28 Apr 2020: The Indian Express Editorial Analysis
1) Ways of opening up-
On Monday, Prime Minister Narendra Modi held another video conference with state chief ministers to discuss the ongoing battle against the coronavirus, and to plan ahead.
This, the fourth such interaction, was held amid(among) growing signals of the government preparing for a gradual easing of the national lockdown as economic concerns begin to loom larger — with the prime minister himself noting that “we have to give importance to the economy as well as continue the fight against COVID-19”. This signals a cautious shift in strategy.
As the lockdown has progressed, with the disruption in economic activity intensifying, its toll(numbers) becoming more visible, the stark debate of lives vs livelihoods is being steadily(gradually) recast and reframed. Among several state governments too, as the fiscal strain is beginning to show, the mood seems to be shifting from unqualified support for a nation-wide lockdown to a push towards a gradual and calibrated(measured) exit.
DIFFERENT INFECTION TRAJECTORIES:
To be sure, as states are on different infection trajectories, each one will have to firm up separate plans for easing and exit. States with lesser number of infections, or with a better grip over the spread of the virus, are likely to press for easing more restrictions so as to allow economic activities to resume, at least in the green zones.
Yet even the modalities(particular method or procedure) of the exit from the lockdown in the green zones will have to be worked out carefully. One thing is clear: Both Centre and states must work together to figure out ways to allow economic activities to resume while minimising the health fallout — even as any such joint strategy will need to take into account, and make space for, the differences across states and the varied emphases of state governments.
As the number of cases mounts(increases) – during a meeting of state chief secretaries, the central government projected the number of infected in the country to reach 65,000 cases by May 15 — and the capacity of the healthcare system of the country comes under more strain, coordinated action at various levels of government will become more urgent to ensure continued expansion of the institutional capacity — setting up of containment wards, production of ventilators, ensuring adequacy of testing equipment.
During the course of the interaction on Monday, the prime minister also spoke of the need to usher in reforms that touch the lives of common citizens. While fiscal and monetary support will be needed to nurse(bring) the economy back to health, given the collapse in economic activities, the need to push through contentious but required factor market reforms that address the long-standing structural issues that plague the economy, cannot be overstated(exaggerated).
2) RBI should preserve its inflation credibility-
Following the global financial crisis of 2007-08, India, like many other countries, embarked on a stimulus(encouragement). The pump-priming(the stimulation of economic activity by investment) did not end too well. By 2013, India crossed or approached double-digit figures in inflation and the national fiscal deficit, in addition to looming bad loans.
In summer 2013, when the Federal Reserve indicated a possible reversal of its ultra-accommodative policy, macroeconomic parameters for India were so weak that it got caught up in the “taper tantrum” and experienced external sector fragility(weakness).
While fiscal excesses and financial sector stress remain issues today, India has improved significantly on at least one dimension — namely, inflation — which has also stabilised the external sector.
(TRIVIA- Financial crisis of 2007–08, also called subprime mortgage crisis, severe contraction of liquidity in global financial markets that originated in the United States as a result of the collapse of the U.S. housing market.
A fiscal deficit is a shortfall in a government's income compared with its spending. The government that has a fiscal deficit is spending beyond its means. A fiscal deficit is calculated as a percentage of gross domestic product (GDP), or simply as total dollars spent in excess of income
Macroeconomic indicators are a key part of fundamental analysis for traders, as they provide insight into the state of a country’s economy e.g GDP )
INFLATION TARGETING FRAMEWORK:
How was this beneficial progress achieved? Starting in September 2013, the Reserve Bank of India (RBI) initiated an effort to build credibility with domestic savers and international investors on maintaining inflation at prudent(careful) levels. Three years thereafter, the RBI Act was amended to put in place a flexible inflation targeting framework.
A Monetary Policy Committee (MPC), comprising of RBI representatives and external members appointed by the Government of India, was enjoined with the legal mandate of managing the policy (repo) rate — the rate at which the central bank lends money to banks, so as to keep consumer price inflation at a target level of 4 per cent, while keeping in mind economic growth.
By objective measures, the MPC framework until recently worked rather well. It lent transparency and democratic accountability to the process of interest-rate setting; combined with efforts on managing food inflation, it has brought inflation closer to the target; it has contributed to tempering household inflation expectations; and, it has kept borrowing costs in the economy at reasonable levels in spite of the high level of government borrowing and several other distortions.
Indeed, rating agencies and multilateral institutions repeatedly mention the MPC and the inflation targeting framework as a landmark structural reform towards sound macroeconomic management.
Yet, since last year, somewhat inexplicably(in a way that cannot be explained), a series of monetary actions by the RBI have left the MPC’s decision on the policy rate partly redundant(needless), diluted(impure) the accountable process of monetary decision-making, and put at stake the sanctity(authenticity) of the framework.
Let me elaborate:
With a stated intention to improve the transmission of monetary policy to households and corporations, the RBI has pumped(added) unprecedented levels of money (close to Rs 7 trillion) into the banking system. It has done so mostly by purchasing government bonds but partly also by purchasing dollars.
