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Twenty-First EGROW Shadow Monetary Policy Committee Meet held on April 1, 2022


Recording of the Event

Key takeaways

  1. Global conditions have worsened since Feb 2022, given rise in commodity prices and geopolitical risks to supply chain.
  2. The growth rates in advanced countries, as published by the IMF in Jan 2022, for 2023 is estimated to be lower than that in 2022. The expected Covid, wave 4, adds to uncertainty. This can impact India’s exports.
  3. Analysis of components of CPI and WPI suggests that the rising prices in recent times, could be transitory.
  4. High inflation is the cause of tightening interest rate cycle in select, not all, advanced countries, like the USA as also in EMEs like Russia
  5. RBI should continue with policy of liquidity normalisation started from second half of last financial year.
  6. Contact Services are expected to recover in Q1 of FY23.
  7. GDP growth can be expected to range between 7.5 +/- 1 percent given the uncertainty in oil prices.
  8. If the oil prices rise to USD 115 per bbl then the Current Account Deficit could rise to 3.5 percent of GDP
  9. In uncertain times, gold serves as a relevant, much-demanded asset. The imports of gold can be expected to increase significantly, impacting overall economic policy.

Recommendations of EGROW Shadow MPC

Members of EGROW – 4

Repo Rate

  • Retain at 4 percent – 3
  • Increase – 1

Reverse Repo Rate

  • Retain at 3.35 percent – 2
  • Increase – 2

Policy Stance

  • Accommodative should continue – 1
  • Accommodative to Neutral – 3

Guests – 3

Repo Rate

  • Retain at 4 percent – 2
  • Increase – 1

Reverse Repo Rate

  • Retain at 3.35 percent – 2
  • Increase – 1

Policy Stance

  • Accommodative should continue – 2

Detailed Views by Members of the EGROW Shadow MPC

Dr. Arvind Virmani, Chairman, EGROW Foundation

The new major change since the last SMPC meet is the war between Russia and Ukraine. The immediate effect is on commodity prices. The biggest effect to be concerned about, apart from inflation, current account deficit, fiscal deficit, etc., is the impact on income and consumption.

There are two parts to that- (i) crude oil (which stands out itself), (ii) other commodity prices.

As far as other commodity prices are concerned, we are going to benefit from wheat and iron ore. We lose from many other commodities. We are left with is the huge increase in oil prices which will become a kind of tax on income and so we lose a portion of real income in terms of trade effects. This means that there will be less in terms of recovery and private consumption will be slower and that will affect GDP.

We should see a recovery in contact services in Q1 of the current financial year. Real estate will show visible recovery in Q2. Private investment recovery will be starting in the second half of the year. The net result of all this on GDP is that the range of uncertainty of the forecast which was given as 7.5 +/- 0.5 per cent, now that range has in effect expanded to 1 per cent. The uncertainty in GDP is connected to the huge uncertainty on oil prices which is forecasted for the full year to be 100 +/- 20 because there are many reasons including sanctions on Iran, restrictions on Russian oil exports, etc.

The Important effects which will keep coming back to us during the year are:

  1. There are two possible scenarios- one a messy win for Russia and the other is a messy loss for Russia. In both scenarios, Ukraine will be the loser and some form of sanctions against Russia is going to remain.

    1. There will be restructuring of oil and gas trade, from Russian oil and gas going to Europe to Russian oil and gas being redirected to China and European demand shifting to the Middle East.

    2. A speeding up of investment and non-conventional energy sources.

    3. Revival of nuclear power in Europe.

  2. Russian- China linkage trend is going to continue getting stronger and closer. There is going to be an increase in closeness between Russia and China economically.

    1. Technological decoupling will accelerate. Decoupling of technology will happen into two loosely led blocks- one led by the US and the other led by China.

    2. The supply chain diversification will happen. Speed of diversification is going to accelerate. Supply chains have been shifting to India since last year, slowly, but a new jump in this will happen where companies and firms will take up full- fledged shifting of supply chains. The way of thinking about it is changing in the US.

  3. India is heavily dependent on Russia for defence imports. The ongoing war will have a dual effect on the imports. One is in terms of low medium technological items and the other is in high tech items and finally nuclear. In low medium tech. we are certainly going to observe an acceleration of Atmanirbhar defence production. So, greater opportunities for private sector to invest in low medium tech items. On the high tech side, hybridization will take place because certain items like electronics, which have faced the brunt of sanctions, some electronic parts will be made in India or will be imported from some other countries like France, Israel or the US and then put together along with system parts which will be brought from Russia.

