Brexit, Monetary Policy & RBI

Q&A: Financial Express (25/6/16; Appeared on Monday 27th June 2016)

Q1: Britain's exit from the EU and its impact on the rupee, India's foreign trade, capital flows in and out of the country, the bond markets and the overall economy.

A1: The immediate effects of the referendum (1-2 days) are due mostly to the forecasting error made by the betting markets (those who put their money on the line). Most of the short term capital movements viz India will be adjused in a couple of days & wont be very significant. The Rupee dollar rate will depreciate by approximately the same % as the US dollar depreciates against the broad index.

    Unlike earlier shocks, this shocks was known but its probability was underestimated. I believe that many observers are over estimating the direct economic effects of Brexit based on earlier economic shocks. The heightened risk in this case arises mostly from the uncertainty in predicting adverse politico-economic developments in the EU and in the US elections. These will of course have economic consequences: Increased risk will likely result in lower real investment and consequent further weakening of growth impulses in the developed countries. This will have little net effect on India because of the offsetting effect of slower rise in oil prices and continued weakness in demand. If economic reforms continue at steady pace, there could be a larger surge of capital inflows into India, "reverse safe haven" or "relative economic opportunity" effect. 

 Q2: How should the government and RBI deal with the likely eventualities?

A2: RBI and other Central Banks have had many experiences of shocks and by know well how to minimize any financial contagion by ensuring liquidity.

Q3: How serious is the possibility of competitive devaluation of currencies?

A3: Most countries will let the markets adjust to the new expectations. Some like China which do not really have a market determined exchange rate, may use this occasion to nudge their exchange rate a little lower, but not enough to cause widespread alarm.

Q&A (Bloomberg News: 25/6/16)

Q1: How do you see the Brexit and what impact do you see this having globally and especially for India?

A1: The immediate effects of the referendum (1-2 days) are due mostly to the forecasting error made by the betting markets (those who put their money on the line). Unlike earlier shocks, this shocks was known but its probability was underestimated. I believe that many observers are over estimating the direct economic effects of Brexit based on earlier economic shocks. The heightened risk in this case arises mostly from the heightened risk of adverse politico-economic developments in the EU and in the US elections. These will ofcourse have economic consequences: Increased risk generally results in lower real investment and consequent further weakening of growth impulses in the developed countries. This will have little net effect on India because of the offsetting effect of slower rise in oil prices and continued weakness in demand. If economic reforms continue at steady pace, there could be a larger surge of capital inflows into India, "reverse safe haven" or "relative economic opportunity" effect. 

Q2: What's your outlook for the rupee going forward? What are the factors you think will be weighing on the rupee?

A2: The Rupee dollar rate will depreciate by approximately the same % as the US dollar depreciates against the broad index.

Q3: Can you please share a level for the rupee by the end of September and Dec.-end?

A1: No

Q4:  Do you think a weaker rupee is good for India given global central banks weakening their currencies, and hence its support for exports? Or how do you see it?

A: A competitive rupee, as defined by the real effective exchange rate is good for India. This means the smaller the inflation differential the less the nominal depreciation of the rupee that maintains competitiveness.

Q5: What's your outlook on inflation and interest rates? Do you think surging price pressures means the RBI is done with rate easing?

A5: As I forecast in March 2016, end year 2016-17  inflation is likely to be between 4 and 5% with 70% probability. Interest rates will depend to a much greater degree than earlier, on the Monetary Policy Committee to be appointed by end-August.

Q6: How do you view Governor Rajan's departure and what it means for the rupee and rupee stability?

A6: His departure is now a given and its short term effects have already been incorporated in market reactions. What happens in future depends on the credibility of the new Governor.

Q&A (Dalal Street Investment Journal 22/6/16: Appeared in Vol 31, No 15, 10 July 2016)

Q1. How would you rate current RBI governor and his term on the face of his policies and activities than a person?

A1: The RBIs performance during the past 3yrs was better than that during the previous 3-5 yrs. 

Q2. Looking at the current mounting NPA’s of public sector bank, does it looks possible that bank balance sheet will look clean by 2017? Do you think RBI under his leadership swung into action little late when it comes to cleaning the NPA mess? 

