Vijay Kumar Gaba

The State Minister for Finance, recently informed Lok Sabha that the government had stopped printing of the currency notes of Rs2000 denomination in 2019 itself. This step has been taken to prevent hoarding of currency and curb the circulation of black money in the economy. It is pertinent to note in this context that Rs2000 denomination notes were introduced in 2016 post cancellation of the then prevalent currency notes of Rs1000 and Rs500 denomination. That step, in the first place, was also apparently taken to curb the circulation of black money in the economy.

Besides, the color of money {white, black, pink (Rs2000), green (INRUSD) etc.} which remains an active topic of discussions, the temperature of money is also becoming a topic of interest. Rise in the stock and flow of “hot money” is becoming a worry for authorities. “Hot money” could be loosely defined as the liquid money that flows very fast across asset class and jurisdictions in search of short term trading opportunities. This money usually has no commitment to any asset class (debt, equity, commodities etc.) category (emerging markets, developed markets etc.) or country. Both, the entry and exit of hot money to any class, category or country usually are disruptive, due to high speed and force of such flows.

Multiple bouts of stimulus provided by governments and central banks to counter the slowdown induced by the pandemic related safety measures, seems to have created billions of dollars in “hot” money. This hot money is apparently fueling the asset prices world over. The prices of most liquid assets, like publically traded equities, crypto currencies, precious metals have gained maximum; though the prices of physical assets like metals, real estate etc. have also gained materially.

As per some reports, recently “Beijing officials and policy advisers have been highly critical of US President Joe Biden’s newly signed US$1.9 trillion American Rescue Plan, warning that it could cause massive capital flows and imported inflation that could exacerbate domestic financial risks from already high debt levels."

Zhang Xiaohui, former assistant governor of the central bank, was reported to have said that “The [US Treasury bond] yield hike driven by inflation expectations will lead to a revaluation of asset prices, or even turmoil in financial markets. Domestic markets are unlikely to remain unresponsive.” This is seen as a caution that Chinese domestic markets will respond to rising rates, and should rates spike even more, Chinese assets face a world of pain.

Relative to China, India has not received much of hot money in 2020 and 2021 (YTD). The total FPI flow in India in past 12months (net flows in equity plus debt in secondary markets) is less than US$5bn. Much of this flows are apparently through ETF route, which is usually not hot money.

The first Monetary Policy Committee (MPC) of RBI met for the last time during 4 to 6 August 2020. To commemorate the end its four year term, the Committee thankfully did not take any populist decision. It prudently kept the policy rates unchanged, as I had wished for (see To cut or not to cut is not the question), and focused on mitigation of stress caused by the economic lockdown due to spread of COVID-19.

In line with the stand taken by the government, the MPC refrained from issuing growth and inflation estimates. However, the governor's statement makes the following things clear:

(a)   Inflation, especially food & energy inflation, is a matter of serious concern at present and development on this front need to be watched carefully; though the governor expressed hope that as the monsoon progressed well and base effect comes into play, the food inflation will ease in 2HFY21 leading the headline inflation below the MPC target range. It is pertinent to note that for past almost one year the headline inflation is running above the MPC target range of 2 to 4%. Despite this violation, MPC has continued on the path of substantial monetary easing even before the COVID-19 breakout.

(b)   GDP Growth for the current year shall remain in contraction mode, despite robust recovery in the rural sector. MPC noted that "Manufacturing firms expect domestic demand to recover gradually from Q2 and to sustain through Q1:2021-22. On the other hand, consumer confidence turned more pessimistic in July relative to the preceding round of the Reserve Bank’s survey. External demand is expected to remain anaemic under the weight of the global recession and contraction in global trade. Taking into consideration the above factors, real GDP growth in the first half of the year is estimated to remain in the contraction zone. For the year 2020-21 as a whole, real GDP growth is also estimated to be negative. An early containment of the COVID-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks."

(c)    There is scope for further cuts in rates. Most likely these cuts will be implemented in 2HFY21 as the outlook for inflation and growth becomes clear.

(d)   The Statement on Developmental and Regulatory Policies, the Monetary Policy Statement, 2020-21 Resolution of the Monetary Policy Committee and the Statement of the Governor, totally avoided any mention of the word "Fiscal". This makes it very clear that monetary policy function has chosen to overlook the fiscal digressions at present at least.

