Vijay Kumar Gaba: Repo Rate

Showing posts with label Repo Rate. Show all posts

Friday, May 6, 2022

Leaving the straight path for the ‘curves’

The Monetary Policy Committee of the Reserve Bank of India, in an unscheduled meeting on 04 March 2022, decided to hike the policy repo rate by an unconventional 40bps to 4.4%. Besides, the RBI also decided to increase the standing deposit facility (SDF) and marginal standing facility (MSF) rate by 40bps to 4.15% and 4.65% respectively. The cash reserve ratio (CRR) for the banks has also been increased by 50bps to 4.5%. This action of the RBI is not entirely surprising, given that the consumer inflation (CPI) rate in the country has been consistently running close to or over the RBI’s tolerance band for the past many months.

The decision of the RBI came a few hours after an unscheduled 25bps hike by the Royal Bank of Australia (RBA) and a few hours before the much anticipated 50bps hike by the Federal Reserve of the USA (the Fed). With this over 55 central bankers have hiked their respective policy rates in the past 10 weeks. This includes about one half of the members of G-20. Interestingly, the countries struggling with financial crises and growth like Zimbabwe (2000bps); Sri Lanka (700bps) and Pakistan (250bps) have tightened most aggressively in the past 10weeks. Besides, Australia, the commodity exporters of Africa and Americas have also hiked the rates. Russia and Singapore are the only two notable countries that have cut the policy rates since March 2022.

Evidently, inflation is the overriding concern of most central bankers at this point in time. Even the central bankers like US Federal Reserve and Reserve Bank of India which were insisting that inflation is transient, being a consequence of the temporary supply chain disruptions due to the pandemic, and could be surmounted by focusing on growth, are now according higher priority to price stability rather than growth. Both the Fed and RBI have hiked rates despite palpable slowdown in the growth in recent quarters, and consensus downward revision of the future growth forecasts. Obviously, the policy decisions lacked conviction and thus did not elicit the desired response from commodity, currency and bond markets.

The Fed itself blunted its attack on inflation by ruling out aggressive hikes of 75bps in the forthcoming policy meets. The RBI governor was conspicuously apologetic while making the announcement. It is pertinent to note that bonds and currency markets were already anticipating these hikes and had discounted some of the impact beforehand; these actions were mostly expected to have “signaling” value for the markets only. By communicating a weak signal both the fed and RBI have disappointed the markets.

RBI takes a ‘curved’ path

For the past four years, the RBI had been following a straight path. It gave top priority to economic growth, followed by financial stability and price stability in that order. The commitment to this order of priority afforded it the strength to handle the pandemic led crisis remarkably well, while aiding the government efforts to stimulate the growth. Both the RBI and the government were seen operating in perfect tandem, unlike in the preceding years when the monetary and fiscal policies were often at odds.

With this decision, the RBI seems to have deviated from the straight path to take a curvaceous road. Under the pressure to stay on or ahead of the ‘curve’, the RBI has distorted its order of priorities.

It is a common belief that most of India’s current inflation has been caused by (a) high prices of imported energy, edible oil and industrial metals; (b) higher fruits & vegetables prices due to poor weather conditions; (c) rise in food prices due to higher support prices and (d) global supply chain disruption impacting the production. There is no sign of over speculation in the domestic commodities markets. There is no sign of overheating in the housing or auto markets. The credit growth has been below normal for past three years. It is difficult to explain how, in the Indian context, a rate hike could calm down the prices, except by destroying the demand that itself is below normal. In fact only a couple of day ago, the RBI itself has forecasted that it will take 12 more years to fully recoup the losses suffered by the economy due to the pandemic.

On the negative side however, higher rates will further constrict the already tight fiscal space for the government. Higher interest expense would have to be compensated by lower spending, as in a falling growth environment hiking tax rates may not be a viable option. A stronger INR (due to higher rates) could negatively impact the exports that have been the only bright feature in the struggling Indian economy in the past two years.

…ignoring the latest empirical evidence

The most unfortunate part of this episode is that the RBI has not learned anything from history. During 2010-2014, when the economy was still struggling to overcome the effects of the global financial crisis, the RBI started hiking rates unceremoniously from 5% in March 2010 to 8% in January 2014. These hikes not only negatively impacted the recovery, but also weakened the financial system materially. The rate had to be cut by 50% to 4% in the next 6 years to stabilize the financial system and bring the economy back on the growth path. It is important to remember that the RBI was cutting rates consistently from January 2015 (except two hikes of 25bps each in June and August 2018). Only the last 40bps was cut as a pandemic stimulus in March 2020.

