Rajan raised repo rate despite panel majority for status quo

Four members recommended that status quo be maintained with respect to the policy repo rate in January

Reserve Bank of India (RBI) Governor Raghuram Rajan had raised the repo rate by 25 basis points (bps) in the third quarter review of monetary policy held in January, despite a majority of Technical Advisory Committee (TAC) members recommending a status quo.

Four members of RBI’s panel were in favour of status quo. “Most of these members were of the view that political uncertainty in the near term is the dominant factor constraining monetary policy. Given the political uncertainty and the fact that growth is already weak, a 25-bp increase in the repo rate may not have much impact on inflation unless a long-term path is chalked out. The other reasons for status quo were existence of excess capacity in the economy, decline in nominal rate of wage growth, the softening of international commodity prices, and the stability in the exchange rate. One of the members who recommended no change in the policy rate commented that political uncertainty may not be a major risk, as India’s medium-term fundamentals are strong,” said RBI, in the minutes of the meeting.

One member recommended a cut in the policy rate by 25 bps to support interest-sensitive sectors, especially construction. While the member recognised Consumer Price Index (CPI) inflation will remain elevated even in 2014-15, much of it was due to the aggressive push by the government for service tax collection. A rate cut, said the member, would demonstrate RBI’s concern that growth did not come to a halt.

However, two members recommended an increase in the policy repo rate by 25 bps. According to them, since CPI inflation excluding food and fuel was flat, and Wholesale Price Index (WPI) inflation excluding food and fuel has gone up, RBI should raise the repo rate to be consistent with its guidance. In their assessment, all estimates indicated that the output gap in India is minimal.

“Inflation is persistent, despite a low output gap, possibly due to elevated and sticky inflation expectations. They referred to the conundrum posed by high CPI core inflation coexisting with the negative output gap, and cautioned that when the economy recovers, there could be upward pressure on inflation. To address the elevated levels of inflation expectations, RBI should not wait for stability in the political situation to emerge; they recommended that the policy rate be increased in the upcoming policy review,” said the minutes.

As far as growth is concerned, members felt that global growth was showing signs of improvement in 2014, even though there are risks to this outlook.

While growth in advanced economies may improve, recovery in the emerging market economies is expected to be slow. Uncertainty regarding the pace of tapering of quantitative easing by the US remains a major source of risk for India.