6. Consequently, the reverse repo rate under the LAF stands adjusted to 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 per cent.
7. The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
8. Global growth has been slowing more than anticipated through 2016 so far, with weak investment and trade damping aggregate demand. Meanwhile, risks in the form of Brexit, banking stress in Europe, rebalancing of debt-fuelled growth in China, rising protectionism and diminishing confidence in monetary policy have slanted the outlook to the downside. World trade volume has contracted sharper than expected in the first half of 2016, and the outlook has worsened with the recent falling off of imports by advanced economies (AEs) from emerging market economies (EMEs). Inflation remains subdued in AEs and has started to edge down in EMEs.
9. International financial markets were overwhelmed by the Brexit vote in Q2, with equity markets losing valuations worldwide, currencies plunging and turning volatile, and investors rushing for safe havens. Markets, however, recovered quickly and reclaimed lost ground in Q3, with a return of risk appetite propelling capital flows back into EMEs. Nonetheless, an uneasy calm prevails on uncertainty about the stance of monetary policy of systemic central banks. Commodity prices have firmed up slightly, easing stress for commodity exporters and shaving off some of the terms of trade gains accruing to commodity importers. Crude prices rose to a recent peak in Q2 of 2016, mostly on supply disruption in various parts of the world, and again in late September as the OPEC announced intentions of cutting back on supply; but, the upturn has been curbed by higher inventories.
10. On the domestic front, the outlook for agricultural activity has brightened considerably. The south west monsoon ended the season with a cumulative deficit of only 3 per cent below the long period average, with 85 per cent of the country’s geographical area having received normal to excess precipitation. Kharif sowing has surpassed last year’s acreage, barring cotton, sugarcane and jute and mesta. Accordingly, the first advance estimates of kharif foodgrains production for 2016-17 by the Ministry of Agriculture have been placed at a record level, and higher than the target set for the year. The industrial sector, by contrast, suffered a manufacturing- driven contraction in early fiscal year Q2, after a sequential deceleration in gross value added in Q1. Even after trimming the statistical effects of the lumpy and order- driven contraction of insulated rubber cables, industrial production as measured by the index of industrial production (IIP) turned out to be slower than a year ago. In August, steel production rose to a 37-month high and cement production maintained momentum - auguring well for construction activity - even though the output of core industries as a whole was weighed down by a decline in the production of coal, crude oil and natural gas and deceleration in refinery products and electricity generation. Nonetheless, business expectations polled in the Reserve Bank’s industrial outlook survey and by other agencies remain expansionary in Q2 and Q3. The strong public investment in roads, railways and inland waterways, the recent efforts to unclog cash flows in large projects under arbitration, and the boost to spending from the 7th Pay Commission’s award, should improve the industrial outlook. In the services sector, the acceleration in the pace of activity in Q1 appears to have been sustained. An increasing number of high frequency indicators are moving into positive territory, construction is boosted by policy initiatives, and public administration, defence and other services will be supported by the pay commission award.
11. Retail inflation measured by the headline CPI had been elevated by a sharp pick-up in the momentum of food inflation overwhelming favourable base effects during April-July. In August, however, the momentum of food inflation turned negative and surprised expectations; consequently, base effects in that month came into full play and pulled down headline inflation to an intra-year low. Fuel inflation has moderated steadily through the year so far. Inflation excluding food and fuel (including petrol and diesel embedded in transportation) has been sticky around 5 per cent, mainly in respect to education, medical and personal care services. Households reacted to the recent hardening of food inflation adaptively and raised their inflation expectations in the September 2016 round of the Reserve Bank’s inflation expectations survey of households. Input costs in the manufacturing sector, including staff costs, have firmed up slightly as evident in various surveys, but the presence of considerable slack has restrained their transmission into corporate pricing power.
12. Liquidity conditions have remained comfortable in Q3, with the Reserve Bank absorbing liquidity on a net basis through variable rate reverse repo auctions of varying tenors. Liquidity was injected through open market purchases of ` 200 billion in line with the system’s requirements. As a result, the weighted average call money rate (WACR) remained tightly aligned with the policy repo rate and, in fact, traded with a soft bias. Interest rates on commercial paper (CPs) and certificates of deposit (CD) also eased.
13. In the external sector, merchandise exports contracted in the first two months of Q2. Subdued domestic demand was, however, reflected in a faster contraction in imports. Moreover, the still soft crude prices pared off a fifth of the oil import bill and gold import volume slumped to a fifth of its volume a year ago. Consequently, the merchandise trade deficit narrowed by US$ 10 billion in April-August on a year-on- year basis. These developments are likely to have contained the current account deficit in Q2 at its level in Q1, although the decline in remittances and the flattening of software earnings warrants monitoring. While the pace of foreign direct investment slowed compared to a year ago, portfolio flows were stronger after the Brexit vote, galvanised by a search for returns in an expanding universe of negative yields. The level of foreign exchange reserves rose to US$ 372 billion by September 30, 2016 – an all-time high. Outlook
14. The Committee expects that the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook. It notes that the sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect. The Government has announced several measures to cool food inflation pressures, especially with regard to pulses. These measures should help in moderating the momentum of food inflation in the months ahead. This has opened up space for policy action, as indicated in the third bi- monthly monetary policy statement. The easy liquidity conditions engendered by the Reserve Bank’s operations should also enable the smooth transmission of the policy action through various market segments. Furthermore, banks should find added impetus for better transmission by the recent downward adjustment in small savings rates. The Committee took note of potential cost push pressures that may emerge, including the 7th pay commission award on house rent allowances, and the increase in minimum wages with possible spillovers through minimum support prices. The fuller play of these factors will need vigilance to prevent a generalised cost spiral from taking root. On balance, the Committee envisages a trajectory taking headline CPI inflation towards a central tendency of 5 per cent by March 2017, with risks tilted to the upside albeit lower than in the second and third bi-monthly monetary policy statements of June and August respectively (Chart 1).
15. The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award. The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors. The continuing sluggishness in world trade and smaller terms of trade gains than in the past point, however, to further slackening of external demand going forward. Accordingly, the projection of growth of real gross value added (GVA) for 2016-17 is retained at 7.6 per cent, with risks evenly balanced around it (Chart 2).
16. Six members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published on October 18, 2016. The next meeting of the MPC is scheduled on December 6 and 7, 2016 and its resolution will be announced on December 7, 2016. Voting on the Resolution to reduce the policy repo rate by 25 basis points Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Shri R. Gandhi Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
17. In view of a good monsoon, a decline in food inflation and better food supply management by the government, there has been some abatement of both cyclical and structural risks to the March 2017 consumer price index (CPI) inflation target. With persistent slack in the economy evidenced by unutilised capacity over the past few years, corporate pricing power remains weak. The persistence of core inflation remains a concern. While I recognise that upside risks to meeting the objective of 5 per cent CPI inflation by Q4 of 2016-17 remain, given the current juncture, these are acceptable risks. Expectations of future inflation at the monetary policy horizon, as evidenced by the survey of professional forecasters, are closer to the inflation target, which is also expected to contribute to low and stable inflation.
18. On growth, there are signs of revival of economic activity, which needs to be nurtured.
19. Taking into account these considerations, I vote for a 25 basis points (bps) cut in the policy repo rate from 6.50 per cent to 6.25 per cent at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
20. The modest softening of inflation and inflation expectations seen in some of the surveys conducted by the Reserve Bank, along with lacklustre private investment spending and unused capacity, provides a window for a reduction in the policy rate.
21. While RBI’s Inflation Expectations Survey of Households suggests elevated inflation expectations, the Consumer Confidence Survey presents an encouraging outlook for the price situation as well as future economic conditions. Further, while RBI’s Industrial Outlook Survey suggests some increase in input price pressures in the manufacturing sector in the short-run, this is not expected to transmit to higher selling prices. On the other hand, input cost expectations are muted in the infrastructure sector. Additionally, the Survey of Professional Forecasters suggests anchoring of inflation expectations.
22. In this backdrop, I feel that it is a good time to support growth by reducing the policy rate.
23. Accordingly, I vote for a 25 basis points (bps) cut in the policy repo rate from 6.50 per cent to 6.25 per cent at today’s meeting of the Monetary Policy Committee. Statement by Dr. Ravindra H. Dholakia
24. Some of the upside risks to inflation discussed in the MPC meeting on October 3 and 4, 2016, particularly arising out of the award of the 7th Pay Commission, are largely statistical according to me. Looking forward, in my opinion, the probability of inflation turning up from the current level is reasonably less. On the other hand, there are good chances for the consumer inflation to soften further substantially, benefiting from a good monsoon, supply management measures of the Government and ongoing reforms gaining traction in terms of reducing costs and improving output response.
25. As far as the growth outlook is concerned, I hold the view that the potential growth path of the Indian economy is gradually moving up, particularly in response to several reform measures implemented by the Government. Since there is substantial under-utilisation of capacity in the system, I do not see major risk to inflation if the output gap closes fast. The above assessment gives me the comfort to vote in favour of a cut in the repo rate by 25 basis points. Statement by Dr. Michael Debabrata Patra
26. I vote for a reduction in the policy repo rate by 25 basis points and I fully endorse the rationale for the decision set out in the fourth bi-monthly monetary policy statement.
27. Several parts of the economy are languishing, but as the statement points out, other parts – agricultural activity; steel production; public investment in roads, railways and inland waterways; some categories of services; transmission of policy impulses through financial markets stimulated by ample liquidity; foreign portfolio investment – are mending and coming together for a potential revival. The most important among these positives is the improvement in the inflation outlook. In a framework in which inflation forecasts congeal all available information and serve as the intermediate target of monetary policy, two aspects are noteworthy: (a) the level of the inflation forecast for Q4 of 2016-17 is closer to the target than before; and (b) it has been moving down in relation to the second and third bi-monthly statement projections. This is not to say that the beast has been beaten or it’s back broken, but there is a turn in its momentum that is exploitable, especially by measures that hold down month-on-month changes in prices of essential food items. Moreover, the reduction in inflation in August is more real than statistical – a collapse in momentum which allowed the play of base effects. If the beneficial effects of the satisfactory monsoon keep momentum muted and take inflation below the projection for Q3, the target for Q4 should be achievable. Therefore, while staying focused on the path of disinflation set out in previous monetary policy statements, it is, in my view, most timely now to reduce the policy rate by 25 basis points and drive the actualisation of the macroeconomic configuration that seems to be forming – a reasonable probability of inflation converging to its target and the economy poised on the threshold of an acceleration of growth in the next three quarters of the year. It is crucial, however, to step up vigil around the upturn in inflation projected in the last quarter of 2016-17 to guard against any risk to the target. Statement by Shri R. Gandhi
28. I agree with the assessment of risks to growth and inflation presented in the MPC resolution and vote in favour of lowering the policy repo rate by 25 basis points because of the following specific reasons.
29. While risks to India’s growth from a still fragile global economy have increased, particularly through the trade channel, risks to inflation from global factors may be easing, going by the observed high intensity and spread of global disinflation.
30. From amongst the domestic sources of risks to inflation, I see the maximum comfort coming from pulses. The first advance estimates of kharif foodgrains point to pulses production rising by 57 per cent this year. Despite two consecutive years of droughts, food inflation could be contained because of effective supply management measures by the Government. With a normal monsoon this year, I expect food inflation to stay even more firmly contained. Given the high weight of food in the CPI basket, supply response and supply management will remain critically important to influence the space for monetary policy actions.
31. On the growth front, while the pace is expected to gain gradual momentum, the private investment cycle remains depressed and is yet to respond adequately to the improving consumption demand. Recent data on production of capital goods, imports of capital goods and flow of credit to industry indicate the weak state of investment demand. In this environment, a rate cut according to me will help in stimulating investment demand while also easing somewhat the pressure on firms stemming from balance sheet repairs. Statement by Dr. Urjit R. Patel
32. Indicators of economic activity pointed to a subdued outlook, though gradually improving; further, continuing low capacity utilisation in industry and the persistence of the output gap suggested that pricing power is likely to remain low. Importantly, high frequency data embedded in our forward-looking surveys as well as daily movements in prices of fruits and vegetables, cereals and even pulses across the country gave us some confidence that the inflation target of 5 per cent for Q4 of 2016-17 can be achieved. Therefore, while our model-based projections indicated upside risks to the target, a calibrated policy judgement was warranted, given that some space for policy action had opened up with the fall in inflation in the August reading. Nonetheless, inflation outcomes in Q4 will have to be carefully and continuously monitored as upside risks, albeit lower now than before, persist. Alpana Killawala Press Release : 2016-2017/954 Principal Adviser
6. Consequently, the reverse repo rate under the LAF remains unchanged at 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent.
7. The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
8. Global growth picked up modestly in the second half of 2016, after weakening in the first half. Activity in advanced economies (AEs) improved hesitantly, led by a rebound in the US. In the emerging market economies (EMEs), growth has moderated, but policy stimulus in China and some easing of stress in the larger commodity exporters shored up momentum. World trade is beginning to emerge out of a trough that bottomed out in July-August and shows signs of stabilising. Inflation has ticked up in some AEs, though well below target, and is easing in several EMEs. Expectations of reflationary fiscal policies in the US, Japan and China, and the waning of downward pressures on EMEs in recession are tempered by still-prevalent political risks in the euro area and the UK, emerging geo-political risks and the spectre of financial market volatility.
9. International financial markets were strongly impacted by the result of the US presidential election and incoming data that raised the probability of the Federal Reserve tightening monetary policy. As bouts of volatility fuelled a risk-off surge into US equities and out of fixed income markets, a risk-on stampede pulled out capital flows from EMEs, plunging their currencies and equity markets to recent lows even as bond yields hardened in tandem with US yields. The surge of the US dollar from late October intensified after the election results and triggered sizable depreciations in currencies around the world. Commodity prices firmed up across the board from mid-November on an improvement in the outlook for demand following the US election results, barring gold which lost its safe haven glitter to the ascendant US dollar. Crude prices have firmed after the OPEC’s decision to cut output.
10. On the domestic front, the growth of real gross value added (GVA) in Q2 of 2016-17 turned out to be lower than projected on account of a deeper than expected slowdown in industrial activity. Manufacturing slowed down both sequentially and on an annual basis, with weak demand conditions and the firming up of input costs dragging down the profitability of corporations. Gross fixed capital formation contracted for the third consecutive quarter. Although government final consumption expenditure slowed sequentially, it supported private final consumption expenditure, the mainstay of aggregate demand. The contribution of net exports to aggregate demand remained positive, but on account of a sharper contraction in imports relative to exports.
11. Turning to Q3, the Committee felt that the assessment is clouded by the still unfolding effects of the withdrawal of specified bank notes (SBNs). The steady expansion in acreage under rabi sowing across major crops compared to a year ago should build on the robust performance of agriculture in Q2. By contrast, industrial activity remains weak. Among the core industries in the index of industrial production (IIP), the output of coal contracted in October due to subdued demand, while the production of crude oil and natural gas shrank under the binding constraint of structural impediments. The production of cement, fertilisers and electricity continued to decelerate, reflecting the sluggishness in underlying economic activity. On the other hand, steel output has recorded sustained expansion following the application of countervailing duties. Refinery output accelerated on the back of a pick-up in exports and capacity additions. The withdrawal of SBNs could transiently interrupt some part of industrial activity in November-December due to delays in payments of wages and purchases of inputs, although a fuller assessment is awaited. In the services sector, the outlook is mixed with construction, trade, transport, hotels and communication impacted by temporary SBN effects, while public administration, defence and other services would continue to be buoyed by the 7th Central Pay Commission (CPC) award and one rank one pension (OROP). GVA by financial services is expected to receive a short-term boost from the large inflow of low-cost deposits.
12. Retail inflation measured by the headline consumer price index (CPI) eased more than expected for the third consecutive month in October, driven down by a sharper than anticipated deflation in the prices of vegetables. Underlying this softer reading, however, was an upturn in momentum as prices rose month-on-month across the board. Still elevated prices of sugar and protein-rich items, coupled with a turning up of prices of cereals, pulses and processed foods pushed up the momentum of food prices, which partly offset the moderation in food inflation brought about by a strong favourable base effect. In the fuel category, inflation eased with the decline in LPG prices on an annual basis and a fall in electricity prices from a month ago. Inflation excluding food and fuel continues to show strong persistence. Although housing and personal care inflation softened marginally, the steady rise in inflation in respect of education, medical and health services, and transport and communication has imparted stickiness to inflation in this category.
13. Liquidity conditions have undergone large shifts in Q3 so far. Surplus conditions in October and early November were overwhelmed by the impact of the withdrawal of SBNs from November 9. Currency in circulation plunged by `7.4 trillion up to December 2; consequently, net of replacements, deposits surged into the banking system, leading to a massive increase in its excess reserves. The Reserve Bank scaled up its liquidity operations through variable rate reverse repo auctions of a wide range of tenors from overnight to 91 days, absorbing liquidity (net) of `5.2 trillion. The Reserve Bank allowed oil bonds issued by the Government as eligible securities under the LAF. From the fortnight beginning November 26, an incremental CRR of 100 per cent was applied on the increase in net demand and time liabilities (NDTL) between September 16, 2016 and November 11, 2016 as a temporary measure to drain excess liquidity from the system. From November 28, liquidity absorption fell back and the Reserve Bank undertook variable rate repo auctions of `3.3 trillion on November 28. As expected, money market conditions tightened thereafter and the weighted average call rate (WACR) traded near the upper bound of the LAF corridor on that day before dropping back to the policy repo rate on November 30. All other rates in the system firmed up in sympathy, with term premia getting restored gradually. Through this episode, active liquidity management prevented the WACR from falling even to the fixed rate reverse repo rate, the lower bound of the LAF corridor. Liquidity management was bolstered by an increase in the limit on securities under the market stabilisation scheme (MSS) from `0.3 trillion to `6 trillion on November 29. There have been three issuances of cash management bills under MSS for `1.4 trillion by December 6, 2016.
14. In the external sector, India’s merchandise exports rebounded in September and October. The return to positive territory was supported by a pick-up in both POL and non-POL exports. After a prolonged fall for 22 months, imports rose in October on the back of a sharp rise in the volume of gold imports and higher payments for POL imports. Non-oil non-gold import growth also turned positive after a gap of seven months. For the period April-October, the merchandise trade deficit was lower by US $ 25 billion from its level a year ago. Accordingly, the current account deficit is likely to remain muted, notwithstanding some loss of remittances and software exports under invisibles. Net foreign direct investment has remained reasonably robust, with more than half going to manufacturing, communication and financial services. By contrast, portfolio investment outflows of the order of US $ 7.3 billion occurred in October-November from both debt and equity markets – as in peer EMEs across the board – reflecting a strong home bias triggered by the outcome of the US presidential election and the near-certainty of monetary policy tightening in the US. The level of foreign exchange reserves was US$ 364 billion on December 2, 2016. Outlook
15. The Committee took note of the upturn in the prices of several items that is masked by the easing of inflation on base effects during October. Despite some supply disruptions, the abrupt compression of demand in November due to the withdrawal of SBNs could push down the prices of perishables in the reading that becomes available in December. On the other hand, prices of wheat, gram and sugar have been firming up. While discretionary spending on goods and services in the CPI excluding food and fuel – constituting 16 per cent of the CPI basket – could have been affected by restricted access to cash, the prices of these items may weather these transitory effects as they are normally revised according to pre-set cycles. Prices of housing, fuel and light, health, transport and communication, pan, tobacco and intoxicants, and education – together accounting for 38 per cent of the CPI basket – may remain largely unaffected. Going forward, base effects are expected to reverse and turn unfavourable in December and February. If the usual winter moderation in food prices does not materialise due to the disruptions, food inflation pressures could re-emerge. Furthermore, CPI inflation excluding food and fuel has been resistant to downward impulses and could set a floor to headline inflation. With the OPEC’s agreement to cut production, crude prices may firm up in the coming months. Global developments, especially as financial markets factor in the future stance of US monetary and fiscal policy, could impart volatility to the exchange rate thereby feeding into inflation. The withdrawal of SBNs could result in a possible temporary reduction in inflation of the order of 10-15 basis points in Q3. Taking these factors into account, headline inflation is projected at 5 per cent in Q4 of 2016-17 with risks tilted to the upside but lower than in the October policy review. The fuller effects of the house rent allowances under the 7th CPC award are yet to be assessed, pending implementation, and have not been reckoned in this baseline inflation path (Chart 1).
16. The outlook for GVA growth for 2016-17 has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2 and the effects of the withdrawal of SBNs which are still playing out. Downside risks in the near term could travel through two major channels: (a) short-run disruptions in economic activity in cash-intensive sectors such as retail trade, hotels & restaurants and transportation, and in the unorganised sector; (b) aggregate demand compression associated with adverse wealth effects. The impact of the first channel should, however, ebb with the progressive increase in the circulation of new currency notes and greater usage of non-cash based payment instruments in the economy, while the impact of the second channel is likely to be limited. In October 2016, GVA growth in H2 was projected at 7.7 per cent and for the full year at 7.6 per cent. Incorporating the expected loss of growth momentum in Q3 and waning effects in Q4 alongside the boost to consumption demand from higher agricultural output and the implementation of the 7th CPC award, GVA growth for 2016-17 is revised down from 7.6 per cent to 7.1 per cent, with evenly balanced risks (Chart 2).
17. The liquidity management framework was refined in April with the objective of meeting short-term liquidity needs through regular facilities, frictional and seasonal mismatches through fine-tuning operations and more durable liquidity needs for facilitating growth by modulating net foreign assets and net domestic assets. The Reserve Bank has conducted liquidity management consistent with this framework, progressively moving the system level ex ante liquidity conditions to close to neutrality. In Q3 up to early November, liquidity conditions remained in mild surplus mode. The Reserve Bank injected liquidity of `1.1 trillion through OMO purchases during the fiscal year so far, including an OMO purchase auction of `100 billion in October. Although the replacement of SBNs has engendered large surplus liquidity warranting exceptional operations, this needs to be seen as transitory. The Reserve Bank is committed to conducting liquidity operations in pursuit of the objectives of the revised framework put in place in April to restore system level liquidity to a position of neutrality as the surplus liquidity pressures abate.