A2: The NPAs mounted from 2010 to 2013, they are being recognized and revealed over the past few years. Both RBI & Govt (with respect to Public sector Banks) were a little slow in focusing on them.

Q3. Dr Raghuram Rajan was successful in bringing down the CPI index which is the indicator of inflation-has he made the right move by adopting CPI as a inflation index and ignoring WPI index? If he has not, then can you suggest what could have been the right ones?

A3: The creation of the national CPI was initiated, when I was CEA. Once it was created it was necessary to switch over to it as per global best practice. Unfortunately global deflationary forces have opened a large gap between CPI and WPI, which complicates the change over. A more pragmatic approach would used this indicates in setting a lower value for the neutral real repo rate target.

Q4. Amid his achievement, when he started with his rate cut cycle he did very little to give liquidity to the money market? Do you agree with the statement that Dr Rajan kept the money market gasping for a long time?

A4: Monetary policy in an less developed financial market like India doesn't work like the Near perfect markets of US or UK. Thus the Repo rate is an inadequate instrument. Traditional measures like reserve money, money supply/credit growth continue to be relevant.

Q5. Dr Rajan has been successful in stabilizing the rupee – dollar price in a range of Rs 66 to 68. However, on the other hand, it also made Indian imports a bit expensive. Your comments on this.

A5: From macro-economic perspective, the important rate is not the RS USD, but the real effective exchange rate, which depends on the inflatin differential between India and the world. A real appreciation of the rupee, as happened under the previous Governor, is bad for competitiveness of Indian economy. 

Q6. It is widely believed that Dr Rajan has been successful in curbing the inflation which was the prime agenda when he took the office. However, Dr. Rajan has been accused of keeping interest rates higher for too long. Do you agree?

A6: Governor has been successful in curbing inflation expectations. Most of the decline in deflation is due to declines in commodity prices, global deflation & better management of food economy. However, real policy rates have risen sharply during this process, resulting in a tightening of real monetary policy in a period when the large corporate sector is weak. I have argued for faster easing of monetary policy for the last 12-18 months.

Q7. From a borrower’s point of view how efficient is the MCLR, (Marginal Cost Lending Rate)? As the new borrowers are postponing the home loan in anticipation of much lower interest rates. On the other hand, existing borrowers are worried that banks may charge hefty conversion fees to shift them from Base Rate to new lending rate i.e. MCLR.

A7: I don't think there has been much impact either way.

Q8. The markets on the REXIT has not reacted much, the issue of REXIT was wider than the policies which he implemented? Was the discussion by the corporate leaders and general public valid? Is it reflects an individual is bigger than the institution?

A8: Most of the issues have a short term effect, but what matters in the medium term is the policies adopted, now & in future.

Non-Alignmet 3.0?

History

   Even the votaries of non-alignment have either forgotten or don't seem to understand the original concept. It almost seems to have become a mantra which is chanted periodically. It is a concept developed in the context of the Cold War between USA and USSR that followed World War II. The battle lines were drawn between the USA and its non-Russian WWII allies and the USSR and its acquired territories in Eastern Europe. India and other newly independent countries were not the object of hostility from either side. They were however being asked to join the "Cold War" on one side or another. The issue of joining one side or the other and fighting the Cold War or joining neither side and staying out of the Cold War were genuine issues. The Cold War ended with the collapse of the USSR in 1990 as did the issue which it addressed.

Non-alignment post 1990

  With the Cold War ended, what was the war that anyone was aligned for against or neutral towards. The "Non aligned Movement (NAM) " became a secular mantra for the left, socialists and communists. For a wide swath of intellectuals it become a substitute for rethinking their foreign policy in the light of a changing India and changing world environment. Indian growth accelerated sharply during the 1980s and further after the 1990s reform. As India's economic heft in the global economy increased during the 2000s it became impossible to resist a re-evaluation of India's foreign policy. The response of our ruling intellectuals was a hybrid called Non-alignment 2.0, an attempt to disguise the evolution of foreign policy in the 1990s & early 2000s, and reassure the left that the pre-1990s Bipolar World was alive and well, with their favorite socialist country as one pole. 

