Citizen's Monetary Policy panel: RBI to pause on rates

Q: Since February 7 2017 policy what is your assessment of inflation, is it likely to be more benign than what you thought it was in February 7?

Sen: It depends upon what kind of time perspective you are dealing with. If you look at the immediate future, the likelihood is that inflation will accelerate a bit. The WPI came in with a very high footprint and that takes about two months or so to feed into the CPI. So, in terms of short run inflation, I believe that there is a danger of the headline inflation going up.

In somewhat longer run on the other hand, that is not very clear. My personal sense is that inflation will go up and then taper downwards, whether it will come down to 4 percent target for next year, I do not know. However I don't think there is any great danger of inflation as yet.

On the other hand the global economy is picking up, I don't think there is any question about it and we really don't know what is going to be the impact of that on global commodity prices.

There are couple of things I think we need to keep our eyes on. The first is that what is happening globally in terms of the sectoral distribution of growth that is taking place there? Second is the stance that a lot of these countries are going to be taking given the kind of history they have had in terms of their monetary policy, are they going to be aggressively rolling back the liquidity injection, are they going to be very gentle about it? So, it is a wait and watch as far as the global economy. However here is the question - the question that really I think we have to address is that given the current situation, do we start signalling now or do we wait until our monetary conditions in terms of the availability of liquidity comeback to something which looks like normal.

Even today we are roughly 70 percent below on M0 and we have been flat on M3 for months. So, despite the fact, you have had growth, you are getting rising inflation, so we need to be very careful about what we are doing in terms of liquidity management and what we expect to happen as we go forward.

Q: How would you assess the global environment today viz-a-viz where we left it on February 7 2017?

Ghosh: If you look into the last meeting and this meeting there has been a fundamental structural shift in the global economy as well as also the domestic economy.

If you look into the global economy, I think the bellwethers of global economic activity are on the upswing. Look at the European - euro zone numbers, the inflation rate is now at 2 percent, the unemployment rate has been steadily declining, the PMI is at some multiyear high, so all the numbers are showing that possibly the QE in these euro zone might end at the end of this December after the French elections. That is the case across the globe - Japan, Taiwan, Korea, even to some extent the Latin American economies. However the good thing about this global reflation story as we just discussed is that the oil prices have somehow retreated and that is because of ramping up of US shale production and that is going to be maintained at the current level.

So, my sense is that future what is going to happen will largely depend on the trajectory of the oil prices given the fact that Indian exports have also shown an significant uptick in the last month, some of which are now showing to be structural in nature. For example the jump in the steel product exports, that will also help the domestic economy and the industry come out of the long standing recession. So, in my sense the global activity is getting an upswing and it remains to be seen, how far we can remain insulated from those activities in terms of better inflation number.

Q: Would you be more hawkish on inflation than you were on February 7 2017?

Varma: On the inflation aspect I think the upside risk to 4 percent today are as much as they were in February. If there is a difference it is largely on account of the fact that the risks of el-nino conditions developing this year do look a bit higher. Given that we have seen fairly subdued food prices, perishable inflation being so low, which means that the supply response to such low prices actually might be to keep production low.

In the event of below normal rains particularly in the month of July and August, the risk of food inflation picking up indeed do look higher.

The other concern is on the cost push inflation. In the last couple of months, rather in the last two quarters the cumulative cost increase from manufacturer's perspective has been tremendous and none of this has been passed on in terms of end product prices. It could partly be because producers are also not clear on the growth effects of demonetisation and given the confidence on growth is going to come back, I think there is a risk of this cost push inflation actually feeding into final inflation.

So, the risk therefore to the 4 percent inflation target are still very much to the upside. So, from that perspective the growth inflation dynamics are sort of similar to February, maybe a bit more confident on growth, a bit more upside risk to inflation and therefore the guards have to stay.

Q: You put the point as firmly as Dr Sen himself put it. More or less, ground covered would you say that the RBI MPC stance moving towards neutral and worrying about inflation is now justified? No reason to be dovish?