Given impaired(weakened) financial sector balance-sheets, transmission to economic growth has been at best muted(quiet and soft); liquidity is no silver bullet to durably address financial sector stress. The primary effect of excessive liquidity has, instead, been to monetise the government’s expenditures and keep its borrowing costs low.
With its declared aim not being met satisfactorily, the RBI has doubled down on liquidity supply, with the same outcome.
IMPORTANT CASUALTY HAS BEEN THE MPC FRAMEWORK:
At times, even when the MPC has kept the policy rate unchanged, the RBI has injected yet more liquidity to move medium-term interest rates down; the two actions have been noted to be in direct contradiction of each other. If the objective is to move medium-term rates, why not build consensus within the MPC to cut the policy rate more aggressively and communicate the rationale?
Further, given the enormous(huge) liquidity glut(surplus), every night banks park liquidity with the RBI at a (reverse repo) rate lower than the policy rate and which is not set by the MPC; nevertheless, this rate used to be changed only as part of the MPC Resolution.
Lately, the RBI has moved this rate progressively lower than the policy rate; recently, it has done so outside of the MPC meeting cycle and not as part of the MPC Resolution. There are straightforward tools in liquidity management to ensure that in surplus conditions also, the central bank transacts with banks at the policy rate — technically, by switching from “deficit” to “floor” system of liquidity management. Such a switch is routinely adopted by central banks when they provide excess liquidity; the RBI has chosen not to do so.
The net effect is that market interest rates are being increasingly controlled by the RBI rather than the MPC. Indeed, there is a proposal that the rate at which the RBI absorbs liquidity be still lower, likely divorced(seperated) from the policy rate set by the MPC.
The spirit of the MPC framework enshrined(given) in the RBI Act is being violated. It is unclear how the MPC can be expected to satisfy its legal mandate if what it seeks to achieve via setting of the policy rate is in conflict with, or compromised by, the RBI’s liquidity management.
These developments have the potential to pose risks for India’s macroeconomic stability going forward: The implicit(indirect) monetisation of fiscal expenditures through government bond purchases by the RBI in the secondary market has postponed the recognition of the untenable(indefensible) fiscal reality.
The delay has meant the government has had limited policy space since the onset(start) of COVID.
COST-PUSH INFLATIONARY PRESSURES:
Supply-chain disruptions due to measures taken to contain the pandemic raise the possibility of cost-push inflationary pressures, especially given the excessively easy fiscal and monetary conditions. This can abruptly(sudden) raise economy-wide borrowing rates, inflict losses on banks, and imperil(risk) financial stability.
If the gains in inflation credibility built by the MPC framework are dissipated(disappear) by ineffective policies and operations, both household and investor expectations for inflation in India could unhinge(unbalance).
It is disturbing that while referring to desirable levels of inflation, analysts appear to have already stopped referring to MPC’s mandated target inflation rate of 4 per cent and the focus has instead shifted to the upper tolerance limit of 6 per cent.
Worse, it could instigate turmoil(disturbance) in the external sector. Excessively low bank deposit rates may induce(force) some non-resident deposits to exit the country.
(TRIVIA- Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials. Cost-push inflation can occur when higher costs of production decrease the aggregate supply (the amount of total production) in the economy)
In a highly unpredictable time such as this, the RBI should preserve its inflation credibility. This requires making the institution of MPC more enduring(lasting over a period of time), not bypassing it.
Decision on monetary policy actions based on voting by committee members, provision of inflation and growth forecasts in the resolution statement, and coordination of rate-setting and liquidity management, need to be adhered(followed) to.
Even in desperate times, we need to follow due processes and justify with substance the extraordinary actions so that commitment is provided as to how these actions will be unwound(relax) when necessary.
3) Sharp fall in oil prices is opportunity for India to increase stockpile-
Oil prices continue to decline globally, with crude hitting multi-decade lows, as global demand evaporates(decreases). Earlier last week, in unprecedented price action, the near-month contract for West Texas Intermediate (WTI) sweet crude oil dropped to -$37.63 a bbl.
A negative price has never before been registered for a major global crude oil benchmark. The extreme price action is a signal that there is a global oil glut(excess) with few places to store oil. Global oil markets have been severely disrupted(harmed).
While WTI does not feature in India’s basket, Brent Crude Oil, which does, is trading around $25 a barrel, the lowest in 18 years.
West Texas intermediate, also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. This grade is described as light crude oil because of its relatively low density, and sweet because of its low sulfur content)
The economic consequences of COVID-19 are going to be drastic for India and the world. It is hard to say what kind of recovery the economy and markets will undergo when this is over, though there is much glib(fluent but insincere and shallow) talk of it being “V”, “U” or “L” shaped.
But whichever letter of the alphabet wins the race, one opportunity is clear: Even as India suffers from a lockdown, a silver lining(metaphor for optimism in the common English-language which means a negative occurrence may have a positive aspect to it) for future recovery and reconstruction is the price of oil.
