No Comfort On Growth But Inflation Risks Kept MPC On Hold
Five of six MPC members saw upside risks to inflation and voted to keep rates unchanged
Members of the Monetary Policy Committee focused on rising risks to inflation in the economy, most recently from higher oil prices, as they voted to keep interest rates unchanged at the panel’s last meeting in December. The decision for a status quo in rates came despite continuing uncertainty expressed by most committee members on a revival of growth.
Five of the six members of the committee had voted in favour of holding rates.
Explaining his view, Reserve Bank of India Governor Urjit Patel said the inflation scenario is evolving along expected lines, but added that there are “several” risks to the expected inflation trajectory.
Risks highlighted by Patel included:
- An increase in inflation expectations of households for the three-months ahead and one-year ahead periods.
- Rising input cost pressures across the board for both manufacturing and services, which have raised the risk of pass-through to output prices.
- Concerns of fiscal slippage, which would have implications for the inflation outlook.
The governor, however, added that these risks could be balanced to some extent by a seasonable moderation in vegetable prices and the pass-through of lower GST rates. The GST Council reduced rates on as many as 200 items in November.
At its December meeting, the MPC had increased its inflation forecast for the second half of the current fiscal to 4.3-4.7 percent. In November, retail inflation rose above that band to 4.88 percent. Over the medium term, the MPC has been targeted with maintaining inflation in a band of 4 percent (+/- 2 percent).
RBI Executive Director Michael Patra, in his comments, said that inflation risks cited in previous resolutions are materialising and are no longer restricted to a few items alone. Patra expects inflation to come in higher than the MPC’s target from here on. RBI deputy governor Viral Acharya noted that oil prices have rebounded and this has created “significant input cost pressures in the economy”.
The view was shared by external members Pami Dua and Chetan Ghate.
Compared to the last review, various risks are materializing around inflation becoming generalized and need to be watched carefully. The positive co-movement between the output gap and inflation excluding food and fuel since 2010-11 suggests that a closing output gap will generate demand-pull pressures on inflation as growth revives. The conquest of Indian inflation is certainly not a done deal!Chetan Ghate, Member, MPC
Ravindra Dholakia, the lone MPC member who voted for a rate cut, said the RBI has wasted a window to reduce rates and revive growth in the economy. Dholakia, until the October MPC meet, had argued that a 50-basis-point cut is warranted given the state of the economy. At the December meeting, Dholakia reiterated that the inflation situation is under ‘reasonable control’.
“The real cause of concern right now is the economic recovery and its slow pace,” said Dholakia while adding that fiscal space to push growth is “more or less exhausted”.
Had the policy rate been cut to 5.75 per cent in June 2017 as I had argued then, the economic recovery would have been far more rapid and we would have been in a much better position. Although we have missed the bus, it is still better late than never.Ravindra Dholakia, Member, MPC
While other members of the MPC did not share Dholakia’s comfort on inflation, they did not dismiss his concerns on growth.
Ghate noted that the growth revival “lacks animal spirits”. He expressed concern about the decline in consumer confidence and muted investment demand, despite a pick-up in headline GDP growth to 6.3 percent in the second quarter of the current fiscal. Acharya added that the output gap remains ‘somewhat negative’ as reflected in present low capacity utilisation and high inventory.
Governor Patel, however, highlighted some factors that hint at an improvement in the quarters ahead.
Financial conditions have improved significantly in the recent period as reflected in large capital raised from the primary capital market and a pick-up in bank credit growth. These perhaps may be indicating a long-awaited (modest) upturn in an investment cycle.Urjit Patel, Governor, RBI
Most members who voted for a status quo in rates were in favour of maintaining a neutral stance, which allows them to respond to incoming data.
One member—Michael Patra—felt that it was time to signal a turn in the policy stance.
“The time has come for monetary policy to take guard and be ready to go on to the front foot,” Patra, who has consistently been the most hawkish member of the MPC, wrote in his statement.
The current phase of accommodation in the monetary policy stance – reduction of the policy rate by 200 basis points–is one of the deepest barring the easing associated with the global financial crisis. Also, it has been more fully transmitted. In my view, this phase has matured; it is time now to signal its end and commence the withdrawal of accommodation, consistent with the evolving stance of liquidity management.Michael Patra, ED, RBI
The repo rate has been brought down from a high of 8 percent since the start of this interest rate reduction cycle, which began in 2015, and now stands at 6 percent.