Third Bi-Monthly Monetary Policy – R3’s Final Move

The Reserve Bank of India, will announce its third bi monthly monetary policy for the year on Aug 9,2016. This policy review shall be the final move from Dr. Rajan (R3 – RaghuRam Rajan) – the man in the hot seat for the past 3 wonderful years. Will it be a rate cut, a status quo or a rate hike in anticipation to the current economic and global conditions? Lets take a glimpse at the domestic conditions and the global economic conditions as well to assess the probable outcome of the monetary policy on the coming Tuesday. We will discuss the current scheme of things with the monetary policy, various domestic parameters, monetary policy transmissions – improvements and finally what would be the outcome of the monetary policy this time.

A quick background of the current stance in terms of the rates – CRR at 4%, SLR at 21%, Repo Rate at 6.5% (stagnant at that stage for quiet a while now) and the rupee has been hovering in the range of 65-67. On the global front, the Federal Reserves have kept their rates unchanged as well for a significant time span. The Bank of England was witness cutting the lending rates from 0.5% to 0.25% last week. Generally, when the interest rates are near zero levels, if a central bank chooses to cut it further, it essentially signals that the growth is stunted and the central bank wishes to spur the same to the extent possible without using any unconventional monetary measures.

A lot has happened since the past 3-4 months – the Brexit and its global effects, the gradually syncing fear of another global meltdown with most of the advances economies unable to exit the recession ill effects. India, although has been stable so far, cannot afford to think yet another time that we are decoupled from the global turmoil. Being emerging nations, we will be affected by the global downturn if the right measures are not in place. The global conditions are signaling a more accommodative and stable monetary stance (which essentially means a status quo).

On the domestic front, the headline inflation has been inching northwards from the past 3 months. This aspect would definitely get Dr. Rajan worried since the inflation targeting regime would be breached in case the inflation keeps increasing with the persistent rates. The CPI inflation has been hovering around 5.5-5.7% levels lately, however the same going anywhere beyond 6% would have an impact on the consumption and demand growth in the near future. With the target of maintaining the average inflation at 4% by Jan 2017, this monetary policy stance should be a status quo. Food inflation, although increasing at a decreasing rate, should essentially provide some relief for the central bank. The rainfall also has been fairly above the average levels compared to the previous 3 years.

With the auto-regressive integrated moving average predicted forward curve shows a probably uptick in the inflation rates as shown below. RBI would want to wait and watch for the inflation numbers to be published on the 12th of August before they create a case for a rate cut.

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Wholesale price index which was showing deflationary trends in the previous quarter has now started to head northwards sharply in the past 3 months. As far as the inflation metrics are concerned, it certainly reemphasizes a status quo in this monetary policy review.

On the growth front, Index of Industrial Production has shown clear signs of stagnancy so far, but the central bank seems to be hopeful about the revival in the next two quarters since the rate cuts will kick in with a lag. However, the Q2 earnings of most companies have been satisfactory amidst such global turmoil in the rest of the advanced economies. With IIP slowing down, it might act as a key parameter in deciding the policy actions this time. The downward trend however indicates a case for a 25bps rate cut sometime before the end of 2016. Here’s a quick look at the IIP and the forecast so far:

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The currency markets being in turmoil, the rupee has managed to perform significantly better than the rest of the emerging economies, especially against the dollar. I feel, the RBI has create significant foreign currency reserves in order to deal with the turmoil in a much robust way that ever before. With no requirement to stabilize the currency from policy actions, it indicates a status quo as well.

Banking sector, however, has been still struggling with the asset quality. The loan growth still is unable to surpass the barrier of 12% levels, whereas the deposit growth stands at 11%. However, we must appreciate the fact that the inflation targeting regime has been managed efficiently and the loan growth rate has been taken care of simultaneously as well. Although, the loan growth seems subdued, RBI still has room to take hits on the same for a few more months and wait for the global unrest to stabilize. A quick glimpse at the loan growth will indicate the improvements and the forecasts as well:

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The call money markets and the inter bank lending rates have shown a fairly stable nature. The indication of stability of these rates is when they do not break the 200 bps window created by the RBI by setting the repo rates. For the readers: Repo rate is at 6.5%, in order to conclude that the call money rates are stable, they need to be between the 6% (Current Reverse Repo Rate) and 7.0% (Current MSF rates/ Bank Rate) corridor. This corridor usually used to be 200 bps when the liquidity conditions were tight. In case, they break either levels, it calls for a interest rate action to accommodate the change. The current scenario indicates that there is absolutely enough liquidity in the system and no action whatsoever is required by the central bank via the monetary policy tools. A quick glance at the IBLR and its forecast:

