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Focus of Monetary Policy is Now Conclusively on Ensuring Better Transmission

As per our estimates, the so-called ‘core' system liquidity (total banking liquidity minus government balances) is around Rs 65,000 crore

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Monetary, Policy, Transmission
It thus seems reasonable to infer, in the absence of an official framework on liquidity ‘targets', that the RBI will want to ensure sustained liquidity surpluses of this magnitude going forward as well. Pixabay

The focus of monetary policy is now conclusively on ensuring better transmission. Towards this, for the first time in recent history the RBI has consciously moved liquidity stance to positive. Indeed, the Governor has lately referred to the Rs 1-1.5 lakh crore positive system liquidity as a comfort factor and facilitator for banks.

It thus seems reasonable to infer, in the absence of an official framework on liquidity ‘targets’, that the RBI will want to ensure sustained liquidity surpluses of this magnitude going forward as well.

The micro aspects:
As per our estimates, the so-called ‘core’ system liquidity (total banking liquidity minus government balances) is around Rs 65,000 crore as on early August. Assuming currency in circulation (CIC) seasonality of last year and superimposing a nominal growth rate to this, the system will lose around Rs 2,20,000 crore from here to March 2020.

Monetary, Policy, Transmission
The focus of monetary policy is now conclusively on ensuring better transmission. Pixabay

Adding back a higher RBI dividend and some balance of payment accretions, we are largely left with zero core liquidity by end of the financial year. However given the RBI’s current liquidity preference, we would assume they would want core liquidity to be at least be in surplus by a similar magnitude as today. This means that one should reasonably expect further open market operation (OMO) bond purchases from the RBI of at least Rs 65,000-75,000 crore between now and end of the financial year.

A further implication of this is that domestic net government bond supply between October and March is largely agnostic to whether the government decides to do a foreign currency sovereign bond issue or not. This is assuming that say $10 billion raised by government from offshore sovereign bonds would have been entirely converted by RBI into rupee liquidity. Thus the need for OMOs would have fallen to that extent.

Refreshing a table we had done in an earlier note, the Rs 70,000 crore assumed for the sovereign bond issue may just end up getting replaced as RBI OMO should the bond issue not happen.

While on the subject, one has to comment on the conceptual fallacy in the criticism often levied towards RBI’s OMOs as being monetisation of government deficit. Assuming an unwillingness to cut Cash Reserve Ratio (CRR), the only two other tools for policy driven liquidity creation is purchase of forex or bonds. Long term repos are no solution since this is ‘borrowed’ and not permanent liquidity.

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Given that purchase of forex is a function of flows that the RBI doesn’t directly influence, it has to resort to purchase of bonds for discretionary enhancements in core liquidity. Now, if this were being done much beyond the requirements of liquidity creation for the explicit purpose of supporting the bond issuance program or was systematically tied to the quantum of such program or didn’t display two-way directionality, then one could have legitimately argued for backdoor monetisation.

However, there is no evidence of this as well. Thus, any impact from OMOs has to be treated as largely an unavoidable cost of policy implementation just as other tools affect other market variables.

The macro aspects:
As can be seen, after the disruption from the global financial crisis (GFC) had subsided, the ratio of broad money (M3) as proportion of quarterly GDP had largely settled in a range. This broke lower post demonetisation, but hasn’t reverted still to its previous range. This is despite the well acknowledged growth slowdown that has now been underway for some time.

Monetary, Policy, Transmission
Towards this, for the first time in recent history the RBI has consciously moved liquidity stance to positive. Indeed, the Governor has lately referred. Pixabay

After largely tracking nominal GDP growth rates between 2012 and 2015, M3 growth had started to fall below GDP growth from early 2016, even before demonetisation. It is only very recently that M3 growth has been catching back with nominal GDP.

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It can be argued that a necessary ask from monetary policy in response to the broad-based slowdown is for a higher rate of money supply growth than what has been in the recent few years. Indeed, that seems to have been the case also in the ‘golden’ growth period of 2005 – 2008, where M3 growth was much above nominal GDP growth. Assuming no changes to the money multiplier, this implies a higher pace of expansion in RBI’s balance sheet, including through more aggressive purchases of domestic bonds. (IANS)

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Trump’s Deep Misunderstanding of Trade Policy is Threatening the American Economy

President Donald Trump's aggressive and unpredictable use of tariffs is spooking American business groups

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Trump, Trade, Policy
FILE - Steel rods produced at the Gerdau Ameristeel mill in St. Paul, Minn., await shipment, May 9, 2019. The recent flareup with the U.S. over Mexico tariffs may prove to be a pivotal juncture. VOA

President Donald Trump’s aggressive and unpredictable use of tariffs is spooking American business groups, which have long formed a potent force in his Republican Party. Trade

Corporate America was blindsided last week when Trump threatened to impose crippling taxes on Mexican imports in a push to stop the flow of Central American migrants into the United States.

The two sides reached a truce Friday after Mexico agreed to do more to stop the migrants. But by Monday, Trump was again threatening the tariffs if Mexico didn’t abide by an unspecified commitment, to “be revealed in the not too distant future.”

Such whipsawing is now a hallmark of Trump’s trade policy. The president repeatedly threatens tariffs, sometimes imposes them, sometimes suspends them, sometimes threatens them again. Or drops them.

