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We are moving from globalisation to slowbalisation: Chetan Ahya, Morgan Stanley

"We've moved away from the benign environment and continuous uncertainty hurting corporate confidence."

ET Now|
Updated: Jun 12, 2019, 04.49 PM IST
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Chetan Ahya-Morgan Stanley-1200
India needs to kick start the growth cycle and that will be the solution for all the problems that it has whether it is high fiscal deficit, jobs etc, says Chetan Ahya, Managing Director and the Asia Pacific Economist, Morgan Stanley, in an exclusive interview with ET NOW at the Morgan Stanley India Summit.

Edited excerpts:


Why are we getting mixed signals from equity and the bond market? The bond market is telling you a recession/slowdown is coming, the equity markets are telling you let us ignore the bond market, earning expansion is coming and we want to celebrate?
The framework by the risk market seems to be that the US might be actually muddling through. Yes there is a slowdown in the US but the bond market is implying that there would be probably 1.5-2% GDP growth and the Fed is going to be supportive. That is always good for risk assets, particularly for the rest of the world outside of the US. But if you get US tipping over recession, then this whole situation reverses. Every time the US heads into a recession, the dollar rises, emerging market currency suffers and financial conditions tighten in emerging markets which actually hurts their growth.

We are right now in terms of expectation, sitting at that cusp where people think we will get to muddle through the outcome which is good for risk assets. We will have to see what happens on June 29, which is a critical date where we can get a clue of what happens on trade tensions and which will determine where the US goes in terms of growth outlook.

Nobody wins in a trade war. Americans, Russians, Chinese everybody wants to protect that turf, everybody wants to reach their prosperity goals. Id the shape of the world going to change dramatically and drastically because trade war was not part of the projected template five, six, seven years ago?
Yes, I think so. We are moving in from globalisation to slowbalisation. Unfortunately, it is looking real and would probably be long lasting. We have moved away from the benign environment where there was predictability on what happens on global trade front into this environment where there is going to be probably continuous uncertainty hurting corporate confidence. It is not a great environment from a medium-term perspective either.

Do you think the American economy has peaked out on all basic parameters? Unemployment is at an all time low, GDP growth for the US was strong, the market cap for the US market is at an all-time high. Can we work with the thesis that it is going to be peak America for the next two or three years and if the biggest economy in the world is peaking, wouldn’t that have repercussions for all of us?
That is right and that is something we were concerned about independent of trade tensions because we have a situation where US unemployment is very low and it is in late cycle. The US started to see wage growth pick up and that was beginning to hurt corporate margins. All the signals which would indicate that the US in late cycle were already beginning to come through as it is, without trade tensions. We were worried about the corporate credit risk because that is what usually you tend to be worried about in the late cycle -- either the household or the corporate balance sheet whichever is levelled up when cost of capital goes up could tip over and create a bigger slowdown in the economy. We were watching the corporate credit risk, the late cycle dynamics in the US. Now these trade tensions have only accelerated and increased our concerns on the US outlook.

You are using the word recession very freely now. Recession means bad news, recession means more price adjustment and recession means that equity markets and bond markets will suffer. When you are projecting a recession, what exactly are you meaning?
From a global economy perspective, when you hit global growth of below 2.5% IMF has defined that as a recession threshold. Currently we are at 3.2%, we were at 4% in first quarter of 2018. So we have seen an 80 bps deceleration and what we are saying is that if you do get a bad outcome on trade tensions, then it persists for some time. If it is for a few weeks, it is okay but the economy will not be able to withstand a severe deterioration in global trade dynamics which will take this global growth from 3.2% to below 2.5%. That is how we are worried about recession mark.

Are financial markets prepared for this contraction in growth?
Definitely not. Our strategists are highlighting that if that is the case, you would probably see a much severe correction in the risk assets globally.

In a scenario where world is slowing down, there could be possible correction in risk assets which include emerging markets. What will happen to flows, liquidity? Which asset classes will do better and which underperform?
I am not a strategist. All I can tell you is that generally when you are heading into recession, risk assets do badly, bond yields would fall. In that scenario of recession, where global growth is below 2.5%, we are expecting the Fed to take rates down to zero and that will probably be taking down the 10-year bond further down than where we are today.

Global commentators again and again are saying that central bankers should be beware of the debt on their balance sheet; that they do not have the ability to come out with too many policy changes if global growth slows down. Do you think we should be cognisant of the fact that central bankers are running out of options?
Yes, we have been highlighting that and I wrote a long report on this saying that in the next downturn, you will have to use fiscal policy more actively because in the DMs, central banks do not have much room to cut rates. The US has some room to cut rates but all the other central banks like Japan or ECB, BoJ or ECB do not. They will have to think about how to have fiscal policy play a complimentary role and drive that recovery. It is in this context that we are hearing the arguments about MMT (Modern Monetary Theory). I do not think that is the solution. We have existing institutional framework which allows us to use all the tools and the fiscal policy tool will have to be used more actively to get out of the next downturn.

