Minutes of the January 23, 2013 Meeting of the Technical Advisory Committee on Monetary Policy
February, 25th 2013
The thirty first meeting of the Technical Advisory Committee (TAC) on Monetary Policy was held on January 23, 2013 in the run up to the Third Quarter Review of Monetary Policy 2012-13 on January 29, 2013. The main points of discussion in the meeting are set out below.
On global economic conditions, most of the Members were of the view that the situation is better than it was six months ago and the outlook has also improved. In particular, the probability of a significant adverse event is much lower now, even though some of the major economies - which are generally seen as the locomotives of global growth - continue to face sluggish growth prospects. Retail sales in the US rose more than expected in December and housing starts were at a four-year high. In Europe even Germany contracted in the fourth quarter of 2012. France could face another credit rating downgrade on the likelihood of missing deficit reduction targets. Yet European bond yields have been receding from crisis levels. In China, economic growth has accelerated for the first time in two years, rising to 7.9 per cent in the fourth quarter. Going ahead, there may be some softening of global commodity prices.
On the domestic front, Members were of the view that there has been an improvement in sentiment since September when the Government initiated measures to attract FDI and for fiscal consolidation. The establishment of the Cabinet Committee on Investment to fast-track delayed projects is also a welcome step. However, the underlying macroeconomic conditions are still sluggish. Investment has not revived yet and contraction is still underway in the capital goods industries. Also, demand is trailing behind capacity. Furthermore, besides persisting infrastructure constraints, there are continuing signs of slack in the service sector, which accounts for two-thirds of GDP. However, in 2013-14, if there are no major shocks and the budget perseveres with fiscal consolidation measures, investor confidence may improve further and concomitantly investment could pick up.
Members were of the opinion that WPI inflation, despite the recent deceleration, continues to be high, and CPI inflation in double digits is a matter of concern. The economy should benefit from the likely softening of global commodity prices which will bring down headline inflation. Going forward, inflation is likely to rise again as the Government moves to correct petroleum product prices. The CPI is already carrying some cost of fiscal correction since the base of the service tax has been substantially increased. According to some Members’ assessment, inflation in 2013-14 could be only marginally lower than in 2012-13.
On the fiscal front, Members thought that the fiscal situation is still very difficult. However, the recent fiscal consolidation efforts should be taken as significant efforts, particularly the (i) increase in railway fares; (ii) recent deregulation of diesel prices; and (iii) emphasis on containing the size of the fiscal deficit. Some Members were of the view that government expenditure is flabby and despite the recent efforts, there is still an overwhelming likelihood that the fiscal deficit will be at a minimum of 5.5 per cent of GDP when the actuals become available. Lack of fiscal discipline is going to make it difficult for the Reserve Bank to sustain its efforts to support growth through policy easing.
On the balance of payments (BoP), the current account deficit (CAD) to GDP ratio reached a historic high in the second quarter of 2012-13. Members regarded it as the most important macroeconomic concern. Financing such high levels of CAD is worrisome, as it is accentuating external sector vulnerability. While the likely softening of global commodity prices may bring down the CAD, the elevated levels of oil and gold imports are a major concern. Gold demand exhibited a seasonal surge in November-December. Members felt that the current large demand of gold is due to its value as an asset class. Once inflation subsides and growth improves, people will have less incentive for flight to safe haven assets.
On monetary policy measures, all external Members were unanimous in recommending a reduction in the policy repo rate. Four of the six Members suggested that the Reserve Bank should reduce the policy rate by 25 basis points. They felt that favourable global conditions as well as marginal decline in WPI inflation provide room for some monetary easing. This would also support the reform initiatives implemented by the Government. Two of these Members felt that a 25 basis points reduction in the repo rate alone may not induce banks to reduce their lending rates and a cut in the CRR of 25 basis points to nudge the lending rates down is in order. This would also enable loan rates to reduce more than deposit rates. One of the other two Members felt that the Reserve Bank should make use of open market operations (OMOs) to manage liquidity and keep the CRR unchanged. Two Members recommended a sharper reduction in the repo rate by 50 basis points and use of OMOs to manage liquidity. One of these two Members was indifferent between a 50 basis points cut in January 2013 versus a 25 basis points cut in January followed by a 25 basis points cut after presentation of the Union budget if it envisages credible consolidation and keeps the fiscal deficit contained to less than 5 per cent of GDP in 2013-14. In this scenario, there could be some post-budget expectations for monetary policy to reinforce the impact of fiscal consolidation. The other Member was of the view that a 50 basis points cut in repo rate would increase working capital loans, thereby increasing capacity utilisation. This would invigorate growth and also work towards reduction in inflation.
The meeting was chaired by Dr. D. Subbarao, Governor. Other internal Members present were: Dr. Urjit R. Patel (Vice-Chairman), Dr. K.C. Chakrabarty, Shri Anand Sinha and Shri Harun R. Khan, Deputy Governors; and external Members, Shri Y.H. Malegam, Prof. Indira Rajaraman, Prof. Sudipto Mundle and Dr. Shankar Acharya. Prof. Errol D’Souza and Prof. Ashima Goyal, who could not attend the meeting, submitted their written views. Officials of the Reserve Bank Shri Deepak Mohanty, Dr. Michael D. Patra and Dr. B.K. Bhoi were in attendance.
Since February 2011, the Reserve Bank has been placing the main points of discussions of the TAC on Monetary Policy meetings in the public domain with a lag of roughly four weeks after the meeting.