GST to stoke inflation in near-term, positive in longer term: Sudhir Agrawal, UTI MF

In a chat with ET Now, Mythili Bhusnurmath, Consulting Editor, and Sudhir Agrawal, Fund Manager-Fixed Income, UTI MF, discuss macro cues, GST and impact of a Fed rate hike.

Edited excerpts

Mark Mobius is saying there is going to be a delay in GST implementation even though we heard some very positive and reassuring sound bites from the Finance Minister who maintains that he would try and make it to the mark. We understand the GST Council will also meet in early November to iron out the issues?

Mythili Bhusnurmath: It is really difficult to say because if you look at it, nobody expected the GST Council to move so fast. In fact, nobody even give the constitution bill a chance. So I would hesitate to stick my neck out and say that we will not achieve the deadline of 1st April. It is going to be difficult but I would not rule it out altogether because the centre has put so much its stake about actually achieving the deadline, bending backwards.

I would not really be very emphatic in saying that we will not achieve that target but it looks difficult. Even so, by September it should be possible for the simple reason that the constitutional amendment was notified in September and after a year all the other laws that we have as far as VAT and excise duty and service tax are concerned, will no longer be enforceable. So by September 2017, definitely there is a hard constraint by which GST must come in.

However, I am a little wary about the “excessive bullishness” shown by Mark Mobius. Of course, he is a seasoned market player but I think as soon as GST is implemented, there will be a brief period of utter chaos. For once, the government is more prepared than industries. So I think industries are yet to get their houses in order.

But medium to longer term certainly the GST is the mother of all indirect tax reforms and we should get enormous benefit from it as Mobius himself pointed out.

What is your own take on the GST implementation process what have you observed thus far and the outlook there?

Sudhir Agrawal: The government has set a time line of rolling it out from 1st April. First off all, we have to first wait and watch and see if it is actually implemented from 1st of April.

From bond markets perspective, it might be slightly negative in the very starting because that tends to have some kind of inflationary impact because of higher taxes in some of the items.

So overall, the first impact might be slightly negative but at the same time, RBI is ready to strip out that impact and look at the inflation taking out the impact of this GST up move in the prices, GST driven up move in the prices.

Mythili Bhusnurmath: It is not it a little early in the day for us to say that the impact will be inflationary because so much depends on the classification of the goods because depending on how they are classified, we still do not know what the rates are going to be – whether it is going to be two standard rates, one standard rate. Of course, the centre has set four rates, so it might be little difficult for us to stick our neck out and say that it might be inflationary.

But even so as far as the bond markets are concerned, if the economy really picks up and there is enormous growth and tax revenues increase, do you foresee a situation where the government borrowing may come down and how will that impact the bond market? Of course, we are talking about the medium to long term. Nothing is going to change dramatically overnight but will there be an impact on the government fiscal deficit? Do you see it coming down, what does that mean for government borrowing, what does that mean for bond yields?

Sudhir Agrawal: That is definitely true. The medium-term impact of GST is definitely going to be the positive for both equity market as well as bond market and if things were to go the way they are planned and if in GST we see the overall tax base and government revenue increase, then in that case, definitely it is going to be better for the economy from fiscal perspective. That might also mean lower dependence on the market borrowings. But at the same time, what we were talking about is that is very near-term impact that is going to prevail for the next one, one-and-a-half years. If at all, the government is able to successfully increase its revenue base, that means it is also collecting higher taxes from the economy. That is the reason why we are saying that if the assumption is that revenues, government revenues are going to be higher than what they are today, then definitely it is going to be inflationary in near term in one, one-and-a-half year but ultimately positive in medium to longer term.

Mythili Bhusnurmath: The RBI has announced an OMO of Rs 10,000 crore on October 25. Has the RBI been swinging from one extreme to the other from the time when they held liquidity very tight to now when they are very wary about liquidity becoming tight and so are keeping liquidity very flush? How will that impact interest rates?

Sudhir Agarwal: The OMO which was announced yesterday seems to be priced in. This was during the April policy when RBI announced its intention that they intend to move the liquidity to the neutral zone. In order to achieve a neutral kind of liquidity scenario, RBI has to continuously do OMOs. So it is just a matter of timing. The market was waiting for OMO for the last 10-15 days which has come now. That has come as a relief for the market in the very near term.

Incrementally, the assumption is we will see more OMOs in rest of the fiscal year, an additional Rs 50,000-60,000 crore. Again, it is a function of how much of forex flows do we get as an inflow because ultimately RBI’s intention is to make liquidity positive by way of combination of forex asset purchases and domestic asset purchases which is OMO actually.

Overall, it is good for the bond market and that is probably one of the reasons we saw a significant fall in the bond yields over the last five, six months. The demand supply situation by virtue of aggressive OMOs from RBI have turned in favour of bond market and as a result we are now seeing a lower term premium which used to prevail at close to 100 bps. Now, it is ruling close to 50 bps over the overnight repo rate.

Mythili Bhusnurmath: As far as bond yields and forex flows are concerned, what kind of impact do you see of a Fed hike which most people now seem to be pencilling in for December? How will that impact both?

Sudhir Agarwal: I think it is not the Fed hike but it is rather that fear of that hike which is probably making markets slightly more volatile. I do not think one rate hike by Fed in December is going to actually disrupt the market in a big manner.

So for the market to get disrupted, there has to be one hike and that too removal assurance from the Fed that they will move gradually which I do not think will happen. The Fed is going to retain its language of moving gradually. One Fed rate hike per se should not impact the market in a big way.

Probably there will be a lot of volatility pre Fed hike but post Fed hike we expect things to settle. Beyond that, now we have to look at not at the intention of the Fed but rather at how fast inflation starts moving up in all those global economies because that will be something if at all we are to see inflation moving up. Getting into December we reach to a level whereby the favourable impact, the base effect of that last commodity price fall is almost getting over. December was the period last year when we saw almost all the commodities hitting the bottom and from there we have seen a sharp recovery.

So right now at current year-on-year, we are actually seeing disinflation from a lot of commodities but getting into December that disinflation starts turning into inflation, probably that might be something which might start putting some pressure on the inflation to the upside on the headline basis. And probably that one has to be careful about and that should not be in a way which forces Fed to move at a higher pace compared to what market is anticipating but apart from that, the December hike itself we are not worried at all about.