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Twentieth EGROW Shadow Monetary Policy Committee Meet held on February 5, 2022


Recording of the event

Key Takeaways

  1. Globally, tightening of the interest rates has begun
  2. The growth impulse in the domestic economy is strengthening
  3. Greater push for capital expenditure on infrastructure by the Center and States will lead to surge in employment/growth
  4. Greater profitability is expected in the banking sector due to higher capital expenditure of Government and hence a reduction in NPAs
  5. Impact of borrowings larger than budgeted needs to be managed
  6. Inflationary pressures are expected to wane away during the year
  7. Oil prices add to uncertainty - with a 10 dollar rise in oil prices/bbl leading to a rise in CAD to GDP by 0.5 per cent.
  8. Uncertainty regarding economic growth recovery due to COVID-19 pandemic amidst subsequent waves
  9. Uncertainty regarding the impact of Central Bank digital currency on bank deposits and monetary policy
  10. RBI needs to continue with liquidity normalization drive

Recommendation of EGROW Shadow MPC

Members of EGROW – 4
Repo rate retain at 4 per cent – 4
Reverse repo rate retain at 3.35 per cent- 2
Reverse repo rate should be changed (by 15 bps to 40 bps) - 2
Accommodative should continue- 1
Accommodative to neutral 2
No view- 1

Guests– 5

Repo rate retain at 4 per cent-2
Reverse repo rate retain at 3.35 per cent- 1
Reverse repo rate should be changed (by 15 bps to 40 bps) - 1
Accommodative should continue- 2

ASSOCHAM Members- 3
Repo rate retain at 4 per cent- 1
No view- 2
Reverse repo rate should be changed (by 15 bps) – 1
No view- 2
Accommodative to neutral 2
No view- 1

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman, EGROW Foundation

The previous prediction of GDP for FY22 being 1 to 3 per cent higher than that of FY20 holds true. Taking all factors together, the GDP will grow between the 8.5 to 9.5 per cent. The Omicron wave will be virtually over by March. By the first quarter of FY23, a strong revival of the contact services particularly, trade, hotels, restaurants, transport, etc. will be followed by some revival in household investment structures and selective investments in some sectors followed by revival in private consumption by the last quarter, having caught up with 2019 figures.

The Budget is laying down the framework for inclusive growth by placing a focus on fast sustained growth over decades if we are to become an upper middle income country and equality of opportunity where the equality means among rural-urban areas and male- female or gender equality. There are four pillars in the Budget- two major pillars and two minor pillars where the latter two will take time to become important. The two minor ones are green economy and urbanization. Urbanization committee has been constituted to assess what needs to be done to accelerate urbanization and further it to grassroots levels. In 10 years, urbanization will become a big driver of growth and the Budget is trying to lay foundation of that. The green economy will be slow as getting rid of legacy systems like thermal power plants is not possible. The two major pillars are investment, the surprise was the extent of the increase of 35 per cent over the previous year; and a shift from mere IT, to technology start ups, to a fundamental digital economy. In the next 10 years, this is going to be a huge driver of growth. The government has spoken about every aspect keeping in mind the potential of digital economy. Digital economy is not only going to power the economy but it is also to empower the people. Further, it will pave the way for higher quality of education and medicine to the rural areas.

Previously, I recommended a change in the stance from accommodative to neutral. The danger for us, specifically were the oil prices. The latest information shows is that this problem about excess demand where supply is not keeping up with the rise in demand because of the repeated shocks with the delta and omicron variants. The temporary increase in prices is now clearly becoming a problem in the US particularly. The European Central Bank’s President is still following an accommodative or a neutral stance. In the upcoming MPC meet, the stance regarding the interest rates will see a change.

2. Shri Indranil Sen Gupta, Head of India Research, CLSA

We expect the Reserve Bank of India (RBI) monetary policy committee (MPC) to lift the reverse repo rate by 15 bps at its 10 Feb meeting despite a shallow recovery. We see three reasons. The Fed has preponed hikes to March. Second, lending rates are unlikely to react before the busy season ends as they are linked to the RBI repo rate. Last, Budget 2022’s fiscal deficit target is higher than expected. The RBI should continue to lock up surplus liquidity in, say, 2-3 year reverse repos, to create space for open market operations (OMO). We see hikes of 85 bps in FY23 as well as 50 bps in FY24.