Chakraborty: I would probably have a slightly different view on this. My sense is that compared to the February policy, I would say that the inflationary impulse has been slightly lower. Yes, we are all talking of global reflation, but let us face it that the global reflation story we have been talking of from the time Trump was elected in US.

So, if I just compare the November-December global reflation story versus global reflation story today, I think the people are less worried about global reflation now compared to what they were three months back. It is a bit more generalised not just in US, but across the world, there is some bit of inflation. But say, in our own forecast, if we were predicting 2.75 percent global inflation in 2017 versus 2.2 last year, my sense is that that number might change at some point of time if this trend continues of lower global oil prices, lower global commodity prices and stronger rupee.

So, I guess that is something that we have to build into our forecast slowly. Yes, I do get it that what we are seeing today is kind of a lagged effect of the input price increases that Sonal was talking of, maybe some of the guys will be able to pass it on now. And there is this elephant in the room of GST and what it does to inflation. And even as Sonal was talking about manufactured costs push, if you look at agricultural costs push, this year, the agricultural input cost is already up more than 10 percent year on year. So what it does to your MSP calculation this year, that will also be very interesting to see. So, there are risks, but if you just compare February versus today, I would say at least from the global front, the inflationary impulses are lower.

Q: Inflationary impulses, higher or lower than February 7?

Chinoy: I would go further than Samiran. I would say the tables have turned compared to February. In February, this was all about the global environment. I would actually argue that global risks have faded. You may actually be in a situation in 2017 where you get a rate hike cycle from the US Fed, but the dollar does not strengthen on the back of the strengthening in the last two years.

And you have seen the dollar come off in the last couple off in the last couple of months. If you think of what were the two upside risks, the RBI pointed to in February, one was the volatility of the rupee which has gone the other way, the rupee has strengthened like other emerging market currencies. And the second was oil prices which have also come off 10 percent.

So, I would argue the global environment at the margin has become a little more benign. You will see a dovish Fed, a dollar that is weaker, oil that has come off, commodities are down 7 percent. All this shows up in the fact that the US ten-year is today, 25 basis points lower than what it was at the time of the Fed. But, that said, domestic risks have increased just a little bit for two reasons. One is much of the disinflation has been food. Food inflation today has been 2 percent in the last four months. You will get a mean reversion.

What you are seeing is the effects of a good monsoon year on a drought year. When you now project forward and say if you get a good monsoon year on a good monsoon year, that will mean revert back to 5-6 percent. So, to summarise, global risks have come down. Domestic inflation risks have edged up just a bit.

Q: Samiran, what is your vote on whether you are more hawkish or less hawkish on inflation?

Chakraborty: Less hawkish.

Ghosh: More dovish.

Chinoy: I will keep it the same. Lower global risk, higher domestic risks.

Varma: Same to more Hawkish.

Sen: Same to more hawkish.

Q: You correctly said that if you looked at loan growth, that is pathetic, a historic low of 4 percent. Would you therefore say that central bank at this juncture should not drain out liquidity to bring liquidity on par with its monetary policy stance, that it should worry about growth and leave liquidity as it is?

Sen: In fact the process of putting liquidity into the system has to continue for some time. At the moment, I am not even sure that the banks as a collective are able to meet their own cash requirements. I suspect that is going to take a little bit of time. But much more importantly, the question that is going to arise is when will investment demand pick up and when will the demand for bank credit pick up. It is not going anywhere today.

Q: What is your sense of what the RBI ought to do about liquidity? There are four options basically. They could leave liquidity as it is, not tinker at all. The other thing they could do is that the standing deposit facility that has been spoken about could be introduced and that could be at a higher rate than the reverse repo rate. It could be third option at a lower rate than the reverse repo rate. Fourth option, they could do open market operations (OMO). What according to you should the central bank do given that liquidity seems to be at variance with its policy stance?

Varma: Also on Dr Sen's comment on credit growth being low, there are certain non-monetary factors also at work. So, simultaneous resolution of the NPA side has to take place because part of the reason credit growth is weak is because of the balance sheet issues that banks are facing and to that extent, it is more sort of non-monetary policy factors that have to go on simultaneously to resolve that issue.