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Inefficient monetary policy transmission has been creating hindrances for RBI from a year now in terms of passing on the benefit to the customers. The RBI has reduced the repo rate by over 125bps yet the banks seem to have passed on the rate cuts only to the tune of 60-70 bps. The reason being, the stressed assets and the intense pressure on profitability due to increasing costs and provisions. In order to address this, the RBI asked the banks recently this year to shift their calculations of cost of funds to a efficient method called as the marginal cost of funding. Since then, the banks have implemented the same and a few of them have managed to pass on the benefit of another 5-10 bps recently. Although, the results have been evident, the transmission is going to be a key concern for the RBI in the coming period as well.

Considering the average CPI at 6% and the repo rates at 6.5%, ERI is hovering around 0.25-0.5%  which might affect the growth in the coming future. Although, the ERI is much lower than the RBI comfort zone of 1-1.5%, this might not act as a trigger for a rate cut since taming inflation shall hold priority. However, it does call for a rate cut sometime this year to increase that ERI window to 1% at least.

To sum up, the domestic conditions for growth are improving gradually, mainly driven by consumption demand, which is expected to strengthen with a above average monsoon and the implementation of the Seventh Pay Commission award. Higher public sector capital expenditure, led by roads and railways, should crowd in private investment, offsetting somewhat the subdued requirement for fresh private investment due to financial stress. Yet, business confidence will be restrained to an extent on account of uncertain global factors for the next 6 months at least.

What does all of this mean for the upcoming monetary policy?

It is needless to say that the global economy is under significant pressure. Certainly, the solution does not seem to lie in the monetary sphere at the current moment. I predict, that the RBI might hold the repo rates at the current levels of 6.5%. CRR and SLR might also be untouched due to the ample amount of liquidity and money supply in the system. But witnessing the current conditions and the forecast, RBI might have to step on the gas in the next review with a rate cut of 25 bps. However, the tone of the policy would continue to be fairly dovish and reform driven. However, RBI shall continue to keep its inflation targeting focused until it is tamed to a consistent 4% levels by 2017.

Thank you. 🙂

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When The Acche Din Were Around The Corner…

When the acche din were just around the corner, here are two big events that have occurred in the past two weeks (Brexit and Rexit). I would like to talk about brexit in one of my other blogs, and would be focusing on Rexit ( Dr. Rajan opting out of the second term as the RBI Governor) in this one. Raghuram Rajan will step down as the 23rd governor of the Reserve Bank of India when his term expires on 4 September,2016. In this blog, I would be giving in sense of his achievements post his appointment as the RBI Guv, the likely impacts on the markets due to REXIT and the next likely predecessors for the position of the RBI Guv. I will also share statistics in terms of the key indicators before and after Dr. Rajan took over on the Sept 4, 2013.

From converting the Reserve Bank of India into an inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan’s three year term has created significant progress. Dr. Rajan, has always been a inflation targeting Guv since the belief was strong that neither higher inflation nor lower interest rates are going to boost growth solely, the growth is always a mix and balance of the two parameters. With his highly focused regime of concentrating on the monetary aspects of the economy by considering various external and internal events has been effective in all the possible ways.

Here’s a list of the key improvements/actions/achievement by the veteran:

  1. MPC (Monetary Policy Committee) – Dr. Rajan announced a committee to review the monetary policy. Although, the attempt was then tweaked by the Govt in such a way that currently there is a hint of RBI Guv losing his rights to take the final decision on the policy actions.
  2. Inflation Targeting – Right after taking over as the governor, Raghuram Rajan appointed a committee to review the monetary policy framework. The committee recommended that the RBI formally shifts its focus on to the consumer price inflation index as the nominal anchor for monetary policy in the country rather than WPI. As part of this framework, the RBI was to bring down inflation to 6% by March 2016 and 5% by March 2015. Over the medium term, the RBI now has a target of bringing inflation down to 4% (+/- 2%). Looking at the current situations, the RBI has fairly achieved its targets.
  3. Revitalization Stress Assets – RBI took various measures against the stressed assets of the banking sector especially in terms of the corporate and strategic debt restructuring norms.
  4. Bank Licensing – While the process of licensing another round of universal banks was kicked off during D. Subbarao’s tenure, Rajan’s tenure saw two new banks (IDFC Bank and Bandhan Bank) being licensed. The more significant step in this context, however, was the licensing of differentiated banking licenses.  11 payment banks were given an in-principle approval and at least eight of them will launch operations by early next year to increase penetration in the rural economy. In addition, ten small finance banks were also given in-principle licences to serve small borrowers and businesses. Rajan also floated the idea of wholesale banks and custodian banks, although, with no guidelines as of now. The RBI put out a draft framework for on-tap universal bank licensing as well.
  5. 5/25 Scheme – RBI allowed corporate to extend tenors of credit in case of infrastructure projects thus providing them with a higher gestation period.
  6. Market Development – Market development has been top of the agenda for Rajan as well. The RBI, under Rajan, has also for the first time put in place a framework for foreign investor participation in the bond markets. The RBI may start accepting corporate bonds as collateral for its liquidity operations.
  7. Repo Rates Decline – Repo rates were brought down to 6.5% ( Lowest in the past 6 years) with inflation targeting as the key focus.

Apart from the above mentioned monetary measures taken, Dr. Rajan’s timely actions on the monetary policy decision has enabled a huge change in the key macro economic indicators of India before and after Dr. Rajan taking over. There has been a huge difference in the numbers including the credibility in the world economy and the reduction in the instability of the economy. Here’s a quick stat on that:

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Although, it was an extremely surprising decision by Dr. Rajan, it was very well anticipated looking at the tension between the RBI and the Govt in the recent past. The markets have reacted negatively because of the sudden decision to not continue. The short-term blip will continue for the next 3 months and might settle down once the monetary front is stabilized post appointment of a new RBI governor. However, markets will keep dipping in the short term amidst the uncertainty on the global front, whereas the medium and long-term trend look significantly bullish.

Who Will Fill Rajan’s Shoes:

Lets look at behind-the-scenes scenario of how the RBI Governors have been appointed till date. Even though the Appointments Committee is the official vehicle to do the job, typically, the Prime Minister’s Office chooses the governor with inputs from the finance ministry and the outgoing governor and, on most occasions, there is no written recommendation. The politicians of the ruling party play an important role in the selection but the corporate houses that normally try to influence the appointment of CEOs of commercial banks do not have a voice here, although they have their own preferences.

Here are some of the options that the government may consider as it searches for the 24th governor of the RBI. The four likely candidates are: the current RBI Deputy Governor Urjit Patel, former deputy governors Rakesh Mohan and Subir Gokarn, and State Bank of India Chair, Arundhati Bhattacharya.

Here’s our quick analysis on who would be the probably choice of the Govt:

  1. Rakesh Mohan – A former Dy Guv and a veteran economist. Logically, he will be apt for a fiscal role rather than a monetary chair role due to experience in the former. However, politically he might stand a chance in case the Govt is looking for an economics reforms expert to head the RBI.
  2. Subir Gokarn – A former Dy Guv and a veteran economist especially in the areas of food inflation and inflation related research. However, he might not be the right candidate to head the RBI since that would require the expertise and experience on handling the monetary front of an economy.
  3. Arundhati Bhattacharya –  A career banker, Bhattacharya may make a good candidate against the bad loan crisis in the banking sector. The trouble with appointing Bhattacharya as the head of the central bank is that there is no precedent in recent times of a banker being appointed as the RBI governor. While one of the four RBI deputy governor’s is always a senior banker, the central bank chief has typically been someone who has had an understanding of the wider economy.
  4. Urjit Patel – Current Dy Guv of the RBI. Urjit Patel, who chaired the committee on a new monetary policy framework, has overseen the RBI’s transition to an inflation targeting central bank. Patel has also been driving the central bank’s liquidity policy as well. According to me, Urjit Patel has the highest probability to be appointed as the next Guv of the RBI. However, the political front of the appointment may be different from the predictions that are logically sound.

To sum up, India was in deep trouble in terms of macro economic indicators and the stability of the economy. Dr. Raghuram Rajan, took over on 4th Sept, 2013 and changed the overall image and credibility of the economy. However, it is a sad event that he choose to return back to academia from being the dashing RBI Guv. Although, he has made his choice to join academia, he will always be remembered as the youngest and the most respected Guv of RBI in the coming years. It will be difficult for any other veteran to fill in his shoes, but however, Urjit Patel and Arundhati Bhattacharya look to be the probable candidates to head the RBI so far. When the acche din were around the corner, its hard to believe that Dr. Rajan has quit. 

