Finally, some real tightening

The following is a note written by Yours Truly for a client in the early hours of Friday (July 26):

India’s monetary policy – belated real tightening

On July 15, the Reserve Bank of India (RBI) hiked interest rates effectively by 200 basis points and reduced the amount of liquidity it was making available to banks. However, it was not willing to see market interest rates spike up immediately. Its reluctance to walk its talk showed up in its unwillingness to accept any bids for the one-year T-bill auction last week. Its open market operations (OMO) to sell government bonds and mop up liquidity also saw the RBI sell only a small fraction of the INR120bn it has targeted to sell. This seeming half-halfheartedness drew justifiable criticism. The central bank’s objective of shoring up the rupee was questioned. Some wondered if it was half-hearted. We felt that the RBI had made the right move and we also felt that it was prepared to go all the way to defend its credibility. The only thing we were not sure was whether it meant that the Indian rupee had found a firm floor.

The RBI governor must have thought a lot over the weekend and additional tightening measures were announced on 22 July. The central bank reduced the liquidity made available to banks on a daily basis even further than it did on 15 July. Also, in the 91-day Treasury bill auction, it allowed the yield to spike to 11% from 7.45% in the last auction. The swap curve has moved materially higher compared to one and three months ago. Government of India borrowing costs have gone up across the term structure. This is serious stuff.

Although the RBI hiked the policy rate in 2011 and in 2012, real rates were not climbing since the central bank was playing catch up with inflation and, more importantly, it was forced to undo its tightening efforts by its responsibility as a debt manager to the Government of India. It had to ensure that the government borrowed at as low a rate as possible. That obligation forced RBI to engage in OMOs to buy government debt or to shove government debt on to banks to keep yields down. So, the tightening work was not successful and that largely explains India’s inflation persistence. Now, with inflation having come down, the jump in Indian nominal rates is actually a jump in the real rates of interest. This should support the currency even as it significantly hurts economic activity.

RBI appears determined to see its mission through to its logical conclusion and the mission is to stabilise the rupee. Undoubtedly, the central bank has information on the stress that the weak rupee was causing. Hence its new-found determination. The central bank now cannot turn back half way. That would hurt the Indian rupee much more as it would damage the bank’s credibility rather badly. Therefore, we feel that this move would support the Indian rupee even as it materially reduces India’s aggregate demand and the rate of inflation. It will be a matter of time before the current account deficit begins to come down.

Consensus opinion is beginning to grasp the mission underway. Growth forecasts for 2013-14 and for 2014-15 are being lowered towards the 5% level. That is the upper end of the growth rate range that we have been forecasting for quite some time. The latest moves by RBI create further downside risk to even our growth forecast.

However, with the United States likely to engage in tokenism with its tapering move and with Bernanke having gone out of his way to reassure markets of the likely long duration of policy accommodation and with RBI’s determination, we think that the US dollar has seen its highs against the Indian rupee. The big caveat, though, is that RBI does not blink now.

This follows the weekly column published on Tuesday in MINT.

Niranjan Rajadhyaksha has written a good piece on whether the Indian policy rates are too low. In effect, he defends the recent RBI measures. [Warning: you may face difficulty in accessing the column. I am unable to post the link here due to difficulties in signing into MINT pages. They must do something about it, real fast].

TGS has always held the Business Standard newspaper in high regard. That is why it is particularly hard to record our disappointment at their hyperventilation on the recent RBI tightening. The newspaper has written three edits in the space of less than ten days on the RBI measures. You can read them here, here and here.

One of the first principles of economics is that the effects of economic medicine do not conform to the rules of Twitter and Facebook world. They take time. Hence, it is wrong to write three edits in ten days when the RBI was still unveiling its measures and when a monetary policy statement is due on July 30. Some patience is required.

Second, until recently, most were talking of rates being cut. RBI was obliging, even if grudgingly. Now, for the central bank to turn around and start tightening liquidity while simultaneously causing interest rates to go up effectively by 200 basis points at the short end and, at the long end, by around 100 basis points, there must clearly be some reason. One must give them some credit. After all, it is one of the few institutions in the country with some reputation intact for its competence. Surely, they must have their reasons?

