‘Inflation pressure is building up’

Biswa Swarup Misra’s career path has traversed the corridors of central banking, academia and commercial banking during the past 15 years with stints in Union Bank of India, RBI, Xavier Institute of Management, Bhubaneswar, Bank of India and now Bank of Baroda. He loves the autonomy and freedom of the academic world but comes to the corporate world at regular intervals to update his knowledge and tools and pick up insights that would offer a rounded perspective to his students. The combination of research and teaching experience as well as his understanding of commercial and central banking make him an expert who can interpret developments in the economy in a simple and lucid manner. Excerpts from an interview:

Were you surprised by the RBI’s decision to maintain status quo in last month’s credit policy?

No. We were not surprised. Let me divide how we approached the issue – with both a short-term outlook and a near-term outlook. The short-term outlook was that they should not reduce rates and that they should maintain status quo. This we have been holding from the previous policy — even when the market was expecting a cut. We were not surprised by the status quo. But the near-term outlook (just a few days before the recent policy), we had changed our expectation from status quo to a cut.

Why?

The reason was mainly — if not now, then when would be the best time?

And more so in the larger perspective of the RBI’s stated stance that they want to take India to a lower interest rate regime. Recall that the repo rate was cut by 175 basis points over the last two years.

If you see the spectrum of interest rates, on an average the 10 year G-sec yield was about 65 basis points above the repo rate. But because of huge liquidity after demonetisation, the yields in G-sec came down — to such a level (around 6.4 per cent) that the difference between G-secs and repo rate came down to 15 bps from around 65 bps.

We guessed that the RBI will use the opportunity of the policy to take interest rate further down and maintain that spread (about 65 bps) in tact. There are two ways that could have been done — either cut the policy rate or take the yields up. The RBI ended up taking the second option and achieved the same objective — by taking a hawkish approach.

How low can interest rates go in the Indian context?

Remember a country like India also looks for foreign inflows. Policy observers will look for growth and stability — both internal and external. Internal stability will show up in inflation and external stability in exchange rates.

Exchange rates depend on FII flows and that depends on the kind of proportion that comes into debt and equity.

If the debt yields are very low given country risks, then the flow may weaken. Also, remember US yields were up around the time Trump won and our yields were down — so the spread between the two which used to be around 520 bps had come down to 400 bps.

To that extent, debt becomes less attractive and some outflow took place in November and December of last year. In a way, the RBI has indicated that the floor for interest rates cannot be below 6 per cent.

What were the other cues you took away from the policy?

They have changed their stance from accommodative to neutral. We had said earlier that the RBI should not reduce rates because while headline inflation was low, core inflation was high.

For me, the most important thing is GDP deflator-based inflation. In September 2015, GDP deflator-based inflation was negative. Then it went up and now it is 4.6. That means in the overall economy, inflation pressure is building up. Besides, the interest rate spectrum has become more aligned – because there must be some premium for tenor.

What should we make of the RBI’s ‘stance’? Since the RBI always reserves the right to act in whatever way it deems fit or appropriate, what is sacrosanct about this ‘neutral’ stance?

In the standard definition, a stance is a posture. It is like a batsman getting ready to play a stroke as he awaits a delivery. You are indicating a direction. The stance should be looked at more from a directional point of view.

A stance generally has two connotations.

One for rate and another for liquidity — both are linked, of course. When they say that they are neutral, then neither is there systemic surplus nor deficit on a durable basis — although on any given day there will be some deficit or excess because some banks will have to borrow. But from a system point of view, banks should not be borrowing too much or too less.

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