   The geopolitical situation had, by 2007-8 been completely and fundamentally transformed from the perspective of India and several Asian countries, though perhaps not for many Latin American, Caribbean, and African countries. Even these countries have been actively making deals with old and new powers, while continuing to use this forum to have a voice in the multilateral institutions. For a while the four largest non-G7 countries tried to do the same through the informal grouping named BRICs. China's global stance started changing from passive to aggressive around 2006 and more so since the Global Financial Crisis in 2008. This has transformed it into a protagonists of the US over the last five years, with the US responding with its "Pivot to Asia". The anticipation of an emerging cold war between China and USA has revived the outdated & irrelevant concept of non-alignment in India. 

      But this is not some distant war fought in the battle fields of Europe, but an expansion of a war that has been fought against India by one of the protagonists China for more than half a century, while the other protagonist USA did everything it could for 30 yrs to help this protagonist become economically strong. Belatedly the USA recognizes the threat to itself from China, a threat India has faced with varying intensity, for decades. China has continuously endeavored to undermine our security since 1960s by proliferating nuclear and missile technologies to hostile neighbor Pakistan (and other terrorist nations). It's hostile actions since 2006 are too many to list in this short note, but a significant one was the declaration of Arunachal Pradesh as South Tibet and the personal abuse of the President of India for speaking there(by the Chinese Ambassador to India).  

 National Interest and Beneficial Deals

   How can one be "non-aligned" between a country willing to help us strengthen our economy, defense forces and strategic presence (albeit at a price) and a country working to undermine our national security (while extracting economic gains through non-market means).  The mind boggles at an attempt to define the concept of non-alignment between a group of friendly countries and another group of hostile countries.  Unless of course the underlying idea is to appease ones enemies to avoid getting too close to anyone we dislike for ideological reasons, even if it professes friendship. 

   The issue here is not the 1950s issue of alignment versus non-alignment, but of how best to use the capabilities of a super-power to accelerate our economic growth and strengthen defense and strategic capabilities, while minimizing any adverse reaction from an aggressive, hostile power which happens to be our neighbor.  This requires using our rising economic & strategic power to make deals that further our national interest (economic, technological and strategic) and promote our security. Doing something merely to avoid getting punched by the local bully is appeasement not mutually beneficial deal making.

Conclusion

  Foreign policy starts with a clear definition of national objectives and a realistic appraisal of which countries interest are most closely aligned with ours (potential friends)) and those countries which are most hostile to our interests (potential enemies). One cannot be non-aligned between friends and enemies so defined. One can however promote overlapping interests together and make deals with all countries (friendly, neutral, hostile) if and only if they promote these identified national interests. Constantly looking over our shoulder at what our enemies will think and not doing deals that provide an overall net benefit to us merely because the enemy will react negatively, is appeasement, not pragmatic promotion of one's interest in peaceful developmen.
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A version of this note appeared in DPG Policy Brief Vol. I No 5 at  http://www.delhipolicygroup.com/publications-detail/dpg-policy-note-vol-i-no-5-non-alignment-30-or-strategic-relevance.html

India's National Security Doctrine: An Approach

National Objective: Public Welfare

Economic

•          Sustained fast growth of economy and economic/employment opportunities  for all citizens

o   Supply of Public Goods & Services to all citizens, through commensurate, non-inflationary increase in revenues

o   To promote and enhance Equality of Opportunity for all citizens

o   Growth Target: Close the Per Capita GDP (welfare) gap with China within 30 years.

Social equality & Diversity

•          Strengthen & enforce constitutional principles of equality of all citizens (equal rights & responsibilities) under the constitution and the law.

