RBI rate hike

In December, the Reserve Bank of India did not raise the interest rate but engaged in tough talk. I had expected them to raise rates. RBI did not and I had written then that the RBI press statement after the meeting almost sounded like an apology for not raising rates. Data released in December showed that both wholesale and consumer price inflation rates were sharply higher in November. Hence, there was enough of a smoking gun then for RBI to move decisively – raising the policy rate by as much as 50 basis points. It chose not to do so. In December, it was a combination of no action and tough talk.

In January, the headline inflation rate slowed sharply because of the reduction in vegetable prices. Core inflation rates remained broadly unchanged. Yet, RBI chose to hike policy rates in its monetary policy meeting held on 28 January. The repo rate was hiked to 8.0% from 7.75% and accordingly, the reverse repo rate to 7.0% and the rate on the Marginal Standing Facility (MSF) were hiked to 9.0%. This was a surprise move. Consensus anticipated no rate action and I was broadly in agreement with the consensus view.

RBI hiked the rate and combined it with a reassuring talk on future rate hikes. It appeared to signal that the rate hike was ending.  I am not sure I agree with that. The downward path of Indian retail prices is likely to be one with the strong resistance. The central bank might have to raise rates by 25 to 50 basis points more before the tightening cycle ends.

So, it is a rate hike + easy talk OR no hike + hawkish talk.

Perhaps, the central bank had to take note of the turmoil in emerging currencies in the last week or more, especially in the light of the upcoming Federal Reserve Open Market Committee Meeting on 29 January. In case the Federal Reserve surprised markets by increasing the amount of tapering to USD20.0bn from USD10.0bn, emerging currencies could come under pressure further. That is the only plausible explanation we could come up with for their rate hike action on 28 January. [The Governor has denied this logic, however]

It was also unclear whether RBI had accepted the recommendations of the Committee the Governor had appointed to come up with a new monetary policy framework. On the one hand, the Governor said that the report was being studied and, yet, on the other hand, he cited the report’s recommended inflation target (8% CPI inflation rate by 1Q2015) as a justification for hiking the policy rate.

Anyway, the final message is that India’s interest rate and monetary conditions are tightening through a combination of words and deeds, even if in an awkward manner and it is not over yet. That can only be a good thing for the Indian restructuring story.

In that regard, this blogger disagrees with the sharp criticism that the rate hike has drawn from Professor Charan Singh at IIM, Bangalore.

In his article in ‘Business Line’, he says that rate hikes did not hurt inflation but India’s manufacturing and growth. Real rates are negative. Credit is available still. Non-food credit growth is in double digits. RBI had, in any case, neutralised its rate hikes with its OMOs. Otherwise, benchmark government borrowing rates could be much higher.

India’s manufacturing and growth have been hit by capricious policies. Look at how Air Asia’s application for flying a low-cost carrier service in India is being subject to a public referendum based on a 1937 law! Were other private carriers subject to a similar process? Road building had slowed to a crawl. Telecom licenses have been cancelled and spectrum is in short supply. Quality of telecommunication has dropped. Agriculture remains chained, despite decent monsoons boosting production. Income Tax collection and policies have become regressive and arbitrary.

He is right that monetary policymakers played an important role in the onset/breakout of the global crisis of 2007-08. But, that was not because they tightened too much but by too little. Whether or not, monetary policy and central bank independence is good in the developed world may evoke a different answer than it does in India. The answer, in the case of India, is an unambiguous YES.

The Finance Ministry and its friends in the so-called policy research circles are keen to ape the West and introduce harmful financialisation into India with undue haste and eagerness.

In my recent MINT article, I had praised the Committee on the Framework for Monetary Policy for its hardcore stance on the formation of the monetary policy committee with only five members with no space for government nominees and for it choosing both the inflation metric and the numerical target.

In fact,  I feel that politicians should do whatever they can, to support the RBI goal of bringing down the inflation rate. It is not only a tax on the poor but also a source of temptation for corruption as inflation renders many an income inadequate to meet even legitimate aspirations.

