Macro-prudential Policies – Need of an hour!!

Lessons from the recent financial crises put emphasis on the literally adverse and chaotic situation that can arise yet again, if not paid any attention to the cyclical irregularities that emerge in the global financial system. It has been more than six years now and can see a light at the end of the tunnel. United States is on a verge of recovery, unemployment rate is at six years’ low, at around 5.8%, GDP growth is back in the rage of 2.3-3.5% QoQ. Earnings of the people participating in the labour market are also growing a tad and that is encouraging.

One can take a sigh of relief that atleast we have a recovery now(only from the largest economy’s point of view), though it was inevitable, but are we prepared now for another global financial dent? Do we have a cushion (in terms of stress tests undertakings, reserved capital and equity to sustain any sort of financial aberrations) yet to sustain? Here, Macro-prudential policies come handy. Worldwide monetary policies do provide a direction to sustainability, in terms of coping with an unexpected event (read, Quantitative easing) but can there be a prudential policy in place, which can act as a bulwark for the financial system against any unprecedented crises. This is exactly what Governor Lael Brainard (At the Hutchins Center on Fiscal and Monetary Policy, The Brookings Institution, Washington, D.C.) reiterated in her address on 4th December, 2014). She has also focused on the in tandem usage of both monetary policy and macro-prudential policies for safeguarding the globally linked financial market.

Reserve Bank of India has also accepted that it is the Macro-prudential tools which are necessary today for keeping the financial institutional network intact. Urjit Patel’s report also reiterates the same view and hence stressing the importance of prudential tools. The steps taken for these policies are charted of by the Implementation of Basel III Capital Regulations in India. As per RBI’s notification of March,2014, the transitional period for full implementation of Basel III Capital Regulations in India is extended upto March 31, 2019, instead of as on March 31, 2018. This will also align full implementation of Basel III in India closer to the internationally agreed date of January 1, 2019.

Indian Banks are to be capitalized with clear charted way out for enough equity and liquidity capital essential to wither away any crises where survival becomes essential. And to make this a reality, Central bank and the Government need to work hand in hand. But, the way our political decision making process is undergoing a drastic change, we hope that the new government becomes a little prudent and start charting out plans for 2019. The political juggernaut which is being witnessed these days in the parliament with regards to the Hate Speech is something which is not accepted. The entire political fraternity should take responsibility and let the nation move forward. These small political incidents should not abandon the path for a stronger financial stability.

Falling Oil Prices – A Blessing in Disguise, but will the trend Sustain?

OPEC, a group of 12 Oil producing nation did not budge to reduce the production of crude oil touching the mark of 30 million Barrels a day. Making it difficult for the fracking industry in the US to remain relevant economically. This tussle between the two major oil producers of the world is proving to be fiscally healthy for a country like India, which imports 80% of its oil requirement.

Brent Crude and West Texas Intermediate basket humming at around $70 and $66/barrel, makes it really “Acche Din” sort of days for huge importers like us. It would ease our inflation, Wholesale and Consumer inflation, will have positive impacts on our deficits (as reported in ET, dated 29^th November, 2014, Deficit hits 90% of Budget in 7 months) and will give some leg room for the government in restricting the total deficit to 4.1% of GDP in FY15. But is it sustainable? Will this Oil bonanza sustain?

Inflation, both WPI and CPI are easing for past 3-4 months and touched multi years’ lows. With almost an average monsoon and drop in oil prices in this calendar year, the first three quarters of the FY15 has been nothing short of spectacular. Also, increasing pressure on RBI governor to reduce the rates. But will Dr. Rajan blink? Surveys conducted in the fraternity clearly highlights that Dr. Rajan is focusing on culling this inflation for once and all. Urjit Patel’s committee’s recommendation of keeping the CPI tamed at the range of 2-6% till H1, 2016, is being considered by the governor as the long term target. So bowing down at this aberration of lower prices is something which is not expected by the fraternity in the next Bi-monthly monetary policy meet, scheduled on 2^nd Dec, 2014.

 On the other hand, for the majority driven ruling party, BJP, the oil slack could not be better timed. With just 3 months left for the fiscal report to be presented for FY15 and target setting for FY16, north block should consider to make the maximum of the plummeting oil prices (promote renewable sources of energy, this sector needs dire attention of the government). At a time when the prices reflected at the fuelling pumps are market driven, the retail consumers would reap benefits of the slack. Automobile and ancillary units would also make the most of the situation as it is expected that the demand would soar and would bolster their top line.

