Macros improve: Will RBI bite the bullet?


On the eve of every monetary policy CNBC-TV18’s Citizen’s Monetary Policy Committee meets to deliberate on what the official Monetary Policy Committee (MPC) should be doing.

In an interview to CNBC-TV18, Chairman Pronab Sen, Former Adviser to Planning Commission and Members Sonal Varma, MD & Chief India Economist at Nomura Financial Advisory & Securities, Soumya Kanti Ghosh, Chief Economic Advisor to State Bank of India, Sajjid Chinoy of JPMorgan and Dr Samiran Chakraborty, Chief Economist at Citi shared their views on the likely outcome of the meet.

The growth inflation context has clearly changed. The 2Q gross domestic product (GDP) numbers have shown an upturn but consumer price index (CPI) numbers may also see an uptick given the sustained increase in crude and global metal prices as well, in fact global growth also appears to have surprised on the upside.

Below is the verbatim transcript of the interview.

Q: How would you read the second quarter GDP number and as well, put it in context with the recent uptick in prices as well?

Sen: As far as the second quarter is concerned, it has to be seen in the context of the first quarter. In the first quarter, we do know what happened. It came down. There was a destocking issue. We knew the destocking was going to get overcome in the second quarter and that showed up in manufacturing. The problem of course is we do not know where we are on the cycle because we are still essentially jumping up and down on a fairly unpredictable trajectory. So we still need to wait and see at least for the next two quarters where we are going and how things are heading. The investment numbers still do not look good. 4.7 percent growth may be exciting, but seen against GDP growth of 6.3 percent or still sequentially getting a lower investment to GDP ratio. So all of that means we are in a very uncertain zone even today.

Q: The growth looks like it needs less support now, would you say, given the way in which the GDP numbers have turned out?

Chakraborty: In our assessment, it is a pretty nascent recovery at this moment. We have had significant slowdown in growth for five quarters so we are just recovering out of that. I do not think we need any particular stimulus at this moment, but at the same time we should ensure that there are no more headwinds coming which will derail the growth process at this moment. Let us face it that global growth cuts both ways. While it helps us increasing exports, at the same time we have to be worried about the commodity price impact coming out of it. So, from that perspective we have to be much more careful. We have just done significant structural reforms. The structural reforms often have short-term costs associated with it, so we possibly might see a little bit of that still lingering on in the system and whatever little of third quarter data we have seen, that has been a bit tepid. So we have to keep that in mind as well. So I would say that it is time to be a bit cautious on growth rather than showing a green flag and saying that everything is fine.

Q: Let me get the global context as well in. Do you think the global growth is extremely positive? What should we expect in terms of rate cycles as well as global commodity prices? What should the MPC worry about?

Varma: The global growth front is definitely looking one of the best we have seen in the last six-seven years now and most projections for 2018 are that this global synchronised recovery that we have seen for the last 12-18 months will actually continue. So the growth outlook is quite positive. Fortunately for emerging markets, inflation is still under check. So we are in this goldilocks zone for emerging markets in terms of capital flows still continuing and the pace of monetary policy normalisation also being gradual. So in this backdrop and the world that we are stepping into in 2018 as of now does appear like this goldilocks kind of a scenario can continue for the foreseeable future and a bit of policy normalisation continuing from the Fed on both rate cycle and on the balance sheet normalisation. The European Central Bank, we think, will announce a tapering off its asset purchase programme mid-2018 and we have a lot of other global central banks also normalising. If we look at more regionally, Korea is one of the first Asian central banks to actually join the Fed-lead normalisation and the cues we are getting from other central banks in the region is that Malaysia, Philippines, Taiwan, a lot of these central banks actually will be also gradually hiking interest rates in the next 6-12 months. So, that is the global backdrop we are getting into. It is very different from the backdrop we have had in the last two-three years and from a commodity price perspective, of course, it suggests that there is still demand and perhaps, stable commodity prices around current levels should be the baseline that we work with.

Q: How worried should we be about inflation? I will come to growth as well, but inflation?

Chinoy: Since the last review, all the inflation risks have moved in one way. Oil prices are now 12 percent higher than they were when the RBI last met. They are 12 percent higher than what is presumed in the RBI’s inflation forecast. You saw some unseasonal increase in vegetable prices. Global commodity prices, metals have gone up, but most importantly, if you look carefully, at core inflation – and this is not trivial because you have got to adjust for petrol, diesel, housing – what you see surprisingly, or at least at the time, was that core momentum both in September and October was quite steep. Prices went up 0.5 percent month-on-month, seasonally adjusted. This was not goods and service tax (GST) related because the GST impact was July and August. Now, that makes sense. If you look closely at the GDP numbers that came out, the headline understates the kind of recovery in the private sector. Adjusted for agriculture and government spending, we have gone from 3.8 percent in the first quarter to 5.5 percent to 6.8 percent. Now the pieces add up that India’s domestic recovery is nascent, but is occurring, maybe a little more strongly than the headline numbers suggest. That, in conjunction with the pickup in commodity prices and oil prices is forcing producers to pass this on. So either pricing power has picked up or you being forced to pass on these input price increases. What all this means is November’s consumer price index (CPI) will likely come out higher than 4.5 percent, December could be at 5 percent and the first quarter of next year could be closer to 4.8 percent which is above the RBI’s forecast. And most of next year, I think, will be between 4.5 and 5 percent. Even if you net out the 40 basis points from the house rent allowance (HRA), what that tells you is underlying inflation is close to about 4.5 percent in the first quarter, number one. More importantly, this is not vegetable induced. For me, the core is the key here that the fact that core momentum has gone up means core inflation will be above 4 percent correctly measured in the first quarter of next year. So this becomes relatively straightforward meeting for the MPC. It has been a tricky year, but now all the forces are moving in the same direction. Global growth is solid, India’s growth is following suit, albeit slowly, commodity prices are picking up, core inflation is picking up, fiscal risks still linger, all this argues for policy to behave in one particular way which is to stay on hold at the moment.

