Why MPC members are a worried lot today

'Overall, domestic demand has moderated significantly.

'The weakening of private consumption, which for long has been the bedrock of aggregate demand, in particular, is a matter of concern,' RBI Governor Shaktikanta Das said in the MPC meetings, in October.

The six members of the Monetary Policy Committee (MPC) expressed dismay at the lack of monetary policy transmission and were alarmed at the slowdown in the economy and the fall in private sector investments, edited minutes of the meetings show.

The Reserve Bank of India’s (RBI’s) MPC met for three days on October 1, 3 and 4, after which the central bank cut policy repo rate by 25 basis points and said the stance would remain “accommodative” as long as required to revive growth.

“Overall, domestic demand has moderated significantly.

"The weakening of private consumption, which for long has been the bedrock of aggregate demand, in particular, is a matter of concern,” RBI Governor Shaktikanta Das said in the meetings, the minutes show.

According to Das, private investment has also lost traction, “with the corporate sector reluctant to make fresh investments even though capacity utilisation in the manufacturing sector has operated close to the long-term average in the recent period”.

Considering that inflation would remain below the target of 4 per cent in the remaining period of 2019-20 and the first quarter of 2020-21, there was policy space to address growth concerns, the governor observed.

Maintaining of the stance was the governor’s idea, which he expected “should strengthen monetary transmission and support the real economy”.

External member Chetan Ghate expressed concerns over the state of transmission in the banking system.

Till the August policy review, the decline in the weighted average lending rate of banks for fresh loans was down 29 basis points, despite a cut of 110 basis points since February, but it was observed that the average rate on outstanding rupee loans had increased by 7 basis points.

In this context, the members commended the RBI for forcing mandatory linking of an external benchmark for lending, which they hoped would improve transmission going forward.

However, the monetary policy works with a lag, but in the case of India, “these lags are made worse by frictions in the banking system, complicating the MPC’s efforts to implement counter-cyclical policy”, Ghate said.

He was also worried that the inflation expectations were firming up after falling for several quarters.

The uptick in food inflation, 3 per cent in August, needed a careful watch, but the late exit of the monsoon would be favorable for rabi crop growing.

While the monetary policy “cannot be a permanent form of stimulus”, Ghate said the corporation tax rate cuts will have a minor impact on the fiscal deficit of the government.

Pami Dua, another external member, expressed concerns on the private consumption and investment activity remaining weak, while the business and consumer sentiment was downbeat.

While there was a scope to wait and watch what impact the government measure and pending transmission would have on the growth, Dua favoured a 25-basis-point rate cut, given the growth slowdown and benign inflation.

External member Ravindra Dholakia was the only one who wanted a 40-basis-point cut, as it was necessary to act “more aggressively so as to correct the real interest rates in the economy in due course”.

The sharp cut proposed by him would “still leave some space for the rate action if required in future”, Dholakia said.

He also harped on the need for corporate bond market reforms by allowing entry to corporations with lower rating than AAA, encouraging issuance of long-term bonds and creating a proper yield curve for the government bond market to serve as a benchmark.

This, he argued, would deepen the market and improve the transmission.

“In this challenging environment, my call would be for prudence rather than being data-dependent,” said Michael Patra, executive director of the RBI.

“In its counter-cyclical role, monetary policy has to be pre-emptive in addressing the negative gaps - inflation below target, and output below potential - that seem to be developing some persistence.

Available space for policy action has to be calibrated to secure the closure of the gaps,” Patra said, advocating a 25-basis-point cut.

According to B P Kanungo, executive director in charge of the monetary policy, gross domestic product growth at 5 per cent for the first quarter of 2019-20 “was a surprise as it significantly undershot the Reserve Bank’s projection of 5.8 per cent”.

“This is particularly a cause of concern because it was caused by a sharp slowdown in private consumption expenditure.

"Investment activity remained weak, and exports contracted reflecting weak global demand,” Kanungo said.

The slowdown was caused by deficient domestic demand. While the government measures and the impact of past policy rate cuts “would help the real sector gradually, there was a need to reinforce the past monetary policy measures and the recent steps taken by the government in supporting domestic demand”.

A cut of 25 basis points, and maintaining the stance until the economy was on a revival path, within the mandate of flexible inflation targeting, was his prescription.