(e)    RBI is mindful of the stock markets digressing from the economic realities and surge in the prices of gold. However, RBI refrained from making any specific provision to control the excesses in stock and bullion markets. Rather, it has relaxed conditions for loans against gold when gold prices are ruling at highest levels. The central banker obviously does not want to rock any boat at this point in time.

(f)    RBI is actively managing liquidity and short term rates through various tools, and it seems to be enjoying the game. Expect this to continue for next few months at least.

(g)    The realization within RBI is growing that a large number of MSME and individual loans may be terminally sick. Setting of a Committee under chairmanship of K. V. Kamath, a vocal supporter of one-time restructuring of stressed loans indicates that there is virtual acceptance within RBI that these loans would need to be restructured. I guess, the only thing that remains to be decided is the modalities of restructuring and who takes how much hit. The complete omission of the term "Moratorium" from the statement explains the caginess of RBI on this issue.

To sum up, RBI has impregnated the markets with the twins - hope and caution. The morning sickness will keep bothering in coming days; and joy and bliss will keep it hopeful.

The three day periodic review meeting of the Monetary Policy Committee of RBI started yesterday. The Committee may review the monetary policy of RBI, in light of (i) the prevalent macroeconomic conditions-  especially inflation, fiscal balance, growth outlook; (ii) working of the financial system, e.g., liquidity situation, financial stress, credit off take, etc.; (iii) the global economic developments; and (iv) the assessment of economic shock in the aftermath of the pandemic.

The market participants are mostly focused on the monetary stimulus, which the MPC may propose, especially cut in the policy repo rate. Besides, the market will be watching out for the RBI stance on further extension of the debt moratorium; targeted credit for weaker sections; relaxation to the bank and non bank lenders from provisioning norms; inflation outlook and growth outlook.

In my view—

1.    Any cut in policy repo rate at this stage will be mostly meaningless, having only a symbolic value. The credit demand and the willingness to lend are abysmally low presently. Despite multiple rate cuts, incentives and assurances the credit growth has failed to pick up. The latest data shows that the in the second fortnight of July 2020, the overall credit demand slipped to 5.8%, which is close to the lowest level in a decade.

2.    The RBI has been maintaining surplus liquidity in the Indian banking system for past many quarters now. The liquidity has been boosted materially by (i) Forex accumulation by RBI in current account surplus situation; (ii) rate management actions of RBI through LTRO, etc. and (iii) other measures like CRR cut etc.

The excess liquidity is helping the government in funding the enlarged fiscal gap while maintaining the borrowing cost at lower level. However, the side effect of this has been total crowding out of private capex. The risk wary bankers are too happy to buy government securities which are available in abundance. Scheduled commercial banks’ investment in central and state government securities had increased by over 19% as on July 3 compared to last year, led by weak credit growth and surplus liquidity. 

In this situation, any liquidity enhancement measure may not yield any positive outcome.

3.    Insofar as extension of moratorium on certain debts is concerned, the situation is rather tricky. The disclosed amount of debt under moratorium varies widely across lenders and category of borrowers. The latest commentary of bank management indicates that the number of people and entities availing moratorium facility has come down materially in July. If this is the correct position, there should be no need to extend the moratorium deadline further. Even if it is extended, the number of beneficiaries would be supposedly much lower.

However, there is a section of analysts who believe that many lenders may not be presenting the true picture of the accounts under moratorium and expected recovery from such accounts. In their view, the lenders may be pushing RBI for extension of moratorium to March 31, 2021 so that they could make adequate provisions for the anticipated losses on this account.

The analysts at brokerage firm, Edelweiss Securities believe that the NPAs of banks may only peak by end of FY22, assuming material rise in FY21.

4.    The monsoon progress appear to have stalled and large parts of India are staring at deficient rains. If the monsoon fails to gather steam in August, as forecasted by IMD, the food inflation may spike further. MPC may be mindful of this event in taking rate cut decision.

5.    Last but not the least, in my view, motivating bankers to begin taking risk would be more productive than rate cut etc. For example, widening the policy corridor dramatically by cutting reverse repo rate by 50bps may encourage lending to some extent.