on ETNow: India Development debate 5th August 2022

 https://www.timesnownews.com/videos/et-now/shows/is-50-bps-hike-the-new-normal-for-central-banks-india-development-debate-latest-news-video-93378333

Credit policy: What lies ahead? Financial Express 6th August 2022

 This particular round of policy-setting by Reserve Bank of India (RBI) was always going to be critical for the economy for many reasons. The high-frequency indicators available so far point to the economy doing rather well on, which is reassuring. At the same time, the markets have been quite volatile, though they turned positive on the eve of this announcement. Stocks are up, the currency is stronger, and bond yields are lower. This sounds too good to be true, juxtaposed with the inflationary concerns of households confronted with high prices. The external environment doesn’t sound too encouraging with the “R” (recession) word—even the “S” (stagflation)one—being reiterated in discussions.

RBI has been quite steadfast in its battle against inflation, and hence has gone in for a significant 50 bps rate hike. This is based on two premises. The first is that inflation is a worry even if it is under control at around 7%. There has been no change in the forecast here for the year, which remains at 6.7%. But the fact that it is still out of range of the MPC’s tolerance zone and will be so for the next two quarters is reason enough to get aggressive here. The other premise is that growth is on target. The forecast here has not changed, and it stands at 7.2% for the year. The fact that India remains the fastest-growing economy is significant for RBI because it makes decision-making easier. Interest rates have a dichotomous impact on the economy. While higher rates can bring down excess demand forces and hence inflation, they can also come in the way of growth if the cost of borrowing goes up. This is a constant struggle for central bankers. But once there is a conviction that growth is on the right path, it becomes easier to tackle inflation in a more aggressive manner, which is what the policy has done.

How much further will RBI go? Here, there can be varied opinions. If inflation remains high for all three remaining quarters, there will evidently be pressure to keep increasing rates. Another 50bps hike looks imminent and logical and will take the rate to 5.9% by the end of the cycle. This will still not yield positive real interest rates with inflation at 6.7%, but the negativity will be curbed. The OIS 1-year rate, which is what the market players hold sacrosanct, points to 6.25% or its whereabouts, and hence this theory says that the repo rate should get aligned at this level. Another theory espoused is that (while it is not designed this way) there is a relation with the Fed rate, and if the Fed decides to push up its rate to say 3.25% or so this year, given the historical difference of 350-400 bps with the repo rate, the latter should definitely cross 6%. Therefore, there are many guesses going around.

What will higher rates mean for the economy? Deposit-holders can heave a sigh of relief at the announcement, though the earlier rate hikes have not quite moved the needle at the ground level for them. The response of the banking system needs to be noted here as decisions will be taken depending on their flow of funds relative to the demand for credit. But some upward movement will definitely be there.

For borrowers, it will be a mixed bag. For those with rates fixed to the repo , there is no escaping the higher cost. Home loans and loans to SMEs tend to be linked to this benchmark, which will cause more pain to the borrowers. The days of easy money will be over as capital gets priced properly—the pandemic had led to rates coming down sharply as RBI took a stance of doing everything to save the economy. The cycle had to change anyway, and it was only a matter of time before it got reversed.

However, for the larger borrowers, where lending rates are based on MCLR, the increase in cost will be marginal as this benchmark is formula-driven, and when the deposit rates do not move up commensurately, intuitively, it can be seen that the base will also rise very gradually. Therefore, these companies will be better off than those who borrow on the basis of the external benchmark.

For other market borrowings, the situation will be very different. Government bonds have shown a different tendency since the last policy, where the increase in the repo rate had finally got the yields down by 25-30 bps on the eve of the policy. Clearly, these yields are driven by other factors such as liquidity in the system, policy actions of other central banks, fund flows, and so on. Therefore, the increase in cost would be less than 50bps and more likely in the range of 20bps on an average basis. This is good news for the bond market where rates tend to be benchmarked with G-Sec yields and, hence, the AAA and AA rated companies, which are the large borrowers in this market, would face a more gentle interest cost curve due to this increase in repo rate.

Central banks worldwide seem to be united in fighting inflation, quite like how they did everything for growth for two years when the pandemic started. Clearly, going too easy on liquidity infusion had provided a push to inflation that seems hard to control, guided as it by other factors such as the Ukraine invasion. RBI was quite dexterous while being accommodative and hence does not have the same challenges as the Fed, which also had the backlog of the QE rollback, a legacy of Lehman. The gradual but firm rollback by RBI hence stands out in this story.

