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For the first time, the Indian financial system has been given a chance to peep into the room (albeit a fortnight after the event) where designated policy makers sit down to discuss a key component of our monetary policy – the policy repo rate. This insight comes by way of the minutes of the discussions that were held at the maiden sitting of the Monetary Policy Committee, the MPC, which in itself is a new process under which RBI’s internal leaders work with non-RBI experts to deliberate and decide on policy rates.
Both the former RBI governor Dr. Raghuram Rajan and Dr. Urjit Patel who succeeded him have played an active role in bringing about this institutional reform in the monetary policy framework, which places it somewhere on a par with the system followed in advanced economies. Yet, these are first steps and the MPC itself will take time to mature as an institution as members learn the delicate dance of working with RBI data and yet make space for inputs and perspectives from outside the RBI cocoon.
Governor Dr. Patel while making a statement on growth outlook mentioned the low capacity utilisation in industry, persistence of output gap, low pricing power. He noted that the inflation target of 5 per cent for Q4 of 2016-17 can be achieved but then comes along a rider: “inflation outcomes in Q4 will have to be carefully and continuously monitored as upward risks albeit lower than before, persist.”
The minutes of the first ever MPC meeting were released on October 18, 2016, precisely 14 days after the Committee met as per the mandate set out under section 45ZL of the amended Reserve Bank of India Act, 1934. We now have key insights into the process through which a repo cut of 25 basis points has been adopted. The minutes give us (a) the vote of each member on the resolution adopted and more importantly (b) the statement of each member. As far as the voting was concerned, it was already known that all the members had voted for a 25 basis points reduction in policy repo rate to 6.25 percent. Thus, what is of interest is the argument in favour of this cut.
A common thread that runs through the minutes indicates that members focused on the current status and outlook on inflation and growth. They unanimously agreed that the 2017 March-end inflation rate as measured by the consumer price Index (CPI) will be closer to the RBI’s inflation target of 5 per cent. Furthermore, the members also recognised the acceleration of growth of the economy.
While each of the members has articulated their views, the overall impression that flows is that the members were keen to reduce rates rather than free themselves of the noise that the clamour for lower rates has created, and then approach the issue by looking purely at data rather than expectations from powerful quarters.
The three non-RBI members on the MPC are Dr. Chetan Ghate, Dr. Pami Dua and Dr. Ravindra Dholakia.
In his observations, Dr. Ghate mentioned some of the upward risks in terms of persistent slack in the economy evidenced by unutilised capacity, weak corporate pricing power and persistence of core inflation but has referred to these as “acceptable risks”. Dr. Pami Dua was more explicit on growth. In support of her case for policy rate reduction, she argued that a modest softening of inflation and inflation expectation, lackluster private investment spending and unused capacity “provides a window for a reduction in the policy rate”. Dr. Dholakia presented a sunnier side and argued that that “the potential growth path of the Indian economy is gradually moving up, particularly in response to several reform measures implemented by the Government.”
From the RBI side, Executive Director Dr. Michael Patra reported an improvement in inflation outlook. Importantly, he explicitly stated that inflation forecast serves as the intermediate target of monetary policy framework. He further mentioned that the “inflation forecast for Q4 of 2016-17 is closer to target than before” and it is moving down. This should make the RBI comfortable on the inflation front but then comes this important rider: “This is not to say that the beast is beaten and its back is broken.”
RBI Deputy governor R. Gandhi has supported a rate cut to help “stimulating investment demand while also easing somewhat the pressure on firms stemming from balance sheet repairs.”
Governor Dr. Patel while making a statement on growth outlook mentioned the low capacity utilisation in industry, persistence of output gap, low pricing power. He noted that the inflation target of 5 per cent for Q4 of 2016-17 can be achieved but then comes along a rider: “inflation outcomes in Q4 will have to be carefully and continuously monitored as upward risks albeit lower than before, persist.”
Thus, another common thread running in all the statements given by the members is cautious optimism on inflation rate. In essence, what they are saying is that the patient is getting better, the medicine is working but equally, the situation needs to be watched and it’s too early to celebrate. In this light, a rate cut is much like candy that could have waited for some more time.
The remarks of the MPC members and their decision also raises the question that if the trend in inflation outlook is so close to targeted inflation, then why did Dr. Raghuram Rajan not offer a repo rate cut? The same information was available to him. So was he being cautious? Was he expecting that the inflation rate would be volatile and go up in the future? And the big question: Is it true that the political economy of inflation and policy rate reduction took the lead and virtually drove the decision of the MPC? These questions will remain alive as long as, by the RBI’s own admission, the inflation beast has neither been beaten nor its back broken.
(Dr. R K Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIMR)