MPC Minutes: Understanding The MPC’s Switch From Hawkish To Dovish

Lower-than-expected inflation, some signs of a slowdown in growth and a legal mandate that targets headline inflation gave four of six members of India’s Monetary Policy Committee enough reason to cut interest rates earlier this month. The two outliers remained focused on elevated core inflation and felt that policy rates were at an appropriate level given the growth-inflation mix in the economy.

At its February meet, the Monetary Policy Committee decided to cut its benchmark repo rate by 25 basis points to 6.25 percent in response to lower-than-expected retail inflation. The committee also changed the policy stance to ‘neutral’ from ‘calibrated tightening’ and indicated that there may be scope for more rate cuts. The MPC voted 4:2 in favour of the repo rate cut. MPC members Viral Acharya and Chetan Ghate voted against a rate cut. All six members voted in favour of a change in stance.

The minutes of the meet, released on Thursday, give a glimpse into the view taken by each member.

Das vs Patel: New Governor, New Stance

The February meet was the first for RBI Governor Shaktikanta Das. The stance he adopted was one which focused on supporting growth now that the mandate of bringing down headline inflation had been met. Das expects food inflation to remain benign due to strong supply of key commodities. That, together, will lower oil prices means that risks to inflation are balanced, he said.

However, Das felt that growth impulses have weakened and that “there is a need to spur private investment and strengthen private consumption”, especially due to the added concerns of slowing global growth.

The time is opportune to seize the initiative and create a congenial environment for growth to revive and ensure a sustained trajectory. Hence, I vote for a reduction in the policy repo rate by 25 basis points.  
Shaktikanta Das, RBI Governor

In contrast, former RBI governor Urjit Patel, who chaired the MPC in December, had chosen to approach the softer-than-expected inflation cautiously.

“Although the inflation trajectory has been revised downwards, several uncertainties persist, especially about the medium-term outlook of food inflation and oil prices,” Patel had written in the minutes of the MPC meet. To be sure, the former governor had added that if inflation risks do not materialise “on a durable basis in the coming months”, space for policy action may open up in “due course”.

Viral Acharya: Holding The Line

Acharya voted against a rate cut but in favour of a stance change.

According to him, a 6.5 percent policy rate may be “just right” for the medium term. He added that the elevated level of core inflation does not suggest any room for accommodation.

Acharya noted the lower level of headline inflation emerging from the fall in food prices but questioned whether this would lead to a policy response to address any emerging agrarian distress. He also said that while the output gap had opened up marginally, “realised output is slightly above the potential output.”

Combining my inflation and growth assessments, and given the Monetary Policy Committee (MPC)’s mandate to target headline inflation at 4 percent on a durable basis while paying attention to growth, I prefer to “take off the helmet” but “stay within the crease”.  
Viral Acharya, RBI Deputy Governor

Acharya’s views remained mostly unchanged between the December and February meetings. At the last meeting, he had said that it is necessary to watch data a bit longer. He had flagged high core inflation, relatively elevated inflation expectations over a one-year horizon and uncertainty over whether the low food inflation scenario will persist.

Also read: RBI ‘Introspective’ About Revisions In Inflation Projections, Says Deputy Governor Acharya

Michael Patra: Taming Of The Hawk

The big shift in stance came from Executive Director Patra, who, until now, had been seen as the most hawkish member of the committee. Had Patra voted to keep rates unchanged at the February meeting, we would have seen a tie in the votes. In that scenario, Governor Das would have had to use his casting vote for the first time in the MPC’s tenure.

Explaining his about-turn, Patra said the amended RBI Act allows the MPC to address the objective of growth if the primary target for headline inflation is achieved on a reasonably lasting basis. He also argued that in an inflation targeting framework, the intermediate forecast becomes the target.

Weighing in on the debate over whether headline inflation would converge towards core inflation or vice versa, Patra said that since core inflation has been elevated but sticky, trajectory of headline inflation will be determined by food prices.

Patra also flagged growth concerns emerging from global developments and added that it is important to insulate the domestic economy.

In this scenario, it is prudent to preserve sufficient policy space to insulate the economy from adverse external shocks and boost the domestic economy in an opportune manner rather than deplete it in haste.  
Michael Patra, RBI Executive Director

In December, Patra had taken a different line. “Although softer inflation prints could likely lull inflation expectations, abundant precaution and decisiveness in quelling risks to the target are warranted if the hard-earned gains in terms of macroeconomic stability and credibility are to be preserved,” he had written. Patra had also explained lower food prices as a “supply shock”, which could reverse.

Ravindra Dholakia: Real Rate Debate

Dholakia’s stance in February was similar to that in December, although he made his point more forcefully at the most recent MPC.

He argued that real rates in the economy are too high and are impacting real GDP growth. He also added that inflation may fall further if spikes in services inflation prove to be one-offs. Dholakia noted that inflation expectation too has been on the decline.

The experience of this MPC corroborates a negative correlation between the real policy rate and the real GDP growth. One cannot reject the hypothesis that the recent slowdown in the real GDP growth in India is on account of high real policy rates among other factors. If so, now is the ripe time to correct the real interest rates and create policy space for future actions if required.
Ravindra Dholakia, MPC Member

Dholakia had made a similar case at the last MPC meet. “In my opinion, this would be the right time to cut the rate and bring the unduly high real interest rates in the country back to around 2 percent,” Dholakia had said in December.

Chetan Ghate: Eye On The Medium Term

Like Acharya, Ghate voted for a stance change but not a rate cut.

Inflation has softened but not in a broad-based way, Ghate said while reiterating that the elevated core remains challenging. He also raised concerns about the quality of fiscal consolidation, given the high level of extra budgetary spending.

A significant improvement in consumer sentiment in the latest RBI survey and improved capacity utilisation gave Ghate comfort on growth, despite lower-than-expected GDP growth in FY19.

Maintaining status quo on the rates would be consistent with sustainable growth in the economy and achieving the inflation target over the medium term.   
Chetan Ghate, MPC Member

Ghate had questioned the elevated level of core inflation in the December meeting too. “The reversal in inflation excluding food and fuel needs to be carefully watched,” Ghate had noted then.

Pami Dua: Following The Data

Dua changed her view in February and voted for a rate cut and a change in stance.

The Economic Cycle Research Institute’s Indian Future Inflation Gauge, a harbinger of inflation, has declined, signalling a moderation in future inflation, said Dua. She also cited lower business inflation expectations as measured by the IIM-Ahmedabad survey.

On growth, Dua, too, sighted downside risks that may emerge from developments in the global economy. On balance, she felt that lower interest rates were justified.

In light of the benign inflation outlook and a moderation in inflation expectations, as well as the likely headwinds due to the global growth slowdown, I vote for decreasing the policy repo rate by 25 basis points and changing the stance from calibrated tightening to neutral.   
Pami Dua, MPC Member

At the previous MPC, Dua had said that while inflation has softened, upside risks remain. “It is therefore best to pause and wait for incoming data while maintaining a vigil on inflation, especially with respect to food and crude oil,” she wrote.