Trump, Trade, Policy
FILE – Traffic moves on the old Gerald Desmond Bridge next to its replacement bridge under construction in Long Beach, Calif., July 2, 2018. President Donald Trump’s tariffs provoke retaliatory tariffs on U.S. exports. VOA

Business groups, already uncomfortable with Trump’s attempts to stem immigration, are struggling to figure out where to stand in the fast-shifting political climate. They have happily supported Trump’s corporate tax cuts and moves to loosen environmental and other regulations. But the capriciousness of Trump’s use of tariffs has proved alarming.

“Business is losing,” said Rick Tyler, a Republican strategist and frequent Trump critic. “He calls himself ‘Mr. Tariff man.’ He’s proud of it. … It’s bad news for the party. It’s bad news for the free market.”

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“It was a good wakeup call for business,” James Jones, chairman of Monarch Global Strategies and a former U.S. ambassador to Mexico, said of Trump’s abrupt move to threaten to tax Mexican goods.

Creating distance from Trump

Just last week, the sprawling network led by the billionaire industrialist Charles Koch announced the creation of several political action committees focused on policy — including one devoted to free trade — to back Republicans or Democrats who break with Trump’s trade policies. A powerful force in Republican politics, the network is already a year into a “multi-year multi-million dollar” campaign to promote the dangers of tariff and protectionist trade policies.

The Chamber of Commerce, too, is in the early phases of disentangling itself from the Republican Party after decades of loyalty. The Chamber, which spent at least $29 million largely to help Republicans in the 2016 election, announced earlier this year that it would devote more time and attention to Democrats on Capitol Hill while raising the possibility of supporting Democrats in 2020.

Trump, Trade, Policy
FILE – A field of soybeans is seen in front of a barn carrying a large Trump sign in rural Ashland, Neb., July 24, 2018. President Donald Trump’s enthusiasm for tariffs has upended decades of Republican trade policy that favored free trade. VOA

Few expect the Chamber or business-backed groups like the Koch network to suddenly embrace Democrats in a significant way. But even a subtle shift to withhold support from vulnerable Republican candidates could make a difference in 2020.

Trump’s boundless enthusiasm for tariffs has upended decades of Republican trade policy that favored free trade. It has left the party’s traditional allies in the business world struggling to maintain political relevance in the Trump era.

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Uncertainty for businesses

Trump’s tariffs are taxes paid by American importers and are typically passed along to their customers. They can provoke retaliatory tariffs on U.S. exports. And they can paralyze businesses, uncertain about where they should buy supplies or situate factories.

“Knowing the rules helps us plan for the future,” said Jeff Schwager, president of Sartori, a cheese company that has had to contend with retaliatory tariffs in Mexico in an earlier dispute.

Trump seems unfazed.

Trump, Trade, Policy
FILE – Sen. Chuck Grassley, R-Iowa speaks at a town hall meeting in Greenfield, Iowa, June 2, 2017. VOA

Myron Brilliant, head of international affairs at the U.S. Chamber of Commerce, went on CNBC on Monday to decry “the weaponization of tariffs” as a threat to the U.S. economy and to relations with trading partners.

Trump responded by phoning in to the network to declare “I guess he’s not so brilliant” and defend his trade policies.

“Tariffs,” he said, “are a beautiful thing.”

Trump can afford to be confident about his grip over the party: Roughly nine in 10 rank-and-file Republicans support his performance as president, according to the latest Gallup polling. So Republicans in Congress have been reluctant to tangle with him.

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But last week’s flareup over the Mexico tariffs may prove to be a pivotal juncture. The spat was especially alarming to businesses because it came seemingly out of nowhere. Less than two weeks earlier, Trump had lifted tariffs on Mexican and Canadian steel and aluminum — action that seemed to signal warmer commercial ties between the United States and its neighbors.

“This really came out of left field,” said Daniel Ujczo, a trade lawyer at Dickinson Wright. “It was something we thought we had settled, and we hadn’t.”

Weighing legislation

Congress was already showing signs of wariness, especially over Trump’s decision to dust off a little-used provision of trade law to slap tariffs on trading partners. Section 232 of the Trade Expansion of 1962 lets the president impose sanctions on imports that he deems a threat to national security.

Trump has deployed that provision to tax imported steel and aluminum. And he’s threatening to impose Section 232 tariffs on auto imports, a chilling threat to American allies Japan and the European Union.

Congress is considering bipartisan legislation to weaken the president’s authority to declare national-security tariffs. In doing so, lawmakers would be reasserting Congress’ authority over trade policy, established by the Constitution but ceded over the years to the White House.

The legislation has stalled in Congress this spring. But on Tuesday, Iowa Republican Chuck Grassley, chairman of the Senate Finance Committee, said the bill would be ready “pretty soon.” Given “how the president feels about tariffs,” Grassley said, “he may not look favorably on this. So I want a very strong vote in my committee and then, in turn, a very strong vote on the floor of the Senate.”

Congressional reluctance to challenge Trump could be tested in coming months. Lawmakers may balk if he proceeds with plans to tax $300 billion worth of Chinese goods that he hasn’t already targeted with tariffs — a move that would jack up what consumers pay for everything from bicycles to burglar.

Likewise, taxing auto imports — an idea that has virtually no support outside the White House — would likely meet furious resistance. So would any move to abandon a trade pact with Mexico and Canada. Trump has threatened to withdraw from the 25-year-old North American Free Trade Agreement if Congress won’t ratify a revamped version he negotiated last year.

For all their disenchantment with Trump, the Chamber of Commerce may yet find it hard to break its ties to the party. Though the chamber says it’s weighing a more bipartisan approach, it recently featured a sign on its front steps: It likened Trump to Republican icons Ronald Reagan and Dwight Eisenhower. (VOA)