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Eleventh EGROW Shadow Monetary Policy Committee Meet on July 31, 2020


Recording of the event

Key Takeaways

  1. Pandemic represents a unique Supply cum Demand Shock
  2. Monetary (credit & liquidity) policy has to focus on financial stability
  3. Inflation is high, mainly on account of food, and could be temporary
  4. Focus on Transmission of interest rates and credit delivery
  5. Recovery needs a counter-cyclical rise in credit growth.
  6. NBFC sector needs serious attention.
  7. Widen corridor between Repo and Reverse Repo rate
  8. Extend HTM to banks to incentivize them to invest surplus money market liquidity without fearing MTM hits.
  9. Monetary Policy should prepare to accomodate fiscal policy
  10. Need to relax Basel Norms as it could restrict credit flow to markets/industry

Recommendation of EGROW Shadow MPC

  1. Reduction in Repo Rate

EGROW Shadow MPC Members
1 - 50 bp in August + 50 bp in October
1 - 25 bp in August
1 - 25 bp in August + 75 later in the year
3 - Pause

Guest Panelist from ASSOCHAM
1 – 50 bp in August

  1. Widening the corridor between Repo and Reverse Repo

2 – Members of EGROW Shadow MPC

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman EGROW Foundation

Pandemic represents a unique Supply cum Demand Shock; Conventional Aggregate supply demand analysis underlying traditional Monetary and Fiscal policy insufficient/inadequate during pandemic and highly misleading during lockdown. In between during transition from lockdown to normalcy or new normal, different containment/lockdown policies have interacted with the natural spread of the Corona virus, to produce different relative intensity of, and variation over time in, demand vs supply shock.

In the Transition from Lockdown to Normalcy there will be Logistics problems and supply chain disruption and Market fragmentation (goods, factors). Logistic issues are visible even in in Essential Goods & Services during lockdown => Unprecedented gap between CPI food inflation (10%) and WPI food inflation(-2%) in May-June.

Supply chain disruption is predicted to be worse in manufacturing because of more complex supply chains on both goods & factor side. Resulting market fragmentation in India was predicted to be much higher, than one expects in USA or EU. Thus, pockets of both excess supply and excess demand will appear on both goods & factor side, during the transition to normalcy, which must be managed at a much more disaggregated level than for normal fiscal policy.

Monetary (credit & liquidity) policy has to focus on financial system stability, minimization of additional financial fragmentation & financial risk in every segment of the financial system. It has to ensure that the Govt bond anchor(10 year) is stable, at a level required for economy functioning up to 35% below its confirmed capacity (December 2019 - January 2020 = 100). Given the high degree of uncertainty, Easy monetary policy must continue. To attain a negative real repo rate by year end, when CPI inflation is projected to be 3%, I recommend a 25-50 bps reduction in nominal repo.

Rate: Cut by 25bps

2. Prof. Ashima Goyal, IGIDR and Member, PMEAC

The divergence between CPI and WPI inflation has appeared once again with the former at the RBI target band and the latter negative. In 2010 this was responsible for the industrial slowdown, as RBI targeted the higher CPI but WPI was low and more relevant for industry.

Today, however, short-term rates are lower at below the Reverse Repo, inflation figures unreliable, there are inherent uncertainties due to the spread of Covid-19 and arbitrary state lockdowns that are disrupting supply chains and it is important to continue anchoring inflation expectations, so a pause is called for at present. But the temporary supply bottlenecks are expected to be resolved, and the headline will converge to a core that will be soft due to a collapse in demand. The RBI should clearly signal this and that it continues on the accommodative path and has space for future cuts.

Meanwhile, it needs to focus on transmission, on reducing spreads and increasing credit delivery. Recovery needs a counter-cyclical rise in credit growth. Liquidity should be kept in surplus since that is helping transmission, but the degree of surplus can be reduced since that also creates risk. Banks have been given carrots and now need some competition. Reverse Repo rate can be lowered 10 bps to make it more attractive to banks to lend. Corporate repos can help bond markets recover and increase market confidence, at a time when risk aversion is high. Counter-cyclical macro and micro prudential regulations can also induce more lending as well as increase financial stability. Ways should be found to enable term loans for smaller NBFCs.

Since India has limited policy space its use has to be sequenced so it is most effective. Since household precautionary saving is rising in these uncertain times, government spending has to kick-start growth. The RBI has to enable frontloading this by signalling OMO support. Some kind of capital flow management may be required to restrain the large expected surge in liquidity from capital inflows when the current account is in surplus.

