At RBI's Sept 30 review, most external members sought a rate cut

At the Reserve Bank of India (RBI)’s bi-monthly review of monetary policy on September 30, the central bank’s governor, Raghuram Rajan, had gone against the advice of most members of RBI’s technical advisory committee, showed minutes of the meeting, released on Wednesday.

While four of the seven external members sought a cut in the repo rate, Rajan had kept the rate unchanged at eight per cent, saying retail inflation was still higher than RBI’s medium-term tolerance level.

While three members sought a cut of 25 basis points (bps), one argued for a 50-bps cut.

“According to these members (who sought a rate cut), since industrial demand was stagnating, some focus on the more pressing need of weak demand and high levels of unemployment would be consistent with fighting inflation. With the decline in headline CPI (Consumer Price Index) inflation, the real policy rate has become positive,” the minutes said.

The central bank has set a CPI-based inflation target of six per cent by January 2016. For January 2015, the target has been set at eight per cent.

In September, CPI-based inflation stood at 6.46 per cent, the lowest since January 2012, owing to a fall in the prices of fruits and vegetables.

The three external members who sought the repo rate be kept unchanged felt if the rate of disinflation was faster than anticipated, there might be a case for a rate cut, particularly if inflation expectations softened.

Some members derived comfort from the recent decline in inflation, saying they expected inflationary expectations of households would see a sharp drop, if food prices corrected.

At the monetary policy review, one of the external members cited the sharp decline in Wholesale Price Index (WPI)-based inflation. In September, WPI inflation eased to a five-year low of 2.38 per cent, compared with 3.74 per cent the previous month and 7.05 per cent in September 2013.

On the state of the Indian economy, the members said while the market sentiment had improved, economic activity continued to be weak, adding there was a disconnect between activity in the corporate sector and buoyancy in the capital market.

“The pick-up in real GDP (gross domestic product) growth in the first quarter of 2014-15 was primarily due to a favourable base effect. In the second quarter, the base effect will turn unfavourable and growth could register a fall; it might remain below potential for some time to come,” the minutes of the meeting said.

On the global economic environment, some members felt India would gain from a revival in economic activity in the US because the beneficial effects through higher trade and investment could partially offset the adverse impact of expected capital outflows. The members felt markets might have already factored in some of the likely action by the US Federal Reserve on monetary tightening.