Vijay Kumar Gaba

The Reserve Bank of India (RBI) made its last policy statement for the current fiscal year FY22. The statement is unambiguous on all four key issues:

1.    The inflation is likely to peak in the current quarter and fall to the RBI’s tolerance range from next quarter onward.

2.    The overall growth has recovered to the pre-pandemic level, but private consumption is lagging. The risks to the growth are on the downside and 2HFY23 growth should moderate to ~4.5%.

3.    The Monetary Policy Committee (MPC) is unanimously of the view that in view of the present growth vs inflation dynamics, there no case for a hike in the policy rates.

4.    The growth recovery is fragile and requires monetary policy support. Hence, MPC has decided to keep the policy stance accommodative by a majority vote of 5 to 1, as was the case in the previous two policy statements.

This accommodative stance of the RBI in total defiance of the global trend of monetary tightening led by inflation concerns is not surprising, given the fact that the RBI has been solely focused on growth for past 3years, since the incumbent governor has assumed the office.  In the post meeting press interaction also the governor and his deputy sounded calm, defiant and confident.

Obviously, the RBI knows much more than most of the market participants and commentators and is certainly in a much better position to decide the best course of action. From the policy statement and officials’ replies to the press it appears that RBI is relying significantly on (i) the outcome of the monetary tightening by global central bankers and consequent cooling down in global inflation; (ii) a favorable monsoon; and (iii) full success of government’s plan to catapult private capex and consequent pickup in private consumption. The RBI also appears to be assuming that “India’s inflation” is different from the “global inflation”, and it will ease without any monetary policy intervention.

The argumentative Indian in me is restless to explore between the lines and find what has not been said and what could wrong. I am sure a trader who takes the governor’s statement at face value and places his bets accordingly would make more money than someone doubting the words of the governor and taking a deep dive to explore the words that were not said.

Citing the first part of a verse from famous Shailendra song from Movie Guide raises suspicion whether the governor is gambling with Knightian Uncertainty. He only mentioned “Aaj phir jeene ki tammna hai (Today I wish to live again), signifying strong survival instinct. What he did not say was ‘Aaj phir marne ka irada hai (…even if I have to die for it today) signifying the willingness to take high risk.

Regardless, I would like to argue that the RBI is worried about—

·         A prolonged growth recession. 2HFY23 growth projection of below 5% is not in consonance with the projection made by the Economic Survey and professional forecasters.

·         Rise in cost of borrowing for government and consequent interest burden on the budget.

By completely side stepping the large borrowing program of the central government in the policy statement, the RBI has opened the doors to the speculation of a significant balance sheet expansion (QE in simple words). The reliance on foreign funds for financing the deficit is also seems high, implying that RBI is expecting the yield differential between developed market bonds and Indian bonds to remain attractive and also inclusion of Indian bonds in global indices.

The RBI has categorically accepted the subordinate role of monetary policy to the fiscal policy; though the statement claims “equality” of two policies.

Both the government and the RBI might be hoping and praying that Russia-Ukraine conflict is averted; US and China growth cools down and OPEC+ agrees to increase the oil production materially so that the global energy prices cool down materially. Else, the government may be forced to take the incremental fuel prices on its fiscal account, either by way of duty cuts or subsidy to the OMCs. This not only takes the BPCL disinvestment off from the table, but also brings a downgrade of India’s sovereign rating in the frame.

Notwithstanding, what the RBI statement reads, the inflation projection chart of the RBI is sufficient to raise suspicion. From 0 to 8% inflation range would render any forecasting method meaningless. It is reasonable to suspect that “hope” is one of the horses pulling the policy cart.

The steep yield curve that allows short term borrowing at 3.75-4% vs long term borrowing at 68% to 7% .This is obviously encouraging borrowers to borrow more through short term instruments. The risk of ALM mismatch that played havoc with non-bank lenders and real estate developers in recent past is thus increasing. By not doing anything to flatten the yield curve, the RBI perhaps has stretched its luck little too far.

Last but not the least, “staying put” is the best strategy when in doubt. The complete status quo in the RBI policy, when the things have changed so much since the last policy statement, signals a banker in doubt and not a confident policy maker as the governor has pretended to be.

The Monetary Policy Committee of the RBI has been consistently facing the growth vs inflation challenge for past three years at least. However, the conditions have become significantly more challenging and complicated for the MPC in the recent months. Hence, in the past couple days MPC may not have spent much time on resolving the growth vs inflation conundrum.

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.