Amid muted growth, RBI may go for 25 bps repo rate cut: Experts

Ahead of the Reserve Bank of India (RBI) meeting on February 8, the question doing rounds is whether the central bank will cut rates or hold its decision to do so in the meet next week.

According to economist Pronab Sen, growth will be muted for a while and RBI should be concerned about this and it is important for it to take an independent call.

Concurring with Sen, Sonal Varma of Nomura says the impact of demonetisation is still playing out and things are not looking as rosy as the RBI has expected. And, Sajjid Chinoy of JP Morgan says that the central bank has to also watch out for global uncertainties.In conclusion, majority of the panel, including Pronab Sen, Sajjid Chinoy and Sonal Varma expect RBI to cut interest rates by 25 basis points (bps). On the other hand, Soumya Kanti Ghosh, Chief Economist at SBI and Samiran Chakraborty Economist at Citi India expect the central bank to hold its decison to cut rates. Ahead of the Reserve Bank of India’s (RBI) monetary policy on Wednesday, Latha Venkatesh, in discussion with experts, talk about what will be the central bank's decision in the meet. Below is the transcript of the discussion. The panel includes- Pronab Sen Former Chief Statistician Chairman, Citizens\\' MPCSonal Varma India Economist, Nomura Member, Citizens\\' MPCSamiran Chakraborty Economist, Citi India Member, Citizens\\' MPCSoumya Kanti Ghosh Chief Economist, SBI Member, Citizens\\' MPCSajjid Chinoy Asia Economics, JPMorgan Member, Citizens\\' MPCQ: Your take on growth, do you think it now needs more support than it has already got in the form of lower rates?Sen: I think there is more to come. Growth will be muted for a while and I think it is something that Reserve Bank of India (RBI) should be a little concerned about. The government has to put a brave face on it but the RBI really needs to take an independent call on it.Q: Assessment of growth?Sen: Assessment of growth, I would still say that for the year we are still looking at 6-6.5 percent. 6.5-6.75 percent of the Chief Economic Advisor (CEA) is a little bit of dissimulation. Q: Your assessment of growth but more importantly of inflation? We have seen it tick below 4 percent for three months now. Do you see this continuing and therefore more space for the RBI?Varma: Both the growth and the inflation outlook, the view for the next 3-4 months will be very different from the view for second half of 2017. Right now I think the impact of demonetisation on growth is still playing out. We have seen certain sectors like in services rural economy being more hit than others. Our assessment is that growth in the second half of FY17 will be closer to 6 percent. The impact of that on inflation therefore in terms of perishable food prices staying lower for some more time also does exists which means that the RBI which in December was also still talking about 5 percent with an upside risk, that obviously is not going to play out. Inflation is tracking closer to 4.5 percent. So, both the growth assessment of RBI which is 7.1 percent and the inflation assessment of the RBI which is 5 percent with upside risk, clearly things are not looking that rosy. The view post the next 3-4 months in our view will be very different because if the economy is remonetised, wealth distribution has happened, lending rates have come down, then activity levels should start to stabilise sometime around March and should see a decent rebound post April-May onwards. If that is the case then there is no reason why perishable inflation will stay low. So, we will also see some mean reversion in growth and inflation going forward. I think for now things are not looking as rosy as RBI had expected. Budget has been very prudent, so there is space.Q: What do you expect the Reserve Bank of India (RBI) will say on growth? They passed up the question or said it was minorly affected; now we have our two economists and all of you assessing it to be a deeper cut in growth. What do you expect RBI will say on growth and on inflation? Chakraborty: I think we have now got some organised sector data on how much impact has been. To be fair, the way the market feared there will be a big decline in things, the organised sector data at least is showing that the decline is not large enough. However, unorganised, informal sector impact, it will still be somewhat of a guess work from RBI’s perspective. So, I suspect that they might not immediately revise down their gross domestic product (GDP) growth estimate. They might wait for the Central Statistics Office (CSO) to come out with their own estimate before RBI actually altering their own. Q: They will stick with 7.1 percent? Chakraborty: My sense is that it will be difficult for them to give out a number so early which is different from the CSO’s number. So, I will be slightly surprised if they actually quote a number which is different from the earlier number. Q: In inflation, 5 percent looks ridiculous now? Chakraborty: Inflation, my sense is that