Interview with Gerard Lyons, Chief Economist & Group Head of Global Research, Standard Chartered

Gerard Lyons, Chief Economist & Group Head of Global Research, Standard Chartered talks to Jitendra Kumar Gupta on the Indian economy and the factors that may help or hinder the growth.

What is your view on the Indian economy in terms of the GDP growth, especially after India’s central bank’s recent measure to raise CRR and Repo rates?

We think the industrial recovery in India is well under way with the average growth in industrial production at 12.7% for the last 6 months. Some service sector activities are also showing signs of improvement. Export growth has come back into positive territory. We expect GDP growth in India for FY11 to be in excess of 7.5% with chances of an upside surprise.

Simultaneous tightening of fiscal and monetary policies are possible headwinds along with a staggered recovery in the developed world. Also some support for the labor intensive industries need to continue because they are still not faring well.

Post budget do you think India's worries regarding the fiscal deficit seems to be easing? Will government be able to achieve the targeted fiscal consolidation?

The 13th Finance Commission report has laid down a roadmap for fiscal consolidation and the Finance Minister has accepted the targets of reducing the deficit and debt over the next 4 – 5 years.

In the near-term, buoyancy because of higher GDP growth, partial withdrawal of the fiscal stimulus translating into higher revenue, much larger divestment proceeds and the marginal reduction in subsidies should help government in this fiscal consolidation.

At this point, this seems to be a credible strategy. As the year progresses, there is also scope for further withdrawal of fiscal stimulus if growth momentum continues. This could balance any shortfall in divestment proceeds.

Do you think recovery in India’s exports is for real and sustainable?

Part of the recovery in exports is because of base effect of last year as well as restocking activity in the developed world. In US dollar value terms, exports in January 2010 were marginally lower than in January 2008.

So although the y-o-y growth rate might look impressive, in level terms we are still flat over two years. Also, some part of the increase in exports in value terms could be because of price effect (prices being higher compared to last year).

Although recovery in the developed world might be slow, Indian exporters are actively looking to diversify into other markets. We anticipate more than 10% growth in the US dollar value of exports in FY11.

How do you think the things could shape up over the next six to eight months given that RBI wants to maintain higher GDP growth while there is an inflation overhang?

A large part of inflation in India was caused by food prices which are showing signs of moderation. While it is true that non-food inflation is rising on a rapid clip as capacity constraints start impinging and companies get back some purchasing power, the upsurge in the headline number should be capped.

The recent stance of RBI seems to suggest that controlling inflation is a bigger worry at this point of time and hence policy normalization will continue. This normalization is not likely to derail the momentum of the cyclical recovery that we are observing.

When and how much do you think interest rates could go up in India and what impact will it have on the industries?

The process of interest rate normalization has already started. We expect RBI to hike the policy rates again in April by 25bps. Over the course of FY11 there should be gradual increase in rates by about 100bps.

Even after that, policy rates will be just equal to their lows of the last cycle in 2004. So, the impact on the borrowing cost of the industries should be manageable as long as liquidity in the system is not tightened too much and the rise in lending rates is gradual and non-disruptive.

We also need to understand that unbridled inflation could be a bigger threat to growth than gradual rise in interest rates.

Do you think that the strong IIP numbers in India are for real and sustainable in the near-term?

Part of the impressive IIP readings is because of the low base of the last year. However, even the seasonally adjusted month-on-month growth rates have been very high (3-month average is about 3% month-on-month in Jan 2010).

It might not be easy to sustain such high sequential growth which was driven by fiscal stimulus, restocking of inventories and pent up consumer demand, among other things.

A careful analysis of the IIP data suggests that some of the labor-intensive industries are still not doing that well and only a few industries are driving this rapid growth. While industrial growth rates will moderate to more realistic levels, a sustained recovery in the capex cycle will ensure that industrial growth remains buoyant in the coming months.

What is your view on the Chinese Economy? Do you think it is really heating up or there is some degree of bubble?

China is witnessing an industrial revolution similar in scale to the one seen in Europe in the 18th century, but over a much shorter span of time. This is a big positive. However, the Chinese economy is imbalanced.

This is highlighted by a number of factors, particularly investment as a proportion of GDP is running high at 45% of GDP. This is even higher than in many Asian Tiger economies in the 1990s.

In addition to the imbalanced nature of the economy there is evidence of overheating in specific areas, such as real estate – a fact that is not lost on Chinese authorities who are trying to curb loan growth. It is important to note, however, that much of the economic growth seen in China is genuine, and not speculative in nature.

Overall, China has bubbles in some places but it would be wrong to believe that it is a bubble economy. It is for real.

Will the recent tightening measures taken by the Chinese authority’s help in this?

Chinese authorities have been proactive since the start of the year in tackling the high levels of investment. Authorities have set a 22% lower lending target for the banks this year (at CNY 7.5 trillion) compared with 2009. They have also raised reserve requirements for banks since the start of the year.

Expect further monetary policy tightening in the coming months – including interest rate hikes. These measures should go a long way in cooling down certain sectors of the economy which are overheating. New projects are not being started.

As a result, we’re looking for GDP growth to slow towards 8-9% in the second half of this year after 11-12% pace in the first half. Do not be surprised if there is increased future economic volatility.

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