MPC Members Concur On Growth Slowdown But Differ Sharply On Fiscal Risks

India’s six member Monetary Policy Committee, which voted — this time unanimously — to cut the benchmark policy rate for a third time in 2019, agreed that slowing growth in the economy warranted a strong monetary policy response. The members, however, differed on the role that fiscal policy will play in the outlook for inflation and interest rates in the coming period.

On June 6, the MPC cut its benchmark repo rate by 25 basis points to a nine-year low of 5.75 percent. The committee also voted to change its stance from ‘neutral’ to ‘accommodative’, suggesting room for more rate cuts.

Growth Concerns Dominate

The minutes of the meeting, released on Thursday, paint a picture of a dovish MPC, with most members citing the fall in core inflation and GDP growth as signs of a weakening economy. Even previously hawkish committee members — Viral Acharya and Chetan Ghate — acknowledged the need for monetary stimulus, albeit reluctantly.

RBI Governor Shaktikanta Das was among the stronger proponents of monetary stimulus on the committee and called for “decisive action.”

Das cited both the weakness in GDP data and high-frequency indicators to support his view, while adding that both core inflation and inflation expectations have moderated as well.

Deputy Governor Acharya, who until the April policy, had voted for a status quo in interest rates took a philosophical approach while describing his dilemma on which way to vote.

In the minutes, Acharya asks: How should I vote? I found that I was speaking to myself as Santiago, the old fisherman, in “Old Man and the Sea” by Ernest Hemingway: “It is better to be lucky. But I would rather be exact. Then when luck comes, you are ready.”

His dilemma was eventually resolved in favour of a rate cut as he saw lower rates as an “insurance” against a deeper growth slowdown. He, however, continued to cite upside risks to inflation and fiscal concerns as balancing factors for monetary policy.

Each of the remaining four MPC members also expressed worries on growth, emerging largely from the weaker-than-expected GDP growth of 5.8 percent in the fourth quarter of 2018-19.

“The evolving macroeconomic configuration imparts urgency to strong policy support for the flagging economy in pursuance of the goals set for the MPC,” wrote RBI Executive Director Michael Patra. He also called for fiscal support to growth, saying that while monetary policy acts as a first line of defence, “a coordinated full throttle effort by all arms of macroeconomic management is the need of the hour”.

Ravindra Dholakia, who has been the biggest proponent of lower rates, continued to cite the need for lower real interest rates in the economy but also noted that such a lowering of rates will create space for future policy action.

Pami Dua cited both domestic and global signs of slowing growth in support of her vote for lower rates.

Chetan Ghate noted that the “divine coincidence” of a widening output gap and lower-than-target inflation allowed for lower rates. “ A rate cut at the current juncture would help both close the output gap and bring inflation back to target, a situation of “divine coincidence,” Ghate wrote.

Fiscal Divide Within The MPC

While all members agreed on the need to support growth, the committee was sharply split on the emerging fiscal risks.

‘Team Acharya and Ghate’ took on ‘Team Dholakia and Das’ on this front.

Acharya noted that overall public sector borrowing requirements– which appropriately accounts for extra-budgetary resources and other off-balance sheet borrowings of central and state governments –have now reached between 8-9 percent of GDP.

Acharya highlighted the following implications of these large public sector borrowings:

• There is a significant aggregate demand push linked to government expenditure that needs to be recognised as a source of inflation.
• Increase in issuance of public debt and country risk premium can feed into imported inflation.
• High public sector borrowing impair monetary policy transmission due to crowding out effects on bonds and bank deposits through small savings which continue to offer rates that are significantly higher than market yields.
• This channel bites particularly when the domestic savings rate is on a decline and increases economy’s reliance on external sources of funding.

Ghate supported that view, writing that fiscal “prestidigation” can lead to a “doom loop”.

Dholakia took on his argument.

“The concern about first, the fiscal slippage at this stage and second, its adverse impact on inflation in my opinion is both misconceived and misplaced,” Dholakia argued.

He explained that a slowdown in nominal growth can lead to fiscal slippage even without a change in expenditure patterns. To attempt to meet a stated fiscal deficit number under such circumstances could make fiscal policy “pro-cyclical” and deepen the slowdown.

According to Dholakia, fiscal performance must be evaluated through the concept of “full-employment budget deficit” or “the structural budget deficit”, which is not observed but has to be calculated taking potential output rather than actual (or observed) output.

Governor Das added to that argument saying that the government has been broadly a fiscally responsible one. The government has “adhered to the fiscal deficit glide path in the last 5 years, though at a somewhat slower pace than committed earlier”, Das wrote.

The increased public sector borrowings, according to him, should be seen separately from the central government’s balance sheet.