Expect another 100 bps rate hike in India: Leif Eskesen, HSBC (ET)

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In an interview with ET Now, Leif Eskesen, Chief Economist India & ASEAN, HSBC talks about interest rates, crude price movements, BRIC economies and QE3. Excerpts:

When do you believe interest rates are actually going to peak out for India?

We have to go a lot further in terms of rate hikes in India. We are expecting another 100 basis points in rate hikes during the course of this fiscal year. It is true that growth in India is finally showing signs of cooling. That is partly in response to the rate hikes that the RBI has undertaken so far. It also reflects basically that you have seen inflation coming quite elevated, there is uncertainty about the macroeconomic outlook that is also in essence dented growth and then finally in our assessment, India exceeded its potential in terms of output last year. So effectively the economy is facing a natural speed limit and we are seeing that basically embossed tight capacity in the economy.

The capacity utilisation is very high; you have labour markets which are quite tight as being reflected in rising wage pressures as well. Even though the economy is going to slow in our assessment over the next couple of quarters, again in response to the tightening undertaken so far and the further tightening we expect, it will still go strong enough to keep these capacity constraints tight and thereby keep pressures on inflation in upward direction. That is why they need to tighten further to take out this demand led inflation pressure that is still very prevalent in the economy.

Given your outlook in terms of the possible rate increases, can we see growth go to levels of even 7% which many people are factoring right now though the government has given an optimistic 8%?

We overly revised that growth forecast downwards. Our current growth forecast that we did about a quarter ago was for 7.9% growth for this fiscal year, which is certainly below current consensus based on possibility that we might tweak that a little further downwards as well, but not very much. It is in that sort of range below 8 for sure that we are going to look at for this fiscal.

How about inflation worries in India; the whole issue of the balancing between growth and inflation?

Certainly, the interesting thing about the inflation in India is the change in inflation dynamics over the last 12 months. Initially in early 2010 there were supply side factors. You had the dry monsoon in 2009 that limited the supply of food and that significantly increased food prices and kept food inflation quite elevated during the course of 2010, but then as the economy continued to grow quite strongly, we started to see capacity constraints in the economy becoming tighter towards the end of 2010. Now basically we have started to see core inflation building up.

We had a shift from supply-driven inflation pressures towards more demand-driven inflation pressures in the economy and that is also something that the RBI has recognised very explicitly in their latest monetary policy statement that this change in inflation dynamics has taken place and that is also why they were feeling compelled to do 50 basis points in rate hikes rather than just 25 because inflation dynamics are more driven by the demand side and you really need to slow down the demand side and sacrifice growth in the short term to take out this type of inflation pressures.

What do you make out of the crude price movements post OPEC feeling to come out with the increase in the production output and prices have, any which ways, gone beyond $100 a barrel?

More generally, in terms of crude oil prices, what we are witnessing globally is that we are entering into soft patch as far as growth is concerned. There is also some possibility that supply from the OPEC could be increased. There is a possibility we could see some easing off in crude prices on a global scale over the next few months as the global economic growth is in a soft patch. However, looking beyond that into the second half of this year, we expect global recovery to resume and pick up pace again. Then you could start to see crude prices again being driven upwards at that point in time.

How would you position yourself when it comes to the BRIC economies and especially in the India context?

India stands out very favourably compared to the other BRIC countries. We look at India's growth over the last two decades and India has clearly been in the growth premier league together with China relative to the BRIC countries and it has been one of the factors for growing economies over the last few years. At the same time, India relative to the peers in the BRIC countries faces probably the biggest structural hurdles to growth going ahead and here I am thinking in particular about the lack of basic infrastructure where they also lack behind its peers in the BRIC countries.

Also in terms of product market and labour market, the issues there are that the structural constraints on growth are bigger in India. India effectively has to do more in terms of undertaking structural reform to easily structure constraints to remain seriously in the growth premier league among BRIC countries over the medium to long term.

What is your own view on the relevance of and the impact of this region including India of the ending of QE2 and about the possibility of a QE3?

It is premature to conclude that we are going to see a QE3. Again our promise is that the slowdown we are going through right now on the global economy is a soft patch and we are going to start to see recovery picking up pace in the second half of the year as well. In that scenario, we do not see a need for a QE3. Also, keep in mind what the FED is planning to do and certainly what they indicated is that although QE2 will end relatively soon. The FED is going to continue to reinvest money into the treasury markets as well.

It is not going to shrink its balance sheet over the next six months or so. Effectively, you will still see quite lose monetary conditions in the United States during the second half of the year. If QE3 should be on the table, which we do not believe at the moment, then of course you could start to see again that that would reflect somewhat lower prospects for growth in United States and would impact emerging economies such as India