Time for noise cancellation: Economic Times 28th November 2022

 

A fresh look at municipals is needed: Free Press Journal, 26th November 2022

 

The RBI has recently brought out a study on municipal finances and has recommended that they should be borrowing more in the market. However, for such activity to take place, several reforms are needed to ensure that they are run on sound lines.

Gokhale Bridge is a name that has been in the news and is now familiar to all residents of Mumbai, and it speaks a lot about how municipalities are run and why they fail. The bridge connects the Eastern and Western sides of Andheri on the Western line, and the storyline goes like this.

During the monsoon in 2018 a part of the bridge collapsed, resulting in casualties. The bridge was under renovation for four years, during which time only half the bridge was operational for traffic moving on both sides. Simultaneously another flyover was commissioned from the highway to the start of Gokhale Bridge which is now in a precarious state. The side roads, which saw traffic crawl for four years, deteriorated with potholes and were never repaired. Curiously, post the collapse of Morbi Bridge in Gujarat, a report was flashed to say that the bridge is dangerous and cannot be used. It has been shut down. A new one is to be built now by September 2023. And more recently, VJTI and IIT have been asked to submit reports on whether the same should be open to light vehicular traffic because of public umbrage.

This story is both hilarious and serious. Wasn’t Gokhale Bridge under renovation for four years? If it could not be done in four years how it can be done in less than a year? Who takes responsibility for nothing being done all along? Why are authorities enthusiastic in getting new bridges built where the contract sizes are large, but never take responsibility for repairing roads? How can a decision to build a new connecting flyover be taken without being sure of the viability of Gokhale Bridge? Till the issue came up, no one was even sure whether it was the responsibility of the BMC or the Railways to break, renovate or construct the bridge. How can a bridge which has been certified by experts to be unsafe again be open to opinion over being selectively operational?

This is the problem with most municipal corporations in the country which are inefficient in terms of delivery of services. The stories of Bengaluru and Gurugram are well known where due to unplanned concretisation of roads, monsoon leads to flooding of magnitudes never witnessed in these cities as the drainage systems have not been provided.

The problems with municipal bodies are manifold. They are run by political parties which win popular vote. The officials are bureaucrats who move the files. Most projects are outsourced to contractors. Maintenance is outsourced. Construction and plan designs are outsourced. Consultants with the best pedigree are appointed to guide. If all the practical work is being done by outsiders, does it then make sense to privatise them? This question is far-fetched, because municipal bodies are part of the federal structure enshrined in the Constitution.

The RBI has recently brought out a study on municipal finances and has recommended that they should be borrowing more in the market. However, for such activity to take place, several reforms are needed to ensure that they are run on sound lines. The problems of the large municipal corporations is not about finance as they are cash-rich (the BMC has over Rs 90,000 crore in fixed deposits). The problems are on the operational side.

First, the governance structures are fragile as there is a lot of politics mixed with administrative and financial subjects. The link with state Governments is strong and there could be other Government agencies involved in carrying out specific functions. Second, the process of charting out responsibility is not clear. This means that while funds are allocated, there is no way of ascertaining how the money is spent and whether the terms of engagement with contractors are being enforced. Third, there are no efficiency benchmarks that are monitored on a day-to-day basis, like the case of potholes being addressed during monsoons. Fourth, given the system of governance, accounts are not available on time and are hard to understand as the systems used differ between states and the Centre. Hence, even statistical evaluation is a challenge with data coming with big lags. Budget numbers are aspirations and come long after the year begins for most local bodies.

In such a situation there will always be a trust deficit when it comes to investing in municipal bonds, as the chain of responsibility is not known. Also investors would always judge municipal corporations not entirely on their finances but also what they see around them. The case of Gokhale Bridge (and there are many such projects in different cities) is an example of how projects are undertaken and probably abandoned at times.

It will be useful to get credit rating agencies to do a detailed evaluation of how these municipal bodies are run and provide a rating which goes beyond what is revealed in outdated budgets and financial reports that are presently available. The CRAs should be empowered to have access to all possible data on the subject (which is not easily available today). Agencies like CARE, CRISIL, ICRA have had a very good track record of rating of municipals and would have to extend the approach to cover the physical side of their operations. This would mean moving around the cities and observing whether or not the basic functions of a local body are being carried out, and evaluate the status of projects when awarding a rating.

