Looking beyond Urjit Patel

Niranjan Rajadhyaksha feels that RBI’s independence from the government is worth preserving as, otherwise, it might return India to the days of directed credit, outright deficit monetisation, etc. That is his broader concern. I think his fear is legitimate.

Given that, he is more inclined to overlook RBI’s failings and turn a harsh spotlight on the government. He is right, given the line in the sand that he has drawn. I must say that if RBI headed in that direction under the new Governor, it would not be progress but regression.

But, should that come in the way of judging Urjit Patel’s tenure? Niranjan feels Urjit Patel stared down the government on more than one occasion. That may be right but a narrow consideration, in my view. I had commented on it when that happened.

He credits Urjit Patel with stabilising the inflation mandate and the new Monetary Policy Committee arrangement. R. Jagannathan of ‘Swarajya’ has different and more valid views on them. See below.

But,  there is yet another broader issue and that is one of consumer interest.  I have long opposed the formation of appellate tribunals to contest policy decisions of RBI. There is judicial redress. But, on consumer matters, perhaps, is there a need for a higher authority, above RBI, since RBI seems intent on protecting banks rather than consumer? Read Monika Halan here. I hope readers will remember the blog post I wrote on November 27 where I had linked a piece by Debashis Basu in ‘Business Standard’. Debashis Basu’s piece is well worth a read. Monika Halan links to another piece by him in her op.-ed cited above.

I have heard this from some friends who had worked for other regulators that RBI operates more as a ‘Don’ who protects his men (banks, here) rather than as a neutral regulator of the entities that come under its watch.

More narrowly, specifically with respect to Urjit Patel, R. Jagannathan minces no words in evaluating his tenure. He sheds no tears and he makes equally valid points too. Inflation forecasting failures and the consequent needlessly tight monetary policy – based on a doctrinaire adherence to their inflation targeting mandate – come under deservedly harsh scrutiny from him.

If we are keen on preserving institutions that have stood the time, as RBI undoubtedly has, we should also not hesitate to call out its mistakes and its shortcomings. No one is above or can be above criticism.  If the survival and the thriving of an institution is in national interest, then we will be failing the institution if we don’t hold it to a higher standard.

In my previous blog post on this topic, I had mentioned clearly what RBI has to do on its part. As for the government, in this blog post, I had mentioned what the Government should do, with respect to RBI.

On inflation targeting, if the new Governor revisits the 4% mid-point and redefines the range around it making it asymmetric, I will support it. See here for my column on whether inflation is really a matter for monetary policy and, see here for my views on the inflation targeting framework in India.

Lastly, I do not have a view on Mr. Shaktikanta Das. I do not wish to pre-judge him. Let us wait. What is the rush?

A (t)horny issue and other links

The Swiss sure have their problems!! The rest of us will only be too happy to trade ours for theirs. Referendum on cows’ horns is coming up in Switzerland! [Link]

Augustin Carstens called the bitcoin ‘a bubble, Ponzi scheme and an environmental disaster’ way back in February. Well said [Link]. The value of bitcoin has collapsed and I suspect that the benefits of ‘Blockchain’ are vastly overstated.

Paul Tudor Jones sounds the alarm on corporate credit in the United States:

If you go across the landscape you have levels of leverage that probably aren’t sustainable and could be systemically threatening if we don’t have . . . appropriate responses [Link]

IMF had chipped in with its own (eloquent, doubtless) warning on leveraged loans, little realising its own culpability on the matter. It warned central banks against raising rates ‘prematurely’ from 0.0%. The truth was that in 2015-16 the world was in dire straits. Hence, their warnings, perhaps, on premature tightening. But, then, it means that the programme of zero short-term interest rates and QE (which held down long-term rates) were a failure. Why persist with them? So, they created the mess that they are warning against now!

Cannot learn, won’t learn

Robin Harding of FT wrote an article on why Japan should not withdraw its monetary policy stimulus and listed instances in which the Japanese economy went into recession when the stimulus was withdrawn ‘prematurely’. May be, true. But, if it is always the case that one has to increase the intensity of the treatment, when would one consider the possibility that the treatment was wrong, in the first place?

Is it possible to keep an economy on life support all the time? What are the costs of doing so? A reader had sent a good set of comments on the Harding column:

Japan’s central bank now owns bonds and shares equivalent to a full year of national economic output. Real interest rates have been negative for years, something not seen in 5,000 years of recorded debt history. The long-term effects of such monetary policies are quite simply unknown, but the asset bubble created by QE has been nothing short of obscene.

The results on Japan’s domestic economy have been, at best, unimpressive, and at worst, an absolute disaster for the country’s competitiveness. Why bother to adhere to good corporate governance principles if the government is going to prop up your stock price anyway? Or why bother to make money if you can borrow to pay back interests? Mr. Harding is actually calling for more of this madness. What has the world come to? The end of capitalism is in sight.

This comment correctly focus on many unintended consequences of policy decisions and actions.

India’s good luck

On September 21, I listened to an oil market expert make a rather convincing case for why the price of oil could rise up to USD100 per barrel. But, the opposite has happened. Brent crude oil price has dropped from a peak of around USD78 to USD66 now. It is good news for India. 

