RBI's steps on liquidity matter as much as rate action: Experts

The Reserve Bank of India's bi-monthly policy, which is scheduled for June 7, will focus more on Governor Raghuram Rajan's moves towards trimming inflation and his transmission of rate cuts.  "We will be looking for steps but not so much on the rate cut side. I don’t think (a rate cut) is coming up as yet but clearly on the implementation of the new liquidity framework, we will be looking for steps," said Anant Narayan of Standard Chartered Bank to CNBC-TV18 on Indianomics with Latha Venkatesh.Jahangir Aziz of JP Morgan was also a part of the panellist, and he is more curious about the RBI's views on India's growth apart from inflation targeting.

The market will also be interested in the Governor's view on global commodity prices, and RBI's decision of infusing enough liquidity to stop banks from borrowing using the repo window. Apart from these key metrics, the country will also try to seek a clarity on who will head the RBI after September 4.   Below is the verbatim transcript of Anant Narayan, Jahangir Aziz and Ashish Parthasarthy’s interview with Latha Venkatesh on CNBC-TV18. Q: The previous policy, the April policy, was more known for its liquidity policy. What is your sense, has the Reserve Bank of India (RBI) walked the talk, any more to watch out for in the current policy, upcoming policy on the liquidity issue? Narayan: I think RBI has indeed walked the talk and has done a lot towards implementing the new liquidity paradigm which it announced the last policy. Specifically it is blessed the market the with Rs 70,000 crore of open market operation (OMOs) clearly in a bid to infuse in primary liquidity and the liquidity optical shortfall that we saw hovering around Rs 2 trillion in the worst stage of March, has come down a lot more to about Rs 80,000 crore. Now, having said all of that, clearly there is still an issue. We still have not reached the neutrality which the RBI has indicated. Of course the Governor did indicate that this would take time, it won’t happen overnight. In fact he gave a timeframe of eight months or so. What we would like to see in this policy is maybe some more steps towards achieving that neutrality which we think is very critical. There are ways in which this can be done including by giving some more relaxation on liquidity coverage ratio (LCR) as they did in February of this year which would then remove the double counting of LCR and statutory liquidity ratio (SLR), ease the issues on liquidity, allow large scale OMOs to go through and plus give some relief to the bankers in the upcoming foreign currency non-resident (FCNR) (B) repayment as well. So, we will be looking for steps, not so much on the rate cut side, I don’t think that is coming up as yet but clearly on the implementation of the new liquidity framework, we will be looking for steps on that. Q: I want you to add to this, definitely how that Rs 25-30 billion of FCNR (B) which was deposits, which were collected September 2013 will be rolled over or paid back will be an issue. As Ananat pointed out, the banks are still going to the BRI window to borrow, at the repo window, it is not zero borrowing. Will those two things be very critical for you, anything else? Parthasarthy: Firstly, there needs to be some more clarity on what it liquidity neutrality. Is it zero borrowing from RBI? I don’t think so because what I have heard in various statements that the government cash balances will continue to be auctioned through the repo process. As long as the government runs those cash balances, it is not going to be zero. How do you define liquidity neutrality is I don’t think extremely clear. I think if we can get more clarity on that, it will be very helpful; that is one part of it. FCNR, at the systemic level, RBI doesn’t see too much of an issue because they have some amount of forward purchases, dollars, they have reserves, they are obviously letting some of the forward purchases mature so they have increasing reserves, they will give out some dollars from their reserves. However, it is a large amount, so, that could cause some amount of disruption during that period. So, what one would like is an over management of that situation which is coming whichever way, both in terms of giving comfort on the rupee liquidity as well as on the dollar liquidity. So, I think the situation will need to be over managed so that you don’t create any distortion, disruptions. Q: The Governor actually has more time on FCNR (B). There is a policy coming up in August as well and the FCNR (B) deposits were collected from September 2013 onwards, so, they mature all the way up till November. He has more policies to show his hand. Parthasarthy: Definitely he has more policies. I think the bulk of the maturities will come in October and November but this will be less of a policy issue, it will be more of a process and how it gets managed. Q: On liquidity itself I have an issue with you bankers. The noise that was made up until the run up to April and on Indianomics itself is that because there is so much of liquidity deficit Rs 2 lakh crore plus the monetary policy is not getting transmitted. What has happened after the Rs 70,000 crore of open market operation (OMO). All that we have seen is that the tenure has come down by 15 bps. The shorter term rates were about the spread was 10 bps, it has become like 6 bps. Why was the market complaining so much. There seems to be not that much of transmission in the money market? Parthasarthy: There are two aspects. One is rates, and one is liquidity. Rates also there has been - if you see during the last one month or so you had occasions when the actual MIBOR has come below the policy rate and so, it is fluctuating on both sides rather than very sticky 10-15 bps above the policy rate. Second is rate can be maintained either way whether the system is surplus or deficit. Q: I don't see so much of yield drop is what I say. Parthasarthy: If you see money market instruments, if you see CDs, if you see CPs there has been significant drop in those yields. 