All in all, drop in oil basket is a huge positive for the country but in order to have a sustained impact, it is important for the government to bolster policies for renewable sources of energy. Reliance on non-renewable energy should be reduced (atleast a committee formation with recommendation on reliance should be reduced to 70-75% of our total requirement is desirable). A 5-year course for reduction in reliance is imperative. Use the drastic deduction in the fuel imports for giving incentives to the public for using constant source of energy.

Look at the positives and contribute in low carbon emission efforts. Tap this time and take some swift action PM Modi. It can’t get better for energy reforms. 

The Tale of 3 Central Banks!

Central banks around the world are going through a phase which need maneuvering every time in order to sustain the drastic domestic headwinds and the harsh external shocks. Across the globe, there are two such central banks which are closely watched always and have given clues of what is about to come in couple of weeks. These references of what is about to come acts as a cushion for the rest of the world to get its financial act together and sustain the changes with ease. However, for last couple of months there have been some changes which has raised eyebrows of economists around the globe and made them think on their toes to counter the unprecedented events from two major developed nations.

On one hand, Federal Reserve is pondering over the much debated issue of "When to move up from Zero-Lower Bound?" with the final taper act in couple of months and on other hand the lack of take-up for the TLTROs (Targeted Long Term Refinancing Operations - under which banks could disburse loans at an interest rate of 0.15% for four years provided they increased lending to businesses or households) will force the ECB into more drastic action, including buying government bonds under a quantitative easing programme. The actions of major developed economies have forced the developing economies to keep a hawk-eye on the easy money flowing in their countries and their after effects. Reserve Bank of India led by Dr. Raghuram Rajan has reiterated the effects of saturation of the present easy money from the economy. It’s depreciating effect on the currency and the bubble creation in Real Estate and Stock Market (with many believing that markets are way over their sustained fundamentals).

In this case foreign investors’ flight for safety would pressurize the currency and when ECB's easy money flowing into the economy would soon become a reality, focusing on the fundamentals for an emerging economy would be the survival mantra. It is a mantra that can help us tackle the external headwinds with enough ammunition. Easing Consumer Price Index at sub 7.7% levels, with our crude basket at sub $100/barrel levels and with monsoon deficit receding at present 10% from a scary 20 plus percentage a month back coupled with pro-reforms action taken by the majority backed governments highlights are strong fundamentals and preparedness to face the external economic pressure with much confidence.

Though as of now the Indian economy has sustained the taper effect quiet comfortably, I am still curious about the after effects of, A) "Flight for Safety" on the domestic economy with interest rates being raised from the Zero Bound level and B) Europe’s easy money pouring into the emerging economies.

Productivity over Commission

The recent announcement made by Prime Minister Narendra Modi regarding the dissolution of “Planning Commission” acted as a catalyst in making the discussion and debates possible to ponder about relevant existence of the institution.

A think tank which was structured to guide the way for government in policy formulation and push reforms, slowly but steadily lost its sheen in this ultra-fast paced world, in terms of economic and technological changes. There have been questioned raised about its relevance in today’s time and so any major shuffle in the commission’s structure was jinxed by political procrastination but the majority backed Prime Sevak bit the bullet and scrapped the commission.

What did the commission fail to acknowledge that it became redundant? What did it ignore and why? Author Shankkar Aiyar hits the nail with his explanation “Centre allocated resources, the Planning Commission monitored/regulated/directed the deployment, and the states were tasked with implementation. The Centre had no responsibility to deliver, the commission no power to enforce and the states who had little say or incentive felt dumped upon. The Planning Commission represented a multi-polar disorder in the structure of governance.”

More than the Planning Commission’s execution failure it was the emergence of Individual States as a Distinct Business Unit which marred the long term plans laid down by the commission. From Gujarat to West Bengal and from Himachal Pradesh to Kerala each state found its mojo back and started attracting Domestic and International investors to invest on their land. And in the process, each state demanded autonomy in the execution of funds and the way resources should be utilized. The commission which laid the Five Year Plans could not accommodate these rapid changes in their long term plans for each state. This slowly started acting as a major glitch in the individual states’ working. Marring public sentiment and bureaucracy delayed the investment cycles. This was for me the imperative reason of why the Commission could not survive. When the world is changing every year how can a too long 5 year plan mechanism work in a growing country like ours.

