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EGROW Shadow Monetary Policy Committee – Recommendations for June 6, 2019

Dr. Arvind Virmani, Former CEA, MOF and ED, IMF

  1. Encouraged by Regulatory actions taken by RBI to solve the Banking, PSB, NBFC problem of NPAs, Asset-Liability mismatch and Borrower bankruptcy. RBI & Govt must work together to clean up financial intermediation system quickly!

  2. Inflation outlook remains benign(domestic & international), but GDP outlook has deteriorated over past 6 months both in terms of Internal developments and greater uncertainty and risks arising from external Geoeconomics environment.

  3. Indian fiscal deficits and Real interest (Policy-Repo, Govt Securities, Corporate paper/Loan rates) remain among highest in world. Danger of crowding out of private credit is higher and possibility of negative impact on inflation lower.

  4. Fiscal Deficit should remain on Glide path defined by revised FRBM passed by Parliament. Monetary policy must use both Repo rate reductions and monetary expansion (long term liquidity injection) to improve transmission to real lending rates.
    Recommend a 50 BPS reduction in repo rate, as I did before last MPC (- 25 bps likely)

Policy stance: Shift to accommodative

Rate: Cut by 50bps

Prof. Ashima Goyal, IGIDR and Member, PMEAC

A number of indicators suggest the fall in growth and therefore in investment may persist without a policy response. Headline inflation has been below the RBI target for long, and now there is a sharp fall also in core inflation. In mid-May the 1 year GOI T bill was 6.5% with the inflation forecast at 4% or below one year ahead real interest rate is above 2.5—the highest in the world. Since the neutral real rate is about1% there is space to cut policy rates by 1.5%. Policy cannot afford to be this tight when growth is slowing and inflation is in the target band. Even if the MPC cuts only 0.25 now, while waiting for the budget and the monsoon to play out, the RBI can communicate a softening stance and act on liquidity to reduce market rates, reducing rising spreads for borrowers.

The composition of liquidity also matters. Although the RBI is now keeping short-term liquidity in surplus, banks scarred by a long battle with NPAs are just parking it back with the RBI instead of increasing lending. M3 and credit growth rate is low. If the share of durable liquidity is increased it will encourage banks to lend and also reduce market rates. The RBI made it easier for banks to lend to NBFCs but they are not doing so. Even the better NBFCs are hoarding liquidity and lending less. The growth slowdown indicates continuing spillovers to the economy which may escalate. Apart from an overall rise in liquidity, a temporary window for NBFCs that makes liquidity available at high cost and good collateral would not be used much, but may build confidence and allow lending to resume, while long-term reforms make regulations uniform.

Policy stance: Shift to accommodative

Rate: Cut 0.25 basis points

Dr. Surjit S Bhalla, Contributing Editor, Indian Express

  1. Whether one looks at the economy, inflation, private investment, credit availability, sentiment, or global growth – the signs are clear – India needs a more active monetary policy.

  2. The NPC, in my view, has been a prisoner of a view about inflation and/or policy which cannot be justified by any of MPC’s own logic, and own diktats. At its first meeting in October 2016, the MPC announced that it was moving away from the real repo target of former Governor Rajan of 1.5-2 %, and was now targeting 1.25 %. It even gave a rationale, definition, and method of estimating the real repo rate. Take the most recent estimate of CPI available to the RBI (in October 2016 it was the August y-o-y inflation number of 5 % and add 1.25 %. The repo rate prior to the October 2016 meeting was 6.5 %; hence, and therefore, the MPC reduced the repo rate by 25 bp to 6.25 %

  3. The MPC is now 33 months old. Except for a few months in 2018, the real repo rate has been substantially higher then 1.25 %, and has averaged around 2.75 %. The latest inflation estimate available to the MPC is April 2019 y-o-y inflation of 2.92%; the MPC defined real repo rate is today at 3.08 % (6-2.92).

  4. The MPC’s own forecast of inflation for fiscal 2020 is around 3 %; hence there is a need to reduce rates by 175 bp obtained as: 6 – 3 – 1.25 = 175 bp.

  5. Hence my expectation is that the MPC should cut the repo rate by at least 50 bp, and change the stance from neutral to accommodative. It is difficult to state what the MPC will do, since, to date, there is no replicable model of MPC actions.