18. In the view of the Committee, this bi-monthly review is set against the backdrop of heightened uncertainty. Globally, the imminent tightening of monetary policy in the US is triggering bouts of high volatility in financial markets, with the possibility of large spillovers that could have macroeconomic implications for EMEs. In India, while supply disruptions in the backwash of currency replacement may drag down growth this year, it is important to analyse more information and experience before judging their full effects and their persistence – short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance. If the impact is transient as widely expected, growth should rebound strongly. Turning to inflation, food prices other than vegetables are exhibiting sustained firmness and a pick-up in momentum. Another disconcerting feature of recent developments is the downward inflexibility in inflation excluding food and fuel which could set a resistance level for future downward movements in the headline. Moreover, volatility in crude prices and the surge in financial market turbulence could put the inflation target for Q4 of 2016-17 at some risk. Given these indicators of underlying inflation, it is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs while setting the monetary policy stance. On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance.
19. Six members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published on December 21, 2016. The next meeting of the MPC is scheduled on February 7 & 8, 2017 and its resolution will be placed on the Reserve Bank’s website on February 8, 2017. Voting on the Resolution to keep the policy repo rate unchanged at 6.25 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Shri R. Gandhi Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
20. Because of the increased uncertainty due to the withdrawal of SBNs, and virtually no hard data for November, it would be prudent to ‘wait-and-watch’.
21. While a negative demand shock because of the withdrawal of SBNs will lead to a decline in consumption demand, the risks that such a reduction will have longer term effects by impinging on overall investment sentiment and investment activity are low. The risks that weakening aggregate demand could exacerbate a current type of “credit cycle” where a weakening of the real economy leads to a reduction in bank profits, leading to credit restrictions which further weaken the real economy, are also low. What counters the adverse effects of the withdrawal of SBNs is the aggressive pace of digitisation, and the fast restoration of the transaction demand for money from the re-tendering process. I therefore expect the demand and supply effects from the withdrawal of SBNs to be transient with the accompanying increase in the output gap likely to be temporary. This makes it inappropriate to respond with a rate cut.
22. My paramount concern at this juncture has to do with the stickiness of inflation excluding food and fuel. While headline inflation declined in October, inflation excluding food and fuel increased to 4.9 per cent in October, and remains sticky despite favourable base effects. It may be that a decline in core only comes after there is a substantial decline in inflationary expectations. Since the last review, there has also been a reversal of the non-food commodity cycle (e.g., metals, oil). Having said this, food inflation declined sharply in October although cereal inflation has been increasing gradually, and pulses and products continue to be major contributors of food inflation. While cereal prices may be constrained by buffer stocks, vegetable inflation is transient in nature, with possible reversals in trend. What is comforting though is that fewer commodities are driving inflation now compared to last month, which means that inflation is less generalised. Some disinflation will also come about because of the withdrawal of SBNs, although with a lag.
23. Despite a 175 basis points cut in the policy rate between January 2015 and November 2016, the reduction in the weighted average lending rate (WALR) on outstanding rupee loans for data up to September 2016 was only 71 basis points. Because of imperfect interest-rate pass through so far, an additional cut at this juncture may not yield any further transmission from banks.
24. Once the union budget is announced in the first week of February, there will be one more data point.
25. Taking into account these considerations, I vote for keeping the policy repo rate unchanged at 6.25 per cent at today’s meeting of the Monetary Policy Committee. I also believe that the Committee should now focus on the mid-point of the medium-term inflation target of 4 +/- 2 per cent given the lags associated with the transmission of monetary policy. Statement by Dr. Pami Dua
26. On the basis of the Indian leading indices produced by the Economic Cycle Research Institute (ECRI), it can be inferred that the Indian economy was in a resilient state ahead of the decision to withdraw SBNs. It may be noted that a leading index predicts changes in economic activity and thus, cyclical turns in the economy. Specifically, with the Indian Leading Index growth in a clear cyclical upswing and rising to a two-year high before the withdrawal of SBNs, the economic growth outlook going into the autumn months had become increasingly optimistic, underscoring the economy’s resilience to potential negative shocks. Thus, from a business cycle perspective, at the time, the Indian economy was not vulnerable. Moreover, growth in ECRI’s Indian Leading Exports Index, a harbinger of India's exports growth, was also in a decisive cyclical upturn. This indicates that improved exports growth may provide additional support to growth in economic activity, particularly in the context of the brighter global growth prospects suggested by ECRI’s global leading indices. In this backdrop, the withdrawal of SBNs is expected to have only a transitory impact on economic activity.
27. Moreover, with a cumulative reduction in the policy rate by 175 basis points since January 2015, conditions are conducive for further transmission to lending rates by banks. Meanwhile, in the light of higher international bond yields and a strong upturn in ECRI's U.S. Future Inflation Gauge (that anticipates U.S. inflation), the U.S. Federal Reserve is expected to raise its policy rate this month.
28. Keeping in view the above, I fully endorse the resolution to keep the policy repo rate unchanged at 6.25 per cent. Statement by Dr. Ravindra H. Dholakia
29. After carefully considering all arguments for and against holding the policy rate constant in the December review, I find the following reasons convincing for my vote:
30. The Reserve Bank’s forecast of the CPI headline inflation rate obtained by assessment of commodity groups in the CPI basket for the end of March 2017 is about 5 per cent with some upside risks. While my own point forecast based on a more aggregative econometric model is lower, the range estimates of the same indicate a significant chance of the inflation rate exceeding the threshold in March 2017 and in June 2017.
31. Stickiness in the core inflation (other than food and fuel) at close to 5 per cent over the past several months is observed. This coupled with marginally declining but still very high inflationary expectations revealed by the RBI surveys need to be considered seriously.
32. Given the recent developments on SBNs and related policies, the banking sector is likely to be flooded with liquidity for some time to come that on its own may exert a greater influence on the lending rates of banks than the repo rate.
33. Transmission out of the cumulative reduction of 175 basis points in the repo rate since January 2015 has so far been substantially less than 50 per cent in the weighted average lending rate (WALR) for the outstanding Rupee loans and around 60 per cent in the WALR for the fresh rupee loans, whereas it is above 70 per cent in the deposit rates. Thus, there exists enough space for further transmission in the lending rates by the banks.
34. Both external and domestic economic environments are currently impacted by some unique uncertainties as pointed out in the resolution of the Committee. The magnitude of individual and net impact is not very clear at this juncture. In such an environment characterised by uncertainties, any policy intervention in terms of repo rate with acknowledged longer outside lags is likely to add to the uncertainties, which will not be good for the economy.
35. While the recent developments on SBNs can be considered as an exogenous shock to the economy that results in downward revision of the GDP growth forecast, it is widely perceived to be a transitory or temporary phenomenon. If it is so, it is not advisable to respond with a policy intervention that involves longer distributive lags, because otherwise it can destabilise the system or create avoidable uncertainty in policy stance and action in future. Statement by Dr. Michael Debabrata Patra
36. As the resolution of the Monetary Policy Committee (MPC) sets out, an exceptional configuration of factors is obscuring a clear assessment of the outlook. While domestic supply disruptions and demand compression appear to be transient, global developments, including the morphing of political changes into macroeconomic risks, could likely be longer-lived and more challenging. Under these conditions, precaution warrants careful monitoring of the manner in which these forces play out and influence the near- to medium-term. In particular, it is critical to stay focused on the inflation target of 5 per cent for Q4 of 2016-17 amidst subsiding but still-present upside risks in the form of firmness in prices of several food items barring vegetables, hardening international commodity prices – especially of crude oil – and the downward inflexibility in inflation excluding food and fuel. Achieving 5 per cent will imbue credibility into the commitment of monetary policy to the inflation target of 4 per cent, i.e., the centre of the target band. Accordingly, I vote for keeping the policy rate unchanged, while allowing the transmission of policy rate reductions of 175 basis points effected from January 2015 to maintain accommodation in the monetary policy stance. Statement by Shri R. Gandhi
37. I fully concur with the assessment set out in the monetary policy resolution of the MPC and vote in favour of no change in the repo rate because of the following reasons:
38. There is uncertainty about the short-term impact of the decision to withdraw the legal tender status of `500 and `1000 denomination bank notes on the macro- economy, although the impact is likely to be transitory. I, however, don’t see any significant downside risks to the medium-term growth prospects of the economy. However, there are other uncertainties as well, especially the oil price situation and geo-political situation. For a forward looking monetary policy framework, given the lags in monetary policy transmission, a policy rate action amidst heightened uncertainty will only implicitly allow short-term developments and expectations to impact the medium-term outlook, which needs to be avoided.
39. In an environment characterised by uncertainty, it is more important to create or reinforce enabling conditions for monetary policy actions to work more effectively, going ahead. Hence, my vote for maintaining the policy rate at current level. Statement by Dr. Urjit R. Patel
40. Inflation excluding food and fuel remains sticky. International crude oil prices have firmed up. Global financial conditions pose a threat to macroeconomic and financial stability, with large fluctuations in capital flows and asset prices imparting volatility which gets transmitted into inflation. This uncertainty shows no sign of subsiding, and is likely to get accentuated in the coming year as US macroeconomic and trade policies realign. Even as growing credibility in the disinflation process in India has lowered households’ inflation expectations from double digits prevailing until December 2015, they remain elevated and feed into the services component of inflation. More recently, the steady easing of food inflation has brought about a decline in inflation expectations in the latest round of the survey.
41. The impact of the withdrawal of SBNs on growth and inflation, while uncertain, is transitory. Against this backdrop, it is important for monetary policy to stay focused on the medium-term and strive to achieve, on a durable basis, the middle of the notified inflation target range i.e., 4 per cent. There are other risks to this objective. The full cost-push effects of higher allowances under the 7th CPC’s award will impact inflation outcomes and inflation expectations in 2017-19. Also, the implementation of the goods and services tax could produce a one-off step-up, albeit modest, in inflation. The decision of the Organisation of Petroleum Exporting Countries (OPEC) to cut production, supported by key non-OPEC members, will harden crude prices further as demand and supply get balanced out. Recent movements in other commodity prices also suggest that the global commodity price cycle could be turning. Inflation in advanced economies is turning up incipiently and is expected to rise significantly in 2017 from 2016 levels. Achieving the inflation target of 5 per cent for Q4 of 2016-17 and securing 4 per cent – the central point of the notified target range – remains the primary objective. Ajit Prasad Press Release : 2016-2017/1606 Assistant Adviser
6. Consequently, the reverse repo rate under the LAF remains unchanged at 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent.
7. The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
8. Global growth is projected to pick up modestly in 2017, after slowing down in the year gone by. Advanced economies (AEs) are expected to build upon the slow gathering of momentum that started in the second half of 2016, led by the US and Japan. However, uncertainty surrounds the direction of US macroeconomic policies with potential global spillovers. Growth prospects for emerging market economies (EMEs) are also expected to improve moderately, with recessionary conditions ebbing in Russia and Brazil, and China stabilising on policy stimulus. Inflation is edging up on the back of rising energy prices and a mild firming up of demand. However, global trade remains subdued due to an increasing tendency towards protectionist policies and heightened political tensions. Furthermore, financial conditions are likely to tighten as central banks in AEs normalise exceptional accommodation in monetary policy.
9. International financial markets turned volatile from mid-January on concerns regarding the ‘Brexit’ roadmap and materialisation of expectations about economic policies of the new US administration. Within the rising profile of international commodity prices, crude oil prices firmed up with the OPEC’s agreement to curtail production. Prices of base metals have also increased on expectations of fiscal stimulus in the US, strong infrastructure spending in China, and supply reductions. Geopolitical concerns have also hardened commodity prices. More recently, the appetite for risk has returned in AEs, buoying equity markets and hardening bond yields as a response to the growing likelihood of further increases in the Federal Funds rate during the year. Coupled with expectations of fiscal expansion in the US, this has propelled the US dollar to a multi-year high.
10. The Central Statistics Office (CSO) released its advance estimates for 2016-17 on January 6, placing India’s real GVA growth at 7.0 per cent for the year, down from 7.8 per cent (first revised estimates released on January 31) a year ago. Agriculture and allied activities posted a strong pick-up, benefiting from the normal south-west monsoon, robust expansion in rabi acreage (higher by 5.7 per cent over the preceding year) and favourable base effects as well as the continuing resilience of allied activities. In contrast, the industrial sector experienced a sharp deceleration, mainly due to a slowdown in manufacturing and in mining and quarrying. Service sector activity also lost pace, concentrated in trade, hotels, transport and communication services, and construction, cushioned to some extent by public administration and defence.
11. Industrial output measured by the index of industrial production (IIP) finally shrugged off the debilitating drag from insulated rubber cables from November and was also pushed up by a favourable base effect. In December, the output of core industries accelerated on a year- on-year as well as on a sequentially seasonally adjusted basis. The drivers of the upturn were steel production and petroleum refinery throughput, the former, inter alia, supported by import tariff safeguards and the latter buoyed by external demand. The acceleration in coal production and thermal electricity generation since November after three consecutive months of contraction augur well for the outlook for power. Reflecting these developments, the manufacturing purchasing managers’ index (PMI) returned to expansion mode in January on the back of growth of new orders and output, and the future output index has risen strongly. On the other hand, the 76th round of the Reserve Bank’s industrial outlook survey suggests that financing conditions facing the manufacturing sector have worsened in Q3 of 2016-17 and are expected to remain tight in Q4. This is corroborated by the sharp slowdown in bank credit to industry and continuing sluggishness in the investment climate in some sectors.
12. High frequency indicators point to subdued activity in the services sector, particularly automobile sales across all segments, domestic air cargo, railway freight traffic, and cement production. Nevertheless, some areas stand out as bright spots, having weathered the transient effects of demonetisation – steel consumption; port traffic; international air freight; foreign tourist arrivals; tractor sales; and, cellular telephone subscribers. The services PMI for January 2017 remained in retrenchment, but the fall in output was the least in the current phase of three consecutive months of contraction.
13. Marking the fifth consecutive month of softening, retail inflation measured by the headline consumer price index (CPI) turned down sharper than expected in December and reached its lowest reading since November 2014. This outcome was driven by deflation in the prices of vegetables and pulses. Some moderation in the rate of increase in prices of protein-rich items – eggs, meat and fish – also aided the downturn in food inflation.
14. Excluding food and fuel, inflation has been unyielding at 4.9 per cent since September. While some part of this inertial behaviour is attributable to the turnaround in international crude prices since October – which fed into prices of petrol and diesel embedded in transport and communication – a broad-based stickiness is discernible in inflation, particularly in housing, health, education, personal care and effects (excluding gold and silver) as well as miscellaneous goods and services consumed by households.
15. The large overhang of liquidity consequent upon demonetisation weighed on money markets in December, but from mid-January rebalancing has been underway with expansion of currency in circulation and new bank notes being injected into the system at an accelerated pace. Throughout this period, the Reserve Bank’s market operations have been in liquidity absorption mode. With the abolition of the incremental cash reserve ratio from December 10, liquidity management operations have consisted of variable rate reverse repos under the LAF of tenors ranging from overnight to 91 days and auctions of cash management bills under the market stabilisation scheme (MSS) of tenors ranging from 14 to 63 days. The average daily net absorption under the LAF was ` 1.6 trillion in December, ` 2.0 trillion in January and ` 3.7 trillion in February (up to February 7) while under the MSS, it was ` 3.8 trillion, ` 5.0 trillion and ` 2.9 trillion, respectively. Money market rates remained aligned with the policy repo rate albeit with a soft bias, with the weighted average call money rate (WACR) averaging 18 basis points below the policy rate during December and January.
16. Turning to the external sector, export growth remained in the positive zone for the fourth month in succession in December. Imports other than petroleum oil and lubricants (POL) came out of the spike in November and moderated in December. In contrast, there was an increase of over 10 per cent in POL imports, in part reflecting the rise in international crude oil prices. Overall, the trade deficit shrank both sequentially and on a year-on-year basis, being lower for the period April-December by US$ 23.5 billion than its level a year ago. On the whole, the current account deficit is likely to remain muted and below 1 per cent of GDP in 2016-17. While the buoyancy in net foreign direct investment was sustained, there have been portfolio outflows beginning October on uncertainty relating to the direction of US macroeconomic policies and expectations of faster normalisation of US monetary policy in the year ahead. Foreign exchange reserves were at US$ 363.1 billion on February 3, 2017. Outlook
17. In the fifth bi-monthly statement of December, headline inflation was projected at 5 per cent in Q4 of 2016-17 with risks lower than before but still tilted to the upside. The decline in headline CPI inflation in November and December has been larger than expected, but almost exclusively on the back of deflation in vegetables and pulses. While the seasonal ebb in the prices of vegetables that usually occurs with the onset of winter as well as some demand compression may have contributed to this outcome, anecdotal evidence points to some distress sales of perishables having accentuated the decline in vegetable prices, with spillovers into January as well. Looking beyond, prices of pulses are likely to remain soft with comfortable supply conditions, while vegetable prices may potentially rebound as the effects of demonetisation wear off. 17. Discretionary consumer demand, which got impacted in the immediate aftermath of demonetisation, is expected to bounce back. Limited data available on the corporate sector performance in Q3 suggests that sales growth may have improved relative to the previous quarter. According to the latest round of RBI’s consumer confidence survey, the one year ahead outlook is upbeat, with significant improvement expected relative to the situation in Q3 of 2016-17. The Union Budget for 2017-18, while being prudent, has stepped up expenditure on infrastructure and emphasised affordable housing. Global growth is projected to be higher in 2017 than 2016. These factors, along with improved monetary transmission, have markedly improved growth prospects for 2017-18 compared to the current year.
18. The Committee is of the view that the persistence of inflation excluding food and fuel could set a floor on further downward movements in headline inflation and trigger second- order effects. Nevertheless, headline CPI inflation in Q4 of 2016-17 is likely to be below 5 per cent. Favourable base effects and lagged effects of demand compression may mute headline inflation in Q1 of 2017-18. Thereafter, it is expected to pick up momentum, especially as growth picks up and the output gap narrows. Moreover, base effects will reverse and turn adverse during Q3 and Q4 of 2017-18. Accordingly, inflation is projected in the range of 4.0 to 4.5 per cent in the first half of the financial year and in the range of 4.5 to 5.0 per cent in the second half with risks evenly balanced around this projected path (Chart 1). In this context, it is important to note three significant upside risks that impart some uncertainty to the baseline inflation path – the hardening profile of international crude prices; volatility in the exchange rate on account of global financial market developments, which could impart upside pressures to domestic inflation; and the fuller effects of the house rent allowances under the 7th Central Pay Commission (CPC) award which have not been factored in the baseline inflation path. The focus of the Union budget on growth revival without compromising on fiscal prudence should bode well for limiting upside risks to inflation. 18. On the external front, exports growth is likely to continue to provide support to the economy, but volatility in the foreign exchange markets is a concern. Moreover, while the US Fed maintained the status quo on interest rates, it is expected to hike rates in the future.
19. GVA growth for 2016-17 is projected at 6.9 per cent with risks evenly balanced around it. Growth is expected to recover sharply in 2017-18 on account of several factors. First, discretionary consumer demand held back by demonetisation is expected to bounce back beginning in the closing months of 2016-17. Second, economic activity in cash- intensive sectors such as retail trade, hotels and restaurants, and transportation, as well as in the unorganised sector, is expected to be rapidly restored. Third, demonetisation-induced ease in bank funding conditions has led to a sharp improvement in transmission of past policy rate reductions into marginal cost-based lending rates (MCLRs), and in turn, to lending rates for healthy borrowers, which should spur a pick-up in both consumption and investment demand. Fourth, the emphasis in the Union Budget for 2017-18 on stepping up capital expenditure, and boosting the rural economy and affordable housing should contribute to growth. Accordingly, GVA growth for 2017-18 is projected at 7.4 per cent, with risks evenly balanced (Chart 2).
20. The Committee remains committed to bringing headline inflation closer to 4.0 per cent on a durable basis and in a calibrated manner. This requires further significant decline in inflation expectations, especially since the services component of inflation that is sensitive to wage movements has been sticky. The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and the output gap play out.
21. The Reserve Bank has conducted market liquidity operations consistent with the liquidity management framework put in place in April 2016, progressively moving the system level ex ante liquidity conditions to close to neutrality. This stance will continue. Surplus liquidity should decline with progressive remonetisation. Nonetheless, the currently abundant liquidity with banks is likely to persist into the early months of 2017-18. The Reserve Bank is committed to ensuring efficient and appropriate liquidity management with all the instruments at its command to ensure close alignment of the WACR with the policy rate, improved transmission of policy impulses to lending rates, and adequate flow of credit to productive sectors of the economy.
22. The Committee believes that the environment for timely transmission of policy rates to banks lending rates will be considerably improved if (i) the banking sector’s non- performing assets (NPAs) are resolved more quickly and efficiently; (ii) recapitalisation of the banking sector is hastened; and, (iii) the formula for adjustments in the interest rates on small savings schemes to changes in yields on government securities of corresponding maturity is fully implemented. 1
23. Six members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published by February 22, 2017. Since the introduction of the formula in April 2016, interest rates on small savings are about 65-100 basis points higher, depending on tenor, compared to what they should be if the formula is followed. If the spread between small savings rates and bond yields remains wide, the diversion of deposits to small savings would impede a full transmission to bank lending rates.
24. The next meeting of the MPC is scheduled on April 5 and 6, 2017. Voting on the Resolution to keep the policy repo rate unchanged at 6.25 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
25. The Union budget has largely adhered to a path of fiscal consolidation as shown in both the continuous decline in the revenue deficit and fiscal deficit. The focus in the budget on reducing revenue expenditure without compromising on capital expenditure suggests that the budget will not add to the inflationary momentum of the economy.
26. There is more clarity on the impact of demonetisation on real output in terms of its temporary component and its permanent component. The temporary (adverse) effect is getting reversed as the economy remonetises. This is confirmed by various enterprise surveys conducted by the Reserve Bank since the last review. What is a little more uncertain is the permanent effect, which will operate through wealth destruction, and work more gradually. Even so, the permanent (adverse) effect is not likely to be large in the long run. Overall, and as I mentioned in the last review, it appears that uncertainty on the production side has largely been mitigated. Since I do not see a persistent opening up of the output gap because of demonetisation, this does not warrant a rate cut.
27. Unlike production, uncertainty in the price level persists because of demonetisation obfuscating some of the trends that existed before November 8. While both 3 month and 1 year median inflationary expectations have fallen, it is unclear whether this will sustain. While fire sales have led to vegetable prices collapsing, vegetables always have a seasonal rebound. In fact, inflation net of vegetables continues to remain at 4.8 per cent, and momentum in food inflation increased in December. Inflation excluding food and fuel remains sticky, and since it is above headline inflation, this will exert upward pressure on headline inflation. These arguments suggest that a quicker pace of disinflation may not sustain on a durable basis. With a shift in focus towards the mid-point of the medium-term inflation target of 4 +/- 2 per cent, these arguments warrant no change in the policy rate.
