On June 21st, the Monetary Policy Committee made its minutes of the monetary policy discussions public. These MPC minutes are extremely valuable as they provide an insight into the thinking of each of the members. This MPC meeting came in the aftermath of weak GDP growth numbers in the aftermath of the demonetization as well as tepid food inflation. The MPC was considering rate action on the back of a scenario where inflation was well under the stipulated limit while growth in GDP and IIP was extremely tepid. Interestingly, after 4 MPC meetings with 100% consensus on rate view among the 6 participants, the fifth MPC saw a dissent vote for the first time. Here are the key takeaways from the MPC minutes for the meeting conducted on June 06th and 07th.
While Dr. Ghate was surprised by the sharp fall in CPI inflation, he maintains the view that the sustainable inflation needs to be looked at, net of pulses, vegetables and fuel. Since the inflation net of food items still remains sticky, Dr. Ghate is of the view that upside risks to inflation remain. Although inflation expectations of the RBI are also down, his view is that inflation net of food and fuel needs to sustain lower on a more consistent basis. Dr. Ghate is also not too keen to consider the lower GDP data as that could be more an impact of the seasonal lag effect of the demonetization drive. As a result, Dr. Ghate’s view is to wait and watch for the sustainability of non-food inflation and growth without the impact of demonetization. Dr. Ghate has voted for a status quo to be maintained with repo rates retained at 6.25%.
While Dr. Dua also sees a case for a rate cut in the falling inflation rate, she is keen to examine the impact of implementation of GST, remonetisation and the implementation of the IBC Code before taking a decision. Dr. Dua is of the view that GST could add to GDP growth as well as to inflation. She is also of the view that the lag effect of remonetisation would start to show up soon and hence the impact could be higher inflation and higher GDP growth. Also, the bankruptcy proceedings could have a structural effect on growth and that may also be an interesting data point. Dr. Dua has also expressed apprehensions that in the event of the US Fed hiking rates, the rate differential may be critical. Dr. Dua has also voted for maintaining status quo on rates.
Dr. Dholakia has been the sole dissenting voice in the MPC. In fact, Dr. Dholakia has gone to the extent of calling for a 50 basis points cut to attack the twin challenge of low inflation and tepid growth. Dr. Dholakia’s argument is that the RBI projected inflation has been the lowest in recent memory and this has a major insufficiency of demand factor attached to it. Dr. Dholakia’s argument is that even assuming that inflation goes higher from here, it is likely to be absorbed by higher growth and is unlikely to pose any problems. In his view, a rigid approach to rate setting may not work in this case and the only solution would be a sharp cut in rates. Such a move is also likely to help the Indian industry bridge the current output gap, which is around 25%. Dr. Dholakia has recommended a 50 basis points cut in repo rates from 6.25% to 5.75%.
In fact, Dr. Patra was the member who had originally suggested shifting the stance of the RBI monetary policy from “Accommodative” to “Neutral”. With both Dr. Patra and Dr. Urjit Patel warning of upside risks to interest in the April policy, any sharp shift appears to be unlikely. Dr. Patra is of the view that deflation in pulses and vegetables prices could hardly be a steady-state sustainable scenario. Dr. Patra is of the view that for India to grow at 7.3% GDP, the output gap of 25% itself should be sufficient. Hence a rate cut at this point would not only be unnecessary but also redundant. Dr. Patra would prefer to wait and watch till the time the transitory and structural factors manage to de-couple giving a more sustainable measure of inflation. Dr. Patra voted for a status quo in repo rates.
As the deputy governor of the RBI, Dr. Acharya’s view assumes significance as he represents the insider view. His concern has been more on the forex flows front. According to Dr. Acharya, with the Fed looking to hike rates till the end of 2018, the risk of the yield spread narrowing was real and that could lead to a quick risk-off trade by FPIs. Dr. Acharya is of the view that such a shock may create an unnecessary disruption in the overall economy with implications for the external value of the rupee and the financial markets. Dr. Acharya also believes that rate cuts may not be meaningful unless the banks are restructured so that transmission can be ensured.
Dr. Patel has preferred to err on the side of caution as he feels that any premature policy action may be hard to unwind. Also Dr. Patel believes that monetary policy has done its bit and it is now for fiscal policy to play its part. That will be key to a revival of the investment cycle, which would require a clean-up of the bank balance sheets. Dr. Patel has also voted for a status quo on rates.
The good news is that the MPC narrative appears to be changing. While only Dr. Dholakia has tuned
dovish, the broad hawkishness of central bankers is missing. That will make the next MPC a lot more interesting.