You have mentioned again and again that do not look at Indian economy in isolation, look at what is happening in the world! Export growth is at a multi-year low. If for two or three quarters the global growth contracts, then we are potentially standing on very bad news?
Yes, unfortunately that will be a challenge. What I have been highlighting is that India has already been going through this multiple years of weakness in investment cycle. We have had slowdown in growth, lower nominal GDP growth because pricing power has also been weak. If you look at WPI, that has resulted into lower corporate return expectations and so in some ways we are stuck in this vicious cycle.

We need to have an environment where the financial system is robust enough to support recovery in the economy but unfortunately that is not there. The government is working towards it but it is taking its own time. Meanwhile, there is this window to fix this financial system. If you have global recession in three-four quarters, that will create additional problem for India to get out of this persistent weakness in investment and therefore lower growth.

Do you think the slowdown in India is a cyclical one or we could be in for a prolonged and a structural slowdown for 12 to 18 months?
I would not call 12 to 18 months a structural, I would still call it cyclical. If you take a 10-year view or a five-year view, this is more like a deep cyclical slowdown rather than structural slowdown. India has great demographics. There are pockets of leverage in the corporate sector but in aggregate, the debt levels in India are not that high. So, the structural story is quite robust and it is just that we have got into this deep cylical challenge.

You can go back in history and keep giving an explanation as to what will happen. Not all of it is due to the government decisions; a lot of it is due to the external environment. Clearly, the government has not really been working as actively to revive that investment as it should have and hopefully we see that action coming in through now.

The Reserve Bank of India policy meeting which came out last week seems to be hinting towards growth. Is that the right way to go? Should compromise on fiscal right now but get the growth back be the priority and not get obsessed with fiscal?
RBI is looking at just simple mandate of inflation versus growth and inflation is looking comfortable and in the background, we have this persistent weakness in investment and growth. It is the absolutely right decision from RBI to focus on growth right now because they have comfort on inflation outlook. I do not think it is at the cost of a compromise of inflation outlook.

Attempts have been done to kick start the rural economy. Food inflation is missing but the rural economy is under stress. If the government spends, there is a challenge on fiscal management. Are we stuck between a rock and hard surface because if you do not spend you do not get the fruits and if you spend, the rating agencies will come out with their knives?
There is room for fiscal expansion. It’s the way you take up fiscal expansion that rating agencies watch. If there is a fiscal expansion for productive investment as well as tax cuts for the corporate sector, that would be viewed positively because the challenge that India faces right now -- even the fiscal challenge --, the problem is on the revenue side and not on the expenditure side. You need to kick start the growth cycle and that will be the solution for all the problems that India has whether it is high fiscal deficit, jobs etc.

For the first time, the consumption engine in India is slowing down. We have seen a marked slowdown in autos, in all the high frequency data points. Why do you think between January and now, in six months, the composition of the data has changed completely?
Look at PMIs globally. They have been decelerating quite aggressively over the last few months and India can see less decline in PMI, less decline in corporate confidence but it has to see the same downturn as we are seeing everywhere else in the world. So, it is not isolated. Very often, I get a lot of explanation on growth changes from domestic side. But it is really linked with the global economy and global economy has been doing badly. Exports are doing badly, corporate confidence is going to be further affected.

Already there are challenges in the domestic economy and if you get this downturn on the exports front, it is going to be difficult. At the same time, FII inflows were also not so great and have only revived recently. All kind of ties up together that this was a global factor which was affecting India over the last six months.

What would you say was the unfinished agenda of NDA-1. purely from a policy framework standpoint which needs to be expedited in the NDA 2?
It is two simple areas of focus. We do not know what happens externally. So, domestically, the first and the most important one is to fix the financial system. I know they are working towards it but there needs to be some kind of priority and a concerted effort to fix it in a time bound manner and then one has to have some ideas to revive investment -- be it tax cuts or government takes of some select high level of investment infrastructure projects, which needs to be done to kickstart the investment cycle.

Some would argue that in last five years, the regime has not been bad. We have had a stable inflation in last five years. Crude prices have been benign and yet corporate confidence is lacking. Why do you think the animal spirits is missing?
Going back in time, it all started with taper tantrums, when India had to take up tight fiscal policy, tight monetary policy, curtail down domestic demand because current account deficit was quite high and the rupee was declining.

After that, in about 18 months or so, there was some kind of recovery in domestic demand. The consumption data had started to recover but there was a global slowdown with China’s problems on Fx in 2015. Then all emerging market economies also went down, including the developed world. After that we had demonetisation and 2017 and 2018 first half was actually a synchronous global recovery environment where every other economy was doing well but we were dealing with our lagged effects of demonetisation. Then we implemented GST and outcome for the corporate sector was weak corporate revenue growth, weak aggregate demand that has been persisting for a long time, killing their confidence to invest.

The environment is not very conducive but India is a country which surprises everyone. We have managed to always disappoint the optimistic and surprise the pessimistic. What is the good news for us?
The good news is that finally you have political stability for five years and the government will take this opportunity and work towards whatever is needed for the economy. At least you know that if you are making a demand as an independent economist, these are the things that I want to see for the economy to improve. You have a political environment which is going to be able to respond.

If you had a bad political outcome where there is unstable government, it would have been just about expecting but not actually being able to execute. The good news is that you have this stable government and hopefully we will see some execution.
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