The Reserve Bank of India (RBI) is set to annouce its bi-monthly policy on December 7. Market and bankers are betting on a 25 basis points reduction in the interest rate.
In CNBC-TV18's 'Citizens' Monetary Policy Committee' (MPC) meeting, a panel of experts discuss the impact of demonetisation on growth and RBI's decision on rate cut.
The panel includes Pronab Sen, Chairman of MPC, Sajjid Chinoy, Chief Economist at JP Morgan, Sonal Varma, Chief Economist at Nomura, Soumya Kanti Ghosh, Chief Economist at State Bank of India (SBI) and Samiran Chakraborty, Chief Economist at Citi India.
"It is bizarre to talk about monetary policy when its instruments are not working. The entire banking sector in India is in default mode," said Pronab Sen. He added that MPC should recommend a cut in bank saving rate.
Sonal Verma said, growth for December and March quarter will be lower by 100-150 basis points (bps). She said demonetisation is turning out to be a wealth re-distribution scheme.
Demonetisation is transitory not permanent, believes Samiran Chakraborty. He said there will be decline in growth due to lack of cash in the system.
"Growth target for FY18 has been cut by 40 bps largely because of headwinds like goods and services tax (GST). FY18 inflation forecast has been set at a higher level than FY17," said Chakraborty.
The SBI Economist is of the opinion that RBI clarification on cash reserve ratio (CRR) can hint at rate cuts in subsequent months. Ghosh said, RBI needs to signal that incremental CRR will be phased out.
The panel also voted whether RBI will cut rates or not and the economists bet on rate reduction while, Sen voted for RBI to hold the cut.
Below is the verbatim transcript of the interview to Latha Venkatesh on CNBC-TV18.
Q: Do you expect that you are assessing the impact of the demonetisation to be rather severe on growth, will that impinge on your decision whether to vote for a cut or not?
Sen: I find this whole thing completely bizarre having we are sitting and discussing monetary policy, when all instruments of monetary policy are not working and will not work for a while. Today, I think we really need to shift our discussion a little bit and worry not just about the economy, but the fulcrum of all monetary transits which is the banking sector, because my sense is that as we stand today the entire banking sector in India is in default mode and we are just lucky somebody has not taken them to court - - so we really need to talk about what do we need to do in terms of Reserve Bank of India (RBI) policy to make sure that the banking sector is in deep trouble. Rate cuts are part of it, but I think one would have to pretty much stand the perspective on its head.
Q: You warned us as well about the precarious state of the banking sector’s health, but go to court why?
Sen: For the very simple reason that there is already a legal and technical run on all banks. While it is perfectly legitimate for the government to impose restrictions on withdrawals, if banks are unable to meet even the government imposed limits then the banks are in default. Government has said and the courts have upheld Rs 24,000 per week most banks are unable to meet even that need - - so technically every customer who is being turned away from the banks saying we don’t have cash for him the bank is a defaulter.
Q: What’s your assessment of the damage to the economy and what can the monetary policy committee (MPC) do?
Varma: The main question the MPC has to answer is whether they expect the demonetisation to have a transitory effect on growth or more permanent damage to the economy, because of the wealth destruction that might happen as a result of this and at this stage the assessment is that it is more and our view it is more of a short term damage because of huge dependence of cash on various segments of the economy, whether it agriculture, trade, construction, real estate and the time it is going to take the RBI to really replenish the notes - - so growth in the fourth quarter of calendar year so the December quarter and the March quarter our assessment is it is going to be at least a percentage points maybe between 1-1.5 percentage points lower.
The reason we don’t see this as a permanent growth damage is because it is turning out to be a scheme more of wealth redistribution, whether money is going into the banking accounts of the poor, the money that the government is going to get on additional tax revenues, which it can use for infrastructure and rural sector spending or the money that was lying under the mattress going to the banks, which can now be circulated back into the economy and therefore velocity of money picking up and for more productive sectors. This is going to start showing up as well on growth although with a lag, so it is a short term growth disruption, a transitory disruption in our view should not have a significant negative longer term effects.
Q: How much are you estimating growths to be cut?
Chakraborty: If you look at it I am quite agree with Sonal that it is more of a transitory thing rather than a permanent thing, unless this process of making an informal economy more formal which increases efficiency, but at the same time have an impact on employment. If this process if you take it too far and too quickly - - in fact, we know that goods and services tax (GST) is also going to come sometime soon that can also add to the pressure, then it can become a bit more structural in nature and the weakness can persist a little bit longer which is not as yet or base case. Our base case is very similar to what Sonal was saying about 100-150 basis points decline in the second half of the year.
Q: Do you assess that the removal of probably Rs 4-5 lakh crore black money, while it has come back or will may come back in the laundered version some part of it at least. Does it prevent say buying of luxury goods, conspicuous consumption, real estate deals and therefore will that part lead to a slightly more longish impact on growth. Is FY18 growth in danger?
