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Can the RBI afford to lower rates further? Experts discuss

It is the last weekend before the credit policy. Traditionally this is the most important policy – considering this is the first in the new financial year. The markets and the economy will not only watch for the rate action but also for RBI’s assessment of the new year, its growth and inflation forecasts as also Governor Raghuram Rajan’s views on the prevailing external environment which by any reckoning is quite important.

A cross section of bankers, bond dealers, and economists were polled by CNBC-TV18 to understand their expectation from the RBI going ahead. 

Rajan has already surprised the market twice with out of turn rate cuts on January 14 and March 4. In the intervening schedule policy on February 3 he refused a cut on the grounds that the rate cut had happened just 20 days before on January 14. Consequently this time around too 75 percent of the bankers and economists polled said they don’t expect a rate cut. After all Governor Rajan gave one just a month ago on March 4.

Also the only inflation data that came after March 4 surprised on the upside. But does that mean that he will cut the Cash Reserve Ratio (CRR) and an even more overwhelming 85 percent said no, though a small minority is expecting the Reserve Bank of India (RBI) to lower CRR by 25-50 basis points. CRR being the percentage of deposits that banks must keep as cash with RBI.

Will RBI cut the Statutory Liquidity Ratio (SLR) percent of those deposits that banks must invest in government bonds – a good 40 percent said yes, though even here a majority of 60 percent said no.

This being the first policy of the year, the market is also watching for RBI’s growth forecasts. This is a tricky issue for RBI after the CSO while revising the base year from 2004 to 2011 revised the FY16 growth forecasts to 7.5 percent from much lower levels earlier. A majority or 60 percent of the respondents expect RBI to forecast a 7.6-8 percent gross domestic product (GDP) forecast this year i.e. FY16.

The Governor’s speak on inflation will also be closely watched. Is he lowering his inflation target from FY16 from the current six percent, and will it be able to meet its FY18 target of four percent, the response of the respondents were mixed. Only a minority of 40 percent gave a high probability of 75 to 100 percent of meeting this target. 60 percent sees very low chances of RBI meeting this target.

Accordingly, the number of cuts expected hereafter also varied. A majority of 65 percent said only one more cut is possible. 30 percent said two more cuts are possible, while only five percent said three more cuts are possible. 65 percent of industrial experts expect the next rate cut in June. 15 percent see another mid-policy cut in May and another 15 percent see the next cut in August.

Besides rates and forecast, the Governor could make regulatory announcements in the policy such as schemes of monetisation of gold or standardising the ways banks calculate the base rate. Above all, the governor’s comment on the rupee will be closely watched and parsed.

Bhanu Baweja, head of emerging markets strategy, UBS says the markets are expecting a series of rate cuts from the RBI. He expects the RBI to lower rates on April 7 and sees one more cut after that.

Sajjid Chinoy, chief economist, JP Morgan, on the other hand sees just one more cut this financial year – and that too not in April, but in June.

Sonal Varma, chief economist, Nomura too does not see any rate cut in April. She believes the RBI has frontloaded the interest rate cuts in order to give more time to banks to respond going forward. She too feels there is a probability of one more rate cut after that.

Below is the verbatim transcript of Bhanu Baweja, Sonal Varma and Sajjid Chinoy’s interview with CNBC-TV18’s Latha Venkatesh.

Q: Since you are in a sense cut away from the noise in India and in Mumbai from your perch over there what is the general expectation that there will be rate cut, there will be many rate cuts?

Baweja: The markets are expecting a series of rate cuts actually. If you look at what is priced into the curve also the markets are expecting two rate cuts and perhaps they are hoping for more. My sense is that they are taking the view and this is not just specific to India, this is also across emerging markets. They are taking the view that emerging markets could conduct monetary policy independent of the Fed. That is slightly over optimistic and slightly rich.

I would expect that we get cuts in India and if we were to get cuts we would get cuts sooner rather than later. So April 7 we can get a cut and it is possible that we get one more cut after that. We ourselves do think Indian debt represents pretty decent value but that is not because the central bank is cutting. In fact on the contrary it is because the central bank is saying we are focussed on providing a positive real rate of return to investors and that is more than many central bank governor’s elsewhere in the emerging markets (EM) are doing. So that is quite important as holders of longer-term debt we are in good hands with Governor Rajan.

Q: What is your sense, two cuts is what at least global investors seem to be expecting if Bhanu represents the London view?

Chinoy: The space of monetary easing is a little bit less. We have one cut in and for a couple of reasons. One is that as Bhanu mentioned the focus is very much to keep real policy rates positive. The Governor has actually given us a range of one and half to two percent. We have to look at that across the cycle. So, it is unlikely to be the case that inflation remains at five percent over the course of the economic cycle. Our own forecast is somewhere between five and half to six. So that is where inflation averages over the next 12-18 months and you add on one and half to two percent in terms of real rate then you are looking at the policy rate somewhere 7 and 7.50 percent. So, 7.25 percent is where we are.

