Big Talk- Subir Gokarn

BIG TALK:
SUBIR GOKARN, ED AND CHIEF ECONOMIST, CRISIL

‘Even Rs 39 may be a conservative estimate’ Avinash Singh And Sandeep Singh Posted online: Monday , July 23, 2007 at 1450 IST Updated: Wednesday, June 29, 2005 at 1257 hours IST --

An appreciating rupee is knocking the wind out of the sails of software companies. However, says Subir Gokarn, executive director and chief economist, Crisil, it’s not such knowledge-based industries, but labour-intensive, easily substitutable ones like textiles that will feel pinch of a rising rupee more. In a wide-ranging interview to our correspondents, Gokarn dwelled at length on the prospects and impact of the rupee, why he believes GDP growth will average 8-8.5 per cent a year for the next five years, and much more.


Q1 results are trickling in. What are your first impressions?
They are still too few to spot trends, but my first impression is that there isn’t a slowdown from the previous quarter, but there is no acceleration either. The numbers suggest plateauing, but without any clear indication of a slowdown.
The maximum results are in IT, where an appreciating rupee is taking its toll.An appreciating rupee will hurt any sector where exports account for a majority of revenues. But sectors that are domestically driven or have a balance between domestic revenues and exports won’t be affected. The trend for the IT sector is quite clear.

Some are saying a dollar rate of Rs 39 by mid-2008. What’s your outlook?
It depends on policy. Ever since our balance of payments (BoP) turned positive, four or five years ago, the RBI’s stance has been to resist appreciation. But in a BoP surplus situation, the natural tendency of a currency is to appreciate — it’s a simple demand-supply argument. In that sense, the RBI has kept the rupee undervalued during this entire period.If it decides to go back to that stance, the rupee will settle for some time. If it decides not to resist appreciation, there is no telling where the rupee will go. However, the more it appreciates, the probability of it appreciating further will reduce. What’s that point of equilibrium — Rs 39, 38 or 37 — is difficult to tell. The BoP numbers for the last quarter of 2006-07 show a significant surplus, both in the current and capital accounts. Even capital inflows are very high. So, even Rs 39 may be a conservative estimate, but the question is whether the RBI will let it go.

You feel the RBI will eventually step in.
The pressure from the export lobby will be there. Most of our exports, other than software, are very labour intensive, like jewellery, footwear and garments. They will get hurt, as they are easy to substitute. You can stop buying from India and, without disrupting your supply chain, start buying from Thailand, Vietnam or China. When there is ease of substitution, price competitiveness is important.The commerce and the finance minister tried to work out a package last week, and the signal was that we have to live with this for some time, so let’s try to find other offsets. In other words, the rupee might appreciate further. If I’m forced to take a call, as inflation numbers decline, they might resume a stance of resisting appreciation. But when that will happen is difficult to say.

So, export-driven sectors are in for a period of pain.
Typically, a sector that works entirely on domestic inputs and exports all its output is one that will be hurt the most, the extreme example being software. However, software is not easy to substitute, as clients tend to stick with their partners. However, a JCPenny or Wal-Mart, who are sourcing garments or footwear can easily terminate a contract and replace it with another one from some other country.

Is the manoeuvring room for such Indian exporters very small?
It is, as commodities like garments and footwear is completely replicable. There is no inherent advantage one country has over the other, and price is everything. A change of 2-3 percentage points in a currency can change the attractiveness of a location.It won’t happen in industries like software, or in knowledge-intensive industries like auto components or pharmacy. In auto components, it takes a long time and a lot of investment to set up a supply chain. If the rupee appreciates, GM or Ford, who are buying components from suppliers in India, can’t decide overnight that they are going to abandon them. They will take six months to a year to decide whether they need to source more from, say, Thailand and China, where the currency is to their advantage. But they can’t decide in one go that we are going to buy nothing from India because the capacity in other countries is not there, the quality control is not there and they can’t just abandon investments made in the supply chain. In such sectors, margins will fall, but not so much production.

Going beyond the rupee, is there enough investments and capital expansion happening to sustain 8-9 per cent GDP growth?
A lot of growth momentum came from sectors sensitive to interest rates like auto, construction and housing. If rates rise, some of this momentum will weaken, which will reduce the willingness of companies to set up new capacity. So, we expect to see some decline in investment activity. The numbers of capital goods manufacturers, or those of production and capital expenditure, still look buoyant. Simultaneously, there are signs of higher interest rates hurting housing, auto, especially commercial vehicles and two-wheelers, over the past six to nine months. But even then, it’s not a dramatic change. We still have substantial growth momentum.

The FM is talking of 10 per cent GDP growth rate, provided agriculture grows at 4 per cent.
In the current macroeconomic situation, 10 per cent is more of an aspiration than a forecast.

What is Crisil’s forecast?
An average of 8-8.5 per cent over the next five years.
What gives you the confidence that 8.5 per cent is realistic?Many bits and pieces of the reforms process over the last 15 years contributed to growth, but it never gained a critical mass till about three or four years ago. There were a couple of triggers. One was interest rates, which fell from 16 per cent in 1996 to 7.5 per cent about two years back. Currently, they are at 9.5-10. We can’t expect them to go back to 16 per cent, but now they are moving in a range of 6.5-10 per cent. That means something fundamentally happened in the financial sector to allow lenders to reduce rates from 16 per cent. Competition increased dramatically, efficiency of lending has increased dramatically, risk management has become quite efficient.This was supported by fund inflows, which started in 2002 and accelerated growth, and productivity gains. Our demographics present a big long-term opportunity. All these factors that held back growth have eased considerably.

In the context of growth, you seem to mention interest rates as the critical factor. Is it really that big?
No, I was referring to the structural change between the mid-nineties and today, when rates have fallen by 5 percentage points. Borrowing at 16 per cent versus borrowing at 7 per cent makes a huge difference in the affordability to borrow, and that’s where demographics come in. You have the potential, you convert it into reality.What’s happening with interest rates now is a cyclical change, not a trend change. When rates reach 10 per cent, you shut out few potential borrowers. But that’s not the same as 16 per cent, where you change the trend.

In the current interest cycle, are we close to peaking?
The moderation in growth rate does suggest the cycle is turning, which means there will be a reversion of growth rate towards the trend. Once a trend is identified, the objective of monetary policy is to minimise fluctuation. In a macroeconomic situation, the closer growth patterns are to the trend, the easier it is for investors to take long-term decisions. You are then more confident that your long-term forecast, assumption and expectations will more or less materialize.
Lastly, what’s happening at Crisil with IPO grading?The gradings we did as part of the pilot project painted a wrong picture. Stock exchanges sent us only those companies that they felt needed a grading. I think only one of them got 3 out of 5, the rest were 2 or less. If you are telling investors that all the companies graded are 2 or below, what does a good one look like? Unless investors have something to benchmark them against, the value of this product is limited.


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