28. While the Indian economy is very different now compared to the summer of 2013, the impact on financial markets of the possible ending of re-investment of principal payments by the US Fed from its balance sheet holdings needs to be watched carefully. Such a “balance sheet reduction” by the Fed may impart volatility.
29. Taking into account these considerations, I vote for keeping the policy repo rate unchanged at 6.25 per cent at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
30. While the transitory effects of demonetisation on inflation and output gap have yet to be fully assessed, the ratio of currency in circulation to GDP is on the rise, suggesting that remonetisation is progressing well. Furthermore, in the aftermath of demonetisation, due to the increase in liquidity with the banks, banks have already reduced the marginal-cost-based lending rates which should fuel demand in the economy. The Budget is also conducive to growth in the key sectors and is expected to have multiplier effects. On the inflation front, while CPI inflation has softened primarily due to lower food prices, core inflation (excluding food and fuel) remains sticky, close to 5 per cent, partly due to rising international commodity prices. The Survey of Professional Forecasters conducted by the Reserve Bank also indicates that core CPI inflation is likely to remain sticky around 5 per cent till Q3-2017-
31. Furthermore, the international leading indexes produced by the Economic Cycle Research Institute (ECRI) indicate stronger global growth and inflation prospects for the coming months. The continued cyclical upswing in ECRI’s U.S. Future Inflation Gauge (that anticipates U.S. inflation) points to further increases in inflation. Further, the strength in leading indexes of U.S. economic growth signal higher economic growth. Both these factors may be consistent with multiple Fed rate hikes this year.
32. Taking the above considerations into account, I vote to keep the policy repo rate unchanged at 6.25 per cent. Statement by Dr. Ravindra H. Dholakia
33. Surveys conducted by the Reserve Bank to provide input for the Monetary Policy indicate that: a) the capacity utilisation may decline marginally; b) cost of raw materials is likely to rise and firms may lose pricing power; c) investment outlook may remain subdued; d) lack of clearances and lack of funds are the major reasons for the stalled projects; e) inflationary expectations are declining for three months and one year ahead; and f) sentiments on employment and household income have worsened. These findings are consistent with our view that demonetisation of high value currency notes would have transitory adverse impact on growth of income and employment. The Economic Survey 2016-17 by the Ministry of Finance also corroborates the transitory nature of the impact though their estimate of the slowdown in the growth is marginally higher than the Reserve Bank’s forecast. In any case there is a general agreement that the growth in the coming quarters is likely to pick up with the economy returning to its pre-demonetisation growth path.
34. In this context, the Union Budget for the year 2017-18 presented on the 1st February 2017 has been very pragmatic and disciplined providing adequate boost to help the economy return to its pre-demonetisation growth path. However, the State Budgets have been the cause of concern of late because the movement in their fiscal deficits largely determines the variation in the combined fiscal deficit of the country. States have now started forming a larger proportion of the public expenditures and having a clear idea on their fiscal deficits is important for the monetary policy.
35. While the commodity prices are firming up, the wholesale price index (WPI) for manufacturing shows very low inflation. Since the items affected by it in the CPI do not have high weightage, the CPI inflation without food and fuel continues to be high around 5 per cent. The decline in overall CPI inflation is not reliably stable because it is mainly on account of vegetables and pulses coupled with the transitory impact of demonetisation.
36. As the transitory impact of demonetisation recedes and remonetisation sets in, the banks’ MCLRs are likely to increase marginally. Moreover, under the current global environment, the real neutral rate of interest in India seems to be higher than the one for most of the developed countries. However, their future policy direction indicates rapid strengthening of the rates.
37. Given all these factors, it is prudent not to tinker with the policy rate at this stage. In any case, under the given circumstances and reasonable forecasts for the future, I find the current rate to be optimal for liquidity in the economy. Therefore, a change of stance from accommodative to neutral at this stage is desirable. It can impart the necessary flexibility for the monetary policy in future to respond to any development on either side. Statement by Dr. Michael Debabrata Patra
38. I vote for keeping the policy rate unchanged and for starting the withdrawal from accommodation in the policy stance for three compelling reasons. First, the recent sharp disinflation is entirely driven by transitory forces. Underneath, there is a broader-based firming up of inflation pressures. Excluding vegetables, CPI inflation was 4.8 per cent, 136 basis points above the headline number of 3.4 per cent in December. Vegetable prices may have been impacted by demonetisation, but they also exhibit strong seasonal behaviour and tend to turn up as the winter gets over. Excluding food, inflation was 4.7 per cent; and excluding both food and fuel, inflation was 4.9 per cent. Moreover, all of these levels have become persistent since September 2016. Secondly, the reflationary effects of remonetisation are likely being underestimated in the commentary around it. With transactions requirement of currency amply met, the positive shock that is travelling through the economy can be expected to fuel inflation well before the more sluggishly moving activity and demand respond. If the seasonal upturn in vegetables prices and these reflationary effects coincide as they might by as early as March-April, monetary policy needs to be preemptively on guard. Thirdly and importantly, forward-lookingness necessitated by lags in transmission requires monetary policy to centre its focus now on the mandated inflation target of 4 per cent – deviations out of the tolerance limits around the target for nine months consecutively will no longer be tolerated. This acquires some urgency because the tailwinds that propelled inflation down through 2014-17, some fortuitous like the collapse of international commodity prices, do not appear to be in sight over the next 12-month horizon. Instead, upside risks from global financial turbulence, international crude prices and a less than normal south west monsoon could individually materialise and even intensify together into a perfect storm.
39. It is eminently possible that the reasons cited above do not turn out to be so compelling and even dissipate. That will open up headroom for monetary policy to more directly address the objective of growth. If, on the other hand, they turn out to be real and present dangers, it is vital to unfetter monetary policy from a unidirectional stance. Statement by Dr. Viral V. Acharya
40. This was a tough policy decision to take.
41. On the one hand, headline inflation has remained low, and there is a good case to be made that there is at least a temporary output gap created due to liquidity shortage induced by the currency replacement. Since our flexible inflation targeting mandate also requires paying attention to growth, it could be natural to lower the policy rate to restore growth levels, especially if the lower policy rate could be passed onto the areas of the economy most affected by the liquidity shortage, in particular, rural households, non-bank finance corporations which undertake most of the auto-based lending, and the realty sector.
42. On the other hand, low headline inflation has been largely driven by food deflation, and the most recent numbers have been heavily driven by the large dip in vegetable prices. In the past, food deflation has had strong seasonal patterns which have tended to rebound and with vengeance when rainfall disappoints. While some of the food deflation over the past few months has been steady due to supply-side factors, on balance it is fair to draw the conclusion that statistically, food component of headline inflation has had less signal to noise quality compared to the core inflation that excludes fuel and food, the latter having been more or less sticky in recent months. Rapid remonetisation implies likely swift reversal of the aggregate demand loss and the significant transmission to borrowers of easy funding conditions at banks suggests unlikely further transmission of a rate cut by banks.
43. Given the difficulty in resolving this trade-off between temporary effects on output gap and the persistent nature of core inflation, my attention turned heavily to international factors. Global uncertainty in trade due to protectionist tendencies in major developed economies, the prospect of a stronger dollar in wake of a probable "border tax" on imports in the US, and rising world-wide inflation in food, fuel and metals, have created a significant risk to domestic inflation. Second-round effects on funding costs due to portfolio outflows from debt and equity markets could be substantial if the central bank is not perceived as staying course on credible inflation targeting.
44. It is important to guard the Indian macro-economy from global headwinds, and having a reasonably good chance of attaining the 5 per cent target for headline inflation by end of March 2017, to keep the option open to start getting closer to our long-term target of 4 per cent headline inflation on a durable basis. Overall, this required no rate cut for now and switching to a neutral stance so as to remain fully flexible to raise rates, or to stay put, or to cut rates, as more data becomes available on both domestic and international fronts.
45. One final note on the monetary policy decision: The balanced budget, by focusing on fiscal stability and expenditure reorientation to rural and housing, seemed to exonerate the Committee from the burden of skewing rates to bridge the output gap and instead allowed the Committee to focus squarely on the inflation-targeting mandate.
46. Such a time, while difficult for interest-rate setting, appears right for pushing forward on structural reforms of the banking sector: its asset quality and resolution, and its recapitalisation needs - both factors that have stunted credit growth at banks; and, the normalisation of administered small savings rates that have prevented a seamless transmission of monetary policy to bank funding and lending rates. Statement by Dr. Urjit R. Patel
47. The short-run assessment of evolving macroeconomic conditions remains clouded.
48. On the inflation outlook, transient factors, including anecdotal evidence on fire sales of perishables, have discoloured an objective assessment of inflation pressures in recent months. Past experience suggests that the rebound in vegetable prices could be sharper than normal. Importantly, non-food non-fuel inflation has remained sticky, notwithstanding the transitory impact of demonetisation on consumption demand. Crude oil and commodity prices (including for food) have firmed up globally, thereby potentially raising risks to the headline inflation. Domestic industrial input and farm costs, including rural wages, have increased in recent months. Inter alia cost push effects of 7th pay commission allowances, and exchange rate volatility arising from possible shifts in risk premia on a full rollout of US macroeconomic policies impart uncertainty to the inflation trajectory going ahead.
49. With the remonetisation of the economy taking place at an accelerated pace over the last two months, economic activity is expected to pick up from the latter part of Q4 of 2016-
50. While pursuing 4 per cent CPI headline inflation that became effective from August 2016 as per the Gazette notification, it is necessary to adopt a calibrated approach so as to minimise the collateral costs of achieving the target as well as ensure its durability. By shifting the stance of monetary policy from accommodative to neutral, there will now be sufficient flexibility to move the policy rate in either direction, depending on future data outcomes and projections, to help ensure that inflation is brought closer to 4 per cent. Jose J. Kattoor Press Release: 2016-2017/2263 Chief General Manager
6. Consequent upon the narrowing of the LAF corridor as elaborated in the accompanying Statement on Developmental and Regulatory Policies, the reverse repo rate under the LAF is at 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.50 per cent.
7. The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
8. Since the MPC met in February 2017, indicators of global growth suggest signs of stronger activity in most advanced economies (AEs) and easing of recessionary conditions in commodity exporting large emerging market economies (EMEs). In the US, high frequency data indicate that the labour market, industrial production and retail sales are catalysing a recovery in Q1 of 2017 from a relatively subdued performance in the preceding quarter. Nonetheless, risks to higher growth have arisen from non-realisation or under-achievement of macroeconomic policies. In the Euro area, the manufacturing purchasing managers’ index (PMI) rose to a six- year high in March amidst improving consumer confidence and steadily strengthening employment conditions. In the Japanese economy, nascent signs of revival are evident in the form of falling unemployment, improving business sentiment on fixed investment, and rising exports helped by the depreciation of the yen; however, deflation risks linger.
9. For EMEs, the outlook is gradually improving, with indications that the slowdown characterising 2016 could be bottoming out. In China, supportive macroeconomic policies, surging credit growth and a booming property market have held up the momentum of growth albeit amidst concerns about financial stability and capital outflows. In Brazil, hardening commodity prices are providing tailwinds to reforms undertaken by the authorities to pull the economy out of recession, although financial fragilities remain a risk. Russia is benefiting from the firming up of crude prices and it is widely expected that growth will return to positive territory in 2017.
10. Inflation is edging up in AEs to or above target levels on the back of slowly diminishing slack, tighter labour markets and rising commodity prices. Among EMEs, Turkey and South Africa remain outliers in an otherwise generalised softening of inflation pressures. Global trade volumes are finally showing signs of improvement amidst shifts in terms of trade, with exports rising strongly in several EMEs as well as in some AEs whose currencies have depreciated.
11. International financial markets have been impacted by policy announcements in major AEs, geo-political events and country-specific factors. Equity markets in AEs were driven up by reflation trade, stronger incoming data and currency movements. Equity markets in EMEs had a mixed performance, reflecting domestic factors amidst a cautious return of investor appetite and capital flows. In the second half of March, dovish guidance on US monetary policy lifted equities across jurisdictions, especially in Asia, as the reach for EME assets resumed strongly, although doubts about the realisation of US policies, Brexit and softer crude prices tempered sentiments. Bond markets have mirrored the uncertainty surrounding the commitment to fiscal stimulus in the US and yields traded sideways in AEs, while they generally eased across EMEs. In the currency markets, the US dollar’s bull run lost steam by mid-March. EME currencies initially rose on optimism on the global outlook, but some of them have weakened in recent days with the fall in commodity prices. Crude prices touched a three-month low in March on rising shale output and US inventories. Food prices have been firming up globally, driven by cereals.
12. On the domestic front, the Central Statistics Office (CSO) released its second advance estimates for 2016-17 on February 28, placing India’s real GVA growth at 6.7 per cent for the year, down from 7 per cent in the first advance estimates released on January 6. Agriculture expanded robustly year-on-year after two consecutive years of sub-one per cent growth. In the industrial sector, there was a significant loss of momentum across all categories, barring electricity generation. The services sector also slowed, pulled down by trade, hotels, transport and communication as well as financial, real estate and professional services. Public administration, defence and other services cushioned this slowdown. To some extent, government expenditure made up for weakness in private consumption and capital formation.
13. Several indicators are pointing to a modest improvement in the macroeconomic outlook. Foodgrains production has touched an all-time high of 272 million tonnes, with record production of rice, wheat and pulses. The record production of wheat should boost procurement operations and economise on imports, which had recently surged. Rice stocks, which had depleted to close to the minimum buffer norm, have picked up with kharif procurement. The bumper production of pulses has helped in building up to the intended buffer stock (i.e., 20 lakh tonnes) and this will keep the price of pulses under check – the domestic price of pulses has already fallen below the minimum support price (MSP).
14. Industrial output, measured by the index of industrial production (IIP), recovered in January from a contraction in the previous month, helped by a broad- based turnaround in manufacturing as well as mining and quarrying. Capital goods production improved appreciably, although this largely reflected the waning of unfavourable base effects. Consumer non-durables continued, however, to contract for the second successive month in spite of supportive base effects. Thus, investment and rural consumption demand remain muted. The output of core industries moderated in February due to slowdown in production of all the components except coal. The manufacturing purchasing managers’ index (PMI) remained in expansion mode in February and rose to a five month high in March on the back of growth of new orders and output. The future output index also rose strongly on forecasts of pick-up in demand and the launch of new product lines. The 77th round of the Reserve Bank’s industrial outlook survey indicates that overall business sentiment is expected to improve in Q1 of 2017-18 on the back of a sharp pick up in both domestic and external demand. Coincident indicators such as exports and non-oil non-gold imports are indicative of a brighter outlook for industry, although the sizable under-utilisation of capacity in several industries could operate as a drag on investment.
15. Activity in the services sector appears to be improving as the constraining effects of demonetisation wear off. On the one hand, rural demand remains depressed as reflected in lower sales of two- and three-wheelers and fertiliser. On the other hand, high frequency indicators relating to railway traffic, telephone subscribers, foreign tourist arrivals, passenger car and commercial vehicles are regaining pace, thereby positioning the services sector on a rising trajectory. After three consecutive months of contraction, the services PMI for February and March emerged into the expansion zone on improvement in new business.
16. After moderating continuously over the last six months to a historic low, retail inflation measured by year-on-year changes in the consumer price index (CPI) turned up in February to 3.7 per cent. While food prices bottomed out at the preceding month’s level, base effects pushed up inflation in this category. Prices of sugar, fruits, meat, fish, milk and processed foods increased, generating a sizable jump in the momentum in the food group. In the fuel group, inflation increased as the continuous hardening of international prices lifted domestic prices of liquefied petroleum gas during December 2016 – February 2017. Kerosene prices have also been increasing since July with the programmed reduction of the subsidy. Adapting to the movements in these salient prices, both three months ahead and a year ahead households’ inflation expectations, which had dipped in the December round of the Reserve Bank’s survey, reversed in the latest round. Moreover, the survey reveals hardening of price expectations across product groups. The 77th round of the Reserve Bank’s industrial outlook survey indicates that pricing power is returning to corporates as profit margins get squeezed by input costs.
17. Excluding food and fuel, inflation moderated in February by 20 basis points to 4.8 per cent, essentially on transient and item-specific factors. In February, favourable base effects were at work in the clothing and bedding sub-group as well as in personal care and effects, the latter also influenced by the disinflation in gold prices. The volatility in crude oil prices and its lagged pass-through are impacting the trajectory of CPI inflation excluding food and fuel. Much of the impact of the fall of US $4.5 per barrel in international prices of crude since early February would feed into the CPI print in April as its cumulative pass-through occurred with a lag in the first week of this month. Importantly, inflation excluding food and fuel has exhibited persistence and has been significantly above headline inflation since September 2016.
18. With progressive remonetisation, the surplus liquidity in the banking system declined from a peak of ` 7,956 billion on January 4, 2017 to an average of ` 6,014 billion in February and further down to ` 4,806 billion in March. Currency in circulation expanded steadily during this period. Its impact on the liquidity overhang was, however, partly offset by a significant decline in cash balances of the Government up to mid-March which released liquidity into the system. Thereafter, the build-up of Government cash balances on account of advance tax payments and balance sheet adjustment by banks reduced surplus liquidity to ` 3,141 billion by end-March. Issuances of cash management bills (CMBs) under the market stabilisation scheme (MSS) ceased in mid-January and existing issues matured, with the consequent release of liquidity being absorbed primarily through variable rate reverse repo auctions of varying tenors. Accordingly, the average net absorption by the Reserve Bank increased from ` 2,002 billion in January to ` 4,483 billion in March. The weighted average call money rate (WACR) remained within the LAF corridor. The maturing of CMBs and reduced issuance of Treasury bills leading up to end-March has also contributed to Treasury bill rates being substantially below the policy rate.
19. Merchandise exports rose strongly in February 2017 from a subdued profile in the preceding months. Growth impulses were broad-based, with major contributors being engineering goods, petroleum products, iron ore, rice and chemicals. The surge in imports in January and February 2017 largely reflected the effect of the hardening of commodity prices such as crude oil and coal. Non-oil non-gold imports continued to grow at a modest pace, though capital goods imports remained sluggish. With imports outpacing exports, the trade deficit widened in January and February from its level a year ago, though it was lower on a cumulative basis for the period April-February 2016-17.
20. Balance of payments data for Q3 indicate that the current account deficit for the first three quarters of the financial year narrowed to 0.7 per cent of GDP, half of its level a year ago. For the year as a whole, the current account deficit is likely to remain muted at less than 1 per cent of GDP. Foreign direct investment (FDI) has dominated net capital inflows during April-December, with manufacturing, communication and financial services being the preferred sectors. Turbulence in global financial markets set off a bout of global risk aversion and flight to safe haven that caused net outflows of foreign portfolio investment (FPI) during November 2016 to January 2017. The tide reversed with the pricing in of the Fed’s normalisation path and improvement in global growth prospects. FPI flows turned positive in February and welled up into a surge in March, especially in debt markets relative to equity markets (which had been the dominant recipient until February). This reversal appears to have been driven by stable domestic inflation, better than expected domestic growth, encouraging corporate earnings, clarity on FPI taxation, pro-reform budget proposals and state election results. The level of foreign exchange reserves was US$ 369.9 billion on March 31, 2017. Outlook
21. Since the February bi-monthly monetary policy statement, inflation has been quiescent. Headline CPI inflation is set to undershoot the target of 5.0 per cent for Q4 of 2016-17 in view of the sub-4 per cent readings for January and February. For 2017-18, inflation is projected to average 4.5 per cent in the first half of the year and 5 per cent in the second half (Chart 1).
22. Risks are evenly balanced around the inflation trajectory at the current juncture. There are upside risks to the baseline projection. The main one stems from the uncertainty surrounding the outcome of the south west monsoon in view of the rising probability of an El Niño event around July-August, and its implications for food inflation. Proactive supply management will play a critical role in staving off pressures on headline inflation. A prominent risk could emanate from managing the implementation of the allowances recommended by the 7th CPC. In case the increase in house rent allowance as recommended by the 7th CPC is awarded, it will push up the baseline trajectory by an estimated 100-150 basis points over a period of 12-18 months, with this initial statistical impact on the CPI followed up by second-order effects. Another upside risk arises from the one-off effects of the GST. The general government deficit, which is high by international comparison, poses yet another risk for the path of inflation, which is likely to be exacerbated by farm loan waivers. Recent global developments entail a reflation risk which may lift commodity prices further and pass through into domestic inflation. Moreover, geopolitical risks may induce global financial market volatility with attendant spillovers. On the downside, international crude prices have been easing recently and their pass-through to domestic prices of petroleum products should alleviate pressure on headline inflation. Also, stepped-up procurement operations in the wake of the record production of foodgrains will rebuild buffer stocks and mitigate food price stress, if it materialises.
23. GVA growth is projected to strengthen to 7.4 per cent in 2017-18 from 6.7 per cent in 2016-17, with risks evenly balanced (Chart 2).
24. Several favourable domestic factors are expected to drive this acceleration. First, the pace of remonetisation will continue to trigger a rebound in discretionary consumer spending. Activity in cash-intensive retail trade, hotels and restaurants, transportation and unorganised segments has largely been restored. Second, significant improvement in transmission of past policy rate reductions into banks’ lending rates post demonetisation should help encourage both consumption and investment demand of healthy corporations. Third, various proposals in the Union Budget should stimulate capital expenditure, rural demand, and social and physical infrastructure all of which would invigorate economic activity. Fourth, the imminent materialisation of structural reforms in the form of the roll-out of the GST, the institution of the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board will boost investor confidence and bring in efficiency gains. Fifth, the upsurge in initial public offerings in the primary capital market augurs well for investment and growth.
25. The global environment is improving, with global output and trade projected by multilateral agencies to gather momentum in 2017. Accordingly, external demand should support domestic growth. Downside risks to the projected growth path stem from the outturn of the south west monsoon; ebbing consumer optimism on the outlook for income, the general economic situation and employment as polled in the March 2017 round of the Reserve Bank’s consumer confidence survey; and, commodity prices, other than crude, hardening further.