Now is the time to look forward and yet again don’t establish another bureaucratic structure which would hamper the states or the Center to function effectively. Rather, this is the time to focus more on productivity of each Act or Policy which is being framed or implemented. There is news that a similar structure of what China has, called as “National Development and Reforms Commission” is being envisaged in India too, having complete autonomy and constitutional authority. But, I personally feel that again we would waste our precious time in miring another structure in political logjam by doing the same.

Rather, we should follow what Australia’s Productivity Commission does, reiterated recently by Economist Ajay Shah, focus more on productivity and not forcing upon its decision on the government. Encourage discussions within the contours of the government authorities and let the consent be earned. Don’t constitutionalize the structure so that it doesn't get dragged into the patchy waters of where the likes of CBI and CAG find themselves today. Don’t politicize the new structure. Use it as a catalyst that encourages Inclusive ideas for Inclusive Growth.

Post the Unconventional Monetary Policy and its effects on India

Since the time recession hit the shores of America and it repercussions spread across the globe, there has been a sudden drop in the Short Term Interest rates level to almost zero and large scale asset purchase became the survival plot for the mature economies.

Buying in long term bonds and Mortgage Backed Securities every month has boosted in the reserves for the banks in the industrial economies. This boost then was pushed to reap in on the interest rate gaps of the Emerging economies and the other investment opportunities which seemed attractive for large fund houses and banks. This formed the backdrop of Hot Money which poured in India aggressively. Our major indices touched all-time highs every day and gave great returns in first quarter of 2014 calendar year.

First half of 2013 calendar year was a nightmare for a country like India. Reeling with huge Current and Fiscal Deficits, rapid depreciation of the currency and depleting exports all made worse for the government and the central bank. Pushing them hard to take some serious steps before our sovereign rating gets a beating and investors’ confidence further dwindles. Few but important policy measures brought back the situation in control. And the investors’ confidence further got a boost. INR appreciated deficits under control and Forex reserve has ballooned.

In May, 2013 when the Fed hinted about their plan to reduce the asset purchases, the markets reacted aggressively, leading the Fed to clarify and pacify the situation. But the reality is it has to stop one day. And with successive reduction the complete pause in purchases of long term assets by Fed is not far away. How will the markets react? How will India handle such a situation? Will the new government put things in place before the fundamental scenario becomes unsustainable again?

Presently, the influx of external funds in indices, debt market and other assets of our country is led by factors not controlled by the domestic economy, i.e. spillovers of quantitative easing. There has been no major policy reform undertaken for the investors to believe in the long run story of India. The new government will take its position at a very critical stage of the year. When on one side USA’s economy is improving and Fed is reducing the asset purchase and on other side the overall global economy is coming back on track, luring the investors to invest for long in India need some serious policy changes.

If the new government fails to take some rapid actions and investors’ can't associate with the Indian story then the repercussions would be unimaginable. More than relying on external spillovers, it’s time for the economy to introspect and make necessary domestic policy changes to enjoy the perennial external investors’ trust and grow our domestic markets too.

Mt GOX’s Debacle: A definite learning

World’s largest Bitcoin exchange’s collapse has forced investors in this virtual currency to rethink about their investments. As per the reports, security system of Japan’s based exchange was compromised and lakhs of Bitcoins worth around $400 millions were lost/siphoned off.

It’s an eye opener for the developed and developing economies which were balancing their act together to introduce these “cryptocurrencies” in their economies for daily transactions. The volatility of this intangible currency was astounding, from $30 to $260 then touching $1000 and now dropping back to $550 within 8 months time is quiet tough for any economy to absorb.

In one of the conference, late last year, RBI Governor Raghuram Rajan explicitly highlighted the instability of such currency a threat for the economy. Although, never brushed away the reach-potency of such currency in a country like India where there are about 900 million mobile subscribers out of which 20% have internet connections on their sets but with a tighter control over Bitcoins.

As MT GOX has started counting its days before it completely perishes, similarly one day even Winkdex (active qualified U.S. dollar denominated bitcoin exchanges)would wink off completely until a tighter control is imbibed in its system.

Though one should never undermine the importance of such virtual currency, which would certainly have the next big transactional value as the world takes another leap virtually, a better control/regulation is something which would make such transactions more secure, reliable and worthy.

How to regulate such currencies? What are the steps involved in measuring inflation through these currencies? How to increase the transactional reliability among the users?  The world’s biggest economies should now take some comprehensive steps towards dealing with such issues and making such currencies a viable option for future transactions.

A step in this direction is a must now.