But there is another element to this which we cannot ignore which is that a lot of the monetary easing this year was contingent on there being fiscal consolidation which opened up more monetary space and we found that there is much less of that. In fact we find that the fiscal impulse this year – Centre and state combined – could well be positive for the first time in seven years.

Q: What is the number you have in mind?

Chinoy: We know the central government deficit are net of assets sales is programmed to expand by 0.1 percent of GDP. Having analysed the state deposits across the board on the last month, the sense is that there is almost no fiscal consolidation happening. So the combined deficit net of assets sales picks up by about 0.1 percent this year and then if you cyclically adjust it given that output gaps may close this year and growth picks up you are looking at a positive fiscal impulse of about 0.3 percent which means fiscal policy is expansionary after six or seven years. It may not be a bad thing given where growth is but it does correspondingly reduce the space that the central bank has. So we are going with one more cut but not in April, the cut will be in June. There is a sense here that India is far more insulated from global shocks and therefore even if you act in June which is closer to any Fed lift off that would be okay.

Q: I read your report and you make a very strong pitch that rural wage growth which was slowing down perceptibly has picked up and picked up rather sharply, does that reduce the pace for rate cuts?

Varma: Yes, I mean it has not picked up sharply. What we are seeing on the rural wage front is wages starting to stabilise now. So in the last 12-18 months, we have seen rural wages collapse from growing above 20 percent to now. It hit a low of about 2-4 percent in November and in the last couple of months, it has come back higher to around 6-7 percent in that range. Our sense is that what we are seeing is rural wages stabilising and I think this is important because when we talk about consumer price index (CPI) inflation, we know that more than 80 percent of the CPI basket is largely non-tradable and it is wages that drive the cost for non-tradable that drives the future direction for inflation in the economy. So I think what the wage numbers are suggesting is that the big disinflation we had seen in India in the last 12 months is largely behind us. There can be some undershoot in the short-term but on a steady state basis we are more likely to see inflation stabilise rather than continue to moderate.

The bigger debate we need to have therefore in that context is how much of the inflation fall is cyclical versus more secular decline in inflation because oil prices have collapsed, rural wages have collapsed because of the cyclical slowdown in the economy and because of the reversal of some of the government policies and the shocks from vegetable prices have been fairly subdued in the last six months, which could reverse going forward given the unseasonal rains we have seen. So our sense is that the steady state basis CPI is still around 5.5 percent in the economy and therefore policy has to be cognisant of that.

Q: In your book, is that one more cut, no more cuts?

Varma: Our base case is for no more cut. I think the language used in the March surprise intermitting statement was that RBI has pre-empted the rate cut given the weakness in the economy. So our sense is that the RBI has frontloaded the interest rate cuts in order to give more time to banks to respond going forward. So I guess the focus in this policy should be much more on transmission rather than RBI actions per se. So unchanged at the April policy is our expectation.

Q: And no cuts thereafter?

Varma: We are saying that there is probability of one more cut maybe about a 35 percent probability but if the growth cycle is expected to pick up and most of the indicators that we track suggest that we are in the initial stages of a business cycle recovery. Second, inflation is stabilising around 5.5 percent right now. Also, given the RBI’s medium-term inflation target of 4 percent, third completely concur with Sajjid Chinoy that on a general government basis, the fiscal stance is expansionary, it is not contractionary and fourth if the RBI wants macrostability, which means that you don’t want to depend too much on foreign flows to fund your current account deficit, you need to continue to provide higher real rates to increase domestic saving. So in that context, our expectation is that policy rates are already close to neutral. So not much space for aggressive easing that some parts of the markets are pricing in.

Q: I wanted to know about the external environment basically, you began by saying that you can’t take the Fed position very lightly. What do you expect Raghuram Rajan will say and what ought to be his concerns? Can he afford to cut when the Fed is going to cut say in June or in September or should he cut precisely because of that- that his hands will be tied in June?

Baweja: I think he will need to go early rather than late because our base case is if the Fed is going to go this year and they are going to go in September, I don’t think that emerging-markets (EM) central banks and India has come a long way in terms of healing on the current account and on the basic balance. But despite that I don’t think EM central banks can focus only on their domestic inflation in making choices on interest rates, when US interest rates are going up. Mind you, thus far what we have seen in terms of a dollar rally has really been a euro sell-off and that has been driven by low European rates rather than high US rates. So as US rates pick up the room for easing in EM is likely to be more limited. I do think that governor Raghuram Rajan has to go sooner rather than later if he wants to cut rates.

