Category: Uncategorised

Modulate liquidity minus rate hike

Last month, as a policy response in an unscheduled meeting to CPI inflation breaching the upper band for three consecutive months, RBI announced a 40 bps hike in repo rate to 4.4% and 50 bps hike in CRR to 4.5%. The MPC also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Earlier in April, the central bank has instituted Standing Deposit Facility at 3.75% as floor for LAF corridor replacing Reverse repo which was at 3.35%. Effectively, two rate hikes in succession.

Later, the central government announced a slew of fiscal measures to douse the effects of supply shocks – steep cut in oil excise duty, zero duty on edible oil and a duty reduction on a host of other items like ferronickel, coking coal – which can lead to decline in inflation by an estimated 40 bps. The duty cuts and ban has kept the prices of essential items – edible oils, wheat, rice, atta and sugar under check. Should the RBI MPC meeting in June continue the rate hike trend for the larger public good of taming the trajectory of CPI inflation or go for a rate pause to soften the blow on consumers and growth as FY22 GDP barely crossed the pre-pandemic level on the account of two waves?

The historical high inflation across the globe compelled the central banks in reversing the interest rate cycle. To avoid the flight of capital and the subsequent rupee depreciation manifesting as increased liquidity and higher imported inflation, the prescription is to hike policy repo rate. The same prescription holds for savers facing negative real interest rates. However, a further rate hike is not warranted in battling these scenarios.

While RBI stalled the runaway depreciation and volatility by intervening in forex market, a perception among the financial market participants is that the FII outflows from debt and equity markets may have peaked. 40 bps repo rate hike in May, RBI’s strong dollar war chest, estimated 100 billion dollar FDI in FY23 and reversal of FII outflows owing to recessionary concerns in US and Euro zone should ease the pressure on Rupee, subsequently on RBI to vote for a rate hike.

The RBI Retail Direct Scheme aimed at greater retail participation through the improvement in ease of access to G-Sec market helps individuals including senior citizens earn more than 100 bps in holding a 10-year G-Sec in comparison to 10-year FD. The narrow interest rate and inflation differential addresses the negative real interest rates conundrum while strongly dismissing a case for a rate hike.

According to an RBI Working paper, coefficient of policy rate i.e., repo rate was negatively related to credit growth. An increase (decrease) in policy rate by 100 basis points causes the credit to decline (increase) by 1.95% with a lag of six quarters. The prevailing inflationary pressures are on account of external supply shocks and persistent liquidity surplus for which rate action is dispensable. So, a calibrated and targeted approach leveraging the plethora of policy instruments is suggested over a series of rate hikes.

The monetary action in the June should largely be a play on modulating liquidity whose impact is immediate. It is suggested that RBI undertake the following incremental and temporary liquidity measures which also conform to its intent of withdrawing liquidity over a multi-year time frame in a non-disruptive manner. To begin with, CRR could be hiked by another 50 bps. At the start of this month, weighted average call money rate (WACR) – the operating target of monetary policy – is ruling below the SDF rate. This should aid in lifting the WACR towards policy rate. Further hikes in CRR could be assessed as the risks evolve.

As per the recent SBI Ecowrap report, new investment announcements in FY22 are at an all-time high of approximately 20 trillion – double that of FY21. Private sector too has recorded an all-time high of 13.6 trillion which is 2.5 times that of FY21. Implementation ratio, defined as project investment under execution as a percentage of investment announcements, is at 36.24% implying around 64% of announcements are yet to take-off.

That said, as a second measure, RBI could hike the CRR to 10% for 2 years on incremental loans to both food and non-food excluding Industry and housing for a period of 3 months. This has the effect of interest rate hike for extending credit to services and personal loans which will aid in ebbing sticky core inflation. This measure ensures capital investments – large government capex and private investments – don’t take a rate hike hit and can sail unhindered.

In a policy note in December 2021, RBI Governor mentions that operations of 14-day VRRR would continue to be complemented by longer-term VRRRs, the size and maturities of which will be decided based on continuous assessment and committed to undertake Operation Twists as may be required for effective monetary transmission and anchoring yields. So, as a third measure, 56-day and 84-day VRRR could be introduced to shift the liquidity towards longer maturities.

