More than FCNR-(B), new Governor will have to deal with Fed challenges: Jayesh Mehta, BofA-ML

Mythili Bhusnurmath, Consulting Editor, ET Now and Jayesh Mehta, MD & Country Treasurer, BofA-ML discuss macro issues including Rajan's succesor, FCNR (B) and Fed challenges. Edited excerpts

ET Now: Now the Dr Rajan’s terms is coming to an end, what does this mean broadly for the direction of monetary policy in India under the new regime which is likely to take over come September?

Mythili Bhusnurmath: We really have to see once the monetary policy committee is formed, whether the government lays down different monetary policy inflation targets because the amendments to the RBI incorporated and notified post the passage of the finance bill, did not really specify an inflation target. So going by what Urjit Patel agreed to and what the government has signed with the RBI in terms of monetary policy framework agreement, though we temporarily have a regime which says the inflation target will be four plus minus 2 per cent, it is basically for the government to perhaps periodically review and decide what the target will be. So even though there is monetary independence in the sense that it will be a three plus three committee with the governor having a second casting vote in case of a tie, one really have to see what does the government mean by the monetary policy committee in terms of target number one.

Number two, who are the people the government appoints as its nominees and how much of a say does the RBI have in appointing what it considers its own nominees. Of course, it will be the Deputy Governor who will be in charge of monetary policy, the fact remains that one Deputy Governor post is coming to an end, there is a new Deputy Governor going to come in the government is going to have a say unlike in the past where the choice of the Deputy Governor was largely left to the governor and the finance ministry. So there are lot of changes in the kind of names which we see in the MPC so it is a little uncertain but I think the broad direction of the RBI remaining in inflation target will remain. Of course, a lot depends on the kind of governor we get because the RBI Governor’s post is a very technical post, it requires a deep understanding not only of financial markets but also of the economy and some amount of understanding of the real political economy aspects. So it is a very complex issue and all depends on we hope we should get the right man. Merit should be the overriding consideration and not anything else.

Mythili Bhusnurmath: I am not going to ask you about the controversy because so much has changed between Friday and today. We have seen a lot of heat but not much light in the discussion. But what I would like to ask you is – are you a little surprised by the market’s relatively muted reaction? The Sensex, in fact, is up. The rupee fell but it has recovered. So speaking for myself, I am a little surprised. Does it mean that our markets have matured and it is institutions rather than individuals who matter because that really is the mark of a matured market; Can we hope that we have reached there or is it too early? It is a lull before the storm?

Jayesh Mehta: I think it is a little too early and I think we are seeing a muted response because there have been some positive news on the global side. If you really look at Brexit which is the worry for the week and the last poll Brexit is now talking about only a 30 per cent probability. So that has also triggered a little bit of sentiment particularly on the equity side and on the FX side, yes as expected it opened up, of course, the Friday closing was 67.10 but if you compare with what it was on Thursday or so, it was around 67.25-67.30 and it really gapped up today morning opened at 67, 65, 69 it went then we saw some intervention that is what we hear. We do not know yet.

We will know only after two weeks but there was some intervention and then some corporates also book some profit. So to that extent, I think it got little muted. It started off with a little bit of intervention. But then it got muted more because of the global positives. I would say it would have been a lot of positive news. If you look at the rest of the Asia, it is doing quite differently. It is quite positive. So from that perspective, it got kind of muted. So it is more about people over geared for Brexit and now that Brexit poll is coming out to be more biased towards not happening, people are positive. But who knows what is going to happen? We will see that volatility but as of right now, it was more about the surprise news over the weekend on the Brexit poll along with the negative of Rajan exit. So both put together, we are kind of seeing muted. But if both were negative, then it would have been a different situation.

