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Twelfth EGROW Shadow Monetary Policy Committee Meet on September 23, 2020


Recording of the event

Recommendation of EGROW Shadow MPC

  1. Recommendation of the EGROW Shadow MPC Members
    1 Member - 50 bp in October
    1 Member - 25 bp in October
    1 Member - 15 bp in October
    3 Members – Pause

  2. Forecast of the EGROW Shadow MPC Members
    1 Member – reduction by 25 bp
    1 Member – reduction by 15 bp
    4 Members - Pause

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman EGROW Foundation

While looking at Q1 GDP data for 2020-21 relative to 2019-20(ratio), it is clear that the biggest hit from the Pandemic Lockdown was taken by construction with ratio of 0.5 and “Trade, Hotels, Restaurant and Communication& Broadcasting” with a ratio of 0.53. Manufacturing was a little better with a ratio of 0.61, relative to the total GDP ratio at 0.77. Surprisingly, mining was exactly at 0.77, perhaps because many mines are located in rural & remote areas were note touched by the lockdown orders. If we look at IIP for mining, electricity and manufacturing the ratio of this year Q1 data to last years, it is almost similar to previous year data. June 2020 IIP ratios show that capital goods and consumer durables remain the worst effected sectors, with textiles and wearing apparel, motor vehicles and other transport equipment the industries

The Unemployment Index (based on CMIE data) in February this year when pandemic struck, it was 1.1 and rose to 1.3 in March. It spiked to 3.3 in April and 3.3 in May, as lockdown took effect. However, with the lifting of the lockdown it declined to 2.4in June. Surprisingly it had become completely normal at a value of one in July and August. There is caveat, however, because the labor force participation rate (LFPR) in June, July and August was 2 percent point higher than the average rate of last year. This was primarily due to regular wage employees, who had both the knowledge and the economic capacity to withdraw from the labor force while the pandemic raged.

Given this background it is rather surprising that most members of the MPC not only stuck to a literal, narrow interpretation of their mandate, but also chose to focus on short run inflation instead of taking a forward-looking approach. Given the once in a century shock, comparable to, but structurally different from, the Great depression, many central banks, like the US Federal Reserve, have innovated. There is a need for the MPC to do the same.

Rate cut: Recommendation - Cut by 25bp/ Forecast - Pause

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

The divergence between CPI and WPI inflation continues with CPI inflation still above the RBI’s target band. That CPI food inflation exceeds WPI food inflation suggests it is temporary due to disruption of retail supply chains. Heavy rains have also contributed to raising food prices. The low increase in minimum support prices and flat rural wages imply there will be no second round effects, and headline is expected to revert to a core that will be low because of soft demand.

It is important to continue anchoring inflation expectations, so a pause is called for at present. But clear communication is required that the inflation spike is temporary, and will be looked through, that the RBI will remain accommodative— as long as it takes for growth to revert to potential—which is likely to be longer since the virus has turned out to be persistent. The US Fed has given such an assurance for 3 years. Although details may be difficult to give now because of extreme uncertainty if the direction is made clear, industry and markets will respond now.

Since fiscal borrowing and spending will have to step up, a similar assurance of support for government spending should be given. Special Covid-19 bonds can be announced to make clear that such support is limited to the current special situation. Other measures should continue to be taken to reduce interest rate spreads. For example TLTRO could be made conditional on reducing loan rates, and tiered reverse repo support for banks conditional on passing through in deposit rates. The ECB has tried this ‘dual interest rate policy’.

Excess capital flows due to QE when there is a current account surplus, add to liquidity, expand the RBI’s balance sheet and make it difficult for it to support government borrowing. In the literature it is acknowledged that emerging markets need some kind of market-based capital flow management and macro-prudential measures as well as more exchange rate flexibility to manage this quadrilemma.

Rate cut: Recommendation – Pause/ Forecast - Pause

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

We look for an out of the box 15bp cut in RBI policy rates. Three reasons:

We worry about GDP contraction of 7.5% in FY21. With the 'busy' industrial season around the corner, time is running it for the RBI MPC to cut rates. As it is, 2020 is seeing a second mal mass that dampens consumption. Festive demand will also remain muted in view of rising COVID-19 cases. Although the worst may be over, there is a lot of pain left.

We do not really worry about inflation crossing the RBI's 2-6% mandate. Ironically, the very COVID-19 shock that led to GDP contraction has led to supply disruptions that are temporarily driving up CPI inflation. We see inflation peaking off to 6.5% in September and 2.5-3% in 2HFY21 from 6.7% in August on base effects, good rains, low 'imported' inflation and poor demand.

Finally, bank lending rates to SMEs, retail and mortgages are largely linked to the RBI policy rate. So, reduction in RBI policy rates is sine qua non for lower lending rates to sensitive sectors.

