RBI's Third Quarter Review and Rational behind it

Recently RBI had announced its Third Quarter Review (for Full review of TQR Click here). Many analysts, economist and markets were surprised of its announcement because it has raised the Repo Rate by 25 basis points. RBI had said that from next announcement it will follow Dr. Urjit Patel Committee reports recommendation. But, when one reads the policy he will definitely see that even this quarter review announcement of RBI seems to be based on Committee report; because it talks more about CPI (whereas in its earlier policies it use to mention both CPI as well as WPI).

Let us have a look what is some rationale behind the hike of Repo rate. If one sees the graph above then one will see the main rationale behind the policy, as it says, is inflation control, is absolutely right and acceptable. But when one read the graph carefully then one will see when WPI had fallen (which was the lamp post for earlier policies) then Repo rate should have also reduced which never happened (RBI cities due to other reasons for it- which is not clear). In November 2013 there was little hike in Inflation where policy and inflation almost same and in December the inflation had fallen. The present hike is based on the December inflation, but not on the basis of WPI but CPI.

Those who are good at IS-LM Space of Monetary Policy will understand the above graph easily. For others here are the basic 3 conditions 

   1.   Price  Increases – Demand Increases - Interest Rate Increases

   2.   Price  Decreases – Demand Decreases -  Interest Rate Decreases

   3. Price Increases – Demand Decreases - Interest Rate
   (may be in) Status Quo (or) Increases!!

I leave this post wide open for readers perception.

Second Quarter Review of Monetary Policy 2013-14 and Decoding Rajanomics

Reserve Bank of India (RBI) had announced its Second Quarter Review of Monetary Policy 2013-14 recently (i.e. on 29^th Oct 2013).  In its Policy RBI had said the following major stance

1. Reduction of marginal standing facility (MSF) rate by 25 basis points from 9.0 per cent to 8.75 per cent with immediate effect;
2. Increase  in policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5 per cent to 7.75 per cent with immediate effect; and
3. The liquidity provided through term repos of 7-day and 14-day tenor has been increased from 0.25 per cent of net demand and time liabilities (NDTL) of the banking system to 0.5 per cent with immediate effect.

In its policy RBI had said that it is more concerned on Inflation along with the growth rate – “Curbing mounting inflationary pressures and managing inflation expectations will help strengthen the environment for growth by fostering macroeconomic and financial stability. The Reserve Bank will closely monitor inflation risk while being mindful of the evolving growth dynamics.”  (for full policy click here)

Two days after policy announcement RBI Governor Mr. Raghuram Rajan has said that tough measures like raising rates are needed to tackle inflation in India (In an exclusive interview to NDTV’s Mr. Prannoy Roy). Dr Rajan's said to India Inc is: Bear with us. If we don't fix inflation now, the problem will get worse. (For Highlights and full Interview video click here)

My Perspective

I am little surprised on reading the Second Quarter Review of Monetary Policy 2013-14 (to read second quarter review click here). The second quarter review says that "Strengthening export growth and signs of revival in some services, along with the expected pick-up in agriculture, could support an increase in growth in the second half of 2013-14 relative to the first half, raising real GDP growth from 4.4 per cent in Q1 to a central estimate of 5.0 per cent for the year as a whole (Chart 1). The revival of large stalled projects and the pipeline cleared by the Cabinet Committee on Investment may buoy investment and overall activity towards the close of the year." Not for the reason that RBI had estimated GDP growth of 5.0 per cent for whole year but for the statement - revival of large stalled projects!!! These large projects are stalled for past 2 to 3 years; they got to be revived because election is on card now. 

I saw the full interview of RBI governor to NDTV (click here for Transcript), Where Dr. Rajan said that ".........Oh, these guys don't have manufacturing", that's really why they are in the dumps. No. No. That's not why we are in dumps. We are slowing down because we expanded too fast and we have these..." "Dr Prannoy Roy: Old Systems."  and "Dr Raghuram Rajan said Yes"

When Dr Prannoy Roy asked that: So what you are saying is with these old systems, if these remain in place, our growth rate is going to be capped at 4 to 5 percent. If we change the system we can go back to our 9-10% on a long-term basis.

