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Ravindra H Dholakia’s proposition, that plunging inflation called for a drastic rate cut of 50 basis points (bps) or more, clearly did not find other buyers in the six-member Monetary Policy Committee (MPC) that met on June 6 and 7.
As the statements of the minutes show, they favoured a wait-and-watch. The MPC voted five against one to keep the Reserve Bank of India’s (RBI’s) repo rate (at which it lends to banks) unchanged at 6.25 per cent, though retail inflation had fallen below three per cent in April.
From the minutes of the two-day meet, economists say, the chance of a rate cut at the next review, in August, look slim.
“The chances of a 50-bps cut in October is more than a 25-bps cut in August,” said Gaurav Kapur, chief economist at IndusInd Bank.
“One has to see through the noise. Given the nature of the concerns by various MPC members, it doesn’t look like they will all be convinced so soon that a rate cut should be done because food prices are on a downward trajectory.”
Perusing the minutes, most of the members saw core or headline inflation, excluding food and fuel, as ‘sticky’. The core inflation print has been hovering around more than four per cent for quite some time. However, Dholakia, a professor at the Indian Institute of Management, Ahemdabad, and a dove on the subject for some time, argued there had been a “clear declining trend, rather than stickiness as predicted in the RBI forecast”.
“In my opinion” the minutes show he said, “this is the most opportune time for the MPC to effect a major cut of 50 bps in the policy rate, to bring it down from 6.25 per cent to 5.75 per cent.” RBI in the policy review had lowered its inflation forecast to 2-3.5 per cent during the first half of the financial year and 3.5-4.5 per cent during the second half, from an earlier average 4.5 per cent in the first half and five per cent in the second half.
“The three-months and 12-months advance inflationary expectations as per the RBI survey of households are unambiguously declining and are among the lowest levels observed in the history of such surveys,” Dholakia argued.
Beside, he said, a good monsoon would bring good crops for a second year.
According to Dholakia, capacity utilisation in industry remaining consistently below 75 per cent clearly pointed to a large output gap. “There cannot be disagreement on the Indian economy significantly under-performing compared to its potential now for quite some time.” In this context, “any theoretical rule-based policy for flexible inflation targeting would not only justify but also necessitate at least a 50-bps cut in the policy rate”. Dholakia also criticised RBI’s fear of price rise due to the pay commission report on house rent (HR) allowance for government staff.
“The impact assessment on headline CPI inflation of about 150 bps by RBI is highly overstated,” he argued. He felt the central bank was assuming simultaneous and instantaneous implementation of the recommended HR allowance at the Centre and all states almost immediately.
The same set of numbers, though, failed to infuse confidence among other members, including governor Urjit Patel.
Patel saw the pay commission recommendation and farm debt waivers as risk enough “to avoid premature policy action at this stage”.
The RBI governor also argued that one had to be “mindful of pitfalls in assessing the overall (national) output gap”. In some sub-sectors, such as public sector infrastructure, the output gap could be positive, thereby impeding further growth acceleration, as well as undermining competitiveness.
RBI Executive Director Michael Patra, who in the April 6 policy review had recommended a 25-bps hike, had a balanced approach this time but argued that the output gap could automatically narrow in an economy growing at a fast clip. Food prices, he argued, unlikely remained low at a time when rural wages and input costs were rising.
RBI deputy governor Viral Acharya took the argument to another trajectory. According to Acharya, the purpose of monetary policy being transmission of rates, a rate cut at this point might not push the private corporate sector to invest. He cited the accommodative phase of the central bank in 2015-16, when, despite low rates, companies refused to borrow.
“What is required for monetary policy to do its job better is to address the stress on bank (and highly-indebted borrower) balance sheets,” Acharya said. “Once the transmission mechanism is restored to better health, monetary policy will more pervasively touch different parts of the economy.” Other external members Chetan Ghate and Pami Dua also suggested a wait-and-watch. Both argued for the stickiness of core inflation above four per cent. Kapur of IndusInd also agree with the members who preferred a pause.