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Here is what experts have to say about RBI's monetary policy meeting this week

Here is what experts have to say about RBI's monetary policy meeting this week

Here is what experts have to say about RBI's monetary policy meeting this week
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By Latha Venkatesh  Oct 3, 2018 7:12:36 AM IST (Updated)

The Reserve Bank of India (RBI) monetary policy committee (MPC) will start its three-day meeting from October 3 to decide on the fourth bi-monthly monetary policy. After two successive hikes, the repo rate currently stands at 6.50 percent.

The Reserve Bank of India (RBI) monetary policy committee (MPC) will start its three-day meeting from October 3 to decide on the fourth bi-monthly monetary policy. After two successive hikes, the repo rate currently stands at 6.50 percent.

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CNBC TV18's Citizens MPC comprising of Pronab Sen, former principal adviser of the planning commission, Sajjid Chinoy, Asia Economics at JP Morgan, Samiran Chakraborty, chief economist at Citi, Sonal Varma, India chief economist, Nomura and Soumya Kanti Ghosh, group chief economic advisor, State Bank of India met to discuss how the RBI can accomplish such nearly conflicting objectives.
A majority of the economists in CNBC-TV18's Citizen's MPC voted 3-2 in favour of dropping neutral stance.
Does the current situation call for the RBI that not just inflation but financial stability has to be addressed?
Sen: Now, RBI not only has to do inflation targeting but even financial stability has to be addressed. The question, of course, is that how should they position themselves? Because the finance ministry is already taken a whole bunch of steps mostly contractionary in nature. They will have to talk about that, they will have to say whether the further monetary contraction is called for, so this discussion is going to have to be there.
At the end of the day, a decision as to what they are going to do with the policy rate may have to depend on other considerations. But they will certainly have to talk the market into a calmer state mind.
Explicitly do they have to say a financial stability or do they have to reiterate inflation targeting and generally continue to speak about neutral liquidity?
Ghosh: There are two things, I will state very quickly. The first thing is that the current disturbances in the global market is because of the emergence of the dollar as an overemphasized currency. The important thing is that in the last couple of years after 2010 the dollar-denominated securities have actually outpaced the bank loans given the bank aversion to lend after the crisis. and that has been one of the reasons why the dollar has gained so much in pre-eminence. About 62 percent of the global debt now, 56 percent of the international loan, 46 percent of the global foreign exchange market turnover and 63 percent of the global foreign exchange reserves are based on dollar. So, the emphasis on the dollar as a dominating currency is most in the current era and that is why the depreciation in the emerging market currencies happening.
Now coming to your question of the financial stability, I think it is a very interesting point. In the last Fed meeting when Jerome Powell was made a statement that US FOMC has been repeatedly emphasising that there could be a more flexible and reactive analysis of the neutral interest rate which is an unobservable variable.
A recent research shows that in times when the financial stability is in a little bit of crisis the FOMC take explicit note of that and possibly mentions it implicitly in the policy statements which may also have an impact on the interest rate decisions for the Fed.
If I take that cue into consideration the RBI obviously have the right to state in implicit or explicit terms what are the problems of inflations stability even though it is an inflation targeting central bank.
So, we can expect some sort of statements on the financial stability front maybe something to assuage the market that liquidity is not going to be constant. The central bank has announced an open market operations (OMO) calendar today, so I think it will find some mention in the policy in terms of some regulation with respect to the NBFCs, with the banks so as to take care of the current market disturbances.
What do you expect to hear on inflation since there could be two or three factors -- rupee, crude, output gap?
Chakraborty: Compared to the August predictions that RBI had made, inflation has under short by about 50-60 basis points in the last couple of prints. So, purely based on that the forward-looking trajectory should have been comfortable.
Especially, what we are seeing is that the minimum support price (MSP) hike is not yet getting pass through at all even on a sympathetic basis in market prices.
Doesn't the undershoot get more than countered by the core as well as fuel and rupee?
Chakraborty: Exactly, so even core inflation the momentum has softened a bit but now with fuel at 83 and rupee at 73 there is this risk that inflation expectations increase quite substantially.
I think the data point for me which will be most important in the October policy is how much inflation expectations have gone up in comparison to the August policy and that is the thing that will drive the RBI policy.
If inflation expectations have gone up then regardless of the near term decline in inflation RBI would be wary of the fact that this financial stability argument can actually go head and destabilise the inflationary expectations as well.
Let us not forget that while Pronab Sen was mentioning that there is a little bit of contraction required because RBI's own estimate is that even the financially neutrally output gap is closed down completely they have to do its bit to correct the current account deficit itself. So, some amount of softness in growth is required just to ensure that the current account comes off.
We can't only rely on import tariffs to do that. So, that is why the possibility is that despite current inflation to be low with higher inflationary expectations and the need to moderate the growth in output, the RBI policy can turn out to be a little bit more hawkish than what we had anticipated in August.
