MPC Minutes: MPC Sees ‘Avant Garde’ Role For Monetary Policy Amid Covid-19 Risks 
An Indian national flag flies at the Reserve Bank of India (RBI) building in Mumbai, India. (Photographer: Kanishka Sonthalia/Bloomberg)

MPC Minutes: MPC Sees ‘Avant Garde’ Role For Monetary Policy Amid Covid-19 Risks 

Faced with an abrupt change in the macroeconomic scenario due to the local spread of Covid-19, India’s Monetary Policy Committee called for coordinated interest rate cuts and liquidity infusion to counter emerging growth risks and ensure financial stability.

The committee, which held an emergency meet from March 24-27, decided to cut the policy repo rate to 4.4 percent. Alongside, the Reserve Bank of India announced measures to infuse Rs 3.75 lakh crore in liquidity, include a 100-basis-point cut in the cash reserve ratio.

The minutes of the meeting released on Monday showed that most committee members felt that these measures were essential to maintain financial stability and impact some support to growth.

Shaktikanta Das, RBI Governor

The RBI governor said arresting risks to the growth outlook and preserving financial stability should receive the highest priority at this stage.

  • Space for policy action has opened up in view of the disinflationary effects of deceleration in demand under the impact of Covid-19.
  • Weaker overall demand outlook and lower crude oil prices should keep upside risks to inflation firmly contained, even in the face of temporary supply chain disruptions and scope for opportunistic use of pricing power.
  • Arresting risks to the growth outlook and preserving financial stability should, accordingly, receive the highest priority.
  • The substantial rate cut, along with several other regulatory and liquidity augmenting measures being announced as a part of developmental and regulatory policies today, convey the resolve of the Reserve Bank to deal with the macroeconomic fallout of Covid-19 preemptively.
The Reserve Bank will continue to remain vigilant and will not hesitate to use any instrument — conventional and unconventional — to mitigate the impact of Covid-19, revive growth and preserve financial stability.   
Shaktikanta Das, RBI Governor

Michael Patra, RBI Deputy Governor

Noting that risks emerging from the spread of coronavirus, highlighted in the February policy statement, have come to the fore, Patra argued for the need for monetary policy to play an ‘avant garde’ role.

  • Even as it fights the corrosive impact of Covid-19 on macroeconomic and financial conditions, monetary policy has to provide confidence and assuage fear.
  • This involves easing financing conditions for people and institutions, keeping finance flowing to all agents in the economy, ensuring that markets do not freeze up.
  • Inflation has peaked and will likely ease well below the target in the second half of 2020-21. In the extreme scenario in which we are, however, the easing off of inflation may occur sooner and faster.
  • This outlook offers the scope for taking a calculated risk on current levels of inflation — which rule above the target — and focus on the 12 months ahead forecast.
  • By this rule, there is space for policy action that is large in size relative to its past but still keeps the policy rate positive in real terms over a one year ahead horizon so as to see off any lingering or latent inflationary pressures.
  • Output gap is widening and may become pronouncedly negative as the situation evolves.
The RBI must provide the assurance that the RBI is at the forefront in the war against Covid-19 and will use all instruments at its command to fight the virus and mitigate its fall out.
Michael Patra, RBI Deputy Governor

Janak Raj, RBI Executive Director

The RBI executive director, who recently joined the MPC, highlighted the likely impact on growth, even though the MPC has stayed away from providing any forecasts.

According to him growth for the year as a whole is likely to be weak for three reasons. First, discretionary spending by households is likely to be curtailed in general even though there could be some pent-up demand in some sectors. Second, external demand will remain weak, impacting our exports. Third, weak domestic and external demand is likely to cause a delay in revival of investment activity. “However, the increased government spending may cushion the slowdown,” he said.

According to Raj:

  • Various segments of the financial market have become extremely volatile and trading volumes have declined, pushing yields across the spectrum of yield curve.
  • The domestic equity market has plummeted in the face of massive selloffs by foreign portfolio investors.
  • On the whole, domestic financial conditions have tightened and could seriously undermine monetary transmission, which otherwise improved in the more recent period.
The main challenge for monetary policy at this juncture is to ensure that the adverse impact of Covid-19 on domestic demand is not amplified. It is also necessary to make sure that financial markets, which have been under stress with yields hardening across the maturity spectrum, do not intensify macroeconomic risks by impairing monetary transmission and giving rise to financial stability risks.
Janak Raj, RBI Executive Director
The three RBI executives along with Ravindra Dholakia voted for a 75-basis-point cut, while Pami Dua and Chetan Ghate voted for a 50-basis-point cut in rates.

Pami Dua, MPC Member

Dua, like others, saw the room for significant policy action, but added that it is important to preserve space for interest rate cuts down the line.

  • In the current scenario, with heightened uncertainty and a near-standstill in economic activity, this (interest rate cuts) may not necessarily lead to an increase in borrowing, but should raise consumer confidence and investor sentiment, going forward.
  • It may be better to conserve some policy space for later, when those binding constraints are removed and the economy will require a further boost to recover from the pandemic.

Chetan Ghate, MPC Member

Ghate saw the interest rate cut at this stage as ‘insurance cut’, but added that it may not have an immediate impact in a demand-constrained economy.

  • Monetary policy should minimise the fall in aggregate demand, that is, we should minimise the extent of permanent damage done to growth by the Covid-19 shock.
  • Hence, the required cut in the policy rate should be large given the severity of the shock. What is required is in the nature of an insurance cut.
  • In a demand-deficient economy, a large rate cut, however, will be akin to pushing on a string. This concern prevents me from voting for an even larger cut in the policy rate this time.
As noted recently by former Fed Chairman Ben Bernanke in an AER article, monetary policy has never proved able to reverse large shocks. It only helps to mitigate the worse effects of shocks, and speeds up the recovery.   
Chetan Ghate, MPC Member
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