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.