The rupee depreciation risk is considerably reduced. Of course, there is political risk, especially if the elections to State assemblies come up with adverse results for the BJP. 

In this connection, I thought that the comment made by the Chief Economist of the State Bank of India after the latest inflation reading substantially undershot expectations was an interesting one:

The other point of big concern is now uncertainty surrounding the CPI forecast made by MPC. It is interesting to see what forecasting technique the MPC members adhere to. Generating forecasts under (and often unstated) assumptions about exogenous variables such as oil prices, government spending, and global growth will throw up illusory or elusive results. Under such circumstances, it may be better for the MPC to work with short-term forecasts for next three to six months as macro-variables like oil prices are now almost difficult to predict. Remember the oil price crash in FY15 that had resulted in inflation undershooting RBI projection by more than 300 bps in December 2014 (currently it now close to 100 basis points!)

Source: SBI Ecowrap, Nov. 12, 2018

Rakesh Mohan’s trilogy

I just finished reading a series of three articles that Rakesh Mohan wrote on RBI and the government relationship. He wrote about the attempts to scuttle its independence, to extract a higher dividend out of it, the changes to the composition of the RBI Board and the proposal to set up an independent Board for payment and settlement, away from RBI and on the composition of the Monetary Policy Committee, etc. It is a good three-part series.

The series was a much-needed articulation of the priorities of RBI and their importance in the national context.

I did not know about the changes to the process of nomination of Government directors made in 2012:

After the Department of Financial Services was carved out from the Department of Economic Affairs in the Ministry of Finance, provision has been made for a second nonvoting government director on the RBI board. This provision amending the RBI Act was quietly inserted in 2012 as a clause in the Factoring Regulation Act (!) with almost no discussion in Parliament. [Link]

Also, the other amendment that the government had made in 2013 to make directors demit office after the completion of four years without appointing their replacement promptly.

Notice that both these changes happened under the watch of the UPA II government. Yet, the Congress was very strident in its criticism of the government’s thrusting of the decision on demonetisation on the RBI in 2016 as an infringement of its independence.

His points on the merits of the Board for Payments and Settlements being under the RBI umbrella and on the drawbacks of the composition of the Monetary Policy Committee (MPC) without all Deputy Governors were well made.

A credible central bank is actually a boon to the government and an instrument it can deploy in times of stress. That credibility is earned through protecting, preserving and nurturing its independence rather than through curtailing it or chipping it away slowly and slyly.

You can read all the three articles here, here and here. They may be behind a paywall, though.

While Dr. Rakesh Mohan’s articles constitute a defence of the institution, Rajeev Malik raises some valid questions on the recent meeting of the Monetary Policy Committee of the Reserve Bank of India. They are pertinent questions. I am sure that the MPC was not unaware of them.

They just attached a different risk weights to the arguments than Rajeev does here. It backfired in the market – based on stock market reaction. I am not sure that it is the relevant yardstick to judge a central bank’s effectiveness.

Be that as it may, these views were worth airing.

The hole in Jackson Hole

Read the speech delivered by Jerome Powell, the Fed chairman at the Kansas City Symposium – an annual jamboree of central bankers in Jackson Hole, Wyoming. He has said all the right things only to either discount them later or to ignore them.

For example, he recalls the Brainard principle:

Brainard principle, which recommends that when you are uncertain about the effects of your actions, you should move conservatively. In other words, when unsure of the potency of a medicine, start with a somewhat smaller dose.

This is perfectly valid in the case of QE. But, precisely that is what he goes on to defend, in the next sentences.

He correctly notes:

in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.

But, he reserves the brave words ‘whatever it takes’ only to fight unanchored inflation expectations and financial crises of the type we encountered in 2008. If financial excesses precipitated the last two recessions, one would expect the Fed leadership to pledge to do whatever it takes to avoid building up financial excesses. But, he did not say that.

In the meantime, signs of financial excess abound. We documented one yesterday.  Here is another:

Before the financial crisis, about a quarter of the leveraged loan market was termed “covenant-lite”; today it stands at almost 80 per cent, according to Moody’s. Almost two-thirds of the entire market now has a lowly credit rating of B2 or worse, up from 47 per cent in 2006. In other words, an already junky market has deteriorated further…..

More than half of loan issuers have zero “unsecured” debt that could insulate lenders from the pain of a debt default, AllianceBernstein pointed out in a report this week. [Link]

Alliance Bernstein pointed out,

investment-grade credit quality got worse. Today, 48% of the bonds in the index are rated BBB, the lowest rung on the investment-grade ladder, up from 33% at the end of 2008. A-rated bonds declined from 50% to 41% over that time. [Link]

Channelling Greenspan for risk management makes one wonder if the Federal Reserve has learnt anything from the mistakes it made in the last twenty years because ‘the once in a lifetime improvement in productivity’ that Greenspan swore by, proved to be a chimera.

But, there are cheerleaders for a policy approach that avoids dealing with financial excesses. See this, for example.

John Authers of FT thinks that the overall message of Mr. Powell’s testimony at Jackson Hole was dovish in tone. May be, he is right.

The more things change, the more they remain the same.

Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.