Status Quo Policy: Withdrawal limit restriction may go beyond Dec, say experts

There was widespread expectation that if certain amount of old notes were not back into the system then the Central Bank to that extent could declare dividend to the government. However, RBI Governor Urjit patel in the policy said: “The withdrawal of the legal tender characteristics status does not extinguish any of the RBI's balancesheets. And therefore there is no implication on the balancesheet as of now."

So, the question is does this mean the fiscal largesse from RBI should be ruled out in the current Budget on February 1, 2017.

According to Arvind Virmani, Former Chief Economic Advisor, Finance Ministry there was never a doubt in his mind about a windfall. There will be no fiscal largesse to the monetary system but one could look forward to higher tax collections.

V Srinivasan, Deputy Managing Director, Axis Bank said as far as this fiscal is concerned one has to assume that there is nothing coming out of the RBI balance sheet.

On the whole, the key takeaway form the policy is that RBI is say the impact of demonetisation is transitory and short-term and the fundamentals of the economy will playout shortly, said Srinivasan.

Both Srinivasan and Parthasarthy agree that the withdrawal limit could extend beyond December 30 because the limit depends on the availability of currency.

When asked if with the abolishing of incremental CRR, would interest rate fall going forward, Parthasarthy said, maybe the banking system has a whole would come down by 15-25 basis points. Meanwhile, Srinivasan said it could be closer to 25 basis points.

Neeraj Gambhir, Head, Fixed Income-India, Nomura said with the market not giving up hope of a rate cut from RBI in month of February, the 10-year yields would likely trade between 6.25-6.50 percent. However, if February also turns out to be a negative surprise then bond markets would take a different course.