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

FY2023 Union Budget rightly and expectedly has prioritized growth over aggressive fiscal consolidation through an inclusive approach of incentivizing domestic manufacturing, infrastructure impetus, transparency and policy stability. The government has budgeted the FY23 fiscal deficit at 6.4 per cent of GDP from a 6.9 per cent estimated in FY22. The government has also budgeted 24 per cent increase in capital expenditure to Rs 7.5 tn for FY2023 with housing, railways and roads witnessing larger allocation. Notably, the Centre has provisioned Rs 1tn of support to states as long-term interest free loans to incentivise further capex. On the positive side, the mix of expenditure has continued to move away from revenue to capital. The broader measure of capital spending (Centres’ budgeted capex, Grants in Aid for creation of assets and PSU capex) is expected to improve to 6 per cent of GDP in FY23 compared to 5.8 per cent this year while the revenue expenditure (adjusted for grants for capital asset creation) is expected to fall to 11.2 per cent of GDP from estimated 12.6 per cent in FY22 (RE). While the capex thrust is a clear positive for the economy but much of the multiplier impact will depend on the timely execution and implementation-- both by the Centre and the States. We do however, see the final outturns of fiscal deficit to be lower by 0.5 per cent of GDP across FY22 and FY23.

While the pro-growth expansionary Budget provides comfort for long-term sustainable growth trends, the consequent heavy bond supply is expected to weigh heavily on market sentiments. Higher-than-expected market borrowing along with absence of clarity on global bond index inclusion has unnerved the bond market. As the far end of the yield curve is expected to remain heavily weighed down by excess supply, the near end is likely to be guided by monetary and liquidity normalization measures.

As the global backdrop turns negative amidst tightening financial conditions, elevated crude oil prices and with domestic growth on a relatively better footing, we believe the RBI will need to shift its focus towards reining in inflation towards 4 per cent. With RBI’s close management of liquidity through different tenures of VRRRs the operative overnight target rate is already gearing towards the repo rate. While we believe that a one-shot 40 bps hike in reverse repo rate in the upcoming policy should be undertaken to bring the policy to normalcy and provide clarity, the recent negative sentiment in the bond market post the Budget could postpone the decision to the April policy. We, thus expect RBI to continue with shorter tenure VRRRs, with a likely shift towards overnight VRRR to shift the overnight money market rates consistently towards the repo rate of 4 per cent, irrespective of the levels of fixed reverse repo rate.

Overall, I recommend 40 bps of reverse repo hike to regain the normal policy corridor and status quo on stance and repo rates in the upcoming meeting. We do however see the need for repo rate hike of 50 bps beginning from August 2022.

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

The reversal of interest rate cycle has started and in the US, expectation is that the rate would rise by nearly 175 bps during the current year. Brazil has aggressively raised the rate by 150 bps and Russia by 100 bps.

Gold futures reflect a benign trend and oil could decline to about US$80 per barrel (USD 75 per barrel was assumed in the Union Budget presented on February 1, 2022). Inflation and consumer prices in India are within the band and expected to moderate during the year. The performance in real sector is encouraging.

The stress in the banking sector is high and with increasing number of COVID waves could go higher. The implications of high capital expenditure in the Budget imply robust business for the banks. However, introduction of CBDC by the RBI can cause uncertainty in the monetary policy.

In general, given the above uncertainty in domestic market and changing financial cycle globally, RBI could move to neutral stance but not change any of the rates - Repo or Reverse Repo.

Guest Panelists – Specialists from Market

1. Shri Siddhartha Sanyal, Chief Economist & Head- Research, Bandhan Bank

A closer look at the different waves of the COVID infections shows that there was damage to growth with each wave and Omicron fortunately dealt less damage than previous waves. Globally, there was damage in growth recovery prospects for most countries and there was near term supply chain disruptions. This led to damage through inflation, rather than the damage on the growth and made inflationary pressures more persistent and more nagging. Even if the demand recovery is not that strong and central bank is gearing towards withdrawal of liquidity or towards tightening the rates, the commodity prices are behaving in a different way, which we were not anticipating 6 months or 1 year back. With respect to inflation, the supply chain disruption and persistent nagging inflation are possibly here to stay.

