MPC concerned about oil prices, capital formation, fiscal slippage

Monetary policy should be ready to go on to the front foot, says Michael Patra

The minutes of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) meeting on December 5 and 6 show that its members were concerned about global oil prices, the output gap, and underperformance during the rabi season. 
 

RBI’s Executive Director Michael D Patra hinted at a possible rate hike, while external member Ravindra Dholakia argued once again for a rate cut.  

Additionally, the MPC feels that fiscal slippages, given the kind of Budget announcements state governments have made in tandem with the central government, will affect inflation.

The RBI on December 6 left the repo rate unchanged at 6 per cent. Five members of the MPC chose to keep the repo rate unchanged, but Dholakia, the only dissenter, sought a policy rate reduction of 25 basis points.

"The recent upturn in crude oil prices has emerged as a source of concern. Several uncertainties, especially on the fiscal and external fronts, persist. It is, therefore, important to be vigilant,” RBI Governor Urjit Patel said. “Financial conditions have improved significantly in the recent period as reflected in large capital raised from the primary capital market and a pick-up in bank credit growth. These perhaps may be indicating a long-awaited upturn in an investment cycle.”

Inflation expectations for three months and a year have moved up, according to RBI surveys. The RBI’s industrial outlook survey points to an improvement in the manufacturing sector’s business expectations in the third quarter.

The MPC in its last meeting revised its inflation forecast for the next two quarters from 4.2-4.6 per cent to 4.3-4.7 per cent. Inflation based on the Consumer Price Index (CPI) rose to a 15-month high of 4.88 per cent in November, up from 3.58 per cent in October. 

Geopolitical uncertainties in West Asia have caused crude oil prices to rise to above $60 a barrel, which Chetan Ghate said “poses an upside risk to the medium term inflation target of 4 per cent”. “Consumption, the mainstay of the Indian economy, at 54 per cent, exhibits a declining share of the GDP (gross domestic product). Consumer confidence is at its lowest since September 2013. There has been a reversal of the commodity price cycle. Investment demand continues to be muted, despite a recent uptick in the second quarter of 2017-18,” he said.

Growth in GVA (gross value added) rebounded in the second quarter of 2017-18, after slowing down for five consecutive quarters.

Pami Dua, who voted for status quo in the policy rate meeting, said, “The RBI’s surveys indicate that performance in the services and infrastructure sectors is expected to improve in the fourth quarter on account of increase in demand, financial conditions and the overall business situation. Further, recapitalisation of public sector banks may help in sustaining the renewed credit flows.”

Additionally, she said the recent reduction in tax rates on many goods and services in the goods and services tax (GST) would provide a boost to the economy. However, there are downside risks to growth emanating from lower sowing projections in the rabi season and lower reservoir levels.

The investment climate continued to be lacklustre, given the persisting slump in the rate of capital formation, said Patra. He added reforms were required to free up product and factor markets, reduce barriers to entry and exit, and improve overall productivity and competitiveness. “Financial markets, especially the bond market segment, are sensing higher inflation.”

Patra noted that the time had come for monetary policy “to take guard and be ready to go on to the front foot”.

RBI Deputy Governor Viral Acharya said the output gap remained negative, given low capacity utilisation and high inventory levels. “Gradually improving credit metrics in several distressed sectors should pave the way for improved investment over the next year. This process is expected to be further supported as cases referenced to the Insolvency and Bankruptcy Code (IBC) resolve, facilitate consolidation, and restore pricing power,” he said, while recommending no change in the central bank rate.

Improved global demand has shaped oil prices along with the Opec’s decision to extend production cuts to the end of 2018. “This development poses difficult domestic policy challenges — countercyclical adjustment in cess would require fiscal balancing elsewhere, whereas lack of such adjustment would imply pressure on domestic inflation (temporarily latent, since the price pass-through at pumps has not been immediate),” he said.

As the only dissenter, Dholakia, cited low capacity utilisation as the reason for his recommending a rate cut.  “The growth recovery expectation of the RBI during the June-September quarter of 2017 turned out to be a substantial overstatement. Yet, the RBI has not revised its growth forecast from the earlier 6.7 per cent for 2017-18,” Dholakia said.

“The output gap will not start narrowing unless the current growth rate exceeds 8-8.5 per cent. It means that the output gap is going to expand till the middle of the next year. That, in itself, will put downward pressure on prices and neutralise several upside risks to inflation,” he added.