…and trampling on the nascent economic recovery

A 40bps higher policy rates, in conjunction with the 50bps hike in CRR and 80bps hike in the effective reverse repo (including 40bps done in April MPC meet) will definitely tighten the money market, impacting the working capital facilities and short duration personal loans. Given that we are in a lean season, the impact on the overall credit market may not be visible immediately, but the impact on growth may be felt in 2HFY23. The higher cost of capital may further delay the elusive capex recovery.

Impact for equity markets

A popular saying in the equity markets literature says, “Market stops panicking when the central bankers begin to panic”. If we go by this saying, we should be expecting a bottom in the equity markets very soon.

I am not sure if this saying will come true this time (even though I am secretly wishing for it). In my view, the markets will eventually call the bluff of central bankers and force them to revert to the straight path. Till then I expect the equity markets to stay volatile and range bound. Obviously, this market is for the swing traders to make money. For investors, it may be advisable to follow another popular market saying – “Sell in May and come back in October”.

Friday, October 4, 2019

Thursday, August 8, 2019

Another uninspiring act of MPC

Some food for thought

"When a thing is said to be not worth refuting you may be sure that either it is flagrantly stupid - in which case all comment is superfluous - or it is something formidable, the very crux of the problem."

—Percy Bysshe Shelley (English Poet, 1792-1822)

Word for the day

Spondulicks (n)

Money; Cash

First thought this morning

Very few people I know are aware about a place called Punaura exists in Sitamarhi district of Bihar. Sita Kund situated at this place is most popularly believed to be the birth place of Mother Sita. As per Valmiki Ramayana and Kamban Tamil Ramavataram, Sita appeared from the womb of Mother Earth when the King Janak of Janakpur (situated in present day Nepal, about 40miles from Punaura, Sitamarhi) was ploughing a field in Punaura on instructions of sages.

Mother Sita is also known as Annapurna, provider of nourishment and prosperity. The legend says that the kitchen of Mother Sita never lacked adequate food for all. That is a metaphor for the crop that is born from the womb of Mother Earth and nourishes the life on this planet. Reverence for Mother Sita is therefore in fact reverence for Mother Nature, Sustainability, and Ecology. There are numerous instances in Ramayana depicting how Mother Sita cared for environment and sustainability during her exile years with Sri Ram and Sri Laxman.

While the issue of birth place of Lord Sri Ram is ingrained in the consciousness of most Indians, and enormous efforts are being made to construct a grand temple at the place of his birth, little awareness exists about the birth place of Mother Sita, who the Lord himself admitted as equal to him in all respects.

It is high time that we also declare Punaura Dham (Sitamadhi, Bihar), birth place of Mother Sita a monument of national importance and develop it as equally grand pilgrimage as we plan for Ayodhya. This will not only delight the millions of devotees but also convey a strong message to the world about our full commitment to gender equality and sustainability.

Chart of the day

Another uninspiring act of MPC

The Monetary Policy Committee (MPC) of the Reserve Bank of India decided to cut the policy repo rate by 35bps to 5.4%. It maintained "accommodative" policy stance. MPC recognized the growth challenges and cut the GDP growth forecast for FY20 6.9% from 7% earlier, while maintaining CPI forecast at 3.5 - 3.7% range. RBI governor ruled out any CRR cut as the system liquidity continue to remain in surplus.

Besides RBI also announced the following measures to support higher credit growth:

(i) The risk weight for all consumer credit categories has been cut to 100 percent from 125 percent earlier. This excludes credit card receivables

(ii) The exposure limit for single NBFCs has been raised to 20 percent from 15 percent earlier.

(iii) Bank lending to NBFCs for specified agriculture and SME lending will now be eligible for priority sector lending.

An overwhelming majority of market participants and experts were anticipating a repo rate 25bps cut. To that extent the decision to cut 35bps was a "small surprise" (borrowing the expression from the recent Credit Suisse research report upgrading India to "small overweight").

It is evident from the policy statement released by MPC (read here) that the Committee and RBI are fully conscious of the challenges posed to the Indian economy. It is categorically acknowledged that both global and domestic growth environment have worsened materially in past few months. The need to stimulate growth is also admitted, as could be read from the following excerpts from the policy:

"Even as past rate cuts are being gradually transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap. Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture while remaining consistent with the inflation mandate." (Paragraph 20)

In this light, I find the policy stance of MPC seriously lacking. In my view, the situation today warranted a categorical "whatever it takes" commitment from RBI. By making minimal apologetic rate cuts RBI is just wasting bullets while not helping anyone's cause.