But on the liquidity aspect, our assessment is right ow liquidity in the system is closer to Rs 4-4.5 trillion and we are looking at a balance of payments surplus which is going to generate another Rs 1.3-1.5 trillion of excess liquidity and even if cash withdrawals obviously, limits have gone and even if currency in circulation starts to rise at an old rate which it most likely should not, given that we are moving towards digital payment, we will be looking at liquidity staying in excess of Rs 3 trillion or definitely in excess of Rs 2.5 trillion for most part of this year. And therefore, such a long period of excess liquidity, even if it is not generating any asset bubble pressures or any excesses that are visible right now has to be checked, particularly if it is permanent.

Now, if it is a permanent liquidity then optimally, a permanent liquidity absorption tool has to be used. Typically, one looks at a cash reserve ratio (CRR) hike or an OMO sale as potentially a permanent liquidity tool. The one issue going into this policy is that the withdrawal limits on the deposit withdrawals have just been released. And therefore, it might make sense to wait for maybe another 1-1.5 months to see how much of liquidity withdrawals happens post the limits going away because we do not want to be in a situation to tighten liquidity permanently and then turn south that actually withdrawals have been massive.

So maybe hold off on the permanent liquidity tools for now, but that is an option that potentially might need to be used during the course of the year. I mean a CRR. The standing deposit facility is something that the Urjit Patel Committee report already talked about in terms of uncollateralised absorption of liquidity. Definitely, that is something that should be introduced. The only catch there is that as far as I understand the RBI act needs to be amended for that. And therefore, whether it can be immediately operationalised or not is a question, but definitely the introduction has to take place as soon as possible.

In terms of the rate at which it is withdrawn, it is really hard to judge at this stage. Given it is uncollateralised it should ideally be like a low rate of liquidity withdrawal, it should not be higher than the reverse repo rate. But ultimately, the objective should be that it does not conflict with your monetary policy stance. It should not be that because you are withdrawing liquidity at a certain rate which is lower, the effective interest rates in the system fall lower. So, that definitely is one aspect, from a more technical perspective has to be taken care of.

Q: What is your sense on the standing deposit facility (SDF) rate? First of all, should a standing deposit facility be introduced which cannot be done by the RBI as Sonal points out. The government will have to chip in. is it needed and secondly, how should it be priced?

Chakraborty: At a broad level, first there needs to be some kind of a guidance on how comfortable or uncomfortable RBI is about this so called excess liquidity situation. If you recall, when RBI moved from the tight liquidity to neutral liquidity, the governor expressed that it could take about a year to two years to make this transition. So in this case, from this excess liquidity to neutral liquidity, how much time RBI is comfortable giving the markets in making the transition, is going to be quite crucial.

Q: So at the moment, you do not see any hurry to move towards SDF or even price it lower, you are comfortable with liquidity as it is?

Chakraborty: I think we can keep on doing some more temporary measures to see how this thing is panning out. We are talking of a behavioural issue here of cash withdrawal and nobody has yet tested that behavioural issue in the past to comment with any amount of certainty how it will pan out.

Q: So, two people saying leave liquidity as it is at least for the moment. One charge against the RBI which of course many traders didn't say but genuinely felt was that even if it was time perhaps from inflation point of view to move from accommodative to neutral, by signalling that on February 7, banks were inadvertently hurt because just two months back they were saddled with cash, some of it had to go into bonds and they are probably staring at fourth quarter losses. So, what would you advice as a monetary policy member? Would you leave liquidity as it is and not signal liquidity tightening, live with the contradiction of a neutral policy but excess liquidity?

Ghosh: On the hindsight the move from the RBI to the neutral strategy in February perhaps may have taken the market by little bit of surprise and perhaps we can debate on that whether it should have happened in February or in April. However in hindsight I think it was a well thought out policy because if you look into the effects of the rupee now - 3 percent appreciation, then portfolio capital inflows is now at Rs 7.7 trillion from January to March after a Rs 10 billion outflow. So, in hindsight it appears that the move was correct.