26. Overall, the MPC’s considered judgement call to wait out the unravelling of the transitory effects of demonetisation has been broadly borne out. While these effects are still playing out, they are distinctly on the wane and should fade away by the Q4 of 2016-17. While inflation has ticked up in its latest reading, its path through 2017-18 appears uneven and challenged by upside risks and unfavourable base effects towards the second half of the year. Moreover, underlying inflation pressures persist, especially in prices of services. Input cost pressures are gradually bringing back pricing power to enterprises as demand conditions improve. The MPC remains committed to bringing headline inflation closer to 4.0 per cent on a durable basis and in a calibrated manner. Accordingly, inflation developments have to be closely and continuously monitored, with food price pressures kept in check so that inflation expectations can be re-anchored. At the same time, the output gap is gradually closing. Consequently, aggregate demand pressures could build up, with implications for the inflation trajectory.
27. Against this backdrop, the MPC decided to keep the policy rate unchanged in this review while persevering with a neutral stance. The future course of monetary policy will largely depend on incoming data on how macroeconomic conditions are evolving. Banks have reduced lending rates, although further scope for a more complete transmission of policy impulses remains, including for small savings/administered rates 1. It is in this context that greater clarity about liquidity management is being provided, even as surplus liquidity is being steadily drained out. Along with rebalancing liquidity conditions, it will be the Reserve Bank’s endeavour to put the resolution of banks’ stressed assets on a firm footing and create congenial conditions for bank credit to revive and flow to productive sectors of the economy.
28. Six members voted in favour of the monetary policy decision. The minutes of the MPC’s meeting will be published by April 20, 2017.
29. The next meeting of the MPC is scheduled on June 6 and 7, 2017. Voting on the Resolution to keep the policy repo rate unchanged at 6.25 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
30. Core inflation (CPI inflation excluding food and fuel) continues to be sticky, and its persistence poses upside risks for meeting the medium-term inflation target of 4 per cent within a band of +/- 2 per cent. Other exclusion based measures also remain elevated, although there have been transient declines in the demonetisation period. There has also been an inching up in the median 3 month and 1 year ahead inflationary expectations. The recent decline in headline inflation has been driven completely by food inflation and is likely to reverse in the summer months.
31. A strong upside risk to the inflation trajectory is the HRA implementation of the 7th Pay Commission. This needs to be watched carefully in terms of (i) to what extent Since the introduction of the formula in April 2016, interest rates on small savings are about 61-95 basis points higher, depending on tenor, compared to what they should be if the formula is followed. If the spread between small savings rates and bond yields remains wide, the diversion of deposits to small savings would impede a full transmission to bank lending rates. the increase in the centre HRA is matched by state HRAs; and (ii) the extent to which the centre and state HRAs are implemented simultaneously (which means the inflationary effects will be stronger) or is staggered (which means the inflationary effect will be weaker). While we should see through any statistical effects from an increase in the HRA, the size of the second round effects may potentially be large depending on the extent and manner in which the HRA implementation takes place, in which case, there may be a need for a monetary policy response. Our focus on meeting the medium-term inflation target should remain laser sharp in light of such risks.
32. Since the last review, there is more clarity from both “soft” data (based on surveys), and “hard” data (based on actual economic performance), that the overall impact of demonetisation on the real economy has been transient. Importantly, the PMI in services has come out of contraction mode. The impact of demonetisation on Rabi sowing has also been very modest and transient – with a good monsoon and the strategic timing of the MSP helping in this regard. The performance of the real estate sector listed companies has seen an improvement. Large and medium industries have also recovered handsomely in terms of demand after demonetisation, although the small and micro sectors continue to be adversely affected. Overall, the output gap, while marginally negative, is closing gradually leading to the possible building up of inflationary pressures
33. As I mentioned in the last review, the pace of the ending of the re-investment of principal payments by the US Fed from its balance sheet holdings needs to be watched carefully, as also the extent to which such a “balance sheet reduction” by the Fed, as well as rises in the Fed funds rate, are disruptive for financial markets.
34. Taking into account these considerations, I vote for keeping the policy repo rate unchanged at 6.25 per cent at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
35. Several factors indicate positive and modest growth in the economy. The remonetisation drive is progressing well, with the currency in circulation restored to almost 75 per cent of its value by end March of this year, which is expected to support discretionary spending. Spending in cash-intensive activities such as hotels, restaurants, transportation and the unorganised sectors is also on the rise. Further, a decrease in bank lending rates due to a delayed transmission of policy rate reductions in the past augurs well for the economy and may enhance consumption and investment spending. Various measures outlined in the Union Budget 2017-18 are conducive to growth in key sectors including the rural economy, infrastructure and housing, and are expected to have multiplier effects. The March 2017 round of the Industrial Outlook Survey undertaken by the Reserve Bank also shows improvement in sentiment in the corporate sector. On the external front, positive signs of growth across Advanced and Emerging Market Economies may boost demand for Indian exports. This optimism regarding domestic and global economic growth is also reflected in the leading indexes compiled by the Economic Cycle Research Institute (ECRI), New York.
36. On the inflation front, CPI inflation remained soft, primarily due to lower food prices, as vegetable prices declined, possibly due to distress sales as a result of demonetisation. However, core inflation (excluding food and fuel) continues to be higher, although it moderated slightly to 4.8 per cent in February. At the same time, upside risks to inflation remain, including remonetisation, rising rural wages, narrowing output gap, implementation of 7th CPC’s higher house rent allowances, rollout of GST, possibility of El Nino conditions, higher global commodity prices, uncertainty regarding prices of crude oil and exchange rate volatility. A Survey of Households Inflation Expectations undertaken by the Reserve Bank in March 2017 also indicates a rise in 3-month and 1-year ahead inflation expectations. Furthermore, ECRI’s Indian Future Inflation Gauge, a harbinger of Indian inflation, indicates some firming in inflation pressures. Statement by Dr. Ravindra H. Dholakia
37. The effects of demonetisation on the Indian economy so far have turned out to be transitory and of lower magnitude vindicating our stand earlier. There are indications of a modest improvement in the domestic macroeconomic performance. The global outlook for growth, trade and prices has also improved. It is likely to have a favourable impact on Indian exports and the economy. The manufacturing purchasing managers’ index (PMI) and the Reserve Bank surveys also point to better sentiments on both the domestic and external demand. However, the capacity utilisation in industries has remained persistently low indicating at least continuing, if not widening, output gap. Against this, the headline inflation has been substantially below 4 per cent largely on account of vegetables and pulses. Inflation excluding food and fuel (core inflation) has been fairly sticky though has marginally declined to 4.8 per cent in February. Surplus liquidity in the economy since January 2017 has been steadily declining from ` 8 trillion to ` 4.8 trillion in March 2017.
38. The core inflation according to my calculations is likely to show a declining trend over the year. Moreover, the dynamics of pass-through from the non-core to the core inflation is changing such that volatility in the food/fuel prices would penetrate into core less easily than before. Oil prices according to me are not expected to stay high consistently. Simultaneous implementation of house rent allowances recommended by the 7th CPC by the Centre and all State governments is less likely and consequently its impact on inflation during 2017-18 may not be as high as 1 to 1.5 percentage points. The rising probability of El Nino event around July- August may adversely affect food production but may not seriously impact the food prices in view of comfortable buffer stocks. The GST implementation may not substantially impact the headline inflation because of multi-tier rate system.
39. In view of all this, the inflation projection according to my calculations is an average of around 4 per cent for the first half of 2017-18 and around 4.5 per cent for the second half of the year. Given the surplus liquidity still floating in the system, any change in the policy rate is not desirable at this stage. The liquidity position is expected to return to the normal level consistent with the neutral stance soon. Statement by Dr. Michael Debabrata Patra
40. True to projections made at the time of the last meeting of the Committee, inflation is turning up. It seems to me that it is coming out of the U-shaped compression imposed by demonetisation and is now positioned on the rising slope. Several factors merit pre-emptive concern.
41. First, just as it drove a disinflation that started in August – well before demonetisation, which is responsible only for the sub-4 per cent trough – it is food that has pushed up headline inflation in February. And it is not the usual suspect – vegetables. It is the more sinister elements – protein-rich items other than pulses; cereals; sugar. When inflation rears its ugly head in these items, experience suggests it is likely to stay.
42. Second, inflation excluding food and fuel has been unrelenting. It is only in the February reading that there is a small downward movement, but is it sustainable? I think not: it is item-specific rather than generalised. If staff's projections are indicative, inflation excluding food and fuel will probably run ahead of headline inflation throughout 2017-18.
43. The consequence of the firming up of these salient prices is that inflation expectations have reversed and hardened, and not just in the near term but also a year ahead and across all product groups. Consumer confidence in the price situation has deteriorated. Firms are regaining pricing power.
44. Third, high frequency indicators may be indicating that demonetisation affected actual output rather than potential. With remonetisation, therefore, the output gap may close sooner than expected – perhaps at a sub-optimal level since there is slack in several industries – and demand pressures could soon confront the path of inflation in the months ahead.
45. These developments suggest to me that momentum is gathering underneath inflation developments, which appear benign at this juncture. In the second half of 2017-18, favourable base effects fade, and if food inflation rises alongside the stickiness in underlying inflation, it could become a perfect storm.
46. So much for the ingredients of inflation. Let me turn to costs.
47. The most important cost push will emanate from the 7th pay commission's house rent allowance. The first order statistical impact on the CPI may take headline inflation to or beyond the upper tolerance band. Second order effects will work through expectations and ‘Deusenberry effects’ as it spreads to states, PSUs, universities, and onwards. These effects will occur on top of the first order effect and 6 per cent plus inflation could be here to stay for some time.
48. The second one is the one off effect of the GST - small relative to the 7th pay commission and short lived, it could still last a year and push up inflation.
49. Third, several administered price elements are being adjusted upwards – milk; gas; kerosene; the MSP, as usual – and they will take their toll on headline inflation.
50. Finally, let me turn to the elephants in the room, keeping in mind that whether elephants fight or play, the grass suffers.
51. Closest to home is the south west monsoon. The probability of an El Niño event is rising and if food inflation gets entrenched as it did in 2009 in the trail of a sub-normal monsoon, there will be second order effects.
52. The second one is imported inflation, including through bouts of financial market turbulence and the rising tide of protectionism.
53. The third is global inflation – mercury is rising across advanced economies and it cannot be that India will be immune to it. Normalisation of monetary policy has begun in those economies, and it is not just the raising of policy rates/short-term rates. Normalising overly distended balance sheets can produce tightening of longer rates as well.
54. To sum up, I believe that a pre-emptive 25 basis points increase in the policy rate now will point us better at the target of 4 per cent to which the Committee has committed explicitly. It will also obviate the need for back-loaded policy action later when inflation is unacceptably high and entrenched. On balance, however, I vote for holding the policy rate unchanged in this bi-monthly meeting and await a few more readings of incoming data so that remaining transitory factors have passed and a clearer assessment of domestic and global macroeconomic conditions emerges. Statement by Dr. Viral V. Acharya
55. Headline inflation is set to rebound from its recent lows due to the expected (and in the past month, realized) mean-reversion in food inflation, especially in vegetables. Global inflationary trends have remained on the upside too. There is some uncertainty as to when the headline inflation might cross the target inflation rate of 4 per cent and keep inching above, given that inflation without food and fuel is stubbornly above the target rate. We have laid out in the resolution several upside risks, of which geopolitical risks and undoing of the center’s fiscal discipline by the states concern me the most. Commodity prices, especially crude, have been volatile and so has the exchange rate. Hence, risks are evenly balanced around the inflation outlook.
56. On the growth front, the remonetisation is continuing apace and many sectors of the economy are recovering steadily after the transient slowdown. There are signs though that the recovery is somewhat uneven. Private investment, given the high indebtedness of several stressed sectors, remains a particularly weak spot. Household expectations of income, spending and employment appear to have weakened, but may be anchored to the past few months and need to be tracked in the coming months. Other signs of economic activity paint a rosier picture for the growth over the next year, with the external sector having been remarkably resilient.
57. Should an inflation-targeting central bank react to a narrowing output gap in such a scenario? Given the balanced nature of risks and uncertainty that abounds, I lean towards continuing the neutral stance and pause for now. There are many important issues to attend to, notably (i) resolving bank stressed assets and correcting weak bank balance-sheets; (ii) mopping up in a more durable manner the surplus liquidity sloshing around post-demonetisation and which is keeping short- term money market rates away from the policy rate; and (iii) unleashing the true potential of our capital markets further, by enhancing liquidity in the corporate bond market, and improving the ease and the suite of financial hedging options. It seems an opportune time to focus on these issues. Statement by Dr. Urjit R. Patel
58. After reaching a historic low in January 2017, CPI inflation in February 2017 edged up, as expected. However, in all probability, inflation will significantly undershoot the 5 per cent target set for Q4 of 2016-17. Vegetable prices, which had declined sharply during November 2016 to January 2017, seem to have stabilised but may go up in the coming months due to a seasonal pick up. CPI inflation excluding food and fuel remained sticky, especially services. Also, given the volatility in the CPI, it is not easy to read its evolution. The outlook for inflation faces several other risks. Input costs have been rising, which could be passed on to output prices as demand strengthens. Further, the implementation of the HRA allowances recommended as part of the 7th CPC and the GST are risks, which could alter the inflation outturn in 2017-18. Uncertainty about the crude oil price trajectory is both ways given recent movements. Heightened geo-political risks continue to impart financial volatility in global markets.
59. The latest data released by the CSO suggested that the impact of demonetisation on economic activity was modest. Economic activity is expected to pick up in 2017-18, although there is the usual uncertainty about the monsoon at this stage. Several lead indicators suggest some improvement in the economic outlook. The industrial outlook survey of the Reserve Bank suggests positive outlook for the manufacturing sector. However, investment activity continues to be weak, but which is unsurprising given the headroom with respect to capacity utilisation in industry (Reserve Bank surveys).
60. Demonetisation induced liquidity facilitated faster monetary transmission. There is still room for banks to cut lending rates. For efficient transmission, it is important that interest rates on small savings are not out of line with interest rates on other comparable instruments in the financial system.
61. Notwithstanding likely favourable base-effects in the next few months, the outlook for inflation calls for close vigilance with a view to ensuring that the medium- term inflation trajectory evolves in line with the objective of bringing headline inflation closer to 4.0 per cent on a durable basis and in a calibrated manner. Therefore, I vote for maintaining the status quo in both the policy repo rate, and the stance. Ajit Prasad Press Release : 2016-2017/2844 Assistant Adviser
6. Consequently, the reverse repo rate under the LAF remains at 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.50 per cent.
7. The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
8. Since the April 2017 meeting of the MPC, global economic activity has expanded at a modest pace, supported by firming growth in major advanced economies (AEs) and in some emerging market economies (EMEs) as well. In the US, a tightening labour market is generating wage gains. Alongside, industrial production has steadily improved in recent months and retail sales remain robust, although home sales ebbed in April. Political risks remain high, however. In the Euro area, the recovery has been underpinned by consistently falling unemployment, rising retail sales and a brighter outlook for manufacturing reflected in purchasing managers‟ and business surveys. In Japan, exports supported by a depreciated yen and industrial activity are driving an acceleration in growth. Wages and inflation, however, are depressed and holding back domestic demand. Among EMEs, the Chinese economy is stabilising, especially in manufacturing, but financial risks in the form of the credit-fuelled debt overhang could impinge on the outlook. Brazil appears to be emerging out of recession, although growth dynamics remain fragile due to worsening labour market conditions and political turmoil. In Russia, the strengthening global environment is supporting the recovery with improving macro fundamentals. South Africa is grappling with structural constraints which are depressing economic activity.
9. The pick-up in global merchandise trade volume since the start of the year has been sustained in Q2 of 2017, buoyed by strengthening global demand as reflected in rising international air freight and container throughput. Crude prices fell to a five- month low in early May on higher output from Canada and the US, and remain soft, undermining the OPEC‟s recent efforts to tighten the market by trimming supply. Among non-fuel commodity prices, metal prices have been retreating on expectations of weak demand from China. Bullion prices remain range-bound, while food prices eased in April but rose in May. These developments suggest that the inflation outlook is still relatively benign for AEs and EMEs alike.
10. International financial markets have been lifted by improving global growth prospects, broadly accommodative monetary policy stances of systemic central banks and generally positive incoming data. Increasingly, financial markets have shown resilience to geo-political events and have swiftly priced them in. This has been reflected in the reinvigoration of the reach for returns. Country-specific factors have modulated investor sentiment. Equity markets in most AEs have gained in Q2, surpassing past peaks in the US; boosted by corporate profits in Japan; and supported by easing political tensions and upbeat data in the case of the Euro area. In EMEs, equities have turned in a mixed performance, with high valuations across Asia, but weaker in Latin America on softer commodity prices. Bond yields in major AEs have been largely range-bound. In EMEs, yields have hardened in the few countries facing inflation pressures and political uncertainties, but for commodity exporters, there has been some recent decline. In the currency markets, the US dollar has weakened in May after dovish guidance by the Fed and unexpected political events. Since mid-May, the yen has shed its depreciating bias and appears to have gained safe haven appeal. EME currencies, which had depreciated on the strength of the US dollar, have steadied more recently on renewal of capital flows and risk-on investor appetite.
11. On May 31, 2017 India‟s Central Statistics Office (CSO) released quarterly estimates of national income accounts for Q4 of 2016-17, provisional estimates for 2016-17 and revisions for the preceding five years. The growth of real gross value added (GVA) for 2016-17 has been pegged at 6.6 per cent, 0.1 percentage point lower than the second advance estimates released in February 2017. Underlying the revision is a downward adjustment in services sector growth in Q4 for the constituents of construction, financial and professional services, and real estate. Estimates of agriculture and allied activities have been upgraded to incorporate the all-time high production of foodgrains and horticulture in the year. GVA in industry has also been placed higher in the provisional estimates relative to the earlier reading to reflect the impact of new indices of industrial production (IIP) and wholesale prices (WPI) rebased to 2011-12. The new data reveal that a slowdown in activity in both industry and services set in as early as Q1 of 2016-17 and became pronounced in Q4. Moreover, the deceleration of activity coursing through the year has had underlying drivers that have been in operation since Q2. Components of aggregate demand reflect a contraction in gross fixed investment in Q4, reversing the turnaround evident in the second half of the year in the advance estimates. This is also reflected in the contraction in the production of capital goods in the new IIP. However, private final consumption expenditure recorded robust year-on-year growth.
12. On May 9, the Ministry of Agriculture (MoA) released its third advance estimates of foodgrains production, which confirmed the record level of output achieved in 2016-17 and, in fact, revised it upwards to 273 million tonnes. The MoA also set out its second advance estimates of fruits and vegetables on May 30, which was also a historical record. Benefiting from the bumper harvest, rabi procurement during Q1 of 2017-18 so far has been significantly higher than a year ago, replenishing food stocks and taking them to 61.9 million tonnes in May 2017, three times the buffer norm. On June 6, the India Meteorological Department (IMD) re- affirmed its forecast of a normal and well-distributed south-west (June-September) monsoon, which augurs well for the agricultural outlook.
13. The new series on the IIP released by the CSO on May 12 improves the coverage of industrial activity, realigns weights and reclassifies sub-sectors to better capture the underlying structural dynamics of the sector, and smoothens the impact of lumpy items on the index. As a result, industrial production expanded by 5.0 per cent during 2016-17 based on the new series (as against 0.7 per cent in the old series). Turning to the current financial year, the output of eight core industries decelerated sharply in April on account of contraction in coal, crude oil and cement due to structural constraints and low demand. Furthermore, electricity generation decelerated due to depressed demand pricing out relatively expensive thermal output. By contrast, the production of steel and fertiliser picked up, the former driven up by exports and the latter by expectations of a normal monsoon.
14. The business expectations index generated by the Reserve Bank‟s April round of the Industrial Outlook Survey reflects optimism in the manufacturing sector in Q2 of 2017-18, driven by expectations of rising rural demand, exports and profit margins. On the other hand, the manufacturing purchasing managers‟ index (PMI) moderated sequentially in May as employment contracted and new orders, both domestic and exports, slowed down. The index, however, remained in the expansion zone and the future output index accelerated for the third month in succession.
15. High frequency real indicators of activity in the services sector point to a mixed performance in April. In the transportation sub-sector, freight carriage by air and rail gathered momentum, and passenger car sales accelerated on the back of sustained strength of urban demand. Sales of commercial vehicles and three-wheelers contracted, however, reflecting in part the effects of new emission norms and technology changes. Two-wheeler sales remained depressed, indicative of still subdued rural demand. In the communication sub-sector, there was a strong growth in the subscriber base of voice and data services. The sustained growth of foreign tourist arrivals and air passenger traffic, both domestic and international, supported activity in the hotels, restaurants and the hospitality sub-sector. Both steel consumption and cement production were, however, sluggish, pointing to continuing weakness in construction activity. The services PMI for May rose to its highest reading since November 2016, with an expansion in new business reflecting improving underlying demand conditions, alongside optimism on employment.
16. Retail inflation measured by year-on-year changes in the consumer price index (CPI) plunged to a historic low in April, pulled down by a large favourable base effect which overwhelmed a momentum that was feeble relative to the historical record for the month. Underlying this surprising softness was a sharp fall in food inflation brought about by a deflation in the prices of pulses and vegetables. In addition, moderation in the prices of cereals, eggs, oils and fats and spices contributed to the loss of momentum. In the case of pulses, the large-scale augmentation of supply on account of expansion in acreage, procurement, buffer stocking and imports caused a sharp decline in prices starting in August 2016. Propelled by significantly higher arrivals in mandis relative to the seasonal pattern, prices of vegetables also fell markedly from July and bottomed out in January 2017, with fire sales during the demonetisation period accentuating the fall. The seasonal uptick that typically occurs in the pre-monsoon months has been muted so far. In the fuel group by contrast, inflation surged across the board. Prices of liquefied petroleum gas (LPG) and kerosene rose in sympathy with international prices even as the subsidy was set on a path of calibrated reduction. Fuel used by rural households rose for the third month in succession, narrowing the wedge between fuel inflation facing rural and urban households. In response to these developments, inflation expectations three months ahead and a year ahead surveyed in the Reserve Bank‟s inflation expectations survey of households have ticked down marginally.
17. Excluding food and fuel, inflation dipped 60 basis points from a month ago to 4.4 per cent. The delayed and cumulative downward adjustment of domestic petrol and diesel prices in April to the softening of international crude prices in preceding months was among the factors at work. Inflation in respect of services embedded in transport and communication, education, recreation and health also moderated. The industrial outlook survey and the PMIs for manufacturing and services indicate that pricing power remains weak.
