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Low inflation calls for policy rate cut, says principal economic advisor Sanjeev Sanyal

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Sanyal says fall in inflation calls for a bigger rate cut by the Reserve Bank of India (RBI).

Low inflation calls for policy rate cut, says principal economic advisor Sanjeev Sanyal
Sanjeev Sanyal, principal economic adviser to the finance ministry, is widely regarded as one of Asia's leading economists. He has spent two decades working in international financial markets and was named Young Global Leader 2010 by the World Economic Forum. In 2007, he was awarded the Eisenhower Fellowship for his work on urban issues and was also honoured by the Singapore government at the World Cities Summit, 2014. Born in Kolkata and studied at St. Xavier's School and St. James' School, Sanyal holds a bachelors degree in Arts from Shri Ram College, Delhi University along with two Masters Degrees from Oxford University where he was a Rhodes Scholar. He has authored four best-selling books The Indian Renaissance: India's Rise after a Thousand Years of Decline , Land of the Seven Rivers: A Brief History of India's Geography, The Incredible History of India's Geography and The Ocean of Churn: How human history was shaped by the Indian Ocean. Sanyal says fall in inflation calls for a bigger rate cut by the Reserve Bank of India (RBI)
. Speaking exclusively to CNBC-TV18, he said cost of capital for farmers and small businesses is very high.
Edited excerpts:
Q: How are you looking at 2019? Are we going to see this balance sheet crunching by global central banks beginning to make the cost of money expensive? Is it a difficult 2019 for us as far as the world is concerned?
A: Yes, certainly there are a lot of uncertainties. But on the other hand, some things have also flowed our way. For example, oil prices have come off a long way from when they peaked in October-November, they were at $85 per bbl and now we are looking at $53 per bbl. Yes, there are some apprehensions about the world economy slowing down. But on the other hand, the US Federal Reserve has suggested that it will probably tighten somewhat at a pace that somewhat less steep than otherwise been, which by the way is good for us as it means that the global liquidity conditions of anything will be somewhat easier than we had earlier anticipated. There may still be some tightening, but much easier than people had anticipated earlier.
Of course trade wars makes thing uncertain, but as I said not entirely gloomy.
There are areas where if we in India look at it positively and try and find ways in which India can insert itself into a new global supply chain that maybe emerging out of these trade wars, then in fact we can take advantage of it. So I would argue that there are some challenges, but there are many areas where India can take advantage of the situation from lower energy prices, somewhat easier, global interest rates and perhaps a liquefied global supply chain, where we can insert ourselves and many other things as well. So no really such a gloomy picture of the world as maybe somebody else would have told you.
Q: The most immediate news that we are getting is that the fiscal deficit is now 114 percent of the full year budget. It normally tends to be higher in the months of November-December and gets corrected as advance taxes come in the last quarter. But never the less it's a slightly higher number than we are used to as early as November, plus we hear that the government is planning some kind of a farm support, maybe a basic income, maybe a waiver, maybe some way of supporting farm prices. It does look like fiscal deficit is going to get much bigger than we thought?
A:
Let me clarify that we continue to remain very much committed to fiscal consolidation.
So we are not contemplating moving away from that commitment. As far as the farm sector is concerned, I think we need to be clear on what is the issue that the farm sector is facing. In the past, the problem used to be drought, floods or weather related factors. We used to be shortage country. Now, because of our own success and in fact, increasing farm production, we have ended up in a situation where we are producing a lot more food than we could possibly consume. So this whole 1960s Green Revolution approach to agriculture that we used to have is basically run its course. We now produce way more food than we consume or store and so we need to relook at that.
How do we transition away from this – let us grow more calories approach to agriculture. First thing, in short-term, we need to make sure the fact that this excess is leading to food prices being under continuous pressure downwards and we need to deal with that. There are a few things we need to take into account. One is, we need to make sure that these food prices are held up in some ways and Minimum Support Price (MSP) is one way of doing it. But also remember the farmers are also facing very high cost of capital. So their output is food and other agricultural products. Inflation for that is essentially at zero right now and they are all borrowing at more than 10 percent.