Policy stance: Shift to accommodative

Rate: Cut by at least 50bps

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

I vote for a 35bp cut in the RBI repo rate. May inflation is tracking a low 3.3%. While it can touch 5% in end-2019, especially if the monsoon disappoints, this will be largely driven by base effects. Second, growth remains weak with March quarter dipping to 5.7% on the end-2018 liquidity crunch and base effects. While RBI OMOs have stabilized markets, the end-2108 liquidity crunch is still hurting the real economy. Although we expect growth to bottom out in 2HFY20, that presumes lower lending rates. Finally, PM Modi’s historic mandate has defused fiscal/INR risks. In our view, the Modi government has shown its firm commitment to fiscal responsibility, by not responding to the Congress’s NYAY proposal of 1.9% of GDP even in the heat of polls. There is thus no reason to wait to see if there is fiscal slippage in the July 5 Budget. We expect the new finance minister Nirmala Sitharaman to adher to the 3.4% of GDP fiscal deficit target set in the February budget.

I expect the RBI to continue to infuse US$2-3bn of durable liquidity a month via OMO/FX swaps. It should inject US$35bn for the fiscal as a whole. Re 1 multiplies into Rs5 of deposits/credit in some 6 months. It is then only logical to pro-actively put in liquidity in the April-September ‘slack’ season to ensure sufficient liquidity in the ‘busy’ October-March season. It is for this reason we expect the RBI to let the money market sustain in surplus reverse repo mode now. This is essential for the RBI’s policy rate cuts to transmit into lending rate cuts by September.

Finally, we see no change in the neutral policy stance.

Policy Stance: Keep policy stance unchanged at Neutral

Rate: Rate Cut by 35bps

Ms. Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank

Given the strong political mandate and the assurance of policy continuity, market focus has now shifted towards policy initiatives that can be undertaken on the monetary and fiscal side to revive the economy. While the next generation reforms on land, labor and capital will be necessary to step up the economy on sustainably high growth path, the need of the hour is to arrest the sharp slowdown currently plaguing the economy. Financial market tightness, adverse terms of trade in the agricultural sector, income uncertainty, slowing real estate and construction activity amid credit squeeze and weak global demand have led to a broadbased economic slowdown. Most of the investment growth was being driven by government in the past few years with private investment mostly missing. But now the government has limited fiscal flexibility given the significant shortfall from tax revenue. Given the limited fiscal space, we see further downside risks to growth as we await the reforms to begin bearing fruits in the medium term. FY20 GDP growth is expected to remain muted, with slowdown in 1H likely to continue and some improvement in consumption and investment likely in 2H. Against this backdrop of weak growth, I see core inflation to moderate and remain muted even as food reflation begins. Overall, headline inflation is expected to remain near the 4% mark (+/- 50bps) over the next 9-12 months.

With controlled inflation, relatively high real interest rates and limited fiscal space, we see the RBI to become an important bastion for supporting growth. This can partly be achieved by monetary accommodation, especially when globally the Central Banks are turning dovish. I see room for atleast 50bps rate cut in 2019 but timing remains to be seen as RBI may want to weigh the monsoon risks. However, for effective monetary policy transmission, liquidity conditions need to be supportive. I continue to highlight the need for further affirmation by RBI on keeping the liquidity conditions in surplus mode atleast in the near term. Of course with the government spending expected to begin, we see liquidity to turn surplus in the coming weeks. But an assurance by the RBI of sustaining a surplus liquidity would provide comfort and bring down rates more sharply. Further RBI may want to relook at the operative rate to be closer to reverse repo rather than Repo. Any mix of these measures could lead to effective transmission of 50-100bps. Of course, the assured banking liquidity surplus condition may not necessarily ease the credit concerns for the NBFCs but smoother monetary transmission could at least seek to mitigate the adverse impact brewing from slower NBFC credit growth and divergence in public and private bank liquidity profile.

Overall, I expect RBI to -

  1. Keep policy stance unchanged at Neutral

  2. Decrease policy rate by 25bps

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

The June 6th monetary policy decision will be announced in an environment where there are elements of both certainty and extreme uncertainty. What is certain? There seems to be broad consensus on the fact that there is a marked slowdown in the economy and the dismal GDP print of 5.8 per cent for the last quarter of 2018-19 corroborates this.

