The macros have now turned favourable for Indian markets. On Thursday, rupee rose almost a percent. At 70.67 to a dollar, rupee traded at the highest level since August 29 2018.

The 10-year-bond yield ended at 7.71 percent and that is the lowest level since first week of May. All this as crude fell below $63 per barrel, its lowest level since February 2018, a full 30 percent below its October highs.

How does this change the landscape of interest rates and liquidity in India? The liquidity in the interbank market has also fallen sharply in the entire year since big cash withdrawals in the two weeks leading to Diwali and big dollar sales by RBI this year, when the rupee was depreciating fast.

CNBC-TV18 caught up with B Prasanna, group executive and head, global markets group, ICICI Bank; Sajjid Chinoy, chief India economist, JPMorgan and Soumya Kanti Ghosh, SBI group chief economic advisor, to understand if there is a scope to cut interest rates and not hike them as the policy stance indicates.

Watch the video here:

Edited Excerpts:

We have almost forgotten that we have an instrument called cash reserve ratio (CRR), now that there are other ways in which the prudential norms are implemented like the liquidity coverage ratio did not exist for decades. It is about one or two years old, do you think we should not keep so much cash as CRR and is it time to bring the ratio down?

Prasanna: CRR is not exactly a forgotten instrument so if you remember it has been discussed a lot over the last couple of policies and the Reserve Bank has actually gone out in a limb to say that it is an instrument which is a long-term instrument and they would like to keep it under rate of 4 percent for a considerable period of time.

They have not really wanted to touch CRR as a liquidity infusing tool. So to answer your question as what are the various tools which can be used for liquidity infusion, so obviously open market purchases is one such very important tool which has been used already by RBI and for the month of October and November you have seen calendars coming out and they are doing a good job in terms of infusing liquidity.

The other way in which you can infuse liquidity by RBI staying intervenes on the buying side when dollar comes in the foreign exchange market and just let the liquidity remain in the system rather than postpone it by doing a forward purchase.

So these are broadly the only the two instruments. Technically or theoretically, the CRR is also a potential tool which is available but that is for the Reserve Bank to take a call as to whether they want to really use it as an instrument to change a liquidity. In the past they have always linked CRR along with the rest of the instruments like Repo rates as a signaling tool and so if RBI is still in a tightening stance like you have rightly put, it is going to be a little tricky for them to look at changing that stance so quickly and say that okay I will touch CRR.

Having said that there must be a lot of other considerations also in terms of what is the right level of CRR that potentially banking system like India can have and it probably requires far more analysis and a detailed study before we can really comment on that.

I also wanted to ask you what is your estimate of the amount of liquidity the system will need even now when we are all complaining and ministers are complaining louder than anyone else that there is tightness in the market. This despite Rs 40,000 crore of open market purchases on bonds being done by the Reserve Bank and Rs 80,000 crore notes being put in two months. if the Reserve Bank were to only use OMO then it becomes very distorted. The government sells Rs 8,000 crore of bonds or Rs 10,000 crore of bonds in one week and two days later it comes and buy back that much this is almost monetisation of deficit. It will distort the yield curve won’t it? So do you think OMO as a single instrument is enough?

Prasanna: You are right it is very difficult to disagree with you on that particular argument. But in terms of requirement of liquidity what you were asking, I think our estimate goes that till the end of the year. You would expect currency in circulation leakage to be around Rs 1.2 lakh crore further from here till end of the year. The fact that we are already sitting on a core liquidity deficit of around Rs 1 lakh crore means that the total liquidity requirement according to our estimate would be around 2-2.5 lakh crore by the end of the year. That is provided RBI wants to really go to a system a stance of zero neutral liquidity what they have been telling over the last few policies.

So, it is a call that the Reserve Bank will need to take whether they are wanting to go to zero neutral liquidity and a call which they need to take is as to how much of bonds they can actually use to purchase. Your point is right that if the government is borrowing Rs 6 lakh crore in a year and RBI is buying more than Rs 2 lakh crore beyond a point it becomes really unsustainable. My calculation shows that there is scope for both. They could do maybe around another Rs 75,000 to Rs 1 lakh crore of bonds further as well as there is some scope for CRR. But like I said that is a call which the Reserve Bank will have to take that is not for something that really we can comment on it at this stage.

Is the calculation of inflation likely to change? Any question of CRR cut or rate stance change will happen only if inflation is durably lower, it seems to be that way with food disinflation being higher than we thought and fuel prices suddenly coming like a shock.

Chinoy: The world and India is a very different place, macro-economically from even six weeks ago. Remember what the environment was at the last policy meeting, oil prices had moved up 10 percent, the concern was minimum support prices will push up food prices and there was still a belief that global growth was powering on all engines. The food inflation trajectory in our view is changing and changing very rapidly.