Thank you. 🙂

 

 

 

 

 

 

Dashing Denmark – A Case of Extraordinary Monetary Easing

An unusual way of monetary easing has become a favorite solution of most central bankers in the recent past. Lets take a look at the meaning of the word monetary easing before we discuss on those lines. Monetary Easing can be defined as an “Action by a central bank to reduce interest rates and boost money supply as a means to stimulate economic activity”. Precisely putting it, the actions taken by the RBI in the past few bi monthly meetings can be referred to as monetary easing.However, monetary easing can be bifurcated further into the ordinary(rate cut) based on macro economic indicators and the other being the unusual monetary easing used in adverse situations to get the economy moving. Few examples of unusual monetary easing can be US Quantitative Easing, Japan’s QE(Quantivative Easing) to revive their deflationary scenario and the most recent one being the ECB (European Central Bank) starting the Euro QE to revive its economy which will continue at least till Sept 2015.The move by the US Fed, ECB and Bank of Japan seems to be very similar and been done for very similar reasons but what they missed was the currencies they were dealing with were completely distinct, in value terms.

The best way of easing the monetary policy can be a rate cut. It was most certainly ruled out since Japan, US(0.25%) and Euro zone(0.05%) were all witnessing near zero interest rates from a long time. The measures taken by the above mentioned central banks were thus in the form of printing and putting in more cash in the system to revive the economy since all of them were out of options. But Denmark, decided not to go for QE at the time of slowdown ( although interest were near zero) but instead go for further rate cuts, making it an extraordinary monetary easing scenario.

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This move created a problem in the economy instead of boosting growth. So what exactly did the Danish central bank do ? In January, looking at the economic slowdown, the Danish central bank decided to cut rates( which were already hovering near 0%). The central bank, instead of going for a QE, went in for 4 consecutive rate cuts since January thus leading to an interest rate of -0.75% which ultimately brought the bank deposit rates into the negative rate zone. On the other hand, the Govt of Denmark was paying the corporate companies an interest of 1% for advanced tax payments and prepaid tax payments if any. This made the bank deposits less attractive as compared to the tax payments. Companies usually enlist legions of lawyers and even move headquarters to minimize tax payments. In Denmark, they could be better off overpaying them. The companies started holding immense amount of money with the tax authorities since they were paying 1% on their advance payments. This started costing the Govt as well as leading to dilution of transmission effects of the monetary policy. The banks on the other hand were charging their corporate customers to hold cash in banks. This has led to a disastrous situation where the money is being moved out of the real economy which is supposed to be the other way round.

It created high costs for bank because of the low-interest rates in terms of lending business. The loan became cheap and the prices of the real estate started shooting up. All this can be related to the Gold monetization happening in India. If we are struggling to get the already existing gold reserves to the banking system, just imagine what can be the condition if money moving out of real economy is to be brought back in. Customers or general public on the other hand in Denmark are facing what people in India holding gold jewelry have been facing. A person holds gold with the bank on which they wont pay interest but instead take locker charges from them for keeping those safe. In the same context, Denmark citizens are facing similar problems on the cash side of it which is making them move away from the bank deposits. The customers are feeling like the following images in Denmark:

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NIRP

Entire situation has created immense problems for Denmark including the revival, the rising real estate prices, banks taking a hit on their profits and money moving out of the real economy. Although Denmark Govt has taken charge of the situation and are trying to come up with various legislations to make sure the economy can be insulated from these unexpected effects of monetary easing.

To sum up, such actions if continued by various central bankers, will result into tremendous decline in the global growth rate. The economic slowdown in the world, where the world economy is growing by mere 3-4%, is because of the attempt of the monetary policy to be made in such a way that it affects the world instead of having effects. Dr Rajan in his recent press conference gave an immensely important statement,

 ” The world economy can grow in a sustained manner only if the monetary policy of each country is designed with a view of facilitating trade in the entire world economy rather than with a mindset of affecting the various economies because of the mere reason of inter-dependencies”

The conclusion being that each country is different in its various aspects of the economy, which should be respected and the Central bank should work in tandem with the policies of the Central Govt and vice versa. Every Central Banker and the Govt should take lessons from this event that none of the two institutions can run without appropriate guidance from each other. Denmark was a case of non accommodative policy execution more than an extraordinary monetary easing. 

Thank you 🙂