Therefore, to criticise the RBI and to want a bigger role for the government is to ignore India’s copious history with government influence, interference and incompetence.

Delhi beats Beijing hands down

This article confirms what I had suspected all along, having visited Delhi in winters:

Various recent studies and data suggest that air quality in Delhi is worse than in Beijing, though India’s air pollution problems do not get nearly as much attention on the world stage as those of Beijing. One study shows that Indians have the world’s weakest lungs. The World Health Organization says India has the world’s highest rate of death caused by chronic respiratory diseases, and it has more deaths from asthma than any other nation.

The link in the article above provides the following information:

Lately, a very bad air day in Beijing is about an average one in New Delhi.

The United States Embassy in Beijing sent out warnings in mid-January, when a measure of harmful fine particulate matter known as PM2.5 went above 500, in the upper reaches of the measurement scale, for the first time this year. This refers to particulate matter less than 2.5 micrometers in diameter, which is believed to pose the greatest health risk because it penetrates deeply into lungs.

But for the first three weeks of this year, New Delhi’s average daily peak reading of fine particulate matter from Punjabi Bagh, a monitor whose readings are often below those of other city and independent monitors, was 473, more than twice as high as the average of 227 in Beijing. By the time pollution breached 500 in Beijing for the first time on the night of Jan. 15, Delhi had already had eight such days. Indeed, only once in three weeks did New Delhi’s daily peak value of fine particles fall below 300, a level more than 12 times the exposure limit recommended by the World Health Organization.

Indians’ indifference to what matters and their warped priorities should not be a surprise. For self-destruction, it is hard for the Rest of the World to match India or Indians.

Scanning China exports

Hong Kong’s December imports from China fell 1.9 percent from a year earlier to HK$176 billion ($22.7 billion), the city’s statistics department said yesterday. That compares with $38.5 billion in exports to Hong Kong reported earlier this month by China’s customs administration, up 2.3 percent, based on data compiled by Bloomberg [Full article]

This reaction is hilarious:

Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, said the gap between China’s reported increase in exports to Hong Kong and the city’s reported decline in imports isn’t big enough to raise any red flags when compared to the difference earlier in 2013.

How is 2014 shaping up?

The Forbes blog post on PBoC suspending cash transfers during this crucial Chinese New Year week sounds more plausible than the ‘system maintenance’ explanation for suspending cash transfers.

I scoured Taiwan newspapers. There is a news story warning of an imminent default in the Chinese shadow banking world but nothing more sensational than that. Of course, there are non-economic (but important) stories – that 80% of China cities failed to meet air quality standards in December and that it was the worst month of average air quality. Then, there is the story on the number of human infections of H7N9 in China numbering around 100 since last Fall. But, none on the PBoC suspension of cash transfers.

The same is the case with Taipei Times but among its most read stories is this one on the fear of China hard landing stalking Davos. The BBC page on China leads with the violence in Xinjiang province and it also reports on the deadly avian flu.

Amidst all this, the piece by David Pilling on China’s future growth and its ability to manage the transition sounds too unusually sanguine.

This story on HSBC restricting cash withdrawals is quite inexplicable and troubling simply because there are more questions than answers.

However, in FT Asia edition, it appears like ‘business as usual’. The front page top story is about ECB preparing to fight deflation with the ECB getting ready to buy securitised loans to companies and households. European banks have not shrunk their assets. Hence, an attempt to get them to kickstart their lending sounds like a dangerous but a rather familiar policy measure these days.

The emerging market turmoil is just a very small lead in the front page. Strange.

Last week, Argentina and Venezuela devalued their currencies. The Turkish lira price of one US dollar has almost doubled in the last three years. Sounds too exaggerated to me. One of my friends pointed out to me that this is the same-old dollar liquidity issue. As the US current account deficit shrinks (see my blog post on a related issue here), the world dollar liquidity drops and all sorts of fundamental problems become too glaring, come into sharper relief and get magnified.