Right now assuming that oil stabilises around $65 per barrel, you have seen a dramatic food disinflation and here I think all credit to the government. The fact that food inflation has been moderating for five successive years tells me there is clearly a structural component to the disinflation, supply bottlenecks have been alleviated, the transmission of price signals from consumer to farmer is faster and more complete and therefore the supply response is greater.

So, to the extent that food inflation is so exceptionally benign and assuming that oil is at $65 per barrel or between $65 and $70 per barrel and assuming that the rupee is stable, we are actually looking at a big undershoot to what the RBIs forecast is. Our own sense is November inflation, for example, is going to be below 3 percent at 2.7 percent. However, between October and March our forecast is around 3.3 or 3.4 percent. Remember what the RBI had 3.9 to 4.5 percent was their range for the next six months and we are looking at inflation in the low 3 percent. Even if you take that some of these are base effect induced, if you go from January to June which are the clean inflation prints, even building in some mean reversion of food prices, we are looking at a 4 percent inflation average. So, yes the world has changed, the inflation trajectory has dramatically changed and that opens up many more degrees of freedom for the central bank.

To the RBI's credit, the world was screaming that there should be a rate hike in the previous policy and they stood their ground and did not hike and only changed their stance. However, now even the change of stance needs to be changed once again, is it? If Sajjid is right and I think your figures were even more dovish when I last spoke to you, please give me your inflation forecast for March and it looks like the positive real rate is 300 basis points or almost that. Surely this calls for at least a change in stance or a rate cut or do you think that will be too embarrassing at this juncture, that is why I was suggesting CRR?

Ghosh: First let the concept of a rate cut out of the window because yes RBI has moved to a calibrated tightening, but to be fair to the RBI, the volatility in the oil prices - nobody expected that oil would decline close to $60 per barrel within a span of one month, not even the most optimist of the market participants.

So, from that point of view, I think the change in the stance in the October policy I believe was a little late, it should have happened in the June policy when the first rate hike was done because, with two successive rate hikes and no change in the stance, I think that was the time when the RBI could have moved the change in the policy stance.

What I am trying to say is, now a change in the policy stance at this point of time with the current disruptions in the food supply management, I think will look a little odd and that could actually lead to a discontinuity in the policy description.

In terms of inflation numbers which we are talking about, our estimates also for the inflation numbers at least till June 2019 is very dovish and next 2-3 months inflation number could be in the range of 2.6 to 2.7 percent and in March inflation number which was higher than 4.5 percent at some point of time, is now actually closer to 4 percent. So, if the current trends in inflation continue, any possibility of rate action looks a little remote. Also, a change in the policy stance at this time could also look a little bit uncertain or looks a little bit odd out of the market uncertainty.

I wanted to first make it more sectoral. There are some sections which are hurt both by liquidity tightness and by other problems, probably trust. If there is sufficient liquidity then maybe a little part of the trust problem also goes away. I mean the NBFC sector and the real estate sector, anything at all the policymakers can do to make life easier for them since clearly there is scope? Inflation worries are at least not there at all?

Prasanna: For that particular problem my perspective would be for people to really decide and sense whether is it a liquidity deposit, is it a solvency issue or is it a liquidity issue and I think all of us know and agree that it is more of a solvency and ALM gap kind of an issue that has actually led to some of the problems that you are really talking about.

Yes, liquidity at the system level has also been an issue but that has been an issue because of the foreign portfolio investment (FPI) outflows that we have seen plus the CIC (core investment companies) leakage that part of the liquidity, the quantity of liquidity which was a concern is being addressed by RBI by virtue of the open market operations.

Now as far as the targeted liquidity is concerned, yes you are right that when you try to solve a particular segments problem by infusing liquidity in general then it leads to other kinds of assets allocation decision which would not necessarily be optimal. So, it is very important for regulator to think from an overall macro perspective does the system require liquidity and if so how much liquidity it is needed. So at this point in time, I think the understanding is that overall system liquidity is required because we are at a huge negative and that is the reason RBI is doing OMO that not really for the purpose of the NBFC issue that came in.

As far as the sectoral liquidity issues are concerned maybe some of the demand from the industry perspective is being that they want some kind of a back stop from RBI in terms of lending to this kind of institutions. But I am a little bit more conservative in my approach. I would say that the RBI should not get into the business of actually taking credit risk and it should actually provide the appropriate level of liquidity to the banking system and then ensure that it is capable of taking the relevant risk appetite and the relevant exposure on to its books on lending it to the NBFCs either by way of direct lending or by way of picking up NBFC portfolios on to its book. That is the best way that we should go about thinking about this whole problem.

You have yourself said that system liquidity is Rs 1 trillion at this point in time and going forward it is going to be Rs 2 trillion in a few months. So, what else can they do and is the worst of the crisis over because most of the CPs have been rolled over?

Prasanna: I would say a substantial part of the rollovers have happened and the liquidity has started flowing in and banks have started looking at taking exposures to a lot of these NBFCs in various forms, not just direct lending but also through other methods of buyouts and pass-through certificates (PTC ) and securitisation and so on and so forth.

