'RBI's decision to maintain status quo on rates did not surprise us'

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, the Xavier Institute of Management, Bhubaneswar, Bank of India and now Bank of Baroda, where he is Chief Economist. He loves the autonomy and freedom of academia 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 itself -- even when the market was expecting a cut. We were not surprised by the status quo. But for the near-term outlook (just a few days before the most recent policy), we had changed our expectation from status quo to a cut.

Why?

The reason was mainly – if not now, then when (would the best time be)? And more so in the larger perspective of 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, the 10-year G-Sec rate and the repo rate, on an average the G-sec yield was about 65 basis points above the Repo rate. But because of the 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 the repo rate came down to 15 bps from around 65 bps.

We guessed that RBI will take the opportunity of the policy to take interest rates down further and maintain that spread 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.

If they are trying to take the country to a lower interest rate regime – how low can it 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 what kind of proportion 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.

So, what does it imply for interest rates?

In a way, the RBI has indicated that the floor for interest rates cannot be below six per cent.

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

They have changed their stance from accomodative to neutral. We had said earlier that 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 your overall economy, inflation pressure is building up. Apart from this, what was important from the policy was that the interest rate spectrum has become more aligned – because there must be some premium for tenor.

What happens post June? Is there scope for a cut then?

RBI has made it clear that there is still scope for transmission. Banks are, of course, not in a good shape to pass on the reduction – because of NPA concerns. It is a drag.

That needs to be solved. But borrowers need to improve their credit worthiness. Even in a high interest rate regime, good borrowers get funds at lower rates. They will borrow if there is a good growth opportunity because they will pass on the interest costs.

What should we make of the RBI ‘stance’? Since 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.