Last of all, liquidity neutral operation twist – buying longer dated and selling shorter dated securities simultaneously – to be undertaken on a regular basis to anchor the yields at the long end. Remember, the fiscal steps announced earlier has a cost associated. So would any likely measures in the course of year to contain inflationary pressures. This may necessitate government of India to borrow more than the specified in the Union Budget which can put stress on the long end. RBI, as a banker to the government, should bring down the term premia – difference between the policy repo rate and yield on 10-year government securities – which is at more than a 12 year high of 300 bps. Borrowing costs would head south, so would inflation expectations.

Considering the public welfare, the RBI MPC meeting in April prioritized inflation over growth and the off-cycle meeting in May stressed on anchoring the inflation expectations so that inflation trajectory is not self-fulfilling. RBI repeatedly asserted that it monitors the inflation growth dynamics continuously and it is hoped that it takes policy decisions, excluding rate setting decisions by Monetary Policy Committee, outside the window of planned policy meetings.

RBI must act agnostic to the apprehension of inflation breaching the band for three consecutive quarters as many known unknowns are evolving – protracted geo-political tensions, elevated commodity prices, external demand slowdown due to threat of Eurozone recession and revised lower international trade growth from WTO. All attempts to overdo to rein in the inflation will do more harm than good. In the words of RBI Governor – it can’t be a situation where the operation is successful and the patient is dead.

MSP: Modi Supports Peasants

AgricultureShould I till the land or lease it out or leave it barren? Or resort to extreme step. A situation that prevailed until Modi regime began in 2014. His regime inherited intimidating conditions like shattered economy, banking crisis, rural distress and agony in agriculture. Modi addressed the apathy towards agriculture by introducing a slew of gap-filling and highly impacting measures – schemes like soil health cards, fasal bima; initiatives like neem coated urea, E-Nam; policies like PSS for pulses and oilseeds and MIS for non-MSP crops. Announced in the Union Budget 2018-19 and of historical significance is the Modi government’s Minimum Support Price (MSP) policy of assured procurement or price support for 23 notified crops at cost (A2+FL) plus 50 percent margin.

Out of 23 MSP notified crops, 59% and 39% agricultural households grow just paddy and wheat respectively in 40% of gross cropped area. Green revolution incentivized only grain community whereas the MSP policy will incentivize the agrarian. MSP policy prompts the Government of India to instantaneously plunge into support operation unlike the current system of delayed approval process with the request originating from the states. Distress sale would have caused the damage with delayed decision making. Earlier MSP was different for each state. Now since MSP is same across, states can declare bonus if the cost of cultivation of the crop is relatively higher in that state.

MSP policy a practical instrument; Input support a political one

Telangana government has announced investment support scheme with great fanfare. The objective is to provide 8000 rupees per acre for kharif and rabi seasons combined so as to shield the farmers from the clutches of private money lenders and their exorbitant rates. The intended end use is to purchase agri-inputs and hire labour. But is there a fizz in it. The giveaway is neutral to the landholding of the farmers and thus large farmers reaped windfall gains without even getting onto field for the kharif season.

Also, the scheme does not recognize tenancy and sharecropping arrangements. A fifth of 72 lakh farmers in Telangana are tenant farmers. To add to the injury, a report by Rythu Swarajya Vedika reveals that, in last 4 years, 75 percent of farmer suicides were committed by tenant farmers. Apparently, the state machinery from Minister-in-charge to MRO and Secretary to Sarpanch have been deployed to distribute input support cheques to farmers, put it other way, to landowners. The same reach out and a tiny fraction of this corpus fund suffices to provide kisan credit cards and thus institutional credit to avoid private money lenders. The other fraction of fund could be utilized for interest subvention. Additionally, as in Madhya Pradesh, Telangana government could offer to repay only 90 percent for crop loan upto 1 lakh.

MSP policy, unlike investment support, is agnostic to agricultural production arrangements. A monetary benefit analysis of MSP announced for kharif marketing season (KMS) 2018-19 for Ragi, as an example, fetches more than 4000 rupees compared to MSP for KMS 2017-18. A good economic policy or scheme should be linked to stages of production and MSP policy is one such. In comparison, investment support scheme mirrored the design of universal basic income. Agriculture, as a state subject, is classified as economic service whereas input support scheme treats the same as a welfare scheme. Agrarian community is not seeking alms rather they are aspiring for an amount commensurate to the cost of cultivation topped up by a profit margin as with any economic service.