Dr Raghuram Rajan: See 7-8 is what is feasible. These are all numbers, guess work.

This surprised me because our manufacturing sector is widely affected and it is a fact that we have weak manufacturing sector. Even the IIP data replicates only 0.6 percent growth over last year. If we are not worried about our manufacturing sector now, then when!!! In his Monetary Policy statement as well as in his interview, RBI Governor, talked about changing financial systems. This is another alarming thing (at least from my perspective) because this statement means two things either we have a weak financial system (this includes inefficient structure, where financial system fails to absorb shocks) or outdated financial system (which also means the flow of money in the economy is not that smooth)!!! 

Financial system is a engine for any economy; if that fails then economy will be in trouble. It is still too early to say where Indian Economy is heading to!!! We need to wait and watch!    

RBI Second Quarter Review of Monetary Policy 2012-13

Today (i.e. 30.10.2012) RBI had announced “Second Quarter Review of Monetary Policy for 2012-13”. It had announced in his statement (click here for full statement) that: Based on an assessment of the current macroeconomic situation, we have decided to:

Ø   Cut the cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.5 per cent to 4.25 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning November 3, 2012.

Ø   The reduction in the CRR, will inject around `175 billion of primary liquidity into the banking system.

Ø   There is no change in policy interest rate. Accordingly, the repo rate under the liquidity adjustment facility remains at 8.0 per cent.

Ø   Consequently, the reverse repo rate under the liquidity adjustment facility (LAF), determined with a spread of 100 basis points below the repo rate, will continue at 7.0 per cent, and the marginal standing facility (MSF) rate, determined with a spread of 100 bps above the repo rate, at 9.0 per cent.

It had the above mentioned following stands:

i. enable liquidity conditions to facilitate a turnaround in credit growth to productive sectors so as to support growth;

ii. reinforce the growth stimulus of the policy actions announced by the Government as inflation risks moderate; and

iii. anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation.

Within few hours of RBI Second Quarter Review Finance Minister made following statements to the media:

"Growth is as much a challenge as inflation. If government has to walk alone to face the challenge of growth, then we will walk alone," he said in his reaction to the RBI's second quarter policy review. 

He also stated that “Government is doing its best to send the clear message that we are on the path of fiscal consolidation. It is my hope that everyone will read and understand the government commitment to path of fiscal consolidation. I haven't read last few paragraphs of the statement but if it holds out hope for the future I look forward to that future”.

My Perspective:

The RBI stance on Monetary Policy had received many criticism and many economist/analyst are disappointed of its Second Quarter Review. I am not at all surprised by this move of RBI since the reputation of RBI is already at stake. RBI may not have surprised the economy in positive manner but definitely it did surprised the economy in its own ways (of course in negative manner) as it does in the recent past. If one reads the reasons for the policy stance, especially third point "anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation", then one will realise that RBI in its Mid-Quarter Review Statement (on 17th September, 2012) had reduced CRR by same 25 percent and injected Rs. 17, 000 Crore primary liquidity into the banking system. For this stance it had said that "As inflationary tendencies have persisted, the primary focus of monetary policy remains the containment of inflation and anchoring of inflation expectations. In this context, the Government’s recent actions have paved the way for a more favourable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI)."

Many may argue that it was the expectation of the outcome but since it was not achieved RBI had made the current stance. True, the expected outcome had not been Achieved, but, on what basis the current stance of RBI is expecting that it will anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation? The present market situation needs a boost in investments in order to stimulate the economy. No doubt, at the same time we need to have eye on inflation; when one notice the present scenario then one can realise that most of the inflation may be due to failure of supply side boost. Inflation even though most of the times monetary phenomenon, does not mean that only through Monetary Policy measures it can be controlled. RBI again fails to read the situation of the economy and provide appropriate policy measures.

CRR DEBATE – Whether CRR will survive?

During the past few weeks, in the newspapers and televisions, many would have read, saw, and heard that whether CRR is required or it should be abolished? In fact, the close follower of this news would have noticed that the debate was initiated by SBI chairman, Mr. Pratip Chaudhuri and in response to his comment (on abolishing the CRR) RBI Deputy Governor Mr. K. C. Chakrabarty said that CRR is the only and important tool with RBI and it cannot be abolished.