In the same interview, economist Jahangir Aziz, Asia Economic Research, JPMorgan and banker Ananth Narayan, Head - Financial Markets, Standard Chartered Bank also shared their views on the status quo decision of RBI.The Central Bank today also slashed its growth forecast for this financial year from 7.6 to 7.1 percent that 0.5 percent down. “The effect of demonetisation would be to reduced the growth rate between 0.2 and 0.5 percent,” said Virmani. Below is part of transcript of Arvind Virmani, V Srinivasan, Jahangir Aziz, Neeraj Gambhir, Ashish Parthasarthy and Ananth Narayan’s interview to Latha Venkatesh on CNBC-TV18. Q: Would you agree with the assessment of risk of inflation and monetary policy decision? Virmani: I have disagreed with the inflation forecast from the last meeting that I attended of the advisory committee which was in March and I had gone on record in my blog to say that at the end of March, the consumer price index (CPI) inflation rate would be between 4 and 5 percent with a 70 percent probability. And at no time during the year have I wavered on that forecast and it has been on target and will be on target. So, there is question of agreeing with that. Q: I want you to assess the decision not to cut. That came as a shock of course to the market. To just argue on behalf of the RBI, right now there is not so much demand for credit anyway because the nation is in the process of exchanging notes. They have time in February after they see the fiscal deficit number as well. Would so much be lost if they waited till February to assess inflation and then cut? How would you assess the rate decision? Virmani: Let me say a little bit about monetary policy. As I said, in March again, the second point I made was that the Indian monetary policy, the international inflation targeting type of approach which I have often called the New York-Chicago approach to monetary policy is being Indianised by bringing in long-term liquidity into the picture. This is on my blog, so I am not inventing it now. And to me, what seems to be my initial reaction is that this dual focus is coming in. The repo rate part of it which is a standard global type of approach is being in some sense more factored towards the global side whether it is the way global markets perceive it, whether it is the issue of rate rises by the Fed, whether it is the issue of commodity prices and so on. And the second part is the liquidity part which really is much more important in the Indian context. So, that is how I view it.  Q: From a treasury man’s point of view, you have not got the rate cut. As well, neutrality in liquidity is going to be maintained. The surplus is seen as transitory. How do you react? Shocked? Parthasarthy: Of course, the decision on the rate was very unexpected. The market, clearly, 25 basis points cut was taken as granted and maybe a chance of a 50 basis point cut. So, that is where the markets were. So obviously, it is something which is not expected. Obviously, it was to some extent a surprise, for some it could be a shock. Liquidity framework has not changed. They have always said that we will move to a neutral liquidity stance and surplus was always assumed to be transitory. I do not think there is any disconnect on that. But of course, the rate was something which was a surprise. Q: So do you expect transmission now because the load of cash reserve ratio (CRR) has anyway gone. It is only a one fortnight load and it will be a small number for you. Does the path clear for transmission now? Parthasarthy: Two points. The number across the banking system would be quite significant for everybody. Even the fortnight maintenance of that kind of CRR is large. Having said that, we have been seeing deposit rates coming down over the last few months, weeks, etc. so obviously, that gives an indication that yes, lending rates will come down given that now we are an Marginal Cost of Funds based Lending Rate (MCLR) which is a formula based, based on your cost of funds, etc. Q: Are you cutting on January 1 or next month? Parthasarthy: Everyone, every bank now has a date on which is announces MCLR. So, our next date would be sometime first week of January. We have to wait till end of December to figure out what is the composition of our liabilities, what are the marginal rates and figuring out where the number will stand. We have not computed that right now, so I cannot say what will be the outcome as of January. Q: What did you make of that fiscal statement, there were some people who thought the Governor said there is no question of extinguishing liabilities as of now, so some people are interpreting that probably there will be an amendment, but at the moment what would you assume if you have to look at the Budget for next year in terms of a fiscal boost? Srinivasan: I think you have to go by the what the Governor said that there is no change in the composition of the Reserve Bank of India (RBI) balance sheet as of now and even if you look at the window which is open, even after December 30 there is an opportunity to go to RBI and deposit currency. I think the entire final exact number won’t be frozen even after December 31. I would think we have to assume as far as this Budget is concerned or as far as this year is concerned, there is nothing which is coming out of the RBI balance sheet. Q: Would you take away positives, your money is going to earn 5.75 percent no less at least that, what have you taken away as a bank are you better off after the policy and the cash reserve ratio (CRR) rollback? Srinivasan: There is always this pluses and minuses you can always argue that if yields were 20 basis points lower what would be your treasury gains and what sort of book you have. However, we could argue that my CRR was earning me nothing and I am getting 5.75 percent on the excess CRR which I was maintaining that is very bank specific. On the whole if we have to take RBI judgement what they are saying is the impact of demonetisation is transitory and very short term and they believe the fundamentals of the economy will play out shortly and that should sort of instil some more confidence in terms of how exactly to plan in terms of both credit as well as in terms of growth at least for the next financial year.Q: As a bond expert what are your key take away from this policy and how would you draw the 10-year for the first calendar quarter of 2017? Gambhir: It looks like that it is a bit of a wait and watch at Reserve Bank and to see as to how much is going to be the long term effect of this demonetisation scheme. Market was obviously in a particularly mode and this was not the result that market was expecting, so we have sold off about 20 basis points. We are currently at about 6.40 percent in terms of yields. I think that given the amount of liquidity in the system and given the fact that banks still need to make a reasonable amount of investments into government bond market. I don’t expect a much bigger selloff from here. I think another 5-10 basis points and we should see the investor sort of coming back to buy bonds. Over a slightly longer period of time, I feel that the market hasn’t given up hope for a rate cut in the month of February and if the inflation numbers continue to be surprising on the downside then that