This can be extended to also use this rating as a basis for additional funding being provided to the body. Alternatively a performance-based reward can be given to the staff of the municipal body, based on this rating. We need to think differently.

Have the markets turned around? Financial express, November 23 2022

 The last Fed meeting was a turning point as things have changed across countries almost in harmony. The Fed did what it wanted to do, which was expected, with an increase in rates by 75 bps. But the indication given is that its action will become tempered, which means that it will be less aggressive in the future, though rates will probably still go towards the 5% mark next year. The signals, however, have been quite strong across all the markets, and India, too, has benefited a lot. The rupee, it may be remembered, had moved towards the 83 to the dollar mark, and forecasters did not feel shy to even talk of 85. However, with the Fed’s announcement, the dollar has started weakening with the dollar index moving down. Collateral benefits have been witnessed across most currencies. The rupee, too, has now moved to the 81-82/$ range and the question asked now is whether this will be a phase of appreciation that can go below 80/$.

The rupee has been guided by two sets of factors. The first is the external one which had the strong dollar driving all currencies down. The rupee did better compared to other currencies. Now with the dollar weakening somewhat, the rupee has gained. And this will continue as the dollar gets softer as the economy slows down. The second relates to fundamentals. The trade deficit has been widening primarily because exports are declining, which is expected due to the slowdown in the global economy. Imports growth has receded due to commodity prices easing, but it is still higher than that of exports, thus widening the trade deficit. Software receipts, too, would slowdown as demand for such services, particularly from the US, would be impacted. A lot now depends on how the FPI flows behave. They have been positive from the last week of October and all through November, which has helped to firm up the rupee on a daily basis. But for how long will this last? Normally, the FPIs square up their positions towards December when they repatriate their profit. In case they do so, the net inflows can turn negative, in which case the rupee will be impacted in the reverse direction.

The Fed action also had a salubrious effect on the stock markets, and the Sensex has been on an upward trajectory aided by the FPI inflows. This is quite surprising because the corporates that have announced their results for the second quarter have, in general, shown a smart increase in turnover though a decline in profits. In fact, this has been the paradox across most non-financial sectors where turnover recovered due to pent-up demand, but profits came down due to higher input costs. Clearly, the profit logic of today does not work in evaluating value tomorrow, as the stock market has brushed these results aside as being only transient. The long-term story remains intact.

The other consequence of the Fed tempering its commentary is that the bond yields have come off highs, even in the USA and European markets. The US 10-year treasury yield was closer to the 4% mark as long as there was uncertainty regarding the Fed’s move. But now, things have changed, and the softer stance has brought the yields down. This has also worked through the Indian market where the 10-year yield, which had been displaying rather volatile tendencies, has moderated to less than the 7.3% mark. It may be recalled that the earlier Fed action and tone had driven the yield past the 7.6% mark. It was moderated when there was news of the Indian bonds being included in global indices. The deferment of this inclusion drove the rates up to the 7.4-7.5% range, and now the trajectory seems to be downwards toward the 7.2% mark.

Therefore, while there is a lot of talk and speculation on RBI action, which can provide forward guidance for the market, it has been observed that the Fed’s action has an equivalent impact on domestic markets. And this can be felt even before RBI takes a call. In fact, the RBI rate hikes have not quite brought about a similar reaction in the bond market, though liquidity considerations have impacted the lower maturity yields. But the benchmark 10-year bond has been more or less resilient to RBI action. Similarly, RBI’s actions in the forex market were not able to do what the Fed announcement did, as it does appear that our fundamentals may not be that strong to warrant an appreciation. However, the global spillover effect has been impactful.

The power of globalisation has hence been more evident in the three markets like never before. The global slowdown or the action taken by Jerome Powell leaves an indelible mark for sure and cannot be brushed aside. It is not surprising that in the last monetary policy meeting, the RBI governor highlighted the importance of the announcements of the central banks of advanced economies.

Ours is the fastest growing major economy: How come? Mint 23rd November 2022

 A statement made in various conferences and investor calls is that India is the fastest growing major economy today at 7%, and while the world will sleep through a recession, we will be awake and have plenty of opportunities to leverage. The tone assumed is one of pride as well as schadenfreude. Are we really in this sweet spot? Are we really disconnected from the world?

