Strong Case For The MPC To Shift Stance Back To Neutral, Says Rajeev Malik

RBI is accountable to the sovereign but it can’t be used as a vacuum cleaner, says Rajeev Malik of River Valley Asset Management.

A man drinks tea as he walks past the Reserve Bank of India (RBI) headquarter building in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A man drinks tea as he walks past the Reserve Bank of India (RBI) headquarter building in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

Growth in the current financial year is likely to fall marginally below the Reserve Bank of India’s estimate of 7.4 percent, with GDP growth in the second half of the year likely to slip below 7 percent, said Rajeev Malik, strategist at River Valley Asset Management. The 8.1 percent GDP growth seen in the first quarter was exaggerated and any celebrations following that data release were premature, Malik said in a conversation with BloombergQuint.

Official data released on Friday showed that the Indian economy grew at 7.1 percent in the second quarter of the year. The data suggested that consumption growth is slowing even though investment remains strong.

I think the bigger issue here is that a lot of the hyped-up expectations about growth picking up, accelerating, etc. have generally been disappointed apart from this quarter-to-quarter volatility that has been seen.
Rajeev Malik, Strategist, River Valley Asset Management

With growth slowing and inflation staying below expectations, Malik expects the Monetary Policy Committee to keep interest rates on hold. The committee announces its decision on Wednesday.

After hiking the benchmark repo rate twice by 25 basis points each, the MPC maintained a status quo in October. However, it changed its stance to ‘calibrated tightening’. In the two months since the last policy meet, oil prices have fallen sharply, the rupee has stabilised and food prices have defied seasonal trends.

I think there is a strong case for the MPC to actually shift stance back to neutral. I’d be surprised if they do it this week because MPCs don’t like to swing about. But come February, there is a pretty good chance that will shift to a neutral stance once again.
Rajeev Malik, Strategist, River Valley Asset Management

From Economic Data To Economic Controversies

Commenting on the tussle between the government and the Reserve Bank of India, Malik said that the manner in which the two have conducted each other is a lesson in “how not to do things”.

The RBI is accountable and not a legally independent regulator, Malik said. “Equally the government must understand that central bank is not a vacuum cleaner which will clean up whatever mess exists elsewhere,” Malik added.

On the topic of the capital structure of the RBI, the right approach was always to set up a panel. I think the RBI needs to understand that it can express an opinion but in the end the sovereign calls the shots. What is required from the government’s perspective is not to do anything reckless.
Rajeev Malik, Strategist, River Valley Asset Management

Malik elaborated and said that India must not find itself in the position of Israel. In 1999, Israel’s central bank was pushed into a ‘negative equity’ position after it had transferred the majority of its exchange rate translation-related gains to the government.

Malik also felt the controversy surrounding the new series of GDP data should have been avoided.

“The new GDP data raises several questions. But whatever the justification behind the GDP revision, the optics of the NITI Aayog releasing the revised GDP data along with the chief statistician is highly regrettable and should have been avoided,” Malik said.

Watch the full interview here and read the edited excerpts below:

Growth-Inflation Dynamics

What was your analysis of the GDP data? Most analysts highlighted the slowing growth in consumption.

That is the fair assessment although  the expenditure side GDP accounts for India need to be taken with a bag of salt. The GVA (gross value added) numbers tend to be more reliable but even they showed moderation. The fiscal first quarter growth of 8.2 percent was an exaggerated number. Celebrating that kind of momentum was early and premature.

My sense remains that growth in the second half of the fiscal year will be below 7 percent. So, anyone who had a full year GDP growth forecast of 7.4 percent, will have to shave down numbers marginally. The bigger issue is that hyped-up expectation of growth accelerating has been disappointed, apart from quarter-to-quarter volatility.

Growth is soft. Inflation has under-performed expectations. So policy rates should stay steady?

For the next several months, yes. There has been a sea change in the global environment compared to the last time around in October, when the MPC stayed on hold but shifted its stance to ‘calibrated tightening’ -- although we still don’t understand what that means since very few central banks define tightening in that manner.

There is strong case for the MPC to shift stance back to neutral. I would be surprised if they do it this week because central banks or MPCs don’t want to swing about too much. But in February, there is a good chance that they will shift to a neutral stance once again. Don’t forget staying on hold this week is consistent with the initial guidance that the MPC had given, which meant that they can stay on hold or raise rates.

Raising rates in the current environment is a low probability unless once again we see a massive reversal of the news flow we have seen recently.

Have the RBI and the MPC gone wrong in their understanding of inflation?

There are couple of factors. The only way one can get a forecast right consistently is by not making one! All analysts will realize that they have got stuff wrong from time to time but analysts don’t necessarily get as much heat as much as central banks do.

The most puzzling aspect of inflation has been the well-below-trend food inflation. It is easy for the government to claim this is a sustained downshift but I am not convinced. You will not have this level of food inflation without distress in the farm sector. Unless we are going to think that is the new normal, we can’t take food inflation numbers at face value.

