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Last Updated : Aug 08, 2016 10:50 AM IST | Source: CNBC-TV18

CNBC-TV18's Citizen Monetary Committee sees no rate cut on Aug 9

In June this year, CNBC-TV18 started a new initiative ahead of the monetary policy on June 7.

In June this year, CNBC-TV18 started a new initiative ahead of the monetary policy on June 7. It constituted a Citizens' Monetary Committee, which had discussed and voted on what the Reserve Bank should do in the policy. For the record, the committee had voted no change in rates and the Reserve Bank abided by their advice.

With the next policy due on August 9, it has once again convened a meeting of our citizen's committee. The members include Chairman of the committee Dr Pronab Sen and the members, Samiran Chakraborty of Citibank, Soumya Kanti Ghosh of State Bank of India, Sajjid Chinoy of JP Morgan and Sonal Verma of Nomura.

The format of the discussion is as follows: the committee discusses the growth and inflation and liquidity trends of the past quarter, also any other issues that it may deem necessary for the Reserve Bank to take note of. It will vote on the policy action they desire and also the committee has a right to make recommendations to the Reserve Bank for further action on any front, liquidity, banking regulations, financial stability.

Below is the verbatim transcript of the panel’s discussion with Latha Venkatesh on CNBC-TV18.

Q: The last reading of inflation was 5.8 percent. In June the fourth quarter gross domestic product (GDP) was 7.9 percent and the last core sector reading that we have is 5.2 percent. Your assessment of growth, does it need help, your assessment of inflation and do you think rate action is possible?

Sen: As far as growth is concerned I don't think it needs very much help at the moment. But as far as inflation is concerned we need to be a little cautious. One of the good things that has happened since the last policy is that there has been significant easing of liquidity, which had been constraining the development of the economy prior year or for more than a year actually. However now I think we are at a tipping point and the Reserve Bank of India (RBI) has to take a call not about whether the liquidity should continue to be eased by the pace and the timing of the easing.

We should be aware very clearly that with the kind of monsoons we are having we are going to get a great kharif. Now, that is going to be very good for prices but a great kharif almost always means a huge amount of procurement which means a huge sucking out of liquidity from the banking system.

And that is something we need to bear in mind and the question that RBI needs to ask is do we continue to pump in liquidity at a regular basis from now until November-December or do we wait a little bit and start the easing of liquidity again closer to the date.

Q: The growth and inflation trends and what needs help now?

Chinoy: Before we get there, let me say that between the last time we met and this time we have almost seen an inter meeting cut so to speak. If you look at how liquidity has changed the RBI has new framework and the global bond yield rally, t-bill rates have fallen by 25 bps in the last six weeks, g-sec yields have fallen by 25 bps and liquidity is basically at neutral. This is tantamount to there have been rate cut in the last six weeks. Interestingly, despite that we haven't seen much softening in either bank deposits or lending rates, raising the larger question of whether those rates are sticky only because of tight liquidity conditions or are there more fundamental factors at play.

On the inflation outlook the RBI signalled there were upside risk to the five percent forecast for next March. My suspicion is the risks are more balanced now for a couple of reasons. A: we have seen the monsoons start pretty strongly, the spatial distribution has been good, pulses which are a key driver of inflation their sowing is 40 percent above normal. Now we have to be careful they were 40 percent above normal, this time last year and actual production was four percent below normal, but the fact is if these trends proceed even though there is no direction connection between the monsoon and food inflation these should have depressing effects on food prices.

Secondly, oil prices are down 25 percent since the RBI last met, USD 50 a barrel is now USD 40.

Finally if you look at core prices they have been very sticky for 15-16 months. Just the last month, there is some softening and if you look at the first half of the results season you are not seeing much pricing power.

So, if you put all these pieces together which is a good monsoon, oil is down 25 percent, there is not too much pricing power, despite the fact that there is a pay commission that is not going to come in and despite the fact that inflation surprised to the upside, my sense is you are tracking 5 percent and the risks are more balanced for the moment.

