While agreeing that inflation outlook remained ‘highly uncertain’, the members of the Monetary Policy Committee (MPC) sparred at its 21st meeting here between February 4-6, on whether policy space was available for further rate action in the current cycle and if the budget toed the right fiscal line.
Calling the Centre’s fiscal stance for FY20 and FY21, as unveiled in the recent Budget ‘contractionary’ rather than counter-cyclical, Ravindra Dholakia said that given India’s ‘high’ real interest rates and still ‘very low’ global rates, “there is a definite space for policy rate action”. He, however, laced his argument, saying, “We need to wait for the other half of the fiscal policy given by the budget of the States”.
The hawk in the pack was Chetan Gate who saw the need to accept tighter-than-desired monetary conditions to stick to the medium-term inflation target. “If growth hasn’t revived with a 135 bps cut in the policy rate (since February 2019) and a tax stimulus amounting to 1.2% of GDP (corporate tax & PIT cuts plus GST rate reductions), then the need of the hour is more structural reform,” Gate argued, according to the minutes of the meeting released on Thursday. “For those who advocate targeting an inflation rate higher than 4%, I’m sorry; 4-6% inflation is not price stability,” he iterated.
At the end, the MPC resolved to keep the repo unchanged at 5.15% – it had last cut the rate at October bi-monthly review (by 25 bps) – and “continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target”.
On his part, governor Shaktikanta Das said at the latest MPC meeting that, considering the overall evolving growth-inflation situation, it would be prudent to continue the focus on growth in the context of the expected moderation in inflation. This would indeed be in sync with the concept of flexible inflation targeting, he said, and added that financial stability also required revival of the growth trajectory. “The Union budget has sought to provide counter-cyclical support to the economy, while broadly adhering to fiscal prudence,” Das said.
According to the governor, while some green shoots were visible in the economy, their durability would become more clear in the coming months. He said that the rabi sowing, horticulture production, index of industrial production, and business sentiment of manufacturing firms were starting to look up.
Industrial output shrank 0.3% y-o-y in December 2019, reversing a modest rise in November and recording its fourth contraction in five months, while retail inflation spiked to a near six-year high of 7.59% in January. This dashed hopes for an early industrial recovery and also complicated the task of the MPC/RBI in balancing the growth-inflation dynamics.
Of course, in keeping with Das’ views, the RBI announced a slew of steps to push growth and lower interest rates on February 6. It decided to lend Rs 1 lakh crore of one-year and three-year money to banks at the repo rate and gave them a six-month CRR-break on new home, auto and MSME loans, both steps aimed at ensuring they have durable, low-cost funds.
“The pre-emptive easing of monetary policy since February 2019 is now turning out to be fortuitous,” said RBI deputy governor Michael D Patra. “Over the 12 months ahead horizon, the forecasts are indicating some let-up in inflationary pressures, but it is not yet clear as to when and how the current inflation surge will bottom,” he added.
After a post-Budget meeting with the finance ministry in New Delhi on February 15, Das sought to allay fears of the Budget proposal on fiscal slippage causing a spike in inflationary pressure, saying the government had largely remained within the deficit road map set by the FRBM Act.
He asserted that credit off-take was gathering pace and the transmission of the cut in the benchmark lending rate had improved by 20 basis points since the December 2019 monetary policy review to 69 basis points.
Invoking an escape clause, the Budget for FY21 proposed to inflate fiscal deficit by 50 basis points for this financial year and the next to 3.8% and 3.5% of GDP, respectively, amid a sharp cut in the corporate tax rate and a shortfall in revenue mop-up following a broader economic slowdown.
The six-member MPC has revised CPI inflation projection to 6.5% for Q4FY20, 5.4-5.5% for H1FY21 and 3.2% for Q3FY21, with risks broadly balanced.