Before going further let us see what exactly CRR is and its purpose?  Cash Reserve Ratio (CRR) is ratio of reserves at which commercial banks must hold or deposit with the central Bank. In other words it is a central bank regulation that sets the minimum reserves that each commercial bank must hold physically in bank vaults or as deposits made with the central bank. This reserve can be maintained either in cash, gold or unencumbered government securities.

The reserve requirement, on one hand, helps the bankers to have enough cash to meet any crisis and on the other hand, they serve as tools for Central Bank to control the liquidity in the system in order to manage the Inflation. When CRR is altered then the interest rates will be changing as per availability of funds with the commercial banks.

Now coming back to the debate that SBI Chairman said Abolish Cash Reserve Ratio, he said that "CRR does not help anybody. It is locked up in the vault and not ploughed back into the economy. It is unfairly applied on banks. If CRR is a liquidity mop-up tool, why not apply it to insurance companies, NBFCs and debt mutual funds, who as well mobilize deposits from the public?" he asked.

After three days of SBI chairman commented the RBI Deputy governor K C Chakrabarty commented that “the banks must work within the frame work of the regulatory norms”. He also said that “If SBI is not protected, the risk may catch other banks leading to a systemic failure and SBI is too big to fail.” He further went on to say that “If the SBI Chairman is not able to do business as per our regulatory environment, he has to find some other place”

This row has become a big debate now. Recently, Reserve Bank of India Governor D. Subbarao made a prank up his sleeve at a banking summit in Mumbai. In serious tone he announced that central bank has set up a ‘committee’ to review the need to retain the much-debated cash reserve ratio (CRR)” But when the Governor revealed the names of the committee members and its conditions, people realised he was only joking.  He said that “The members of the committee, Subbarao said, would be Pratip Chaudhuri, Chairman, State Bank of India, and K.C. Chakrabarty, Deputy Governor, RBI. Both, with opposite views on CRR (the percentage of deposits that banks need to keep with RBI), have sparred over the issue.” He also went on to say further that “the two conditions for such a committee would be: First, the two members would be locked up in a room till they come to an amicable solution. And, second, the findings of the committee should not be made public until his own term as Governor comes to an end.”

So let us see the main reason why SBI chairman said CRR is not required. The main reason for it is that CRR has come down from its peak level of 15% in 1994 to 4.75% at present. Few years ago RBI had ceased to pay interest rate on CRR, which affects the commercial banks. This is one of the main reasons why SBI chairman wanted CRR to be abolished. SBI chairman had got some support for his view from Former RBI governor and present chairman of the Prime Minister's Economic Advisory Council (EAC) C Rangarajan; he said on that there is a need to bring down the cash reserve ratio as the instrument is no longer used in credit control and liquidity management. In his own words "We need to move towards a situation in which the level of CRR comes down and it is used as an instrument of credit control only in extraordinary circumstances," he also stated that "As OMO (open market operations) becomes increasingly a major instrument of credit control, the role of CRR as an instrument of credit control will come down,".
 
Here are 2 more articles on this debate 1.     CRR harsh on public sector banks
2.  CRR has outlived utility

My perspective with a Thank Note:

When one reads the debate then one may come to a quick conclusion that SBI governor is right and CRR should be abolished. If CRR is abolished then what are the other tools through which RBI can control credit and inflation? (Even though this is not the only tool to the do this, but one of the major tool for RBI). No doubt as EAC chairmen said that OMO becomes increasingly a major instrument of credit control, but at the same time we cannot ignore or doubt the credibility of CRR. The Problem with commercial banks is few years back RBI had stopped paying interest rates on the cash reserves; this affects the business of the commercial banks, because without any incentive when the cash is kept then it is no use for anybody. RBI need to find a amicable solution to stop this debate, either by paying some interest rates or through some other incentives. 

