Modi did OMO!

Select excerpts from the latest weekly missive, ‘Greed & Fear’ put out by the irrepressible Chris Wood of CLSA. He puts them out every Thursday. So, this incorporates RBI’s rate cut on Tuesday.

… decision by the new BJP government last July to sell 10mn. tonnes of wheat stock into the market, appears to have been brilliantly effective in sucking liquidity out of the economy. In this respect in a country like India, which is still in many respects rural and “disorganised” in macroeconomic terms, sale of excess food stock can amount to a highly effective form of “open market operations” (OMO). In this respect, too narrow an approach to monetary policy can be counter-productive.

This raises the second point why India is slowing. This is that in GREED & fear’s view, and most others, monetary policy is way too restrictive even after Tuesday’s rate cut of 25bp. This can be seen by looking at the level of real interest rates, most particularly if in the case of the corporate sector prices are deflated, as arguably they should be, by the WPI. Thus, the RBI cut the policy repo rate by 25bp to 7.25% on Tuesday, which in real terms is now 2.3% if deflated by CPI and 10.2% if deflated by WPI see Figure 7).

there is no evidence for now of a turn in fixed capital formation, and GREED & fear suspects there may not be for another 12 months which does expose the stock market to the risk of further cyclical disappointment, most particularly if the equity market is not being supported by more aggressive monetary easing. Gross fixed capital formation as a percentage of nominal GDP has fallen from 33.6% in FY12 to 28.7% in FY15 ended 31 March (see Figure 8).

So, the reason India is still not enjoying as strong a rebound as hoped is in part the consequence of a policy mistake in the sense that monetary policy has remained too tight, even in the face of collapsing inflation expectations and in the context of a situation whereby incremental deposit growth has been running ahead of incremental loan growth since October 2013.

Now, I looked at the real rate of interest.  Like ‘beauty’, most things in economics are in the eyes of the beholders and the ‘Real Rate of interest’ is no exception. I took the Prime Lending Rate and subtracted inflation as measured by the GDP deflator. Both are from the individual country data from the World Bank Meta database. India’s real lending rate, as per this measure, was 6.0% by end-2014. The average since 1990 has been around 6.1%. Yes, clearly, the real lending rate has picked up from around -0.65% in 2010 to around 6.0% now. That is quite a move. So, data support arguments that monetary policy has been too restrictive relative to near-term trends and not-so-restrictive in the historical sense. I attach an image of my chart.






Further, credit growth, in an overall sense and not just from banks, does not seem to be languishing too much. Fiscal policy has been restrictive too. Of course, Chris Wood notes, citing his India strategist, that fiscal tightening in 1Q2015 was not all that much. But, on most counts, both fiscal and monetary policy have been restrictive. Is that really bad?

Again, from a stock market perspective, perhaps it is. From a structural reform perspective, it could be deemed positive. The new government might have chosen to take pain upfront and secure a long-term victory against inflation. If so, that should be applauded and not criticised.

But, why not communicate this policy goal and design to the unwashed masses like us? Therein lies the problem. This blogger used to lament ‘reform by stealth’ but, unfortunately, in India (and, perhaps, in most countries), that is what works. The public does not and will not understand, especially since it is being fed by an uninformed (worse, misinformed) media. That too is not just unique to India. For example, check this link out.

Some might say that this is elitist and not democratic. My answer is that IT IS and yes, welcome to the real world of policymaking, if you have never visited it before. Too bad for you.


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