Coming to the liquidity part, I think the RBI is now in a good position to at least keep the liquidity sloshing around for the time being because all the impulses are now favourable if you look into the exchange rate, capital inflows, export growth, let even the growth numbers. So, RBI can actually itself give it a little time to give growth impulses a push. Remember that the capital expenditure this year if you look into the overall numbers, it is unlikely to grow at more than one percent and the second half of this fiscal shows the capital expenditure has in fact contracted.

Therefore given the fact that if you look into the November 11 till first week of February the total amount of cash sloshing in the system was around Rs 4.3 trillion which is exactly Rs 1.5 trillion incrementally higher than the corresponding period last year.

So, my sense is that around at least Rs 1.5 trillion of permanent liquidity should be injected into the system. Another positive thing is that given the rupee is appreciating, the RBI will be in a position to buy dollars. So, that will also add into the liquidity.

So, give it some time, let the liquidity slosh around in the time being for some time, give the growth impulses a push and in the meantime inflation numbers I also think if you look into the trend trajectory, I think they are likely to surprise on the downside in the first half and possibly surprise on the upside in the second half.

On the whole net-net my sense is that try to give growth a push given that the macro numbers now look a lot favourable than what it was earlier.

Q: Would you go one step further and say that a Standing Deposit Facility (SDF) be created because it is very good to create these institutions and you were one of the authors of that report. Good to create that institution, give it a higher rate than the reverse repo rate simply because banks need help?

Chinoy: What is the primary objective here? The primary objective is if you do nothing, I agree like Sonal Varma, you could be in a situation where the interbank core surplus is at about Rs 3 trillion for a year. This could take two years to actually go to neutral.

Monetary conditions in India today as measured by the weighted average MCLR, bond yields and liquidity are at a two year low. So, I would be uncomfortable to say that my rate stance is neutral and the next move could be a hike but I am going to keep monetary conditions at a two year low. Now the issue is not the rate, the issue is whether you suck out the liquidity durably. They are sucking this out every day through reverse repo. However the term reverse repo have not been subscribed very well.

So, the object of an SDF would primarily be to absorb the liquidity form of a term deposit, whether that is 14 days or 28 days, that is a matter of discretion.

Q: So, you would want the deposit?

Chinoy: Number one, you would want to suck out this liquidity in a term deposit. Number two, as Sonal Varma said, you don't want to do it by disturbing the operating target which is to say that the call rate must still operate in the range. So, what you want to do is take out the infra marginal call liquidity but at the margin banks will still go to the reverse repo window, so your call rate doesn't change.

Your last question about the rate, that is purely a judgement about whether that surplus - the trade-off here is the higher the rate, the higher the sterilisation cost of the government and the more the indirect recapitalisation of banks. If you take a rate of 6 percent on a surplus of Rs 3 trillion that is Rs 18000 crore. If that rate is 4 percent, it is Rs 12000 crore. This is purely a judgement the government has to make but whether they would rather have that money on the Budget and explicitly recapitalise certain banks or do it indirectly.

Q: Let me ask you to vote on liquidity first. Would you allow liquidity to remain surplus at this point in time and not drain it or would you have the RBI drain liquidity?

Sen: Do not drain.

Varma: Drain.

Chakroborty: Gradually remove.

Ghosh: At current levels, do not drain the liquidity. I would to add just one point to what Sajjid was saying in terms of the rates setting of the SDF. It will crucially also depend on that corridor because if you currently took that term-reverse repo rate and the repo rate are restricted to move in that 5.7-6.25 corridor. So, until and unless you elongate the corridor, it is difficult to set a rate of SDF in line with the reverse repo rate currently.

Chinoy: I would say gradually drain, but not through the CRR or OMO sales. Do it through remunerated SDF.

Q: The last vote and I think this is a given. Rate action at this point in time, pause, hike or cut?

Varma: Pause.

Chakraborty: Pause.

Ghosh: Pause.

Chinoy: Pause.

Sen: Hold.