Monetary & Fiscal policy: Post-budget thoughts

Post-budget Q& A with Ms. Sandrine Rastello of Bloomberg (march 3, 2015)

Q1: Should the revised budget deficit forecasts be a cause for concern for the central bank? Could that delay a rate cut?

A1: It should not be (in my view), as the primary driver should be the Very steep decline in inflation & the consequent rise in the real policy rates. But the new time path for deficit reduction, could change the timing and phasing of monetary easing by the RBI.

Q2: At the same time, Gov. Rajan was looking for high-quality fiscal consolidation.  Do you consider that it was achieved in this budget and if so, which were the most important measures to that effect?

A2: The quality of the fiscal consolidation has certainly improved with a rise in share of government investment/capital expenditures and the fall in share of revenue/current expenditures.

Q3: As a result, is the budget good enough to give the RBI a case to cut rates? If so, do you think it should act now, in between policy meetings, as it did in January, or is April early enough.

A3: I do not wish to speculate on what is on RBI's mind. But I certainly think that RBI should loosen monetary policy by reducing (nominal) repo rates.

Q4: Does the economy still badly need a rate cut? Don't revised GDP numbers complicate the outlook?

A4: I view Monetary policy in the context of the appropriate mix of monetary and fiscal policy, given the growth & inflation rates & forecasts. Though GDP growth has accelerated over 2013-4 & 2014-5, corporate output growth lags (IIP, sales) as well as growth in interest sensitive sectors. Therefore, even though new GDP numbers show higher growth, they have not changed the need for an easier monetary policy - tighter fiscal policy mix.

Q5: The summary of the technical advisory committee consultation shows three members advocating for a cut ahead of the Feb. meeting. Where you one of them and were you the advisor calling for a 75 bp cut? If so, why so much? How much this year is needed in your opinion?

A5:  It would be inappropriate for me to expound further on the minutes of the TAC of which I am a member along with many others. But I have made my views quite clear: The fall an inflation rate has resulted in a rise in the real Repo rate to over 2.25%. This is close to historical peaks.  The repo rate can therefore be reduced by 1% to 2% during the next 12 months (see blog 1/3/15) & still remain well above the historical average (which is negative). However, I also feel that timing and phasing decisions are best left to the Central Bank, as consistency of messaging is very important for markets.

Q6: Is there a cost for the economy for not cutting enough? Is the RBI behind the curve?

A6: The cost of a tight money policy is currently concentrated in the Automobile, Housing and Real estate sectors. The former has multiplier effect on many sectors and the latter two on demand for labor. A change in the fiscal-monetary mix along the lines suggested above will lead to higher growth and employment generation.

Q7: Do you expect the fact there is now an agreement on an inflation target and a monetary policy committee to have any impact on monetary policy from now on? Won't an inflation target make the RBI even more cautious?

A7: The agreement should certainly give greater confidence to the many monetarists in the investment banks and stock markets. The new inflation targets apply from 2016-17 onwards and give enough flexibility (4%+/- 2%) to the RBI Governor.

Q8: More generally is India ready for an inflation target? In particular, are food prices under control?

A8: There are two approaches to this issue. One is that the financial system is too fragmented, the transmission mechanisms weak, the forecasting models & tools too poor and food supply too erratic.  The other approach is to wade right into it and deal with these issues as we go along (as the system will be forced to deal with them). I have an open mind.