Numerically, there’s no contesting the number, just as our economy clocked high growth in 2017-18 despite demonetization. Also, going by most forecasts, including those of the International Monetary Fund, growth will slow down in 2023-24, but will be in a range of 6-6.5%, which will still be higher than that in all other major economies. So, the Indian growth story will be a winner all the way. The curious part of this 7% expected growth of ours in 2022-23 is that our economy will slow down in the year’s second half. If one goes by Reserve Bank of India (RBI) forecasts, we see a sequential slowing down from 13.5% in the first quarter to 6.3% in the second, and then to 4.6% each in the third and fourth quarters. The last two quarters will be disturbing because in 2021-22, growth was just 5.4% and 4.6%, which should have ideally provided a statistical low base for higher growth this year. But this will not be the case, which is why it is necessary to evaluate what is not right in our economy.

The first issue relates to corporate profitability, which shows how inflation has affected balance sheets. Second-quarter results present a picture of robust growth in sales of non-finance companies by as much as 25-30%, thanks to pent-up demand. However, almost universally profits have declined and the reason is that companies have witnessed high growth in input costs that could not be passed on completely. This also means that the affliction will persist through the rest of the year, as inflation will remain high for the next 3-4 months. The solution is to keep working to bring down inflation.

Second, data once again shows that high inflation (and its mirage of higher consumption) has had a negative effect on savings, which have been under pressure this year. In 2021-22, financial savings came down as per RBI data. The fact that consumption has been steady, yielding good GST collections and boosting company toplines, has been at the cost of savings. It’s the impact of inflation again. This is not good news, given that banks confront the challenge of slower growth in deposits relative to credit. We need to revive savings through suitable tax incentives. The savings decline also means that we will run a large current account deficit (CAD), defined ex-post as the difference between savings and investment. This deficit can be in the region of 3-3.5% of GDP in 2022-23.

Third, exports have been impacted by recessionary conditions in the West. Textiles, engineering, jewellery, chemicals, etc, are some sectors impacted sharply by the slowdown, as demand has come under pressure with a Western combination of low growth and high inflation hurting our exports. While inflation will probably come down in the West too next year, recession-like conditions will persist. Therefore, exporters need to be prepared for a prolonged slack. We need to think differently and take a hard look at the composition and destination of our exports.

Fourth, a sluggish West is a red flag for the software industry. We are already seeing layoffs at Big Tech companies which will get reflected in outsourcing. This is important because both software inflows and remittances support our current account. Our trade deficit will surely widen, as with 7% growth, import demand will hold steady. Exports will remain low key until such time the world economy recovers. Annual software receipts of over $ 120 billion in the past have supported our current account, but a slippage here will be hard to avert.

Fifth, as India’s finance minister pointed out, the private investment cycle needs to pick up. The picture so far is that it’s concentrated in few sectors, like steel and telecom, and is not broad-based. A wider recovery is likely to take time.

Sixth, consumption growth could be an inflation-backed mirage, as several marketers of consumer goods have flagged low rural demand as a concern. Kharif output will be lower for rice and pulses this season, which will impact farmer incomes. Hence, one must be cautious in interpreting signals here.

Seventh, the employment question still hangs in suspension. There is constant debate on whether it is going up or not. The fact that several new-age firms, especially startups, have gone in for layoffs is bad news. Post-covid, many companies have embraced technology for routine processes. Now with profitability under pressure, jobs would be at stake even on the domestic front. We need more openings in the skilled market space, rather than mere delivery jobs at the lower end, to keep consumption ticking.

While we have ambitious goals of joining global supply chains, being relatively aloof has helped us this time, as ours remains the world’s fastest growing major economy. This epithet would not hold once India’s growth gets linked to the fortunes of other countries. Presently, only foreign portfolio and direct investments are vulnerable to external factors, while exports are growth supplements.

In conclusion, we should interpret the title of ‘best growing economy’ with caution. There is still a lot to be done by the government and RBI in providing the right policy environment. But the steering wheel will be in the hands of private investment.