sitting in February talking about one month ahead, March 2017 inflation is not what a central bank should be doing. A central bank should be putting out at least a 9-12 month ahead inflation forecast. So, from that perspective, I am hoping that they will put a March 2018 forecast in play and in my view that number should be around 4.5 percent. Q: Your expectation of what the RBI might say on FY18? Ghosh: There are two things playing out over here. The first is obviously the growth numbers and second is the inflation numbers. If you ask me, if I talk about the inflation numbers first, if you look into the RBI fanchart, in the past also, in 2014-2015, every time the forecast and the fanchart has been significantly on the upside. For example, in 2014 November, we had the RBI fanchart showing 8 percent inflation, then it crashed to 5 percent. A part of that because was the oil effect but there has been an over shooting of the fanchart. So, in my sense, as I agree with Samiran that they will give out a fanchart, but I will be very eager to see how the fanchart is moving. In my sense, inflation is going to significantly be lowered than the expectations which we have – the RBI could be as of now and possibly it could hit 5 percent or even below 5 percent for a large part of the next fiscal year because note that we are actually going over a very low base and this year by March, the undershooting could be as much as 60-70 basis points. So, that is a big number. The second point I would like to see is on the growth numbers. Growth I think as of now if I look into the CSO numbers, if I look into different commentaries, if I look into the results which have been coming out, if I look into the organised data, I think the impact is not that significant. However, I would still be hesitant to stick out my neck and say that the impact of the demonetisation on the growth should not be playing out. In my sense we should be very minutely looking at the next quarter. I think some of the results which have been good this quarter, may be hit in the January to March quarter. So, in my sense, you should be looking out those trends and then have a firm view on the GDP numbers. So, in my sense, the RBI may just not be ready to say that there is a downside risk to the 7.1 percent, they may still go with it. However, in my sense, the growth numbers this year as of now looks a little bit on the upside in terms of the estimate. Q: Look at the MPC minutes, release of the minutes and I am only reading Urjit Patel’s comment since I guess that would be a decisive factor. His last sentence is achieving the inflation target of 5 percent for Q4 of 2016-2017 and securing 4 percent. The central point of the notified target range remains the primary objective. So, I want you to outguess what the RBI might say about FY18 inflation and about their own goal itself? Chinoy: I think a few implications -- I think that is the operative sentence in the last minutes, growth matters much less. What matters is, it only matters to the extent that it influences the RBIs inflation forecast and growth for this year doesn’t matter at all. This is water under the bridge. The RBI has to look four to six quarters ahead. What matters very much is what is their growth forecast for next year and does that mean more pricing power and therefore higher inflation. That is the key here. Number one, I think there are two factors or three factors that will drive their thinking. One is how do you view inflation next year. Our own sense is you get an average of about 4.5 percent, but the key is when do they want to get to that 4 percent inflation target. We know the 5 percent is undershot; if in their minds they want to get to 4 percent by March 2018, that leaves very little space. If you give yourself two years, there is some space. Two, what you didn’t read out is they worry a lot about global factors. The fact is, since November, financial conditions around the world have tightened meaningfully, that has closed space for many central banks. India in the last three months has seen USD 10 billion of portfolio flows – the largest negative streak in almost four years; that is going to close some space. Thirdly, I would argue the pressure in them is a little bit less because for years we have been talking about transmission, the transmission happened. The banks have already cut lending rates, yield curves have flattened, some of this will remain no matter what the RBI does but the monetary stimulus is already underway. Market rates have come down, that takes some of the pressure off the RBI.Q: The RBI has kind of not allowed us to outguess its dovishness or hawkishness, the guesses have been wrong but you got it right last time. What is your sense on February 8? Should they worry about growth and inflation trajectory and therefore come with a cut?Sen: Of course they should worry about the growth and inflation trajectory but they also should be a little careful about what is happening in the banking sector. As somebody mentioned the pass through is