Benign inflation, risks to growth led MPC to cut rate, change stance

Benign inflation and possible downside risk to growth due to continued global growth slowdown prompted the Reserve Bank of India to cut the policy repo rate to 6.25 per cent from 6.50 per cent and change the monetary policy stance to ‘neutral’ from ‘calibrated tightening’, indicate the minutes of the Monetary Policy Committee (MPC) meeting, which took place earlier this month.

While the decision to change the monetary policy stance was unanimous, four MPC members voted for a rate-cut and two preferred status quo. 

Growth impulses 

RBI Governor Shaktikanta Das observed that growth impulses have weakened, and there is a need to spur private investment and strengthen private consumption, especially in the wake of slowing global growth. 

“Inflation readings since the December 2018 policy have shown a sharp decline. The overall food outlook remains benign, and the headline inflation one-year ahead is projected to remain below the target level of 4 per cent. 

“Risks to inflation at this stage are also broadly balanced around the baseline. Hence, space has opened up for policy action to address the growth concerns in pursuance of the provisions of the RBI Act as amended in 2016,” said Das. 

Growth revival

The Governor elaborated that the favourable macroeconomic configuration that is evolving underscores the need to act decisively. The time is opportune to seize the initiative and create a congenial environment for growth to revive and ensure a sustained trajectory, he added.

Deputy Governor Viral Acharya said he prefers to “take off the helmet” but “stay within the crease” – that is, vote for a change in the stance from calibrated tightening to neutral to retain policy flexibility at future dates based on incoming data, but to hold the policy rate at 6.5 per cent. 

“Given the elevated level of inflation, excluding food and fuel, our counterfactual exercises do not suggest any room for accommodation; keeping the policy rate at 6.5 per cent under these exercises turns out to be “just right” over the medium term,” said Acharya.

Biggest risk

Michael Debabrata Patra, Executive Director, RBI, cautioned that the biggest downside risk to growth is likely to stem from global developments – the weakening of global growth in the second half of 2018 may prolong into coming quarters; global trade and investment may be impacted by ongoing trade tensions; and tail risks from policy uncertainties in systemically important economies may crystallise. 

“Should a deeper than currently anticipated global slowdown take hold, domestic activity could be dragged down by retarding impulses transmitted through the channels of exports and investment. 

“In this scenario, it is prudent to preserve sufficient policy space to insulate the economy from adverse external shocks and boost the domestic economy in an opportune manner rather than deplete it in haste,” said Patra.

‘High policy rate’

Ravindra H Dholakia, former Professor, Indian Institute of Management, Ahmedabad, said: “With the policy rate of 6.5 per cent, this implies the real policy rate of about 2.6 per cent, which is one of the highest in the world…We do not need such a high real policy rate. 

“It only discourages private investment and impedes growth and employment. There is an urgent need to correct the situation by bringing down the real policy rate to a more reasonable and acceptable level particularly when the expected inflation 3-4 quarters ahead is within the target of 4 per cent.”