Q: Do you think the Reserve Bank of India will get to 5 percent? We were expecting that it would be 5.4 percent or less in May, June and July but the numbers have turned out to be 5.8 percent, is there a danger to 5 percent inflation target in January-March?

Varma: Since the last policy, inflation readings have surprised on the upside and the upside risk has come primarily from food prices. So, one is hoping that food prices will ease. However I think broadly, unfortunately there hasn’t actually been any big movement on the macro front. We are yet to see growth significantly accelerate. There has been no broadening out of the growth recovery.

Similarly on the inflation front headline has been volatile but there has been no significant deceleration in the inflation momentum. Now 5 percent - are we going to meet the 5 percent target, I think risks actually are a bit skewed to the upside, primarily because the uptick that we were expecting on account of the allowance increase for the pay commission that has been put off till October, till the committee decides on what to do with it. So, if that gets implemented sometime in early 2017 then for the March 2017 target actually there could be some upside risk stemming from there.

Q: As it is the RBI's fan chart was indicating below 5.4 percent, 5.5 percent for the past three months. The index has not remained at that level. As Sajjid said and Sonal has pointed out in some of her reports, the monsoon and relation to food inflation has been a very weak one. Are you certain about the 5 percent achievement with or without the pay? Does the RBI have any space for easing up until January?

Chakraborty: The way to look at it in my mind is that the inflation path is not going to be uniformly down. So, in the next two months you are likely to see two trends which can be above 6 percent also. Having said that, after that the base effect kind of catches up with you. Particularly, on pulses our view is that the pulses inflation could come down to single digit if we are lucky, partly because of the base effect and partly because of a certain global glut in pulses. Indian production if it goes up and the world production if it is tuned towards 5.8 million tonne of imports from India then we might see a situation where you have pulses prices correcting quite suddenly.

On top of it, the pay commission effect -- if house rent allowance is deferred, last pay commission we had seen that for the house rent allowance to actually figure out in the CPI data it took 9-12 months. So, it could well be the case that for the January-March 2017 quarter we do not see the effect of the pay commission coming in. It will be kind of a Damocles sword hanging on top of your head but overall it is in our view still possible to meet the 5 percent target. Let us not forget that if you take out the vegetables, sugar and pulses which is 10 percent of the weight in CPI, the rest 90 percent is growing at just 4.3 percent. So, if these three things correct to some extent you could still see 5 percent within the realm of possibilities.

Q: The monetary policy committees mandate is to reach ultimately a 4 percent inflation plus or minus 2 percent. Given that ultimate goal and this Damocles sword of the pay commission, how much space do you think the RBI has to ease and let me dovetail it with liquidity, that seems to be providing a lot of space for actual rates to go down?

Ghosh: If I just take the second question - the liquidity part. If you look at the liquidity situation which was in April and in July, in April we had a core liquidity deficit and today we are sitting on a liquidity surplus. So, from that point of view liquidity is plentiful and that has actually prompted the money market yields to go down significantly from the current levels, that's the first thing.

Second thing is that because of this yield declining, the problem is that the banks are paring their MCLR rates but there are some fundamental and structural issues which may prohibit the banks of cutting their deposit rates and possibly the lending rates more fiercely in the coming months. The most obvious reason is the FCNR(B) outflows. So, because of that and given the fact that deposits are currently growing at much below the historical trends, banks will be a little bit reluctant to cut deposit rates because they don't want to lose their deposit base. If you rule out that hypothesis then the lending rate transmission which may have happened because of the liquidity may not continue in the same pace.

Second thing regarding the inflation trajectory is concerned, after the last trends if you look into the data food prices have continuously surprised on the upside and there is every possibility that this month also the food prices, the pulses and the cereals actually have grown at a much higher rate than last month even though the vegetable prices have dropped in the last fortnight.