Banks left to juggle with rates: Business Line 21st November 2022

 Economic discussions these days are invariably related to financial markets and ultimately come back to the banking sector’s doorstep. The latest cause for worry is that deposits are not rising at the same pace of credit. Meanwhile, there are concerns over rising repo rate hitting investment.

The increase in deposits since the beginning of the year to November 4 is around ₹9.04 lakh-crore while credit is up ₹10.34 lakh-crore. At the same time the central bank is concerned that while the repo rate has gone up by 190 bps, the deposit rates have remained rather sticky (weighted average rate changed by 35 bps between May and September) which in turn has caused deposit growth to slow down. The weighted average lending rate on new loans has increased by 108 bps while the same for the entire portfolio by 51 bps. What does one make of this situation?

Theoretically, when the central bank increases the repo rate or the monetary policy rate, growth in credit has to slow down as the cost of borrowing goes up and people borrow less. If this does not happen there is a problem with monetary policy efficacy.

Therefore, when we talk of the Fed raising rates to slow down the economy, it can be effective only in case firms borrow less leading to fewer homes being bought. It is expected to lead to cautious investment by companies given the high borrowing costs. This holds good for India too.

Rate hike impact

Hence if the RBI has been raising rates, economic activity should slow down as borrowing comes down. Logically, then growth in credit has to slow down to vindicate monetary policy decisions. The RBI has made this transmission partly automatic by linking certain loans to an external benchmark which is largely the repo rate and at times the treasury rates. And this will carry on until inflation comes down.

Theory says that by raising rates, demand comes down for homes and tepid investment will lower demand for steel, cement, use of credit cards, plastics, chemicals etc, that will slow down price increases and hence inflation. This should play out in the system.

The transmission process deserves some thought. By having some loans linked to the external benchmark the transmission of repo rate hikes becomes automatic. However, bank deposits are based on fixed contracts. Thus even if deposit rates rise, they would apply only to future deposits and the existing deposits don’t get impacted.

Once they come up for renewal, they would be repriced at the new rate. Therefore, there will always be sluggishness in upward movement of bank deposit rates. Customers are rarely flexible when it comes to switching banks and tend to remain with the existing bank. New deposits, however, could be in new banks offering higher rates.

Now, loans which are not linked to the external benchmark would be reckoned at the MCLR which is calculated as marginal cost of new funds. Here the critical aspect is how banks change deposit rates. Banks need to constantly look at the asset and liability maturity profile while pricing deposits.

Further, there has to be an informed decision taken on future of interest rates. Are we sure that the RBI will keep increasing the repo rate or will there be a reversal once inflation comes down?

It is likely that after inflation falls below 6 per cent the repo rate will be lowered. In such a case the loans at repo rate will yield lower returns. It has been seen that banks are selectively increasing deposit rates in certain maturity buckets and not making it a general increase. This way they would not lock in deposits at high rates for long-term deposits.

The MCLR, which is driven by a formula, automatically does not show a commensurate increase in cost. Therefore, the MCLR increase is lower again. The anomaly here is that the retail segment and SMEs borrow normally at the repo based rate and end up paying a higher price. Corporate loans are linked to the MCLR and do not get impacted that much. This explains the transmission conundrum.

Under normal conditions, in the next couple of months the gap between deposits and credit growth should decrease as the former increases and the latter slows down.

But the fundamental problem is the state of financial savings in the economy.

Today it has been observed that consumption has been rising for the first seven months of the year as evidenced by the growth in GST collections.

But inflation has been relentlessly high for the last 10 months. This means that as households keep spending on consumption which is at a higher price, less is left for savings. Here allocation of resources into different channels is important. The stock market has done well since the pandemic. Mutual funds offer a balance between direct and indirect investment in the market.

Indian ‘QE’

Since the pandemic set in the RBI policy has focussed on maintaining growth and so the repo rate was set at a low level of 4 per cent over an extended period of time, deposit rates had come down to the range of 5-5.5 per cent when inflation had been ruling at over 6 per cent. So households naturally moved away from bank deposits to other avenues to protect their real returns.

This has been the fallout of our version of monetary easing where the savers bore the brunt of low interest rates. The low interest rate environment did not lead to higher offtake of credit as demand was selective and banks were cautious. Now with conditions normalising the contradictions are playing out. This is the pain involved in moving back to a new equilibrium.

