the added pressure.

So it will depend on where the Fed futures go and where the oil prices go. The combined effect of that will determine the direction of currency. At this point of time, we are expecting the dollar to appreciate generally against Euro and other currencies. I think the oil prices are not going to come down. So I think the rupee has got to move down going forward. The direction and magnitude will be determined by how the Fed Futures and oil prices move.

Q: What do you think is the most likely outcome of this impasse on oil price hike? What would be the contours of the package you think and how much would it stoke inflation?

A: It is not going to be a very significant move by the Government, it will be possibly be a weighted average hike of about 10-15% and that is also, if at all.

If they don�t touch kerosene, then diesel and petrol are the only ones which move then the weighted average hike will not be more than 10-15% which will not be enough to reduce the subsidy burden.

I think ideally the response right now from the government should have been to run a tighter fiscal policy; one good measure out of that would be to hike the oil prices. Although it will hurt the population at large right now but from a macro stability perspective, that is the ideal response from the policy makers needed right now. That will reduce the import bill for oil because the oil demand will come off too and that will help the overall macro stability. But I think we will probably not get that response soon.

Q: Do you think we will get substantial duty cuts, excise and customs. If yes, how much does it worsen the already precarious fiscal situation?

A: It�s just an accounting effect; so for our purposes we count that as a subsidy burden. Only if the consumer is bearing the increase in prices, then the overall subsidy reduces whether they account it by way of tax reduction in fiscal deficit or it stays with the oil companies. At the end of the day, it's still oil subsidy. So it�s just an accounting issue.

Q: What number are you penciling in, in terms of fiscal deficit? All these items put together above and below the line by the end of this year?

A: The headline fiscal deficit is 5.1%. But if you add the farm loan write-off, the fertilizer subsidy, food subsidy and oil subsidy with oil being at USD 100 per barrel for 12 months ended March �09, we are at 9.4% fiscal deficit and if oil stays at USD 120 per barrel average for F2009, then fiscal deficit will basically cross 10% of Gross Domestic Product (GDP).

Q: Are you talking about just the center or Center plus States?

A: Center plus State plus all the off-Budget liabilities. I need to qualify; we have also taken the oil subsidy borne by the oil companies which the Finance Minister does not include in his estimates.

Q: What do the dealing room guys tell you about how nervous all this is making India in the eyes of global investors; this kind of macro, current account and fiscal situation?

A: I think everybody is hoping for oil to come down and the last two-three days' moves have raised that hope. So it�s all predicated on where oil goes and I think everybody is hoping for oil prices to come down. But there is quite a difficult macro environment and almost all of Asia is facing this. So India is not alone. But I think India�s fiscal balance condition is probably one of the worst compared to the rest of the region.

So everybody is watching on what happens - as you may have probably known there are some concerns on some of the other countries in the region -like Pakistan is facing some challenges, Vietnam is facing some challenges. So the environment is getting concerning, particularly from what�s happening on oil prices to a lot of the countries in the region.