complete. However it is not just complete, what is going to happen is, as the remonetisation process progresses you are going to see upward pressure on bank interest rates. The MCLR is going to change upwards.Q: Why would you say that the lending rate will go up?Sen: For the very simple reason that as the currency leaves the accounts the balance between the different forms of deposits is going to change. The huge decline that you saw in the MCLR is going to reverse itself, the question is how far?Q: What is your expectation? At the moment I think it is Rs 6 lakh crore excess, about Rs 3 lakh crore in MSS bonds and about Rs 3 lakh crore going into reverse repo. When are you expecting the situation to reverse and would that be one of the calculations before the RBI moves on February 8?Chakraborty: We are slightly surprised that the outflow in January has been lower than what we were expecting. So, it appears that the money is a bit more sticky in nature. However as Dr Sen mentioned that at some point of time this money can flow out. At this moment if this money does not flow out fast enough then we are already seeing that the MSS proportion is coming down and the reverse repo proportion is going up. If RBI wants a neutral liquidity situation to finally come back then how long will it wait for that neutral liquidity to come out from about Rs 6.5-7 lakh crore of excess liquidity that is there in the system.However it might not be a call which will be made in February itself. It might be deferred to April to get a better idea of how things are panning out. It can be even within the two monthly policy committee meetings. However it is something which is definitely important because it will guide the overall interest rate scenario and have a bearing on the RBI’s policy rate as well.Q: So, a CRR hike is not on the cards at all however temporary? Chinoy: I would not imagine that at all. I think the point here is that the RBI thinks that at least for the most part policy rate cuts are done, we have got maybe a little bit left. The focus was how do you get the transmission? As it turned out to be we got much of the transmission because of demonetisation. I am of the view that the yield curve could of course change if the RBI cuts or doesn’t cut. It could normalise especially given what is happening globally. I would be hard pressed to think that lending rates would reverse because when banks cut lending rates they had the expectation that only some part would remain.I think the next leg of transmission is that once the process is liberalised you might see deposit rates being cut, so that banks net interest margins are preserved. So, the way I see it is that because much of the transmission has happened, that will give the RBI little bit more elbow room that what we were worried about all this time has finally gone through.Q: You also don’t expect lending rates to go up for banks?Ghosh: As of now I don’t expect because I also share the same view that there is still scope for the deposit rates to go down from the current levels because once the demonetisation is complete I think banks will definitely take a call on the deposit rates, if not this fiscal at least in the next fiscal beginning. Q: From the rupee angle do you think a cut is warranted and that the rupee ought to depreciate?Varma: Central bank shouldn’t try to target too many variables using one policy instrument. It is not clear that the rupee will depreciate if you do a 25 basis point rate cut and more importantly it is not clear India will suddenly become very competitive because of X percent rupee depreciation. We all know that there are many other factors that go into making a country competitive – whether it is productivity, infrastructure and many other things.Q: My fear also is that if the rupee is way out of whack and is 18-19 percent overvalued, it may work to edge it to depreciate merely to avoid a quantum fall when maybe global factors become volatile?Varma: How much rupee is overvalued first of all depends on the metrics you are using. Simply based on rear metrics the extent of overvaluation that they show may be an overestimate. So, if you adjust for productivity the extent of overvaluation is not much. So, I don’t think rupee should be a consideration at this stage.Chinoy: I think just because the Real Effective Exchange Rate (REER) was at 100 some years ago, doesn’t mean that was fair value. Fair value is a very complicated dynamic phenomenon. I think it is very glyph to say that there is an 18 percent over valuation. I would agree with Sonal that if you were seeing secular loss in market share or secular increase in non-oil, non-gold imports which is also not the case, it is hard to make the argument. What you can say is, the stability of the nominal effective exchange rate masks certain bilateral imbalances. What I worry about is the India Chinese exchange rate. The rupee is appreciated 9 percent versus the CNY in real terms in the last 15 months and China accounts for 40 percent of our trade deficit. So, there