So the combination of unusual monetary policy followed during the pandemic combined with high consumption at the cost of savings has contributed to the present disruption which will get ironed out as monetary policy works through the system. This can take some time.

Six years on, cash still rules: Free Press Journal 12th November 2022

 

Clearly, the appetite for currency has been on the rise. And given that the RBI revealed that neither black money nor an abnormal amount of counterfeit currency was unearthed, it can be assumed that the demand is genuine and people like cash.

Nov 8, 2016, was a chilling evening and will be remembered by the entire nation. This was when the infamous demonetization exercise was announced, which literally brought the economic system to a standstill with high denomination notes of Rs500 and Rs1000 being demonetized. The ostensible reasons for announcing the move was to get hold of black money, curb terrorism and identify counterfeit currency.

Along the way, as individuals and bankers struggled to meet the norms for exchange, which changed by the day, it was argued that demonetization would help in digitization. While this argument appeared to be an afterthought, several changes have taken place in the way in which business is transacted.

The curious thing about demonetization was that the logic of big denomination notes being responsible for black money was defied when the Rs2,000 note was introduced, as it makes it easier for black money to be stored.

There were other reforms brought in like GST, which sought to ensure that all businesses were registered, rules put in place on the maximum amount of currency that can be used for purchase transactions, and so on. Simultaneously, the Government propagated the trinity of JAM, which included a Jan Dhan account, Aadhaar card, and mobile phone which helped in making direct transfers.

The UPI system for payments has now become a household term which has been made popular through incentives rather than threats, as the consumer so far does not pay for the transaction made. This has led to multiple-level growth in the volume of transactions both in terms of number as well as value. Clearly there is a revolution taking place at a pace never seen anywhere in the world. And the reason is definitely not demonetization.

With six years now having passed, the apologists for demonetization use the proliferation in use of digital payments as vindication of the process. If that were the case, then are we holding less currency today than we did in 2016? This is pertinent, because if everyone is using the digital mode, then logically the RBI should be printing less currency than it did earlier. In this context it would be instructive to look at some data.

As of Nov 4, which was just before the announcement was made, currency in circulation was Rs17.74 lakh crore. As old notes were exchanged and limited quantities were made available by the RBI, it came down to a low of Rs9.92 lakh crore in January 2017.

In January 2022, which is a five-year period, it had grown to reach Rs30.04 lakh crore and rose further to Rs31.82 lakh crore by October 2022. The average compound annual growth rate for the period January 2017 to January 2022 was 24.8%.

The growth rate of currency in circulation in the five years preceding Nov 4, 2016, was 12.2%. Clearly, the appetite for currency has been on the rise. And given that the RBI revealed that neither black money nor an abnormal amount of counterfeit currency was unearthed, it can be assumed that the demand is genuine and people like cash.

Interestingly if the CAGR is reckoned for the first three years, which was before Covid-19 struck and the lockdowns were imposed, the growth rate was as high as 32%. This means the demand for currency was increasing at a greater pace immediately after demonetization.

However, after the lockdown, when people perforce could not move out at various points of time and going to banks was arduous, digital modes became more popular. For the two-year period from January 2020 to January 2022, growth averaged 14.7%.

Why is it that even while people are using digital modes of transactions, currency is still in demand? The first reason is that people are just more comfortable using cash and this has a generational bias.

Second, after the pandemic, the precautionary motive has become important and everyone would like to keep a certain amount of currency at home for emergencies. In fact, even today surgeons charge separately in cash for high-level operations even in top starred hospitals.

Third, several enterprises in the unorganised sector, which include the kirana stores, prefer cash because once they come under the composition scheme, GST filing is not required. Here they would prefer business transactions to be kept opaque.

Fourth, most real-estate transactions of the non-corporatised entities are conducted partly in cash as the argument given is that the seller has normally paid cash when acquiring land or the house and hence needs an offset through partial cash payment.

Fifth, small, unbranded jewellers deal primarily in cash and prefer not to accept digital payments. Often when digital payment is permitted, a premium is charged.

Sixth, professionals like doctors, lawyers and accountants often accept only cash to have control over their taxable income. Lastly, even today people have to pay bribes in cash when dealing with any state department, whether it be a simple police verification for a passport or any dealing at the housing counter. Therefore there will be an ambivalent structure in the country where currency and digital modes of transaction will coexist.