This slowdown is not confined to the rural segments but has spread to the urban economy as well. There is also evidence of credit rationing with the riskier retail and corporate segments facing funding constraints. This comes on the back of a funding shortage for NBFCs and risk aversion by banks. Inflation at stage remains benign and while there has been an uptick in food prices, the headline CPI has been reined in by softer core inflation seen in April.

The uncertain elements in this environment are both local and global. On the domestic front, the probability of a sub-normal monsoon seems significant and the paucity of pre-monsoon rain has seen a rise in prices of some agricultural products. For the past couple of months food prices have been moving faster than long term trend growth and this could accelerate if the monsoon is weak. Thus there is a risk of sharply rising food prices and our forecasts of average CPI inflation for the first half of 3.3 per cent and 4.2 for the second half could be breached. This might demand stable rather than expansionary policy action from the RBI.

Uncertainty about the new government’s fiscal roadmap could also be a factor that could hold the RBI back. This roadmap will become visible only in the new budget likely to be announced in July. Recent fiscal data shows a considerable shortfall in tax collections in 2018-19 and in the absence of large expenditure cuts towards the end of 2018-19, there would have been a significant overshoot in the deficit from the 3.4 per cent level announced in the revised estimate of the January budget.

With the economy slowing down further, revenue collections are likely to remain weak making fiscal management a challenge. While the re-election of the NDA suggests continuity in fiscal strategy and focus on consolidation, this cannot be taken for granted. Besides the credibility of the fiscal plan also needs to be assessed to gauge whether an announced headline target for the deficit will be met or not. Fiscal expansion tends to be inflationary and can potentially lead to other imbalances such as a large current account deficit.

The global situation is risk-heavy with the US-China trade (and now a technology) war, a global growth deceleration that a trade war would exacerbate and possible volatility in crude oil prices. The specific risk for India stems from the possibility of capital outflows from Emerging Markets (EMs). These markets have taken cues from both China in the past–sharp depreciation of the Yuan and slow Chinese growth tend to induce outflows across emerging markets. Capital flows to India are known to be rate sensitive and the risk of a pull-out by debt investors might warrant a ‘hold’ by the RBI. As trade talks progress (or regress for matter) between the US and China over the next couple of months, the impact on EMs will become clearer. The RBI might want to wait for this clarity.

On balance we see concerns about growth outweighing the risks associated with a rate reduction. Thus the RBI should reduce the policy rate by 25 basis points in the June meeting. However, while policy rate cuts make for good optics, they remain largely ineffective if they are not “transmitted” to borrowers. There are a number of factors impeding transmission at this stage, both structural and cyclical. The NBFC crisis, for instance, needs to be resolved for “disintermediation” to return and lower rates on market instruments like Commercial Paper to force banks to lower their lending rates. Small savings rates remain artificially high and impede the pass-through of policy rates. These, however, are long term challenges. The sole thing measure that the RBI can take in the short term is to ensure adequate liquidity through its chosen instruments – open market operations and foreign currency swaps.

Policy Stance - Accomodative

Policy Rate – reduction by 25 basis points

Charan Singh, CEO and Director, EGROW Foundation

The global oil prices are expected to continue to decrease in the current year. However, there is uncertainty on the Indian basket, as well as domestic prices, as oil prices have been range bound in the last few months because of elections.

The El Nino is lingering on the horizon though IMD has predicted normal monsoons.

The GDP growth rates are not encouraging. Some segments of manufacturing, anecdotally, have been suffering. Illustratively, sales of motor vehicles is poor.

Investment continues to be sluggish, partly explained by the political uncertainty.

The global trade war could escalate, and India should position itself to benefit from the same.

The annual results of commercial banks have already been declared and most continue to be in losses. The liquidity in the NBFCs sector also continues to be a concern.

In view of the above, a sharp reduction in interest rates would be warranted to kick start the economy.

Policy Stance – Should be accommodative

Rate Reduction – 50 basis points immediately.

SUMMARY

Recommendation of Rate Reduction –

50 bp – 3

25 bp - 3

35 bp - 1

Prediction of Rate Reduction- 25bps cut by 4 members of EGROW Shadow MPC

Policy Stance- Accomodative- 5

Neutral- 2