Peace clause of WTO, procurement strategy and pressure on inflation

Since India is signatory to WTO, India’s public stockholding program of food grains from procurement operations drew sharp criticism from WTO members for they have alleged it as trade-distorting. Though India secured adequate protection in 2013 Bali summit, it was during Modi’s regime that India secured a permanent protection from the penal provisions under the peace clause. This ensured peaceful and perennial procurement from peasants.

Minimum support price works as a tool to stabilize production and control consumer prices. Accordingly, the previous regimes notified prices for MSP crops so as to contain the price rise and thus a check on inflation. Even their trade policies and procurement operations followed suit. Unlike previous regimes and thus to fulfill its manifesto promise of pro-farmer stance, Modi government announced MSP policy i.e.; cost + 50% in the 2018-19 Union Budget and subsequently notified prices for 14 kharif crops with returns ranging 50 to 97 percent.

As laid out in the recently approved MSP strategy by Union cabinet, policy implementation will take the form of either procurement or price deficiency payment as in the case of Madhya Pradesh or through marketing structures to match supply and demand. The procurement strategy will follow RBI’s open market operations for raising financial resources for Government of India. In the process, RBI ensures interest rates are not artificially elevated. Similarly, Government of India’s procurement will ensure no spillover effect on consumer prices and thus inflation. This policy implementation will ensure the interests of both the farming and consumer segments.

Detour in cropping pattern, doubling income and decreased imports

India is largest producer and consumer of pulses in the world but 25 percent of the pulses consumed are imported. There have been multiple attempts to increase pulse production in the past but none of them fructified. Since Modi government assumed office in 2014, crop diversification program and targeting rice fallows helped improve pulses and oilseeds production considerably but not to the desired levels owing to lack of procurement and low MSP. A hundred day toil is not aimed at hunting for honorarium but an honest and fair price.

With MSP policy, crop diversification, targeting rice fallows and increase in rabi cropped area will pick pace to the extent of considerable reduction in import of pulses and oilseeds which constitute a significant share of agri-import basket. Significant economic gains will be witnessed – saving FX reserves and higher agricultural contribution to GDP and thus its growth. Not only will there be change in temporal cropping pattern but also spatially. Intercropping techniques like row, strip etc. will gain momentum if any of the cultivated crops is MSP notified. Net resultant of the changes in temporal and spatial cropping patterns is cost reduction, increased yields and higher incomes aiding the cause of doubling farmer’s income.

FPO establishment – a first order effect

Market access and contracted cash flows drive enterprises to either innovate or establish efficient procedures or expand or a combination thereof. A case in point is that a turmeric farmer from Nizamabad district has decided to produce higher quality crop as he witnessed a higher realization for his produce with the introduction of E-NAM in the Nizamabad APMC. Similar was the determination of a cotton farmer at Karimnagar APMC.

With insulation and thus assured base income under MSP policy and different market conditions, farmers will explore efficient methods of production and yield improvements. One policy that will attract the attention of farmers is setting up FPO – farmer producer organizations. FPO’s with turnover upto 100 crores have been provided tax exemption for a period of 5 years in the Union Budget 2018-19. Apart from the extrinsic tax benefit, innumerable intrinsic benefits flow to FPO structure like availing institutional credit as well as procuring quality and high yielding variety of seeds and fertilizers at wholesale prices.

Other intrinsic benefits include awareness and thus availing government schemes, training and exposure visits, technical assistance, sharing and implementing good agricultural practices, renting out or sharing machinery across farming operations, combined transportation of harvest for transacting at markets and, not the least, processing and value addition of produce. The cumulative effect of intrinsic benefits will consummate into cost reduction, higher price realization and thus higher incomes mustering the Modi’s mission of doubling farmer’s income.

Green revolution was largely confined to northern belt as well as to no more than two crops. On the other hand, MSP policy will be a pan-India phenomenon percolating to, not just two, but 23 notified crops. If Green revolution achieved nation’s food security, MSP policy will provide income security to farming community. In effect, India will be advancing to an era of Extended Green Revolution with farmer’s welfare ingrained. As the farming community realizes income stream from MSP policy, the nation will witness another MSP – minimal suicides of peasants.