Ahead of the Reserve Bank of India monetary policy committee (MPC) meeting later this week, CNBC-TV18 assembled a ‘Citizens' MPC’ to discuss the issues likely to bediscussed by the panel and a vote on an interest rate change. All economists on the CNBC-TV18 panel unanimously voted for a 25 basis points rate cut and four of the five members expect the RBI to keep a 'neutral' stance. The RBI's next monetary policy will be announced on June 6.
The Citizens' MPC comprises Sonal Varma, chief India economist, Nomura; Sajjid Chinoy, chief India economist, JPMorgan; Samiran Chakraborty, chief India economist, Citi; Soumya Kanti Ghosh, group CEA, SBI and Pronab Sen, former adviser, Planning Commission.
Here are the excerpts: We have just got the gross domestic products (GDP) numbers. How bad is the growth slowdown problem? Varma: The slowdown actually is on anticipated lines, and no matter how we slice or dice the data, it is clearly showing a slowdown in the underlying momentum. What it is actually suggesting is that the economy has been hit both by the global shock and the domestic shock because both private consumption and investment have slowed down. The more important question is the growth impulse going forward. As of now, the numbers for April and the early indications for May show that the growth momentum actually has continued to slowdown. So the worry at this stage is that the growth impulses, both domestic and global, look weak and risks to the growth profile for FY20 are to the downside. The Monetary Policy Committee’s (MPC) primary mandate is inflation control. But now with global and domestic slowdown, as Sonal Varma points out, is the inflation trajectory likely to be even lower than what RBI forecast in April? Chinoy: There will be more comfort now that the four percent target over the next three or four quarters is not under immediate threat. Until a few months ago, the worry was that core inflation was very elevated, stuck around 5.5 percent for about six months at the end of the last year. Food inflation was particularly lower and the concern always was that at some point food prices would bounce back, and that together with core inflation would take the headline number above four percent. Now with core momentum slowing in the last three-four months, which is perhaps the best manifestation of what Sonal Varma was saying, growth has slowed. I would argue that domestic consumption has slowed, exports will slow in the coming quarters given the global outlook and when two engines suddenly slow there is a real concern of hysteresis in the economy.
So with core inflation softening, it does two things - first, it kind of re-affirms to the MPC that growth momentum is slowed and they had spoken about output gaps opening up two months ago. They would probably think output gaps are getting a bit bigger and second, it provides comfort that even if there is some mean reversion of food prices, the 4 percent target is protected. The incremental information between the last review and this review is that perhaps for now inflation is not to exceed 4 percent and more concerns that both domestic growth and global growth momentum have slowed further.
Traditionally, a loose monetary policy or when you are loosening the monetary policy, you have to have one eye on the fiscal. The budget is a month away, but the tax revenues of last year have been Rs 1.6 lakh crore short. On that base, the February budget was expecting 15 percent tax revenue growth. It is clearly going to look like a fiscal breach. Is that okay at this point? Chakraborty: Traditionally, MPC has not second-guessed the government on the budget, so they will probably wait for the actual budget announcements before taking a firm call on the fiscal. But if we are right on our characterisation that growth has definitely slowed down and inflation risks are not on the horizon, then you can tolerate a bit of fiscal slippage as long as it is well understood that it is for a temporary period and it will come back on course. So from that perspective I don’t think in the June policy the MPC will be that much worried about fiscal slippage. This is a time to think of more growth, less of fiscal. The MPC’s mandate is to keep inflation under control while concentrating on growth. So this time you are pretty sure that that caveat is well taken care of inflation control? Chakraborty: In a sense, as Sajjid Chinoy was mentioning, at least for the foreseeable future we are not seeing inflation breaching the 4 percent mark and in the past also, if you take relatively long period average, it is staying below 4 percent on a durable basis. So for a while we could have justified having somewhat tighter monetary policy because we were coming up from a very high inflation. So there was need to keep policy tighter to change inflation expectations. Now we have achieved it and that is why we can look at growth more closely. The whole problem appears to be that even the rate cuts have not been transmitted. We are unable to loosen the policy effectively even when we cut rates. How do you assess this situation? Ghosh: This transmission has been a perennial problem in the banking sector. I think there are several idiosyncrasies involved. The first point is that the banks borrow not more than 1.5 percent of the total liabilities from the repo window, which is basically the signal for transmission. In the last two-three months if you look into the data, the total currency leakage from the system last year has been Rs 3 lakh crore which actually at record high. The problem is that the banks have to maintain statutory liquidity ratio (SLR) and liquidity coverage ratio (LCR). Currently, if you do a simple calculation, 15.5 percent can be carved out for 19 percent. So that means the banks have to effectively maintain 19 percent SLR plus 3.5 percent because of LCR plus 2 percent margin, so effectively the banks have to hold around 24.5-25 percent in government securities. Now that number is coming down significantly. It is currently around 26.2 percent. Therefore, until and unless the deposit growth rate peaks up, the banks cannot sustain credit growth and this situation is unlikely to revert in the next couple of months because there has been a significant currency leakage. If that is the case then banks cannot cut deposit rates. If the banks cannot cut deposit rates then lending rate transmission will be equally difficult. So given this issue I think the transmission will remain an issue in the next couple of months and for that the RBI has to think some out-of-the-box ideas