Support For Rate Cut Remains Restricted To One Member, Show MPC Minutes

India's monetary policy committee (MPC), which voted 5-1 to keep interest rates unchanged at its June meeting, remains unconvinced that inflation has taken a structural turn to the downside, show minutes of the meeting released on Wednesday.

With the exception of Ravindra Dholakia, who voted for a 50 basis point cut in rates, most members cited the need for more data before they can decide if prevailing macroeconomic conditions justify more accommodative monetary policy. The minutes come against the backdrop of heightened expectations of a rate cut and may prove to be dampener for the bond markets, where yields fell to 4-month lows ahead of the release of the MPC minutes.

Sharing his assessment of the economy, Reserve Bank of India Governor Urjit Patel noted that there has been “unusually low momentum” in food prices. He also acknowledged that there was disinflation in services, which has allowed consumer price inflation to soften. On the flip side, Patel highlighted the elevated inflation expectations and fiscal pressure, emerging from farm loan waivers, which could push up inflation.

Patel's view was matched by that of RBI Executive Director Michael Patra who said that monetary policy cannot be conducted by looking in the rear-view mirror. Patra also questioned the premise that the recent fall in vegetable prices, which in turn has brought down headline retail inflation to a record low of 2.2 percent, is sustainable.

“It is hard to believe that deflation of 15.9 per cent in the prices of pulses and 8.6 per cent in the prices of vegetables is the steady state that will define the medium-term food inflation path,” said Patra.

He went on to lay down the following factors which could push up rural inflation:

• Agricultural wages have risen by 8.5 percent
• Farm input costs are by 10 percent
• Bank credit to agriculture is up by 13.5 percent in the past year
• Output gap in agriculture is turning positive on rising rural incomes

The MPC's decision to leave rates unchanged at its June meeting was the first split decision taken since the committee-based approach to monetary policy was adopted last year.

Ravindra Dholakia, one of the three external members of the MPC, dissented on the decision. The minutes show that Dholakia was in favour of a 50 basis points cut in the benchmark repo rate from 6.25 percent to 5.75 percent.

In an extensive note explaining his stance, Dholakia argued that there have been several noteworthy developments that warrant “decisive action”.

He lists the following among them:

• Headline CPI inflation over the next 12 months likely to be at least 50 basis points lower than anticipated in April
• Three-month and 12-month advance inflationary expectations unambiguously declining
• Low capacity utilisation, which indicates the existence of a large output gap

Chetan Ghate and Pami Dua, the other two external members on the MPC, maintained a neutral stance and vote for status quo. Dua cited “mixed risks to inflation and growth” and said that a wait-and-watch stance is appropriate.

Ghate said that the recent decline in inflation and inflation expectations is comforting. He added that he would like to see a decline in food and fuel inflation on a more durable basis. Ghate also noted the fiscal risks that could emerge from the growing trend of state government's annoucing farm loan waiver.

Uttar Pradesh, Maharashtra, Punjab and Karnataka are among those that have announced loan waivers.

Banking Stress And Rates

Viral Acharya, deputy governor at the Reserve Bank, added another dimension to the interest rate debate. Apart from joining other members in flagging off the risk that fiscally expansive measures, like farm loan waivers, could spark off generalised inflation in due course, Acharya also linked interest rates to the banking crisis.

Acharya noted that the monetary easing in 2015-16 had failed to have a positive impact on the private sector investment cycle. He also said that the treasury gains that banks accrued due to lower bond yields (and higher bond prices) helped mask the true level of stress on bank balance sheets.

Acharya went on to counter arguments that lower interest rates would help in easing the stress on bank balancesheets. This, he said, would be counter productive and relax the pressure on cleaning up the banking sector.