So, my sense is that you could see some amount of unfavourable inflation but purely driven by food because core inflation has remained at 4.5 percent steady for the last 15-16 months and after that because of the base effect inflation moderates and possibly hits 5 percent. I say possibly because I don't think that 5 percent is sacrosanct as of now if the food inflation continues to move at this level. If that is the case then the rate cut option which the RBI is having right now may be little bit limited even though I still believe that there is a possibility of further monetary accommodation on the part of RBI in the second half of the current fiscal.

Q: The RBI has pumped in Rs 80,000 crore almost at an average pace of Rs 20,000 crore every month. Do you think that it should continue with this pace or do you think it is in danger of over loosening?

Chinoy: The new liquidity framework essentially says that durable outflows will be matched by durable inflows and if kept up to their word, whatever currency in circulation outflows have been seen, you have seen open market operation (OMOs) offset that. Over the next four or five months, starting September, currency in circulation typically increases by close to Rs 100,000 crore between September and December which means if you continue with the same framework, you will see Rs 25,000 crore or so of OMOs every month in keeping with their current momentum.

I guess the question is why are we doing this and the initial thinking was well because this is impeding monetary transmission. Banks aren’t cutting deposit rates because liquidity is too tight, if they can’t cut deposit rates they won’t cut lending rates. The jury is still out but three months into the new liquidity framework, there is very little to suggest that the transmission in wholesale market rates and easier liquidity conditions is having any salutary impact on bank rates, there are various factors that play. Soumya Kanti Ghosh mentioned FCNR, I would argue there are more fundamental issues that until you solve the NPA problem banks will be less inclined to grow their balance sheets.

I will just make one final point which is that if in fact you continue to find that easier liquidity conditions are not creating this transmission, we may run the risk that if the inflation cycle turns, what you don't want is it at some point to honour these liquidity requirements is, your base money growth outstripping what would have been appropriate to support the final inflation levels. So, you don’t want the system to be over determined where you have an inflation target but you also have a liquidity target and you may find that these are internally inconsistent; that is my only concern. We are not there now; it is a concern I have before the next 6-12 months.

Q: The RBI can always start selling bonds if it reached a situation where liquidity is too good and inflation is actually becoming a problem. At the moment they seem to have developed a very good marksmanship on maneuvering the overnight rate. What I wanted to ask you is that is the RBI now required to do something more on non-performing assets (NPA) or do you think this pressure of lower yields, yields have gone down to 7.1 percent, now if most of the corporates start borrowing from there, market will cast its pressure on the banks you think, so, is the RBI just to leave the liquidity and the rate situation as it is or does it need to do something more to ensure transmission from the banks?

Varma: One of the things that was highlighted in the last policy was a sort of a review of the marginal cost lending rate (MCLR) mechanism because when we moved from the base rate to the MCLR mechanism, there was an assumption that transmission would be much better. It has been marginally better but not significantly better. So, even within the MCLR there seems to be areas where banks have discretion which is partly impeding transmission, which is more on the technical side. I think the RBI is probably going to shed more light on this either in this policy or maybe the October policy but clearly that is required.

On the liquidity front, I agree with Sajjid, they have done a fabulous job in terms of bringing down systemic liquidity now almost close to zero in our view. Post September is when the challenge will start when the currency outflows continue and they will require to do a substantial amount of open market operations. Whether they need to do bond sales or not also depends on the outlook on foreign capital. If you do see substantial amount of inflows then yes, but remember September to November is a period where we will see foreign currency non-resident (FCNR (B)) outflows, even the RBI expects almost USD 20 billion worth of outflows.

So, there is going to be some liquidity tightness not just because of the currency outflow but also potentially because of additional dollar selling that the RBI might have to do during that period. Therefore from an OMO perspective, I think the chances of sales look low right now. It looks more like it is going to be bond buying at this stage.

Finally, on NPAs and transmission, I agree that partly NPAs are an issue in terms of impeding transmission and to the extent that the treasury profits that banks make now because of yields coming down, they might be more open to sort of narrowing the lending deposit spread which has widened because banks have been trying to offset the NPA losses by keeping the lending deposit spread quite high. So, to the extent that treasury profits are coming in, banks might be more open to actually passing on cuts going forward.