  4. The actions which the US and Europe have taken swiftly is going to have important medium term effects on many central banks who were thinking about diversification in different ways. As a means of reducing risks in the international payments systems for the future is to initiate what may be called a convertible digital rupee. Before the conflict in Ukraine, the digital rupee was thought of a small initiative, a replacement for physical currency. Now, the convertible element of rupee is essential, all it requires is to use the technology developed in UPI with some improvements and addition of an anonymity protocol. We already have the structures and ease of doing it and it is important to have a digital rupee to compete with the Yuan. We will remain in the block led by the US, but we should still aim to have our own convertible currency.

  5. The RBI should change its stance from accommodative to neutral.

Shri Indranil Sen Gupta, Head of India Research, CLSA

Expecting a 15-basis point hike in Reverse Repo in the April 6 RBI MPC meeting. Overall, 100 basis point hike in policy rates in FY23. Further 50 basis point hike in policy rates for FY24. This is due to:

Oil prices averaged at USD 115 per bbl hence inflation is expected to average at 5.5 percent higher than the earlier forecast of 4.75 percent. There are limits to a low reverse repo rate of 3.35 percent. It is alright to run negative interest rates given a crisis but prolonged low rates lead to a rise in inflation as seen earlier in history. For example, in 2004, 2005 and 2006 RBI acted fast and hiked policy rates to 4.5 percent hence there was reasonable economic growth. In 2010, the RBI delayed increasing policy rates that had an adverse impact on economic growth. Federal Reserve is set to hike policy rates due to high inflation in the USA. High inflation of this order does not come down easily. The rising inflation in India was thought to be a supply side shock. However, it is now believed by experts to be due to demand side issues. If inflation is allowed to rise to such high levels it is not easy to reduce inflation without monetary tightening and thus leading to a recession.

Another 175-basis point hike in policy rates in FY23 should be undertaken given the uncertainty due to the rise in commodity prices and crude oil prices from the Russia-Ukraine war. FX reserves are high and this will protect the Rupee from depreciation. There is a limit to waiting as the Federal Reserve is going to hike rates by 200 basis points. The differential Indian-USA policy rates is 300 basis points which is below historical levels. If RBI keeps on waiting then like 2005, RBI will have to undertake swift and rapid hikes. In 2005, there was an advantage of high economic growth but in the current period there is a shallow recovery. It is important to start gradually hiking the policy rates earlier as hiking them later and rapidly would destabilise the economic system. RBI should gradually hike policy rates starting now.

The fiscal deficit is high, there is a gap of Rs 4-5 trillion gap in bond market. There is less market demand in the bond market hence the government cannot borrow. Foreign exchange reserves (FER) of India are high at USD 670 billion hence if RBI sells FER this creates room for open market operations (OMO). Reserve money requirement is USD 56 billion in FY23. If oil prices stay at a certain level, then the Government will have to cut taxes to prevent further rises in inflation thereby reducing government revenue. If the oil prices are at USD 115/bbl then current account deficit is at 3.5 percent of GDP and if RBI loads about USD 20 billion of outflows the RBI would have to sell USD 70 billion of foreign exchange. If RBI is going to use USD 56 bn of reserve money then in theory RBI can do an OMO of USD 126 bn. The bond market is prepared for a policy rate hike hence there will be no adverse effects on the bond market. The current yield of the bond market is 7 percent and if policy rates are hiked then the yield will be 7.5 percent. The current period is a period of shallow recovery. The base case growth of GDP is estimated to be 7.4 percent for FY23 and there could be some downside risks to this by raising policy rates but as history has brought out that if policy rates are hiked gradually then there is a greater economic growth while delaying and then rapidly hiking later can impair economic growth.

