By K. Yatish Rajawat
“It has been adopted and has become too much of a convention… “, RBI Governor Shaktikanta Das angry explanation on cutting the repo rate by 35 bps instead of following the tradition of cutting it in multiple of 25 bps.
The RBI Governor reacted angrily on being questioned on why he is breaking the convention, he was angry that it was adapted as a convention. If there is a convention which RBI Governor and MPC (Monetary Policy Committee) needs to challenge, it is the convention of incrementalism.
The frustration and anger that the Governor expressed is also because every twitch of his is analysed. Every alphabet and comma in the policy statement is questioned. When every move is tracked, small dalliance from past are pounced upon by commentators viciously sliced and diced. It makes one defensive about changes as things seems to be out of control. But it’s not the change, it’s the lack of pace that is bothersome. A incremental change as an institutional approach is serious issue. Now compare the anger of businessman, employees who feel that their businesses and jobs are going away due to circumstances beyond their control.
If the same problem has to be solved, every quarter by making another small change it shows a fearful mindset. It shows a mindset afraid of taking a bold step. A mindset mired in tradition of gradual shifts, postponing the ultimate. This is Central bankers’ approach to solving a problem bit by bit. Not roil the market, prepare it for the change before making it. A sudden step can lead to a rout in currency which may affect confidence in the market and impact even the stock market. A sharp turnabout can crush the bond market raising bond prices. Foreign investors, credit rating agencies may get startled with the risk as they anticipate that the central bank is always hiding more than it is revealing. A central banker cannot be alarmist, it’s not his job to create turbulence in markets. Even if there is a fire, he has to make it appear that its not going to burn anything. He cannot provide oxygen by his utterances or action.
Hence, incrementalism as an approach comes naturally to a central banker, there are no sudden moves that the market cannot anticipate and predict. Incrementalism is identified with conservatism and worn as a badge of honour. Hence, even after retirement it is difficult for Central bankers to shed it as this article by former Governor D.V. Subbarao says about sovereign bond. According to him, the idea is good but the timing is not right. He does not know when the timing is right but does not want to surprise the market. Change slowly is the maxim.
The incrementalists are also perfectionists they know the problem too well they have discussed it threadbare. They do know that India is the only large economy with positive interest rates in the world. Take a look at this data sheet comparing real interest rates across the biggest economies it shows that the real interest rates in India are higher than the Europe, US, China and Japan. We had negative interest rates in 2012 and the economy was doing well but the obsession with inflation ignoring the other factors is taking its toil now. The data clearly shows that there is need to cut rats by more than 135-150 bps.
The RBI is not ready but the market is awaiting this. There is another thing that the RBI is not preparing the market. That is the pace of slowdown. Auto numbers have been falling since April 2019, June saw the biggest fall in 18 years. The largest company Maruti Suzuki saw the biggest dip in July . The demand slowdown happened earlier it did not appear on companies balance sheet because they were still choking the supply chain and the dealer with unsold inventory. The demand got hit further by banks and NBFCs stopping consumer credit . The auto dealers are burdened with unsold inventory, working capital has dried up, and they are threatening to cut 2 lakh jobs . All this has happened fast in one single quarter – April to June – which is too fast for a central bank to anticipate and prepare the market. Has the government or the RBI respond to the woes of the sector not yet. The pace at which sectors are tumbling is too fast for an incrementalist approach.
The same thing is happening in services and BPO sector. Here the shift and the change is even more difficult for to capture as they do not borrow from banks. There is little or no debt on their balance sheet, no distress in revenues or profit, but they have started shedding people. Overall employment is coming down in the largest job engine of the country, due to automation . These numbers will not show up in the unemployment numbers as it does not track retrenchment of mid-level service sector employees. This will finally show up in lower tax collection, and consumer spending with a lag effect. Indicators come with a lag effect, response time is slow, pace of change is accelerating. Automation is an exponential change. This is a wake up call.
The GDP growth is slipping, but RBI wants to acknowledge it 10 bps at a time. To do so in any other manner will create panic. Indian savers who have been brought up on a healthy rate of interest would panic if the rate are cut rapidly, Though the saving rates in the country is at a historic 20 year low . The incrementalist thinks that people will not notice the drop in deposit interest rates if done gradually. Its built on a premise that people don’t see a change if it happens slowly, the boiling frog thesis. Unfortunately, there is a social shift underway, average of age of savers is rising while numbers are not rising. Culture of saving is changing Millenials look at banking from transactional point of view not fixed deposit. Central bankers know it all but why exacerbate the shift, it will happen.. C’est cera, cera.
The shifts maybe gradual and generational in nature, but there are others the structural shifts which are not being noticed due to the fact that they are happening too fast.
The incremental approach of let’s do a 35 basis points cut wait, than wait for another quarter to do next cut. Wait for several quarters for it to transmit. Wait for more expression of pain for it to flow to the MSME sector. Wait and watch if an NBFC is about to collapse, but don’t interfere.
Its interesting that this approach is not considered wrong. If you go back to the archives of 2008 and see the discussion that were happening in Federal Board of Governor meetings in the US. They were slow to understand the full impact of the calamity facing them even two days after Lehman Brother went down. The Fed’s meeting discussed and kept the rate at 2 per cent.
The RBI is candid about the problem in NBFCs so that the markets knows but it has not done anything about it. NBFCs growth happened in the shadows of a frozen banking sector. NBFCs funded companies that banks would not lend, mutual funds subscribed to bonds that NBFCs would not subscribe. Now they are both collapsing on each other faster than you can say fraud, or contagion.
Almost every sector is slipping and sliding away as credit squeeze, regulatory overreach and technology disruption is affecting them. This is not something that the RBI is unaware it’s overflowing with internal advice, is being pushed by the Minister of Finance and even external analyst. The RBI is stuck with taking baby steps so who will take the leap to solve the whole problem in one stroke.
Developed countries have built their economy by manipulating their currency and interest rates . China has been ruthless with deposit rates for decades, manipulating its currency shamelessly and at will. A former Fed Governor once told me that what is holding India back is self- belief. NDA 2.0 does not believe in incrementalism. Did Amit Shah first abrogate section 35 A than discuss and scrap article 370, and then put up a bill for the bifurcation of the state of J&K ? How long would that have taken, a year or never.
The time to react is rapidly shrinking the time to act is now.
(K. Yatish Rajawat is a policy analyst and journalist. He tweets @yatishrajawat)