I wanted to end this big post with a THANK note to all the Visitors who had viewed, read, visited and commented on this blog. Today, with the help and support from all of you, this blog had crossed 4000 visitors (which you can see in the left side of the screen). I Thank  all of you again for giving your support and encouraging me to keep posting in this Blog. THANKS ALL
  

 

RBI's Third Quarter Review of Monetary Policy 2011-12

RBI’s Third Quarter Review was announced on this Tuesday (i.e. 24.01.2012). The Press statement on the Policy Review stated that “Based on an assessment of the current macroeconomic situation, we have decided to:

Ø   Cut the cash reserve ratio (CRR) of scheduled banks by 50 basis points from 6.0 per cent to 5.5 per cent of their net demand and time liabilities (NDTL). This will be effective the fortnight beginning January 28, 2012.

Ø   This reduction in the CRR will inject around Rs. 320 billion of primary liquidity into the system.

There is no change in the policy interest rate. Accordingly, the repo rate under the liquidity adjustment facility (LAF) remains at 8.5 per cent.

          Consequently, the reverse repo rate under the LAF, determined with a spread of 100 basis point below the repo rate, will continue at 7.5 per cent, and the marginal standing facility (MSF) rate, determined with a spread of 100 bps above the repo rate, at 9.5 per cent.”

The Monetary Policy Stance said that three broad contours of our monetary policy stance. These are:

Ø   to maintain an interest rate environment to contain inflation and anchor inflation expectations;

Ø   to manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission;

Ø to respond to increasing downside risks to growth.

The RBI’s expected outcome from these policy move are as follows:

Ø First, liquidity conditions will ease.

Ø Second, downside risks to growth will be mitigated.

Ø Finally, medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation.

This time RBI had come with risks to our projections of growth and inflation for 2011-12 and it had listed Seven as follows:

1.  Sovereign debt concerns in the euro area pose a major downside risk to the overall growth outlook.

2.  Slowdown of capital flows in the face of a widening current account deficit.

3.  Global energy prices continue to pose a risk to growth and inflation due to geo-political factors and the global macroeconomic situation.

4.  There are signals of increasing risk aversion by banks, which could adversely affect credit flow to productive sectors of the economy.

5.  Inflation in respect of protein-based items remains high due to structural imbalances. In the absence of appropriate supply responses, risk to food inflation will continue to be on the upside.

6. There is a large element of suppressed inflation as domestic prices of some administered products do not reflect the underlying market conditions. Revision in domestic administered prices will add to inflationary pressures, although I should note that such revisions are necessary to maintain the balance between supply and demand. 

7. The fiscal deficit of the government could potentially crowd out credit to the private sector.  Moreover, slippage in the fiscal deficit has been adding to inflationary pressures and it continues to be a risk for inflation.

My Reflection:

          I am glad to see that RBI had finally found out some major risk factors to their Growth projections and Inflation. Hats off RBI!!!  At the same time, it’s surprised many people by cutting CRR rate by 50 basis points from 6.0 per cent to 5.5 per cent. Many people would have expected no action from RBI; but this move would have surprised many, if not many, at least me. I think it would have been better if RBI had not taken any policy measure at this juncture. The new injection of Rs. 320 billion in the economy may lead to increase in inflation again, which slowly cooling down. We need to wait and watch how the Economy reacts for this RBI's policy measure. I am also, looking Forward for the Annual Monetary Policy 2012-13 in order to know RBI’s Inflation Projections for the financial year 2012-13.  

RBI's Second Quarter Review - An Analysis

It's back in news. Yes, Inflation is back again in the headlines only difference is this time with the RBI policy. The Wholesale Annual Inflation was 9.72 percent in September, which had made RBI to again rise its policy rate by 25 basis points . The RBI on Tuesday hiked its policy lending rate, the repo rate, by 25 basis point to 8.50 per cent. This means that the reverse repo rate, at which RBI drains excess liquidity from the economy, will also be increased by same basis point to 7.50 percent (as per the RBI policy rate the corridor of one percentage point is maintained between the two). This also means that the Marginal Standing Facility (MSF) will stands adjusted at 9.50 percent. 