I also think that he is very cognisant of the risk; in fact he seems more cognisant of risks in India than anyone else. If you listen to him in the last 5 or 6 speeches repeatedly there is a theme there. He is talking about corporates, needing to up their hedge ratios and there are vulnerabilities in this economy. At this point, I am concerned that growth momentum isn’t quite as strong as is being made out to be and that is why inflation can remain low.

You had asked a question earlier about whether this is cyclical or structural. I don’t see any signs of a structural downtrend in inflation. We have got lucky with oil, food prices are also coming off but I think he will have to go sooner rather than later. I don’t see him going in completely the opposite direction. By the way the market is pricing in an absolutely flat forward curve in the face of a steeply upward sloping forward curve in the US, again I want to emphasise I think that is rich. I don’t think you are likely to see that, it will be very difficult for India to keeping cutting in the face of US hiking.

Q: So that will be an important factor that he will have to think about. What else would you look out for in terms of the Reserve Bank Governor’s talk, anything in the nature of the run up to 2018 where he expects or has given that 4 percent goal post?

Varma: We would expect to hear something on that front because the monetary policy framework that was signed in end February says that every six months the Reserve Bank of India (RBI) has to come out with the document essentially listing out next 6-18 months their view on where inflation will play out and because of what factors so some sort of a BOE style inflation report. In that context beyond the 6 percent target that the RBI is talking about what is the visibility despite whatever is the base line on growth recovery.

Most of us are expecting a gradual growth recovery, so given that output gap is going to gradually start to close in the next two years what is the base line assessment on inflation. Second, in a sense the March cut sort of already implies this, but some more clarity on what the RBI really thinks about the new gross domestic product (GDP) numbers, where they think potential growth is. Perhaps potential growth is a bit higher because we have seen lower inflation despite supposed upward revisions in growth numbers, so their assessment on where we are on growth and more also on potential growth on the economy.

Third there have been some comments recently on the need for cash reserve ratio (CRR) cuts, our assessment is that the banking system liquidity is quite comfortable and plus the FX intervention that the RBI’s is doing not all of that is sterilised so there is already an unsterilised intervention which is adding to liquidity in the banking systems. So don’t really see a need for CRR cut at this stage.

Statutory liquidity ratio (SLR) definitely has to come down. RBI could chose to move on that in this policy or may be not but something around that as well. I guess finally there has been a lot of confusion around the RBI’s talk and walk in terms of its policy actions, so more clarity on why there is such a big disconnect between what markets have been thinking and the RBI’s interest rate delivery is something that we will also be watching out for.

Q: On growth, governor is handling a hot potato in terms of the CSO numbers. What do you expect to hear, what is the market looking forward?

Chinoy: I won’t be surprised if the RBI has got a 40-50 bps acceleration on the official CSO numbers because as much as we may disagree with what they tell us that is the official series of the country. So like Sonal Varma said, it will be good to get a sense on the RBI, what they think India’s cyclical position today is as per the new series, are output gaps negative, are they closing, are they widening, that is important – I personally think there is downside risk to this year’s number of 7.4 percent because implicit in that is a very large acceleration and manufacturing in the current quarter, which is passed which is unlikely to manifest itself. So if you end up with lower number this year that would then mean a lower number next year.

However, I think the good news is from an inflation target perspective. It is almost less important what the RBI is thinking on growth is because they don’t have a dual mandate like the Fed has and therefore the only worry about the output gap to the extent that it is a leading indicator to what your inflation trajectory will be – ultimately whatever growth, the proof of the pudding will be in the eating. If the inflation numbers remain in the low 5s then you have an inflation target this year of 6 percent that clearly opens up more space for easing. If inflation begins to accelerate as we think it will towards 6 percent target then that closes this space irrespective of what your growth numbers are. So from that perspective, I think moving to flexible inflation targeting makes the RBI’s assessment of where growth is correspondingly less important than when you explicitly had a multiple indicator approach and it was important to know where exactly you are on the growth cycle.

Q: From your perch how was the CSO number being handled, is it seen as bungling or is it something that people are coming to terms with?

Baweja: I don’t think they are coming to terms with that because if you look at the Chinese numbers and if you look at the bottom up numbers in terms of electricity production, cement production people often think that Chinese statistics are nonsensical that was never the case with India till recently. Because again when you look at India’s numbers, when you look at how many projects are still stalled, if you look at the export side and you look at as has been rightly pointed out the decline in rural wages even if it is now stabilising it is very difficult to see how these numbers add up to sort of 7.5 percent. So I am not sure how many people will take 7.5 percent number seriously. So far in the investment community the numbers have rightly met with a fair amount of scepticism.


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