See room for policy easing; inflation may move down: JPMorgan

Q: This policy is new for several reasons. Yesterday Shaktikanta Das told us that a monetary policy committee (MPC) may be in place. He was giving a 99 percent certainty that it could be in place even before October 4. So, what are you looking up to? First the macro data, what is it pointing to and then the institutional change.

A: A couple of things. One is that clearly, you have seen the expected decline in food prices materialise and I would argue September has seen, in the first 15 days and even greater momentum of price declines for things like pulses that August saw. So we do see inflation dipping below 5 percent in September and that means some space for monetary easing is opening up.

I want to caution that we should not confuse cyclical and structural dynamics; the fact is this is going to be cyclical; inflation could go all the way down to 4 percent, but then mean reverts in the first half of next year, all of this is led by food, core inflation is stuck at about 5.3 percent. But the fact is that if you have got a 5 percent target for next March, some space for easing is opening up. We think the RBI, whether it is the governor or the MPC will not front run the inflation. I think in October, perhaps the risk bias on their forecast is changed to reflect downside risk to the 5 percent target and thereby setting the stage for a rate cut, we think, in December. Between now and then, the focus will be very much on liquidity management.

Q: No question of two cuts then?

A: I would be surprised by two cuts. Because this is led by food, because food is so volatile and because the monsoon has been 10 percent below normal in August, 25 percent below normal in early September, that creates some risk but how all this very strong sowing translates into production, you do not want to cut in October and then be unpleasantly surprised by food prices not declining in subsequent months.

Q: We have realised over the last 24 months that rate cuts is non-news. Liquidity is news. How do you see liquidity management by the Reserve Bank moving from now to March?

A: The fact is the RBI has walked the talk. In April, there was a lot of scepticism about how many years it would take to get there. They have taken the deficit quickly to neutral, in fact to surplus and that has involved a large quantum both of foreign exchange purchase and open market operations (OMO). Our estimation is that they have done Rs 1 lakh of OMOs and Rs 100,000 crore of foreign exchange intervention. Now, the problem does not get any easier because in the second half of the year our estimate is currency in circulation is going to accelerate even further. We linked this to rural dynamics - that rural demand picks up, demand for cash picks up and that means to keep the system in balance, you will need to do a lot of OMOs.

Our expectation is if you do not get much foreign exchange opportunity to buy, you may have to end up doing Rs 1.5 trillion of OMOs just to keep the system in neutral and with foreign currency non-resident (FCNR) outflows it is not clear how much scope there will be for foreign exchange purchases. So, the RBI has got its task cut out, but in the near-term, if you are going to cut rates in the coming months, you want to maintain this easy liquidity policy to get the transmission, a year from now, if the inflation guidance changes then we will have to come and revisit this.Q: But does this not make it easy for the RBI therefore to buy dollars probably starting December? You admit that there is a need for RBI to print more notes and we know that despite the very strong denial coming from Shaktikanta Das yesterday and even Mrs Sitharaman that the government will like a weaker currency simply because that would mean that much more export jobs. So, isn't it a great situation for the RBI to be in, to buy dollars simply because yes, we want a weaker currency and we need to replace cash?

A: Two slightly different questions, I agree. And the RBI has demonstrated that, they have been buying foreign exchange at every opportunity primarily because their policy has been to keep the real effective exchange rate broadly in the same range to avoid pressures of appreciation in a world where everybody wants to depreciate. So, that will continue. The question is will you get that opportunity? If a] you have got the foreign currency non-resident (FCNR) outflow in the next few months and if you are looking at a Fed rate hike in December and the Bank of Japan or the European Central Bank (ECB) were to walk back slightly, their negative interest rate policy, will this risk rally towards emerging markets that has continued over the last six months continue on beyond December. If it does, I have no doubt the RBI will keep doing what it is doing.

However, on the devaluation thing, we should not overstate the case. The word 'devaluation' is a construct from 1980’s...

Q: ...depreciation is the word.

A: Exactly. So, anything that happens will be very gradual, very calibrated. I do not think markets should get spooked at all.

Q: So, what kind of a rupee value will JP Morgan look at?

A: I had learned in graduate school that predicting exchange rates and commodity prices is a mugs game. What I will say is the RBI has been looking closely at the 36 country real effective exchange rate. That is the ultimate measure of competitiveness. So the dollar rupee value is a function of how cross currencies move.

Q: Very quickly, how does the MPC cue everything? Can the MPC prevail upon the governor to cut more, to give more liquidity, to buy more dollars? What may the MPC do?

A: It is a great concept because of the way it is structured. You made the point recently that you are only allowed one term for four years. So, the RBI Act has been amended in impressive detail. The MPC, like the governor will be data dependent because the degrees of freedom that the MPC has to operate ultimately are bound by what is in the RBI Act which is that we want to get to 4 percent and the upper tolerance band is 6 percent. So, nothing the MPC does can violate that statutory obligation right now which is why there will be a lot of policy continuity going forward.