However, remember that also banks had garnered a lot of high cost deposits in 2013, some of these worth three year plus fixed deposits. So we are now coming into a period where actually a lot of these deposits will come up for redemption and therefore actually the costs of the banking system will come down. So, if we do get a review of the MCLR mechanism, treasury profits are happening right now, and deposit cost comes down, then I think we should see more transmission. There isn't much that the RBI needs to do at this stage.

Latha: Do you want the Reserve Bank to do anything on the banking front to ensure transmission?

Chakraborty: Well, I think the liquidity part is doing quite well, there would be some challenges after September, but that’s okay, we have found a way to manage it. I think the bigger question is with the NPA situation that we have done a little bit of a simulation exercise, which shows that for the stressed asset ratio to come down to 7 percent which is like the 2004 level, it will take 3-5 years if their credit growth is between 11-14 percent and stressed assets do not increase any further from the current levels.

So are we then talking about a challenged monetary policy transmission mechanism for 3-5 years, because of this NPA problem, so that’s where I think that they have to focus on NPA resolution as a separate objective apart from the normal monetary policy transmission issue and I think that’s going to be quite important.

Latha: What’s your sense, you would be best placed as a banker yourself, the largest commercial banker. Do you think the pressure from the market is enough to bring rates down or would you recommend that the Reserve Bank do something more on the NPA or any other front?

Ghosh: No, I will tell you one thing, we had a lot of discussion about the MCLR, but if you look into the MCLR calculation which is now completely formula based 67-70 percent is driven by the cost of deposits, so I think that’s the most important factor and banks need to pay at the deposit rates downward, so as to do for MCLR effective transmission, which is not happening right now. Because of the fear of possible outflows in September to November because of the foreign currency linked rupee deposits (FCLR), so that’s the first most important thing.

The other thing I think as the period grows by and if you had look to what Samiran was saying, if you had looked into the other cycles for example in 1998, we were sitting on a gross non-performing assets (GNPA) ratio of 16 percent, which was brought down to 5 percent over 2006, but we had the fortune of global growth at that point. Right now, we don’t have that growth, so the best way to go forward is to go for a resolution of the assets quickly, but that easiest said than done, because the banks had been grappling for the resolution for the last couple of years. There has not been coming through because of the plethora of issues.

Hopefully, that will now take off because of the new resolution mechanism. I think more of that thing will happen in the near future and if that doesn’t happen, I think the transmission will continue to happen, but that will not happen at the pace which for example all of us would want us to happen.

Q: Would you think that the pressure from the market with yields falling from 7.4 percent to 7.1 is enough or do you think the Reserve Bank has to do something more proactive to prod the banks to cut probably change the MCLR formula or maybe be more proactive in NPA moral altruism. Does it have to do something in terms of forcing banks to cut rates?

Sen: You have to be little careful on this. The banks are today running the lowest rate of growth on their credit side than they have done in probably a few decades and you are in a situation where the banks are under pressure anyway. Now is this the time when you want them to cut their margins.

In fact, the best time to cut margin is when the turnover is growing rapidly and so if you are thinking about the welfare of the banks and that’s something which we need to keep in mind now because of the pressures they are because of the NPA problem, I wouldn’t get overly critical of the banks not lowering the rates too fast.

Q: What would be your non-rate action recommendations to the Reserve Bank?

Sen: On the rate, we are coming into a season where there is a tendency for prices to go up. My recommendation would be keep the rate where it is, slow down the liquidity increase for a while. Roughly the Rs 25,000 crore that has been pumped in on a monthly basis perhaps bring it down a little bit and start thinking about the timing at which you start relaxing all the taps simultaneously.

Q: What would be your recommendation to the Reserve Bank in terms of rate action?

Varma: No change.

Q: Your recommendation?

Chinoy: No change.

Q: What would be yours?

Ghosh: No change.

Q: What’s your recommendation?

Chakraborty: No change.

Q: Your word, I thought we got it when you were speaking, but what’s your word on rate action?

Sen: No change.
First Published on Aug 5, 2016 09:07 pm