But it is a brave man with zero mark-to-market fears or considerations who will take positions on the Turkish lira or the Brazilian real for that matter, now.

The reality is that pre-2008, the developed world had believed that it had ushered in ‘great moderation’ and paid a price. Post-crisis, the emerging world thought that the world of capital would come to them no matter what they did. The primary source of the problem then was the developed world but the emerging world was not resilient enough then.

Now, the emerging world is the primary source of the problem and the developed world is nowhere near being resilient. Given that China, the big part of the EM world, is part of the problem now, the question to ask oneself is whether 2014 is different from 2008 or worse.

Is a rebalanced world a danger for US rates?

Good friend Niranjan Rajadhyaksha has an interesting piece in MINT on the diminishing current account surpluses in China and dwindling current account deficits in the US. In other words, one of the big worries, pre-2008, is now fading fast. As he correctly notes, this could have implications for interest rates.

If emerging economies, particularly China, are not running up huge current account surpluses, then they do not have to accumulate reserves and then find a parking place for those reserves in US Treasuries. Consequently, yields on US Treasury Bills, Notes and Bonds would rise. Reasonable conjecture.

Let me clarify upfront: I do not think that this conjecture is wrong. If anything, all of us are waiting to see if the hypothesis floated by Warnock and Warnock back in September 2005 is really a valid one. They had told us that bond buying by Asian and other EM central banks could have depressed bond yields by 75 to 150 basis points in the US.

I have been somewhat wary of flow-based arguments. Bond yields are based on the trajectory of short-term interest rates and inflation expectations. Of course, this is a broad statement of central tendency. However, there could be several idiosyncratic factors that make bond yields a function of other factors, for a period.

After all, purchases by the Federal Reserve might have played a role in holding down bond yields. We do not know if bond yields would have, otherwise, priced in a long-term inflation premium. Of course, the counterargument is that the current inflation rate is hardly a matter for worry, for bond markets.

Nonetheless, since the beginning of 2013, US Treasury Note (10 year) yield has crept up slowly, reflecting the market belief that short rates in the US might rise sooner than what the Federal Reserve had indicated. The Federal Reserve had reassured the market repeatedly that it won’t do so, to the point where it might have boxed itself into a corner from which it cannot extricate itself without damaging its credibility. Any way, we are digressing.

But, the point is that the bond yield has been rising because of short rate expectations despite the steady flow of bond purchases by the Federal Reserve which has taken over from foreign central banks.

So the question is if the bond yield would rise under the twin assault of reduced bond purchases by the Federal Reserve and reduced Reserves Investing by EM central banks. US Government yield curve might rise for a while but it would be shortlived. Ultimately, the crucial determinant would be the direction of short rates in the US.

My guess is that bond yields would drop (unless the Federal Reserve throws caution to the wind and goes for esoteric and dangerous concepts like nominal GDP targeting which, it well might) and stay low as the US economy is in no position to withstand sustained higher rates. There is also the risk of a stock market crash which is positive for bonds in two ways – both from a switch in flows from equities to bonds and from the impact it would have on growth and inflation prospects.

Then, when the US dollar begins to weaken again (perhaps, in the second half of the year?), reserve accumulation and Treasury purchases on a larger scale might resume. However, right now, growth in foreign exchange reserves and their allocation to the US dollar has clearly slowed (see chart).

All told, I am prepared to wager that a ‘rebalanced’ world is no (big and sustained) threat for interest rates. But, I could be wrong and it will be interesting to watch what happens to US bond yields this year.

Media watchdog?!

It is not clear to this blogger as to whether Ms. Sevanti Ninan is battling media prejudices and stereotypes or batting for the Aam Aaadmi Party. I had not seen or read her strident criticisms of media’s one-sided and prejudiced coverage of Mr. Modi and no coverage of certain court cases involving a certain media house. We shall let it rest there.

The sentence below took me by surprise:

As a guest on Ravish Kumar’s show on NDTV India asked, was Delhi law minister Somnath Bharti’s behaviour more anarchical than the pulling down of the Babri Masjid?

