After the weak gross domestic product (GDP) reading for the second quarter of FY20, all eyes are now on the Reserve Bank of India (RBI) Monetary Policy Committee's decision that is due on the December 5. The MPC decision will be crucial.
To discuss about what the MPC decision will be Latha Venkatesh spoke with CNBC-TV18’s very own Citizen's Monetary Policy Committee comprising of Dr Pronab Sen, Former Chief Statistician, who is the chairman of this committee, members Sajjid Chinoy, Chief India Economist at JPMorgan, Samiran Chakraborty of Citi, Sonal Varma of Nomura and Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India (SBI).
Ghosh is hopeful that the Central Bank could look through these numbers as a seasonal one and say that growth is their priority and they are going to stay in an accommodative mode perhaps for a longer period than what the market anticipates.
According to Chakraborty policymakers are always a bit more optimistic than market analysts in predicting longer-term growth, so it is unlikely that the RBI MPC will cut FY21 growth as much as the FY20 growth.
Varma said they are looking at growth downgrades not just for FY20 but also FY21 and a fairly prolonged period of output gap staying negative.
When asked what the RBI MPC would do on December 5 with regards to rates, Ghosh, Chakraborty, Chinoy and Varma said they would cut by 25 basis points and the stance would be accommodative, while Sen said they would cut by 50 basis points and stance would be neutral.
Q: Q2 GDP at a decadal low and the nominal GDP at 6.1 percent several decades low, what is the message for the MPC?
Varma: I think one is what the number indicates and two what is the future trajectory. Clearly, what the Q2 number indicates is underlying private demand is very weak because despite higher government spending we have seen a 4.5 percent print. On a sequentially adjusted annualised rate basis, gross domestic product (GDP) is at 3.6 percent. So there is no doubt about it. Demand is very weak - both investment and private consumption.
The second aspect, what does this mean in terms of the future trajectory? Other than the global reasons for India’s economic slowdown, clearly credit conditions being tight have been one of the reasons for this deceleration. Our view is that the underlying credit issues have still not been resolved and therefore Q3 is unlikely to be significantly better than Q2 numbers. Therefore, for the full FY20, we are staring at potentially a growth number below 5 percent.
More importantly, if you have such a prolonged period of demand slowdown along with credit conditions being tight, part of which is a supply side problem, you have a long period of lower capacity utilisation, delay in investment cycle and a decline in long-term potential growth.
We are looking at growth downgrades not just for FY20 but also FY21 and a fairly prolonged period of output gap staying negative.
Q: Let me toss the same question to you. What do you expect the Reserve Bank of India (RBI) to say in terms of growth, GDP for the current year, it has already been downgraded from 6.9 to 6.1, what will they say next and what are they likely to say about the next year?
Ghosh: I think the RBI is currently in a bind because its growth is overestimated by around 100 basis points (bps) and inflation possibly is underestimated by around 70-80 bps. So any Central Banker will always read that over and underestimation. Coming back to the communication in the RBI policy, I think the Central Bank knows that the growth conditions are weak.
Another data point along with GDP data was the credit growth data. It shows an incrementally 82 percent decline in the April to October overall credit growth over the last year. The entire GDP data in Q2 has been driven by government without which the number drops to 2.8 percent. So given the conditions the RBI will be fairly clear in the policy that the growth is its first priority.
However, the problem is that given that recently there is going to be some hikes in the telecom, so there could be an upside risk to inflation and the food prices are currently running at record highs, inflation number could breach through and move closer to the 5.5 percent mark for the next couple of months. So it is an enviable position. But hopefully, the Central Bank could look through these numbers as a seasonal one and say that growth is their priority and they are going to stay in an accommodative mode perhaps for a longer period than what the market anticipates.
Q: You said about a 100 bps lower in growth this year, so from 6.1 they may go to 5.1. What will they do to next year because that indicates how prolonged they think it is?
Ghosh: Next year the growth rate of RBI is at 7 percent but next year will be happy if we get to a growth rate of around 6 percent. I am not sure whether they will indicate it so early but there is an indication that they may say clearly that growth will stay weak for an extended period of time.
Q: Do you agree, they will also give us a different figure for FY21 growth because that has its own implication for how the market reads it and secondly, on inflation will they look through that easily. Carrots I paid Rs 120 a kilogram, it is not only an onion inflation.
