See CRR, repo rate hike by July-end: CERG

Omkar Goswami, Chairman, CERG Advisory sees GDP at less than 7%. He expects the real fiscal deficit this year to be 5 - 5.5% of Gross Domestic Product. He sees crude easing off to USD 85-100 per barrel going forward and expects another 50 bps hike in the Cash Reserve Ratio (CRR) by RBI. He also sees a repo rate hike.

Excerpts from CNBC-TV18's exclusive interview with Omkar Goswami: 

Q: How difficult is the macro setup right now for us?

A: Very difficult. It is important for people to say it honestly without being an alarmist. The reasons are; firstly, after three years of 9% growth we will be lucky if we get 7% growth this year. Growth is slowing down. No country other than China will come close to 7% growth. But we will lose at least 2% growth. It may even be a tad less than 7% growth.

Secondly, fiscal deficit is going to shoot up. If oil is between USD 135-145 per barrel, under recoveries are going to be large. Oil bonds and fertiliser bonds are going to disrupt the Centre’s fiscal deficit. Real fiscal deficit this year will probably be 5- 5.5% of Gross Domestic Product (GDP). That will be a lower growth and higher fiscal deficit.

Thirdly, we do not know how inflation is going to play out. Four classes of commodities: hydrocarbons, minerals, metals and food have gone up fast. It has a lot to do with trading, speculation and with the integrated markets. The whole world is dealing with inflation and India is seeing a double-digit inflation. The numbers today will be around 12%.

There is not much that the government can do because other than good agriculture and good purchase of wheat and rice, there is nothing much that the government can do. This inflation issue is global.                           

Q: Why is it that when we talk to a lot of companies in various sectors, they still seem to be exuding a fair amount of optimism? They are cautious but they say it is not as bad as people are making it out to be. We are still going to go really fast?

A: When we had 14% of WPI inflation, Dr. Manmohan Singh was the Finance Minister and Dr Rangarajan was the governor of the RBI. In that period, companies were far more leveraged than they are today. Today, more companies have balance sheet strength and a much greater topline than before.

In those days, the balance of the foreign exchange reserve was USD 25 billion.

The banking system was in a much greater mess. It did not have the kind of liquidity that we now have even with the liquidity constraint. So, if you compare the previous crunch that we went through with the current situation, we are better than before.

Up to last year, the EBDITA margins were close to 16% at an average of 15.8%. This margin is going to fall by at least 200 basis points but not in this quarter because we are still not seeing it. But if the same trend continues till the end of the year, the EBDITA margin will fall by at least 200 basis points.

The PAT margin, which was earlier at 9%, is now 7.5% or 7%. It’s not the end of the world and therefore there is no reason for alarm, but there is pain. The Indian corporate sector had 4 years of feasting. So, from feasting to getting into a diet is not an easy one.

Q: Aside from the weekly shockers that we are getting, do you think there is a case for a structural increase in the core inflation over a long-term period? Are we going to have live with higher and longer inflation?

A: The days of USD 40-50 per barrel are over. I would look at USD 85-100 per barrel for oil going forward. In general, food prices-both soft food and food grain prices-are going to remain firm for a while.

People all over the world have gotten better off. They have changed their food habits and are consuming more food than before and are consuming higher value of food, which is up the food chain and requires much more base food than before. If you consume more meat, you need more grain. A large amount of area under food has been moved away from food into producing of various forms of bio-foods such as ethanol. You can’t increase the area under cultivation rampantly because of ecological reasons and ecological activism.

Agricultural productivity does not increase very fast and the demand for food is growing faster than the growth and agricultural productivity within India. We have destroyed agriculture for 40 years. So, I expect food prices to remain firm. It will have cycles. So, if the monsoon is good, then vegetable prices will come down. If the amount that has been procured is as good as the government says it is, wheat and rice prices will come down. But every successive peak will be higher than before and every successive turf will be higher than before.  

Q: Because of such high inflation numbers, lending rates and real lending rates have been going up in the system as well. Where do you see us in the entire rate tightening cycle right now? Do you think there is a lot more to go on that front?                                      

A: Since I cannot fix the supply side in the short-term and a lot of this is supply side and since the government has thrown up its hands and the Finance Minister has told Dr. Reddy to do what he can as he has done all that he could.

By the end of July, looking at 12.5% inflation, Dr Reddy will increase the Cash Reserve Ratio (CRR) by another 50 bps and raise the repo rate.

Think of the pathos of the banking system and the people who are borrowing, particularly the small and medium enterprises, not the Group A and the Group B companies.

Of every Rs 100 that is deposited in the banking system, Rs 8.75 paise is going on CRR and Rs 25 on Statutory Liquidity Ratio. So, you are left with about Rs 66, of which 40% is going away on priority sector lending which has (a) high NPA and (b) lower yields. So, you are left with Rs 40 of the original Rs 100 to put in into banking activities that give a return on capital. So the only way out in a situation where the credit is also getting squeezed is interest rate to go up.

So, manufacturing companies as well as service sector companies will find that their working capital cycles will go up and their receivables will get longer because I as a buyer will try to hold back paying to the seller. The payables will get shorter or it cannot get longer. So, the working capital cycle is going to be stressed and raw material prices are going to be stressed. Expect lower corporate profits. It is going to be a time that India has not faced for four-five years.               

Q: Do you think these kind of high interest rate environment and slowing growth environment might lead all the companies to shell or postpone their investment plans which might lead into lower capex and lower growth even 1-2 years down the line?

A: I serve in the board of IDFC and am not seeing any slowdown in the investment demands in the infrastructure sector, given the number of projects that are coming up for approval at the IDFC board level. But this is what I am seeing and it is very early to say whether it is a part of a trend.

Small to midcap to upper midcap companies are trying to postpone the investment decision because funds are not available and they are a little unsure of whether this is the right time. There is a little edginess in taking a big call on investment and I have also seen it being scaled back.

There are companies that have Rs 13 crore to Rs 14 crore of investment, which have tried to scale it back. So, they are making some growth and are doing it in bits instead of putting all their eggs in one basket. 

If the strains continue till 2009, which I suspect it will, then you will see some pain on the investment side. You will have 4-5 quarters of pain and investment will trot along. Also, there is a sense of insecurity now on the economic governance front regarding who is going to come into power and when the elections will be and is the governance going to get worse. All of that may actually create some question marks on investment. But it is too early to make a call whether this is definitive or not.