Personal & Internal Security

•          Strengthen Rule of Law and ensure its effective implementation through institutional reform so as to,

o   Provide safety and security to all law abiding citizens through effective, unbiased  investigation, trial and punishment of law breakers.

o   Internal security: Treat Terrorists, anarchists and secessionists as a priority for national law enforcement

National Security: Peace Through Deterrence

•          A peaceful India and a peaceful neighborhood (continental and maritime) is essential for achieving national objectives, given the multiple and diverse threats India has faced and given new and emerging threats (in the Indian Ocean and West Asia)

•          Our basic approach must be "Peace Through Deterrence" of Nuclear blackmail, Conventional War and Asymmetric/unconventional Aggression (such as cross-border Terrorism and Cyber warfare).

o   Deterrence must be based on an Integrated view of our immediate (Indian sub-continent and Indian Ocean region) and Asian neighborhood (South East,  West and Central Asia), but with a realistic view of the circles of deterrence, based on both the potential and capabilities.  Our involvement will therefore range from deep & active in the immediate circle (Indian sub-continent + Bay of Bengal + Arabian Sea + Indian Ocean & its islands), to collaborative in the middle circle (ASEAN & African continental littoral of IOR) to a presence in support of partners in the outer circle(West Asia, Central Asia, Pacific, East Asia).

o   A reorganization and reform of the higher defense management structure to meet the requirements of 21st century war fighting. A reorientation & enhancement of our naval capabilities and an extension of the reach of our missile, air and space capabilities is essential.

o   Full spectrum deterrence requires development of an Asymmetric Defense Doctrine (ADD) and an integrated strategy (ADS) for deterring Cross border terrorism in all its dimensions. Recognizing the potential of Terrorism and Cyber crime as instruments of coercion, cold war aggression and conventional war. Actionable intelligence is critical  to success of ADS and we must broaden the range and quality of intelligence.

International Opportunity & Diplomacy

•          The challenge of raising per capita income (welfare) rapidly and deterring all forms of war and aggression against India can be met if international economic and political relations are used to complement domestic efforts.

•          A flow of technology (FDI) & risk capital and free trade in goods and services is essential for rapid growth of the economy. In a market economy, economic growth and general technological development go hand in hand, so the private sectors of high income economies have the greatest potential to contribute to our economic & general technological growth. Thus (in ~ order) USA, Japan, Germany, UK, France, Italy, Korea, Canada, Spain & Australia can play an important role in this effort.  Good economic relations with these countries and the EU are important for achieving these flows and minimizing the negative effects of rent seeking monopolies in these countries, which use their political system against us.

•          Strategic (including Defense) technologies are essential for effective deterrence. These are developed under the agies of government and are controlled (monopolized) by them. Thus the degree of strategic understanding and overlap with a country determines the level & extent of strategic technologies and weapons they are willing to share with another country. Ranked by strategic technological capability the countries are (in order) USA, Russia, China, France, Japan, UK, Germany & Italy. However the gap between 1st & 2nd ranked countries (USA & Russia) in this area is over 6:1 and thus has the greatest potential for contributing to India's strategic capabilities.

•          USA is a country with which we have the maximum potential strategic overlap in the Indian Ocean and South East Asia (Indo-Pacific). This must be developed into policies for mutual benefit and enhanced deterrence to aggression against us.  As France, Japan, UK, Germany & Italy are allies of the USA, enhanced US-India strategic understanding, facilitates strategic understanding with most US allies & increases the potential range and quality of strategic weapons and technology available from them. Russia's importance to us lies in its position as a completely independent supplier of strategic technology with competitive strength in areas in which US technology is not available or comes at too high a cost. On the other hand, China's proliferation of strategic (nuclear and missile technologies) to hostile countries is an important factor in our calculus of deterrence.

•          The challenge of deterring cross-border terrorism requires global co-operation, including with West Asia and the European Union. Diplomacy has to focus on this element as well as on elimination of impediments to acquisition of strategic technology, reforming global governance institutions and clubs to give India a role commensurate with its economic power.

•          Peace and security in the Indian sub-continent and the Indian Ocean region (land & maritime) will be facilitated by

o   Accelerated economic growth through enhanced connectivity (hard and soft infrastructure) and economic integration (trade, transit, investment).

o   Development of institutions for promotion of equal human rights for all, tolerance of diversity and reform of institutions/organizations (including schools, college) that promote hatred, violence and killing of "others". India's civilizational cultural links and millennial multi-religious history can contribute to & strengthen this endeavor. 

Conclusion

     With a determined pursuit of these initiatives and reforms, we should be able to achieve the objective of raising welfare in an environment of peace and tranquility in both our neighborhood and our near abroad (figures below).