This is what Sajjid Chinoy of JP Morgan wrote, in a research note (24 July 2013):

For starters, it is important to point out that the true tightening has only just taken effect from today, so the results of the current policy need to be judged going forward. Second, whether or not speculation is currently rampant, it is important for the central bank to take these measures to their logical conclusion to preserve credibility. If these moves are seen to fail, the Rupee could come under renewed pressure as markets would conclude that the policy resolve to anchor the currency is missing. For the sake of credibility, therefore, it’s important to stay the course. Finally, if these measures stay beyond a few weeks they will undoubtedly have a collateral impact on growth. But growth would also be adversely impacted if the FX continues to weaken and inflation is pressured further, unhedged corporate balance sheets come under more stress, and the fiscal consolidation becomes more challenging. There are no easy options at the moment. But now that policymakers have picked one, they need to exercise it fully.

Third, not all reasons can be shared with the public on a real-time basis. The central bank must carefully weigh the commitment to transparency against the risk of setting off a panic. There might have been some actual or imminent default on a foreign currency loan. To announce that in public would set off alarm bells and panic reactions which might be harder to control.

Fourth, neither the central bank nor any one said that the latest tightening measures would have no consequences. They are meant to have consequences and that is to slow down aggregate demand and hence economic growth. That is the price to pay for running up a fiscal deficit, a high current account deficit, high rate of inflation and for running a dysfunctional government for almost nine years.

The reason why economic growth has to really fall out of bed is that, even now, neither the government nor the private sector seems to have fully grasped the enormity of the restructuring that needs to be undertaken to get India back on track to some decent economic growth. India is not in the middle of a cyclical slowdown. Far from it. [Arvind Subramanian calls for a variant of an IMF programme in India without bringing the IMF actually into the picture]

Perhaps, a real growth shock is what was needed to get some structural reform (FDI liberalisation is not structural reform) going and to put the implementation of the Food Security Bill in the backburner. Of course, this is my fond hope that the growth impact caused by the recent spike in interest rates would last long enough to raise government’s borrowing cost, to reduce its tax collections and hence to throw a spanner in the spending programmes, necessitating a roll-back of some or all of them, partially or fully.

If that was the unstated intent of the recent RBI measures, then all strength to those who are doing it and to those who have silently acquiesced in it (from the government).

[p.s: For the record, TGS does not agree with the criticism of Arvind Panagariya of the RBI Governor. There are many reasons. They have been adequately covered in various blog posts and columns in the MINT. Just one rebuttal would do: liberalisation of external borrowing is not a RBI decision but that of the Government of India. RBI may be the one to issue the circulars but they are not the ones taking the decision. For starters, just see these three links. Especially, think about the proposal to liberalise ECB norms for low-cost housing!].

An ignorant defence of the igNobel

The spelling modification in the subject line is deliberate.

I happened to read this outrage against the criticism directed at Mr. Sen for offering his considered opinion on the eligibility of Shri. Narendra Modi to be the PM of India.

If Mr. Sen has a vote, he would not offer it to Mr. Modi. That is fine. Clearly, he is entitled to do that.

However, when he offers his remarks in public, it is legitimate of others to say what they think of his publicly articulated thoughts. It does not matter that he offered his opinion when asked. He could have refused to answer that question, sticking to what he is supposed to know – economics. Second, we do not know if the question itself was planted. So, that he offered his views only when asked is really no reason to expect that others won’t react to it.

Barring Mr. Subramanian Swami’s remarks on his foreign wives, every other response to Mr. Sen’s  views is justified.

If Mr .Sen did not think that NM did not deserve to be India’s PM, then it is equally legitimate for some one to think that he did not deserve his Bharat Ratna.

In fact, I did not even know that he was awarded ‘Bharat Ratna’ in 1999. What a colossal error of judgement on the part of the then NDA government. If it could be revoked, ex-post, then it is best if it were done quickly.  ‘Bharat Ratna’ title/award is not a pamphlet/bill for the next real estate project given to passers-by on the street.

I cannot recall Mr. Sandip Roy being equally outraged when so much hate and venom and ignoble remarks were directed at NM. So, it is clear that Mr. Roy’s conscience wakes up from slumber only selectively.