The RBI has already introduced its digital currency (CBDC) at the wholesale level and while it will permeate the retail layer at some point of time, it may become a substitute for UPI/e-wallets rather than for currency.

Digital transactions look large because the new generation has taken to these alternatives with ease and will continue to do so. The volumes are large because even small transactions of less than Rs100 can be done through UPI. But businesses that are opaque will continue to deal in cash as it is a win-win situation.

Does India really need to issue sovereign green bonds? Mint 10th November 2022

 

Sovereign green bonds (SGBs) are the next big thing on the agenda that was unveiled as part of this year’s Union budget announcements. The Reserve Bank of India (RBI) has already begun pilot trials of a central bank digital currency (CBDC), and an SGB programme will be introduced soon, as the government has indicated. The concept of a SGB is quite rudimentary. Money raised via these by the government, expected to be ₹16,000 crore this year, would be deployed for green projects.

Arguably, the same goal can be achieved even without calling it a ‘sovereign green bond’ by just allocating resources for green projects with the same outlay. These green projects have to necessarily be part of the capital expenditure from allocations made to various ministries. A critic may just say that there is too much ado about what could have been a simple transaction.

The interesting part is the pricing of such bonds and the regulatory structures that could make them attractive for investors. This is important because if such a bond is to be marketed as a special government security (G-sec), then it will need enough buyers.

The first question is whether the rate of interest paid will be higher than what’s paid on a regular G-sec. It is believed an SGB will have a lower yield, in which case, there is no reason for banks holding G-secs in excess of their statutory liquidity ratio (SLR) mandate to opt for a lower-yield bond. Ideally, the interest rate should be higher, as green projects tend to be more expensive.

Also, the government may have to offer some tax concession. Here too, it is open and quite possible that there will be no benefit bestowed on them. If this is so, then banks may like to skip these auctions. As RBI has been trying to get retail investors into the G-sec market, giving tax benefits will make even lower yield bonds attractive. RBI may have to be kept in the loop to create a more friendly investment framework so that banks are enthused. Therefore, the pricing of the bond would be the most vital element of the exercise that must be worked out.

The other area of interest is the deployment of these funds. As they have to be earmarked for green projects, relevant ministries like for roads, railways, defence, communication, etc, will have to look at capital expenditure with clear commitments to green processes. But who will monitor these projects? If the money were to be deployed in, say, a solar project, then it would classify as a green venture. But then, the government does not build solar plants. Money is contracted for the construction of roads or manufacture of railway tracks, coaches and so on. This will mean having in place a thorough and credible rating system for projects to qualify as ‘green’.

Currently, we do not have such systems in place. Construction is considered one of the most anti-green activities, as it usually involves wiping off farm land to build structures that are needed for economic progress but affect the environment. Therefore, much like the concept of net-zero, all such ventures should also have plans in place whereby they generate enough environment-supporting activities. Intuitively, this is a highly complex exercise.

India has had cases of green bonds issued by banks which used the money to fund green projects. Here, it was simpler since the final product was classified as green. But when it comes to government spending, it would be a bit more complicated. Hence, before the launch of green bonds, the Centre would need to rope in rating agencies like Care, Crisil, Icra, etc, and brief them on what would be defined as green. This would set the contours of a rating model devised by these agencies that are conceptually acceptable to the government.

The big challenge will, however, lie in monitoring the progress of green projects. Normally, there are cost overruns, which can upset the budget math. This can lead to compromises. For example, the railways may source power only from a renewable source as it’s part of a green mandate, but a chance may arise of its substitution with conventional energy at some point just to stay within budgetary limits.

It is necessary, therefore, that the government works out all these details before floating green bonds. This would mean that the concept of green projects has to be objectively defined, with rating agencies brought in to lend fund deployment credibility. The budgetary puzzle is that money is fungible; what is raised from any source can be deployed anywhere. Therefore, what’s green can be open to interpretation.