Mythili Bhusnurmath: Yes, it is very difficult to kind of understand markets or even to say what trigger them or attribute any movement to one particular issue but having said that Jayesh if one were to look at the quality I am not asking you to name any particular individual but if I were to ask you what are the kind of qualities that one needs in an RBI Governor. Institutions of course matter much more than individuals but individuals also matter particularly in crucial positions. So what is the kind of qualities that one needs really for an RBI Governor? Would it be an understanding of economics in which case it is an economist, would it be an understanding of financial markets in which case we need somebody who has been a player in the market or would we need somebody who has been a bureaucrat who really understands the real India because political economies are a very important part of it or can we look for a mix because we have seen though it has been reported that the government was not looking for bureaucrats, we had seen very successful bureaucrats as RBI Governors i.e. Y V Reddy, Bimal Jalan were outstanding bureaucrats and outstanding RBI Governors. So what mix should we have? Economist, banker, financial markets, understanding of financial markets, understanding of the real India political economy... how much are we expecting?

Jayesh Mehta: I would put it slightly differently. RBI always worked as an institution. Look at Dr Reddy took over or Jalan or for that matter, Dr Subbarao. The last one had a tough time. He had to face Lehman and within five months of his joining three stalwart Deputy Governors like Usha Thorat, Shyamala Gopinath and Rakesh Mohan retired. So to that extent, it became a little difficult for him but then over a period of time the, institution took ove. So, I would say whether bureaucrat or economist, the institution has all the characteristic in it and that works pretty well.

We have seen that happening with Dr Reddy, we have seen that happening with Dr Jalan and of course before that I do not remember much problem. In 91, I was too young to know that but I would say at least I have seen Dr Jalan and Dr Reddy very very closely and of course during Subbarao what I feel the problem was the continuity in the RBI which change of course it is not that they were not geared up. It takes time for a new Deputy Governor to built up connections with ministry as well as connecting with the governor and getting the induction into the system so that is what really matters. I would say continuity is definitely important, we have enough stalwarts, we have enough bandwidth within RBI at even ED levels at this junctur. So to that extent, you need a person who can independently take back the pressures from the government if required. That is what I would say is the biggest challenge and it comes with the position. So most of the time we have seen that is happening right.

Mythili Bhusnurmath: You have really hit the nail on the head because continuity is very important as is institutional memory and unfortunately we have one deputy governor HR Khan, his term comes to an end quite shortly and the other two deputy governors, Mr Mundra and Dr Urjit Patel have not been spent much time as deputy governors. So that does create a bit of a problem. But for any new RBI governor who comes in, what do you think the immediate challenge will be, will it be the FCNR-(B) or would there be challenges in terms of the Fed action?

Jayesh Mehta: I do not know what is likely to happen in the Fed case. Fed I would say would be a little bit more worrying. I think FCNR-(B) is slightly misunderstood. Maybe I can clarify. What my understanding is if you look at the last policy that RBI has covered, RBI has enough reserves and banks have sold RBI forward dollars. Now there could be two situations happening with banks; a) the exporter for whom the banks have got dollars, might go for rollover or there could be a mismatch like banks might have sold to RBI for say September delivery and the exporter would have sold them for November delivery. So what happens is there is a spot shortage of the dollar but that does not mean there is a shortage overall.

But in case of a sport shortage of the dollar, it has to be filled in by the forwards being lower than the money market rate and that is the cost which banks will have to bear. So it is not that RBI will not supply dollars, RBI has enough reserve. They will supply the spot dollars but there will be a cost associated to that which is the cost of being lower than the money market forward return. So that is the cost one is talking about. So FCNR-(B) now is more of an operational issue and I am sure since it is known, it would be settled out very well.

Operationally the FMD department and the things would be doing it pretty well. I really would not worry too much on that. Yes, there will be operational glitches which can happen, you could see two, three hours panic situation happening if there is operational glitch but otherwise I do not see that is completely meshed so I do not know why we are too much worried about FCNR (B). I would say real threat would be Fed. If Fed right now one rate hike has been factored in globally, if it becomes two then that is the situation which will impact not only India but all emerging markets. So I would say that is the only impact but as of right now it looks like one rate hike and that is kind of very well factored in.