18. Even as surplus liquidity in the banking system post-demonetisation was drained by the ramping up of new currency in circulation by ₹ 1.5 trillion in April and May, massive spending by the Government re-injected liquidity into the system, raising the daily average overall surplus liquidity in the banking system to ₹ 4.2 trillion in April and ₹ 3.5 trillion in May. Unwinding of the excess reserves that banks used to dress up balance sheets for end-March also resulted in an accretion of ₹ 0.8 trillion to the surplus liquidity. Absorption operations undertaken by the Reserve Bank in the context of these developments and the consequent downward pressure on money market rates consisted of ₹ 1 trillion impounded through issuance of treasury bills (TBs) of tenors ranging from 312 days to 329 days under the market stabilisation scheme (MSS), auctions of cash management bills (CMBs) of ₹ 0.7 trillion triggered by the decline in cash balances of the Government, and variable rate reverse repo auctions of different tenors which took in the remaining surplus liquidity averaging ₹ 3.8 trillion in April and ₹ 3.4 trillion in May. With the narrowing of the LAF corridor from +/- 50 bps to +/- 25 bps in April 2017, these operations ensured that the weighted average call money rate (WACR) – the operating target of monetary policy– broadly traded within the corridor. The spread between the WACR and the policy repo rate narrowed from 29-32 basis points (bps) in March-April to 21 bps in May.
19. Merchandise exports posted double digit growth in March and April 2017 in an environment of slowly improving global trade, with 80 per cent of this expansion contributed by engineering goods, petroleum products, gems and jewellery, readymade garments and chemicals. Merchandise imports also increased sharply, propelled by domestic demand, with the jump of 47.2 per cent in US dollar terms not recorded since 2011. Imports of petroleum and products rose strongly on price effects as international crude prices firmed up in the wake of OPEC‟s productions cut. Gold imports also surged in volume terms, initially driven by seasonal and festival demand but subsequently by stockpiling in anticipation of the roll out of the goods and services tax (GST). Non-oil non-gold imports contributed about half of the total import growth in March and April, reflecting higher recourse to electronic goods, pearls and precious stones, coal, machinery and machine tools from overseas markets. With import growth significantly outpacing export growth, the trade deficit increased sizably. The current account deficit (CAD) for the year 2016-17 is likely to remain within 1 per cent of GDP. Unlike in the immediately preceding quarter, capital flows in April-May 2017 were dominated by foreign portfolio investment (FPI), pushed out by risk-on investor sentiment as global growth prospects improved. Also, clarity emerged on taxation issues in the Union Budget and the expectations of faster structural reforms were fuelled by the decisive outcome of State elections. The level of foreign exchange reserves as on June 2, 2017 was US$ 381.2 billion. Outlook
20. The abrupt and significant retreat of inflation in April from the firming trajectory that was developing in February and March has raised several issues that have to be factored into the inflation projections. First, it needs to be assessed as to whether or not the unusually low momentum in the reading for April will endure. Second, the prices of pulses are clearly reeling under the impact of a supply glut caused by record output and imports. Policy interventions, including access to open trade, may be envisaged to arrest the slump in prices. Third, the accumulated downward adjustment in the prices of petrol and diesel effected in April has been largely reversed on June 1. Fourth, the easing of inflation excluding food and fuel may be transient in view of its underlying stickiness in a situation of rising rural wage growth and strong consumption demand. Thus, the April reading has imparted considerable uncertainty to the evolving inflation trajectory, especially for the near months. If the configurations evident in April are sustained, then absent policy interventions, headline inflation is projected in the range of 2.0-3.5 per cent in the first half of the year and 3.5-4.5 per cent in the second half (Chart 1). Risks are evenly balanced, although the spatial and temporal distribution of the monsoon and the government staying the course in effective food management will play a critical role in the evolution of risks. The risk of fiscal slippages, which, by and large, can entail inflationary spillovers, has risen with the announcements of large farm loan waivers. At the current juncture, global political and financial risks materialising into imported inflation and the disbursement of allowances under the 7 th central pay commission‟s award are upside risks. The date of implementation of the latter is still not announced and as such, it is not factored into the baseline projections. The implementation of the GST is not expected to have a material impact on overall inflation.
21. With the CSO‟s provisional estimates for 2016-17, the projection of real GVA growth for 2017-18 has accordingly been revised 10 bps downwards from the April 2017 projection to 7.3 per cent, with risks evenly balanced (Chart 2). The continuing remonetisation should enable a pick-up in discretionary consumer spending, especially in cash-intensive segments of the economy. Furthermore, the reductions in banks‟ lending rates post-demonetisation should support both consumption and investment demand of households and stress-free corporates. Moreover, Government spending continues to be robust, cushioning the impact of a slowdown in other constituents. The implementation of proposals in the Union Budget should crowd in private investment as the business environment improves with structural reforms, including the GST, the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board. Strengthening external demand will likely play a more decisive role in supporting the domestic economy. In addition, the new IIP broadens the recognition of industrial activity. On the downside, global political risks remain elevated and could materialise. Second, rising input costs and wage pressures may prove a drag on the profitability of firms, pulling down overall GVA growth. Third, the twin balance sheet problem - over-leveraged corporate sector and stressed banking sector - may delay the revival in private investment demand.
22. The MPC noted that incoming data suggest that the transitory effects of demonetisation have lingered on in price formations relating to salient food items, entangled with excess supply conditions with respect to fruits and vegetables, pulses and cereals. At the same time, however, the CSO‟s latest releases on national income accounts and industrial production attest to the effects of demonetisation on the broader economy being sector specific and transient, as well as to the noteworthy resilience of private consumption. At this stage, it is difficult to isolate these factors or to judge the strength of their persistence. As the year progresses, underlying inflation pressures, especially input costs, wages and imported inflation, will have to be closely and continuously monitored.
23. Noting that inflation has fallen below 4 per cent only since November 2016, the MPC remains focused on its commitment to keeping headline inflation close to 4 per cent on a durable basis keeping in mind the output gap. The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place. Premature action at this stage risks disruptive policy reversals later and the loss of credibility. Accordingly, the MPC decided to keep the policy rate unchanged with a neutral stance and remain watchful of incoming data.
24. The Reserve Bank will continue to work in partnership with the government to address the stress in banks‟ balance sheets. Better alignment of administered interest rates on small savings with market rates and stepped-up recapitalisation of banks to facilitate adequate flow of credit to productive sectors are important steps to follow through.
25. Five members were in favour of the monetary policy decision, while Dr. Ravindra H. Dholakia was not in favour. The minutes of the MPC‟s meeting will be published by June 21, 2017.
26. The next meeting of the MPC is scheduled on August 1 and 2, 2017. Voting on the Resolution to keep the policy repo rate unchanged at 6.25 per cent Member Vote Dr. Chetan Ghate Yes Dr.Pami Dua Yes Dr.Ravindra H. Dholakia No Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr.Urjit R. Patel Yes Statement by Dr. Chetan Ghate
27. The sharp decline in headline inflation in April was surprising. It should, however, be noted that while headline inflation in April 2017 was 3 per cent, net of vegetables and pulses it was 4.3 per cent. More importantly, it is highly unlikely that a single data point of 3 per cent for April 2017 is the harbinger of 4 per cent for the durable future.
28. I have consistently highlighted the risk that the persistence of CPI inflation excluding food and fuel poses to meeting the medium-term headline inflation target of 4 per cent within a band of +/- 2 per cent. To that extent, the significant decline in CPI inflation excluding food and fuel in April 2017 (from approximately 5 per cent to 4.4 per cent) is comforting and is indicative of a general moderation in demand-pull pressures in the economy. This outcome is possibly consistent with a further widening of the output gap induced in part by demonetisation. There has also been an inching down in the median 3-month and 1-year ahead inflation expectations which is also comforting. I, however, would like to see the reduction in CPI excluding food and fuel on a more durable basis.
29. The slowdown in growth in Q4 FY17 based on the latest CSO figures is suggestive of some adverse effects of demonetisation and that these effects may have widened the output gap. As I mentioned in my previous statement, however, these effects are likely to be transient, and therefore do not warrant a monetary policy response. For instance, private final consumption expenditure, the largest component of final expenditure, has remained robust, despite demonetisation. More clarity is required on the new CSO data on a number of fronts. For instance, the lower growth numbers for Q4 FY17 not being in line with several high frequency indictors for this period is puzzling. The new CSO data has too many moving parts at this juncture to provide a definitive picture on output and growth trends post- demonetisation.
30. At this juncture, it would be prudent to wait and watch to see (i) whether headline inflation durably evolves in line with the medium-term inflation target of 4 per cent within a band of +/- 2 per cent; and (ii) how other risks (fiscal risks in terms of state farm loan waivers, GST, HRA, the monsoon) impinge on the medium term target.
31. I vote for keeping the policy repo rate unchanged at 6.25 per cent at today‟s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
32. Inflation softened considerably with CPI inflation falling to 2.99 per cent in April, 2017 owing to a favourable base effect, moderation in prices of several food items, and deflation in prices of pulses and vegetables. Although prices of food remained subdued during the pre-seasonal months, core inflation stood at 4.4 per cent and continues to remain sticky. The monsoon is likely to be normal and may help to sustain the low food inflation trajectory. At the same time, upside risks include the prospect of rising rural wage growth, the resulting boost in consumption demand, fiscal slippages in the form of farm loan waivers and a possibility of disbursement of allowances under the 7th central pay commission‟s award.
33. While growth in Gross Value Added at 2011-12 prices (provisional estimate) slowed down in the last quarter of 2016-17, several other factors, apart from remonetisation, indicate positive growth during 2017-18. Various reforms including GST, Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board are expected to improve sentiments of domestic as well as international investors.
34. The expected pickup in economic activity is endorsed by the RBI‟s 77 th round of Industrial Outlook Survey which demonstrates much improved sentiment on account of anticipated growth in order books, decline in pending orders and improved outlook of the overall business situation. Moreover, the Consumer Confidence Survey conducted by the RBI suggests that the one-year outlook on general economic situation, employment scenario and household income has improved.
35. The downside risks to growth include an uncertain geo-political environment in several of India‟s trade partners. Furthermore, while there is excess liquidity in the banking system and several banks have cut rates post demonetisation, stressed assets on bank balance sheets may preclude recovery of private investment. There is also a strong likelihood that the US Federal Reserve may increase interest rates later this month, given the earlier cyclical upturn in the US Future Inflation Gauge maintained by the Economic Cycle Research Institute (ECRI), New York, along with the strength in ECRI‟s leading indexes of US economic growth. Meanwhile, growth in ECRI‟s Indian Leading Exports Index recently hit a multiyear high, indicating a still- favourable export outlook.
36. In view of the mixed risks to inflation and growth, it may be best to adopt a wait and watch policy as new data flows in. Statement by Dr. Ravindra H. Dholakia
37. There are several noteworthy developments recently on prices and output fronts that warrant a decisive policy action by the MPC. In my opinion, this is the most opportune time for the MPC to effect a major cut of 50 basis points in the policy rate to bring it down from 6.25 per cent to 5.75 per cent. My reasons for this recommendation are the following:
38. After the MPC meeting of April 2017, the two monthly readings of the CPI- combined inflation turned out to be more consistent with my forecast stated in the Minutes of the previous meeting than of the RBI forecast. The core inflation figures also vindicated my view about a clear declining trend rather than stickiness as predicted in the RBI forecast. Now the RBI has also revised their forecast of CPI- headline inflation downward to 2 - 3.5 per cent during the first half; and 3.5 - 4.5 per cent during the second half of 2017-18. Though my forecasts now are lower than RBI‟s by about 40 and 90 basis points respectively from the RBI‟s upper bounds, the essential point is that the expected headline CPI inflation over the next 12 months is expected to ease by at least 50 basis points compared to the April meeting of the MPC.
39. The 3-months and 12-months advance inflationary expectations as per the RBI survey of households are unambiguously declining and are among the lowest levels observed in the history of such surveys.
40. On the other hand, capacity utilization has persistently remained below 75 per cent now for a long time indicating existence of a large output gap. Although precise measurement of the output gap is highly controversial particularly for a rapidly developing country like India, there cannot be disagreement on the Indian economy significantly under-performing compared to its potential now for quite some time. Moreover, recent policy reforms in the country would certainly lead to the increased potential output and growth in the economy implying persistent if not widening output gap in the near to medium term. If any unanticipated inflationary pressures arise in future, they are likely to be substantially subdued by the presence of the high output gap.
41. Given the change in the outlook and assessment of the inflation and output over time, any theoretical rule-based policy for flexible inflation targeting would not only justify but also necessitate at least 50 basis point cut in the policy rate. This is because, if we are consistent, we must consider changes in the values of the critical parameters during the period since the last meeting of the MPC. Even under the most conservative estimates of the multipliers indicating the assumed sacrifice ratio, a minimum of 50 basis point cut in the policy rate is suggested. If we consider more realistic estimates of the sacrifice ratio for India, the policy rate cut could be even higher.
42. The monsoon forecasts released on 6th June, 2017 have created optimism for the second consecutive good year for agricultural production since the rainfall is expected to be higher at 98 per cent than 96 per cent of the long term average and would be geographically well distributed. Thus, the momentum pick up in agricultural inflation during the next 12 months is substantially less probable with obvious favorable impact on the headline CPI inflation.
43. International developments on oil price front are again not posing major threats. In my opinion, oil prices are likely to remain within the narrow range observed in recent times. Any breach on either side may not last for a longer time. I would not consider any major upside risk to the domestic headline inflation on this count.
44. Stable or appreciating exchange rate provides enough incentives for the FII and FDI particularly when there is a high degree of political stability; and when the observed Indian growth rate of output is among the highest in the world. US Fed rate hike is already factored in by the markets and no surprises are expected on its count.
45. The 7th CPC recommendations on HRA can at best be implemented by the Centre and only a few states during the year 2017-18. The impact assessment on the headline CPI inflation of about 150 basis points by the RBI is highly overstated because it assumes simultaneous and instantaneous implementation of the recommended HRA by the 7th CPC in the Centre and ALL states almost immediately. The impact of its implementation only by the Centre would be about 36 basis points over a six months period and about 106 basis points over a six months period if ALL states implement the recommendations together given the sampling design and methodology of estimating CPI-combined. In all probability, the impact on this count on the headline CPI inflation during 2017-18 would not be more than 50 basis points. On the other hand, it is most likely to be more than off-set by the implementation of GST in its present form.
46. There are concerns about the recent farm loan waivers announced by a couple of states. It is feared that it can lead to fiscal profligacy by other states too and result in significant increase in the fiscal deficits by the states jeopardizing the fiscal discipline and prudent levels of debt by states. In this context, we must note that states are bound by their own Fiscal Responsibility Legislations (FRLs) and that every state has it in place. So far, states have been behaving very responsibly and have collectively reduced their fiscal deficits and debt consistently. Now for quite some time, they have been borrowing directly from the market and their fiscal performance has a direct bearing on their interest costs. As a result, it is not justifiable to assume that loan waivers would directly and proportionately result in increasing their fiscal deficits. Actually, during 2017-18, they have budgeted to reduce their combined fiscal deficit by 70 basis points. The other possibilities for the states are that they may get more revenues from the implementation of GST (which are not budgeted by them) and/or that they may reallocate some of their expenditures to accommodate the loan waivers. So long as the aggregate fiscal deficit of the states does not increase, its inflationary impacts are not going to be felt. Moreover, not all states are likely to follow the suit and certainly not during the same year. Even if we consider that the loan waivers are granted immediately and they result in the increased fiscal deficit, their impact on the inflation would occur only with a considerable time-lag. Hence, these inflation risks, if at all, are in distant future and under normal circumstances are not very probable. It is altogether a different issue whether the loan waivers by some states is the least distorting and inflation impacting option among the alternatives available to address the problem. It need not be a concern for the MPC.
47. GST implementation is most likely to create demand for the working capital credit from the banking sector. Similarly, the corporate bond market needs to be given a boost.
48. All in all, the prevailing inflation and output conditions and prospects are such that there is enough space for a substantial rate cut of 50 basis points if not more. The risk factors appear to be highly mitigated and the probability of circumstances developing to reverse the decision is very low if not non-existent. Under such circumstances, becoming cautious and not acting amounts to ignoring all costs associated with not supporting growth in terms of unemployment and poverty reduction. Becoming too overcautious under such circumstances is against the principle of prudence. In fact, prudence lies in creating space when conditions are favorable and risks are not high than waiting and losing the opportunity. In case, the conditions were really to turn unfavorable in future, the costs to the society would be severe if during the right time expansionary policies are not followed. I, therefore, strongly plead to the MPC to effect a 50 basis points cut in the policy rate without losing any time. Statement by Dr. Michael Debabrata Patra
49. An inflation targeting framework is inherently forward-looking. The focus has to be on steering the trajectory of inflation towards its target over the medium-term and dealing with the risks around it, not on conducting monetary policy by looking at the rear-view mirror (the most recent inflation prints) or deviations of recent outcomes from projections („forecast errors‟) that cannot be presumed to be durable.
50. It is hard to believe that deflation of 15.9 per cent in the prices of pulses and 8.6 per cent in the prices of vegetables is the steady state that will define the medium-term food inflation path. Not when agricultural wages have risen by 8.5 per cent, farm input costs by 10 per cent, bank credit to agriculture by 13.5 per cent in the year just gone by and the output gap in agriculture is turning positive on rising rural incomes! As regards fuel, the wedge in fuel inflation between urban and rural households has closed at an elevated level. Inflation excluding food and fuel has turned down in three readings now, but it is still not generalized and projections still run ahead of headline inflation in the rest of 2017-18.
51. Turning to cyclical factors, households seem to be discounting the near-term and consequently, they expect inflation to rise faster a year ahead than in the next three months. Moreover, an output gap calculated on data for 2016-17 that profile a slowdown will, by definition, be negative and wider than otherwise. For an economy that is projected to grow at 7.3 per cent in 2017-18, however, it must be the case that the output gap would narrow and close. Meanwhile, the MPC has highlighted elements to look out for: the spatial and temporal distribution of the monsoon; fiscal slippages; global political and financial risks; and the disbursement of allowances under the 7th central pay commission‟s award.
52. In the revised inflation trajectory for the first half of 2017-18, the near term inflation outlook is admittedly benign. Yet, in a situation in which transitory and structural factors are meshed and difficult to decouple, apparently divergent messages emanate from the few data points that are available at this stage. Without more clarity, it is possible to make policy errors that can be large and costly in the medium-term. Accordingly, I vote to wait and watch the incoming data while retaining the flexibility of a neutral stance. Statement by Dr. Viral V. Acharya
53. The softness of April inflation prints, in food, and excluding food and fuel, as well as of the CSO's revised estimates of growth for 2016-17, especially Q4, has posed difficult challenges for monetary policy. Our inflation forecasts relied on evidence of gradual reversal after fire sales in several food items, which were partly confirmed by February and March reversion, as well as on the seasonal uptick in food prices during summer. Realized food inflation, however, turned out to be much lower than our forecast. Inflation excluding food and fuel also moderated. The global and goods-and-services tax (GST) related risks, that we have been concerned about, haven't materialized. One needs to wait for some more time to ascertain whether our capital inflows and exchange rate remain relatively immune to the Federal Reserve‟s unwinding of its asset purchase program; we might see a pick-up in imported inflation otherwise. Similarly, a few more months‟ data will confirm if the GST rollout is likely to be entirely benign for inflation. It is the collapse of food inflation, however, that remains the primary driver of a steady decline in the headline number. It is clear now that supply factors, in addition to transitory effects, have been playing a significant role for at least three quarters with no sign yet of abating.
54. The growth slowdown has had two primary components: one, the continuing decline in private investment since the beginning of 2016-17; and second, the more recent fall in construction activity that is also evidenced in the poor performance of cement industry and real estate services.
55. Have we managed food inflation to a stable level so that the medium-term headline inflation path will remain firmly anchored below 4 per cent? While the continuing food disinflation due to supply-side measures in some high-weight food items would suggest so, farmer demands one is witnessing with each passing day gives me a pause. I remain concerned though that this may have sown the seeds of a "tail risk" in the form of fiscally expansive measures that could spark off generalized inflation in due course.
56. The growth slowdown in Q4 has finally led to the outcome that our estimates of “output gap", in spite of substantial uncertainty around such estimates, point to the opening up of a negative gap. In the traditional ways of thinking about monetary policy, this would push the interest rate policy towards being more willing to accommodate. I prefer to approach monetary policy through the finance angle where the focus is on effectiveness of the transmission policy: Will the interest rate changes have the desired amplifier effects on the economy through the bank and non-bank intermediation sector? On this front, we have a problem. A substantial part of the banking sector balance-sheet remains exposed to heavily indebted sectors, a stress that has built up over at least six to seven years. Accommodation in monetary policy during 2015-16 did not get transmitted to the corporate sector, and private investment remained weak then in spite of the monetary stance. The Treasury gains accruing to banks in this time, while not a direct concern for the monetary policy, only masked the true stress of their balance-sheets.
57. In such a scenario, the standard prescription for monetary policy does not necessarily work well. Tolerance for a slightly higher real rate of interest is justified to ensure weak banks do not find relatively low the hurdle rate for ever-greening (perennial extension) of bad loans. What is required for monetary policy to do its job better is to address the stress on bank (and highly-indebted borrower) balance- sheets. The Reserve Bank's efforts on this will start in the earnest in a few weeks. Once the transmission mechanism is restored to better health, monetary policy will more pervasively touch different parts of the economy. Targeted interventions to stimulate demand for sectors such as construction, where the supply is likely affected as an intended consequence of recent policies, would be more effective for now; this would not run the risks of ever-greening, given the relatively low delinquency rates in bank lending in these segments.
58. These considerations prevented me from considering a change in stance or recommending a rate cut based on available data, just before the Federal Reserve rate hike and before we had firmly put in place our efforts on resolution of banking sector stress. I will watch next few months of inflation and real economic activity indicators closely to confirm if lower-than-target headline inflation and negative output gap are persistent.
59. Finally, I wish to clarify one point. Some suggest that monetary policy should be eased with the explicit objective of recapitalizing the weak bank balance-sheets. Nothing could be worse for monetary policy, in my view. This would relax the pressure on good efforts that are underway deploying a slew of measures to improve the banking architecture (through private capital-raising, non-core asset sales, consolidation, divestment and regulatory prompt corrective action). In turn, this would trap the monetary policy from changing its direction if data so demand before the resolution of banks is complete. It is best for sake of policy credibility to not mix instruments with objectives they are not meant to target. Statement by Dr. Urjit R. Patel
60. Considering the high uncertainty clouding the near-term inflation outlook, there is a need to avoid premature policy action at this stage. I, therefore, vote for holding the policy repo rate at the current level of 6.25 per cent and maintaining the neutral stance of monetary policy.
