Reconstituted MPC Widens Debate, Stays Focused On Growth

India’s reconstituted Monetary Policy Committee widened the economic debate beyond the committee’s mandate of controlling retail inflation using a single benchmark policy rate, showed minutes of the October meeting released on Friday. In doing so, the committee chose to stay focused on growth with some members suggesting that room for further rate cuts may open up as inflation falls in the second half of the year.

The committee had voted to keep rates unchanged for the second consecutive time earlier this month. It also voted to maintain an accommodative stance “at least during the current financial year and into the next financial year”. All six members voted for the status quo on rates. JR Varma dissented on the wording of the forward guidance.

Sanguine On Inflation

In contrast to the August meet, the MPC this time struck a sanguine note on inflation, justifying its decision to look through the current bout of above-target inflation.

RBI Governor Shaktikanta Das said supply-side disruptions that are seen to drive the current inflationary pressures are likely to be transient and “wane out in months ahead”. As such, there is merit in looking through the current high levels of inflation and persevere with the accommodative stance for monetary policy as long as necessary to revive growth on a durable basis, Das said.

Headline inflation remained above the committee’s target at near 7% in September.

Deputy Governor Michael Patra pointed to internal analysis that suggests that inflation pressures are mostly supply side-driven. Executive director Mridul Saggar said the current bout of inflation is not monetary in nature.

Cautious About Growth Recovery

Most members of the inflation targeting-MPC gave primacy to growth. The RBI has projected a 9.5% fall in real GDP for FY21.

Patra said “pragmatic caution” is warranted on the rebound in activity. India will likely enter a technical recession in the first half of the year for the first time in its history, he said. “If the projections hold, the level of GDP would have fallen approximately 6% below its pre-Covid level by the end of 2020-21 and it may take years to regain this lost output.”

According to Saggar, if growth contractions stay for long, the hysteresis could stage a comeback “creating renewed feedback loops within public, corporate and bank balance sheets.” If this happens, recovering potential output, some of which may be lost to hysteresis, will take longer.

MPC member Shashanka Bhide said recovery will get stronger but added that accommodative policies are needed.

Forward Guidance & JR Varma’s Dissent

The committee at its October meeting chose to give more explicit forward guidance than it ever has in the past.

The forward guidance read: The MPC also decided to continue with the accommodative stance as long as necessary — at least during the current financial year and into the next financial year — to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.

Committee member JR Varma dissented on wording of the guidance although he agreed with the spirit of the resolution, he said. “...in my formulation, the date-based forward guidance is not a decision but an expectation. In a world that is full of unpleasant surprises, the MPC must of necessity be data-driven.”

Varma said the principal motivation for the forward guidance is to help correct the steep yield curve in India, which is among the steepest in the world. The steep curve reflects the lack of credibility of the MPC’s existing accommodative guidance, he said.

Broadening The Debate

The three new committee members seemed to broaden the debate, bringing in liquidity, yield management and government borrowings into the discussion, even though these are beyond the remit of the MPC and fall in the RBI’s domain.

Ashima Goyal, formerly a part of the Prime Minister’s Economic Advisory Council, said monetary-financial conditions have a relatively greater impact on aggregate demand and output growth. “Moreover, excessive tightness hurts financial stability as much as excessive stimulus does,” she said.

Goyal argued that there is a scope for further prudent expansion of government spending but said this needs to be supported via low borrowing costs.

Varma spoke of the need to bring down excessively high long-term rates, which are inflicting damage to the economy. “Excessive long-term rates exacerbate the collapse of investments in the economy. Second, high long-term rates cause an appreciation of the real effective exchange rate by stimulating foreign capital inflows into our bond markets at a time when the collapse of investment has caused the current account to swing into surplus.”

With short-term rates already low at 3.35%, benefits of a furthering lowering of this rate are relatively low and not commensurate with the risks, he said.

Saggar pointed to the prevailing real negative interest rates scenario. If real rates fall further, “it may generate significant distortions that could adversely affect aggregate savings, current account and medium-term growth in the economy”.