Very quickly can you all three just give me a numerical number of your inflation projects?
Chakraborty: We are between 4.50 and 5 a year ahead.
Ghosh: Our average for this year is 4.4 percent and a year ahead is close to 4.8 percent.
Chinoy: I think the numbers that matter are January to June because the next few months are full of base affects. Average for us is above 5 percent.
The borrowing programme has been announced at Rs 20,000 crore less than what the market anticipated and Rs 70,000 crore less than when the Budget itself was announced. Will that be one argument less for the RBI to be hawkish?
Varma: The borrowing calendar reduction, the fiscal deficit estimate is still very much the same.
It is partly the lower buyback and more financing through the small saving funds which is happening. I think, on the states front there will be a slippage but from the centre's side the message has been very clear that there will be no fiscal slip.
Our own assessment is that GST collections will undershoot and, therefore, the only way to still stick to the 3.3 percent would mean a significant slowdown in spending in the second half of the year. So, we do think that fiscal impasse is going to be negative going forward.
One thing that we need to get out of the way is that the RBI should not hike rates to defend the currency. For a country like India where you have like less than 5 percent foreign ownership, where the banking system is still fragile and shadow banking side is starting to sort of shake, the financial stability argument stems actually not from the currency but more from the credit risk that could rise in the system because of trying to defend the currency.
So, we need to be very clear of what the MPC should and should not do. The MPC should focus on inflation and it should not hike rates to defend the currency.
On inflation outlook necessitate a rate action, our own assessment is that despite the currency and the oil shock, inflation is set to undershoot the RBI's projections in the second half of the year for sure.
Apart from food, the core momentum has been quite stable. As a forward looking MPC, the focus has to be on the growth risk. We have seen significant growth recovery over the last 12 months, the output gap has probably closed. However, all impulses on growth are now pointing to a significant slowdown in growth going forward, not just because of oil prices but because of tighter financial conditions. I think that needs to be considered adequately this time.
I want to refocus on the rupee. Will it not be the RBI's responsibility to at least cool down consumption given the way in which imports are growing even if it is not defending the currency and it may not want to do that?
Chinoy: Let us step back and ask the overarching question on the framework. I agree with Sonal, the framework should not change. In a world where there is so much macro-economic uncertainty, the last thing you want to do is inject policy uncertainty.
The framework has held policymakers very well and to my understanding, it is that we have flexible inflation targeting, policy rate should be set keeping in mind one year inflation projections ahead and that should not change.
At the sametime, we know there are two objectives the central bank has, if there is FX misalignment you address that through sterilised intervention and you address your inflation objective through policy rate.
So, you have two objectives in two instruments. If you follow that framework, I think financial stability, macroeconomic stability follow naturally out of that.
Let me explain what I mean. I disagree with Sonal in terms of inflation projections. Yes food has undershot but if you go to the fact that oil prices are 14 percent higher and going up everyday, it is not just the level of oil prices, it is the fact that now the whole thinking on the oil market has changed compared to three months ago. We know that if all other EM currencies come under pressure, the rupee cannot fully escape that.
So, if you put together crude and the rupee, core inflation in the first half of next year will be closer to 5.5 percent. We know that in emerging markets, it is the headline that asymptotes to the core and not the other way around.
So, if you just stick to the existing framework, some degree of monetary tightening may well be required going forward and that itself will have a fallout impact on the current account deficit, balance of payments and the rupee. If you then go back to your second objective which is sterilised intervention, that itself entails much more injection of liquidity because you have to counter two things, one is you are selling dollars, the second is currency in circulation is still been quite higher.
So, I think this balance actually is working out well. You raise policy rates because inflation expectations are higher, inflation is higher but you offset some of that by injecting liquidity like they have done in the last few weeks and plan to do it in October because we are not adding liquidity, we are replenishing liquidity.
For me the framework is not broken, there is no need to fix it. Policy rates will probably have to go up in October for inflation, you will see more open market operation (OMO) in the second half of the year and that will have a salutary impact on the credit market and on interbank liquidity. Let us not tinker with what has been working so far.
Just how much emphasis should the RBI and the MPC give to the credit markets which at this time are fragile?
Sen: Quite a lot actually. It is not just a question of fragility, it is also the question of loss of confidence. At the moment, I think the confidence issue is the one which really needs to be addressed. There is just too many pieces of bad news floating around and there is a feeling of being unanchored and that needs to be checked.
Now whether this has to be done through obvious overt policy steps or it can be done through actually laying out a roadmap for bringing back financial stability is really the question that MPC has to address. Do we need to do knee jerk reactions now or can we wait?
The market is also talking about a cash reserve ratio (CRR) cut, is that an instrument at all?