Avoid aggressive management of rupee: Business Line 27th July 2022

 

Forex intervention by RBI has actually contained rupee depreciation. But the benefits of heavy intervention are not very clear

The rupee has crossed the 80 mark against the US dollar. It has been sliding in the last five months, ever since the war broke out in Ukraine and the US Fed, in parallel, began aggressive action in response to emerging inflation trends. Each month the rupee crossed a new mark — 75 in January, 76 in March, 77 in May, 78 in June and 79 in July. And the rupee touched 80 in July itself, rather than August. How is one to read this trend?

The important thing is the rupee is not alone in this spiral; almost all currencies are witnessing similar trends. In fact, if one were to look at a point to point change — July 15, 2022 over December 31, 2021 — in value of currencies across the world, the rupee has not really done that badly. It has gone down by around 7.2 per cent, which is just about the median level compared with other currencies (see Chart).

The currencies of China, Malaysia, South Africa and Australia have done better but still fallen by around 6 per cent, while those of Indonesia, Singapore, Hong Kong, Brazil and Mexico have dropped less than 6 per cent.

However, the rupee had appreciated in effect against the euro, pound and yen and did better than the currencies of Taiwan and Thailand. Therefore, the current spate of depreciation is more of a global phenomenon. The rupee is somewhere in the middle, which is comforting.

But this should not divert attention from the fact that the rupee has also been hit by weakening fundamentals, such as a widening trade deficit which will expand further as growth picks up. India is definitely one of the faster growing economies. However, this also means that demand for imports, both oil and non-oil, will increase which will reinforce the trade deficit.

Exports, on the other hand, tend to be guided more by global growth conditions and if there is a slowdown here, there would be an adverse impact. It has been observed historically that exports tend to be influenced more by global growth than exchange rate changes. This is why the trade deficit is expected to widen leading to also a larger current account deficit which is expected to cross the 3 per cent mark this year.

RBI’s initiatives

The obvious question to ask is whether or not the RBI can do anything about it. In a system of free trade and general openness to convertibility, central banks will be constrained and cannot do much to restrict outflows. What can be done through policy has already been done by the RBI, in terms of allowing more NRI deposits, ECBs (external commercial borrowings) and FPIs (foreign portfolio investments). It is however debatable whether these measures will help bring about a turnaround in forex inflow; it can, at best, increase marginally.

For example, ECBs today are no longer attractive, with interest rates overseas increasing. Add to this the foreign currency risk, which is high in these volatile times, and domestic borrowing may be preferred for most companies. Taking forward cover, which is advisable, has a cost and the economics may not make it favourable to do so.

Similarly, allowing higher interest rates on NRI deposits is a good regulatory move. But with deposit rates increasing in the West, savers will see this as an option which may not be significantly more attractive. FPIs were not too interested in corporate paper to begin with, as seen by the relatively small proportion of the limits being utilised. Presently, it is just 18 per cent of the limit permitted. Hence, allowing them to go for short-term investments of less than one year maturity could work only at the margin. But the RBI has surely been proactive in this regard from the point of view of policy.

The phenomenon of currency depreciation is a global problem brought about by the sudden strengthening of the dollar. This may not prevail for long periods; at present, low unemployment and high interest rates signal the strength of the US economy. But as the Fed rate hikes feed into the system and slow down growth, the dollar should weaken and there would be some respite for other countries.

Therefore, trying to arrest the slide in the rupee may not be very meaningful. Using reserves to stem the fall may just mean using up resources with no medium term gain. At the same time, it is essential to ensure that there is no free fall which would be the case in the absence of selective intervention by the RBI.

Handle reserves carefully

The RBI has seen reserves come down by $35 billion over March and are at around $573 billion due to both regular intervention as well as revaluation effects on holdings of non-dollar assets.

Direct intervention through sale of dollars hence has limits. Imports in the first quarter were around $190 billion, which at a monthly average of $60-63 billion would amount to nine months of forex cover for imports, down from 13-14 months last year.

Therefore, while the reservoir looks adequate, management of the same is imperative so that they do not fall below threshold levels determined by the central bank. Therefore, direct intervention would have to be only the last resort.