on how to do that. Can you put all the diagnosis together? We have spoken about inflation growth, liquidity deposit growth and the fiscal situation. How would you assess the situation and diagnose the problem for the MPC? Sen: I think everybody seems to be more or less agreed upon the inflation trajectory, the weakening of growth, the fact that we are at the moment in a situation where liquidity in the banking system is a concern but the one thing we haven’t talked about --- in fact Soumya Kanti Ghosh talked about it, is leakage of Rs 3 lakh crore of liquidity into currency. The question is what is happening to that. This is not unexpected; before elections this always happens, there is always cash withdrawal for election purposes. The real million dollar question is how much of that is going to come back to the banking system and how much of that is going to be retained in the cash economy. Now that’s something that is going to playout over the next month or month-and-a-half. So we will have a fairly decent idea as to what is happening to bank liquidity in about a month or so and that is something we need to keep an eye on. But even if it doesn’t come back to the banking system, we also need to be very clear that there was a liquidity constraint in the cash economy as well. If that liquidity constraint is getting eased, then one should expect to see some growth returning essentially from the cash economy rebounding which will not appear in the GDP data in the immediate future. It will eventually find its way there about three-four quarters later. So you are not that pessimistic on growth, should I gather? Sen: Yes and no. I think as far as the headline figures are concerned, which is quarterly GDP figures. I am pessimistic. I think that will continue to go down for a while and the reason for that is the aftereffects of the slowdown in the micro, small and medium enterprises (MSMEs) sector. They are now starting to get played out in the corporate results and it will take some time to reverse because the process does have a fairly long issue that is involved. So in the next two-three quarters I expect the numbers to get worse and worse. What do you think the MPC ought to do? Varma: We need to go back to the drawing board to ask the question what should be the MPC’s priorities right now. I think the number one priority at this stage is financial stability. The system is quite fragile. We have seen eight months of the NBFC stress continuing and therefore the interlinkage between NBFCs, mutual funds and banks, the problem has persisted for quite some time. Second, the growth problem of course is there as we discussed and third, like you said it is all about transmission at the end of the day. The rate cuts have not transmitted and that is partly because liquidity has been tight. So I think if we keep all these 3 things together, then the common factor here is that the liquidity conditions need to be positive, the skew on liquidity needs to be positive. So that is the number one commitment that the RBI should be giving and second, consistent with inflation being within the target, growth being below target and financial stability being the number one priority right now. I think it definitely calls for frontloading and pre-empting whatever rate cuts need to be delivered. Would you agree that rate cut is not enough, there needs to be some signal on liquidity and the MPC may even proactively make it clear that even with fiscal slippage, which looks maybe likely this time, the MPC should keep its accent on growth. Do you think that should be the message conveyed? Chinoy: A couple of things. One, we should not overload with the inflation targeting framework with so many more objectives than instruments. I agree that financial stability is a concern but there are regulatory measures that one can use. I agree that the NBFC sector is frozen but we have been arguing that some kind of asset quality review (AQR) will be necessary to break the asymmetric information loop.
I think the framework should go back to where is inflation and if inflation is under 4 percent, where is growth. Now, on your transmission issue, I think at the margin, liquidity will help but there are some steps that the government can take to enable higher monetary transmission. For example, those small savings rates being at the level they are make it harder for deposit growths to pick up and when incremental credit deposit ratios get to the levels they are, it is going to be hard for banks to transmit rates. The curve for the most part except the last three weeks has been very steep. I would argue because the public sector borrowing requirement is close to 9 percent of GDP. So my point is while liquidity will help, there are some fiscal things the government can do, things on small savings schemes, which will help enable monetary transmission.
Now the Pradhan Mantri Kisan Yojana (PMKY) is not just for farmers with five acres but for all farmers, so there is going to be a strain on the economy. There is no way deposit rates will come down when, as Soumya Kanti Ghosh said, the gap between deposit growth and credit growth is so high and banks simply are hankering for deposits. And even the liquidity issue, the way in which the RBI keeps the rate at the call rate, keeps the repo rate at the call rate if it is committed to doing that then how will they introduce more liquidity, how will they communicate that they are for a softer side? Chakraborty: One part of your question is about an absolutely structural issue which is saving investment balance. I don’t think we have any short-term solution to a structural problem of increasing saving or even reducing public sector borrowing requirements overnight. Even if this small savings rate is brought down, the deposit rate is not going up so quickly? Chakraborty: This is the first part of the problem which is of a very structural nature, then comes what are the things that can change. So within the household financial savings, you can incentivise a little bit more coming towards bank deposits vis-à-vis small savings. So to that extent, the banking system liquidity might improve a bit but again this is not going to be an instantaneous process. The instantaneous solution that the markets would want is the liquidity provision by the RBI, which in a sense is just kicking the can down the road. So if there is some kind of a guidance from the RBI that liquidity will be kept comfortable in a quantity definition sense in the current level, I think that will provide enormous comfort to the markets.