Chakraborty: On the growth question, policymakers are always a bit more optimistic than market analysts in predicting longer-term growth. So I don’t think the FY21 growth will be cut as much as the FY20 growth. There will be always that hope that stimulus that has been taken both from the monetary side as well as from the fiscal side will work through the system over the next few quarters and that will probably make the growth numbers look somewhat better.
On inflation, I agree with Soumya Kanti Ghosh that it is primarily a supply side problem. In a demand constrained economy and that supply side problem is - at this point they will probably say that this is very much concentrated in a few food items and maybe point to the fact that we will watch out for whether this is getting more generalised into other items as well. The challenge is that this more than 5 percent inflation is going to stay for at least three months and what it does to inflation expectations, what it does in terms of cost push pressures on other kinds of price inflation, that is something which they will have to watch closely. So it is going to be a tough call on inflation for sure.
Q: Give us a little bit of global context, how important is it at all? The food index is moving up a little bit globally, liquidity also always tends to inflate all assets, will inflation be a worry, will growth uptick be approached a little positively?
Chinoy: Given that the growth has been the dominant challenge in India for the last three quarters, question is does the global economy become a headwind as we thought it would three months ago or is it a modest tailwind. I think there the news is slightly better.
If you look at what is happening globally, there has been a huge negative sentiment shock for the last year based on geopolitical concerns, the US-China trade war and Brexit. Thankfully and fortunately, all those risks, at least those tail risks have begun to ebb.
So we at JPMorgan think that over the next six months the global economy is getting primed for a reasonable lift going into 2020 based on three different factors. One is the sentiment shock has begun to stabilise and reverse. To put this in context, the global manufacturing expectations index, three months ago was the lowest in 2008 and that is the reason to be worried about the recession in 2020 that is now stabilised and marginally going up.
Financial conditions around the world are very supportive, we still think central banks will cut which gives some leg room to the RBI to cut and inventories will be supportive of the global economy.
So I think the global at the margin has stopped becoming a headwind, could become a little bit of a tailwind. I think the dilemma for the central bank is the following, in two sentences. When you use a tailor-rule for example and you find that output gaps are clearly negative, the last core inflation print month-on-month was the first contraction in the history of this series. So pricing power is very weak. That should argue for more easing but then you look at the next six months inflation, they are all above 5 percent.
We know food is what drives inflation expectations. So you have this very strange dilemma where growth is very weak, food prices are getting higher and higher, getting more entrenched that may push up expectations. It is the relative way to place on both on these things that will matter. For now, growth will still have to be the dominant focus.
Very last thing I will say is it is now less about policy rate cuts, more about bank lending cuts just to put this in perspective, we were at 110 bps in the first eight months, 110 bps for the last cut. We have got lending rate data till them only about 45 bps of that has been passed on in the 2015 cycle. At this point in the cycle, you have 75 bps of policy cuts and 65 bps of lending rate cut. So the focus has to move away from policy cuts. How do you get banks to cut lending rates if in fact demand is too weak? That needs to be the overriding focus.
Q: Can you put all this together and tell us what should be the composite approach of the MPC to growth and inflation and how to kick-start?
Sen: As Sajjid Chinoy said the situation is complex. It is complex in many ways. We have been talking about inflation expectation and how they are driven by food and then they can have second round effects as the relative prices change.
However, food has another dimension as well. In a situation where the demand growth is weak, food inflation will tend to weaken demand growth for all non-food items. That is something that you have to keep your eye open on.
Earlier that was not so much of a worry when consumption demand was relatively strong. So we are now – at least I am - at the moment staring at a situation where other than agriculture, which we don’t know how that is going to play out, we are looking at the possibility of deflationary trends emerging in the large swaths of industry. That is something that they will have to keep their eyes on because this is not going to just stabilise at the current level or start turning up.
I think the trend that we are seeing in the core inflation is something that needs to be taken very seriously.
Q: Just to make the point, core inflation is going to rise because telecom tariffs have gone up. So what you are saying is look through the 5 percent altogether and concentrate on this debilitating growth, right?
Sen: What I am saying is that when demand is starting to trend downwards, upward movement in prices of anything that is seen as a necessity will put downward pressure on everything else. Food falls in that category and I very strongly suspect so does telecoms.
Q: In terms of instruments, what should the monetary policy indicate because the monetary instrument has not been all that effective so far as the panel has already pointed out? What should they do just indicate a cut or say something more?