Chakraborty: So as long as this money is coming back into the system, I don’t see a reason why it cannot be used for consumption purposes, except for the fact that maybe there could be the shock and awe effect for a while, which might force people not to spend, there is an increase amount of uncertainty which can affect business spending as well, so I am quite conscious about that and maybe that can have a little bit of an impact on growth, but at the moment the kind of declining growth that we are seeing that is more because of lack of cash in the system rather than anything else.
Q: You are not disturbing your FY18 numbers yet?
Chakraborty: Not much we have reduced it by about 40 basis points, but that simply not because of this it is more because of the other headwinds that like GST we were anyway trying to bake in. At this moment what we think is that some kind of an insurance rate cut can come in, which just says that okay we are aware of the decline in growth. This is something which is there just to support the economy a bit and keep the ammunition dry for more action if it is warranted at a later stage.
Q: How do you think the ripple effects can be and if growth remains subdued for a longish bit then are we looking at a totally different trajectory for inflation for FY18 from what you thought maybe 2 months back?
Chinoy: We are not, we are of the opinion always that there was downside risks to the RBI 5 percent forecast and even before the demonetisation had pencilled in about 25 basis points of easing in the cycle. I think what this does is give the RBI a little more comfort that those downside risks exist or there aren’t upside risks. I agree with Sonal completely that three weeks ago people worried about the wealth effect what the impact over the next couple of years, now the concern is much more a liquidity constraint that is going to be binding for households.
The question the MPC has to ask itself is two things; one is, is this a 1-2 quarter phenomenon or is it 3-4 quarter phenomenon. If it is the latter and pricing power doesn’t exist for 3-4 quarters then you have a more sustainable dampening effect on inflation expectations - - I think the space maybe different depending on the assessment.
The second is we talked a lot about the demand shock, this is a negative demand shock but is this also a supply shock, we have seen oil prices move up globally and is there some impact on value chains of supply in the near to medium term, so I think these are the two assessments they have to make, which is that in our view downside risks to inflation that opens up some degree of easing, what that quantum is depends crucially what you believe whether this is a two quarter demand shock or a 4 quarter demand shock, because I think the latter will dampen inflation expectations.
One other thing we should not forget this is being conducted in a very turbulent global environment. We are so focussed on the domestic factors here, you are seeing after the latest NFP numbers 100 percent pricing of the US Fed raising rates in December, the dollar index has strengthened, oil prices have moved up and after the Italian referendum there is more uncertainty in Europe.
In this very turbulent global environment where the interest rates differential between US treasuries and Indian 10 year G-Sec (government securities) have narrowed by more than a 120 basis points in three weeks. The question the RBI has to asked itself is how comfortable are you and in what sequence should one be cutting interest rates - - that will in a way determine whether you want to frontload some easing or stagger it out once more information is known domestically and internationally.
The last thing I will say is we have had one economy wide data point since then the manufacturing PMI which came out late last week, if you look at the new order component it is only three weeks of data in November that fell quite meaningfully. This was the biggest drop in 4 and a half years, so there are lot of moving pieces and I sympathise with the uncertainty that the MPC finds itself in at this meeting.
Q: We are really wanting to listen to what the biggest bank has to say. How deep is the hurt on both the banking front and on the economy front according to you? Is this just a couple of quarters? Will things rebound?
Ghosh: It is very difficult to tell at this point of time because we are getting contradictory points from our grass roots. Let me give you the positive points and then the negative points. The positive thing is that there are reports that there were some disruptions for example in cement dispatches or fast-moving consumer goods (FMCG) sales for the first couple of sales and then their sales have actually rebounded. So, this is the first thing. The second thing is that some parts of the country we are in fact, heard that the pain is not too much. There has been some little pain yes, there has been some disruptions but not to the extent which the markets may tend to believe.
On the negative front, some of the sectors possibly could be a little bit, already has been a drag on the economy for some of the real estate sectors. And also, even though we have been listening positive news, the jewellery sector and this is some of the sectors which has been doing badly and that could actually act as a drag on the growth. So, as of now, it is difficult to say what could be the impact of growth, but I am sure, for this quarter, the growth could be actually impacted by anything upwards between 50 and 100 basis points.
Second quarter, the only thing is how these deposits come back because right now, there is a withdrawal limit on the deposits which are entering the banking system. So, once this withdrawal goes up and even if you are assuming that a 80-85 percent withdrawal deposits and even if you are assuming a Rs 13 lakh crore of deposits comes through as a conservative estimate, there could be an addition of Rs 2 trillion to the banking system which is a permanent injection in deposits in terms of the net liquidity.
So, this is going to be a big positive for the banks. So, withdrawal rate for example, for our banks, which was very low, less than 10 percent at the beginning, if we just take the pure withdrawal rate to the deposits which is coming to our bank is now close to around 45 percent or so at the end of November which has inched up further. So, my sense is that the rebound will depend on how quickly those deposits go up and the banks are able to make business opportunity out of it. My sense is that this figure could be in upwards of 80 percent if we look into the historical trends.
Q: The withdrawal will be 80 percent.
Ghosh: Yes, 85 percent, so the net deposits could be around Rs 2 trillion or so on. In that case, the rebound in the next quarter could be a little bit on the higher side.