Ms. Upasna Bharadwaj, Senior Vice President, Kotak Mahindra Bank

There are rising inflationary risks, volatility is here to stay. The oil prices are expected to be around USD 80 per bbl to USD 120 per bbl. If oil prices are at USD 80 per bbl then GDP is at 8.1 percent and if oil prices at USD 120 per bbl then GDP growth would be below 7 percent. GDP growth would be at 7 percent to 7.5 percent at the current level of crude oil prices. Inflation rate was earlier at 5 percent when RBI projected it to be at 4.5 percent. If the crude oil price is between USD 100-105 per bbl then inflation would be at 5.8 percent. This would be due to rise in fuel prices and a broad-based increase in the prices of raw materials and other commodities. The firms would pass these high prices on to the consumer by double digits to protect gross margin which would create a downward stickiness to the prices despite of the future fuel prices reducing. The government can reduce the impact on inflation through absorbing the fuel prices. The fuel prices could be absorbed through a cut in the excise duty up to Rs 5 per litre. However, if the prices of oil rise are at USD 120 per bbl then the excise duty should be cut by Rs 10 per litre. This will have a bearing on the fiscal deficit. It is imperative to reduce the excise duty to de-anchor inflation expectations. If the oil prices are at USD 120 per bbl then CPI inflation is expected to be at 6 percent for FY23. In the first six months of FY23 there will be a CPI inflation greater than 6 percent. In the next six months of FY23 commodity prices are expected to decrease and the pass through to the consumers will reduce thereby inflation is expected to reduce.

In Feb 2022 the commodity prices were rising globally. The geopolitical risks for supply chain diversification were present. The Federal Reserve was talking about hiking the policy rates. Contrary to market expectations the RBI did not hike the policy rates and pursued a pro-growth strategy. The Russia-Ukraine war magnified the commodity price rise and geopolitical risks. This has led to both the Bank of England and Federal Reserve to suggest a hike in the interest rate. RBI should pursue policy normalisation and change the monetary policy stance from accommodative to neutral. The Reverse Repo rate should be hiked by 15 basis points. However, it is expected that the RBI would hike the reverse repo rate by 15 basis point in June rather than in April.

Dr. Charan Singh, CEO and Director, EGROW Foundation

There is no need for a change in stance or repo rate right now. CPI inflation is on the upper margin of comfort zone. But, if analysed carefully, we know it is something to do with transport, health, as well as oil and fats, and meat and fish. This is more transitory rather than permanent and therefore the policy action should not follow immediately.

It is reflected in WPI in a bigger way. It is so apparent in fuel - crude and petroleum, from the WPI data. We all know how this is played out. This should not really make an impact on the policy immediately.

USA is aggressively hiking the interest rate, the reversal has started, the US Fed Reserve said that they would do the hike by 1.9 per cent this year and they could also do two hikes next year. The UK has also started interest rate hike whereas Australia has not done any such hike in their interest rates. They have resisted the hike. In emerging countries, Brazil and South Africa have also taken steps towards hiking the interest rate. There is a unique trend in the growth rate figures released by the WEO in which it said that in advanced countries in 2022 vis-à-vis 2021, the growth pattern of some countries in 2022 is less than the growth estimation in 2021. The projections for 2023, none of the countries have projections more than that shown in 2022 rather it is less than that. This is a cause of worry. India has touched and crossed the USD 400 billion exports, one has to be really carefully observant of its impact in the years to come.

India’s growth story was based on the USD 70-75 per barrel but as we know that zone has already been crossed and we don’t know how long that zone will be in. One has to be cautious going forward.

Regarding IIP, we are doing reasonably well. The same goes for the eight core industries as well. When it comes to NPAs, the RBI governor while talking about the Financial Stability Report had said the NPAs would increase to 6.9 per cent. This is all time low and we are doing better as we are around 6.5 per cent. However, there are 12,000 odd cases which are waiting to get into NCLT. In NCLT, the data shows that most of the cases end up in liquidation and not resolved. There is stress in the corporate sector as evident by 12,000 pending cases.

The fear of the fourth Covid wave is still hovering and there is uncertainty as to its occurrence, it may come in June. However, as the Chairman mentioned, contact services are normalizing, schools have opened which shows that things are normalizing. We will have to wait and see how it reflects into tax collections and how the revenue of the government starts streaming in. Market borrowing program depends to a great extent on this.

At this point given the uncertainties, it will be comfortable for the industry to know that the RBI continues with its cautious stance, doesn’t change its stance at all, and doesn’t change the repo rate. It allows the growth rate to nurture in the economy. These green shoots that are appearing, the contact services that have started, they are allowed to stabilize before the RBI makes any change in the stance or interest rate.

There is a surge in the demand for gold which is increasing the current account deficit. In my experience gold serves as a hedge for uncertainty across various income streams. The free food programme started by the Government during the Covid-19 pandemic is expected to be extended beyond September 2022 given the political economy aspect of the initiative. This initiative contains the spread of poverty in the country but has an implication on fisc. In view of the fragile recovery the RBI may like to consider assigning concessional rate of interest for loans extended to the health sector-pharma, hospital, rural health, and medical education.

