The central bank’s focus is expected to stay on balancing growth and inflation, prompting questions about whether it might revise its growth forecast amid ongoing economic pressures.
CNBC-TV18’s Citizen’s Monetary Policy Committee, comprising experts including Samiran Chakraborty (Chief Economist, India at Citi), Sajjid Chinoy (Chief India Economist at JPMorgan), Sonal Varma (Managing Director & Chief Economist, India and Asia Ex-Japan at Nomura), Pronab Sen (Former Chief Statistician), and Soumya Kanti Ghosh (Group Chief Economic Advisor, SBI), convened to discuss the challenges before the RBI and its MPC, and what actions they may take
This is the verbatim transcript of the discussion.
Q: Do you think now it calls for a cut, irrespective of the fact that inflation is high?
Chinoy: We have always been in the camp that there will be a cut in February. So it was not this meeting, but the next meeting – what you have seen is this delicate tradeoff where public investment and government spending were doing a lot of the heavy lifting in the heavy lifting in the last couple of years. And the first signs that public investment has stepped back in the first six months of this year softer private demand has shone through that we had worried about and known about.
The complication for the RBI is that the economy in the last two, or three years has been hit by a series of supply shocks – food supply shocks. And so, the average consumer price index (CPI) has been 5.8% for the last four years. This year it has come off. It has still been 5% and so that has been the difficult tradeoff that we understand the government’s doing the heavy lifting. We understand private sector demand hasn’t picked up where it is. But when you have sustained, repeated supply shocks on high food inflation, the worry is at some point this will spill over.
Our sense is, that this increases the conviction that a February cut happens. In December, the central bank, the MPC, sets the stage for a February cut, pivots more dovishly, and more importantly, sets the stage for liquidity management. Without the liquidity management from December onwards, any cut in February will not transmit into financial markets. So the way I see this is, that you use this meeting to inject liquidity pivot and then ease in February.
Q: Is there a case for a Cash Reserve Ratio (CRR) cut therefore? Since liquidity, in a way, is going to be challenged even in the days to come. Look at the way the dollar is strengthening and the rupee is declining.
Chakraborty: If you just look at the liquidity numbers, the durable liquidity is corrected by almost ₹2 trillion in just about a month because of mostly the FX sales and the festive season currency in demand. So one can make a case for some liquidity easing. And not to forget that in the last 10 days or so, the market-based overnight, rates are now running about 20 basis points (bps) higher than where the repo rate is. In the last few months, it has just been reversed and it was lower than the repo rate.
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Now, obviously, we can decide on what instrument is the best instrument to give this liquidity. CRR is a relatively easy one, particularly if you think that pre-COVID CRR was 4% and that is probably the only variable, which has not yet gone back to the pre-COVID level. There might be some justification for considering a CRR as well. But overall, at this time, I will agree with Sajjid that some liquidity easing could be the first step towards a broader monetary policy easing through rates.
Q: You have to rekindle animal spirits. You have to give some confidence as well. So can the RBI stay away from both a repo and a CRR? Some obvious symbolic action may be needed.
Ghosh: I take the point that some sort of liquidity adjustment is to be done in this policy. The simple reason is that food inflation is still running close to double digits, and headline inflation was running over 6% and it does not seem to be coming off the cliff very quickly.
But the point over here is that there has to be a very delicate balance of liquidity. If you look into the liquidity management in the last couple of months, what has been happening is that the government cash balances have become the elephant in the room, from a positive number and then to a negative. So it has been fluctuating significantly in the last two to three months. And you need to remember that a large part of this government cash balance is frictional liquidity. So if there are any liquidity injections or management the RBI wants to do, it has to match that frictional liquidity with frictional liquidity injection itself, instead of permanent liquidity injection.
So from that point of view, I think while the liquidity management has to be done, but there needs to be a debate on how these need to be balanced with an permanent liquidity injection, vis a vis a frictional liquidity adjustment but another point is that because of this significant rupee liquidity suck out, that is also adding to the problem of the central bank.
