MPC Minutes: MPC Finds Itself In ‘Tunnel Of Testing Tradeoffs’

A majority of India’s six-member Monetary Policy Committee, which voted to keep rates unchanged at its meeting in February, sees some space for further interest rate cuts, showed minutes of the meeting released on Thursday.

With growth weak and inflation high, the committee finds itself in, what Reserve Bank of India’s deputy governor called, “the tunnel of testing tradeoffs.”

The MPC met soon after the Union Budget, which pegged the fiscal deficit at 3.8 percent for FY20 and at 3.5 percent at FY21. While economists have debated the government’s ability to meet the targets, most believe the budget will only provide mild support to the economy in the near term. This puts the burden of lifting demand conditions on monetary policy, which is constrained by a sudden spike in inflation, led by food prices.

Shaktikanta Das, RBI Governor

Das struck a dovish note in his commentary suggesting that a focus on growth is important in the current situation.

According to Das:

• Considering the overall evolving growth-inflation situation, it would be prudent to continue the focus on growth in the context of the expected moderation in inflation.
• This would indeed be in sync with the concept of flexible inflation targeting.
• Financial stability also requires revival of the growth trajectory.
• Accommodative stance should be retained “as long as necessary to revive growth, while ensuring that inflation remains within the target”.
• Barring the intensification of global risks, there is policy space that needs to be timed optimally and opportunistically to maximise its impact on growth.

Michael Patra, RBI Deputy Governor

Patra, who was recently appointed deputy governor, was a bit more cautious on the outlook for inflation.

According to Patra:

• The MPC has entered the “tunnel of testing tradeoffs and it may be a while before the light at the end of the tunnel is sighted”.
• Over the 12 months ahead horizon, forecasts are indicating some let-up in inflationary pressures, but it is not yet clear as to when and how the current inflation surge will bottom.
• Monetary policy has headroom to respond to the evolving macroeconomic configuration, but a good fix is needed on the “shape of the inflation hump”. Incoming data will have to be carefully parsed for this purpose.
• The endeavour now should be to improve transmission of the cumulative 135 basis points rate reduction effected since February 2019 and seize the opportunity when it opens up to act judiciously and effectively to support the economy.

Janak Raj, Executive Director, RBI

Raj, who joined the committee just ahead of the February meet, also sees some room for further interest rate cuts when inflation eases.

According to Raj:

• While current low growth is the outcome of deficient demand, high inflation is an upshot of a supply shock. These conflicting dynamics pose a challenge for monetary policy.
• Weak demand conditions warrant further monetary policy easing, while elevated inflation and the highly uncertain inflation outlook call for a cautious approach.
• There is policy space, which could be used once the inflation outlook becomes clear.
• In a scenario of slowdown in growth, monetary policy has a role to boost aggregate demand consistent with the inflation objective.

Chetan Ghate, Member, MPC

Ghate was the lone MPC member who said there was no space for further policy rate cuts.

According to Ghate:

• Monetary policy continues to be well positioned. “While I don’t see space for further cuts going forward, I remain data dependent.”
• While the current spike in headline inflation is likely to lack persistence, the inflation numbers should be carefully watched.
• “Fiscal deficit uncertainty may require the MPC to accept tighter-than-desired monetary conditions to ensure our commitment to the medium-term inflation target.”
• Real GDP growth during March 2015-September 2019 averaged 7.2 percent. This would suggest that the Indian economy has performed like a “7-4” economy (averaging roughly 7 percent growth and roughly 4 percent inflation) over the period of flexible inflation targeting.
• The growing chorus challenging the efficacy of flexible inflation targeting in India is worrying. “For those who advocate targeting an inflation rate higher than 4 percent, I am sorry: 4-6 percent inflation is not price stability!” Ghate said.

Ravindra Dholakia, MPC Member

Dholakia, who has in the past argued for steeper rate cuts, saw enough reason to pause and watch not just inflation but also the outcome of state budgets. He believed that the central budget was contractionary rather than expansionary.

According to Dholakia:

• “Union Budget for 2020-21 has been presented with no major impact on growth and inflation in my opinion.” As a result, there is no risk of output gap closing rapidly in the short to medium term.
• “Under such circumstances, in my view, the monetary policy should preserve policy space for any rate action at an appropriate time.”
• The response of various state governments to the Union Budget 2020-21 in terms of their budgets is a major uncertainty deciding almost the other half of the fiscal policy for the country.
• Real rates of interest and policy rates globally are very low and negative in several comparator counties. “Our real rates are high.”
• There is a definite space for policy rate action. The question is — is this the right time? “We need to wait for the other half of the fiscal policy given by the budgets of the states.”

Pami Dua, MPC Member

Dua was also in favor of a wait-and-watch approach.

• To address growth in the economy, there is merit in adopting a wait-and-watch approach. This will allow for the pending monetary transmission to be realised in the near future.
• Further, measures already undertaken by the government to address the growth slowdown are expected to play out.
• While growth is slowing, headline inflation has increased beyond the upper tolerance band and is expected to remain at elevated levels (5 percent or above) through Q2 2020-21.
• At this juncture, it is, therefore, best to monitor incoming data on both inflation and growth, given the evolving inflation-growth dynamics.