Guest Panelists – Specialists from Market

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

The normalization process that has four steps, is already underway. First step, that is removal of excess liquidity, has about Rs 7 lakh crore excess liquidity in the system. This needs to be gradually removed and is expected to continue for the next 3 to 4 months. Interest rate normalization is the second step and is expected to be conducted in a moderate manner. The reverse repo rate hike is expected in this quarter if not in this MPC meeting, while a hike of about 50 basis points (bps) is expected in the repo rate, across the latter part of this year. The reverse repo rate is anticipated to be raised in 2 tranches of 20 bps each. There is pressure from money market, making a case for reverse repo rate hike in the forthcoming MPC meeting, however given the conservative pace shown by MPC in the past instances, it will be probably postponed to the next meeting. While doing so, it is expected that MPC will signal its motives to change rates in subsequent policy meetings. As the next step, the change from stance to neutral from accommodative is not expected until the entire normalization of reverse repo rate is completed and therefore is expected to take place in the next couple of policy meetings.

The repeated headwinds faced by the economy, has eroded portions of shallow recovery made by the bottom end of the pyramid. Therefore, it is anticipated that this will be also taken into account when MPC decides to go ahead with rate hikes, as the successive rate hikes may make it hard for them to deliver efficiently. Even then the normalization cycle must go on, mainly due to two reasons. The overall inflation came out to be higher than RBI’s projection of inflation, which was around 5.0 per cent for first half of the year and about 4.0 per cent for second half. These projections are facing upward pressure of about 1.5 per cent, which is a significant revision as this takes inflation close to upper tolerance band. The other reason is the global trend to hike the interest rates, as reflected in the actions of US Federal Reserve. However, the MPC is expected to approach these issues in a nuanced manner as it has shown in the past.

In short, the scope for RBI to influence growth or inflation in near term, is very limited and hence they will be mindful to ensure that no disruption is caused to overall financial market stability while normalization process is carried out. Therefore, any major changes in monetary policy by RBI is expected to be announced in advance, before undertaking such actions.

Shri Arjun G Nagarajan, Chief Economist, Sundaram Mutual

In the April MPC meeting it is expected that the RBI would keep both the repo and reverse repo rates unchanged. RBI would also tweak its FY23 GDP growth rate marginally lower and increase its CPI inflation numbers higher. Liquidity is not likely to see any appreciable changes. Frontloading of the H1 borrowing program leading to more supply could possibly see some incentives to increase the HTM limits to absorb this supply.

The reasons for such an approach of RBI is due to the following:

  • US and India on the growth front, are on two extremes. While the US sees very strong growth, India’s growth is still in a process of recovery. Q3/Q4 growth rates for FY23 as of now seem to be in the 4-4.5 percent range.
  • The RBI is under no compulsion to hike rates because, unlike the west where most developed economies are witnessing an inflation problem, India still does not have one. And with soft growth, it would not be appropriate to act pre-emptively on rates.
  • Further, the recent Fed rate hike cycle of 2015-18, showed us that the RBI could cut rates even though the Fed was on a rate hike cycle. Therefore, there isn’t pressure on the RBI to follow the Fed.
  • Credit growth is yet to pickup and the Reverse Repo rate window of the RBI continues to park elevated levels of deposits from the scheduled commercial banks. Repo rate normalisation here is not likely to change this in any way.
  • The best time to review a rate hike/rate normalisation would be when growth sees a pickup, or inflation demand pressures are seen, or (in lighter vein), when the markets start their narrative that the RBI is behind the curve.
  • Being ahead of the curve by a central bank on monetary policy (rather than regulation) is a costly affair

Guest from ASSOCHAM

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

For this Monetary Policy Committee (MPC) meeting to be held on April 6-8, 2022, MPC has two key challenges ahead of them. One is inflation, which was high in January and February, at around 6 per cent and other is the uncertainty created by Russian invasion of Ukraine. The latter event resulted in rise of crude oil prices, which in turn reflected in commodity prices. However, as the inflation is classified to be transitory, it is expected that RBI Governor will prioritize economic growth over inflation. If the inflation persists further only then the interest rates should be raised.

Another challenge that MPC may face is the increase of current account deficit from 1.9 per cent in financial year 2022 to more than 3 per cent, which may persuade MPC for an interest rate hike. Globally, the US federal reserve has hiked the interest rate in March, and it is yet to be seen how Japan and UK will set their interest rates. Likewise, the economists have also reduced GDP estimates from 8.6 per cent to 7.9 per cent. Considering all the above challenges, it is expected MPC will not change the interest rates at this policy meeting, however if there is a change, then a rise of 25 basis points is at most expected.