The introduction of SGBs can be looked at from two points of view. The first is that it will lead to the evolution of systems for objectively grading or rating projects from an environmental perspective. Presently, most companies pay only lip service to ESG in annual reports that talk about the initiatives they have taken. As the rating system evolves, it could directly engage the project appraisal processes of all credit proposals. This will raise consciousness on promoting green approaches. We are already witness to how climate damage has changed almost everything in the world. Our monsoon pattern has got distorted, for example, which has led to crop damage. Cities like Gurugram and Bengaluru have suffered severe waterlogging, mainly due to faulty road planning, where the fault ultimately points to government authorities. The environment is thus also a direct concern of governments and the launch of SGBs would be a big move.

Interview with Business Today TV on 3rd November 2022

 https://www.businesstoday.in/bt-tv/easynomics-with-siddharth-zarabi/video/inflation-interestrates-the-economy-351776-2022-11-03

Inflation blues. Is MPC responsible for inflation? Business Line 2nd November 2022

 The announcement of an MPC meeting to be held on November 3 had a shock effect. This waned, on the realisation that the agenda was not interest rates but the explanation to be given to the government on inflation control.

When the MPC was constituted in 2016 the task was to frame policy such that inflation remained within a band of 2-6 per cent with 4 per cent being the anchor. If there were breaches for three quarters in a row, then it would be interpreted as ‘failure to achieve the inflation target’. As CPI inflation has been above this mark for this period, an explanation is called for under the amended RBI Act.

The RBI has to provide an answer in three parts. First, it has to explain why inflation has been high. Second, it has to state its actions on controlling inflation and the way forward. Lastly it has to give timelines for bringing inflation back within the band. Answering the first two questions are relatively easier, while the third could be tricky.

Confidential reply

While RBI’s reply will be confidential, there is market speculation over its contents. Prices have risen sharply in FY22 which continued in FY23 due to the resurgence in global demand, which pushed up commodity prices. Prices went up further after the Ukraine crisis , and started cooling down from July. The strengthening of the dollar added to imported inflation.

Given the lower base of 2020-21 when the world slipped into negative growth, inflation has been high. Now high commodity prices have caused companies to transmit their input costs this year and hence inflation has become more broad-based.

The services sector has come back into operations post April and increased prices to make up for both input costs as well as business foregone during the lockdowns.

Prices of agricultural products like edible oils and pulses increased too due to shortages, while wheat joined the pack when the war broke out and farmers preferred selling in the export market as supplies from Russia and Ukraine were cut off.

The RBI to combat inflation increased the repo rate by 190 bps over the last four months with more hikes likely. This is in sync with what other central banks are doing.

Ideally an explanation should go jointly from the RBI and government as there have been instances of GST or trade taxes being increased, which have added to inflation. Similarly, high oil prices which are not accompanied by States cutting VAT add to inflation in a dual manner — cost of oil as well as ad valorem taxes. Quite clearly the RBI has an answer here too on the way forward.

The third part is the time taken to restore a balance in inflation. With prices already cooling at the global level, the base effect would automatically make the inflation numbers return to the trajectory of 5-6 per cent in 2023 and the central bank’s forecasts on inflation which are provided in the credit policy will serve as the roadmap.

Food, oil volatility

But oil and food price movements are the big uncertainties going ahead.

The government could get a glimpse of the MPC members’ thinking if it reads the monetary policy minutes.

The minutes provide the members’ perspectives at every meeting which will throw light on how the decisions evolve. But more likely, the explanation would probably be a formality since there is a logical explanation for all the three queries that need to be addressed.

At the broader level two questions arise. The first is whether central banks or the monetary policy committee can be held responsible for inflation given that it is a global phenomenon thanks to supply shocks. In the West, inflation was triggered by fiscal pumping which increased demand across all goods and services.

Similarly high crude oil prices cannot be controlled by raising the Fed rate or the repo rate, but needs fiscal action. Interestingly, other central banks are not accountable to their governments for not meeting inflation targets.

The second is the 4 per cent number for inflation. Admittedly, this number was reviewed and accepted for the second time when the MPC’s first term came to an end. But is this number fair? If we look at the CPI inflation number for the last 10 years, it was higher than 4 per cent in eight of them while in five years it was greater than 5 per cent.

Therefore having a base of 4 per cent looks too optimistic to be taken as a benchmark. There may be a case for reviewing this number.

Call it a recession or slowdown, it is bound to affect us: Mint 1st November 2022