If the BJP said that Mr. Sen should stick to his economics, that is their opinion on his political opinion. What is ignoble about it?

In fact, there is a danger in the BJP asking him to stick to his economics. His economic wisdom is equally in need of dire and urgent repairs.

He is the intellectual godfather of the National Advisory Council (NAC), the Food Security Bill (FSB) and many other hare-brained schemes of the UPA government.

He did not mind resorting to crass emotionalism and to outright lies when he said that the postponement of the consideration of the Food Security Bill amounted to killing of thousands of children per day.

One, most Indian states have a Public Distribution System. The FSB seeks to supplant it and appropriate it for the Central Government.

Second, most States have a mid-day noon meal scheme for children. Those schemes would continue to feed children – FSB or no FSB.

One does not recall reading Mr. Sen’s grief and horror about the actual death of children in Bihar recently from eating pesticide-rich food.

Mr. Sen’s solutions to India’s imagined/exaggerated problems have caused, are causing and will cause untold damage to India’s budgetary health and a sick Indian fiscal situation is a legacy that he and his favourite government will be passing on to India’s children, their children and great grandchildren.

With his comments on the fitness of Shri. NM to be India’s PM, Mr. Sen has merely shown that his political judgement is as suspect as his economic policy prescriptions are flawed.

In one sense, Mr. Sandip Roy is correct. Mr. Sen’s political judgements do not deserve to be taken seriously.

But, it is vital and crucial that India’s children (and all future generations) deserve a break from Mr. Sen’s economic prescriptions.

Kudos to Swapan Dasgupta for flagging the dangers of taking Mr. Sen’s public policy prescriptions seriously in 1998 itself (ht: Anirudha).

The floor gives away

China had dropped the floor on the lending rate. I cannot make out how that constitutes reform. If the People’s Bank of China had removed the ceiling, then one could understand. Earlier, the rule was that banks could only offer a 30% discount to the benchmark rate. If I am not mistaken, it was only 10% and it was later relaxed to 30% in a move, aimed at encouraging lending. Now, if this 30% maximum discount too is removed, does it constitute reform? As my good friend Sanjay Jain of Credit Suisse has written in his note, allowing banks to offer higher deposit rates or complete freedom on deposit rates would constitute real reform. While the big banks are not lending at rates lower than 90% of the benchmark rate, some small banks might. Read FT Alphaville here on this move. It could be a move to bail out local governments. If so, it is clearly not reform but anti-…

Reads this lovely Reuters story on how SELL-SIDE research is bullish on banks in China. Some of the ‘defence’ for their stance makes for funnier reading. The only problem with that story is that analysts are equally guilty of being too bullish on many other markets too. It is in their DNA – for most of them on the SELL-SIDE at least.

This story about funds flowing into US equities is a good contrarian signal, actually. The contrarian dimension of the story becomes even stronger when notes that the flows are the highest since June 2008.







Stuff to read

Andrew Ross Sorkin on the culture of Wall Street greed and its ‘healthy’ persistence, based on a new survey report on Wall Street insiders’ attitudes to greed and immorality. A link to the survey report is available in his post.

Senator Elizabeth Warren wants to revive Glass-Steagall and prevent banking institutions that take risk from relying on FDIC insured deposits to bail themselves out. She wants to make banking boring. All strength to her.

My wife had left this article on the Zimmerman trial and the jury verdict open and so I read it. The article and the comments below it neatly capture the seemingly unbridgeable racial divide and polarisation in the American society.

Jim Walker of Asianomics (I write for Asianomics) looks at China’s nominal GDP growth and notes that it was up by ‘only’ 8.2% (y/y) and it was up 5.4% (q/q, annualised), down from 5.9% in the first quarter. India’s nominal GDP growth is in double digits. China corporate financials should, consequently, be in worse shape than in India? No link here.

China’s investment and consumption growth rates are not yet pointing to a shift away from the former to the latter. Not easy.

Apparently, China has censored the video of the Egyptian 12-year old boy’s remarks that have gone viral on internet. I am yet to see it although I find it hard to believe that he said the words attributed to him. Sounds too profound for his age.