Varma: First of all, we are in a situation where, if you are right and India is sort of moving towards a triple balance sheet problem of banks, non-banks and companies this is going to be a long cycle and therefore we need to think of more collective public policy what the reaction needs to be. It is not just about repo rate any more. Specifically, when it comes to what the RBI and the MPC should do - I think one - we need to focus on what the 12 month average inflation is rather than just the point estimates and as others have highlighted while near-term inflation is going to be above target, if you actually look at the 12 month ahead average it is actually within 3.5-4 percent. So, I don’t think there is a big dilemma between growth and inflation, so that actually supports the case for lowering the repo rate.
Clearly, banking system liquidity needs to stay in surplus to enable transmission, but second is what we really need to do to ease credit conditions and specific to the NBFC sector in terms of the credit risk perception, which is still causing a divergence between the haves and the have nots, there has to be a clear approach and we need to tackle the issue because without that we can keep cutting interest rates, but it is not going to be very effective. To tackle that credit risk issue whether it is doing an asset quality review, taking the bad assets out into a separate vehicle, but I think we need to tackle that issue head-on. This is of course outside just of MPC mandate, but I think it is extremely essential.
Third we need to think about ways to get more risk capital to fund our future growth as well that can come in more externally, that can come in by giving in more incentive to get more private capital to come in. I think the situation we are in right now in terms of the current growth as well as the future growth outlook actually requires a broader concerted effort beyond just the repo rate.
Q: Should the MPC indicate that it is time to bankroll the fisc so many of these encouraging growth has to come from the fisc. I mean spending more on MGNREGS or very blatantly breaching the fiscal deficit target, everything is with the government really, and monetary policy’s inadequacies are there for all to see? What can the MPC say or do? Overtly say bankroll the deficit?
Chakraborty: Let us get the context right first that we are going through a period of all indicators in a nominally deflating fashion whether it is wage growth, whether it is asset prices, whether it is goods prices inflation or whether it is nominal GDP, everything is deflating and in that environment, essentially the policy rate can also come down quite drastically. But what is happening is that since we are in that process of transition right now, it is creating a lot of disruption in the system and we are not even sure that where the final equilibrium would be.
In the middle, in this flux, we are looking for different ways to get back to the whole equilibrium rather than accepting that the new equilibrium could be much lower in terms of the nominal variables. I think that is where the challenge is, if we want to go back to the same nominal equilibrium that we were earlier, then obviously you will suggest things like a large fiscal policy and then fiscal dominance of monetary policy as you used the word bankrolling it. But I guess that the challenge there is that once you do it, it sets the precedence and then in every down cycle it will be used as one of the arguments for doing it again and again and which we all know from our financial stability perspective is not probably the greatest of the ideas.
In a limited way the twist is lesser of a concern because it does not really fund the government deficit, it only manages the term premium.
Q: What is your sense, should they emphasize anything more on liquidity, what can the MPC do to indicate to push monetary policy further effectively to make banks cut rates or cut the premium?
Ghosh: Before I answer that a quick point towards transmission, I think what is going to be interesting is that the as per as the policy statement the rates have to be prefixed every quarter. So whatever the RBI has cut rates in October and December now the banks are external benchmark and December if there is the cut that impact will be felt in January on a cumulative basis. So possibly the transmission will get faster from the next quarter given the way external benchmark has been written.
Having said that I agree with Sonal Varma there is a triple balancesheet problem but I want to go a little further to say that the problem of the balancesheet is not triple but it could be quadrupled because the household leverage ratio is at high levels and the fact is that in the last quarter when you see a jump in the private final consumption expenditure, I am not sure whether it is a debt finance consumption or not. So in a situation when already the balancesheet of all three entities are stretched we should not try to walk down the path to make the system prone to financial instability.
So while rate cuts are welcome, but beyond the point of time there are several other things which you could actually do. Samiran mentioned some, gave a hint, I think these are going to be more important other than just relying on this fiscal and monetary. If you actually take an example of European Union in the last 4-5 years, and look into the yields of Greece and Portugal five years back and look at where it is today, this is because they have undertaken significant structural reforms. We need to walk down that path instead of relying too much of these rate cuts and also fiscal policy as an additional measure.
Q: Are you buying first this argument and it is a very important one that Samiran is making. It is a new low in terms of nominal inflation, new low in terms of earnings growth, all the growth indicators, we used to converge inflation and growth at 6, now inflation and growth are converging at 4.50 and probably inflation is higher. So is it time to say that MPC’s mandate is 2:6 inflation should they directly say that - that we are not stuck up on 4?