The markets don’t want liquidity to be surplus and weighted average call rate to fall from repo rate to reverse repo rate; that does not happen in the current monetary policy operating framework. We have to accept that, but within that framework if liquidity is kept in a sense more neutral, I think that itself will be quite a bit of a positive.
Is this enough because the dislocation is at the housing finance companies (HFCs) space where people or banks are not even willing to lend. So is just an accommodative policy or a comforting stance enough or do you think something extra needs to be done as lender of the last resort, buying stressed assets, something that was done in 2009? Ghosh: Before coming into that, just a point on what Chinoy said regarding small savings. I think it is always a very good suggestion to bring down the small savings but I am not sure whether the government can able to bring down that because in the last couple of years, the government has been financing the fiscal deficit for small savings because once you reduce its reliance on market borrowings, the yields are not impacted. So from that point of view, I don’t know whether that is possible.
Regarding some sort of a window like in 2009, I think the current problem with the NBFCs is mostly on solvency issue because what is happening is that the better rated NBFCs are getting the funds and the NBFCs which are not better-rated, are somehow being distinguished. I think this is a natural course of the problem.
Regarding Samiran Chakraborty’s point in terms of the quantity, I think that is a good idea but my sense is that two things need to be done. The RBI needs to be very clear that it is injecting durable liquidity and not replacing durable liquidity with frictional liquidity or transient liquidity like government cash balances. Secondly, I would like to put the ball on the court of the RBI is that whether the RBI can give instructions to banks in terms of some benchmarking, external benchmarking, I think that has been out in the public domain for a while that banks need to see whether they could actually find out some mechanism whether assets on the liability side move together because until and unless we don’t walk down there, it will be very difficult on part of everyone to transmit the way the central bank wants.
If you can put all these prescriptions together, do you think a separate window is needed to give comfort to the NBFCs as well? What should the MPC ponder about, liquidity, CRR cut, all instruments, what would you do? Sen: I think the points that are being made cover the basis fairly comprehensively. There can be two issues that one needs to look at. The first issue is the NBFC problem and the financial stability issue that Sonal Varma was talking about, and then we have the alternate point of view that came later which said, let the system fix itself for a while. My personal view is that we need to get this NBFC thing sorted out and perhaps let it be sorted out in an organic way rather than through a direct policy intervention because what we have had is that over the last 10-15 years or so, the relationship between the NBFC and the banking sector has changed in a manner which I feel is undesirable. Now, I think this needs to get sorted out, a lot of the weaker NBFCs need to go, there has to be consolidation of the NBFC sector so that something similar to what is happening in banking, which is stronger banks starting to take over weaker banks, this sort of thing will have to happen in NBFCs. That is very desirable.
The second issue has to do with liquidity and this is at the heart of the whole problem. Liquidity is not just for increasing the lending or having the transmission happening. We also have to keep an eye on what is happening to the exchange rates and the exchange rates again do not fill you with joy. As it is the world economy is weak and if the Indian rupee continues to gain, in real terms it is certainly gaining, that is not good for anybody. So I would imagine that the focus now should be on liquidity and less so on the interest rates. I don’t think interest rates matter that much.
Finally on this question of external benchmarking, as a person who believes in markets, my gut reaction is that if you are going to fix the bank interest rates whether you call it external benchmarking or call it fiat, it comes from the same thing. I hesitate to get rid of an instrument which is telling me something about the market which I need to internalise and react to. So loss of information does not help anybody and external benchmarking will lead to a loss of information.
It is time to start voting. What is the action you expect cut or a hike and by how much? Varma: We are expecting a 25 basis point rate cut. Chinoy: We also think the MPC will cut rates by 25 basis points because they will worry about output gaps opening up. Chakraborty: We expect a 25 basis points rate cut. Ghosh: We are expecting a 25 basis points rate cut or larger than 25 bps. Sen: We expect 25 bps rate cut. What should the stance be? Varma: It is a bit too late, so we think at this stage stance would likely stay at neutral. Chinoy: It would be neutral. Chakroborty: It would be neutral because they missed the boat in the last policy. Ghosh: It would basically be neutral, little bit turning towards accommodative but I agree with the rest of the members that it is too late to change the stance now. Sen: I think it would be accommodative. How many rate cuts do you think including the one on June 6? Chakraborty: August rate cut possibilities are now open, so one more. Ghosh: One more but it depends on how much you cut this time. Sen: I think August they will pause because they need time for things to play out.