China’s stock markets are a great and powerful evidence of the hypothesis that economic growth does not translate int o investor gains on stock market. Equally, it is useful for students to remember that it is such a powerful contrarian evidence that it points to the unique characteristics of China’s State-led and State-dominated capitalism. It is an exception that proves the rule, in my view.

In the meantime, these remarks attributed to the Chinese Premier Li Keqiang do little to provide clarity on where the new government stands on growth, reforms, restructuring and rebalancing.

Confidence among home-builders in the US rose to a high last seen in January 2006. Now, that must be good news (?!).

RBI defends

Truth be told, I had not kept my eyes on Brazil and Indonesia interest rate decisions two weeks ago. Both countries had raised their interest rates by 0.5%. Niranjan Rajadhyaksha of MINT reminded me that they had done so. Not only that, MINT had written a quick edit on these two rate hikes and posed the question as to what it meant for Indian monetary policy meeting on July 30. Initially, I felt that strains in the Indian banking system would prevent the Reserve Bank of India (RBI) from following suit.

However, the more I discussed the matter with few friends – as I usually do on Saturday evening walks in the East Coast Park in Singapore – the more I felt persuaded that the RBI had no choice but to send out a strong signal on rupee defence. I wrote my MINT piece accordingly on Sunday night (for a change, I was not racing against the deadline of Monday afternoon). I sent it out to MINT on Monday forenoon. You can find it here (if you are lucky).

Then, on Tuesday morning, I was surprised to find that RBI had already taken its decision and announced  it. Interest rates, effectively, have gone up by 200 basis points. It was inevitable. RBI had to send a strong signal, if it felt so, that the rupee had overshot its fair value. On balance, the RBI had correctly concluded that further rupee weakness, far from helping on the trade account, will be harmful for many other aspects of the economy, corporate balance-sheets included. Check out this simple but very good blog post in ET today (ht: Anirudha).

This measure is bad for liquidity, no doubt. But, it was needed. There was no viable defence of the rupee. Macro policy is either defunct or diabolical or both. Growth and investment have already been killed. There is nothing much left of investment intentions that would be killed by this rate hike. In any case, if corporate balance-sheets are bleeding because of rupee weakness (look at the above ET blog post on how much external debt has exploded), how will they invest?

The problem is that the UPA has pushed the Indian economy and the rupee into such an impossible situation that it is unclear if this latest RBI measure would work and work well and conclusively. That is not a given.

The government, on Tuesday, has tweaked various Foreign Direct Investment (FDI) investment norms, liberalised them and raised them. They are too little, too late and too hasty. One is not even sure if they are ill-advised. When one is boxed into a corner, making concessions raises the risk of being exploited. Indian partners/corporates might have no choice but to yield ground – on unfavourable terms – to their foreign partners or suitors. 100% FDI in telecom is a case in point. By all accounts, this one seems to be a case of ‘reform’ for the optics. In any case, we have often said that FDI liberalisation is not economic reform. For a country seeking to bridge a large current account deficit, it seems more like an act of desperation, coming as it does in the last days of the government.

China headlines

A remarkable set of headlines and stories in Caijing Magazine in recent weeks:

When the cracks appeared – a story on China’s interbank liquidity tightness and what it reflects and means

What to do about the huge shortfall in tax revenue [Link]

Debt of business, financial sectors at 270% of GDP [Link]

This one from Reuters: China warns of grim trade outlook after exports fall [Link]

The ‘boldest’ economic growth forecast for China that some are willing to contemplate is slightly over 6% for 2014. That is still too high.

Politeness and the durability of bad ideas

In MINT today, Niranjan Rajadhyaksha has a good Op.-Ed. on Rahul Gandhi vs. Narendra Modi. He says that, in reality, it is a battle between Jagadish Bhagwati and Amartya Sen. He frames the issues well. But, the fine person that he is, he calls them both two of the finest economists that India has produced. [Link]

In his brilliant piece in Business Standard on the economic consequences of Amartya Sen, Arvind Subramanian calls himself an admirer of Amartya Sen’s exceptional academic work. [Link]

In his piece on the Federal Reserve in the FT, Henry Kaufman credits Ben Bernanke with leadership, boldness and ingenuity, despite the fact that his complacency played a significant role in precipitating the global financial crisis of 2008 and might produce yet another crisis soon [Link].