Given India’s growth aspirations and lack of self-sustaining oil production, a sharp reduction in oil prices is a bonanza. Normally, reduced oil prices would translate into surplus for the consumers and a fiscal bonus for the government through increased tax collections.
However, given that the demand for petrol has slumped, those gains will not accrue right away. But India should look at this as an opportunity to strengthen its energy security by buying oil and filling up our Strategic Petroleum Reserves (SPR).
Considering that India was the third-largest consumer of energy in the world, as well as the third-largest importer of oil in 2018, we are particularly vulnerable to oil price fluctuations. The dramatic reduction in oil prices offers a once-in-a-generation opportunity for us to fill up our reserves in an extremely cost-effective way.
STOCKPILE OF OIL RESERVES:
Currently, we do maintain an emergency stockpile of oil reserves: Under the existing Strategic Petroleum Reserves programme, India claims to have 87 days of reserves. Out of this, refiners maintain 65 days of oil storage and the rest of the reserves are held in underground salt caverns maintained by Indian Strategic Petroleum Reserves Limited (ISPRL).
The existing and planned capacity for the underground reserves is 10 and 12 days of import cover for crude oil respectively.There are a couple of issues to be highlighted here. First, capacity does not directly translate into utilisation, which is partly because oil is an expensive commodity most days of the year.
In 2019, the average closing price of a barrel of crude was $57.05. In 2018, it was $64.90, and in 2017, U$50.84. Of the existing 10 days of capacity, only about 50 per cent is utilised.
The second issue is with regard to the refinery holdings. In India, the Strategic Petroleum Reserves(SPR) arrangement between the oil refineries and the Union or state governments is not specified well, though most of the refineries that hold stock are publicly-owned companies.
In fact, a breakdown of which refineries hold SPR and in what form (crude or refined) or information about where they are located is not publicly available.
TRANSPARENCY AND ACCOUNTABILITY:
The first step, therefore, should be to introduce transparency and accountability in relation to the SPR. The procedures, protocols and facts about Indian SPR storage require greater public and parliamentary scrutiny, just like India’s other strategic reserves (for instance, foreign exchange).
For this, there should be timely and reliable dissemination(passing) of information. Instead, it is now shrouded(hidden) in secrecy.
The lack of transparency around our SPR holdings is compounded by the ambiguity surrounding the mobilisation process. SPR reserves are meant to be used in emergencies, where time is likely to be of the essence.
The SPR mobilisation process could be made more efficient by laying out designated roles for different agencies to avoid redundancies(state of being not or no longer needed or useful) in times of crisis. There should be role and process clarity regarding SPR mobilisation. For instance, to begin with, there should be clarity on who (or which agency) can define an emergency and therefore order a mobilisation.
DIVERSIFY ITS SPR HOLDINGS:
Further, in order to mitigate(lessen) risks better, India should look to diversify its SPR holdings. Diversification can be based on geographical location (storing oil either domestically or abroad), storage location (underground or overground) and product type (oil can be held in either crude or refined form).
Storage and transportation costs could be saved by diversifying geographically. With oil dirt-cheap, if we can purchase more than we can store in our existing facilities, why not go abroad for more storage space?
For instance, one option could be to operationalise, modernise, and add to the oil tanking facilities at Trincomalee in Sri Lanka. Another opportunity would be to enter into a strategic partnership with Oman (Ras Markaz) for oil storage, which would also help India avoid the potential bottleneck of the straits of Hormuz.
However, since many of these places could potentially be vulnerable to geopolitical risks, only a small part of India’s overall SPR strategy should involve storing abroad.
Diversification could also be in the form of ownership — either publicly owned through ISPRL or by private oil companies, such as ADNOC of Abu Dhabi, which could fill up the SPR when prices are low and take advantage of price arbitrage(the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset).
This could achieve a degree of price stability and reduce the cost for India to buy such large quantities of oil. The only requirement for this to work is to have a clear contract with the private companies about the mandatory minimum level of stock that they should preserve for use in emergency times.
The Takshashila Institution, an independent think-tank, has raised several of these issues in a recent white paper. It serves as a timely reminder for policymakers to take action.
To ensure that SPR and oil security remain a priority in the near future, ISPRL should consider filling up the SPR reserves right now — and each time the price of Brent crude oil falls below a certain price, say $35 per barrel. Buying crude on the forward market is another option, but oil prices are in “contango” — which means that, contrary to normal times, future prices are higher than spot prices.
Energy is and will remain vital to India’s aspirations for growth. The sharp fall in the price of oil presents an opportunity for the Union government to increase its SPR stockpile and achieve a degree of energy security.
This is especially important at this time when every rupee needs to be conserved to get back on a positive economic track and lift the most vulnerable segments of our population.
The message is clear: While prices are low, we should fill up our reserve tanks and rent space abroad. The oil will come in handy when prices have gone up — and more importantly, when we need it.