Q: You and Sonal are almost giving me the impression that it is time to hike.

Chinoy: Way too premature.

Q: I want the fiscal picture. One of the big problems that the MPC bothers about, will we see a fiscal slippage? How should the MPC add up those numbers?

Ghosh: In terms of the fiscal, there is a lot of consternation in the market in terms of a possible fiscal slippage. But, even though a part of this maybe justified, given the numbers, the way they have come yesterday, 96 percent of the full-year estimates, but beneath the numbers lies some trends which the market, which all of us should pick up. The first thing is that if you look into the small savings collection, yesterday the total numbers came in at Rs 77,000 crore. So that is from April to October and that is 15 percent higher than Rs 66,000 crore last year. So at these rates, it is likely to be much higher than the Rs 1 lakh crore, budgeted. If that is the case then the government will be able to buy back that Rs 1 lakh crore of securities of which already did Rs 28,000 crore a day before. And that should be the crux of the market’s sentiments because at the end of the day, if you are able to buy back the securities and keep the net borrowing number at Rs 3.5 lakh crore which it has targeted then the markets would take a soothing point even though I believe that the fiscal deficit number could be a tad higher than 3.2 percent. But having said that, there will not be too much waiver on the path of fiscal consolidation because next year the fiscal deficit target could actually then be that much steeper, so I think that the government may actually keep the deficit a little higher but then go down from that level or keep it at the same level for the next year at least till the election is over. So in my sense, the market should look very closely at the net borrowing numbers because at the end of the day, that is one thing which is going to have an impact on the yields which are currently at higher levels than what market fundamentals warrant.

Q: Do you think that rather than rates, the MPC should concentrate on liquidity in the system?

Sen: At the end of the day, monetary policy is ultimately about liquidity. Sometimes, you put the cart before the horse. The interest rate is a derivative. It is liquidity which drives what happens. Now when we talk about monetary policy and we talk about the policy rate, it is what is the cost at which the system will get liquidity? That is the question that is being asked when you talk about rates. In a situation of that kind, sometimes you have to use the rate to drive liquidity as there are other times where you have to use liquidity to drive the rates. I believe today, we are in the latter position.

Q: What is your sense about inflation? Sajjid has been drawing up a position that it might go up to 4.8 percent. Sonal believes that the global inflation scenario also is not looking too benign.

Chakraborty: It is clear that the inflation trajectory is going to be upwards from here for some time now. The question is the degree at which it will go up. I am a little less worried than Sonal and Sajjid on the inflation trajectory at this point of time. My sense is that the output gap is not closing fast enough to cause coal inflation to rise dramatically. Yes, there are commodity price pressures but particularly on oil, our global commodity strategist believes that we should be at below USD 60 rather than above USD 60 on oil for most of 2018. So I have to bake that into my forecast as well. The fact is that it is taking a while for the GST to stabilise, but once the GST is stabilised we should see some of the price increases that we have seen also to come down and at some point of time, the vegetable prices also needs to correct, so that should also have a kind of a soothing impact on the headline number. So I would probably be in the 4-4.5 percent range rather than the 4.5-5 percent range on inflation. That is something which RBI definitely would be cognisant of and probably not give them any farther scope for rate cuts, but at the same time, I do not see a rate hike coming anytime soon if this inflation trajectory materialises.

Q: What would your sense be in terms of what the MPC should bother about on the liquidity front? We saw open market operation (OMO) getting cancelled by the RBI when yields went above 7 percent. Should that be the philosophy that do not get the market too tight either?

Varma: We are transitioning towards a more normal year in the next 12 months vis-à-vis the last 12 months which, in a sense have been completely abnormal on any macro variable. So we are transitioning towards a more normal year in a macro framework. But importantly, the process of banking bad asset resolution still needs to happen and therefore, one expects that with this huge bank recapitalisation that has been promised, the process of resolution is going to move forward, but that still needs to happen. So in that context, the liquidity conditions have to be – around neutral is fine, it should not be too tight to thwart the entire resolution process. And in that context, the RBI has done Rs 90,000 crore of OMO already. Banking system liquidity on our estimates has come down to close to Rs 20,000-30,000 crore now although system liquidity is still above Rs 2 lakh crore on account of the government cash surplus. But looking ahead, the currency in circulation is normalising and therefore, that itself is going to drain out some of the excess liquidity that is still there from a system perspective, so per se RBI actually does not need to do anything because the system automatically on the liquidity front is going to get tighter in the next four months or so.