hope will stay alive - - so we will probably trade between 6.25 percent to 6.5 percent during this period and if February also is a negative surprise then I think the market will take a different course after that. Q: I wanted your comments on the two issues; what did you make of the Governor’s statement on dividend that it seem like the dividend is never coming because of currency swap? Gambhir: I think it is a bit legal issue. We are very clear and in fact I was reading some of the commentary that is coming out from this or the other experts as well - - my understanding is that the government needs to take some legal step i.e., coming up with an ordinance or some kind of a law in the parliament making this demonetisation scheme as a writing off of currency liability in the balance sheet, only once that is done then can Reserve Bank actually think about doing anything with the with the reduction of its liability. At the current stage with the way things are it is not a reduction in the liability of the Reserve Bank and hence the question of dividend is probably a little premature a discussion. Also you need to see as to what is the total size of liquidity or money coming back into the system. Q: What will be the fiscal impact on February 1 when the Budget is presented? Aziz: February 1, the impact is going to be minimal because it will be difficult for the RBI to at that point in time to say that this is the amount of cash that has come in and therefore, I am going to transfer that as profits, because that will mostly likely take much longer. And I would expect that even the government estimates some amount of that flow coming in for the FY18 Budget, we will not have any clarity on that for probably a few more months because I am guessing there will be accounting issues, legal issues, etc. But again, the arithmetic has been made much more difficult by the fact that you still have NSS bonds to pay for that the government will be issuing and not to mention the fact that things are happening on the foreign exchange reserves fund, which has been invested most likely, we do not have numbers on it, then US treasuries.So if you add all of them together, my sense is that you are not going to see very much on the February 1 Budget. We could see some estimates being put in there, probably another 3-4 months later. Q: Net-net, will they collect more in the current year itself in terms of tax revenues? As Neeraj is pointing out, there will be people who have declared their deposits and said that this is tax not paid money and therefore, will there be some kind of a fiscal space available this year itself or will that be taken away by companies reporting lower profit? What happens to current year’s deficit and Budget, and what happens to next year with the data currently available to you? Is there space for a fiscal boost? Aziz: We are looking at a the likelihood that you would probably have to cut back on expenditures to meet the 3.5 percent budget deficit largely because the big items, privatisation, disinvestment, that is the one that has not really happened. So yes, we can get something from the voluntary disclosure scheme that was higher than expected. But at the same time, all these profit transfers taking place from RBI may not be as much. So, as far as we are looking at the first quarter of 2017, we are expecting government spending to be pushed back in 2017 first quarter. This is the relevant quarter for this fiscal year. Q: What is your sense how much of rate cuts can be passed on if it is going to be neutral liquidity? Narayan: I think first of the policy scores high on credibility irrespective of what we think of the policy pronouncements, the reality is almost every stakeholder was almost egging the RBI and the monetary policy committee (MPC) to go ahead with rate cuts. For them to withstand that and take cautious stance just scores very high and it is good news for everybody including for FPI investors. Secondly I think there is a lot of reason and lot of justification for RBI to remain pat on the repo rate. The reality is that global markets are looking extremely uncertain and given those circumstances financial stability does warrants that we shall caution. Third is the relief on the CRR front is very welcome for banks and I think it is good news for everybody to cheer. The jarring note I guess is on liquidity and from a personal perspective one way I thought we could marry the short term impulse of demonetisation causing short term pain with the longer term requirement for caution would have been to allow surplus liquidity to remain in the system and therefore allow transmission to move on towards lower deposit rates, lower market rates and therefore lower MCLR rates. Maybe spurring some amount of consumption and investments in the short run as a relief to what we are going through right now. A move to liquidity neutrality as reiterated from April 2016 policy can take away that impulse for short term rates coming down. In fact, I would argue that a lot of the short term rates coming down since November 8 was because the system was sitting with a lot of liquidity even after the CRR impact, not knowing where to dump that money and that was bringing down deposit rates and short term rates that could be reversed. Today already we saw short term rates going up by 25 basis points and maybe transmission will kind of stop its tracks right now. I personally would have preferred some leeway on liquidity maybe moving away from neutrality to a bit of surplus till such time that the demonetisation impact is digested by the market that could have helped transmission of lower rates and maybe a bit of consumption coming back that is not to be, but you can’t have it all. Q: What did you take away in terms of what we should expect from the Reserve Bank in terms of monetary policy action next year in the first 3 months? Narayan: The domestic impulses for lower rates will still remain. We think given what we are going through on demonetisation which can impact us in the short term, inflation should be about 4.5 percent for this fiscal should continue in that same trajectory for the next year as well. Growth we tend to agree with what the RBI has put out. In fact, there is a risk that it slips below 7 percent, so all those impulses for lower rates will remain as far as domestic context is concerned. However, I would caution on the global front. The reality is that all the uncertainty that we saw listed out today in the policy on the global front will remain. No we don’t know whether it is going to be the Trump reflation trade continuing with the higher interest rates in the US or is it going to be more populism and therefore less trade, less global growth with all the vulnerabilities we have in Chinese banks and in European banks. There is also the added complication of OPEC in commodity prices so there is plenty of uncertainty on the global front which do warrant for caution and for watching the financial stability front, so I would put a bit of caution around on expectations around further interest rate cuts. Yes, domestic impulses in the short run will remain, but probably the reasons for rate cuts and lower interest rates given the global context are fast receding. For the entire discussion, watch video.