Rate: Pause

3. Indranil Sengupta, Chief Economist, Bank of America Merrill Lynch

We expect the RBI MPC to cut 25bp on Aug 6 and another 75bp in FY21. This should pull down lending rates by 25-50bp.

Besides the Covid 19 shock, high real lending rates are a concern. While nominal MCLR has come off 105bp from March 2019, on RBI easing, real MCLR has shot up 44bp due to a 150bp drop in core WPI. Given that the busy industrial 'busy' season commences in October, it is better to cut rates now.

We expect GDP to fall 20% in the June quarter and 6% in FY21. With daily Covid cases rising 6+x to 50+k since Unlock 1.0, we expect the current restrictions to materially persist till mid-November.

We expect CPI inflation to drop to 2.5% in 2HFY21 from 6.4% in July. Although inflation has risen above the RBI's 2-6% mandate, this is driven by supply side & methodological issues. Inflation should come off ahead on base effects, good rains and low demand.

With M3 growth rising and US$105bn of RBI OMO needed to clear our projected fiscal deficit of 11% of GDP, the RBI will likely look for ways to reduce lending rates without too much liquidity infusion. These could include:

a. 25bp RBI rate cut to pull down SME/mortgage/retail MCLRs linked to it;

b. Extend HTM to banks to incentivize them to invest surplus money market liquidity without fearing MTM hits;

c. Buying FX in forward market.

Rate: Cut by 25bp + 75 bp

4. Ms. Upasna Bhardwaj, Senior Vice President, Kotak Mahindra Bank

Previously also the MPC has eased rates in anticipation that inflation will remain benign in the 2HFY21 and that an immediate upside in retail inflation maybe temporary. Hence, June’s retail inflation should not hold the MPC back from delivering whatever little scope is there. While I agree with recent upside inflation prints, the rate cut call has become a close one, we see 25 bps of further easing in August followed by a pause.

Additionally, RBI may look to widen the corridor with a 35bps cut in reverse repo corridor. We do not completely rule out the possibility of an announcement of a SDF to mop up any surplus liquidity if needed. We believe the RBI will wait for a quarter or so to announce measures like an OMO calendar or an HTM limit hike as it gets more clarity on additional bond borrowings.

We also believe that the RBI could announce a one-time restructuring, with some caveats to ease stress of borrowers. Easing of policy rates may incrementally not be as effective as slack in demand persists due to COVID crisis and the related uncertainty. Henceforth, policy measures from the government will be more crucial in easing the frictions in the economy through thought over policies over the unlock phases and how it eases the supply side bottlenecks alongside addressing the demand side shock.

Rate: Pause

5. Mr. Abheek Barua, Chief Economist and Executive Vice President, HDFC

Transmission in the second half of 2020-21 is likely to improve as credit demand declines. Thus even in the absence of a rate cut effective borrowing costs are likely to drop. Thus given current inflation and the need to keep space for further rate cuts should the economic situation worsen, the RBI should pause making it clear however that it stands ready to cut when needed. The space available to cut is 50 bps. Effort should be made to ensure that existing guarantees are utilized fully. Thus the range of borrowers eligible for the guarantee should be expanded

Rate: Pause

6. Dr. Charan Singh, CEO and Director, EGROW Foundation

The Global growth rate has certainly slowed down and is in the negative zone in the current year. In the next year there is expected to be some positive growth, globally. The growth projections for India by many economists and institutions is also in negative zone but I dont agree with that assessment. I am clear that the economy has been slowly growing during the COVID period. The reason for my optimism is that, first, Agriculture sector has done well - had a good Rabi crop, monsoon is doing well and the Kharif crop is also expected to do well. In addition, though there has been lock-down, some sectors have been operational - banking, police, and government has been working. The IT and educational institutions have been also working online. In industry, automobiles are recovering, pharma is doing very well as also medical equipment firms. I say this because if the lock-down gets over by end-August, then the months of busy season are still available and the country can recover, recoup and bounce back in terms of growth in next 7 months

Therefore, only thing that needs to be done is to create a conducive environment. The fiscal and monetary authorities will have to demonstrate that they are focussed on production and growth. Therefore, in busy season, or festival months, things can improve dramatically. The migrant labours that have gone back to their native places will come back as compensation and satisfaction under MGNREGA is not sufficient to retain the migrant in their native place. Once migrant labours, after monsoon, are back, the economy will start galloping faster.