Rate cut: Recommendation - Cut by 15bp/ Forecast – cut by 15 bp

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

Given the near term elevated inflation and uncertainty going ahead, we expect RBI to remain on status quo in the upcoming policy. Constraint by the inflation mandate, unless durable reduction in inflation is visible we see limited room for policy actions. Additional monetary easing will remain entirely a function of how growth-inflation trajectory evolves in the months ahead. Meanwhile, we expect RBI to continue to emphasis on its accommodative stance along with tweaks to liquidity/regulatory operations to keep financial market conditions benign. Notably, even as inflation uncertainty under the current inflation targeting regime constrains aggressive monetary easing to aid growth, it is imperative for the MPC to provide for clear communication on its stance. With growth slowdown clearly a more durable concerns over temporary spikes in inflation, we recommend a more transparent forward guidance by the MPC and to avoid mixed signals by changing the weights assigned to growth-inflation for policy making every now and then. I reckon, though, incrementally, monetary policy can only provide a cushion but the bigger push needs to still come from the government. The government has been consistently having surplus cash balance since June which has now crossed Rs 3 lac cr. Further fiscal spends could aid growth. I recommend a pause for now.

Rate: Recommendation for rate cut – Pause/ Forecast - Pause

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

The RBI exposes itself to unnecessary controversy and credibility problems if it cuts the policy rate. However it should provide a forecast for inflation and state that it is open to cutting if there is space. A clear signal on its commitment to capping government bond yields should come through and the possibility of debt monetization, should the need arise, should be put on the table even if it is to solicit comments.

Rate cut: Recommendation for rate cut – Pause/ Forecast - Pause

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

The economy is passing through an unexpectedly prolonged lock-down and stress due to COVID pandemic. This is once in a century event and there is no recent precedence in economic history to verify the appropriate course of action. The last such event, Spanish flu, had happened in 1918 when the impact lasted nearly 18 months, just after World War 1. The economic implications are increasingly becoming difficult to capture, as there are reports of relapse and second phase in some of the advanced countries.

In the domestic context, expected inflation is likely to be much lower in the days to come because of supply and demand constraints. The rate of inflation in August, as measured by CPI at 6.70 is high and food inflation at 9.05 is very high, mainly on account of meat/fish, oils/fats/spices and pulses. The WPI inflation at 0.16 percent and that of food at 4.07 percent is significantly lower than CPI. There are job losses and production has yet not resumed sufficiently. Given the economic situation, if we look at the data of the eight core industries in July 2020, over March 31 2020, each industry is down except fertilizer. If we look at the monthly performance monthly index over June 2020, there is some improvement in July except in the case of coal and cement, implying green shoots are appearing on the horizon. The data on IIP for July reveals a better performance when compared with June 2020. As things are starting to look up, performance in months of August and September, are certainly expected to improve. The key important area to focus on right now is with reference to the non-performing assets (NPAs) and the expectation that they are going to deteriorate in the days to come. Different estimates have been provided in this regard. It is expected that the NPAs from public sector banks are going to rise to 15.2 percent by end-March 2021 from 11,3 percent; and in the private sector banks they are expected to increase to 7.3 percent from 4.2 percent; and in case of foreign banks from 3.9 percent from 2.3 percent. As can be expected, stress in the economy will get transmitted to balance sheet of commercial banks. As far as the overall capital adequacy ratios are concerned, it may fall from 14.6 percent to 13.3 percent by end of March 2021. Given that COVID has extended beyond it’s originally expected 3-month lock-down period and is currently relapsing, the possibility of another phase of lockdown is also emerging. In such a case there is a possibility of the capital adequacy ratio to deteriorate further as well. There is a lot of uncertainty around the future of the economy and how these stress levels will get reflected in the balance sheet of the banks.

The current market perception is that COVID can create incremental NPAs to the level of Rs. 4-7 lakh crore. The stress at the NBFC levels is also expected to be high and their regulatory capital requirement may also fall below the threshold. Over the last few months, liquidity has been taken care of by the RBI and the Government. The main fear now is that if there is a relapse, how the fragile and weakened economy will cope with it. In this situation, the fiscal authority will have to play a very important role. The monetary authority will have to provide support across various aspects of the economy. But before that, since India, and indeed the world, is currently in the middle of a crisis, the need for the fiscal authority to play an uplifting role in the economy is crucial. The fiscal policy could now follow a targeted approach to support different segments of the economy, highly fragmented already. But the issue is, with prolonged lock-down, and low economic activity, where would the financial resources become available. It is in this context that I would recommend that monetization of deficit must be considered, which has been restricted till now, without fearing the rating agencies, as this is a rarest of the rare situation. The Governments, both central and states, could also borrow extensively, and invest, without fear of crowding out the private sector. Something like pump-priming, once Government starts the investment cycle, private sector will follow suit.

