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MPC Minutes: Need To Support Nascent Growth Recovery Kept Committee On Hold

Committee members observed that while inflation has picked up, the revival in growth is still in its early stages.



The Reserve Bank of India (RBI) logo is displayed at the entrance to the bank’s headquarters in Mumbai (Photographer: Kainaz Amaria/Bloomberg)
The Reserve Bank of India (RBI) logo is displayed at the entrance to the bank’s headquarters in Mumbai (Photographer: Kainaz Amaria/Bloomberg)

India’s Monetary Policy Committee kept interest rates on hold at its last meeting as it sought to support a nascent growth recovery, minutes of the meeting released on Wednesday showed. The MPC, less than 18 months old, is facing the first test of its flexible inflation targeting framework as it seeks to allow a revival in growth while ensuring that inflation remains within its mandate of 4 (+/- 2 percent).

At the meeting that concluded on Feb. 7, the MPC voted to keep the repo rate unchanged at 6 percent by a vote of 5-1. Michael Patra, executive director at the RBI had voted for a 25 basis points increase in the repo rate.

Explaining his decision to vote for a status quo, RBI Governor Urjit Patel noted that the recovery in growth is nascent and more data is needed to judge the persistence of inflationary pressures. The economic environment warrants caution, said Patel.

Although inflation risks have increased in recent months, incoming data should provide greater clarity about the persistence of inflationary pressures. The economic recovery is also at a nascent stage and calls for a cautious approach at this juncture. I, therefore, vote for keeping the policy repo rate on hold while maintaining a neutral stance.
Urjit Patel, Governor, RBI

The MPC expects gross value added growth to revive to 7.2 percent in 2018-19, compared to 6.6 percent in 2017-18. The committee expects inflation to range between 5.1-5.6 percent in the first half of the next fiscal, declining to 4.5-4.6 percent in the second half.

While voting to keep rates unchanged, Patel noted that food and fuel inflation have been on the rise. “With rising input prices, inflation is getting increasingly generalised. Inflation expectations have remained elevated,” Patel wrote in his statement.

Output Gap Factor

RBI Deputy Governor Viral Acharya said that the prevailing economic conditions may have prompted a pure inflation-targeting central bank to switch its stance from "neutral" to "withdrawal of accommodation". He, however, went on to argue that a flexible inflation targeting framework warrants a focus on the output gap as well. Noting that the output gap remains ‘somewhat negative’, Acharya voted to keep both interest rates and the monetary policy stance unchanged. The output gap is the difference between the actual output and potential output in an economy.

The next few months of inflation and growth data will be key to determining the evolution of policy rates. If growth remains robust and inflation prints continue to project headline inflation a year ahead well above the target, then a change in stance from “neutral” to “withdrawal of accommodation” might have to be considered.
Viral Acharya, Deputy Governor, RBI

Inflation Risks

MPC member Chetan Ghate, in his statement, said that the December reading on consumer price inflation showed a rise in all major product groups. All measures of inflation have converged above 5 percent, Ghate pointed out even though he voted to keep rates on hold.

“Adverse supply side shocks could push the Phillips curve of the economy upward posing a strong risk to the medium-term inflation target of 4 percent,” Ghate wrote in his statement.

The Philips Curve is a widely-used model that establishes the inverse relationship between the rate of unemployment and the rate of inflation in an economy.

While the MPC’s inflation target is set in a band of 4(+/- 2 percent), the RBI and the MPC’s communication has suggested that they would like to bring down inflation to the mid-point of 4 percent. This objective is yet to be achieved in a sustainable manner.

Lone Dissenter

While five committee members voted for a status quo, Michael Patra, executive director at the RBI voted for a 25 basis point hike.

Various measures of underlying inflation are converging to the headline at above 5 percent. Expectations are elevated and volatile. Fixed income markets are telling us that we have fallen behind the curve.
Michael Patra, Executive Director, RBI

India’s benchmark 10-year bond yield has risen nearly 100 basis points since September due to fear of rising inflation and higher global bond yields. A pick-up in credit demand has also prompted banks to sell down excess government bond holdings.

Patra noted that that the output gap is starting to turn up from a persistently negative state. “If the professional forecasters’ consensus of around 7 percent plus growth for 2018-19 materialises, the output gap is expected to close going forward,” said Patra.

The MPC’s February meeting was the first after the budget for 2018-19 was presented. For the coming fiscal, the government is targeting a fiscal deficit of 3.3 percent of GDP, wider than the earlier targeted 3 percent. The government also said that the fiscal deficit for 2017-18 would settle at 3.5 percent instead of the targeted 3.2 percent. In its statement, the MPC cited fiscal slippage as one of the factors that could emerge as a risk to inflation.

State Deficits

Committee member Ravindra Dholakia said that along with the center’s finances, watching state finances is important to understand the extent of fiscal slippage.

Although there is substantial fiscal slippage by the Centre, the fiscal performance of major states needs to be watched. Their revenues are now more certain and the Centre has provided for an increased transfer of tax revenues to states by 0.2 percentage points of GDP in the budget. As a result, the fiscal discipline by states is a critical factor to watch – whether it compounds or compensates for the fiscal indiscipline of the Centre.
Ravindra Dholakia, Member, MPC

The next meeting of the MPC is scheduled for April 4-5.