The mutual funds have also not been faced with the kind of redemptions that they were fearing, it has been far lesser. So to that extent, they are also having the liquidity but it is a question of credit risk and risk appetite right now because the lending by mutual funds in the collateralised borrowing and lending obligation (CBLO) market is at an all-time high. So, that clearly means liquidity is available and it is upto them to really take the risk of lending to a few NBFCs which they think is probably over-leveraged.

So, no real answers for those screaming headlines that NBFC companies and real estate need liquidity, there is nothing the RBI can do, you wouldn't advise a Troubled Asset Relief Programme (TARP) or anything like that?

Prasanna: No. I have a conservative thought process in this particular matter and I would not advocate some kind of credit risk lying on RBIs balance sheet. However, it is upto the banking system and as long as liquidity is available with the banking system , provide the right kind of capital and the right kind of environment for them to take extra risk to lend to this kind of institutions and it has to come at the appropriate pricing which the institutions think is good for them.

The framework we now use is the Urjit Patel committee report on monetary framework where repo was the instrument for inflation control and OMO was the instrument for liquidity. Is there no place for CRR at all? China is using it merrily, why can't we experiment, why should we not think out of the framework?

Chinoy: Let us understand what the scale of the issue is. I agree with Prasanna that currency in circulation has been very strong all year long and the fact that the RBI has been selling dollars in the first 6 months of the year has meant that even if you make relatively conservative estimates on currency in circulation growth for the rest of the fiscal year, one needs to inject about Rs 1.5 lakh of durable liquidity into the system.

There are two parts to the RBIs liquidity framework, the minimalist part is to keep the weighted average call rate close to the repo rate and that you can achieve even by doing term repos. The RBI has done 28-day repos, 56-day repos and anchored the weighted average call rate to the repo rate. The second part to their framework is that durable outflows which are currency in circulation and foreign exchange intervention must be offset by durable inflows.

So, the question is what are these durable inflows? Around the world, central banks can only create base money in two ways - net domestic assets through bond purchases or net foreign assets. So, in general, you want to spread the requirement across multiple instruments, so you do not end up distorting prices too much. So, what I would expect is, in the coming months, we will certainly see a lot of term repos, I expect we will have to see a lot of OMOs. Hopefully, because of the relief we have got from oil our sense is the current account deficit in the second half of the year will be tracking closer to 2.2 or 2.3 percent which then means we will probably be in a balance of payments (BoP) surplus and the RBI will be intervening in the forex market and creating rupee liquidity.

To your question about CRR, two points - in theory, yes there could be a fourth instrument and the one that the RBI could deploy. The only difference I would say is not to get into this philosophical argument about whether it is a monetary instrument or a liquidity instrument. It does have monetary dimensions because when you cut the CRR, you change the money multiplier.

I will just say that the level of the CRR when we entered the Lehman crisis was at 9 percent. If you remember between October 2008 and January 2009, that was slashed from 9 percent to 5 percent, there was a 400 basis point cut. So, you want to keep enough gun-powder whereby if god forbid there is a global crisis in the next year or two and we need to in a week infuse a lot of liquidity into the banking system, you want to have enough space by having the CRR at a level which you can cut and slash dramatically.

Even if we were to cut the CRR by 50 basis points today, that gives you Rs 60,000 crore, it doesn't preclude you from having to do the other things which are the OMOs and the term repo's and possibly some forex intervention.

What would your thoughts be, all through the 90s YV Reddy would say the end game of CRR should be 3 percent and at that time we used to work with high CRR percentages, is not 3 percent a sufficient number? Why should it be 4 percent, what is your complaint against that instrument and each economy works on a different plane - China is using CRR, not that it is the most cutting edge economy but in an emergency we can, can't we?

Ghosh: There is one point I would like to mention is that the RBI has actually managed the liquidity regime quite well because they have a stated objective of moving the weighted average call rate to the policy rate and given the fact that durable liquidity, that means the currency in circulation and the liquidity is taken out because of the RBI's forex intervention has been evenly matched by OMO, the term repo and the autonomous factor government cash balances.

If you actually look into the liquidity adjustment facility (LAF) operations and the government cash balances, they have almost matched each other. That means the autonomous factor also has been matched by the LAF interjections. Having said that I think the use of CRR as a policy instrument in the modern financial system is extremely limited. To be fair to RBI, they have clearly said that as an instrument of active money supply, it creates imbalances in the financial system and it should be only used under emergency circumstances. For example, after the demonetisation there was a CRR imposed, then there was also a CRR imposed in 1990s when capital inflows used to come in.

So, I think it is now an instrument only used for emergency circumstances and it actually needles the multiplier and also it is not an effective instrument in controlling the money supply.

As Sajjid just said a 50 basis points cut could only inject around Rs 60,000 crore into the system and create imbalances. So, to be fair I think the instruments which the RBI is currently using are fine and they should continue using it in terms of active liquidity management.