Q: So even if you look at CRR as a more permanent instrument, it looks like this dollar issue is going to be with us. So maybe there is an argument there. What do you think?
Varma: Our view is that we are already late. Monetary policy works with a lag of three to four quarters. The slowdown has been ongoing for six months now, so we think it’s high time to reverse the cycle. If you just go back to what the monetary policy framework is, it is to target inflation at 4% plus minus 2% while keeping in mind the objective of growth. And what has become very clear is that growth is already below trend, and there is no counter-cyclical response that’s coming through even now. And therefore, the expectation that growth will somehow go back to 6.5-7% without a counter-cyclical response looks extremely unlikely.
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The entire debate, therefore, is in terms of how much tradeoff there is at this stage. Now, monetary policy has to be forward-looking. The one-year forward inflation forecast is very much aligned close to the midpoint. The second-round effects have not materialised, and the effects, some sort of a nominal adjustment on the effects is warranted as a counter-cyclical tool as well, and we have an effects reserve.
So the argument that the tradeoffs are significant because inflation is high or because currency is weak does not hold water, and the balance of risk, in my view, definitely calls for supporting growth at this stage, because without growth, there are multiple other macro issues that we will have to deal with.
So it is time to support growth both via a repo rate cut as well as via a CRR cut because even the transmission from the banking system is going to take time. Banks have been busy collecting high-cost deposits, so even if the RBI sort of cuts the CRR now, the entire transmission to the lending rates is going to take time, so we need to act now.
Q: I take your point that it takes time to act, but the counterpoint is also that, why is consumption weak because of inflation? Isn’t it? Can the RBI do a cut without injuring its credibility as well? When the last number is above their mandate – it is 6.2 the October number.
Sen: It depends on what you are talking about. If you are talking about the repo rate, I don’t think there’s much of a case. The interesting question is, what do you do with liquidity management? It seems – one of the standard tenets of economics is that if you are getting inflationary impulses coming from areas over which monetary policy has very little control. And in this case, it is food mostly – your main focus should be to prevent it from spilling over into the core. And for that, interest rate management is not the appropriate tool, it is liquidity management.
Now the question is, so I have got a situation where food inflation is nearly double digits, but I have got a GDP growth rate which is significantly below par 5.4 and so you are getting the liquidity management demands are working on two sides. That is, if you open up on liquidity, you run the risk of the non-core spilling onto the core. If, on the other hand, you are too tight with liquidity, then your growth revival may not happen and Sonal is right we are running below trend.
But I think one has to be a little careful with these growth numbers because there is a very strong base effect, which is playing out and it will play out in the next quarter as well. It is only in the quarter after that should we expect to see any normalisation happening, and we should be very careful about this.
The big question out here is that when you are talking about liquidity, do you create a situation where the increase in liquidity is because the banking sector demands liquidity, or do you create it through an instrument where the liquidity is given to the banks regardless of whether they want it or not. Now that makes a lot of difference. So in a situation like this, the CRR cut is not a particularly good idea. One should focus a little bit more on what do we do with the variable repo.
Q: There is going to be a lot of debate on this within the Reserve Bank MPC itself, though CRR is not an MPC instrument. It will be an RBI decision. But in our case, our MPC is going to vote on both. Let me take the vote first. The first question I am going to ask my panel is, what will the Reserve Bank do to interest rates on December 6?
Chinoy: They will cut in February. So ‘hold’ in December.
Ghosh: ‘Hold’, very similar to Sajjid, ‘hold’ now and ‘cut’ in February.
Varma: 25 basis repo rate cut.
Sen: Hold.
Q: What about CRR?
Chinoy: Some liquidity management for sure, not necessarily CRR – no.
Ghosh: I would paraphrase it, saying that CRR should be used as an countercyclical – not headline CRR, but yes on some specific products – yes.
Chakraborty: I think it is likely, it’s possible to do – yes.
Varma: Yes, CRR cut.
Sen: No.
Q: When do you see the first rate cut?
Chinoy: February.
Ghosh: February of a larger magnitude possibly.
Chakraborty: February.
Varma: December.
Sen: February.
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