RBI says that the Stance of Monetary Policy is Intended to 

• Maintain an interest rate environment to contain inflation and anchor inflation expectations
• Stimulate investment activity to support raising the trend of growth
• Manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission

This the 13^th  time RBI had hiked its interest rate since March last year (i.e. 19 months). 

RBI had not only hiked its prime lending rate but also it had lowered its growth forecast from 8% to 7.6% fro the current fiscal year. It came with the supportive statement by citing the slowing world economy and declining domestic growth. Surprisingly, it had retained the fiscal year-end projection of inflation at 7%.  

My Reflection

First, after reading the RBI's second quarter review, I asked myself that, Do you think RBI's policy will have any impact on Inflation? The immediate answer (like many of the people, I think) was NO. Another interesting point which I would like to reflect here is on the policy stance which RBI had mentioned that "Stimulate investment activity to support raising the trend of growth". I really doubt this RBI policy stance, that by increasing interest rate one can stimulate the investment activity in the economy.  

Second, last month in the post titled "RBI's Goodwill at Stake" it was clearly mentioned how often RBI changes its own stance from one forecast to other. The recent Second Quarter Review of Monetary Policy 2011-12 by RBI proves the same.

Third, is inflation still monetary phenomenon in India? I feel that RBI policies had failed to reflect the real pulse of the economy. 

RBI's Goodwill At Stake?

From the recent review, actions and projections of RBI, I am really baffled on What RBI is trying to do? and raised the question that whether RBI had Gone Mad? I may not be an expert on these lines, but, being an economics student one can at least feel the pulse to certain extent. 

In an weekend newspaper M.D.Nalapat had written an article titled "The RBI had Gone Mad". In this article, the writer says that "India Inc has been crippled by the duo's policy of relentless rate hikes, ostensibly to "rein in inflation". Neither Reddy nor Subbarao had IQ needed to understand that Inflation in India is caused by factors other than the Interest Rate is a Tragedy for the Country". 

He further stated that "Inflation since the UPA took office in 2004 has been largely caused by uncontrolled Government spending, mostly on programmes that are designed to increase the tally of the congress for the next elections. Thus, instead of public works programme that would expand rural infrastructure, what has been implemented is a dole that does nothing to ensure that permanent employment opportunities form as a result of the huge Financial Outlays of the Sonia Gandhi-approved schemes" 

Of course, this post is not about the writer's political view or his general view.  But the above mentioned article have few valid points, which we need to note, that Inflation in India is not only because of the money supply but it is due to various factors. (Austrian economist may argue differently - but, we are not here for any debate). This article further strengthen my queries and doubts on RBI, here are the 2 major points from this article which supports my query on credibility of RBI


1. The article says that Inflation in India is not due to the prevailing interest rates but it is due increase in uncontrolled Government spending. (RBI failed to feel the pulse?)


2. The Interest rate in India is much higher compared to any developed nation(not even UK and Europe) and China is the only country which comes closer to our interest rate.


This article is not the only reason which made me to raise question on RBI's credibility. There are more valid reasons, they are as follows: 


Few days before (i.e. on 16 September, 2011) RBI had announced its quarterly review with an hike of 25 basis points (as expected). They came with the usual reply that this move is to control prevailing inflation. Despite the fact (I hope they know) that raise in interest rate alone cannot contain the present inflation rate. 


For the past few years, predictions and revisions of the Central Bank (RBI) have gone hand in hand. In recent past, whenever RBI makes prediction it hardly takes a month or so that it revises its own estimates. After 3 times revision, RBI had predicted the Inflation level of 8% for the year 2010-11, whereas, the actual Wholesale Price Index (WPI) by March 2011 ended at 9.68 %. In the latest review it predicts that inflation will be 7% by the year-end (i.e. March, 2012). (Note: The current (August) WPI stood at 9.78% (Provisional) as compared to 8.87% corresponding month of last year (2010)) 


Being the Central Bank of country, if RBI fails to feel the pulse of the economy, then it will be a great difficulty for the nation to achieve its macroeconomic objectives. Already people have started losing their confidence on RBI. RBI's credibility and laud which it had received from across the globe are now at stake. In simple, RBI's Goodwill is at stake.