Also, core inflation has been high. If you are a policy maker, the fear you would have, looking beyond just a few months, is that if there is an unexpected jump in food inflation, what does that do to your ability to meet the inflation target on sustained basis. I am not talking for next few months but for the longer term. That is where some additional clarity from MPC members, on what they think about food inflation, will be useful.

Liquidity & NBFCs

On the liquidity front, the complaint is that the RBI has been too conservative. Is this criticism justified?

The criticism against the RBI always gets exaggerated. So, at the first sign of difficulty, everyone wants to see a CRR (cash reserve ratio) cut. That is not how the RBI thinks about CRR, which is partly the reason that it has not been aggressively used for some time. The central bank is injecting liquidity via other means that it has, such as open market operations and intervention in the currency market. Now, I think dollar-rupee has had a good run. The RBI will try and manage it around the 69-70/$ mark. Any kind of flows which try and push it further, there is good reason for the RBI to mop those up.

More importantly, there could be a structural re-assessment in how to think about NBFCs from a macro-prudential standpoint. What got massively hit was the trust factor and the confidence factor. That is where regulatory reform may be needed and that will take time.

Should one expect the NBFC situation to have a bearing on growth?

Definitely. Some of the high frequency numbers for vehicle purchases are indicating that stress. You have to put it in a broader framework to see if the stress would be longer lasting or if we are talking about a couple of quarters before some of that stress begins to improve. A month ago, people were talking about the sector going down the toilet but slowly the liquidity situation began to improve.

RBI-Government Spat

What have you made of the tension between RBI and the government?

It is most unfortunate. If anybody wanted to write a book on communication between central banks and governments, there would be a chapter on how not to do things and this episode should feature there.

It is important to realise the boundaries. The RBI has to be accountable. It is not a legally independent central bank. The MPC component is part of its responsibility. The government needs to be mindful that the central bank is not a vacuum cleaner to clean up whatever mess is made elsewhere. Neither is it operated by a remote control.

May be the lack of experience or adequate experience in engaging with bureaucrats could have resulted in this exaggerated reaction. It is highly avoidable. Don’t forget after all the hue and cry, the government landed up getting most of the stuff that it was looking for.

On the topic of the capital structure as far as the RBI is concerned, the right approach was always to set up a panel to look into various dimensions, which has been announced. Now, we will see who the members are and what the recommendations are.

The RBI needs to understand that it can express an opinion, disapprove of the government’s point of view, but in the end, the sovereign calls the shots in India. What is important from the sovereign’s perspective is not to be reckless in a very politically self-serving manner. Both of them need to avoid Israel’s position where the central bank landed up with negative equity. That was in 1999 where some of exchange rate related translation gains where given to the government, which was part of their whole accounting methodology.

The broad view is that the RBI came out looking bad because it now seems like the central board is calling the shots. So if the MPC decides on policy and the board decides on regulation, what does the governor do?

That is true. We get into what is legal, what is best practice and what should be adopted etc.

Every institution is as good or bad as the people working there. The leadership always has to be at the forefront. This is first time in very long time that we find silence as far as the governor is concerned. Even on issues of topical economic interest for everyone in India. I can’t recall the last time it happened.

You always found some governors running into rough weather. That was true for Dr Y.V. Reddy, Dr D. Subbarao, Raghuram Rajan. But all of them were vocal. We knew exactly where they stand. Communication-wise, the RBI is worsening substantially, I would assess.

So, there is lot which can be said for communication improvement. Just having an ‘item number’ every two months is just not enough. People would love to hear more point of view without communication becoming excessive.

The GDP Series Debate

What did you think of back data of the new GDP series?

GDP is an estimate in every country and every country will have loopholes, qualifiers, assumptions that are put in. To me the biggest issue is far more than the quantum of revisions that have taken place. One can dig into the details and see whether or not this is consistent. At face value, they don’t sync with the kind of momentum we were seeing in other indicators during the past phase. Credit data is a case-in-point. Inflation numbers are very good indicator.

All these revisions will face question about inflation-growth trade-off, do we have to change initial models that we were assessing on, what is potential growth, what are the reliable drivers of growth, etc?

But this controversy would not have been as severe as it has been if the NITI Aayog would not have been involved in that press conference. It has no business to have been there. The optics of the NITI Aayog and chief statistician presenting together just didn’t look good.

Should we discount some of this as chatter which always picks up when we are close to general elections?

It is a topical point but it doesn’t change the underlying. It is true that the growth momentum hasn’t been as great as the government would have been hoping for. But who are they deceiving by cooking up numbers? I am not saying that is what has happened. But many different things raise questions and there still hasn’t been a holistic way of addressing these issues. I don’t think it is going to go away.

It is one thing to revise numbers. The U.S. revises numbers often. Sometimes complexion can be different and this is a developed country. It is not so much data revisions per se but the frequency and magnitude of it. So, what are analyst meant to conclude from a lot of these changes?