That is why it is refreshing to read John Hussman on whether the Federal Reserve or the Financial Accounting Standards Board (FASB) ‘rescued’ American banks:

The Fed did not save the economy. Rather, the Financial Accounting Standards Board rescued the banks by making their accounting more opaque. The Fed’s policies then shifted the costs of financial recklessness onto those who are not financially reckless – particularly ordinary savers and the elderly on fixed incomes, while the economy has more or less floundered. The Fed’s policies aren’t to be hailed as virtuous efforts that saved the economy – they are more appropriately reviled as unethical policies that subordinate Main Street to Wall Street. [Link]

That is why one has to applaud John Kay for writing thus:

Why has so much attention been given to these monetary policies with no clear explanation of how they might be expected to work and little evidence of effectiveness? The very phrase “quantitative easing” seems designed to discourage non-technical discussion. But the real answer, I fear, is all too familiar: these policies may not benefit the non-financial economy much, but they are helpful to the financial services sector and those who work in it. [Link]

Politeness extends the life of bad ideas. By not calling out the authors of bad ideas, good people help to keep both such ideas and such people longer in circulation than they or their ideas deserve to be.

A century of the Federal Reserve

Ben Bernanke, the Chairman of the Federal Reserve Board, had given a speech at the National Bureau of Economic Research at Cambridge, Massachusetts yesterday on 100 years of the Federal Reserve. The full transcript of the speech is here.

It is hard to agree with most of what he has said about the policy mistakes of the Federal Reserve in the Great Depression era, the role of the Fed in the attainment of ‘great moderation’ in the 1980s and 1990s (a mirage, actually), his remarks on the ‘counterproductive doctrine’ of the importance of liquidation in recessions and depressions.

Walter Bagehot, British Economist, urged central banks to lend freely at penal rates of interest. But, Bernanke has lent at zero rates of interest.

It is impossible to separate the length and depth of the post-War boom in the US and in Europe and Japan without the liquidation of the Great Depression in the United States and the destruction of the war in Europe and Japan.

Great Moderation – in economic growth and inflation – was an outcome of a combination of one-off factors such as end of the Cold War, collapse in the price of crude oil, technology advancements in internet, globalisation, etc. The Federal Reserve was incidental.

He turns Modigliani and Miller on their head and actually blames them for policymakers’ indifference to the build-up of debt because M&M said that the capital structure was irrelevant! Well, M&M  said that that was the case under a set of impossible theoretical conditions. Since, in reality, those conditions do not prevail, capital structure obviously matters. That was their implicit theorem.

There was no introspection while there was enough criticism of the conduct of the Federal Reserve Board in the past.

It would have been far more useful for all of us and, above all, the current Fed chairman, had the NBER invited Paul Volcker to speak on the subject.

Mark Carney

Canadian Mark Carney has taken over as the governor of the Bank of England. He had spent a not-so-inconsiderable time with Goldman Sachs in various international locations (thirteen years). He has taken exception to remarks by Andrew Haldane, the Executive Director in Bank of England in charge of financial stability. TGS is a big fan of Andrew Haldane’s work on financial stability, macro-prudential regulation and on financial markets. Hence, Mark Carney’s remarks against Andrew Haldane raises red flags about his understanding of the global financial sector and its potential for damage.

You can read news reports about his views on Haldane’s views on Basle III here and here. TGS must note here that his remarks against Haldane were made in November 2012 and it just so happens that TGS stumbled up on it only recently.

TGS thinks that Haldane has got it right. Basle risk weights do not measure nor reflect risk in bank balance-sheets. They are so opaque and complex that they enable banks to hide, obfuscate, etc. A simple leverage ratio rule and a high enough leverage ratio would work along with appropriate curbs on executive pay and appropriate penalties for criminal executive behaviour in banks.

With the housing bubble back in the UK and with Mark Carney in charge, systemic risks in the UK have risen again. Therefore, the Moody’s upgrade of the UK banking system outlook from negative to stable is simply wrong and wrongly timed.