Comparing the actions of the Minister for Law of a government and the actions of a mob truly takes the cake and betrays her biases too easily.

One wished that she has had time to read and examine the points made by one Mr. Pushpavanam in THE HINDU few days ago (ht: Nitin Pai)

The meaning of A.A.P – part 3

A friend of mine recommended that I watch the interview of Mr. Arvind Kejriwal with Mr. Rajdeep Sardesai of CNN-IBN. He had come away impressed. I watched. I was not.

There is not much to be proud of an announcement of power tariff reduction when an audit of the power utility companies has just been announced. The tariff reduction is to pre-judge (and pressurise) the audit. One should also remember the situation that prevailed before private electricity companies came on the scene.

His action has had a contagion effect. Haryana had announced a tariff rebate. Maharashtra has announced one. The Maharashtra power tariff reduction will cost 70 billion Indian rupees per year according to estimates presented in the media. Is this setting an example of good governance?

Only in the last one and half years, had the State governments gingerly begun the task of hiking power tariffs regularly so that the finances of State utilities could improve to a point that they can make good their promises to lift power produced by private producers. Without tariff hikes, both power producers and distributors would remain sick. AAP has now brought that process to a halt. The consequences are immense and under-appreciated now.

Also, as my friend informed me yesterday via his email, it is one thing to demand that Delhi Police be brought under the State government but it is another thing to share the whole truth with the people of Delhi. Currently, the people of Delhi are being subsidised by the rest of India as they pay for the Delhi Police through the Central government budget. If the Delhi Police were to be brought under the control of the Delhi government, it will become an explicit tax burden on the people of Delhi.

Brandishing a non-existent letter from the Ugandan High Commission to the Delhi government was an act of dishonesty.

One must applaud the new AAP member Gopinath for making the same demand that this blog had made yesterday: If the policemen had to ‘proceed on leave’, the same treatment should have been extended to the Delhi Law Minister too. It is interesting that women’s organisations have come to the defence of the SHO who has been asked to go on leave.

All in all, a sorry state of affairs.

Failure of a journalist ‘elite’

Barely had one finished reading Martin Wolf’s piece on the Failing Elites and how they threaten our future with appreciative and approving nods, comes his farewell praise for Ben Bernanke. It is not that he lacks the intelligence to connect the three visible ‘elite failures’ and the monetary policy of the Federal Reserve. He does not want to do it. This is how the ‘establishment’ closes ranks.

In his piece mentioned above, he talks eloquently of how financial, political, intellectual and policy elites failed to see through the consequences of ‘headlong financial liberalisation’. He also writes about the emergence of a global economic and financial elite that is detached from the countries that produced them.

He fails to hold Bernanke accountable for both these ‘elite failures’. Bernanke’s philosophical attitude to financial liberalisation played a role in the crisis that emerged in 2008. His inability as a policymaker to connect the various dots of sub-prime led him to understate the possibility of a serious crisis. The explosion in the creation of subprime mortgages and their securitisation was either a by-product or a direct consequence of ‘headlong financial liberalisation’.

Mr. Wolf praises Bernanke for ‘saving the day’. Well, it is like praising a miscreant for putting out a fire that he helped create in the first place. In fact, it is premature to say that the fire has been put out. The emergence of an ‘economic and financial elite’ has been helped and stoked by Fed monetary policy of the last fifteen years and certainly of the last five years. Many elites themselves have spoken about it (e.g., Stanley Druckenmiller). It has widened inequality. American median family income has declined since the birth of the new Millennium. Workers get jobs that are long on hours and short on pay.

Further, just as he dismissed the possibility that the explosion in sub-prime mortgages and their securitisation would trigger a nation-wide (forget about ‘global’) crisis, Beranke has again downplayed the risks to financial stability that his extraordinary and extraordinarily long monetary accommodation would cause. Check this out. This is what the outgoing Federal Reserve Chairman said:

at this point we don’t think that – and I think I can speak for my colleagues on this – we don’t think that financial stability concerns should at this point detract from the need for monetary policy accommodation which we are continuing to provide.