are certain bilateral imbalances that can get accentuate, but broadly it is not responsible to say necessarily that you are so overvalued. Q: We have put as many elements as possible to discuss how much space is there to cut for the RBI now and in the near future, in all of 2017.Sen: Space I don’t think is the issue. The real issue is that is the RBI in a position where it can actually give an indication of its forward thinking, the signaling value. I think given that the Budget has been a lot more benign than anybody had expected, I think it is time for RBI to also start thinking about signaling. Q: Signaling more dovishness you mean? Sen: Yes, that is my view. Q: What is your view, how much space is there in 2017? Varma: I think in the bigger scheme of things, there isn\\'t much space. I think for India to sustainably get a 4 percent inflation, I think the structural constraints have to be removed and therefore I think that is still going to be a challenge. Second, I completely agree with Sajjid, I think we are focusing a lot on domestic factors and were monetary policy based totally on domestic factors, I think space was probably a bit more. However, in the context of global factors, i.e. oil prices going up, interest rate differentials already having narrowed so much and likely to narrow even further, I think space is actually not much if you look at through 2017, we are almost at the fag end I would think. Q: Samiran?Chakraborty: We have several issues, we have a sticky core inflation issue, we have a slightly more longer term risk on global reflation sitting onto Indian inflation. We have an issue that the government wants to have farm income doubling by 2022, you cannot have that with food inflation at 2 percent or even below. So, if you put all this together, our sense is that the FY18 average inflation could be higher than the FY17 average inflation. That leaves very little scope for rate cuts. We have already seen most of the transmission happening in FY17 itself. So, if at all one more rate cut is possible, maybe we keep it up our sleeves and use it at a time when we have the global factors in favour of us. So, I would probably wait at this juncture.Q: How much space? Ghosh: I think the RBI is at the fag end of the rate cycle now because if you look into for example the data on yield differential, it has corrected by 115 basis points. So, that is first thing. The second thing is that irrespective of whether the RBI cuts or not, yields are unlikely to decline significantly from the current levels. So, that is basically those two are diverse. So, in any case, if there is plentiful of liquidity, the transmission will continue to happen. In my sense, the only thing the RBI should now think of is the timing because Fed is going to hike possibly two to three times during the year. So, whether if they have a space for rate cut, whether they want to do it now or whether they want to do it later that is the call which the RBI has to take based on what cycle they believe they are in. So, in my sense the rate cut scenario looks almost at the fag end and possibly another 25 could be the best thing under the heat of the hour. Q: How much space does the RBI have and is the word accommodation also likely to perhaps last only one more policy?Chinoy: I agree with everybody, I think we are probably looking at 25 basis points more of space for all the reasons mentioned. It comes back again crucially to the first question, when do you want to get to 4 percent and how do you view the world? The more threatening the world economy is, the less space there is. So, I think about 25 basis points, whether to use it now or April would be very much a judgement call of what the right timing is.In the past what has happened is when you have had rate cuts that the market did not expect but you didn\\'t give the indication that there would be more, you sort of stamped on your own transmission. So, accommodative is just a place holder to say if at some point in the future space opens up, we won\\'t be stubborn about it, we will utilise that space. There is no point spooking markets for the sake of it and then you cut interest rates and yield curve still steepen because people say we have come to end of the cycle so what is the value with that.So, I think they would still say accommodative but we have to read tea leaves now that given all that is happening globally probably 25 basis points more.Q: May I ask tour monetary policy committee to tell what the call is, is there a cut?Sen: 25 basis points cut.Chakraborty: Pause.Ghosh: Hold.Chinoy: Given how responsible the Budget was, maybe now is the right time - 25 basis points cut.Varma: 25 basis points cut.Latha: Since there is a majority already, the chairman, Sajjid and Sonal are voting for a cut but there are two members who are voting for a pause. So, it looks like it is going to be a narrow decision. So, difficult time for the RBI and possibly it will be a narrow vote this time. You may not get a unanimous vote this time from the monetary policy.