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A reverse repo hike may be needed, but RBI may stick to hinting one

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The moot point is - does the RBI’s ultra-cheap money policy percolate to the informal sector at all?

The updates coming from companies for the second quarter are a far cry from an economy in distress. Titan reported a Jewellery Revenue growth of 78 percent in the second quarter from year-ago levels, while its growth over two years is 74.5 percent per annum.
Macrotech or Lodha developers reported a 109 percent growth in sales in Q2 over Q1 and 88 percent over the year. Down South, Sobha developers also reported a 51 percent jump in sales volume over the last quarter.
And this is not just a micro picture. The two-year compounded annual growth in total taxes, April-August is 16 percent , with corporate taxes growing by 23 percent, excise by 34 percent, and GST by 6 percent ( all 2-year CAGR). Yes, this is only formal sector growth. And even within this sector, it may be the cream of the formal sector. Samiran Chakrabarty of Citi pointed out in his report covering Q1 earnings that the wage cost of listed MSMEs fell more than the trend in the April-June quarter. It normally falls by 2.4 percent from Q4-levels; but this year it fell 4.1 percent. Indeed last year wage cost of listed MSMEs dropped by 13.1 percent in Q1 from Q4 levels.
The informal sector is clearly in pain. CMIE’s surveys show the labour participation rate in GDP remains 2.7 percent lower than pre-COVID levels, while the employment rate remains 3.3 percent lower than pre-COVID levels.
The government’s Periodic Labour Force Survey shows that percentage of people in agriculture and in household self-employment has increased, signs that show severe underemployment and unemployment. India’s has always been a 2-speed economy, but now the two halves of the economy (one maybe 20 percent, the other 80 percent) are actually trending in opposite directions.
But the moot point is - does the RBI’s ultra-cheap money policy percolate to the informal sector at all? The cheapening of money is in the hope that low cost of capital will goad the top companies to invest in CAPEX that will generate growth opportunities and jobs for all. Yet right now this argument sounds too inadequate to keep the overnight rate as low as 3.35 percent. Bankers point out that many corporates have been borrowing 10 and 12-year bonds at rates tied to the t-bill, and hence these corporates are currently paying less than 6% for really long tenor loans.
Of course, this low rate is only for a brief period in the life of the loan, but it nevertheless shows how much assets may be mispriced and how skewed the impact of monetary policy can be on the rich borrower and the poor saver. Besides mispricing of loans, can the RBI ignore the impact of its deeply negative real rates on asset price inflation, as savings flee from bank fixed deposits to the equity markets?
The RBI’s big solace is that inflation, especially food inflation is all set to fall, bringing headline CPI even below 4 percent in coming months. But core inflation is likely to remain at the current 5.8 percent and even climb as the high energy costs and shortages due to supply disruptions get worked into prices.
The RBI’s own forecast is for a 5.7 percent inflation for the current year (maybe it will moderate it to 5.5 percent) and a 5.1 percent in Q1 of next year. Under the circumstances, it seems unjustified to keep overnight rates as low as 3.35 percent. One-year t-bill rates are at 3.9 and one-year corporate bond rates at 4.1 percent indicating a 100 basis point loss straightaway for every saver. The RBI needs to ask itself if the risks to the economy require propagation of such severe negative returns for so many for so long.
The AAA and AA corporates are the only ones who access the corporate bond market. It’s this group that’s growing earnings at a CAGR of 25 percent this year and next. Is there any need then to keep 12 lakh crore of loose cash sloshing in the system? Chakrabarty of Citi argued on CNBCTV18 that the patient, ie Indian economy is out of the ICU but not out of his sick bed. And hence, while RBI may raise the reverse repo rate it may clearly explain that it is removing emergency measures introduced last year (like increasing the corridor between reverse repo and repo rates to 65 basis points from 25 bps earlier). RBI may still indicate it is in accommodative stance because growth needs help.
Most economists agree that the overnight rate is way too low, including among them, MPC member J R Varma. But many believe the RBI may want to stay true to its promise that it will start normalising only after clearly guiding so.
The widespread expectation, therefore, is that RBI will :
  • Indicate that normalcy is returning by suitably amending the words “continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis”
  • Not raise the reverse repo rate just yet, but give ample indication it plans to do so
  • Clearly indicate its move to reduce liquidity by announcing longer-term VRRR auctions (variable reverse repo rate auction – a method used by RBI to remove money for 7-14 days)
  • Either stop the Government Security Acquisition plan or reduce the size to under Rs 1 lakh cr and indicate it may immediately suck out the liquidity introduce by the purchase of bonds, with a simultaneous sale of bonds.The market is clearly prepared for some removal of liquidity by RBI, as reflected in the rise in the 10-year bond yields from 6.12 percent on September 20 to 6.28 percent today. If the RBI sticks to elongation of the VRRR auctions for larger amounts, bonds may be bought. But if the RBI hikes the reverse repo or fails to announce a GSAP ( bond-buying) plan, bond yields may rise further. This once yours truly will vote with JR Varma ( of RBI’s MPC) and Samiran Chakrabarty (of CNBCTV18’s MPC).Yes the GDP by March FY22, will barely catch up with the size of India’s GDP in March FY20. But for specific parts of the economy – technology, markets, finance, real estate – the growth in output has been substantial. And a bulk of the borrowers hail from this group. It will be very dangerous for the RBI to keep 12 lakh crores of liquidity sloshing around.
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