The RBI has already used the policy tools to widen the circumference for capital flows, and the benefits would evolve over a period of time. Under these conditions there may not be too much that can be done. Intervention in the forwards market can be used to align the movements to other currencies so that the rupee remains in the middle range of depreciation. As long as interest rates rise in the West and the easy money which came about due to the quantitative easing is reversed, currencies will keep declining. It may be best to avoid any aggressive interventions from hereon.

Book Review | The power equation – From Dependence to Self-Reliance: Mapping India’s Rise as a Global Superpower by Bimal Jalan: Financial express 24th July 2022

 

An optimistic view of the country’s economy, but not so much on the polity

Written by Madan Sabnavis

July 24, 2022 3:30:00 am

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In his latest book, From Dependence to Self-reliance, he achieves this on several aspects of the changing face of the Indian economy in both the economic and political fields.

Bimal Jalan, a well known economist, central banker and politician (former member of Rajya Sabha), will always have a well-rounded view of the way in which the Indian system works. In his latest book, From Dependence to Self-reliance, he achieves this on several aspects of the changing face of the Indian economy in both the economic and political fields.

In the author’s view, there have been two defining moments that have helped to bring about transformation in the economy. The first dates back to 1991 when we went in for economic reforms and moved out of the socialist model of growth and development. This brought in the vibrancy required for making the economy self-reliant, as can be seen by various economic indicators today where India stands tall.

The other is 2014 when the NDA government came to power with a strong majority. Having a strong majority party in power helps to accelerate the pace of reforms, which is what we have witnessed in the past few years. This also helps to enhance federalism where there is more harmony between the Centre and states. More importantly, this also helps to push through political reforms without dependence on the opposition, and hence provides opportunity to bring in change.
While speaking on the economy, Jalan also traces the rise of the services sector in the economy and the difference here is that the ascent has been of skill-based services that provide a comparative advantage to any economy. There has hence been a very blurred distinction between goods and services. This revolution has been brought about by unprecedented and unforeseen advances in computer and communication technology in the past four decades.

A lot of what is written on the economy will be familiar to the reader as these are issues that are debated regularly in the media and discussions in conferences. Jalan is particularly critical of the public sector because of the inefficiencies that have come into the system. This may not have been that important, but for the fact that the onus falls finally on the government and it finally affects the budgets and its spending. His argument is that as these enterprises keep making losses, they have to be financed by the government either through outright subsidies or indirect support. This weakens the budget as the government has less to spend on the poor, which, in turn, hampers their development. Therefore, the comparatively well-off people may not be affected, but it affects the future of the poor. He believes that the steps taken by the present government in privatisation are progressive, and he substantiates this with several global instances.

An area that he talks of in some detail is the political system. He looks at various anomalies that exist in the present system and discusses the pros and cons of the alternative presidential structure. In balance, he feels that the existing system is better, though admittedly, the governments that have ruled have never come close to having 50% of the votes. He does lament the persistence of the feature of having a large number of people with criminal records as members of Parliament. Here one can be helpless, for it is these people who actually garner votes for their parties and claim power subsequently. It is not a happy situation to be in where such people with serious criminal cases, which are yet to be proved, occupy positions of power. An argument often given is that since these members have been elected by the people so there cannot be anything amiss. The author, however, is cautious in not naming any person or party, which has been his trademark non-controversial style.

An interesting turn is taken when he brings in the concept of scarcity, which is an economic subject, into the structure of our political system. He looks at the system with a pyramid-like structure where the government is vast at the bottom but narrow as we move upward. At the panchayat level there are lots of representatives of the people and hence the system is more democratic. However, these so-called leaders have little power and it is more in the area of implementation of schemes where the funds come from the Centre or states. Therefore, there is relatively more cleanliness here.

But as one goes up the echelon to the states and Centre, there are fewer seats, which brings in the scarcity concept and a premium that is attached to every seat that is fought during the elections. No wonder there is substantial muscle clout which comes in the running of parties and governments. The power that is exercised is tremendous as the Centre and states have the right to set of organisations, committees, taxes, expenses, etc, within the realm of what is provided by the Constitution. This is why there is a craze to be in power, as it gives people the right over these critical decisions that are taken by the government. The author has hinted that often all the ministers are selected by the leader and hence when all ministers normally tend to be appointed by a single person who is charismatic, the system may not really be truly democratic.

This is a fairly well balanced view taken on the progress made by our country and the author steers clear of any controversy either directly or by innuendo, especially when commenting on the polity. On the economic front there is a lot of promise according to the author. We do lag, however, when it comes to social uplift, which is highlighted early in the book. We need to work harder on provision of education and health, especially to the poor. Changing the quality of polity, however, one can surmise is a tough nut to crack given the intricacies that have been inbuilt in the system to preserve status quo. Hence while there is optimism on the future of the economy, the same has not been expressed on the polity.

