English version of column in Business Bhaskar - 17th September 2013

Need to shift priority to growth from Rupee, inflation and Current Account Deficit

The Indian markets have been volatile since US Federal Reserve’s (FED) signal of tapering of Quantitative Easing (QE) before end of 2013, which led to pull-out of FIIs from the Indian sovereign debt market. Before this pull-out, 10Y Indian Bond yield dropped sharply from 8.25 to 7.25% and 10Y US Treasury yields rose from 1.5% to 2.5%, which acted as trigger for FII’s exit. This opened up the risk financing the Current Account Deficit (CAD) through FII flows, exerting pressure on Rupee exchange rate. RBI reacted swiftly to this external danger by squeezing the liquidity and lifting the operating policy rate from Reverse Repo rate (of 7.25%) to a revised MSF rate of 10.25%, a technical 3% rate hike. The agenda was to arrest run-away weakness on Rupee at the risk of collapse in the Bond and Equity market. 10Y Bond yield rose sharply from below 7.5% into 9.5%, so was equity market pulling NIFTY down below 5200. Unfortunately, the measures focused to protect Rupee did not work in favour, instead pushing the Rupee down from 57 to 69. The strategy to protect Rupee turned out to be growth destructive as GDP growth momentum fell below 5%, and most economists revising the FY14 GDP growth target to 3.5-4.0% as against Budget estimate of 6.5%. The lack of optimism on the way forward did shake up the confidence of the stake-holders as RBI came up with administrative stricture to tame the Rupee through Sell/Buy FX swap window for Oil Marketing Companies and Buy/Sell swap window for Banks at 3.5% for 3-5Y tenor against similar tenor FCNR deposits. These actions brought relief in an otherwise bearish sentiment, and since then markets have been in consolidation mode with Rupee at 63-65, 10Y Bond yield around 8.5% and major beneficiary being the equity market where NIFTY rallied sharply from below 5200 to above 5900.

What is the root cause for extreme pessimism on the economic outlook? It is obvious that Growth momentum is very critical for economic (and markets) prosperity. The system is in extreme growth-inflation conflicts; high inflation considered as major risk to long term growth prospects. RBI did not have enough bandwidth for shift into growth-supportive monetary policy. Then, emerged Rupee-liquidity/interest rate conflict; RBI had to squeeze liquidity (and tighten short term money market rates) to protect inflation. The combination of both triggered growth-fiscal deficit conflict; risk of slippage beyond estimated FY14 fiscal deficit target of 4.8% budgeted against GDP growth target of 6.5%, with growth estimate slipping below 4%. All taken, the domestic macroeconomic factors have together emerged as serious risk to growth. RBI is running out of options and looks up to the Government to address supply-side bottlenecks and policy irritants to revive growth momentum. During this time, liquidity-led tailwind from external sector has shifted to strong headwind with fear of reverse flow of dollar liquidity from emerging markets to developed markets. The authorities were not prepared to handle the simultaneous combined resistance to growth from domestic and global cues. 

What is the remedy? RBI has to shift into growth supportive monetary stance despite risks from inflation, CAD and Rupee exchange rate. The major issue now revolves around the CAD and ability to finance the CAD through Foreign Direct Investments (FDI) and Non Resident Indians (NRIs). The structural issue of CAD has turned from bad to worse on significant increase in non-essential imports such as Gold, consumer durables etc and higher consumption of essential imports such as Oil and other commodities. This has resulted in export of permanent capital from India (to fund trade deficit) being funded by short term-hot money FII inflows. The immediate option is to reduce consumption of essential imports (to be achieved through pass-through of subsidies), cut consumption of non-essential imports (higher duties and anti-dumping laws), expand exports from services sector to manufacturing, commodities and agriculture and bridge CAD through long-term FDI investments. The Government should immediately address to revive struck infrastructure projects where huge investments are locked in. The policy irritants relating to land acquisition, legal, labour etc needs to be addressed to revive consumption and investment. The results may not be seen in the immediate future and would be a long-drawn process to address these structural problems. Till then, short term remedial measures are needed to revive the long term confidence on the Indian economy and its growth story.

What are expectations from mid-term policy review on 20th September? RBI has shifted its monetary policy from balanced approach to hawkish stance to support Rupee, but these measures have turned out to be growth destructive without any positive impact on Rupee. RBI is expected to shift its stance back to balanced approach between growth versus inflation/CAD/Rupee exchange rate. While RBI is expected to remain steady on policy rates, it is essential to drive call/short term money markets rates down from over 10%. To this effect, RBI would allow higher refinance facility at Reverse Repo rate (of 7.25%) and the balance at MSF rate (of 10.25%); 50:50 mix of refinance will drive call money rates from 10.25% to 8.75%. This stance will revive sentiment and improve the lack of optimism on the way forward. There would be relief rally in shorter tenor Fixed Income market while 10Y Bond stays steady at 8.0-8.25%. An improved confidence on growth will set up bullish momentum in the equity market driving NIFTY above 6000 while allowing stability in Rupee at 62-65. Rupee stability at said higher base of 62-65 is essential to control imports, support exports and to attract off-shore flows into India. The economy (and markets) has escaped from a serious crisis but not yet out of the trouble. It would need aggressive measures jointly from the Government and the RBI to get the investor’s confidence on Indian economy. The key factors to watch for Indian economic prosperity are the trending in investments and growth; while stability in inflation, twin deficits and Rupee exchange rate will add momentum and turn catalyst to growth. It is long way to go but a quick beginning to be made to avoid set-up of yet another crisis which can cause irreparable damage!

Moses Harding

Business Standard Column - 17 September 2013

Rupee protection not at risk of growth destruction

It is time for monetary policy to stay supportive for growth; sustainability of GDP growth below 5% will emerge as serious threat to Indian economy (and markets). Having said this, all domestic macroeconomic cues continue to stay resistive to growth; high retail inflation, uptrend in wholesale inflation, pressure on current account deficit, risk on fiscal deficit, sharp depreciation in rupee, sluggish investments, supply-side bottlenecks etc., do not support shift into aggressive growth supportive monetary policy stance. On the other hand, the tight liquidity and elevated money market rate curve in the shorter end, as strategy to address Rupee exchange rate (and CAD) has not yielded desired results. Taking all these together, the best fit is for RBI to take a balanced approach between growth and inflation, Rupee and liquidity while putting pressure on the Government to remove supply-side bottlenecks and remove policy irritants to revive consumption and investment.

The stake-holder’s confidence on the way forward is weak given the pipe-line political risks from ensuing elections. The new RBI Governor has begun the task well bringing in some kind of relief into the near term. What the system needs now is follow-on measures (and actions) to set up a firm launch pad for strong recovery in GDP growth momentum back into FY14 Budget estimate of 6.0-6.5%. This is the one-point factor to get the economy (and markets) into bullish momentum. The recent IIP print signals formation of turn-around signals in growth while inflation data print provides little comfort on sustainable reversal with pipe-line pressure from fuel and primary articles. The expectation from RBI is to stay focused on growth (as the most major risk to economy) while not diluting its efforts to control inflation and manage CAD (and Rupee exchange rate).

The new Governor is expected to stay pause on policy rates and SLR/CRR, but consider loosening its firm grip on liquidity and interest rates. There is immediate need to shift the operating policy rate from MSF into LAF, if not in full but with higher percentage at LAF so as to drive the call money rate from above 10% into 7.25-8.75% on higher liquidity support at LAF. The highly skewed (and inverted) money market rate curve needs to be reversed which will be bullish on rate and equity markets; resultant marginal pressure on the Rupee may be acceptable if it leads to 62-65 consolidation.  

Moses Harding