Q: You wanted to add something?

Chinoy: Yes, just to say the RBI, in a way, is caught between a rock and hard place and this goes back to the impossible trinity. The fact is that in a non-crisis scenario, the yield curve is extremely steep. The policy rates at 6 percent, the ten-year benchmark is at 7.05 and so, in a way, this interferes with the RBI’s liquidity management. Our own sense is that given cash withdrawal patterns you will still be in a situation where in March, the system as a whole, core liquidities and surplus of Rs 80,000-90,000 crore plus you have the Market Stabilisation Scheme (MSS) bonds for Rs 1 lakh crore, it will be rolled over. Now, in an environment where inflation is picking up, and if our forecast holds, will the RBI be comfortable keeping liquidity in surplus for another 6-7 months, number one? But the question is what does it do to alleviate the situation because if you continue doing OMO sales, given the imbalance in the G-sec market, that would argue for an even steeper yield curve. Ultimately, this goes down to the fact that the classical impossible trinity that emerging markets face, India is renowned for its macroeconomic stability, all this debt money came in, everybody is saying the exchange rate is overvalued, so the RBI is forced to intervene to prevent much appreciation. Then you have to sterilise that. When you sterilise that, you put upward pressure on yields and you are caught between a rock and hard place. So the interesting question is if inflation does trend up, and it is core inflation, how comfortable will the central bank be letting core liquidity remain in a surplus for another six months?

Q: You suspect it will not be?

Chakraborty: The other dilemma for them is that it affects their foreign exchange intervention behaviour which is creating a situation where monetary conditions are becoming extremely tight, both because yields are going up as well as the exchange rate is appreciating and the liquidity is tightening to some extent. So between October and December definitely the monetary conditions have tightened without RBI actually making a move on the rates.

Q: So you are almost asking them to buy dollars? That would alleviate?

Chakraborty: That is what they were trying to do but if they do that then liquidity goes even higher then you have to do OMO sale then your ten-year yields go up.

Chinoy: There is no free lunch here. If you buy in the spot, you add liquidity. If you buy in the forward, you push up the forward premium and that creates financial stability concerns.

Q: That may not be too much part of the MPC statement but MPC definitely has a say on the tone. What should the tone be?

Ghosh: In terms of the tone, before I say about the tone, in terms of the CPI, I just want to share Samiran’s views also. CPI, one interesting point is that if you look at the CPI trajectory from April till the last print, it has increased by exactly 60 basis points, the headline CPI but if you exclude the vegetables, that number has also declined exactly by 60 basis points. So as of now, apart from some fuel price induced core inflation high, this is largely a food driven CPI inflation. And the other thing about the inflation trajectory is that yes, it is going to go up from the next month. Possibly a number could be as high as 4.3 percent or even 4.4 percent. My sense is that January to June next year calendar, the inflation could be in the bracket of 4.5-5 percent, but then because of the base effects, this should come down to below 4-4.5 in the second half of next calendar, July to December. So you could see some good numbers next year towards August or September. So that means on a net-net basis it is going to balance out. So I do not see too much of pressure on the inflation number. Now, in terms of the tone which the RBI would like to say, I would also raise some of the concerns on the liquidity because apart from this CMB sales, Rs 1 lakh crore which is maturing, the other part is that this forward intervention. A large part of this forward intervention is going to mature next year.

Q: So, the tone?

Ghosh: So the tone of the RBI should be neutral because at the end of the day, I think the RBI doesn’t want to sound too hawkish when the growth is recovering and is just in a nascent stage. And even the recovery in growth, if you look very closely, it is mostly a matter of being driven by a deflator rather than a broad-based recovery. So in my sense, a neutral tone but with a little amount of caution on the external front.

Q: How would you want the MPC state to be worded in terms of its tone?

Sen: The way I would want it worded is that we do have a liquidity problem at the moment. We are in a situation where the yields across the board have gone up very significantly in the last month. And this is a time where we need to focus on liquidity, bring the yields down. Once the 364 Day Treasury Bill rate comes below 6 percent, that is when we can start looking, just even looking, at reduction of policy rates.

Q: A very quick statement on whether you want to make a quick note on what the tone of the MPC should be?

Chakraborty: I would also want a neutral tone at this moment. As we were discussing that while growth is picking up a bit, inflation risks are there and there are significant global uncertainties around. So a neutral tone at this juncture should be fine.

Q: When do you see the first rate hike?

Chinoy: I think it is premature to discuss rate hikes. If inflation is going to be in the 4-5 percent bracket next year and growth undergoes incipient recovery, unless India gets a large adverse terms of trade shock from oil prices going up another USD 20.

Q: So what do you expect the MPC should do in terms of rates? Would you want the MPC to hike or would you want it to cut or would you want it to hold?

Varma: Hold, pause.

Chinoy: It is a hold.

Ghosh: Pause.

Chakraborty: Pause.

Sen: Hold.