From Dependence to Self-Reliance: Mapping India’s Rise as a Global Superpower

Bimal Jalan
Rupa Publications
Pp 184, Rs 695

Will inflation go up when prices rise? Free Press Journal 23rd July 2022

 

Clearly the government is looking at tweaking the structure to garner more revenue as the economy is not behaving the way it was expected. The logical question is whether this will work

One of the bolder decisions taken by the government was to increase the GST rates on several goods and services. This was taken at a time when inflation was high at around 7% with surprises coming in every day, the latest being the rupee touching the 80 mark against the dollar.

The justification for the imposition of these rates was manifold. First several goods were kept out of the ambit to begin with, that needed to be corrected. This is logical considering a review was taken after five years. Second, producers were indulging in beating the system through the unorganised sector route through labelling concessions. This led to leakages which needed correction. Third, the government has realised that the automatic buoyancy taken for granted in 2017 did not work out. Hence a review of rates was essential. The ultimate justification was that the average rate now being charged was lower than the pre-GST regime and hence this was only a part of the tax structure as even at the time of imposition of this tax, it was made clear that the rate had to converge. Therefore it was a well thought-out strategy and we can expect more such changes until the convergence takes place.

Hence clearly the government is looking at tweaking the structure to garner more revenue as the economy is not behaving the way it was expected. The logical question is whether this will work. The answer is that it is ambivalent. On one side, increasing the price of packaged atta or taking a hospital bed of above Rs 5000 a day does mean paying more. Hence it will be hard to dodge this tax. The unorganised sector selling smaller quantities, as well as organised sector selling dairy products, will witness higher prices.

Two things can happen. First consumers will shift to unpackaged products if the burden is high. Second producers may stop labelling products, by packing products in packaging material without printing. Even today one can buy a sandal soap of established brands without the cost of the brand, as tax rates are lower. This cannot be ruled out. The same holds for hospital beds which can be priced at Rs 4999 to avoid the tax, just as has been done by hotels to come into a lower tax bracket. The other escape route is the selling of products through the ‘loose’ mode where there is no identification trail.

The other side of the story is interesting. The CPI index may of move much as all commodity prices are based on quotations received which are largely the organised sector, the ratio will be 70-80% and unorganised at 20-30%. Therefore the amount may not be very high statistically as the majority was being taxes already at this rate.

The timing however is curious. On one hand the duty on fuel products has been reduced. On the other LPG prices have gone up. It is hard to guess whether the aim is to protect the common man or not as LPG is consumed by the middle class while petrol supposedly by the rich. Using the same rationale, the present tax of 5% could be affecting the middle class more than the rich. With inflation likely to be above 7% in the next few months the decision could have been kept on hold.

By not deferring this decision inflationary expectations will turn adverse. Also considering the central bank is working hard to control inflation by hiking rates the sentiment change will add to the worries. This will mean that the RBI has to weight this in while taking a call on interest rates which are bound to rise on this score.

This also comes at a time when the rupee is falling. This affects the prices of all imported goods as the exchange rate has moved around 7% in the last 6 months. While it is true that global commodity prices have eased the depreciation neutralises this impact, the final effect will vary across goods. But to the extent prices increases it will increase input costs and make producers consider another round of increase in prices. If chemicals become expensive so will the price of toothpaste and shaving cream. Companies have already started passing on higher input costs and may choose to go in for another round once it starts to pinch their profit margins.

Hence we have to be prepared for higher prices though the inflation rate per se may change marginally. More importantly it will affect all consumers with the middle class probably bearing the brunt. Also given the direction that the GST Council has taken there will be the tendency for more of such hikes to be invoked over the next few years until the equilibrium is attained. Quite clearly the argument given earlier that the tax burden and hence prices would come down will not play out as the economy has not quite behaved the way it was expected. Looking ahead, economic growth is expected to move upwards quite gradually. Even the 7% growth this year will be marginally higher than the pre-pandemic times and hence faster acceleration may be required.

