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    Retaining the incremental CRR and cutting rates defeats the purpose: Indranil Sen Gupta, BofA-ML

    Synopsis

    We have cut down FY18 forecast because clearly there is an adverse wealth effect which is hurting demand in first half, says BofA-ML India chief economist.

    ET Now
    In a chat with ET Now’s Mythili Bhusnurmath, Indranil Sen Gupta, India Chief Economist, Bank of America Merrill Lynch, discuss macro cues and how the demonetisation impact may carry on till the June quarter

    Edited excerpts


    What is your reading of the demonetisation situation? Do you see the impact as short term -- one or two quarters -- or do you see the impact of the demonetisation spilling over to the next fiscal as well, in which case what is your estimate of how much the GDP will be impacted?

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    Obviously there is going to be a short-run impact. We have cut our GDP for this year down to 6.9% from 7.7% earlier that we had a forecast. We have cut down the December quarter forecast to something between 5.5% and 6%. Now we have to wait and see when the situation normalises. Is it December, is it January, is it February that is something we need to wait and watch. We have also cut down our FY18 forecast to some extent because clearly there is an adverse wealth effect which will affect demand in the first half of the year. But, of course, we expect the RBI to cut rates. We expect banks to cut lending rates and the second half probably will see a recovery but maybe we will see this impact carry on till the June quarter.

    Monetary policy always acts with a lag. In fact in Indian context, perhaps the lag is as much as three to four quarters. So given that should the MPC take cognisance of the short term disruption caused by demonetisation or should it look through these as temporary frictional noises and in that case what will their projections really be for monetary policy going forward? We do not know which way the FOMC is going to act. By and large it is expected that they will hike rates but one can never be very sure. So how should the MPC act? Should they take cognisance of what is happening or leave that to the RBI and saying it is a temporary liquidity adjustment which the RBI needs to do? Nothing needs to be done as far as the monetary policy stance itself is concerned. How do you expect the MPC to react to that?

    As it is, lending rates are very high and the RBI needs to put in liquidity and bring down rates for growth to revive. So even if this had not happened, we were calling for 50 bps of lending rate cuts, we were calling for OMO and in fact OMO is something that the RBI had begun to do. As far as the FOMC is concerned, it is an irrelevant issue for India right now because we have an interest rate differential that is almost 600 bps as of now. That is way beyond what we have had historically, so that is number one.

    Number two, what we have seen in the past is that when the US hikes rates, that is seen as a reaffirmation of growth and that leads to flows, that leads to risk appetite for countries like India so the rupee appreciates. When the Fed cuts, that is seen as a growth risk and risk appetite for India comes down and that leads to rupee depreciation. So because in India equity flows tend to dominate bond flows, the math for FOMC action is very different from those of a large number of EMs. I do not think that the FOMC is a constraining factor in any way at all for the RBI at the current juncture.

    Okay, your take on that is really quite different from what a lot of other people would say because a lot of people would feel that given the hike in FOMC interest rates, there is a return of flight to safe havens because why would you want to invest in a country whose future is not that bright? So definitely there is also is a risk of the rupee depreciating. Currency volatility does increase. Typically, most emerging markets tend to do worse when the FOMC hikes rates. So, that is a very different perspective positively. You are right because in macroeconomics anything can happen but what is your view about the suggestion that another way RBI could address the issue right now is to increase the band of reverse repo, make it 100 bps as against 50. Would that be a prudent thing to do?

    I think that is an irrelevant issue right now because basically even the reverse repo you are trying to kind of take up right in the variable rate auctions close to the repo rate. So whether you really reduce the band or not, what difference does it make to anybody?

    Except that of course it reduces the attraction for putting the money in the bank. But then you have the MSS now so perhaps it does not make very much difference but what to your view is the RBI’s stance likely to be on the CRR? Do you see them extending beyond the 9th of December which is when it comes up for review?

    No. I certainly think that they are going to withdraw the CRR and move the money to CMVs because obviously if you have locked the money in CRR, you are not going to see lending rate cuts. There are various bank CEOs who have said that, including the SBI. That defeats the whole purpose of cutting rates today. I mean the whole thing about cutting rates today is that you want to see that lending rate transmission to support the economy when it is hurting. Growth was low to begin with and now you have this demonetisation shock, keeping the CRR and then cutting rates defeats the purpose.



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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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