RBI MPC minutes: Slowing growth, tamed inflation prompted rate cut

Members of the monetary policy committee (MPC) were concerned about slowing growth, while being sure about inflation remaining under control in the coming year, which opened up room for a cut.

The Reserve Bank of India (RBI) cut its policy rate by 25 basis points on June 6, bringing the repo rate to 5.75 per cent, and the MPC also voted unanimously to the policy stance to “accommodative”, from “neutral”.

Minutes of the MPC meetings held on June 3, 4 and 6 showed that the members felt a rate cut, with a change in stance, was necessary for various reasons, including bringing down India’s real interest rate, which was proving to be uncompetitive against the country’s trading partners.

“Growth impulses have clearly weakened, while the headline inflation trajectory is projected to remain below 4 per cent throughout 2019-20 even after considering the expected transmission of the past two policy rate cuts,” RBI Governor Shaktikanta Das, who chaired the committee, said.

“Keeping in view the evolving growth inflation dynamics, there is a need for decisive monetary policy action,” Das said, voting for a 25 basis points rate cut and a shift in policy stance.

Deputy Governor Viral Acharya, though, was a little wary of advocating a cut, but did so with a change in stance nevertheless.

“Counterfactual exercises suggest that under the baseline projections of the RBI, the policy repo rate at 6 per cent is just “right” in the short term to achieve the MPC’s mandated target of 4 per cent headline inflation in the medium term. However, the large decline in ex-food-fuel inflation since the April policy implies some space in these counterfactual exercises to accommodate growth weakness with a policy rate cut of about 20 basis points sometime in the middle of 2019-20,” Acharya said, according to the minutes.

Acharya said it was important for the central bank to maintain its credibility on fighting inflation, especially the imported inflation, as the Indian economy regularly faces the issue of “twin deficit” (current and fiscal deficits) on a regular basis when external shocks amplify domestic weaknesses.

Acharya also defended the relatively tight fist of the central bank in 2018, not cutting rates even when inflation was cooling off.

“Since monetary policy response will cool down inflation only with substantive lags, some headroom needs to be maintained in the inflation trajectory below the mandated target so as to absorb the steep rise in imported inflation without the headline moving far away from the target.”

Similarly, there should be headroom retained in the policy rate space so as to help revive growth with monetary accommodation once the economy has cooled off and twin deficits reined in.

“In my assessment, this is exactly the “robust” approach that the MPC had adopted during the last year.”

The deputy governor in charge of monetary policy said since India’s share in global export was not much, the concerns of global slowdown hitting India on account of trade tensions were “somewhat overstated”.

Acharya also said a good view about the inflation could be formed after carefully going through the Budget, and how that would address the rural distress.

Another RBI insider, executive director Michael Patra, while voting for a rate cut and change in stance, said, “monetary policy by itself cannot bring about a reinvigoration of economic activity. Monetary policy is taking the lead as the first line of defence, but a coordinated full throttle effort by all arms of macroeconomic management is the need of the hour.”

External member Ravindra Dholakia said fiscal slippage at this stage and its adverse impact on inflation “is both misconceived and misplaced.”

“In my opinion, we should continue correcting our real interest rates by bringing down our policy rate. I, therefore, vote for changing the stance to accommodative and reducing the policy rate further by 25 bps, although I would have preferred to cut it by 40 bps this time.”

The real interest rate should be lowered to 1.5 per cent. “With expected inflation around 3.7 per cent, there is a space of about 75-80 bps of rate cut,” Dholakia said. However, caution should be maintained while proceeding with cuts, and slow and steady approach would be preferable, he said.

Chetan Ghate said the RBI’s study on corporate performance paints a less drastic (or mixed) picture on the health of the economy when compared to say other indicators used in the national account statistics, or the index of the industrial production.

“I also worry that the very nature of the Indian growth model, which requires excessive policy induced tinkering with the inter-sectoral terms of trade to meet both distributional objectives and demand push objectives makes fiscal-monetary coordination difficult,” Ghate said, adding that any good policy should close output gaps and therefore, a rate cut can be advocated.

“The gloomy global scenario also highlights the fact that India cannot rely on external engines of growth in the current circumstances. Thus, an internal boost to demand would be the preferable option,” said Pami Dua, another external member.