So the real interest rate for them is over 1,000 bps. So we need to begin seriously about reducing the cost of capital. In fact, in some ways, this is the source, if you think about for the demands you see for farm loan waiver etc. this is the source of it. The cost of capital is very expensive;by the way not just for farmers but for small businesses and many others as well. So this is one big area. The second big thing that we need to think about is to change the overall framework of subsidies, incentives etc., which is essentially been about growing ever more food grains particularly rice and wheat. So we need to rethink this entire gamut of incentives and begin to think about various other options. First of all, we need to begin to think about other crops, we need to think about exports, we need to think much more seriously about cold chains, all of which incidentally are already been thought through. Some of the policies like agricultural exports’ policy was just recently announced. Huge effort is been put into cold chain and so on and of course, we need to think about rural economy as something being beyond just agriculture. In fact, there was a recent NABARD study, which suggests that 50 percent of rural incomes are already non-farm. So we need to take a much more comprehensive view of what we do and what we mean by rural incomes than just farming. Therefore, the point is we need to take a wider view of the whole matter.
Q: Important for me is that you reiterate that fiscal deficit in spite of whatever farm supports we give, will not get disturbed. The government is still looking at 3.3 percent?
A: We are committed to 3.3 percent. Of course, there may be some variation around it, but the variations will be very minor. These are not the days to debate 5-6 percent of gross domestic product (GDP).
Q: Coming to the cost of capital, like you said, we have got severe food disinflation, which is surprising as one though that MSPs would perhaps increase the prices and that has not happened. Now to add to that we also have a fuel disinflation. So, what do you look at in terms of how much rate cuts can come? We already have a fairly comfortable liquidity with the RBI promising Rs 50,000 crore of bond purchases – December, January, February and March. To add to that how much space for rate cuts do you see in 2019?
A: Firstly, let me clarify that this is the prerogative of the monetary policy committee (MPC), so I cannot comment on how exactly much they should cut, but I can lay out the landscape.
Basically, inflation is now running at the bottom of the range that MPC had been given and it is just not something new and we now for some time inflation is running at or below the midpoint of that range.
So, inflation has structurally come-off. It is fair to say that the old 7-8-10 percent range of inflation that we used to have that has been lowered by some good 500-600 basis points.
If that is the case, we need to see a commensurate reduction in nominal interest rates.
Otherwise, you have the real interest rates running about highest in the world. Small business still borrows at 12 percentage points and now if inflation is running at 2 percent, then there is 1,000 basis point or at least 800 basis point real interest rate for large parts of the economy and this is clearly not tenable, because of variety of reasons.
First, this is a source of enormous financial stress to the balance sheets, this is a major problem for small business, large business, for farmers as they can also be seen as small businesses and so on. It also causes stress on fiscal side because the government is the biggest borrower from the system. Also ironically, keeping high interest rates over long periods of time also increases inflation and this is something that economists tend to forget. While higher interest rates in the medium-term lowers inflation, in the long run, higher interest rates mean that you do not build capacities you would have otherwise build whether infrastructure, industry and so on. So you end up with higher supply side inflation in the long run if you keep interest rates high indefinitely, irrespective of where inflation is. I think we have structurally brought down inflation. We now need to take step to structurally bring down the interest rates so that they are in sync with the new level of inflation and that we have to think in 100s of basis points now. Exactly what trajectory the MPC takes is their prerogative.
Q: I would assume that the MPC would be convinced of the food disinflation that they have seen and the fuel disinflation especially if crude continues around $55 per bbl mark up to February when the MPC meets next. But more importantly, they will worry if fiscal deficit is higher than they thought. For instance, we have seen a spate of farm loan waivers coming in from the state governments. In addition, if a big package comes from the centre, that would be a spot of bother for MPC, wont it?
A: I would argue that you cannot see these things in isolation.
One of the points I make in my new book is that you have to think about the system in a holistic way, because everything is connected.
If you keep real interest rates at these high levels for the farmers, then naturally there will be pressure to do farm loans waivers and other things. So you make cost of capital exceptionally high, then it feeds through -- the imbalance shows through somewhere in the system. So the point is once you have lowered food prices and inflation generally, you have to allow the rest of the system to adjust, otherwise the political pressure or other economic pressures will show up somewhere.

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