61. The sharp disinflation in April 2017, coming on the back of firming of inflation in February and March, has imparted considerable uncertainty to the near-term inflation outlook. Food inflation fell sharply, driven by unusually low momentum in food prices combined with favourable base effects. Disinflation in services also resulted in moderation in CPI, excluding food and fuel inflation, which had remained sticky through most part of 2016-17. Incoming data is expected to provide greater clarity on the durability of recent food and non-food disinflation. There is also a need to be alert to elements that may have a significant influence on the inflation outcome over the medium-term. Firstly, inflation expectations of households remain elevated despite some recent moderation. Second, the implementation of 7th CPC HRA award is an upside risk. Third, some increase in MSPs is inevitable. Last, the rising fiscal risks due to growing demand for farm loan waivers also pose a risk to inflation. In this context, it may be instructive to note that the outstanding advances to agriculture & allied activities as ratio to GDP from agriculture & allied activities has increased from about 13 percent in 2000-01 to around 53 per cent at present; average annual nominal growth rate in Scheduled Commercial Banks' advances to agriculture & allied activities was 21.5 per cent during 2000-01 to 2016-17.
62. GVA growth weakened in Q4 of 2016-17 due mainly to slowdown in the services sector growth. On the demand side, while growth in private consumption expenditure was robust despite demonetisation, gross fixed investment contracted in Q4. Going forward, it is comforting that the India Meteorological Department has reiterated its forecast of a normal south-west monsoon. This bodes well for the agriculture sector and rural spending. The business expectation index of the latest round of the Reserve Bank‟s Industrial Outlook Survey points to optimism. Overall, growth is expected to recover gradually in 2017-18. We have to be mindful of pitfalls in assessing the overall (national) output gap. For sub-sectors such as infrastructure (especially public transportation, railways etc.) that enter the aggregate (national) production process in “fixed” (Leontieff) coefficients, the “gap” may be positive, thereby impeding further growth acceleration, as well as undermining competitiveness.
63. The quiescent investment cycle remains a key macroeconomic concern. It is, therefore, imperative to ensure resolution of stressed assets of banks and timely recapitalisation of PSBs. While the transmission of past policy rate cuts continues – with some banks further reducing the deposit and lending rates – aligning administered interest rates on small savings to the committed formula can further strengthen the monetary transmission. Jose J. Kattoor Press Release: 2016-2017/3443 Chief General Manager
6. Since the June 2017 meeting of the MPC, impulses of growth have spread across the global economy albeit still lacking the strength of a self-sustaining recovery. Among the advanced economies (AEs), the US has expanded at a faster pace in Q2 after a weak Q1, supported by steadily improving labour market conditions, increasing consumer spending, upbeat consumer confidence helped by softer than expected inflation, and improving industrial production. Policy and political risks, however, continue to cloud the outlook. In the Euro area, the recovery has broadened across constituent economies on the back of falling unemployment and a pickup in private consumption; political uncertainty has receded substantially. In Japan, a modest but steady expansion has been taking hold, underpinned by strengthening exports, accelerating industrial production and wage reflation.
7. Among emerging market economies (EMEs), growth has regained some lost ground in China in Q2, with retail sales and industrial production rising at a steady pace. Nonetheless, tightening financial conditions on account of deleveraging financial institutions and slowdown in real estate could weigh negatively. The Russian economy has emerged out of two years of recession, aided by falling unemployment, rising retail sales and strong industrial production. In Brazil, a fragile recovery remains vulnerable to political uncertainty and a still depressed labour market. Economic activity in South Africa continues to be beset by structural and institutional bottlenecks and is in a technical recession.
8. The modest firming up of global demand and stable commodity prices have supported global trade volumes, reflected in rising exports and imports in key economies. In the second half of July, crude prices have risen modestly out of bearish territory on account of inventory drawdown in the US, but the supply overhang persists. Chinese demand has fuelled a recent rally in metal prices, particularly copper. Bullion prices fell to multi-month lows on improved risk appetite but remain vulnerable to shifts in the geopolitical environment. Notwithstanding these developments, inflation is well below target in most AEs and is subdued across most EMEs.
9. International financial markets have been resilient to political uncertainties and volatility has declined, except for sporadic reactions to hints of balance sheet adjustments by systemic central banks. Equity markets in most AEs have registered gains, with indices crossing previous highs in the US, but European markets were weighed down by Brexit talks and the strengthening euro. In EMEs, equities have gained on surging global risk appetite underpinned by improving macroeconomic fundamentals that have been pulling in capital inflows. Bond yields in major AEs have hardened on expectations of monetary policy normalisation, with German bunds reaching an intra-year high. In EMEs, the situation has remained diverse, driven by domestic factors, and fixed-income markets have been generally insulated from the bond sell-off in AEs. In the currency markets, the US dollar weakened further and fell to a multi-month low in July on weak inflation and uncertainty around the policies of the US administration. The euro, which has remained bullish, rallied further on upbeat economic data. The Japanese yen has generally eased, interspersed by bouts of appreciation on safe haven demand. EME currencies largely remained stable and have traded with an appreciating bias.
10. On the domestic front, a normal and well-distributed south-west monsoon for the second consecutive year has brightened the prospects of agricultural and allied activities and rural demand. By August 1, rainfall was 1 per cent above the long period average (LPA) and 84 per cent of the country’s geographical area received excess to normal precipitation. Kharif sowing has progressed at a pace higher than last year’s, with full-season sowing nearly complete for sugarcane, jute and soybean. The initial uncertainty surrounding sowing of pulses barring tur and rice in some regions has also largely dissipated. Sowing of cotton and coarse cereals has exceeded last year’s levels but for oilseeds, it is lagging. Overall, these developments should help achieve the crop production targets for 2017-18 set by the Ministry of Agriculture at a higher level than the peak attained in the previous year. Meanwhile, procurement operations in respect of rice and wheat during the rabi marketing season have been stepped up to record levels – 36.1 million tonnes in April-June 2017 – and stocks have risen to 1.5 times the buffer norm for the quarter ending September.
11. Industrial performance has weakened in April-May 2017. This mainly reflected a broad-based loss of speed in manufacturing. Excess inventories of coal and near stagnant output of crude oil and refinery products combined to slow down mining activity. For electricity generation, deficiency of demand seems to remain a binding constraint. In terms of uses, the output of consumer non-durables accelerated and underlined the resilience of rural demand. It was overwhelmed, however, by contraction in consumer durables – indicative of still sluggish urban demand – and in capital goods, which points to continuing retrenchment of capital formation in the economy. The weakness in the capex cycle was also evident in the number of new investment announcements falling to a 12-year low in Q1, the lack of traction in the implementation of stalled projects, deceleration in the output of infrastructure goods, and the ongoing deleveraging in the corporate sector. The output of core industries was also dragged down by contraction in electricity, coal and fertiliser production in June, owing to excess inventory and tepid demand. On the positive side, natural gas recorded an uptick in production after a prolonged decline and steel output remained strong. The 78th round of the Reserve Bank’s industrial outlook survey (IOS) revealed a waning of optimism in Q2 about demand conditions across parameters, and especially on capacity utilisation, profit margins and employment. The manufacturing purchasing managers’ index (PMI) moderated sequentially to a four-month low in June and the future output index also eased marginally. In July, the PMI declined into the contraction zone with a decrease in new orders and a deterioration in business conditions, reflecting inter alia the roll out of the GST; however, both new export orders and the future output index rose, reflecting optimism in the outlook.
12. In contrast to manufacturing, high frequency real indicators of services sector activity point to a mixed picture in Q1. In the transportation sub-sector, freight carriage by air registered a strong performance sequentially and on an annual basis. Commercial vehicle sales rose after two successive months of contraction in response to the Bharat Standard (BS)-IV emission compliance switchover. Sales of passenger cars and two-wheelers suffered temporary dislocation in June even as motorcycle sales continued to grow for the third consecutive month, reflecting the firmness of rural demand. Activity in the communication sub-sector accelerated in May on strong and sustained growth in the subscriber base of voice and data services. The hospitality sub-sector was supported by vigorous growth of foreign tourist arrivals and air passenger traffic. The acceleration in steel consumption in April-May may be a precursor to a pickup in construction activity in Q1, but cement production remains in contraction mode. The PMI for the services sector continued to remain in expansion mode in May-June on expectations of improvement in market conditions.
13. In June, retail inflation measured by year-on-year changes in the CPI plunged to its lowest reading in the series based to 2011-12. This was mainly the outcome of large favourable base effects which are slated to dissipate and reverse from August. Although month-on-month increases in the price level have been picking up since April, they were weak in relation to the typical food-price driven summer uptick. The delay in indirect tax revisions and anecdotal evidence of clearance sales across commodities could have dampened the momentum.
14. Prices of food and beverages, which went into deflation in May 2017 for the first time in the new CPI series, sank further in June as prices of pulses, vegetables, spices and eggs recorded year-on-year declines and inflation moderated across most other sub-groups. There are now visible signs, however, of the usual seasonal price spikes, even if with a delay and especially in respect of tomatoes, onions and milk.
15. Fuel inflation declined for the second month in succession as international prices of liquefied petroleum gas (LPG) fell and price increases moderated in the case of coke, and firewood and chips. Administered prices of LPG and kerosene are set to rise with the calibrated reduction in subsidy. Households appear to have discounted the recent low inflation prints; their three month ahead and one year ahead inflation expectations polled in the June 2017 round of the Reserve Bank’s survey have somewhat hardened.
16. Excluding food and fuel, CPI inflation moderated for the third month in succession in June, falling to 4 per cent as price momentum moderated inter alia in respect of education due to delay in fee revision cycles, and also in respect of health, clothing and footwear. Inflation in transport and communication services was depressed by the pricing war in the telecommunication space. Input costs relating to both industry and farms remain benign tracking international prices. Pricing power polled in the Reserve Bank’s industrial outlook survey and in manufacturing and services PMIs is still subdued.
17. Surplus liquidity conditions persisted in the system, exacerbated by front- loading of budgetary spending by the Government. There was also some moderation in the pace of increase in currency in circulation (CiC) which is typical at this time of the year – as against the increase of ` 1.5 trillion in CiC during the first two months of 2017-18, it was ` 436 billion and ` 95 billon during June and July, respectively. Normally, currency returns to the banking system in these months and is reflected in a decline in CiC; consequently, the increase in CiC recorded this year reflects the sustained pace of remonetisation and the associated absorption of liquidity from the system. Surplus liquidity of ` 1 trillion was absorbed through issuance of treasury bills (TBs) under the market stabilisation scheme (MSS) and ` 1.3 trillion through cash management bills (CMBs) on a cumulative basis so far this financial year. Enduring surplus conditions warranted outright open market sales of ` 100 billion each on two occasions in June and July. Another auction of an equivalent amount has been announced and will be conducted on August 10, 2017. Apart from these operations, net average absorption of liquidity under the LAF was at ` 3.1 trillion in June and ` 3.0 trillion in July. Reflecting this active liquidity management, the weighted average call rate (WACR) firmed up and traded about 17 bps below the repo rate on average during June and July – down from 29-32 basis points (bps) in March-April and 21 bps in May – within the LAF corridor.
18. Turning to the external sector, merchandise export growth weakened in May and June from the April peak as the value of shipments across commodity groups either slowed or declined. By contrast, import growth remained in double digits, primarily due to a surge in oil imports and stockpiling of gold imports ahead of the implementation of the GST. Imports of coal, electronic goods, pearls and precious stones, vegetable oils and machinery also accelerated. As import growth continued to outpace export growth, the trade deficit at US$ 40.1 billion in Q1 was more than double its level a year ago. Net foreign direct investment doubled in April-May 2017 over its level a year ago, flowing mainly into manufacturing, retail and wholesale trade and business services. Foreign portfolio investors made net purchases of US$ 15.2 billion in domestic debt and equity markets so far (up to July 31), remaining bullish on the outlook for the Indian economy. The level of foreign exchange reserves was US$ 392.9 billion as on July 28, 2017. Outlook
19. The second bi-monthly statement projected quarterly average headline inflation in the range of 2.0-3.5 per cent in the first half of the year and 3.5-4.5 per cent in the second half. The actual outcome for Q1 has tracked projections. Looking ahead, as base effects fade, the evolving momentum of inflation would be determined by (a) the impact on the CPI of the implementation of house rent allowances (HRA) under the 7th central pay commission (CPC); (b) the impact of the price revisions withheld ahead of the GST; and (c) the disentangling of the structural and transitory factors shaping food inflation. The inflation trajectory has been updated taking into account all these factors and incorporates the first round impact of the implementation of the HRA award by the Centre (Chart 1).
20. There are several factors contributing to uncertainty around this baseline inflation trajectory. Implementation of farm loan waivers by States may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spillovers. Moreover, the timing of the States’ implementation of the salary and allowances award is critical – it is not factored into the baseline projection in view of lack of information on their plans. If States choose to implement salary and allowance increases similar to the Centre in the current financial year, headline inflation could rise by an additional estimated 100 basis points above the baseline over 18-24 months. Also, high frequency indicators suggest that price pressures are building up in vegetables and animal proteins in the near months. There are, however, some moderating forces at work. First, the second successive normal monsoon coupled with effective supply management measures may keep food inflation under check. Second, if the general moderation of price increases in CPI excluding food and fuel continues, it will contain upside pressures on headline inflation. Third, the international commodity price outlook is fairly stable at the current juncture.
21. Business sentiment polled in the manufacturing sector reflects expectations of moderation of activity in Q2 of 2017-18 from the preceding quarter. Moreover, high levels of stress in twin balance sheets – banks and corporations – are likely to deter new investment. With the real estate sector coming under the regulatory umbrella, new project launches may involve extended gestations and, along with the anticipated consolidation in the sector, may restrain growth, with spillovers to construction and ancillary activities. Also, given the limits on raising market borrowings and taxes by States, farm loan waivers are likely to compel a cutback on capital expenditure, with adverse implications for the already damped capex cycle. At the same time, upsides to the baseline projections emanate from the rising probability of another good kharif harvest, the boost to rural demand from the higher budgetary allocation to housing in rural areas, the significant step-up in the budgetary allocation for roads and bridges, and the growth-enhancing effects of the GST, viz., the shifting of trade from unorganised to organised segments; the reduction of tax cascades; cost, efficiency and competitiveness gains; and synergies in domestic supply chains. In turn, these virtuous forces may spur investment. External demand conditions are gradually improving and should support the domestic economy, although global political risks remain significant. Keeping in view these factors, the projection of real GVA growth for 2017-18 has been retained at the June 2017 projection of 7.3 per cent, with risks evenly balanced (Chart 2).
22. The MPC observed that while inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive. In respect of inflation-sensitive vegetables, prices are recording spikes. Excess supply conditions continue to push down prices of pulses and keep those of cereals in check. The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway. In its assessment of real activity, the MPC noted that while the outlook for agriculture appears robust, underlying growth impulses in industry and services are weakening, given corporate deleveraging and the retrenchment of investment demand.
23. The MPC noted that some of the upside risks to inflation have either reduced or not materialised - (i) the baseline path of headline inflation excluding the HRA impact has fallen below the projection made in June to a little above 4 per cent by Q4; (ii) inflation excluding food and fuel has fallen significantly over the past three months; and, (iii) the roll-out of the GST has been smooth and the monsoon normal. Consequently, some space has opened up for monetary policy accommodation, given the dynamics of the output gap. Accordingly, the MPC decided to reduce the policy repo rate by 25 basis points. Noting, however, that the trajectory of inflation in the baseline projection is expected to rise from current lows, the MPC decided to keep the policy stance neutral and to watch incoming data. The MPC remains focused on its commitment to keeping headline inflation close to 4 per cent on a durable basis.
24. On the state of the economy, the MPC is of the view that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all. This hinges on speedier clearance of projects by the States. On their part, the Government and the Reserve Bank are working in close coordination to resolve large stressed corporate borrowers and recapitalise public sector banks within the fiscal deficit target. These efforts should help restart credit flows to the productive sectors as demand revives.
25. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Viral V. Acharya and Dr. Urjit R. Patel were in favour of the monetary policy decision, while Dr. Ravindra H. Dholakia voted for a policy rate reduction of 50 basis points and Dr. Michael Debabrata Patra voted for status quo. The minutes of the MPC’s meeting will be published by August 16, 2017.
26. The next meeting of the MPC is scheduled on October 3 and 4, 2017. Voting on the Resolution to reduce the policy repo rate by 25 basis points to 6.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia No Dr. Michael Debabrata Patra No Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
27. While a significant decline in both headline inflation and inflation excluding food and fuel provides reason for cautious optimism, it remains unclear at this juncture whether these outcomes will sustain durably in the future. In fact, it is highly likely that inflation excluding food and fuel bottomed out in June. Momentum in June headline index has also picked up (because of the seasonal rebounds of some vegetables) with a reversal in the headline inflation trajectory expected from July. However, what is encouraging is that both the 3-month and 1-year median inflation expectations are stable, despite marginal upticks. The survey of professional forecasters (SPF) also conveys optimism on prices. The government’s push through on key structural reforms, i.e., the GST, will be akin to a positive supply shock in the long run, and will assist in the disinflationary process.
28. New data and information also provide more clarity on the magnitude of upside risks to headline inflation highlighted in my comments in the June review. First, there is more evidence that the current monsoon will be normal. Second, the rise in the housing price index because of HRA is likely to be more gradual than earlier envisaged. While upside risks in the form of second round effects will kick in as private rentals try to “keep up with the Jones’s”, these effects are likely to be muted because of depressed demand conditions in the real estate sector. Having said this, both farm loan waivers and proximity to the 2019 election year suggest that fiscal impulses could contribute to inflationary pressures. These need to be carefully watched. Given the above, at this juncture, I expect headline inflation to evolve in line with the medium-term inflation target of 4 per cent within a band of +/- 2 per cent.
29. A lexicographic flexible inflation-targeting mandate requires monetary policy to now accommodate the objective of growth. While re-monetisation, front loaded government expenditures and a good monsoon will sustain a positive momentum on growth, my biggest concern at the moment is the slowing rate of capital accumulation. Indebted manufacturing companies continue to de-leverage, and envisaged capex continues to decline. A prolonged period of weak investment growth will impact potential growth. Weak investment growth is also associated with slower growth in total factor productivity (TFP) in the long run which is the key driver of long- term real wage growth (after inflation). Both the industrial outlook survey and the consumer confidence survey conducted by the RBI suggest that negative output gaps will remain in Q2 also.
30. With the US Fed announcing a somewhat gradual tapering of its balance sheet to begin in the near term, some volatility from this “quantitative tightening” is likely to be imparted on EME exchange rates and financial markets, and needs to be carefully watched.
31. Taking into account these considerations, I vote for a 25 basis points (bps) cut in the policy repo rate from 6.25 per cent to 6.0 per cent at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
32. Retail inflation has softened, touching a new low of 1.5 per cent in June 2017, slowing mainly due to a favourable base effect, falling food prices, and decline in international prices of fuel, as well as contraction in inflation excluding food and fuel. Going forward, as base effects fade, some upside risks to inflation remain, including rising pressures on the price of food (especially vegetables and animal proteins), inflationary effects from implementation of farm loan waivers, and the possible rise in inflation due to implementation of house rent allowances under the 7th Central Pay Commission. At the same time, some upside risks to inflation have either decreased or not materialised, counterbalancing the inflationary pressures. These include a normal monsoon, along with effective supply management, smooth roll-out of the GST, continuation of moderation in inflation excluding food and fuel, and expectation of stable international commodity prices. However, continuous monitoring of incoming data is required to ascertain the extent to which the recent softening is durable.
33. On the growth front, the agricultural sector is expected to perform strongly on account of a normal monsoon for the second successive year and well-timed sowing for the kharif season. This is expected to further boost rural consumption, as evidenced by the growth in consumer non-durables. At the same time, industrial growth remains subdued on the back of sluggish demand and a consequent build-up of inventories reflected in contraction in consumer durables and capital goods. The twin problems of weak capex cycle and debt overhang have constrained the private sector from undertaking new investment. Infrastructure bottlenecks are also a major constraint, while the government’s plan for housing to all may provide an impetus to growth.
34. Moving on to forward looking indices that predict future economic activity, growth in the Indian Leading Index (constructed by the Economic Cycle Research Institute (ECRI), New York, with which the author is affiliated) is falling, as is Indian Leading Exports Index growth. These are indicative of a fading economic growth outlook, as well as a pessimistic outlook with respect to exports growth. The latter is reinforced by movements in ECRI’s leading indices for the global economy that suggest that international economic growth is about as good as it gets, and could start easing in the months ahead. Furthermore, consistent with the cyclical downturns in ECRI’s international future inflation gauges (predictors of inflation), there are already concerted inflation cycle downturns starting in most major economies.
35. There is thus room for a policy repo rate cut by 25 basis points. Statement by Dr. Ravindra H. Dholakia
36. In the MPC meeting of 7th June 2017, I pleaded for a rate cut of 50 basis points from 6.25 per cent to 5.75 per cent providing several reasons to do so. Most of the developments and additional data points since then have only vindicated my stand and forecasts. In my opinion, MPC should effect a major cut of 50 basis points in the policy rate without losing any more time. My reasons for this recommendation in addition to the ones I mentioned in my statement in the Minutes of the June 7, 2017 meeting of MPC are the following:
37. Subsequent to the meeting of 7th June 2017, the two readings of inflation for the months of May and June 2017 that came in were closer to my forecast than the RBI’s. The RBI has also further revised its base forecast of inflation downward. It now expects the base inflation to be a little above 4 per cent by March 2018 without the statistical impact of the revision of HRA from the 7th Pay Commission. My estimates based on our independent exercise suggest that the base CPI inflation is likely to be about 50 basis points lower than the RBI forecast.
38. Our research now provides an empirical support from the data over the last five years to the hypothesis that the headline CPI inflation in India shows a tendency to drift towards the core inflation (excluding food and fuel) in the long run and not vice versa. I had indicated a possibility of such a result in my statement in the Minutes of the April 6, 2017 meeting of MPC, where I had also clearly stated that the core inflation according to our calculations is likely to show a declining trend over the coming year. The RBI has also acknowledged that the core inflation has shown a declining trend for the last three months (April, May and June). Our exercise suggests that the core inflation is on a declining path with minor spikes ultimately reaching around 3.1-3.5 per cent by March-April 2018. I expect the headline inflation also to show a converging trend over long term.
