Summary of RBI-Analyst Conference Call - Dec 18, 2013

Dr. Raghuram Rajan (RRR): Recent readings suggest that headline inflation, both retail and wholesale, have increased mainly, but not exclusively on account of food prices. There is, however, reason to wait before determining the course of monetary policy. There are indications that vegetable prices may be turning down sharply. RBI has decided to maintain the status quo.

Reserve Bank will be vigilant and will act if expected softening of food inflation does not materialize and it does not translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall.

Gautam Rajesh Kumar, Trust Financial Consultancy: Given the fact that stability in Forex market has returned, CAD has come down, liquidity in the banking system is relatively comfortable, what is the comfort level of inflation for RBI to act on policy rate?

RRR: At this point trying to specify a final target is probably premature, but we do want to see both headline and core inflation come down. So we are also interested in seeing headline inflation which includes the food and fuel component also stabilise and fall.

Srinivasa Varadarajan, Mount Nathan Capital Management: In 1QCY14, it is estimated that about $15 billion of the oil swap will mature and will increase the rupee liquidity in the system. Will the period be used to actually push through the government debt swap at that point in time.

RRR: Actually the net amount is less than $7 billion right now. So that is approximately what will have to be repaid overtime. As and when the time comes, we will take a view as to how that repayment happens and it could be settled through an exchange of rupee funds based on the settlement amount. It could also be, the swaps could be rolled over if necessary and of course if market conditions permit, it can also be repaid. 

Namrata Narkar, IDBI Bank: WPI inflation forecast is being placed largely between 6% and 7% for March 2014. How much of deviation from this forecast is tolerable and if the deviation is above the tolerable level, would the composition of such a deviation then hold significant?

RRR: It depends on not just the WPI, but a whole set of other measures. On the WPI we have been very clear on bringing headline below 5 and core below 3. 

Prasanna, ICICI Securities: You have mentioned the negative output gap as a key factor in helping to contain inflation. Does that mean you do not expect the output gap to narrow in coming quarters and therefore you expect FY15 growth to remain around levels observed in H1FY14?

RRR: My personal sense is that with growth at let us say around 5%, we have somewhere between 1.5%-2% output gap at this point. So with that kind of situation, I think it will take a year or two to get back to potential and therefore we have some room or some time in which the output gap will continue to be negative and exert downward pressure on inflation.

Badri Niwas, Citi Bank: Given you have the experience of July, would you give some guidance to the market on whether the RBI will again use monetary policy tools as a defence for the currency in event of disruption risk that you mentioned manifesting?

RRR: There are some people who argue the disruption this time will be more limited, partly because people have already reacted somewhat over the last 3-4 months. And from India’s perspective, we are in a better position because a) our CAD is much more contained, b) our reserves have grown and we have shown an ability to raise funding if necessary and c) We have lost a fair amount in short maturity bond funds which have the ability to leave more quickly and what remains are the longer term funds. 

Anjali Verma, PhillipCapital: RBI is in favour of removing gold import restrictions. Is it the right time to the remove restrictions and what adverse impact it can have on CAD.

RRR: Gold restrictions are distortion and they are a necessary distortion at this point to restore balance to the CAD. But going forward we would not like this distortion to persist and we would like to remove it.

Ashish Kela, Birla Sun Life Asset Management: Dr. Rajan had highlighted the need to provide real returns to savers. What is the plan on this front? Will this play a role in the monetary policy?

RRR: The question of providing real returns to savers is very much on our minds. We do want to restore savings growth and move towards financial savings by households and I think we have to bring inflation down to make sure that these returns are positive. In the meantime there are stop gap arrangements that are part of a longer term strategy. One example of that is inflation indexed bonds in which real returns are fixed at1.5%.

Rajeev Malik, CLSA: Given widespread macro level demand supply imbalances, what is the efficacy of a blunt instrument such as interest rate in loading CPI core inflation in the supply constrained economy?

RRR: Some of the areas where we had high inflation- pulses and milk- some of that inflation has come down considerably which means there is a supply response that is kicking in and higher prices are a way to activate that supply response. More generally, even in a situation where there are supply constraints of one kind or the other, to the extent that demand exceeds supply, it creates inflationary pressures, some of it is a necessary price adjustment or relative price adjustment, but some of it feeds into more widespread wage inflation. 

Aastha Gudwani, Birla Sun Life: Are we done with the rollback of exceptional measures taken in July, is the cap on LAF here to stay? If yes, then how do you intend to reinstate repo as the permanent operative rate?

RRR: We have ample liquidity and we are largely, with a little bit of volatility, near about the repo rate as being the operational rate. So in that sense I think we have gone back to normal monetary policy at this point.

Inflation Indexed Bonds - Real risk of good intentions turning into bad economics?

Indian FM, in its current pursuit to contain fiscal deficits, have taken certain strong measures. One of the important steps taken is introduction of inflation linked bonds. FM is desperately trying to wean off Indian investors from their insatiable demand for gold which is widely considered a hedge against inflation and one of the main culprits behind rising deficits.

Govt earlier tried to discourage the gold demand by raising the import duty from 2% to 6% in beginning of this year but met with little success. Gold recently sent a shocker down the Govt spine when Apr statistics indicated a 138% jump in gold imports to $7.5 billion, taking the current account deficit to $17.8 billion from $10.3 billion in March.

Govt now is re-attempting to provide an alternative investment route in the form of inflation linked bonds to protect the investors against rising prices. In its earlier attempt in 1997, Govt offered protection to only principal payment. But this time, it went one step ahead and offered interest income to be also indexed to protect against inflation.

RBI's bond sale on Tuesday was a success as the corporates lapped up the product. Issue will open for retail investors in October this year.The main selling point is an offer of 1.44% real yield over the final WPI, with almost four months lag period, which means current offer is linked to January 2013 WPI rate.

There are two major issues with the current bond sale. First, the debt is indexed to WPI, which we know calculates the price changes in the trades among the corporates NOT consumers or retail investors. This essentially means, bond does not provides consumers protection against the rising prices, what best it does is provide partial protection. There is almost 4.5% difference between current WPI and CPI numbers. Though, it is too early to speculate on its impact on gold demand, I am not sure replacing WPI with CPI as the inflation benchmark in the offer would have served the purpose of streamlining the Govt finances.

Second major issue is, which is really a downside, what happens if, we faltered on our path to regain the lost growth, FII flows dries up due to some reason and we are left with falling currency, which fires up the inflation and inflationary expectations in domestic economy and Govt is left with huge bonds liability in a slow growth environment which will raise Govt borrowing costs and inturn stoke further inflation. Nobody on the street is seem to be discussing this.

What all I know is, global economy is not out of mess, markets are been artificially inflated with central bankers printing huge quantity of money, commodity prices are down - not because of increasing competition or supply but decline in demand across the developed countries and every important economy is struggling to get growth back on its feet.