'Pay Commission hikes are not productive'

In his trademark forthright manner, IndAsia Fund Chairman Pradip Shah tells Shobhana Subramanian that the Indian economy is in for hard times. And an unstable coalition could make things a lot worse.

Where do you see GDP growth in 2009-10?

If we are lucky, and the world economy revives, maybe GDP will slow down to around 5.5 or 6 per cent. Otherwise, and I am pessimistic, it could be closer to 5 per cent. It's hard to imagine that we will come out of this earlier than in six months when things will start looking up on the back of the stimulus.

Do you think the stimulus was enough in terms of quantity?

One wishes it could have been higher, especially on service tax, where the reduction was niggardly. Services account for over 50 per cent of the economy -- transportation, logistics, entertainment -- and there would surely have been some elasticity of demand that would have stimulated the economy. But now, because there's going to be an interval when little will happen, we are less optimistic than we were six months back.

Were the interest rates cuts adequate?

Monetary stimulus is not really the chariot that pulls our economy forward. It's the demand that comes first and then the financing. The availability of money is, of course, more important that the price of money and that's where things have to further improve. We see banks, for instance, giving money to government, partly because it's safer and partly because it's mandatory.

Do you feel the banks are justified in not lending aggressively?

The opportunity for banks is to lend safely, albeit making smaller margins and that's what they're doing. They may get hurt in the short term now with interest rates remaining stable because they may not have treasury profits and may even have treasury losses. But they're willing to absorb that if they own a shorter-term government paper.

From their perspective, they are justified in not lending to the corporate sector. But from a nation's perspective, we would like them to lend especially to small businesses because that's where jobs are created. We're already seeing job losses in sectors such as jewellery and that's having an impact on demand because of which there will be further job losses. Also, lower exports are now hurting the rupee.

Where do you see the rupee?

In spite of oil prices coming down to $45 a barrel, the trade deficit is at about $90 billion and the current deficit will be 2.4 per cent this year. We have to be conscious that we have a large amount invested in equities and a large amount in overseas banks deposits of NRIs.

We've seen an outflow of $13 billion last year from the equities market and already $2 billion in the first two months of this year. That money getting pulled out affects both the availability of money and the currency. It is difficult to imagine the rupee being stable without the support of the RBI and it is not inconceivable that there will be a further drop in the rupee simply because it will allow exporters to survive. So the rupee can drop to 55-56 in the next six to nine months.

So what's the solution?

The solution is to increase confidence in the Indian economy to pull in both strategic and financial flows. We need further easing of our investment laws. While some attempt was made in the recent changes to the FDI guidelines, there's also been some, possibly inadvertent, tightening. But it is hard to be optimistic at this time especially as the results of the election are uncertain.

Do you believe long bond yields could harden towards the end of the year?

Yes, it is inevitable because I think, we are not going to see the return of foreign institutional or portfolio flows back into the country soon; in the past we had an excessively easy regime of drawing money. So, therefore, there will be crowding out and companies need to hunker down or conserve cash. They will have to match production with demand because there will be tightening of bond yields. And that further affects the ability of companies to invest and the viability of projects themselves.

So do we make the reverse repo rate zero?

Well, yes, the government should crack down on the reverse repo rate. They must give as much as an incentive to banks to lend for productive purposes and not leave companies to fend for themselves, especially smaller businesses.

Also, I think government has to cut down on unproductive expenditure -- even the Pay Commission hikes are not productive. The spending should have targeted infrastructure such as roads and power projects so that productive assets would have been created and at the same time it would have provided a living for low-income labourers and less-qualified people. They, in turn, would have spent the money on essentials and some long-term assets for themselves. But giving more money to people who will only save that money, which then goes back to government, is an inefficient round-tripping of money.

How long do you think it will be before the economy gets back on track?

It would appear that the Obama stimulus will start working probably later this year and then the sentiment would start seeping into other countries. But the Europeans and the Japanese will be faltering which will cause a shrinkage in the world economy. And India cannot remain isolated, we are inexorably linked with the world economy not just by sentiment but by capital flows and we will suffer along with the world.

There's been some surge in demand following a rapid run-down in inventories and some easing of commodity prices and some impact of the stimulus. But I think the rise in offtake is not sustainable especially for big ticket items such as housing or automobiles. People are still not confident. There is more haze and more menace in the haze than ever before.

Could some of the money being infused into the system overseas flow into India?

Yes, without doubt. Some of the Obama stimulus, for instance, is on renewable energy and, ultimately, assets have to be put up at a competitive cost and, therefore, money will flow to other countries.

Isn't it surprising that real estate prices haven't come off?

Real estate developers have had the benign support of banks -- just four or five developers have an exposure of over Rs 30,000 crore (Rs 300 billion). The RBI was very kind to allow them to roll over the loans till June. But to adjust, they have to bring down prices dramatically and land-banks have to be put on the block to create cash flows. There's a denial to acknowledge this but it is simply a matter of time before they come down to earth and realise that the market will not accept the limited reductions they have made.

If a fractious coalition comes to power how will the markets take it?

The markets cannot take it with ease because if a coalition government comes to power at the Centre, even a good leader could be smothered by the rest of the parties. So, unless we see, over the next month or so, some well-defined coalitions with common manifestos that give us confidence that a stable coalition could come to power, it is unsettling.