Varma: I think in the current environment where there are clearly supply side cost pressures in the form of oil and rupee, clearly a CRR tool which has both the liquidity as well as the monetary dimension cannot be used. Whatever liquidity injection durable needs to be done, will have to be done more or less via OMO buyback which is what the RBI has announced.
However, a cut in the CRR at this stage clearly will be a very risky strategy and not the right thing to do.
Sajjid your comment on that and more importantly, the market is also talking about a 50 basis point rate hike simply to reassure confidence; other central banks have done that as Sonal pointed out.
Chinoy: If you stick to the framework and focus on inflation one year ahead, I do not think that warrants a 50 basis point rate hike. There is a fine line between being preemptive and cautious, and signaling a knee jerk reaction or signaling panic.
So I think what the RBI has done so far, 25 basis points in June, in August, that should be continued because the inflation risk has increased to the upside.
At the same time, for those very reasons, we should not overreact on the liquidity side. There is a well laid out liquidity policy that the headline liquidity needs to be close to neutral and that durable outflows will be met by durable injections. This has worked well for the last two years. The more durable outflows there are, currency in circulation effects intervention, the more OMOs we will see.
I think the CRR is too blunt an instrument because these could reverse in the next three or six months.
Rate hike you are expecting only 25 basis points?
Chinoy: We are expecting in October a 25 basis rate hike, but a continuation of liquidity.
I will make the last point, I do not think there is a conflict between growth and inflation because what the world is seeing is both higher oil prices and higher import tariffs.
These are adverse supply shocks. Both things can happen in tandem. You will have higher prices and higher inflation around the world and lower growth. So looking forward, growth will not be a good predictor of where inflation is and which is why central bank jobs become more complicated when faced with multiple adverse supply shocks.
What about stance, I do not know if you are going with a rate hike, but if the rate hike comes along with a change in stance from neutral to whatever, removal of accommodation will be perhaps the only other phrase, will that be a right signal?
Chakraborty: The question that RBI will have to deal with is that where is inflation expectation and where is one year ahead inflation projections are? If they feel that that number is significantly higher which warrants at least couple of more rate hikes from here, then there is some argument for even change of stance because let us not forget that on a metric like output gap, things have closed down and that could anyway warrant the stance to change.
However, I would agree with Sajjid that the liquidity part has to be kept aside from this. We now have a very easy metric to track liquidity which is that the call rate has to be between the repo and reverse repo rate.
So, RBI can pump in any amount of liquidity replenishment to ensure that the condition is being met. However, the bigger question is on inflation expectations that would drive the change in stance.
Last point I would make that we might not be defending the currency, but it is RBIs responsibility to ensure some of the structural imbalances, be it the savings investment gap or the current account gap, a mirror image of that, they cannot completely ignore that structural imbalance.
If they feel structural imbalances are more acute than before, then change in stance could be warranted on the back of that as well.
Your take on the same, Soumya, change in stance plus rate hike, is something the market can stomach?
Ghosh: Before that, I want to answer one point which has been repeatedly cropping in terms of the liquidity management. I completely agree that liquidity management is a different ball game and that could be kept separately from the inflation targeting. If you look into the current market dynamics, I think the issue is uncertainty.
Reverse repo outstanding with the central bank has jumped 31 times in a span of seven days. So that means the liquidity may not be such a big issue at that point of time and it has to be compensated in terms of the sterilised intervention and other things.
Coming to your point on whether a change in stance is warranted, I think that a third successive rate hike without a possible change in stance may at the same time look a little bit contradictory, even the inflation is going to undershoot the RBI projection.
From that point of view, if the RBI goes ahead with a rate hike and given the fact that the core inflation as Sajjid was saying, I agree with him that core inflation, the momentum is slowing down, but the structural changes in the core inflation will inhibit it from falling significantly below 5.5 percent.
If that is the case, and given the fact that we may be looking at a rate hike in the October policy, a change in stance after three successive rate hikes may not be the ideal message for the market.
Any winding up comments?
Sen: I think we need to be clear about one thing that we are living in a world which is extremely jittery. We have a situation where our investors are jittery, both because of the global news as well as the domestic.
As far as the RBI is concerned, at the moment I think rate management is the least of its worries. A lot will matter as to how the RBI weaves in the larger narrative of bringing back financial stability in the system with its position and its stance vis-à-vis rate hikes and the future prognosis.
This is a very tricky act, in fact, I am not very concerned about what they do in the October policy, but what I am concerned about is how they phrase the policy statement.
We will start the vote. First question on what should the RBI do on the rate action?
Chakraborty: 25 basis point hike.
Ghosh: 25 basis point hike.
Chinoy: 25 basis point hike.
Varma: Hold.
Sen: Hold.
What should RBI do about its stance?
Chakraborty: Change of stance.
Ghosh: Change of stance.
Chinoy: Change of stance.
Varma: Neutral.
Sen: Neutral.
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