If damage to growth is because of supply chain disruption related issues then the RBI’s approach should be more nuanced like it is now. For example, in 2020 when other central banks made huge cuts in interest rates, RBI followed a nuanced approach. This policy should be continued, and RBI should try to address the situation not only by monetary policy, but also using other policy tools. The RBI is in no pressure to hike the interest rates like its foreign counterparts. Therefore, it is expected that repo rate will not see any hike until 2nd half of the coming financial year. The Reverse Repo Rate is expected to be normalised by 40 basis point, which would probably be done in two tranches of 15 to 25 basis points and not in one swift move. This change may or may not happen in the next meeting.

Normalisation process which is expected to take place will have four steps. Liquidity normalisation, which had already started around September- October will go in persistent manner. With respect to VRRR, the operating cost is moving close to Repo Rate, which shows how well the RBI has prepared the market and the system. That is, a hike in Reverse Repo Rate does not have too much of an adverse impact on the system. It highlights that the groundwork for normalisation is well laid.

FY2023 Union Budget maintains a growth supportive stance, with taking into account the short term growth recovery aspects and the long term growth aspirations of the economy. In this juncture the challenge for RBI is the adverse impact of how potentially a larger borrowing program is neutralized or contained on interest rate. It is expected that RBI will do not anything rustic at this juncture, as it had maintained in the past.

Private consumption is very important in terms of India, and consumer confidence had declined in the 2020 and did not recover much in 2021. But in the recent surveys, a slight recovery in the consumer confidence is seen. To some extend that the economic agents have not been harmed much by the Omicron Wave, but it remains to be seen that will this be reflected in consumer confidence.

Therefore, RBI will continue with normalisation efforts in a nuanced way, to support economy in general and to not put any undue pressure on interest rates trajectory. Interest rates are already facing pressure from global indicators and governments borrowing programs. MPC is expected to strike a balance in this regard.

2. Shri Arjun G Nagarajan, Chief Economist, Sundaram Mutual

The Union Budget 2022-23 appears to be a continuation of the government's conservative stance and increased transparency seen last year. The budgets resists the temptation to turn populist and focuses on the much needed supply-side instead. The budget's supply-side focus can be seen in its extended capex narrative, manufacturing incentives, rising infrastructure spends, transition to clean energy and tariff protection for select sectors. The current total capex of the Centre (Budget+IEBR) at Rs.12.2 tr, is 35 per cent higher than FY21 and 25 per cent higher than a pre-COVID FY20. As always, the proof of the capex numbers is in its execution. And the current political dispensation appears be consistent in its narrative of a shift to quality spends and continued focus on domestic manufacturing/industrials/infrastructure. It is important to acknowledge the effort from the government to consolidate its spending gradually increase the component of budgeted capex. Budget support for the Centre’s total capex has risen to 62 per cent in this budget, from 34 per cent seen in FY20 (47 per cent in FY21).

Globally, the market narrative around the Fed has been picking significant momentum. However, the yield spread (30Y minus 5Y) has been narrowing sharply and it appears that the market narrative into the March Fed policy could toy with overtightening from the Fed and a resultant probability of a recession. While this probability is negligible at the moment, it broadly reflects uncertainty on the quantum of Fed rates; even as the trajectory is known. The RBI is not likely to pre-empt the Fed and would wait till the Fed's March policy to take a call on its normalisation and accommodation narratives.

All eyes therefore now fall on the RBI's monetary policy set for the 9th of this month. We expected the RBI to start the normalization of its reverse Repo rate into early FY23, even though post budget, the market sees an increased possibility of this in its 9th Feb policy. The RBI is likely to stay on hold in its Feb policy on all policy rates and maintain its stance on accommodation. However, the narrative within the MPC could see hawkishness and diverge from commentary heard from the RBI governor.