India's ten fold path to manage foreign exchange volatility Mint, 21st July 2022

 The regulatory world of innovation has few boundaries. And the way in which India has tackled foreign exchange crises over the years has been quite profound. A forex crisis can be loosely defined as one where the rupee starts depreciating rapidly or when forex reserves slide precipitously. Normally, the two go together, which raises an alarm as unchecked depreciation is always self-fulfilling. When the rupee is expected to fall, exporters hold back their earnings while importers rush to buy larger quantities of forex for future imports, thus exacerbating the position and causing the rupee to fall faster as demand goes beyond supply.

Ever since India’s reforms of 1991-92, the external sector has been liberalized, with even full capital account convertibility being considered at one point. A flexible exchange rate regime runs the risk of volatility, which keeps central banks alert all the time. On its monetary and forex policies, the Reserve Bank of India (RBI) has maintained that it has an array of options that can be used, and hence its approach isn’t straight-jacketed. In the rupee’s context, let’s look at options that have been used in the last three decades or so.

The first course of action has been selling dollars in the spot forex market. This is fairly straightforward, but has limits as all crises are associated with declining reserves. While this money is meant for a rainy day, they may just be less than adequate. The idea of RBI selling dollars works well in the currency market, which is kept guessing how much the central bank is willing to sell at any point of time.

The second tool used is aimed at garnering non-resident Indian (NRI) deposits. It was done in 1998 and 2000 through Resurgent India bonds and India Millennium Deposits, when banks reached out asking NRIs to put in money with attractive interest rates. The forex risk was borne by Indian banks. This is always a useful way for the country to mobilize a good sum of forex, though the challenge is when the debt has to be redeemed. At the time of deposits, the rates tend to be attractive, but once the crisis ends, the same rate cannot be offered on deposit renewals. Therefore, the idea has limitations.

The third option exercised often involves getting oil importing companies to buy dollars directly through a facility extended by a public sector bank. Its advantage is that these deals are not in the open and so the market does not witness a large demand for dollars on this account. It is more of a sentiment cooling exercise.

Another tool involves a directive issued for all exporters to mandatorily bring in their dollars on receipt within a set time period, with allowances made only for balances kept aside that are needed for future imports. This acts against an artificial dollar supply reduction due to exporter hold-backs for profit.

The fifth weapon, once used earlier, is to curb the amount of dollars one can take under the Liberalized Exchange Rate Management System for current account purposes like travel, education, healthcare, etc. The amounts are not large, but it sends out a strong signal.

Sixth, another route used by RBI is to deal in the forward-trade market. Its advantage is that a strong signal is sent while controlling volatility, as RBI conducts transactions where only the net amount gets transacted finally. It has the same power as spot transactions, but without any significant withdrawal of forex from the system.

The seventh tool in India’s armoury is the concept of swaps, which became popular post 2013, when banks collected foreign currency non-resident deposits with a simultaneous swap with RBI, which in effect took on the foreign exchange risk. Hence, it was different from earlier bond and deposit schemes. The same idea has been used again, though without deposits being raised that involve a sale-purchase transaction which provides dollars to banks with a commitment to buy back after, say, 3 years.

All these instruments have been largely direct in nature, with the underlying factors behind demand-supply being managed by the central bank. Of late, RBI has gone in for more policy-oriented approaches and the last three measures announced are in this realm.

First was allowing banks to work in the non-deliverable forwards (NDF) market. This is a largely overseas speculative market which has high potential to influence domestic sentiment on our currency. Here, forward transactions take place without real inflows or outflows, with only price differences settled in dollars. This was a major pain point in the past, as banks did not have access to this segment. By permitting Indian banks to operate here, the rates in this market and in domestic markets have gotten equalized.

Second, more recently, RBI opened up the capital account on NRI deposits (interest rates than can be offered), external commercial borrowings (amounts that can be raised) and foreign portfolio investments (allowed in lower tenure securities), which has the potential to draw in forex over time. Interest in these expanded contours may be limited, but the idea is compelling.

Third, and last, RBI’s permission for foreign trade deals to be settled in rupees is quite novel; as India is a net importer, gains can be made if we pay in rupees for imports. The conditions placed on the use of surpluses could be a dampener for potential transactions, but the idea is innovative and could also be a step towards taking the rupee international in such a delicate situation.

Clearly, RBI has constantly been exploring ways to address our forex troubles and even newer measures shouldn’t surprise us.

ON ETNow: 19th July 2022

 https://www.timesnownews.com/videos/et-now/shows/what-next-for-rupee-debate-with-madan-sabnavi-and-siddhartha-sanyal-india-development-video-92989117