Fed rate hike or not, Indian economy is unfazed

A significantly lower current account deficit will keep the economy protected, says Subir Gokarn in an interview to Anupriya Nair and Sunanda Jayaseelan of The Hindu BusinessLine. 

This interview was first aired on Bloomberg TV India. Watch the video here. 

It is all about the big Fed and how India is positioned for a possible rate hike by it on September 17. Bloomberg TV India caught up with Subir Gokarn, former RBI Deputy Governor and presently a Director of Research at the Brookings Institution India, who has watched the economy through many twists and turns. Excerpts:

World economy is at a very critical junction. Where does the Indian economy stand? Is it ready for the inevitable Fed hike?

I think we can make a pretty significant contrast with the situation two years ago when we had the Taper Turbulence and the Indian economy took a huge beating, which is manifested in a variety of indicators, particularly the currency. The key difference between then and now is that the macro indicators are much healthier significantly as a result of commodity price dynamics and partly because of some steps that the government has taken in the past two years.

We have much lower inflation, lower fiscal deficit and most importantly we have a significantly lower current account deficit. So this basically makes us less vulnerable to external shocks. Domestic growth drivers are showing some signs of recovery. Obviously, we had some negative news on the growth numbers but it is not dramatic. What is important is that those three macro indicators, particularly the current account deficit, are really the key signal of vulnerability, and right now we are relatively well off on those fronts.

If you are saying that Indian economy is looking much healthier now, what’s the kind of print you are expecting? We are expecting a macro economic data and this comes at a time when you have heard commentary from the IMD saying rainfall is 15 per cent below normal. What is the print looking like for you?

I am out of the forecasting business now so I don’t have specific numbers but qualitatively speaking the industrial growth is consistent with the kind of moderate recovery we have been seeing over the last several months, notwithstanding the GDP numbers we saw in the first quarter. Of course, these numbers will be for July, which is the start of the second quarter.

The combination of lower inflation and some pick-up in momentum, particularly the public spending we are seeing, indications that the highways programme is getting back on track should result in consumer spending. We are yet to see this reflected on the corporate numbers but I think we will have to wait for the second quarter. The inflation number we are seeing is somewhat a worrying sign. We have seen news headlines talking about pulses and onions.

We will have to wait and see how the pulse harvest looks from a month or so from now, but the sowing indicators for pulses were very positive. I think that will help to moderate prices but that is followed now by this 15 per cent deficit in aggregate rainfall. This tends to hit the pulse sowing in parts of the country, particularly the central part of the country.

We need to be a little watchful about what the food inflation numbers will show. For the moment, I don’t think these are going to be any surprises in the July or August numbers. Perhaps, going forward a month or two, some sort of upward movement may be seen. But, overall, I think, the inflation situation is helped by lower oil prices. That is clearly at a level of comfort. It is not a huge red flag at this moment.

We have seen a lot of turbulence in the market, be it the money market or the equity market. China is taking the world on a roller coaster ride. What is the Central banker’s role in such a situation?

I think, there are two points – it is important not to lose focus of the primary target and if there are domestic inflationary factors at work then the conventional instruments of monetary policy have to be aimed at controlling that impulse. There is a temptation to use all instruments to address all points of stress and I think that temptation is something that we need to resist. So if there is an inflation problem, you deal with it using interest rates and so on.

But when it comes to financial stability, particularly impact of external shocks like we see now, it is very important to keep liquidity levels at some degree of comfort so that we don’t have the risk of markets freezing up. For example, redemption pressures on some kinds of investment, some sort of asset classes might cause stress and there is always a risk of spill over – a kind of a run.

So managing liquidity, ensuring that markets are not freezing up and ensuring funds have the capacity to meet redemption pressures – all of these are confidence inspiring, confidence building. And I think these sorts of aspects of financial stability using liquidity instruments, liquidity measures to ensure that the financial system is not derailed, is an important consideration in this situation. It is really a matter of watching out and having a radar that tells you very quickly where the stresses are building up and then having a coordinated response to that. So, this is the role that is visualised for the FSDC (Financial Stability and Development Council) which has set up an early warning group and that is the kind of mechanism that helps to avoid potential break down particularly when liquidity is short and markets are freezing up. That is an appropriate response to this kind of shock that monetary policy focus on the inflation objective but we need liquidity instruments to help us find the stability.

There is an entire money market management which has to be on a different trajectory as the central banker focuses on the inflation target. What does it mean for rates? Does the Fed rate hike mean that the RBI Governor would have to take the step back and pause?

I think the industry is always asking for rate cuts and that is to be expected. Lower cost of capital is something that no industrialist would ever turn down. But here we got to be keeping in mind what the Fed does – it may have an impact on financial stability. But monetary policies of interest rate instruments, particularly now that we have signed the repo rate to the inflation targets, the domestic inflation numbers has to be the determinant of what the repo rate is. Now, you can question whether or not we have the right repo rate, but the factor that determines it is the domestic inflation scenario. What is happening on the external front is going to impact India only in terms of capital flows. At this moment, given the overall global situation, I can’t speculate on whether the Fed raises rates or not. But given the overall Indian macro economic situation, particularly the current account deficit, I think, our level of vulnerability is relatively low right now and even if the action does transpire the interest rate hike, I don’t see the Indian economy affected by this. Again, I want to draw the contrast between the situation today on the current account and the situation in 2013 when the current account deficit was close to 5 per cent of the GDP and it is now 2 per cent of the GDP or less. To me that is the single most important indicator of external vulnerability. On that score we are relatively comfortable right now.

This article first appeared in The Hindu Business Line, on September 13, 2015. Like other products of the Brookings Institution India Center, this is intended to contribute to discussion and stimulate debate on important issues. The views are those of the author.