10 year is a long term thing and until you see actual deposits grow, deposits growth in the banking system had been very anaemic. Then obviously rates will not come down because you need to fund your advances and also let us not forget that the FCNR maturity is coming up which will need some banks to shore up rupee liquidity to replace those. So, there will be some amount of stickiness to fall in deposit rates and if that stickiness is there obviously lending rates will take some time but definitely the direction is down. You have seen Marginal Cost of Funds based Lending Rate (MCLRs) which have come down by at least 15 bps from the earlier base rate and you can see some more downward trend. Q: Since April one trend is very clear that we have seen higher commodity prices generally and higher crude prices in particular as well higher food prices in India. So, do you expect any policy action at all. Our poll says no action expected, but will there be any talk that you will concentrate on, on the inflation front? Aziz: Yes, I would hope that in this policy review the RBI not only talks about the inflation outlook which it has to because it is an inflation targeting central bank whichever way you want to define it but I also would be curious as to how they see the growth outlook. In terms of the rate cut it is very difficult to say that in June you will see a rate cut or rate decision largely because you have two very large global events in the month of June and July. You have the Brexit issue that could be a spoiler for international markets if you do get a Brexit. In addition to that people are waiting to see whether or not the Fed actually raised rates in June or July. So, I would think that doing something like that in the face of these two big uncertainties no central bank would want to do something like that in the month of June. So, even if the RBI does plan to cut rates or let me say rate action as you very politely put it. They would wait at least past July and therefore August becomes a live meeting rather than next meeting. Q: The inflation trajectory of the Reserve Bank of India (RBI) was that we will be 5 percent or maybe even little south of 5 percent by January of 2017. Would you worry that that trajectory could be disturbed? Narayanan: Before answering your question, I would like to react to the earlier question that you asked Ashish about transmission not yet coming through despite the liquidity paradigm changed. To emphasise and to add to Ashish's point, the reality is we still are in a liquidity deficit mode while the intent has been to convert this into a liquidity neutrality mode. We haven't reached there as yet. So until we reach that point, the reality is today's asset liability committees of banks still have a bias towards raising deposits and managing LCR and managing the balance sheet rather than giving out loans and buying bonds and it is very important that the market understands the dynamics behind how this thing works. The difference when we start with a liquidity cash surplus or a deficit - that aside on the inflation trajectory itself - the reality is in our country with 46 percent of our consumer price index (CPI) being determined by food, it is always going to be a very tricky task to try and indicate and try and estimate what CPI will look like over the next few quarters. We have got the monsoon coming up right now; we have got procurement prices, where we expect some clarity to come about. All of this will have a big bearing on how CPI pans out. Is there a risk to the inflation outlook there is. We expect inflation to average about 5.3 percent for this entire fiscal year, so that should be fine. Our estimate is based on much higher oil prices from where they are right now. If you do see lower oil prices or oil prices remaining where they are – they could come down to 5 percent as well, so that should be fine. We do expect an uptick in the main numbers though which will come out shortly after the policy. We expect it to go closer to 5.8-5.9 percent which could be a cause of worry. The reality though is inflation is one part. There are several other indicators which probably indicate that the government and the RBI should continue on the current monetary path. Capacity utilisation remains extremely tepid – credit offtake has again gone below 10 percent. There is still stress in banking balance sheets and in corporate balance sheets and the investment cycle is nowhere to be seen. All these alongside and overvalued rupee indicate there is still room for the current bias to continue. However, of course, our monetary policy will be CPI centric. Q: What is your own trajectory? Would you think that the Reserve Bank indicates its best case through that fan chart? Do you think that fan chart will be revised and the Reserve Bank will allow for the likelihood of higher inflation? Aziz: I would definitely think, for the all the reasons I put forward the fact that global commodity prices have shown that they have risen and even though it hasn’t risen in an alarming sense, it hasn’t really receded back – what is more worrisome is the fact that if you look at core inflation – core inflation has remain sticky most like a year and a half, that 5-5.5 percent and that just hasn’t moved at all. We talked about the urban consumption driving first quarter growth and that is pretty consistent with what we have seen in consumer loans etc. There is part of the economy that is driving growth and that part of the economy that is