Chinoy: No, I think this has been a hard fought battle, I think we tend to forget that it was a short matter of five years ago that one year ahead household inflation expectations were running in double digits and that made the trade-off between growth and inflation much worse off and policy makers both in Delhi and Mumbai have worked hard to get where we are. You can do things without causing inflation expectations, you can unhinged. I completely agree that for the time being is a temporary supply-side a transient food shock, it is precisely the thing that central banks should be looking through and this is why that band of 2-6 were given precisely for these situations.
Q: Should they emphasize it?
Chinoy: I think there is a way to emphasize without undermining the sanctity of a 4 percent average inflation over the medium term which is critical for anchoring expectations. The point is you have this band because when your output gap is negative and inflation is between 4 and 6 for 6-7 months you should look through it for the reasons that Dr Sen also mentioned. I think in terms of this new nominal reset this has happened around the world. The world has been looking for inflation for the last 10 years and central banks are unable to create inflation and therefore there is this nominal reset. But this should not change our monetary policies made because ultimately what you care about is what is that output gap. Even though nominal GDP may be at 6 percent and real at 4.50 percent and the new normal may not be what the old normal was, the output gap is large.
Look at core inflation, I just keep saying when people say India’s new normal is 5 percent growth if potential growth had come down with actual growth output gaps would not have opened up and core inflation won’t have. But look at the dynamics, the last six months of 2018 core inflation was tracking 6 percent, it is now tracking 2 percent what that means is there is substantial slack in the system which means you have negative output gap. So monetary policy is not as complex as we make it out to be, right now the output gap is negative, you were temporary supply side shock, you should look through it for now and hope that this food inflation pick up, doesn’t last long enough to cause expectations to get unhinged.
Q: In some way the MPC has to indicate that for the moment the spike above 4 is temporary or it may say that my mandate is 2-6 and not necessarily at 4. In some way they have to do it?
Chinoy: Undermining the sanctity of what they have done for the last five years.
Q: I have some crucial questions for you, another thing which the RBI has not so far admitted is that the fiscal deficit could be much higher than 3.3. The sheer fall in nominal inflation indicates that GDP is going to be probably Rs 203 trillion and not Rs 211 trillion as the budget had indicated. So fiscal deficit arithmetically will be 3.5 percent. So should they admit to the right fiscal deficit and my big question is should they tell the government or tell the economy that RBI must bankroll, do OMOs to the extent that the government will overshoot the fiscal deficit, should it be as explicit as that?
Sen: I do not think they will do that. It would be rather nice if they did but the fact of the matter is today we have a situation where the government’s fiscal deficit, the real fiscal deficit is considerably higher than what has been reported and there has been a deliberate understating of the fiscal deficit by essentially non-payment of bills to various agencies.
State governments are not getting the money, PSUs are not getting the money, vendors and contractors are not getting money. So there is a huge amount of unpaid bills that have piled up. So the fact of the matter is that RBI is not going to have very much choice and they are not going to have independence in this matter. If the government decides that the situation demands a recognition of the true fiscal deficit and payout of the dues that it owes then the RBI is going to be forced to step in and do OMOs. I don’t think they have a choice in the matter. It is not something that the MPC can debate.
So I completely agree with Sajid that let’s just keep to the cloth – that’s all MPC can do at the moment. What the finance ministry does and how RBI reacts to it is something that is going to unfold over the next couple of months.
Q: Do think that admitting the fiscal deficit is higher and admitting that we are going to borrow more, Rs 50,000 crore more will actually be positive for the market?
Chakraborty: It could be if it comes from the government side then the sword of uncertainty that’s hanging over the bond markets right now, I think that will be gone and maybe that gives a relief rally for the bond market. The only challenge there is that I don’t think even the government is certain about how much the slippage is going to be given the large chunky nature of some of the flows.
Q: What will be get on December 5th – cut, hike by how much?
Ghosh: Cut by 25 bps.
Chakraborty: Cut by 25 bps.
Chinoy: Cut by 25 bps.
Varma: Cut by 25 bps.
Sen: Cut by 50 bps.
Q: Stance – will there be any change, will they worry about inflation and neutralish?
Ghosh: Stay accommodative.
Chakraborty: Stay with accommodative stance.
Chinoy: Stay with accommodative.
Varma: Stay accommodative.
Q: What will be the final repo rate at the end of the cycle?
Ghosh: I would stay in the range of 4.65 to 4.9 percent.
Chakraborty: 4.65 percent.
Chinoy: 4.65 percent.
Varma: 4.65 percent.
Sen: 4.50 percent.
First Published: IST