“It is better to be lucky. But I would rather be exact. Then when luck comes, you are ready.” -- Ernest Hemingway.
The American Nobel Prize-winning author's story "Old Man and the Sea" found a mention in Reserve Bank of India (RBI) deputy governor's Monetary Policy Committee (MPC) minutes of the meeting released by the central bank on June 20.
Acharya began his statement quoting the old fisherman Santiago singing: “Why do old men wake so early? Is it to have one longer day?”
Acharya put in his papers a few weeks before the last monetary policy meeting held earlier this month, the report said, citing people aware of the development, adding that his last day in office will be a few days before the end of July.
Business Standard, on Monday, reported Acharya has resigned from his position six months before his term was to expire and will be returning to NYU Stern in the US where he is a professor of economics. It, thus, becomes pertinent to decode what Acharya said in his last MPC meeting.
The MPC-led RBI changed its stance to accommodative from neutral — members of the panel voted unanimously, but Acharya did reluctantly, it turned out — and cut benchmark repo rate by 25 basis points.
Acharya had said, "In spite of my dilemma, I vote – albeit with some hesitation – to front-load the policy rate cut from 6 percent to 5.75 percent (a 50 basis points rate cut from my April vote to keep the policy rate at 6.25 percent). This would provide an insurance to help prevent the output gap from widening further or the finance-neutral output gap (FNOG) from turning negative. The MPC will need to remain on guard and be prepared to provide such insurance in a symmetric manner if upside risks to inflation were to materialise."
Upwardly cautious on inflation, he further wrote, "...the uncertainty around the upside risks to inflation I have highlighted will resolve only gradually over the next few months and can be factored into future MPC decisions in a data-dependent manner, but seem highly unlikely to lead to a rate hike at the next policy."
In April 2019, the MPC decided to cut interest rates by 25 basis points, to 6 percent whereas Acharya voted to keep rates unchanged. Although, using the power of hindsight, he accepted the repo rate at 6 percent was "just right" in the short term to achieve MPC's mandate of 4 percent headline inflation in the medium term. However, he said, "The large decline in ex-food-fuel inflation since the April policy implies some space in these counterfactual exercises to accommodate growth weakness with a policy rate cut of around 20 basis points sometime in the middle of 2019-20."
There were four major reasons for Acharya to be concerned about on the upside risks to inflation. These are: The monsoon uncertainty imparting further spike in food prices and the possibility of vegetable price reversal in winter months turning out to be lower than expected. Not only would this worsen the inflation outlook directly, but potentially also indirectly via the fiscal channel as it would aggravate the agrarian distress. The rise in implied volatility of international crude oil prices from 30% to 50% over the past month even as oil prices have corrected downwards. The possibility of an upward level-shift in the price of the Indian crude basket due to a shift in its composition from Iran and Venezuela to other oil suppliers. The fiscal undercurrents impacting the generalized inflation outlook. As also conveyed earlier, I worry especially about a worsening of the public sector borrowing requirement (PSBR) in conjunction with rising oil prices, say due to geopolitical tensions; such a coincidence creates a “twin deficit” – fiscal and current account deficits – scenario for imported inflation, a glimpse of which we have had only recently during the first half of 2018-19.
His worries on inflation front did not just end here. He wrote, "There is a latent inflation of around 15 basis points that will enter headline inflation if and when passed through." He warned if this inflation is "absorbed" by the government (through lower profits of public sector undertakings) then it will likely get generalised into headline inflation in due course through a higher fiscal deficit."
"Thus, even as the correction in fuel prices pulls the inflation trajectory down, the incomplete pass-through over the past few months negates some of the decline," he said.
It is this fiscal slippage that became a major reason for his upside risk to inflation.
He said, "Estimates of overall PSBR -- which appropriately accounts for extra-budgetary resources and other off-balance sheet borrowings of central and state governments –have now reached between 8 percent and 9 percent of GDP. This is at a level similar to that in 2013 at the time of the “taper tantrum” crisis."
He said, "Even the cyclical component of PSBR, such as that in the last year due to lower tax collections, raises the inflation trajectory through an increase in issuance of public debt and country risk premium that feed into imported inflation."
He warned, "PSBR impairs monetary policy transmission due to crowding out effects on market financing through public bonds and on bank deposits through small savings which continue to offer rates that are significantly higher than market yields. This channel bites particularly when the domestic savings rate is on a decline and increases economy’s reliance on external sources of funding."
Acharya said the July 5 Budget is, therefore, key to understand the inflation outlook of Narendra Modi government, "Especially the response to ongoing distress in the agrarian economy, caused in part by low food prices and reflected in low rural inflation of less than 2 percent compared to urban inflation that remains above 4 percent."
"Would the response worsen the fiscal outlook for next year and beyond, or keep it contained through pursuit of much-needed reforms for the agricultural sector and reduction/rationalisation of other revenue expenditures?" he asked.
"Equally importantly, the pattern of PSBR evolution during the rest of 2019-20 would also be critical for assessing the inflation outlook," he said.Is there more to Santiago's tale than Acharya's term as the youngest deputy governor of the RBI who is leaving half a year before his three-year term expires?
An answer to this question could possibly be also found in his AD Shroff Memorial Lecture in Mumbai in October 2018.
Taking the government and then finance minister Arun Jaitley head-on,
Acharya said, "The risks of undermining the central bank's independence are potentially catastrophic."
The comments came after government's constant ask of the RBI to ease lending restrictions on 11 public sectors banks with low capital base caused due to their spilling bad loans.
The government has been trying to set up a regulator independent of the RBI for the payments system. The RBI, in its push-back, published a rare note expressing its opposition to the move.
In his speech, he had emphasised on the importance of an independent regulatory institution. He said, "No analogy is perfect; yet, analogies help convey things better. At times, a straw man has to be set up to make succinctly a practical or even an academic point. Occasionally, however, real life examples come along beautifully to make a communicator’s work easier."
“My time at the central bank is up and that is why I have decided to leave my post definitively, with the satisfaction of my duty fulfilled,” Martin Redrado, Argentina’s central bank chief, told a news conference late on Friday, January 29, 2010," Acharya quoted, adding, "We have arrived at this situation because of the national government’s permanent trampling of institutions,” he quoted Redrado. “Basically, I am defending two main concepts: the independence of the central bank in our decision-making process and that the reserves should be used for monetary and financial stability,” the Argentine was quoted.
Coming back to our tale. Santiago's 84-days sail is ending fruitlessly so he ventures deeper only to find a fish pulling the boat for three-days wounding and wearing Santiago. In the end, he manages to kill the fish with his harpoon but cannot save it from the sharks.“But man is not made for defeat," Santiago said, "A man can be destroyed but not defeated.”