39. The Indian Institute of Management Ahmedabad (IIMA) monthly Business Inflation Expectations Survey (BIES) started in May 2017 has provided two monthly readings by now – May and June 2017. Both these readings show that businesses in India expect their cost inflation a year ahead to be around 3 per cent. This measure of inflation closely traces the CPI core inflation. It provides further support to our empirical exercise and estimates derived independently. As it is very well recognised, the fears of upside risks to inflation considered so far either have not materialised or are considerably subdued except the statistical impact of the implementation of revised HRA for the government employees. The HRA impact in any case is a transient influence and not a permanent factor for inflation. However, this influence is likely to persist for 18-24 months because of sequential implementation of the HRA hikes by different states.
40. Monsoon for the second consecutive year is likely to be normal and progressing well. Procurement during the last year, some reforms in the agricultural sector and improvements in the logistics enabled by the introduction of GST may help keep the food inflation under control.
41. As I had argued in the June 7, 2017 meeting of MPC, the farm loan waiver by some states has not resulted in the “expected” fiscal slippage so far. In fact, the budget announced subsequently by the UP state government has absorbed the expenditure to manage the fiscal deficit at 2.97 per cent of the state income – just below the fiscal responsibility legislation (FRL) target of 3 per cent. Some of the states have staggered the implementation and others are yet to work out implementation details. The argument that state fiscal deficits are usually understated by unrealistic assumptions on their revenues may not apply when we have evidence to expect high revenue buoyancy for both the direct and indirect taxes in the country. Thus, the developments on this front so far do not suggest a serious threat to inflation on account of fiscal slippage.
42. On the other hand, capacity utilisation has been consistently below 75 per cent now for a long time. The industrial outlook survey and household expectations survey by the RBI do not paint a rosy picture of the economy. The manufacturing purchasing managers’ index (PMI) has declined to a contraction zone in July 2017. Rupee has continually appreciated and exports are not doing well. Investment demand is not picking up. Simultaneously, several major reforms including GST have started enhancing the efficiency of the system and raising revenue buoyancy enabling the governments to spend more on capacity creating projects and schemes. This is likely to result in raising potential output and its growth. All these observations point not only to the existence but expansion of negative output gap in the economy. It is important to note that output gap in this context is the difference between the level of realised output and the level of potential output, which would have a direct bearing on the inflation rate. Difference between actual growth and potential growth rates to measure the output gap in this context is a misconception and can be misleading for the policy purposes because higher actual growth than the potential growth need not necessarily result in a positive output gap or even in narrowing the negative output gap. With this clarity and all above observations on the output front, expanding negative output gap in India cannot be wished away, but needs immediate aggressive policy action to correct it. Persistence of negative output gap imposes severe social costs on the economy that is largely borne by the poor and the unemployed.
43. The basic purpose of Flexible Inflation Targeting framework according to me is to move away consciously from the Activist Discretion-based policy to Rule-based policy. As I had argued in the June 7, 2017 meeting of MPC, with a year ahead inflation forecast now brought down to 4 per cent by the RBI and existence of expanding negative output gap, any rule-based policy would suggest a cut in the policy rate by at least 50 basis points. My forecasts and arguments above suggest space for even higher cut. However, exercising caution and waiting for further vindication of my stand and forecasts by data and facts, I vote for a cut of 50 basis points in the policy rate at this stage. In my opinion, the neutral policy stance needs to be seriously reconsidered in favour of the accommodative stance given the above arguments. Statement by Dr. Michael Debabrata Patra
44. I have consistently maintained that an inflation targeting framework has to be forward-looking. Setting monetary policy by looking over the shoulder at inflation prints of the recent past runs the risk of time inconsistency with respect to the target. A good example of forward-looking time-consistent monetary policy is the monetary policy committee’s (MPC) first decision in October 2016. In its resolution, the MPC presciently gave forward guidance: “It (the MPC) notes that the sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes…”. Correctly anticipating recent inflation developments back in October 2016, the MPC took monetary policy action that was consistent. To reduce the policy rate now – when inflation is set to rise in a couple of months – will be inconsistent and will undermine credibility.
45. Households’ inflation expectations three months ahead and a year ahead have gone up! More than 70 percent of respondents expect prices to increase, with the sharpest rise expected in prices of household durable goods, followed by prices of services. It seems to me that households have completely discounted CPI inflation’s historic low. Professional forecasters, who are regarded as forward-looking, also see inflation rising over the rest of the year. In this context, I have also consistently held that in reading forecasts, it is the direction rather than the level that matters.
46. There are many moving parts in inflation’s near term path that need to settle. First, the increase of 106 per cent in house rent allowance for central government employees will feed into the CPI cumulatively – starting from July, it will likely reach its maximum effect in December. Given this incremental pattern of build-up, it could potentially stir up second order effects even as the first order impact is getting complete. Second, there is uncertainty around the inflationary impact of the roll-out of the GST – the release of pending price revisions; restocking after clearance sales; unwinding of arrangements that were made to prepare for initial difficulties in pass through of tax credits. My sense is that one-off inflation effects could emerge in the near months. Third, base effects will reverse and turn unfavourable from August – this should go to the top of the hierarchy of moving parts. Fourth, seasonal spikes in inflation-sensitive food prices are already in evidence. The question is: will there be spillovers that induce generalisation of the inflation momentum?
47. All these factors could come together in CPI readings from August. If that turns out to be the case, why not stay on hold now, watch the shape and slope of the upturn and if it is benign, deliver credible monetary policy that supports the economy? In the context of the latter, it is paradoxical that weak aspects of economic activity are widely cited, but every projection of growth – official; multilateral; independent – shows that it is expected to accelerate in 2017-18!
48. The financial environment is bubbly and frothy. The combination of high valuations in equity and fixed income markets, an appreciating currency and the persistence of a liquidity overhang in the money market is a perfect recipe for a financial imbalance. A rate cut can amplify it if the central bank is seen as encouraging risk-taking.
49. In the run-up to the formal institution of the new monetary policy framework, inflation targets adopted by the RBI – 8 per cent; 6 per cent; 5 per cent – were achieved with a considerable amount of good luck (collapse of international crude prices; new CPI index; demonetisation; favourable supply shocks). Now that we are in a formal inflation targeting framework, why not strive to achieve the mandated target with good policy?
50. I vote for status quo. Statement by Dr. Viral V. Acharya
51. Inflation prints since the last policy have turned out even lower, though there are emerging signs that certain deflating food items are on a price rebound. Excluding the HRA impact, headline inflation is now projected to be lower in Q4 of 2017-18 as compared with the projection made in the last policy statement. More significantly, inflation excluding food and fuel has eased markedly, falling to around 4 per cent and suggesting a broad-based weakening of underlying demand. Our 12- month ahead headline inflation projection, without the statistical HRA effects, is now just above 4 per cent, even as the inflation path is projected to be on an upward trajectory. Households’ inflation expectations have, however, slightly moved up even in the face of recent low inflation prints.
52. Our output gap estimates turned somewhat negative after the last quarter's growth numbers and associated revisions. Together with easing of underlying inflation and given that our 12-month ahead inflation forecast (excluding the HRA impact) is in line with the mandated target, there seems some room for monetary policy accommodation. Hence, I vote for a policy repo rate cut by 25 basis points while retaining the neutral stance.
53. Why the neutral stance? I wish to reiterate that growth slowdown since Q1 2016-17 is rooted in the stressed balance-sheets of our banks and corporates in several sectors. Our output gap estimates that account for financing conditions using recent modelling advances do pick up this protracted slowdown. To address this, our efforts on stressed asset resolution are firmly underway. This very stress has also resulted in poor transmission of monetary policy (except after demonetisation, and only for fresh rupee loans, as bank deposits surged).
54. In my assessment, therefore, our focus at the present juncture should be on improving the conditions for sound transmission such as healthy bank and corporate balance sheets, market-based benchmarking of bank lending rates and a thriving corporate bond market. Higher real rates are justified in the meantime as absent efficient transmission, attempts to address symptoms of balance-sheet problems with aggressive monetary easing get wasted and can even backfire by misallocating investments, fuelling asset price inflation, creating false hopes of a growth boost, and relaxing the pedal on deeper structural reforms.
55. I remain concerned about the impact of farm loan waivers on inflation and growth, due to induced departure from fiscal discipline, shift in the nature of state spending and the crowding out of private credit by further state borrowings from the market. Given the additional uncertainty around how much of the real-time economic indicator surprises are due to the likely temporary impact of the GST rollout on business activity, careful scrutiny of upcoming data seems necessary. Hence, I prefer to keep the monetary stance neutral. Statement by Dr. Urjit R. Patel
56. Excluding the house rent allowance (HRA) impact under the 7th central pay commission (CPC), the current assessment is that inflation during Q4 of 2017-18 would be lower than what it was projected in the last monetary policy review. CPI inflation excluding food and fuel has also softened over the last three months. Seasonally adjusted momentum moderated during this period. Available forward looking information on demand conditions for Q2 of 2017-18, particularly the RBI’s industrial outlook survey and the consumer confidence survey do not suggest much risk of immediate demand pressures. While the growth outlook in terms of projected GVA growth for 2017-18 is retained unchanged at 7.3 per cent, there are some signs of downside risks on the underlying growth momentum in industry and services. A normal monsoon for the second year in succession should help sustain some of the disinflationary impulses in food items that generally accompany improved supply conditions. The moderation in pulses prices is likely to continue in the medium-term on account of favourable supply conditions. I vote in favour of a cut in the policy repo rate by 25 basis points.
57. While using the space available for monetary accommodation to support growth, we retain the monetary policy stance as neutral for the following reasons. First, disentangling recent disinflation in terms of relative roles of structural and transitory drivers remains a challenge. Second, HRA will push up the inflation trajectory. Even if one excludes the direct HRA impact, one has to be vigilant about the second order effects, especially on inflation expectations as States would also start implementing revision in salary and allowances. Third, inflation expectations of households edged up even in an atmosphere of significant disinflation. Fourth, specific food items such as tomato exhibited sharp price pressures in recent weeks, which were not reflected in the low June 2017 inflation print. The present low level of food prices is unusual and is vulnerable to upward pressures. An assessment of whether the recent deflation in food items is sustainable, despite a normal monsoon, would require more hard data going forward. Fifth, while the frontloaded expenditure by the Central Government so far during the year has provided a boost to the economy, the implementation of farm debt waivers by the State Governments has significantly increased the fiscal risks and poses an upside risk to the inflation outlook.
58. Effective transmission of a policy rate cut is the key to achieving the goal of supporting the non-inflationary growth. By the Central Government’s own formula effective April 1, 2016, there is scope for administered interest rates to be reduced. While the transmission has improved, there is still some space for banks to cut their lending rates, especially on the existing loan portfolios. Credit growth has also been low partly because of risk aversion among banks on account of their stressed assets position. Resolution of stressed balance sheets of banks, therefore, will remain important for reviving credit demand and the investment cycle. Jose J. Kattoor Press Release : 2017-2018/460 Chief General Manager
6. Since the MPC’s meeting in August 2017, global economic activity has strengthened further and become broad-based. Among advanced economies (AEs), the US has continued to expand with revised Q2 GDP growing at its strongest pace in more than two years, supported by robust consumer spending and business fixed investment. Recent hurricanes could, however, weigh on economic activity in the near-term. In the Euro area, the economic recovery gained further traction and spread, underpinned by domestic demand. While private consumption benefited from employment gains, investment rose on the back of favourable financing conditions. The Euro area purchasing managers’ index (PMI) for manufacturing soared to its highest reading in more than six years. The Japanese economy continued on a path of healthy expansion despite a downward revision in growth since March 2017 on weaker than expected capital expenditure.
7. Among the major emerging market economies (EMEs), strong growth in Q2 in China was powered by retail sales, and imports grew at a rapid pace, suggesting robust domestic demand; investment activity, however, slowed down. The Brazilian economy expanded for two consecutive quarters in Q2 on improving terms of trade, even as the impact of recession persists on the labour market. Economic activity in Russia recovered further, supported by strengthening global demand, firming up of oil prices and accommodative monetary policy. Although South Africa has emerged out of recession in Q2, the economy faces economic and political challenges.
8. The latest assessment by the World Trade Organisation (WTO) indicates a significant improvement in global trade in 2017 over the lacklustre growth in 2016, backed by a resurgence of Asian trade flows and rising imports by North America. Crude oil prices hit a two-year high in September on account of the combined effect of a pick-up in demand, tightening supplies due to production cuts by the Organisation of the Petroleum Exporting Countries (OPEC) and declining crude oil inventories in the US. Metal prices have eased since mid-September on weaker than expected Chinese industrial production data. Bullion prices touched a year’s high in early September on account of safe-haven demand due to geo-political tensions, before weakening somewhat in the second half. Weak non-oil commodity prices and low wage growth kept inflation pressures low in most AEs and subdued in several EMEs, largely reflecting country-specific factors.
9. Global financial markets have been driven mainly by the changing course of monetary policy in AEs, generally improving economic prospects and oscillating geo- political factors. Equity markets in most AEs have continued to rise. In EMEs, equities generally gained on improved global risk appetite, supported by upbeat economic data and expectations of a slower pace of monetary tightening in major AEs. While bond yields in major AEs moved sideways, they showed wider variation in EMEs. In currency markets, the US dollar weakened further and fell to a multi-month low in September on weak inflation, though it recovered some lost ground in the last week of September on a hawkish US Fed stance and tensions around North Korea. The euro surged to a two and a half year high against the US dollar towards end-August on positive economic data, whereas the Japanese yen experienced sporadic bouts of volatility triggered by geo-political risks. Emerging market currencies showed divergent movements and remained highly sensitive to monetary policies of key AEs. Capital flows to EMEs have continued, but appear increasingly vulnerable to the normalisation of monetary policy by the US Fed.
10. On the domestic front, real gross value added (GVA) growth slowed significantly in Q1 of 2017-18, cushioned partly by the extensive front-loading of expenditure by the central government. GVA growth in agriculture and allied activities slackened quarter-on-quarter in the usual first quarter moderation, partly reflecting deceleration in the growth of livestock products, forestry and fisheries. Industrial sector GVA growth fell sequentially as well as on a y-o-y basis. The manufacturing sector – the dominant component of industrial GVA – grew by 1.2 per cent, the lowest in the last 20 quarters. The mining sector, which showed signs of improvement in the second half of 2016-17, entered into contraction mode again in Q1 of 2017-18, on account of a decline in coal production and subdued crude oil production. Services sector performance, however, improved markedly, supported mainly by trade, hotels, transport and communication, which bounced back after a persistent slowdown throughout 2016-17. Construction picked up pace after contracting in Q4 of 2016-17. Financial, real estate and professional services turned around from their lacklustre performance in the second half of 2016-17. Of the constituents of aggregate demand, growth in private consumption expenditure was at a six-quarter low in Q1 of 2017-18. Gross fixed capital formation exhibited a modest recovery in Q1 in contrast to a contraction in the preceding quarter.
11. Turning to Q2, the south-west monsoon, which arrived early and progressed well till the first week of July, lost momentum from mid-July to August – the crucial period for kharif sowing. By end-September, the cumulative rainfall was deficient by around 5 per cent relative to the long period average, with 17 per cent of the geographical area of the country receiving deficient rainfall. The live storage in reservoirs fell to 66 per cent of the full capacity as compared with 74 per cent a year ago. The uneven spatial distribution of the monsoon was reflected in the first advance estimates of kharif production by the Ministry of Agriculture, which were below the level of the previous year due to lower area sown under major crops including rice, coarse cereals, pulses, oilseeds, jute and mesta.
12. The index of industrial production (IIP) recovered marginally in July 2017 from the contraction in June on the back of a recovery in mining, quarrying and electricity generation. However, manufacturing remained weak. In terms of the use-based classification, contraction in capital goods, intermediate goods and consumer durables pulled down overall IIP growth. In August, however, the output of core industries posted robust growth on the back of an uptick in coal production and electricity generation. The manufacturing PMI moved into expansion zone in August and September 2017 on the strength of new orders.
13. On the services side, the picture remained mixed. Many indicators pointed to improved performance even as the services PMI continued in the contraction zone in August due to low new orders. In the construction segment, steel consumption was robust. In the transportation sector, sales of commercial and passenger vehicles as well as two and three-wheelers, railway freight traffic and international air passenger traffic showed significant upticks. However, cement production, cargo handled at major ports, domestic air freight and passenger traffic showed weak performance.
14. Retail inflation measured by year-on-year change in the consumer price index (CPI) edged up sequentially in July and August to reach a five month high, due entirely to a sharp pick up in momentum as the favourable base effect tapered off in July and disappeared in August. After a decline in prices in June, food inflation rebounded in the following two months, driven mainly by a sharp rise in vegetable prices, along with the rise in inflation in prepared meals and fruits. Cereals inflation remained benign, while deflation in pulses continued for the ninth successive month. Fuel group inflation remained broadly unchanged in August even as inflation in liquefied petroleum gas (LPG), kerosene, firewood and chips rose. Petroleum product prices tracked the hardening of international crude oil prices.
15. CPI inflation excluding food and fuel also increased sharply in July and further in August, reversing from its trough in June 2017. The increase was broad-based in both goods and services. Housing inflation hardened further in August on account of higher house rent allowances for central government employees under the 7th central pay commission award. Inflation in household goods and services in health, recreation and clothing & footwear sub-groups increased. Quantitative inflation expectations of households eased in the September 2017 round of the Reserve Bank’s survey. However, in terms of qualitative responses, the proportion of respondents expecting the general price level to increase by more than the current rate rose markedly for the three-month as well as one-year ahead horizons. Farm and industry input costs picked up in August. Real wages in the rural and organised sectors continued to edge up. The Reserve Bank’s industrial outlook survey showed that corporate pricing power for the manufacturing sector remained weak. In contrast, firms polled for the services sector PMI reported a sharp rise in prices charged.
16. Surplus liquidity in the system persisted through Q2 even as the build-up in government cash balances since mid-September 2017 due to advance tax outflows reduced the size of the surplus liquidity significantly in the second half of the month. Currency in circulation increased at a moderate pace during Q2, by ` 569 billion as against ` 1,964 billion during Q1, reflecting the usual seasonality. Consistent with the guidance given in April 2017 on liquidity, the Reserve Bank conducted open market sales operations on six occasions during Q2 to absorb ` 600 billion of surplus liquidity on a durable basis, in addition to the issuances of treasury bills (of tenors ranging from 312 days to 329 days) under the market stabilisation scheme (MSS) during April and May of ` 1 trillion. As a result, net average absorption of liquidity under the LAF declined from ` 3 trillion in July to ` 1.6 trillion in the second half of September. The weighted average call rate (WACR), which on an average, traded below the repo rate by 18 basis points (bps) during July, firmed up by 5 bps in September on account of higher demand for liquidity around mid-September in response to advance tax outflows.
17. Reflecting improving global demand, merchandise export growth picked up in August 2017 after decelerating in the preceding three months. Engineering goods, petroleum products and chemicals were the major contributors to export growth in August 2017; growth in exports of readymade garments and drugs & pharmaceuticals too returned to positive territory. However, India’s export growth continued to be lower than that of other emerging economies such as Brazil, Indonesia, South Korea, Turkey and Vietnam, some of which have benefited from the global commodity price rebound. Import growth remained in double-digits for the eighth successive month in August and was fairly broad-based. While the surge in imports of crude oil and coal largely reflected a rise in international prices, imports of machinery, machine tools, iron and steel also picked up. Gold import volume has declined sequentially since June 2017, though the level in August was more than twice that of a year ago. The sharper increase in imports relative to exports resulted in a widening of the current account deficit in Q1 of 2017-18, even as net services exports and remittances picked up. Net foreign direct investment at US$ 10.6 billion in April-July 2017 was 24 per cent higher than during the same period of last year. While the debt segment of the domestic capital market attracted foreign portfolio investment of US$ 14.4 billion, there were significant outflows in the equity segment in August-September on account of geo-political uncertainties and expected normalisation of Fed asset purchases. India’s foreign exchange reserves were at US$ 399.7 billion on September 29, 2017. Outlook
18. In August, headline inflation was projected at 3 per cent in Q2 and 4.0-4.5 per cent in the second half of 2017-18. Actual inflation outcomes so far have been broadly in line with projections, though the extent of the rise in inflation excluding food and fuel has been somewhat higher than expected. The inflation path for the rest of 2017-18 is expected to be shaped by several factors. First, the assessment of food prices going forward is largely favourable, though the first advance estimates of kharif production pose some uncertainty. Early indicators show that prices of pulses which had declined significantly to undershoot trend levels in recent months, have now begun to stabilise. Second, some price revisions pending the goods and services tax (GST) implementation have been taking place. Third, there has been a broad-based increase in CPI inflation excluding food and fuel. Finally, international crude prices, which had started rising from early July, have firmed up further in September. Taking into account these factors, inflation is expected to rise from its current level and range between 4.2-4.6 per cent in the second half of this year, including the house rent allowance by the Centre (Chart 1).
19. As noted in the August policy, there are factors that continue to impart upside risks to this baseline inflation trajectory: (a) implementation of farm loan waivers by States may result in possible fiscal slippages and undermine the quality of public spending, thereby exerting pressure on prices; and (b) States’ implementation of the salary and allowances award is not yet considered in the baseline projection; an increase by States similar to that by the Centre could push up headline inflation by about 100 basis points above the baseline over 18-24 months, a statistical effect that could have potential second round effects. However, adequate food stocks and effective supply management by the Government may keep food inflation more benign than assumed in the baseline.
20. Turning to growth projections, the loss of momentum in Q1 of 2017-18 and the first advance estimates of kharif foodgrains production are early setbacks that impart a downside to the outlook. The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates. Consumer confidence and overall business assessment of the manufacturing and services sectors surveyed by the Reserve Bank weakened in Q2 of 2017-18; on the positive side, firms expect a significant improvement in business sentiment in Q3. Taking into account the above factors, the projection of real GVA growth for 2017-18 has been revised down to 6.7 per cent from the August 2017 projection of 7.3 per cent, with risks evenly balanced (Chart 2).