As Doug Noland notes, I doubt if all his colleagues at the FOMC would agree to this. This is what Richard Fisher, President of the Federal Reserve Bank of Dallas said in a speech two days before the Brookings discussion with Bernanke. Evidently, Bernanke ignored the points that Richard Fisher highlighted:

  • Share buybacks financed by debt issuance that after tax treatment and inflation incur minimal, and in some cases negative, cost; this has a most pleasant effect on earnings per share apart from top-line revenue growth.
  • Dividend payouts financed by cheap debt that bolster share prices.
  • The “bull/bear spread” for equities now being higher than in October 2007.
  • Stock market metrics such as price-to-sales ratios and market capitalization as a percentage of gross domestic product at eye-popping levels not seen since the dot-com boom of the late 1990s.
  • Margin debt that is pushing up against all-time records.
  • In the bond market, investment-grade yield spreads over “risk free” government bonds becoming abnormally tight.
  • “Covenant lite” lending becoming robust and the spread between CCC credit and investment-grade credit or the risk-free rate historically narrow. I will note here that I am all for helping businesses get back on their feet so that they can expand employment and America’s prosperity: This is the root desire of the FOMC. But I worry when “junk” companies that should borrow at a premium reflecting their risk of failure are able to borrow (or have their shares priced) at rates that defy the odds of that risk. I may be too close to this given my background. From 1989 through 1997, I was managing partner of a fund that bought distressed debt, used our positions to bring about changes in the companies we invested in, and made a handsome profit from the dividends, interest payments and stock price appreciation that flowed from the restructured companies. Today, I would have to hire Sherlock Holmes to find a single distressed company priced attractively enough to buy. [Emphasis mine]

Failure to hold monetary policymakers to account (as much as journalists are willing to do that to politicians) is one of the reasons that these technocrats/policymakers retain the potential to continue to make policy errors.

This is a failure of ‘journalist elites’ of which Mr. Martin Wolf is one.

(Postscript: A modified version of this post was sent to FT and, to my pleasant surprise, it was published promptly. You can read the published version here)

The meaning of A.A.P – part 2

There have been some private email exchanges with friends on the meaning and consequences of AAP for India. I am not optimistic. But, that is an opinion. Opinions can be many and different. But, only one set of facts is possible.

Mr. Arvind Kejriwal should have known, before he agreed to form a government in Delhi, that the Police in Delhi does not report to him but to the Lieutenant Governor. If he did not like it, he should have made that a pre-condition and not formed the government.

He could have then told his followers and the country at large that he wanted the same resources as other Chief Ministers have and that it was denied to him. He could have also shared with his followers and the public what he would have done with police reforms to make them responsive to the public, had they been placed under his government’s supervision and control.

In fact, not just about police being under his government. He could have made common cause with many Chief Ministers and local governments on de-centralisation and devolution. Ultimately, liberalisation (removing government from direct economic activity( and devolution (where government and governance is needed) are answers to India’s corruption and governance problems. Not LokPal and centralisation of power.

All this would have enhanced his stature and made many think and re-think about their own favourites. He would have raised the level of public discourse and public policy.

Even in the current episode, he could have done many things differently. If he wanted the police officials concerned to be suspended pending an enquiry, then he should extend the same treatment to his ministerial colleague who is also guilty of misbehaviour. In his demand for suspension, we should remember that the Delhi Police cannot be accused of insubordination in this case because they do not report to the Delhi government.

Furthermore, whether Mr. Kejriwal intended it to be the case or not, his Minister’s ill-treatment of Ugandan nationals happened on the day that China extended diplomatic favours to Nigeria. Now, on the Republic Day, India will host Japan’s PM as the guest. India needs Japan as much as Japan needs India as a market and as a counterweight to China. By sullying and damaging India’s international image and perhaps preventing or adversely impacting the Republic Day Parade, he is playing into China’s hands.

As some one who said that he would not mind standing for Lok Sabha if his party wanted it, is this what he wants to do for India?