MPC appears to be ignoring the fact that the present crisis is as much about confidence as financial stress. Minor rate cuts can ease a bit of financial stress and other measures may improve access to credit, but these are inadequate insofar as business and consumer confidence is concerned.

I would emphatically suggest that the government must consider some changes in the present process of the management of Monetary Policy itself. In my view-

(a) MPC should be converted into an advisory body, which shall be obligated to consider the representations of industry, trade and government before making its policy recommendation to RBI. MPC must record its reasons in detail for disagreeing with the views and suggestions of stakeholders.

(b) RBI Governor should be at liberty to accept or reject, in full or part, the recommendation of MPC. However, RBI governor must record his reasons in detail for any such agreement and disagreement.

Thursday, July 25, 2019

Lesson from Greece

Some food for thought

"You have to sound sad first of all, then maybe later you can sound good."

—Steve Lacy (American Musician 1934-2004)

Word for the day

Abusage (n)

Improper use of words; unidiomatic or ungrammatical language.

First thought this morning

The incumbent BJP led NDA government seems to have perfected the art of managing denominators. Wherever they find difficult to improve the numerator, they have been changing the denominator itself, such that the resultant figure looks more acceptable and optically pleasing.

Starting with GDP, a number of time series have been modified to make the current set of data look progressive. The latest to join the list is the amount of rain that qualifies a monsoon season to be "Normal". Reducing the amount of rain needed for a monsoon season to classify it as Normal means changing the definition of drought itself. In economics terms it means lesser pressure on the governments to provide drought relief assistance. In social terms it means less panic amongst people dependent on monsoon.

Some psychological relief apart, how would it actually help someone is not clear yet.

Chart of the day

Lesson from Greece

The RBI governor made a totally irrelevant and meaningless comment recently. What he said implies that the liquidity measures taken by RBI in recent past is equivalent to 25bps rate cut. This prompted market participants to believe that MPC may actually not cut rate any further in their next meeting on 5-7 August. Consequently, the already depressed market sentiments sank a little deeper.

I believe that RBI governor is just one vote in 6 Member MPC and need not be considered the sole decision maker insofar as the monetary policy of the country is concerned. From the minutes of last MPC meeting, it is clear that the policy stance may remain accommodative in future. MPC had outlined that supporting economic growth is primary priority as the objective of price stability has been reasonably achieved.

I therefore do not see much reason to worry on policy direction front. However, there could be some concern over the trajectory of policy easing and monetary accommodation. I would prefer a forceful action that can provide adequate escape velocity to the economy struggling to break 7.5 - 8% growth barrier. If it means 150-200bps rate cut, let it be.

Since yesterday, my inbox is full with a forward showing how the Greek Govt 10yr bond yields have fallen below the US Govt 10yr bond yield. This is significant, because Greece was one of the key triggers for the global financial crisis. Greek economy slumped into deep in 2009-12. 10yr Greek bond yields rose to a high of 38% in 2013. Fiscal deficit was higher than 13-14%, and consumer confidence totally in distress. Greek government had to be bailed out by IMF at least twice.

Though, Indian and Greek economies are not comparable. But still it might be noteworthy for the policy makers to study the resuscitation of Greek economy in past five years.

1. Bond yields have fallen to ~2%, lower then lows seen in pre crisis period.

2. Greek economy is hardly growing, but it has escaped the recessionary trap.

3. Current Account deficit that ballooned to over 15% of GDP in 2008 is now reasonable 2.5%.

4. Fiscal profligacy that resulted in budget deficit slipping to as high as 15% of GDP in 2008, looks a lesson in ancient Greek history. In 2019 Greek government presented a surplus budget.

5. Corporate tax rates that have risen to a high of 29% from 25% pre crisis level have begun to fall.

6. Personal income tax rate at 45% and Sales tax rate at 24% remain elevated, highlighting the sacrifices made by Greek populace in economic recovery.

7. Consumer confidence in inching back to the pre crisis level as lending rates have fallen to 15yr low of 4.5%, from a high of 7.25% in 2012. Policy rates in the meantime remain zero.

I am no economists or expert of economic policies, but the data prima facie highlights to me that high level of fiscal prudence and materially lower rates could help overcome the crisis of confidence and stimulate growth.

While the government has been rightly focusing on raising tax revenue, and curtailing government revenue expenditure, more efforts may be needed in raising non tax revenue to pay for public investment. Aggressive disinvestment is an obvious solution.

Cutting rates aggressively and providing a business environment that is conducive for accelerated growth, can stimulate consumer demand and consequently private investment, in my, may be, naive view.