As of now, examining trend of inflation, both WPI and CPI, it is the food inflation, which is high. Even in food, it is potatoes, egg, pulses, meat, fish that is high. This could be temporary. RBI and government have made efforts and taken care of liquidity. My concern is now of Solvency. This is where uncertainty comes in. The RBI has already projected GNPAs to rise to 14.7% vis-a-vis 8.5% one-year back. Then the worry is which sector will record NPA and how will different banks get impacted. The RBI has to prepare for this trend and its impact on the financial sector.

I agree that credit growth has been slower in the current period, around 6% vis-a-vis 10-13% earlier, and obviously if we do not reduce interest rate sharply, credit growth may not take pace. Just imagine when a firm is in financial stress would it prefer to take loan? Interest rate should be reduced so that when industry wants to avail loan, interest cost is not a consideration.

If we have to improve and encourage growth in economy, the repo rate has to decline. What should be the limit to which it should be reduced. Obviously, the health of banking industry needs to be examined and it has to be balanced withd deposit rate. Repo rate cannot be reduced to zero or near zero level or as has happened in Advanced countries. In India, Repo rate can be brought down to 3%. Nevertheless it is already at 4% and to give signal to the market that focus of policy maker is to make the environment conducive for growth, it can be reduced by 50 bps in August and 50 bps in October. If it is agreed that 100 bps are to be reduced, it be done early so that industry/market gets a clear message to plan recovery, and banks get to extend credit. The argument that by lowering rate of interest, the senior citizen and pensioners will suffer is not correct. If we have to subsidize senior citizens and pensioners, that objective can be achieved by directly providing them relief.

In a situation, where so much money is parked with the RBI, under the Reverse Repo, it is obvious that there is scope for making effort in extending loan to industry. The credit growth is low and the banks get some easy return by putting money under Reverse Repo. If not negative, or zero, going for the same consideration mentioned above, Reverse Repo rate should be reduced significantly, so that it is not attractive for banks to keep money with the RBI.

In a growth-starving, high-unemployment and demographic rich country, inflation-targeting regime should be given a pause. The message should be very singular that focus is on growth.

Basel norms need to be relaxed. In post-COVID period, both monetary and fiscal policy will have to be expansionary. Basel norms, generally conservative, could constrain credit expansion. Along with this, stringent risk weights, Basel related, that India has, over and above what the global standards are, need to be relaxed.

Monetary Policy should be ready to accommodate fiscal policy, given that taxes are low as economy is not growing.

The NBFC sector is a black box and that needs to be examined carefully by the RBI. There are government NBFCs and that is one segment. Then there are 70-80 large NBFCs that have taken huge amount of loans from the banking system, which need to be carefully monitored and may have to be separated from others. And then there are large number of NBFCs which operate extensively at the grassroots level. It will be appropriate to make a distinction between different NBFCs and have policies for each segment.

The other issue is about the crisis and the timings. In view of the fact that the crisis has happened after nearly 100 years, it will be necessary to have a study group or High level Committee to understand what the monetary policy should be in next few decades. After all, in 1918, during the Spanish pandemic, the death rate was high, and economies were badly impacted for a long time. But at that time, there were about 2 dozen Central banks, and hardly any regulator or supervisor. There is need to revisit the monetary policy contours, tools and scope arising now, due to do this grim situation. Earlier, in 2008 the objective of focussing only on inflation was challenged. In 2019/2020, the whole world is in locked-up stage and given the probability of high NPAs, it will be useful for policymakers and academicians to revisit the scope of monetary policy. May be it should be now called as the financial stability policy, and the focus should shift from monetary policy to larger financial sector.

Rate: Cut by 50bp + 50bp

Guest Panelists from ASSOCHAM

  1. Subhash C Aggarwal, Chairman & Managing Director – SMC Group

1. RBI should consider the industry demand for one-time restructuring of loans and allow banks/NBFC to restructure debt in the stressed sector of the economy such as, tourism, hospitality, entertainment, real estate, civil aviation, etc.

2. As per a July 20-28 poll of nearly 60 economists conducted by Reuters, the Indian economy has worsened again. The contraction in the Indian Economy is ~20% in 1st quarter and forecasted to be 6% and 0.3% in 2nd and 3rd quarter, respectively. In order to revive the Indian economy, RBI needs to take a bold step – to cut the Repo rate by 50 basis point in the forthcoming MPC meeting.