Guest from ASSOCHAM

1. Shri S. C. Aggarwal, Senior Member, ASSOCHAM & CMD, SMC Group

The budget had increased spending but that did not turn out to be inflationary. The increased capital expenditure is expected to benefit everyone in long term if not in the short term. The Budget was investment driven, to that extent the RBI need not worry about inflationary fiscal policy right now. The budget would be viewed positively and as growth supportive by the RBI as there is increased capital expenditure, quality of spending and directional fiscal consolidation. The unexpected surge in the market borrowing has brought liquidity management to forefront. It is believed that this would require RBI to manage the borrowing and reduce the speed of policy withdrawal.

  • The banking systems liquidity surplus has a steady downward trend for past 1 month due to bond sales by RBI in secondary market and toned down its foreign exchange market intervention.
  • Net durable liquidity has remained sizable at Rs.10 lakh crore. This means that the overnight rate has remained closer to RRR rate of 3.35 per cent bearing occasional spikes. This needs to climb further to RRR.
  • To bring down liquidity surplus is imperative for the RBI, but it cannot sell government bonds to do so, as it will dry up long term yields. And increase in yields will endanger the investment cycle the government is aiming to boost.
  • MPC should ensure that short term interest rate is not too low and long-term interest rate is not too high.

2. Shri Amit Gupta, Chief Financial Officer, U Gro Capital

While system interest rates are an important part of the macro-economic consideration, from the narrow perspective of the NBFCs (especially the ones catering to granular loans to MSMEs) and their borrowers, it’s the access to the liquidity which is more important. Despite the regime of easy liquidity, Private NBFC’s finds capital hard to obtain in the present system. As they are catering to initial supply chains of larger enterprises, more efforts should be made to address this.

During the pandemic despite the historically low level of system interest rates, NBFC’s were borrowing at high cost, which translated to higher lending cost to their clients. Even with this higher cost the lower strata of the borrowers were better served, due to the financial inclusion of the borrowers who were not served appropriately by commercial banks. Another advantage for these borrowers is that their credit history is being built throughout this lending process, which will help them in future. RBI is also giving thrust in this regard through co-lending partnerships of NBFC’s with banks, which should ideally bring the greater reach of these NBFCs and lower cost of funding of Banks together, resulting in the access of formal finance at increasing lower rates to the MSMEs. The co-lending partnership has been slow to take off as the banks are reluctant to adopt the NBFCs credit underwriting policy despite a proven track record of these NBFCs of being able maintain a robust credit quality of their books.

The lower strata of the borrowers are the best borrowers, provided that the money taken is used for the end use for which they were taken for. If banking entity could monitor end use, then they can reduce Non-Performing Assets. Therefore, a mechanism must be made to get this surplus liquidity to these needy borrowers but building this mechanism would take time. The RBI should maintain a neutral stance in terms of Monetary Policy and monitor progress made on the aforesaid channelization of liquidity to the bottom of the pyramid borrowers.

3. Shri Raman Aggarwal, Advisor, Shriram Transport Finance Company Limited

The RBI circular on 12th November 2021 issued a clarification on classification of NPA/SMA of borrower’s account by end of day and directed to upgrade the accounts of classified NPA only when entire arrears, including principal and interest are paid by the borrower. We wish to raise concerns over the impacts of this directive, since private NBFCs cater mostly to the unbanked/underbanked sections of the society like MSMEs, farmers, and retail borrows. The delay, if any, in repayment of loans by the borrowers from these segments is due to genuine business reasons and is primarily driven by the uncertainties in their cash flows and not by their intent. These borrowers are neither financially strong nor as sophisticated in their financial acumen as the large corporates; the MSMEs are totally dependent upon the cycle of payment from users of their services or buyers of their products and hence suffer from fluctuating cash flows. Therefore, we request the RBI to bring an element of flexibility with respect to retail loans up to Rs. 2 crore, which may be permitted to be marked as NPA’s by month end and whose upgradation may be allowed to continue as hitherto (i.e., by partial repayment of arrears). We also request the RBI reporting on NBFC’s to be bifurcated between government owned and private, since majority of the Government NBFCs follow a different business model of big-ticket size lending to industries and infrastructure, which is mostly long-term projects. This will help boost the economy at a time when banks have largely become risk averse.