Consultation with external Members of the Technical Advisory Committee (TAC) on monetary policy was held electronically between May 20 and 22, 2015 in the run up to the Second Bi-monthly Monetary Policy Review, 2015-16 on June 2, 2015. The main points suggested by Members are set out below.

1. Members noted that domestic economic activity was weak and the initial optimism regarding growth and investment was waning. Corporate earnings were subdued, growth in industrial production was muted, investment indicators showed no sign of turnaround, credit expansion was yet to pick up, manufacturing growth was at a 5 month low and exports were declining. However, manufacturing growth would possibly improve with policy efforts, particularly with better input supply. While consumption demand was weak with persistent contractions in consumer goods growth over the last several months, expansion of capital goods output in March was a positive indicator. Continuing weak non-food bank credit growth might slow down the pace of the turn-around in GDP growth. The rupee has significantly corrected, which should provide a boost to export growth. Members felt that more monetary accommodation would support the growth process at this juncture.

2. On inflation, Members were of the view that though there are risks to inflation from a possibly weak monsoon and pickup in oil prices, the inflation – both headline and excluding food and fuel had declined significantly during 2014-15. In April, 2015 inflation edged lower because of a sharp decline in food inflation while inflation excluding food and fuel edged up marginally. Further downturn of inflation excluding food and fuel, which has flattened in recent months, is unlikely. The upside risk caused by increase in crude prices since the last monetary policy review, and the Government’s willingness to allow increases to be passed through into retail prices, will lead to possibly steeper increase going forward. The risks to headline inflation from food, depending on the extent of monsoon deficiency or uneven spatial distribution, can be mitigated by timely release of food stocks, as well as muted MSP increases. High frequency data suggest that the cyclical recovery is weak mitigating demand pressures, and input price pressures are also low. Rural wage growth remains modest despite early signs of recovery. Therefore, both cost-push and demand pull factors are muted. Overall, inflation risks remain under control. A Member felt that low inflation readings also implied that the real interest rates were too high.

3. On the external sector, Members expressed concern over subdued demand from across the globe and reflected in contraction in exports for a few months in a row despite depreciation of the rupee. The European Central Bank’s (ECB) quantitative easing (QE) program has had a powerful effect on weakening the Euro, boosting confidence and lifting inflation in the Eurozone. The program was motivated largely to mitigate the threat to deflation. The US Fed is in wait-and-see mode. Second quarter US GDP was weak, and the annualized monthly rate of inflation for core personal consumption expenditures (PCE) price index was close to 2 per cent. The Fed is aware of the potential of a discontinuous jump in wage growth as the US economy approaches 5 per cent unemployment. This is why the Fed may not want to see accelerating wage growth before hiking rates. However, the odds are against the Fed seeing a path to a June rate hike. This suggests there is some monetary space to increase financial accommodation.

4. All seven Members have recommended a reduction in policy repo rate – four members advocated a cut by 25 basis points; two members suggested a 50 basis points reduction and one member proposed a reduction by 75 basis points. The Members who had recommended a reduction in the policy repo rate by 25 basis points were of the view that notwithstanding risks to inflation from monsoon and oil prices, sharp reduction in inflation warrants a reduction in policy rate when consumption and external demand were weak and investment was showing a potential to revive. Members noted that the monetary policy review in April by the Reserve bank highlighted a set of conditions for further monetary accommodation – more transmission by banks, supply response from the government on food prices, and signs of US monetary policy normalizing. Since the evidence on these is mixed, a wait-and-see approach was warranted. However, with low inflation readings and its likely impact on inflation expectations that are adaptive, there is some monetary space to support the growth process. One of these Members also recommended that the SLR should also be reduced by 50 basis points.

5. The Members who recommended larger reduction in the policy repo rate were of the view that with the continuing benign trends in retail and wholesale inflation, improved prospects of monsoon, oil prices at a sustainable level from which they are unlikely to rise further, weak data on economic activity, and the need to nudge the real effective exchange rate downwards, a 50 bps reduction in repo and reverse repo rates is desirable along with a possible announcement of a pause. Some of these Members were of the view that many central banks have cut rates recently and policy rates in India are one of the highest in the world in comparison to its inflation. This invites carry from arbitrage seeking inflows that reverse during global risk-off, creating volatility. As the US Fed rate hike is likely to be delayed, lower policy rate in India will help banks reduce their loan rates. One of these Members was of the view that a 25 basis points cut now should be followed with another after seeing the performance of the monsoon. One of these Members also suggested that the SLR should be reduced by 50 basis points. According to the Member who recommended a 75 basis points reduction in policy rate, given the size of capital required for infrastructure projects, cost of capital is not a small matter in the investment decision process, even though it is not the only factor holding up infrastructure projects. Although the government has made strenuous efforts to bring down food inflation with sale of stocks and keeping a lid on the minimum support price, food inflation can be brought down in the medium term by enabling investment in drip irrigation systems, storage and logistics.

6. All the seven 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 – sent their feedback through e-mail.

Since February 2011, the Reserve Bank has been placing the main points of discussions of the meetings of 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 : 2014-2015/2725