MPC Meet: Monetary Panel Faced Bouncers On Inflation Mandate, Low Short-Term Rates
Boys play a game of cricket at the Deonar landfill site in Mumbai. Photographer: Dhiraj Singh/Bloomberg

MPC Meet: Monetary Panel Faced Bouncers On Inflation Mandate, Low Short-Term Rates

India’s Monetary Policy Committee, which kept a status quo on rates and maintained an accommodative guidance into next financial year, faced its share of bouncers at its last meeting, show minutes of the meet released on Friday.

Apart from debating the extent of rebound in the economy and persistent inflation, the meeting saw one committee member counter the growing view that the MPC is side-stepping its mandate, while another member questioned whether excess liquidity and low short term rates are benefitting the “oligopolistic core” across the Indian industry.

Debating Short-Term Rates

Going into the policy review, many in the markets thought the committee or the central bank would act to put a floor on excessively low short-term rates. Treasury bill rates and commercial paper rates had traded below even the RBI’s reverse repo rate.

While the central bank stayed away from announcing any changes, the debate found its way into the MPC’s deliberations. JR Varma questioned the benefits of permitting such low rates to persist, saying they may prove to be inflationary and benefit only the largest firms.

A reduction in long-term rates that stimulates investment not only increases demand in the short run, but also stimulates supply in the medium term, said Varma. “By contrast, the demand that’s stimulated by a reduction in short-term rates isn’t accompanied by an offsetting supply boost, and therefore carries greater inflationary risks.”

Varma also questioned the “oligopolistic core”, which has weathered the pandemic well, is benefitting most from these market conditions.

These are also the enterprises that are benefiting from borrowing at rates below the policy corridor through commercial paper issuance. I fear therefore that a sustained failure to defend the policy corridor could prove expensive in terms of creating inflationary pressures and inflationary expectations though, so far, low rates have been feeding into asset markets rather than goods price inflation.
JR Varma, Member, MPC

Varma voted for a status quo on rates and the accommodative stance, with liquidity conditions that keep short-term rates close to the reverse repo rate, “while being wary of a drop below it”.

Ashima Goyal took a differing view.

As long as the MPC stance is accommodative, durable liquidity will be in surplus and short-term rates will not rise above the reverse repo rate, she said in the minutes.

Rates have fallen below the reverse repo because of the combination of excess foreign inflows, intervention and reverse repo access limited only to banks. Even so, excess liquidity is still absorbed. Regulatory exposure norms can help prevent excess low rates driven short-term borrowing that creates risks.
Ashima Goyal, Member, MPC

Is MPC Side-Stepping Its Mandate?

Meanwhile RBI executive director and MPC member Mridul Saggar took on the chatter that the committee is going counter to its mandate by maintaining an accommodative stance and surplus liquidity even as inflation remains above its target of 4 (+/-2)%.

Saggar noted that the Covid-19 pandemic had has left a “huge negative output gap”, which has driven the accommodative monetary policy approach. The output gap is defined as the difference between potential output and realised output.

“As the pandemic shock created a huge negative output gap, even with high weight to core inflation along with lower weights to headline inflation and output gap, the projected path of these variables leaves time before policy rate hikes will become necessary, Saggar wrote.

He, however, said if the output gap closes faster than anticipated, core CPI inflation surges or more supply-side shocks lead to generalisation of inflation, policy will need to respond appositely.

I am labouring to explain this point because accommodative monetary policy has been misread by some as demise of inflation targeting. Quite to the contrary, current policies are consistent with the flexible inflation targeting mandate and hard empirical calculations of how monetary policy needs to react to projected path for key variables. The framework itself has delivered unambiguous gains in disinflating the economy and lowering inflation expectations.
Mridul Saggar, Executive Director, RBI

Window For Lower Rates Narrows

On the core issue of elevated inflation and relatively better-than-expected growth, most committee members were of the view that growth remains fragile and needs support. They, however, acknowledged that elevated inflation can’t be overlooked.

Governor Shaktikanta Das said though the recovery is underway, there is still continuous need to nurture and support growth to make it broad based and durable.

A premature roll back of the monetary and liquidity policies of RBI would be detrimental to the nascent recovery and growth. The overall situation needs to be monitored carefully, both in the sides of growth and inflation.  
Shaktikanta Das, Governor, RBI

Deputy Governor Michael Patra, however, warned that “elevated inflation has checked in and may be here to stay.”

He explained that with retailers striving to recover lost incomes, it’s unlikely that compensatory margins being built into prices will ease in the near term. Meanwhile, households recouping lost incomes may work towards keeping the supply price of services elevated. Returning cyclical demand may allow a higher pass-through of input prices into selling prices.

Economic activity is recovering but hesitantly and unevenly. This warrant continuing policy support till it is set on a firm trajectory of self-sustaining expansion. At the same time, the confluence of forces determining inflation outcomes and their likely persistence imparts downside risks to growth, unless contained early. Amid this high uncertainty, the MPC’s dilemma around its window of accommodation has become more acute than at the time of its last meeting.
Michael Patra, Deputy Governor, RBI
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