The other issue is with respect to how the monetary policy will provide certainty and be accommodative during these testing times. The fact that some members of the MPC are unsure of their stance and sometimes indicate reversal any time, ushers more uncertainty in uncertain times for the economic agents. In the US, the authorities have assured the markets that till 2023 they will not be changing their low rate of interest rates. In this case the market is aware that FOMC is planning to be accommodative for the next three years and will not be changing their interest rate, therefore giving additional boost to the confidence of the key economic agents in the market. This stress on certainty by the central monetary authority goes a long way in making decisions especially during the time of a recovery. Hence the two recommendations are: a 50 bps reduction right now, along with a singular accommodative policy stance which assures the market that until a positive growth is achieved, there will be no changes in the interest rates is the need of the hour. It must be understood that the accommodative monetary policy does not directly and immediately translate into lower interest rates, and therefore, given the high stress levels on the banks, the prudential requirements and the Basel norms need to be flexible. The unprecedented nature of the current scenario requires the regulatory norms to be more accommodating, in order to encourage the banks in going out in the market and increase lending.

The last recommendation is that the reverse repo rates must be re-visited. Banks must look out for green shoots in the market in order to help in the process of revival. These green shoots can be in the areas of MSMEs or NBFCs which need to be identified and financed. A proper calendar of OMOs must be announced to assure certainty in, which will help the economic agents to plan better for the future.

The focus of my recommendations is that the monetary authority should convey the message that the focus of the monetary authority is Growth and only reviving Growth, because that is most important for employment scene in the country.

Rate cut: Recommendation - Cut by 50bp/Forecast – 25 bp

Guest Panelist from ASSOCHAM

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

One Time Restructuring under RBI's Resolution Framework for COVID Related Stress

  1. NBFCs have been mandated to follow IND AS norms on provisioning for credit losses and these provisions are much higher than RBI norms. RBI guidelines on provisioning for restructured accounts require additional provisioning of 10%. IND AS norms require provisioning to be done for credit losses on historical average and own experience of respective lenders and therefore, all accounts are adequately provided for. We therefore suggest that the additional provisioning requirement may be dropped for restructured accounts for NBFCs.
  2. Currently guidelines on one time restructuring prescribe the customer account to be in 0-30 bucket as on the date but exclude standard accounts in 31-90 bucket. Given that the micro & small enterprises have uneven cash flows and even prior to Covid, were having viability issues, we seek your consideration of this scheme for all the standard accounts in 0-90 bucket so that the wider spectrum of customers can benefit from it.

Liquidity for Small & Medium Sized NBFCs

Press Release dt. 17th August, 2020 issued by Ministry of Finance states that only 90 NBFCs (22 NBFCs with bonds rated AA- and above and 68 NBFCs with bonds rated below AA-) have availed funding under the Partial Credit Guarantee Scheme PCG 2.0. Small & Medium sized NBFCs continue to face liquidity crunch. Key issues are:

1. Mode of Borrowing

The small and medium sized NBFCs, generally do not access capital market due to the complexities in compliances to various rules and regulations. As such, they do not issue bonds / debentures (NCDs) / CPs and instead borrow by way of “term loans” secured against their receivables, from banks and FIs like SIDBI and NABARD (including its subsidiaries like NABKISAN & NABSAMRUDDHI).
This single factor has ruled these companies out of contention for availing funding under the TLTRO 1.0 & TLRO 2.0 of RBI and PCG 2.0, SPL (Special Liquidity Scheme) of Ministry of Finance as all these schemes entailed investment by banks and SPV in bonds / CPs issued by NBFCs.

2. Tenure

A vast majority of loans given by NBFC to MSMEs and individuals are for average tenure of 24 to 48 months. Therefore, it is imperative that NBFCs need to borrow for a commensurate period in order to maintain a healthy asset liability match.
Currently, funding under the PCG 2.0 (including the Govt guarantee), SPL and the Refinancing being done by SIDBI, are all for a short tenure of 6 months to 18 months only. We request if the tenure could kindly be increased to at least 36 months for a healthy liability profile.

3. Need to Have a Refinancing Body

Bank funding of small and medium NBFCs has been a challenge due to various reasons, especially, during the last 2 years. The tepid response to the TLTRO 2.0, which mandated banks to invest at least 50% of the stipulated amount in small and medium NBFCs, was a clear example of this. The need therefore, is to reduce the over-reliance on banks and have a dedicated refinancing body.
Parliamentary Standing Committee on Finance in their 45th report of June, 2003 had recommended setting up of a refinance institution for NBFCs on the lines of National Housing Bank for HFCs. More recently, The World Bank Report of June, 2020, on the Development Policy Loan for $750 million, also suggests:

“The post Global Financial Crisis (GFC) experience with large volumes of liquidity provision to the financial system by central banks is important. 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.”

Under the circumstances, we feel SIDBI and NABARD may be assigned this role.