The Reserve Bank of India (RBI) is expected to keep rates unchanged at its policy meeting on Friday, December 6, although a reduction in the cash reserve rate (CRR) remains a possibility.

The central bank is expected to continue to focus on the balance between growth and inflation, raising questions about whether it might revise its growth forecasts amid continued economic pressures.

CNBC-TV18 Citizens’ Monetary Policy Committee, comprising experts including Samiran Chakraborty (Chief Economist, India at Citi), Sajjid Chinoy (Chief Economist, India at JPMorgan), Sonal Varma (Managing Director and Chief Economist , India and Asia excluding Japan at Nomura), Pronab Sen (former chief statistician) and Soumya Kanti Ghosh (group chief economic advisor, SBI), met to discuss the challenges facing the RBI and its MPC, and the actions they can take

This is the verbatim transcript of the discussion.

Q: Do you think there is a need for a reduction now, even if inflation is high?

Chinese: We always thought there would be a reduction in February. So it wasn’t this meeting, but the next meeting – what you saw was this delicate compromise where public investment and government spending was doing the heavy lifting over the last couple of years. And the first signs of a pullback in public investment in the first six months of this year, weaker private demand, which we were concerned about and which we were aware of, emerged.

The complication for the RBI is that the economy has been hit over the last two to three years by a series of supply shocks – food supply shocks. Thus, the average consumer price index (CPI) was 5.8% over the last four years. This year, it’s done. It’s still 5% and so it’s a difficult compromise that we understand has the government doing the heavy lifting. We understand that private sector demand has not recovered to where it is. But when you experience repeated and sustained supply shocks due to high food inflation, there is concern that at some point this could spread.

Our feeling is that this reinforces the belief that a reduction in February will take place. In December, the central bank, the MPC, sets the stage for a rate cut in February, adopts a more dovish stance and, more importantly, sets the stage for liquidity management. Without liquidity management from December onwards, any decline in February will not be reflected in financial markets. So in my opinion you use this meeting to inject liquidity and then ease in February.

Q: So is there a case for reducing the cash reserve ratio (CRR)? Because liquidity, in a way, will be put to the test even in the days to come. Look at how the dollar is strengthening and the rupee is falling.

Chakraborty: If you just look at the liquidity numbers, sustainable liquidity is corrected by almost ₹2 trillion in just about a month, mainly due to foreign exchange sales and festive season demand for foreign exchange. We can therefore argue in favor of some easing of liquidity. And it’s worth remembering that over the last ten days or so, on an overnight market basis, rates are now about 20 basis points (bps) higher than the repo rate. In the last few months it just reversed and it was below the repo rate.

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Now obviously we can decide which instrument is the best instrument to give this liquidity. CRR is relatively simple, especially if you think that pre-COVID-19 CRR was 4% and that’s probably the only variable that hasn’t yet returned to pre-COVID-19 levels. There may also be merit in considering a CRR. But overall, right now, I agree with Sajjid that some easing of liquidity could be the first step toward broader easing of monetary policy through rates.

Q: You must revive the spirits of the animals. You also have to give a certain amount of confidence. So, can the RBI stay away from both a repo and a CRR? Obvious symbolic action may be necessary.

Ghosh: I understand that some sort of liquidity adjustment needs to be made as part of this policy. The reason is simple: food inflation is still close to double digits and overall inflation was above 6% and does not appear to be collapsing very quickly.

But the point here is that there has to be a very delicate balance when it comes to liquidity. If you look at liquidity management over the last couple of months, you will see that the government’s cash balances have become the elephant in the room, going from a positive number to a negative number. So it’s fluctuated a lot over the last two or three months. And you have to remember that a lot of that government cash balance is frictional liquidity. So, if the RBI wants to do liquidity injections or management, it needs to match this frictional liquidity with the frictional liquidity injection itself, instead of a permanent liquidity injection.

So from that perspective, I think that while liquidity management needs to be done, there needs to be a debate about how these should be balanced by a permanent injection of liquidity, as opposed to a frictional adjustment liquidity, but another point is that because of this significant aspiration of rupee liquidity, it also adds to the problem of the central bank.