  1. Raman Aggarwal, Co-Chairman, Finance Industry Development Council (FIDC)

Key Concerns of NBFCs
  1. One Time Restructuring

One time restructuring is always preferred over moratorium as it enables both the lender and borrower to re-set the repayment terms as per the convenience and comfort of the borrower and at the same time ensuring some inflows to the lender. The number of borrowers opting for moratorium have come down drastically which further strengthens the case against any extension of moratorium.

  1. Liquidity to Small & Medium Sized NBFCs

The interventions by RBI and the Government targeted to infuse liquidity have provided only a limited relief to small and medium sized NBFCs as most of the money has flowed into a small number of large NBFCs, which are highly rated. This has been duly acknowledged in the recently released Financial Stability Report, July 2020.

Small and medium sized NBFCs do not access capital markets and as such do not issue bonds / NCDs. They raise funds by way of term loans from banks and FIs. With the risk aversion shown by banks, the solution lies in infusing funds to FIs like SIDBI and NABARD for giving term loans to small and medium NBFCs without prescribing a minimum level of credit rating as an “eligibility criteria”.

Recently, World Bank has sanctioned $750 mn as MSME Emergency Response Program. One of the 3 pillars identified for MSME funding is “Strengthening NBFCs”. One of the proposed actions for this is:

It is critical to ensure that liquidity is not hoarded by banks which have the broadest access to the central bank liquidity windows and is spread widely throughout the financial system, including both to financial intermediaries (such as NBFCs) and ultimate users of finance (such as MSMEs). Public DFIs serving as quasi-lenders of last resort to NBFCs (e.g., Landesbanken in Germany) can serve as highly relevant examples for India due to its large NBFC sector without a dedicated lender-of last-resort (LOLR) window.

Inputs / View of EGROW Expert Through email on July 30, 2020

Dr. Naliniprava Tripathy, Professor (Finance) IIM Shillong

India’s coronavirus epidemic is now growing at the fastest rate in the world, rising at 20% over the last week with more than 1.4 million confirmed cases, with daily cases now at ~50,000 per day. This means that the lockdown restrictions are going to further continue which would continue to dampen the consumer sentiments and poses severe headwind to a recovery. In fact, fiscal stimulus announced earlier have been ineffective due to expenditure cuts and increased taxes on gasoline and related products. This has in fact, added pressure on inflation and one of the reasons for inflation rising to 6.1% in June 2020. This is against the consensus estimate of 5.3%1 as well as higher than the RBI’s target range of inflation of 2-6%.

Given the above, they key driver at this moment in RBI’s radar would be growth, which has many are predicting to be below 0 levels for India. In fact, the consensus estimate is at -2.8% for the current year (2020-21) and therefore, rate cuts during the year are warranted at this point in time. Economists are expecting a prolonged ‘U-shaped’ recovery rather than a ‘V-shaped; recovery which was predicted in earlier times. The demand side, which has shown a weak recovery since early May on a phased reopening of the economy, now appears to have stagnated since Mid-June at depressed levels.

India agriculture boost is only silver lining amid pandemic situation. Surplus monsoon rains and the migration of workers from urban areas to rural hometown due to lockdown are giving rise to a supply-led boost to agriculture activity. The cumulative rainfall surplus from 1 June to 25 July was 4.8% higher than the average leading to higher agriculture sowing of 18.5% YoY.

A drop in India’s unemployment rate masks underlying stress in the labour market. Massive migration of urban workers into rural villages marks a significant shift of labour from industrial and services sector into less productive rural activities. This is already leading to increased underemployment. Looking ahead, as demand for seasonal agricultural tasks wanes and the government’s rural expenditure runs into fiscal constraints, additional labour market stress could re-emerge.

Another reason for not keeping focus on inflation is because, it is expected that food prices, housing rent, retail prices to drop due to widening output gap due to demand slump. The recent pickup in food inflation is likely to be temporary and seasonal in nature. It reflects an increase in waste of perishable vegetables and fruits during the rainy months which is going to end in September. Post the monsoon, the food prices are expected to drop because of huge surplus of grains and other crops. The fundamental reasons for the surplus are increase in sharp jump of sowings, record government food grain stocks, higher levels of seasonal rains and excess labour availability.

Given the current economic conditions, a rate of 25 basis points is warranted with a guidance to further lower the policy rates in the year. The higher points rate cut was feasible at this point but for the high inflation in Q1 2020. It is expected that the policy rate to drop to 3% levels in June because of which economy can then get back into its normal system thereby, we can achieve GDP growth of >6% in FY 2021-22.