The thirty-ninth meeting of the Technical Advisory Committee (TAC) on monetary policy was held on September 23, 2015 in the run up to the Fourth Bi-monthly Monetary Policy Review of 2015-16 on September 29, 2015. The main points discussed at the meeting are set out below.

1. Members noted that global growth is slowing down essentially due to developments in China. Delay in the US Fed’s monetary policy normalisation is adding uncertainty. The effect of the Chinese growth slowdown is expected to play out in the next 6 to 12 months, and may have a much larger impact on capital outflows than the Fed’s decision on lift-off. Given these conditions, significant dynamism from international developments cannot be expected. A few Members were of the view that global risks have receded and are not as serious as they were two months ago. With resolution of the Greece problem, the European Union has addressed the biggest risk to global growth.

2. Members saw no visible signs of recovery in growth domestically. The buoyancy in tax collections was influenced by additional resource mobilisation measures taken by the Government, including increases in excise, cess and service tax rather than a durable pick-up in economic activity. With the marginal increase in net sown area and resilience in allied activities, prospects of revival in agriculture are visible, which may lead to a consumption-led recovery. While industrial production is expected to revive gradually, limited signs of fresh capital expenditure, as reflected in a large decline in new project announcements, is a major concern.

3. Members noted that CPI inflation has declined dramatically and is well below the target of 6 per cent. While food inflation faces upside pressures from pulses, low international food prices, moderation of wage growth and structural measures such as lower increase in minimum support prices, diversification of agriculture to vegetables and protein production, and the government’s focus on improving supply chain management may cap domestic food price increases. Price insurance contracts for shale gas production in the US suggest continuing relief in terms of fuel prices over the next year. On external factors affecting domestic inflation, a Member pointed to global slack and secular stagnation contributing to lower domestic inflation. Services prices were sticky downwards owing to monopolistic competition and fragmentation of markets. Inflation in services such as education, health care and transport, which remain elevated, may moderate going forward, as inflationary expectations are better anchored. Some Members felt that inflation is likely to harden by the end of the year as favourable base effects dissipate. Although the deficient monsoon has not led to any jump in food inflation so far, caution is warranted.

4. Some Members felt that the fiscal deficit target is difficult to achieve, given expenditure pressures from the implementation of one-rank-one-pension, the impending seventh pay commission award, the weak disinvestment situation, special assistance given to some States, and slower domestic growth. The widening of the current account deficit in the context of sluggish investment activity is also of concern. Some Members believed that the Government should stick to the fiscal deficit target – even at the cost of low investment – to get credibility built into the system.

5. External developments, some Members noted, have been both favourable and unfavourable for India. They expressed two views on ongoing global risks – one, that the normalisation of US monetary policy is already factored in and skittish foreign capital has already left. Therefore, the Fed lift-off will be a non-event. The second view was that widespread turbulence, liquidity shortages, and capital outflows from emerging markets may impact India sharply. The best policy response would, therefore, be to ensure that fundamentals remain strong and that interest rate policy is based on the domestic cycle, while different types of intervention (according to the experience gained in 2013) may be deployed to moderate exchange rate volatility. However, Members were unanimous that, with global trade contracting and countries fighting for export shares, rupee depreciation should not be resisted, especially in view of export growth slowing down over the last three quarters.

6. On policy options, six Members recommended reduction in the policy repo rate – two suggesting a reduction of 50 basis points (bps), one being flexible within the range of 25 to 50 bps, while three wanted to move cautiously with a reduction of 25 bps. The three Members who recommended a reduction of the policy rate greater than 25 bps were of the view that during the pre-crisis period, corporate performance was the key driver of growth and going forward, recovery of the industrial sector would be critical for achieving a growth rate of 8.5 per cent. However, the growth of industrial production is tepid at present, real interest rates faced by the corporates have increased sharply and the rise in the real interest rate has more than offset the positive effects of the decline in commodity prices. Moreover, there has been comfort on the inflation front – wholesale prices are contracting, GDP consumption deflator has been low at around 3 per cent, and with vendors engaged in e-commerce offering low prices, retail inflation may be lower than what the headline number suggests. Therefore, a large rate cut at this juncture is warranted to take the economy out from the present drag.

7. Three Members suggested that a reduction of repo rate by 25 basis points would be a timely response avoiding falling behind the curve, signalling continuation of easy monetary policy and helping banks cut lending rates. With the policy repo rate of 7 per cent (after a reduction by 25 basis points) and inflation at 5.5 per cent, the policy rate will still be neutral, given estimates of the neutral rate between 1.5 per cent and 2 per cent. One of these Members also recommended forward guidance to discuss risks to the medium term growth and inflation estimates and suggested a reduction in the statutory liquidity ratio (SLR) by 50 basis points.

8. One Member recommended that the policy repo rate be kept unchanged. Although growth was slowing, CPI inflation would be around 6 per cent by March 2016 and there could be an upside pressure on bond yields if outflows become large. At such a juncture, the Member preferred to wait and watch the unfolding developments rather than going for a rate cut. The US Federal Reserve has become a prisoner of its forward guidance. However, in the last five years, several OECD central banks were forced to reverse their previous guidance. Accordingly, the Member was of the view that the Reserve Bank needs to be careful and should keep stressing on data dependency to avoid getting into a Fed-like trap.

9. The meeting was chaired by Dr. Raghuram G. Rajan, Governor. Internal Members Dr. Urjit R. Patel (Vice-Chairman), Shri Harun R. Khan, and Shri S.S. Mundra, Deputy Governors; and external Members Shri Y.H. Malegam, Dr. Shankar Acharya, Dr. Arvind Virmani, Prof. Indira Rajaraman, Prof. Errol D’ Souza, Prof. Ashima Goyal, and Prof. Chetan Ghate were present at the meeting. Officials of the Reserve Bank Dr. Michael D. Patra, Dr. B.K. Bhoi and Dr. Himanshu Joshi were in attendance.

Since February 2011, the Reserve Bank has been placing the main points of discussions at the meetings of the TAC on Monetary Policy in the public domain with a lag of roughly four weeks after the meeting.

Alpana Killawala
Principal Chief General Manager

Press Release : 2015-2016/972