India story is different from rest of the world, it is still well below potential: Indranil Sengupta, BofA ML

Chatting with ET Now, Mythili Bhusnurmath, Consulting Editor, and Indranil Sengupta, BofA ML, discuss macro developments and how first half inflation is still well below RBI call of 4%.

Edited excerpts:

Let’s discuss the IIP and CPI numbers. The inflation number has hit a 15-month high?
Mythili Bhusnurmath: I was a little amused to see the reaction because even though it is a 15-month high, we are still talking about less than 5%. We have forgotten the times when inflation was in double digits. Though it is not a very happy state of affairs, 4.9% does not mean heaven has fallen.

Let us not forget that the whole idea of inflation targeting was to talk in terms of a flexible inflation targeting and now we seem to have this rather ridiculous position. It is not just the RBI which looks inflexible, even public opinion -- judging by the reaction that we are seeing -- seems to think of it as an inflexible number because we talk about a single month. If you look at the entire first half inflation, it is only about 2.3%, way below 4% called by RBI.

Given the fact that most of it has been driven by food inflation and for transient reasons like the unseasonal rains in November and the fact that we did see fluctuation and a sharp hike in certain vegetable and food prices, egg prices. There was some increase in fuel price and hopefully in December, because of the tweaks that we have seen in GST, prices should come down. I really do not see what the chaos is all about.

Mythili Bhusnurmath: We seem to be getting a little hysterical about inflation and completely almost forgetting about growth?

Indranil Sengupta: Well you know we think that inflation is currently largely driven by tomato and onion prices and while it will go to 5.2% next month, this is again a passing phase. We continue to expect the RBI to cut rates in April.

Mythili Bhusnurmath: Well yes we do expect the RBI, rather you expect the RBI to cut rates in April, but most of the opinion in the market is that the RBI will be in a long pause. It is not because of internal reasons but because the Fed most certainly will hike rates. We will get to know today and also at the same time, there is a very sharp likelihood of almost all central banks going in for a synchronised tightening. It is not just the Fed which is going to reduce the size of its balance sheet but we are going to see it happen with the Bank of Japan and with the ECB. In such a scenario, would you still believe that the RBI is likely to cut rates in April?

Indranil Sengupta: You have to look at the differential. Even if the Fed hikes rates by 25-50 bps and the RBI cuts rates, we will still have a differential that is 4.25%. Historicallym we had a differential of around 1.5-2%. Of course, at that time our forex reserves were much higher in terms of import cover but even assuming that okay our reserves are not that adequate as in the past, I am sure that you do not need 4%-5%-6%. There was a time when the Fed was at zero and there were people saying that the RBI cannot cut from 8.25% because the Fed may hike one day. The point is that the Fed has cut rates, supported their economy. We also have to support our economy, revive our growth.

Mythili Bhusnurmath: That is absolutely true except India is not the US. The day we get to the US situation, then we will be able to do what our economy asks for. Today we are in a globalised scenario and it is the US Fed that calls the shot. Even if the differential is there, the fact is that the US economy is growing remarkably well. In fact, many would argue that the US economy is close to overheating. In such a scenario, do you see forex inflows continue the way they have in the past years, particularly in the case of debt?

Indranil Sengupta: In a way, I will say that there is tremendous interest in Indian debt because this is one market where it is not obvious that interest rates will go up. So that is number one. Number two, as far as equity flows are concerned, they are going to be more cautious because of elevated valuations and we will probably see markets waiting for a turnaround in earnings before coming into the equity side. But on the debt side, given that bond yields have sold so much, this is clearly an economy where growth is very soft.

Mythili Bhusnurmath: With that kind of background, what is your outlook for 2018 especially for the Indian economy?

Indranil Sengupta: The narrative from India is going to be completely different from the narrative of the rest of the world. As you said, the US is close to potential, maybe overheating. India is one rare economy which is well below potential. From that perspective. you think that you are going to see consumption remain the driver of growth rather than capex. People are talking of capex recovery in other countries. Here, of course, that is a long way off. So, consumption is going to be the driver of capex. This also means that inflation barring this potato, tomato, onion price spike inflation cannot be a problem in India because there is going to be weak growth and excess capacity. That will keep inflation down and that also means that lending rates at some stage should soften further.

From that perspective, I think the case for India and the case for the rest of the world is going to be very different. The most important point to note is that everywhere growth is lower than 2005 and 2007.

What has happened in these economies is that potential growth has come down a lot. For the US, potential growth used to be 3%. That is down to 1.8%, for Brazil and Russia, potential growth used to be 7%, that is now down to 1.5%. For China, that used to be probably somewhere around 10% and that is now down to 6% odd. In India, because of our demographics, etc, potential growth is pretty much where it was, it was probably 7% in the old GDP series then, it is 7% in the old GDP series now. From that perspective, we are going to be a very different country with a very different macro narrative.