Q: So even if we look at the CRR as a more permanent instrument, it looks like this dollar issue is going to persist. So maybe there is an argument there. What do you think?

Varma: We believe we are already late. Monetary policy operates with a lag of three to four quarters. The slowdown has been ongoing for six months now, so we believe it is high time to reverse the cycle. If we just go back to what the monetary policy framework is, it’s about targeting inflation at 4% plus minus 2% while keeping in mind the growth objective. And what has become very clear is that growth is already below trend and no counter-cyclical response is in sight, even now. It is therefore extremely unlikely to expect growth to return to 6.5-7% without a countercyclical response.

Read also | As India’s GDP growth slows to a 7-quarter low, analysts say the RBI could ease liquidity in December.

The whole debate therefore concerns the extent of the compromises to be made at this stage. From now on, monetary policy must be forward-looking. The one-year inflation forecast is very close to the midpoint. The second-round effects have not materialized, and the effects, a sort of nominal adjustment of the effects, are also justified as a countercyclical tool, and we have a reserve of effects.

So the argument that trade-offs are important because inflation is high or because the currency is weak does not hold water, and the balance of risks, in my view, undoubtedly calls for supporting growth at this stage, because without growth, there are multiple other macroeconomic factors. questions we will have to face.

It is therefore time to support growth both through a reduction in the repo rate and a reduction in the CRR, because even the transmission from the banking system will take time. Banks have been busy collecting high-cost deposits, so even if the RBI somehow reduces the CRR now, the full transmission to lending rates will take time, so we need to act now.

Q: I understand your point that it takes time to act, but the counterpoint is also: why is consumption low because of inflation? Isn’t it? Can the RBI make a reduction without also damaging its credibility? When the last number is higher than their mandate, it is 6.2, the October figure.

Sen: It depends what you’re talking about. If you’re talking about the pension rate, I don’t think that’s really relevant. The interesting question is: what do you do about liquidity management? It seems like one of the standard principles of economics is that if you get inflationary impulses from areas over which monetary policy has very little control. And in this case, it’s mostly food – your main goal should be to prevent it from spilling into the core. And for this, interest rate management is not the appropriate tool, it is liquidity management.

Now the question is: I find myself in a situation where food inflation is almost double digits, but I have a GDP growth rate that is significantly lower than par 5.4 and so you see that the Liquidity management requirements work on both sides. In other words, if you pave the way for liquidity, you run the risk of non-core elements trickling down to the core. If, on the other hand, you are too cash constrained, then your growth recovery may not happen and Sonal is right, we are below trend.

But I think we have to be a little careful with these growth figures because there is a very strong base effect, which is playing out and will also play out in the next quarter. Only in the next quarter should we expect normalization, and we must be very careful about this.

The big question here is: When you talk about liquidity, are you creating a situation where the increase in liquidity is due to the banking industry demanding liquidity, or are you creating it through a instrument in which liquidity is given to banks regardless of whether they like it or not. Now that makes a big difference. So in a situation like this, reducing CRR is not a very good idea. We should focus a little more on what we do with variable deposition.

Q: There will be a lot of debate on this within the Reserve Bank’s MPC itself, although the CRR is not an instrument of the MPC. This will be an RBI decision. But in our case, our MPC will vote on both. Let me take the vote first. The first question I’m going to ask my panel is: what will be the Reserve Bank’s reaction to interest rates on December 6?

Chinese: They will cut in February. So “hold on” in December.

Ghosh: “Hold”, very similar to Sajjid, “hold” now and “cut” in February.

Varma: Reduction in the pension rate by 25 bases.

Sen: Socket.

Q: What about CRR?

Chinese: Some liquidity management of course, not necessarily CRR – no.

Ghosh: I would paraphrase this by saying that CRR should be used as a countercyclical effect – not a general CRR, but yes, on some specific products – yes.

Chakraborty: I think it’s likely, it’s possible – yes.

Varma: Yes, CRR has been reduced.

Sen: No.

Q: When do you see the first rate cut?

Chinese: FEBRUARY.

Ghosh: February on a larger scale perhaps.

Chakraborty: FEBRUARY.

Varma: December.

Sen: FEBRUARY.

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