From your perch how do you see the top central banks pulling in different directions - the Fed, BoJ, and the ECB. What does it mean for the financial sector?
I agree with Dr. Raghuram Rajan's views that there needs to be coordinated policy action by global central banks and by the G-20. Financial markets are highly integrated and confidence is highly co-related, so you can't have a long stretch of risk-on in some large markets with risk-off in rest of the world! One thing is certain, there is going to be increasing volatility with many spikes and ebbs that will make life difficult for corporate treasurers and asset managers. Whether it's in China's equity and currency markets or Indonesia's bond markets, volatility is here to stay. No one expected the Yen to rally when Japan moved into negative interest rates. It went against intuitive text book economics. Having said that, while central banks would like to coordinate globally, ultimately they would have to solve the issues fundamental to their own governments and tax-payers.
What does that mean for India?
At one end if the US rate hikes are not as steep as anticipated 6-12 months ago, it does mean that emerging market economies will have some time available to correct some of their imbalances through structural reforms. But fear of weakening global growth can easily translate into significant risks like a sharp decline in exports, which we have witnessed in India. Equally highly leveraged corporates in emerging markets may face major refinancing risks as credit spreads widen. We are starting to see signs of this as well, even though there is ample global liquidity.In a risk-off situation countries start to put protection barriers to avoid importing global deflation and dumping. Or countries may expand the fiscal stretch to protect growth and jobs in the short term but this can create medium term deeper issues. Indeed, it's a very difficult job for Finance Ministers and Central Bank governors. India is not the only country to face such an issue, but is better placed than most emerging markets to deal with the likely risks.
There is also this unknown quantity called China where the pendulum seems to b swinging wildly?
As a big picture, I am of the view that China will be a solution and not the problem of world's growth. It's a 11 trillion economy growing at 6%-7% pa. In GDP terms, China adds an India every 4 years. If China actually starts to struggle, which is not Deutsche Bank research's base-case, the amount of deflation it can export can have a devastating impact on India and other Asian countries. A strongly growing China is good for India and for the world. Let's not celebrate that India is growing faster that China. China is on a determined path to move towards a more market driven economy. Many would argue that in this reform agenda, China is already ahead of the curve. China internationalized its currency, got included in the SDR and has recently opened up its bond markets to global investors with minimal restrictions except for hedge funds. These measures are likely to have a significant positive impact on the Chinese economy in the medium term.
There is also this fear of the Renminbi devaluation and everyone else getting into begger-thy-neighbour policy?
Deutsche Bank's view is that the Yuan will gradually depreciate to 7.0 versus the USD by the end of this year. Over the last five years, Indian rupee has depreciated by over 50 % relative to the Yuan, so if Yuan gives up a bit, it's not to suggest that its currency is in a free fall. However, if China were to slow down significantly and Yuan were to get into a 7.25-7.50 range, I think the counter reaction in other emerging markets could be pretty significant. My base line view however is that the rupee does not need to give significantly more at this point of time. It should stay in the broad range of Rs 68-72 versus the USD.
Both China and India are reforming. How do you evaluate the two different approaches?
I think both countries have strong structural reform programmes underway. In India's case, Prime Minister Mod's government has been very impressive in ushering reforms in the controllable domain, but constrained where reforms need Parliamentary approvals. So while India is more transparent in the reforms it needs to undertake, China is more definitive and acts decisively when it warrants. What's common between India and China is that both are focused on jobs and command the attention of Fortune 500 global board rooms. Both countries have very impressive central leadership. I would say Mr Modi has done a remarkable job of wooing global FDI capital even though some big reforms remain in the to-do list.
What are the three things that you want to see in terms of structural reforms in India, apart from usual chorus of GST etc ?
First, restoration of health of the Banking sector. Second, enhanced efficiency of the State and Central Government administrative machinery and state-owned enterprises. Third, institution re-building be it the judicial system, educational institutions, social security etc. Finance Ministry and the Reserve Bank of India have shaken up the banking sector like never before. Froth is rising to the surface and being cleaned up to restore balance between erring private sector borrowers and lenders. International investors have appreciated the focus of Mr Jaitley, Mr Sinha and Dr Rajan on the clean-up and transparency drive. Appointment of Mr Vinod Rai as the Bank Bureau chief has been received positively. Banking sector reforms are truly gaining both substance and traction.
Is that good enough?
The second place where I think the Government needs to reform is providing empowerment and raising efficiency of its administrative machinery and PSUs. As Mr. Modi is a great believer in making state owned enterprises more efficient and competitive, India could exchange best practices from how state owned enterprise have done in other countries including Singapore. That will reduce pressure on government balance sheets down the road. Learnings from enterprises like Singapore Airlines, Changi Airports, Port Authority of Singapore, Temasek & GIC etc can be highly accretive in both directions. Third the government should focus reform on institution re-building, for example the judicial system. While Indian judiciary in independent and fair, it's way too time prolonged and over-burdened; same for educational institutions, public distribution system etc.
But can the state-run banks really come back?
Ultimately, government stake in PSU banks must come down below 50%, ideally to 26%. Earlier PSU banks were the only arm of social inclusivity like farm loans and waivers but that does not happen now. The inclusivity agenda is now shared holistically across the entire banking sector, including the newly announced payment banks and small banks. Amongst PSU bank reforms, consolidation is step one. Hiring key talent at the top to run PSU banks is another positive step forward. However, its not about the corner office alone but the ability to attract strong talent at the bottom and motivate them with a competitive rewards based system that's needed. Even though PSU CMDs are much more empowered than earlier and while they have full independence to make operational and credit decisions, PSU banks are constrained strategically. The public sector banks are running a 3 legged race whereas private banks are running a 2 legged race.
A major constraint in India seems to be domestic investments. Despite all the noise, why is it still below expectations?
Mr. Modi has ignited the confidence of global fortune 500 boardrooms. In my view, there is no other state leader who has done a better job at attracting FDI than Mr. Modi in the last 18 months.
But why is it that Indian industrialists haven't come out yet?
I agree that some Indian industrialists are still sitting on the side lines. In some cases their balance sheets are over-stretched. In other cases the confidence needs to re-emerge. The same tycoons who have created India of today need to invest more, especially in manufacturing and infrastructure. I don't think debt or equity is in short-supply. Indian promoters' confidence must lead and not lag that of Fortune 500 boardrooms, when it comes to investing in their home-market. Some entrepreneurs are clearly doing so.
So what's your take on the India growth story?
India has a huge opportunity ahead of itself. On a relative basis, while global and EMs growth may face challenges, India should be a relative outperformer but key is to increase the pace of structural reforms and maintain fiscal discipline. Under Mr. Modi's leadership, India has a huge competitive advantage in policy intent and opportunity space to build the India of tomorrow. Some constraints are real but India would not wish for some of the challenging issues - much deeper- in many other countries. Also, let's face it, at the end of the day you much rather have a supply side problem than a demand side problem. But I think if the world gets more challenged, which it may and if that leads to much greater risk off, then the government will have to accelerate the pace of structural reforms even faster. I do believe, passionately, that India has the A team to win, both as an economic powerhouse and in the T-20 World Cup!