driving growth is and almost by definition leads to more inflation than to less inflation. It is possible and likely that the RBI is going to move the upside of their fan chart higher or increase the probability of reaching the upper end of their fan chart in this policy review. Q: That’s a hawkish signal. How many rate cuts are you expecting at all in this cycle in 2016 or in FY17, if not in June how many rate cuts at all? Aziz: We are struggling to add one more. We think that perhaps in August we could see one more if the gods are happy with us and we get a good monsoon, if there is no Brexit and if the signal from the Fed remains on a very benign dollar view, if all of those hold together then I think that we might add something in the August review, but now right that’s about it. Q: Do you see any material further transmission until now we had a lot of reasons lag effect, deposits have not matured. We are still lying with the old deposits. I am sure by now all that would have gotten matured or will get matured. The RBI action notwithstanding should we expect further deposit and more importantly lending cuts? Parthasarthy: Firstly, given the new regime which is the marginal cost of lending rate – earlier cost of deposit doesn’t matter, whether they mature or not doesn’t matter. As Anant said it’s I think the liquidity position which will drive deposit rates. If liquidity actually gets to neutral you will see significant change in deposit rates, else you will remain in this kind of a range a small fall in deposit rates not beyond this. If you are still at Rs 70,000-80,000 crore of deficit, whichever way you look at it. Q: You all would have seen a lot of maturity of old 8.5-8 percent deposits considerably by now, the MCRL notwithstanding hasn’t your cost of deposits fallen. How much have you passed it on, have you really passed on everything? Parthasarthy: As I said, one is the cost of deposits have fallen, but we were always at the marginal rate and we had continued to be at the marginal rate in fixing our lending rate. The marginal rates are where they are and our book is growing. Our advances are growing. We need deposits to fund those advances. Deposit growth in the system is anaemic very, very clearly and that can only be solved by injecting liquidity, the liquidity deficit has to go down further. Q: But if the liquidity deficit goes that’s the money market requirement. How will that spur me to put more deposits in the bank? Parthasarthy: That will increase the reserve money growth and obviously it will end up resulting in a deposit growth. Q: I am not able to solve this puzzle, for goodish bit inflation has remained between 5-5.5 percent or max of south of 6 percent and the repo rate has fallen to a 6.5 percent, but we are all borrowing at 9.3 percent plus, isn’t that a very big gap between inflation, repo rate and the lending rate, it’s really huge, lending rate hasn’t fallen? Parthasarthy: If you see the policy rate is 6.5 percent, the maximum deposit rate is 7.5 percent, so on an incremental basis most of the banks would be getting deposits at close to say 7 percent with reserve cost, with all other costs – if you see the short end rates, 3 month MCLR for most people is around 9 percent, so it’s just a 7-9 percent that is required for banks to be profitable. Q: I am very clear that a lot of the Indian banks who have huge non-performing loans (NPLs) need that margin, but the guy who is really making money is HDFC Bank because you are making the same margin and you don’t have to provide for NPLs? Parthasarthy: You can see the numbers are very clear there is margin, but there are always credit costs and you need to eventually have positive accretion to capital. If you keep on eating capital for whatever growth you have than I don’t think the bank get fund. Q: What’s your sense, do we see borrowing costs coming down in the economy? Narayan: I think we will. Just to add to what Ashish has mentioned, look, look at it this way, if he actually have surplus cash in our balance sheet and we start the day with surplus balance sheet cash. It just means our liabilities and deposits are lot more to cover all our bond holdings, all our assets and we have cash on top of it. Now cash is the worst duration asset that the bank can ever hold. It’s overnight, it’s the lowest rent that you received from the RBI for holding the cash and you would do a passing of the parcel of that cash, give it to somebody else, instead buy a bond, instead give a loan. If CP rates are at 8.2-8.3 percent, I would rather buy a CP than hold cash as an asset. The reality is today we are still short of cash. Today, I am still seeing a situation where I need to borrow 7-day, 14-day money from the RBI against my 5 year bond just to meet cash reserve ratio (CRR). My entire algo process works on me trying to grow deposits and increase deposits and not really talk about trying to buy more bonds or give more loans. The entire incentive structure is skewed because of which your deposit rates aren’t coming down. This is the crux of the issue which RBI has now acknowledge and said in an accommodative cycle we will go with the other central banks and do what other central banks do. If this is implemented and if and when this is implemented and we go at least to neutrality not to a surplus this transmission as Ashish says will become a lot more visible to us and rates therefore will come down. Having said that all the imponderables that people mentioned and Jahangir also mentioned the fact that global markets are uncertain, domestic market lots of other things happening. The reality is we don’t know which way CPI will swing and therefore which way monetary policy will eventually swing. For now the accommodative policy continues and we look for rates to come down further.