“I think it (the policy) is largely dovish. It is growth oriented and perhaps a little more. I would borrow from Mr Das’s vocabulary and call it “nuanced.”
The reaction in the government bond market suggests that the Reserve Bank of India’s monetary policy statement which was released today has a hawkish tilt. It is true that the RBI has flagged risks to inflation through higher forecasts and announced a greater degree of liquidity withdrawal from the banking system. But, Abheek Barua, Chief Economist of HDFC Bank, believes that the central bank has not exactly been hawkish. Rather, he preferred to borrow the term from Governor Shaktikanta Das‘ vocabulary and described the statement as “nuanced”. “He (Das) just brought up this additional thing, talking about inflation, talking about the first steps towards liquidity normalisation and perhaps an increased level of comfort with the prospect of growth returning,” Barua said in an interview to ETMarkets.com.
The reaction in the bond market seems to suggest that investors believe that RBI is starting the process of some degree of liquidity normalisation. What is your view on the timeline for normalisation in the monetary policy?
The first step was accepting higher cut-off yields on some of the benchmark bonds that they were auctioning. This is really the second step. The Rs 4 lakh crore liquidity number mentioned by the Governor is some kind of a target level from which you can extrapolate what the system liquidity is going to be. So any aggressive normalisation beyond the schedule that they have provided is unlikely unless liquidity balloons over a period as it has in July and August because of some extraordinary events like very large inflows.
By September end, overall liquidity would likely be in the range of around Rs 5.5 to 6.5 lakh crore or a little more and that will be the level at which overall liquidity will remain.
Having said that, there are two things that RBI is doing here: They are doing a tenor switch through VRRR. It is the same amount of liquidity, but they are enabling banks to keep it in longer term instruments.
From the RBI’s perspective, this is almost liquidity neutral because you are basically doing a switch. The market sees this as some form of normalisation because they see the overnight balances as a benchmark for liquidity. There is the additional question of actual liquidity drainage which can either happen through open market operations or through CRR (Cash Reserve Ratio) increase. I think the earliest it will happen is by the end of this year. If demand comes back along with growth, then there is a possible scenario with non-negligible probability.
Do you think that this particular policy has brought the inflation view back to the forefront? RBI has increased the target from 5.1% to 5.7% for the current financial year. Governor Das mentioned that it might be transient but if it was as transient as he was emphasising, than that measure of an increase would not have been warranted ?
I think the word transient has become a bit of a euphemism for choosing to look through inflation –.whether it is transient or more durable and focus on getting growth back on track relative to pre-pandemic levels. I do not believe that our inflation is as transient as say the US inflation, but it is just the central bank’s peak tolerance for higher inflation.
The governor also mentioned in the press conference that the government has had a well calibrated fiscal response to the pandemic, but while the inflation forecast has risen, growth has been maintained at 9.5%. Is RBI facing a slightly tricky situation on the growth inflation mix?
There is a lot of exogeneity on the growth front. We do not know how the infection will pan out. The fact that they are keeping the growth numbers unchanged is a recognition of risks and comforts. At this stage, through a modelling exercise given the scale of uncertainty, it is very difficult to come out with a growth projection. But they are clearly saying that they are keeping accommodation despite uncomfortable headline inflation numbers.
The fact is that keeping things so accommodative essentially means that they still see growth as a fairly big challenge and 9.5% might seem very comfortable but on a base of last year’s contraction, it is very low. It just takes you back to the pre pandemic level somewhere in the first quarter of calendar 2022. It is a long journey.
Dr Patra had mentioned the fact that the RBI is very acutely aware of the fact that growth in 2019-20 was very low and that was a little before the pandemic actually struck the economy. Would you term this particular policy as being dovish or hawkish?
It is largely dovish. It is growth oriented but perhaps a little more. I would borrow from Mr Das’s vocabulary and use the word “nuanced”. He just brought this additional thing up, talking about inflation, talking about the first steps towards liquidity normalisation and perhaps a certain degree of an increased level of comfort with the prospect of growth returning.
You mentioned a very interesting point about what the governor was talking about. The monetary policy cannot be black and white, it must be nuanced. In terms of the nuances that we have been seeing since the pandemic, a lot of market management has happened through word of mouth. The governor himself had given certain interviews sometime early last month. Do you think these interventions have succeeded?
To a certain extent they have and I think there has to be continuous communication.
A more unified voice from the RBI is needed and the governor is doing his bit. It is not only a growth-inflation tradeoff; there are so many other elements to it; the household balance sheets are being damaged because of health costs, livelihood losses for MSMEs and a lot of the smaller businesses whose balance sheets are damaged.
Recent history shows that when you are trying to repair the balance sheet, you keep interest rates low. That is the best way to do it. Governor Das put it very well, The fact that there are so many moving parts and so many conflicts which they are resolving, sends a longer-term message.
Dr Patra had said in the press conference that the RBI has been very closely watching the situation of inflation, borrowers and depositors. Is there now a new degree of vigilance on the inflation front?
On a micro perspective, yes. The supply of savings is an issue from a welfare perspective. For a large number of fixed income earners, negative real rates ultimately feed into the supply of savings and so these are issues.
There must have been some discussion.
I want to get an outlook on the bond market; 10-year benchmark bond yields have risen by 3 or 4 bps today. Is this the market’s reading of the direction of policy?
Yes, short-term rates have moved up a little more.
I think it has bottomed out and I would look for a 6.25 percent, 6.10 percent yield on the 10-year by the end of the year.
If RBI does not actively diversify their purchases across the yield curve, which is very uneven, across both the short and the very long-term, bond yields will move up by much more than the 10-year.
What do you think are the implications of the policy for the rupee? The governor mentioned strong external demand but, in all likelihood, the current account will slip into a deficit this year; albeit marginally. What is your forecast?
There are three things which are happening. If you look at the dollar in DXY terms which automatically feeds into the exchange rate, that is a negative for the rupee. A lot of money is coming in through private equity and now the FPIs because there is a switch away from China and that would be positive.
Exports are doing well but we have a problem with commodities, including oil imports. On balance, I would think that the rupee would depreciate mildly by the end of the year and I would look at a range, maybe 75.5 by December.