MPC minutes on rate cut pause: Propriety of words or a case of much ado?

External member Jayanth R Varma differed on wordings on the stance, while preferring to keep it accommodative for an extended period

The newly-formed six-member monetary policy committee (MPC) saw ample space for future rate cuts if the inflation evolved in line with expectations, but the “space needed to be used judiciously to support recovery in growth,” minutes of the three-day meetings released by the Reserve Bank of India (RBI) quoted the RBI governor as saying. 

The MPC rather decided to let the past rate cuts transmit properly to help ease out financing conditions.  

After the three-day monetary policy meet that ended on October 9 morning, the RBI announced a pause and said, “The MPC also decided to continue with the accommodative stance as long as necessary-–at least during the current financial year and into the next financial year-–to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.” 

Newly-appointed external member of the MPC, Jayanth R Varma, differed with the rest of the committee on choice of words and not the stance of the policy, the minutes showed, resting the speculation that he wanted to change the stance. 

Varma preferred the word “expected” instead of “decided” in the policy statement. He supported “maintaining the policy rate at its current level,” of 4 per cent, and also the “accommodative stance and liquidity support that drive short term rates towards the reverse repo rate rather than the repo rate.” 

The edited minutes showed that the Indian Institute of Management, Ahmedabad professor had some self-doubt whether he was making a “mountain out of a molehill and creating unnecessary confusion”, but he clarified that the choice of words was necessary to uphold the credibility of the MPC’s accommodative stance, which has recently taken some hit as is reflected by the steep yield curve.  

"I am firmly of the view that the MPC risks a damage to its credibility when it uses words that do not accurately reflect what it means. I therefore disagree with the choice of the word “decided” when it comes to the date based forward guidance in the MPC resolution," Varma said. 

The external member also preferred to give longer period guidance, in order to soften the longer-term yields, which is a key component in fixing long term borrowing cost for companies. 

“To have the desired impact, it is desirable that the forward guidance extend beyond the one-year horizon at which the steepness of the yield curve sets in. Forward guidance of six months in the MPC resolution is in my view suboptimal. I would also point out that the weakness of investments in the Indian economy predates the Covid-19 pandemic, and this merits a longer-term response that goes beyond six months,” Varma said.  

The minutes show the members were worried about the rise in inflation, which prompted them to pause and not cut further. 

“Inflation remained above the upper tolerance threshold of 6 per cent since June, with signs of aggravation of price pressures. The surge in inflation in India in recent period is in stark contrast with the experience of other major emerging market economies (EMEs) where inflation moderated relative to pre-lockdown period," said RBI governor Shaktikanta Das. However, he expected inflation to moderate in the second half of the current year and further in the first quarter of the next fiscal year, starting with lower food prices. 

The RBI governor preferred to give a longer forward guidance so that the bond market and the central bank remain on the same page on the intention of the monetary policy. This, the RBI governor hoped, would "strengthen and quicken the pace of transmission to longer-term yields and help support consumption and investment demand in the economy.” The forward guidance would also help reduce uncertainty and market volatility, he said.  

Monetary policy has to provide adequate support to ensure a “robust revival of the economy from the devastating effects of COVID-19, while at the same time ensuring that any persistence of elevated inflation does not lead to unanchoring of inflation expectations,” the RBI governor said. The supply side disruptions witnessed now would be transient and wane out in months ahead as the economy normalises, and therefore, there was merit in looking through the current high levels of inflation, the governor said. 

Shashanka Bhide, senior advisor at the National Council of Applied Economic Research, said in the meetings that the GDP will see “sustained revival beginning from the second quarter of the year, with the rate of contraction from the levels of previous year declining steadily.” 

While there are “clearly uncertainties facing the growth and inflation projections," the outlook for the next 3-4 quarters suggested the need for a policy environment enabling recovery of output, Bhide said. 

Ashima Goyal, professor at Indira Gandhi Institute of Development Research saw the COVID-19 crisis creating an opportunity for a reversal of tight financial conditions. "An elastic supply curve implies a demand squeeze has little impact on inflation but creates a large output loss. Moreover, excessive tightness hurts financial stability as much as excessive stimulus does," Goyal said.  

“Mitigating the impact of the unprecedented global health crisis has priority. It is important, however, there is neither over-reaction nor untimely reversal. Excess stimulus after the global financial crisis resulted in excess tightening in the decade that followed,” Goyal said, while voting for a pause and accommodative stance.  

RBI executive director Mridul K. Saggar said that output gap in terms of levels of GDP will close only towards the end of 2021-22, “even though a technical rebound is likely to push the economy to above average growth in that year on a low base.” In the coming days complementary actions would be required to support recovery in trend growth in the coming years, but if “current real negative interest rates fall further, it may generate significant distortions that could adversely affect aggregate savings, current account and medium-term growth in the economy.” 

RBI’s deputy governor Michael Patra also supported this view.  

“If the projections hold, the level of GDP would have fallen approximately 6 per cent below its pre-COVID level by the end of 2020-21 and it may take years to regain this lost output. There is also an anecdotal sense that the economy’s potential output has fallen, and the post-COVID growth trajectory will look very different from what has been recorded so far," Patra said. 

While there has been some recovery, Patra advised “pragmatic caution”.  

“In the absence of intrinsic drivers, the recovery may last only until pent-up demand has been satiated and replenishment of inventories has been completed. Empirical evidence suggests that consumption-led recoveries are shallow and short-lived," and therefore, more investment should be pld be made for turnaround in the economy and to sustain it in the medium term, Patra said.

Shaktikanta Das, RBI governor:

"The surge in inflation in India in recent period is in stark contrast with the experience of other major emerging market economies (EMEs) where inflation moderated relative to pre-lockdown period."

"I recognise that there exists space for future rate cuts if the inflation evolves in line with our expectations. This space needs to be used judiciously to support recovery in growth."

Michael Patra, Deputy Governor:

"If the NSO’s provisional estimates for Q2 that are expected at the end of November corroborate at least the direction of these forecasts, India has entered a technical recession in the first half of the year for the first time in its history."

Mridul K. Saggar, Executive Director, RBI

"Moving ahead, there is tough row to hoe requiring acorns to be fed in the form of complementary actions to support recovery to trend growth in the coming years."

Shashanka Bhide, MPC External Member 

"Two key goals from the monetary policy perspective at the present juncture, in which output growth has declined sharply and inflation pressures remain, are enabling sustained recovery of the economy and moderation in inflation rate."

Ashima Goyal, MPC External Member

"Although in normal times India’s correctly estimated interest elasticity of demand is high, during crisis times it is difficult to induce more spending just through higher liquidity and lower interest rates."

Jayanth R. Varma, MPC External Member

"I am firmly of the view that the MPC risks a damage to its credibility when it uses words that do not accurately reflect what it means. I therefore disagree with the choice of the word “decided” when it comes to the date based forward guidance in the MPC resolution."