21. Imparting an upside to this baseline, household consumption demand may get a boost from upward salary and allowances revisions by states. Teething problems linked to the GST and bandwidth constraints may get resolved relatively soon, allowing growth to accelerate in H2. On the downside, a faster than expected rise in input costs and lack of pricing power may put further pressure on corporate margins, affecting value added by industry. Moreover, consumer confidence of households polled in the Reserve Bank’s survey has weakened in terms of the outlook on employment, income, prices faced and spending incurred.
22. The MPC observed that CPI inflation has risen by around two percentage points since its last meeting. These price pressures have coincided with an escalation of global geo-political uncertainty and heightened volatility in financial markets due to the US Fed’s plans of balance sheet unwinding and the risk of normalisation by the European Central Bank. Such juxtaposition of risks to inflation needs to be carefully managed. Although the domestic food price outlook remains largely stable, generalised momentum is building in prices of items excluding food, especially emanating from crude oil. The possibility of fiscal slippages may add to this momentum in the future. The MPC also acknowledged the likelihood of the output gap widening, but requires more data to better ascertain the transient versus sustained headwinds in the recent growth prints. Accordingly, the MPC decided to keep the policy rate unchanged. The MPC also decided to keep the policy stance neutral and monitor incoming data closely. The MPC remains committed to keeping headline inflation close to 4 per cent on a durable basis.
23. The MPC was of the view that various structural reforms introduced in the recent period will likely be growth augmenting over the medium- to long-term by improving the business environment, enhancing transparency and increasing formalisation of the economy. The Reserve Bank continues to work towards the resolution of stressed corporate exposures in bank balance sheets which should start yielding dividends for the economy over the medium term.
24. The MPC reiterated that it is imperative to reinvigorate investment activity which, in turn, would revive the demand for bank credit by industry as existing capacities get utilised and the requirements of new capacity open up to be financed. Recapitalising public sector banks adequately will ensure that credit flows to the productive sectors are not impeded and growth impulses not restrained. In addition, the following measures could be undertaken to support growth and achieve a faster closure of the output gap: a concerted drive to close the severe infrastructure gap; restarting stalled investment projects, particularly in the public sector; enhancing ease of doing business, including by further simplification of the GST; and ensuring faster rollout of the affordable housing program with time-bound single-window clearances and rationalisation of excessively high stamp duties by states.
25. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel were in favour of the monetary policy decision, while Dr. Ravindra H. Dholakia voted for a policy rate reduction of at least 25 basis points. The minutes of the MPC’s meeting will be published by October 18, 2017.
26. The next meeting of the MPC is scheduled on December 5 and 6, 2017. Voting on the Resolution to keep the policy repo rate unchanged at 6.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia No Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
27. In the August review, I was concerned that the downward movement in both CPI headline inflation and inflation excluding food and fuel may not sustain into the durable future. With a roughly 200 basis points increase in headline inflation in the last two months, and with the acceleration of inflation excluding food and fuel to 4.6 per cent from 4.1 per cent, upside risks to the medium term inflation target of 4 per cent have again come to the fore. This suggests that the big dip in inflation excluding food and fuel starting in March has turned out to be temporary.
28. The rebound in headline inflation has largely been due to spikes in vegetable inflation that has made the CPI vegetable index come back to its earlier peak. I am also concerned about adverse demand-supply dynamics in crude prices which had led to a 22 per cent increase in crude prices since June 2017. A relaxation of end- year fiscal deficit targets if tax revenues take a hit due to GST-related disruptions also poses an upside risk to the medium term inflation target. On the other hand, I view the recent round of inflationary expectations data as positive, with the decline in the 3-month inflationary expectations being about 230 basis points since September 2016.
29. While there has been a secular decline in economic growth for the past 6 quarters, it is likely that the Q1:2017-18 GVA growth print of 5.6 per cent was possibly a trough, and that a revival in economic activity is possibly in the works. The economy has been subject to numerous policy shocks in the form of the Insolvency and Bankruptcy Code (IBC), GST, Real Estate (Regulation and Development) Act (RERA), loan waivers, and demonetisation, all of which have undoubtedly lead to some churning, but which will also move the economy to a reformed steady state. What makes me optimistic are the following factors: (i) both the August and September PMI in manufacturing have been in an expansion mode. (ii) An economic revival of the Eurozone will push up exports. (iii) Real wage growth of the magnitude of 6-8 per cent in the rural sector will continue to support consumption driven growth. Having said this, I continue to worry about the slowing rate of capital accumulation and its impact on lowering potential growth and total factor productivity (TFP), but would like to see the next GDP growth print to have a better sense of whether the current decline in growth is transient, or part of a secular trend.
30. In some joint research done by myself and some co-authors, on a calibrated/estimated dynamic stochastic general equilibrium (DSGE) model of the Indian economy, the variance decomposition from the baseline model shows that about half of the fluctuations (variance) in output in the Indian economy in the last five years are explained by TFP shocks, and one-third is explained by fiscal shocks. Monetary policy shocks only explain around 12 per cent of output variations. This highlights not only the weakness of monetary policy transmission in the Indian economy, but the need for continual structural reforms and rule bound fiscal policy which will stabilize the Indian business cycle.
31. Taking into account these considerations, I vote for a pause in the policy repo rate at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
32. On the inflation front, retail inflation recorded a five-month high in August, 2017. This was driven partly by the dissipation of the favourable base effect and a rebound in food inflation, due to an increase in vegetable prices. CPI inflation, excluding food and fuel, rose sharply as a result of hardening of prices in several categories. Housing inflation increased on account of higher house rent allowances for central government employees under the 7th central pay commission award. Other sub-groups witnessing an increase included household goods and services, clothing, footwear, and miscellaneous items.
33. Brent crude oil prices also surged in September, while the rupee weakened. Other upside risks to inflation include the impact of an expected decline in the production of foodgrains due to lower sowing during the kharif season; the uncertainty in the short-term with respect to the effect of GST; the effects of a possible central government stimulus; the likely fiscal slippages due to the farm loan waivers; and the introduction of the pay commission award by states. Further, a potential increase in financial market volatility due to global developments, including the unwinding of the balance sheet by the Fed and the possibility of normalisation by the ECB, are also major concerns.
34. These risks to inflation are reinforced by the responses to forward-looking surveys of consumers. Specifically, the qualitative responses to the September 2017 round of the Reserve Bank’s Inflation Expectations Survey of households indicate that the proportion of respondents expecting the general price level to increase by more than the current rate rose over the three-month as well as the one-year horizons. The September round of the Consumer Confidence Survey also signals the expectation of an increase in the price level in the next one year. Moreover, an uptick in the Indian Future Inflation Gauge, a harbinger of inflation (constructed by the Economic Cycle Research Institute (ECRI), New York, with which the author is affiliated), indicates a firming in underlying inflationary pressures.
35. On the output front, GDP growth slowed down significantly in the first quarter of 2017-18, reflecting slower agricultural and manufacturing growth, along with tepid consumption and investment demand. Growth in services sector, however, picked up with an uptick in trade, hotels, transport and communication. The lacklustre growth is picked up by the September round of the Reserve Bank’s Consumer Confidence Survey, which shows a fall in the Current Situation Index as well as the Future Expectations Index, due to worsening sentiment on income and employment. Furthermore, growth in ECRI’s Indian Leading Index, a predictor of future economic activity, has eased in recent months. This suggests an urgent need to revive investment activity and reinvigorate infrastructure-related projects, amongst other measures.
36. At the same time, growth in ECRI’s Indian Leading Exports Index, that anticipates the direction of growth in exports, is declining. It is also notable in this context that, while international growth is currently robust, ECRI’s Leading Indexes of the global economy indicate waning global growth prospects.
37. In the current scenario, a wait and watch strategy is recommended with continuous monitoring of data to distinguish between a temporary effect and a long- lasting, structural impact.
38. Thus, I vote for keeping the policy repo rate unchanged. Statement by Dr. Ravindra H. Dholakia
39. During the last two months of July and August, the increase in the headline inflation as well as inflation without food and fuel was more than expected. My forecasts had provided for some spikes in inflation during these months, but the actual increase exceeded the forecasts. While the oil prices strengthened in the international markets, they are not expected to increase further substantially. Although the monsoon ended with a marginal shortfall in the rainfall, its impact on the food prices is not expected to be very adverse since the replenished buffer stocks would take care of whatever shortages occur. The real cause of concern right now is the estimates of real GDP during Q1 of 2017-18 that showed a significantly more than expected slowdown of economic activity indicating widening of the negative output gap in the economy. Considering these additional developments, I strongly plead for at least a 25 basis points (bps) cut in the policy rate. Reasons for my vote are the following: i) Households’ one year ahead inflationary expectations according to the RBI survey have fallen over the last year sharply by 340 bps when the policy rate fell by only 50 bps. This implies a significant increase of 290 bps in the real interest rate for the households. ii) The Indian Institute of Management Ahmedabad (IIMA) Business Inflation Expectation Survey (BIES) shows that the businesses expect inflation one year ahead to be around 3.5 per cent in their costs. This inflation number is generally closely akin to the core inflation. iii) RBI survey has found that companies have started investing in financial assets rather than fixed assets. It indicates that the real interest cost on one hand and real interest rate on the other hand perceived by the companies are too high. This is supported by the decline in the new projects announced. iv) My inflation forecasts over six months and one year have only marginally changed upwards since I expect oil prices and exchange rates to be reasonably stable over medium term. Moreover, we had considered earlier such scenarios in our forecasts. Even RBI’s forecast of inflation has not changed substantially and is around 4.3 per cent without the impact of revisions in house rent allowance. As I had mentioned in the August MPC minutes, our forecast is lower. In this context, it is worth observing that the headline inflation without including housing index is currently only around 3 per cent. v) RBI surveys continue to show persistently low capacity utilization at around 71-72 per cent indicating a sizeable negative output gap in the production sector. This is also supported by RBI consumer confidence surveys showing worsening sentiments for income, employment and overall environment. RBI has also revised its GVA growth forecast downward in its October Bi-monthly Monetary Policy Review for 2017-18 by 60 bps and for 2018-19 by 70 bps in its October Monetary Policy Report (MPR) compared to its April 2017 MPR. This by itself suggests that the negative output gap in the economy has widened at present and would continue widening in near future since output gap is calculated on levels and not rates of growth, which implies that the negative output gap would start narrowing only when the current growth rate exceeds the potential rate of growth. vi) There are some sceptics who argue that in India, where physical infrastructure like roads and railways are over-crowded, a negative output gap simply cannot exist. However, this argument is not valid since it is based on misconception of the potential output. Congestion and overcrowding of certain type of physical infrastructure that could be due to wrong pricing and other policies usually lead to very low productivity and indicate sub-optimal allocation of resources. This corroborates rather than negating the existence of a negative output gap, because the potential output is defined in terms of the optimal utilization of resources and not the actual utilization of resources. For instance, previously congested and hence inefficient roads have turned more efficient with introduction of Goods and Services Tax (GST). The existing capital is better utilized and produces more output. Moreover, we need to recognize that many other physical infrastructures like some airports, seaports, irrigation dams, hospitals, institutions of higher learning and several industrial plants and machinery lie severely underutilized. Similarly a significant proportion of the labour force is underutilized. Therefore, negative output gap and its widening at present as argued earlier cannot be denied. vii) A rule-based monetary policy underlying the Flexible Inflation Targeting framework would necessitate a very well justified policy rate cut under the present circumstances. Real interest rate with expected future inflation rate in the economy currently is too high compared to most other countries. Now it has started seriously hurting consumers of durable goods and producers and hence production. We also need to recognize explicitly the cost of sacrificing output growth in terms of unemployment and poverty when inflation situation is practically under control in the near to medium term. In order to address the problems created by expanding negative output gap, we need to bring down the real interest rate in the economy. In my view, the policy rate should have been cut by 50 bps long back in June 2017. A cut of 25 bps in August was too small and too late. We can still make the additional cut of 25 bps now if we want to be extremely cautious. Otherwise, my opinion is that we have a space for a cut of about 40 bps at present with due consideration to any possible upward risk to future inflation. Statement by Dr. Michael Debabrata Patra
40. Recent inflation prints have vindicated my stance. They have also borne out the expectations of households and professional forecasters. All the factors I cited came into play in the inflation reading for August - the house rent allowance (HRA) for Central Government employees; the GST; the unfavourable reversal of base effects; and the seasonal spike in the prices of vegetables. Some of these factors will gain further traction over the months ahead. The firming up of pump prices of petrol and diesel, only partly due to rising international crude prices, has provided an additional upside to the inflation outlook in a froth-suffused financial environment. The recent reduction in excise duties on petroleum products is an acknowledgement of the social tolerance threshold for inflation from this source.
41. By contrast, all the factors conditioning the August rate reduction have either not materialized or reversed - inflation excluding the HRA will likely exceed 4 per cent by the end of the year; inflation excluding food and fuel has turned up and will likely stay above 4 per cent in the months ahead; the rollout of the GST has not been smooth; and the monsoon is sub-normal in terms of its distribution during the crucial sowing weeks. With various alternative exclusion-based indicators of inflation above 4 per cent, a vicious spiral could be developing – input costs; petroleum product prices, exchange rate depreciation; inflation expectations. Professional forecasters project inflation rising to 5 per cent by the first quarter of 2018-19. Households’ qualitative expectations point to the rising probability of inflation rising faster than the current rate over the next three months.
42. Current inflation developments and, in particular, deviations of outcomes from forecasts are shaping the future path of inflation in an ongoing error correction. The primary objective of monetary policy enjoined by the RBI Act is challenged and the credibility of the MPC will be tested in the months ahead.
43. Meanwhile, growth outcomes have surprised on the downside. Parsing the data reveals that agricultural and allied activities are growing at broadly the same pace as in the first quarter of every year, while in the services sector, growth has accelerated. More recent indicators bear out these initial impulses. My sense is that the slowdown is troughing and activity will pick up in the second half of the year with better prospects for agriculture and services, and as the initial hitches associated with the GST get evened out.
44. The slowdown is essentially located in manufacturing, and reinvigorating it holds the key. The question is: is the weakness in manufacturing, which persists in spite of a reduction of 200 basis points in the policy rate, within the narrow remit of monetary policy? The advocacy for a further reduction in the policy rate is essentially a case for lowering the cost of capital or the hurdle rate to a level at which a subdued or even declining internal rate of return (IRR) becomes viable. In my view, this is not a sustainable proposition and may even be self-fulfilling: chasing a deteriorating IRR will only lead to higher inflation and no investment.
45. All indications point to a deeper malaise that chains down animal spirits in private enterprise and cries out for a bold structural transformation of the business and investment climate. The MPC’s resolution sets out the elements of the desired policy response that will revive investment activity. A monetary policy reaction in the absence of mobilising on these fronts is time-inconsistent – the MPC commits to an inflation target over a medium term horizon but the persuasive pull of the transient weakening of growth in the interregnum potentially undermines this commitment.
46. I, therefore, vote for status quo, but only as long as inflation readings stay within the target of 4 per cent. It is time to be in readiness to raise the policy rate to quell the underlying drivers of inflation if they strengthen further. Statement by Dr. Viral V. Acharya
47. Over the past few years, household inflation expectations have been steadily getting anchored down as they are adapting to the realised inflation outcomes. However, these expectations still remain relatively high, and are likely also manifested in the continuing high level of rural and non-rural wage growth. Recent headline inflation prints have risen significantly from historic low in June and in a broad-based manner; in addition, oil-price risk and global market volatility have risen materially. In such a scenario, it is important in my view for the Reserve Bank to persist steadfastly with its objective (and mandate) of keeping medium-term inflation within a striking distance of the target of 4 per cent.
48. Real-time activity indicators have been volatile over the last two quarters and do not yet paint a clear picture. Hence, it is too early, in my view, to be able to isolate the transient component of the recent one-quarter loss of momentum over and above the gradual decline in overall growth that has taken place since the Q1 of 2016-17. The gradual decline, which has turned our measures of output gap negative, is best explained by the deleveraging underway in the heavily indebted parts of the corporate sector and in poor credit growth of public sector banks given they have inadequate capital relative to impending losses on legacy assets.
49. Corporate credit risk profile is showing some signs of improving gradually; the large distressed borrowers are being directed to the Insolvency and Bankruptcy code; and efforts are under way to concretely address public sector bank health in near future. These structural changes will revive the affected economic activity, but with a lag. Teething problems, or at least the uncertainty, facing the Goods and Services Tax (GST) rollout, should also resolve soon. In the meantime, given our inflation outlook has risen quite some distance over the target of 4 per cent, there did not seem much room for monetary policy adjustment.
50. The Reserve Bank remains committed to improving the transmission of monetary policy. I believe there is still some scope left for transmission of past monetary policy accommodation to existing loan portfolio that is tied to the base rate. Our Study Group on the MCLR has proposed what I find a reasonable path going forward in referencing floating rate loans to simple market benchmarks that will improve transparency for borrowers and competitiveness in lending. I am hopeful that switching to one of the recommended benchmarks with more frequent resets will enhance the effectiveness of monetary policy in future. Statement by Dr. Urjit R. Patel
51. Headline CPI inflation has risen sharply in the last two months and there has been a broad-based increase in inflation excluding food and fuel. Even as the assessment of food prices going forward is generally favourable, some factors have imparted uncertainty to the near-term overall inflation outlook. Firstly, international crude prices have firmed up significantly in the more recent period. Second, global geo-political uncertainty and volatility in financial markets have increased. Third, a combination of farm loan debt waivers by state governments and the implementation of the pay commission award could entail some fiscal slippages and pose a risk to inflation. Notwithstanding some softening in the recent period, inflation expectations show downward rigidity. This is reflected in the high increase in staff cost, particularly in the manufacturing sector.
52. The loss of momentum in Q1 of 2017-18 has imparted a downside to the overall GVA outlook. The implementation of the GST has rendered prospects for the manufacturing sector uncertain in the short-term. This may further delay the acceleration in investment activity. However, there is a need for more data to assess whether the recent headwinds in overall GDP growth prints are transient or sustained. Prospects of agriculture are favourable, notwithstanding marginally lower estimates of kharif production. The Reserve Bank’s industrial outlook survey points to overall business sentiment improving in Q3. The manufacturing PMI remained in expansion mode in August and September. Output of core industries showed a robust growth in August. Several lead indicators of services sector activity – sales of commercial and passenger vehicles, international air passenger traffic, railway freight traffic, and foreign tourist arrivals – gained momentum in August. GVA growth is projected to strengthen in the second half of the year.
53. Recent structural reforms may have had some impact on growth in the short run. However, they will boost medium- to long-term growth prospects. To improve immediate growth prospects, teething troubles relating to GST need to be addressed expeditiously. Concerted efforts also need to be made to encourage investment activity by removing various constraints. Resolution of stressed balance sheets of banks remains important for supporting a revival in the investment cycle. Finally, government should adjust administered interest rates on savings instruments every quarter as per the formula to help with monetary transmission.
54. For keeping headline inflation close to 4 per cent on a durable basis, it is important to recognise near and medium-term risks to the inflation outlook. We have to be vigilant on account of uncertainties on the external and fiscal fronts; this calls for a cautious approach. I, therefore, vote for keeping the policy repo rate on hold, while maintaining the stance as neutral. Jose J. Kattoor Press Release: 2017-2018/1081 Chief General Manager
6. Since the last meeting of the MPC in October 2017, global economic activity has been gaining momentum through the final quarter of the year, driven mainly by advanced economies (AEs). US growth remained largely resilient to hurricanes and grew at the highest pace in the past three years in Q3 of 2017, with positive contributions from private consumption, investment activity and net exports. The unemployment rate fell to 4.1 per cent in October, the lowest in the last 17 years. In the Euro area, economic activity expanded, underpinned by accommodative monetary policy and strong job gains. The Japanese economy also continued to grow in Q3, largely supported by external demand, which helped compensate for the slowing of domestic consumption.
7. Among major emerging market economies (EMEs), the services sector remained the main driver of growth in China in Q3. However, weakness in real estate and construction activity remained a drag on growth. In Brazil, incoming data suggest that the recovery gained further momentum in Q3, with unemployment touching an intra-year low in September. Business and consumer confidence rose in October. Economic activity in Russia moderated in Q3 due to weakness in industrial production. The South African economy continued to face headwinds from weak manufacturing activity, elevated levels of unemployment and political instability.
8. The latest assessment by the World Trade Organisation (WTO) for Q4 indicates a loss of momentum in global trade due to declining export orders. Crude oil prices touched a two- and-a-half-year high in early November on account of the Organisation of the Petroleum Exporting Countries’ (OPEC) efforts to rebalance the market. Bullion prices have been under some selling pressure on account of the rising US dollar. Weak non-oil commodity prices and subdued wage dynamics have kept inflation contained in many AEs, while the inflation scenario remains diverse in major EMEs.
9. Global financial markets have remained buoyant, reflecting the improving economic outlook and the gradual normalisation of monetary policy by the US Fed. Equity markets have gained on improved corporate earnings and anticipation of large tax cuts in the US. Although equity markets have made gains in EMEs in general, they faced risk aversion in some economies. While bond yields in most AEs have moved sideways in the absence of inflation pressures, they have risen across most EMEs on country-specific factors. In currency markets, the US dollar has gained, while the surge in the euro on positive economic data lost some momentum in November due to political uncertainty. Several emerging market currencies weakened due to domestic factors. Capital inflows to EMEs have been differentiating among countries, based on investor perceptions of risk-return trade-offs.
10. On the domestic front, the growth of real gross value added (GVA) accelerated sequentially in Q2 of 2017-18, after five consecutive quarters of deceleration. It was powered by a sharp acceleration in industrial activity. All the three sub-sectors of industry registered higher growth. GVA growth in the manufacturing sector – the key component of industry – accelerated sharply on improved demand and re-stocking post goods and services tax (GST) implementation. The mining sector expanded in Q2 due to higher coal and natural gas production. GVA growth in the electricity, gas, water supply and other utility services sector also strengthened on higher demand. In contrast, growth in agriculture and allied activities slackened, reflecting the lower than expected kharif harvest. Activity in the services sector decelerated, mainly on account of slowdown in financial, insurance, real estate and professional services, and in public administration, defence and other services (PADO) following the large front-loading of government expenditure in Q1. Despite some improvement, construction sector growth remained tepid due to transitory effects of the RERA and GST implementation. Growth in the trade, hotels, transport and communication sub-group remained resilient, in spite of some slowdown in growth in Q2 as compared with the previous quarter. On the expenditure side, the growth of gross fixed capital formation improved for the second successive quarter. However, growth in private final consumption expenditure – the mainstay of aggregate demand – slowed to an eight-quarter low in Q2.
11. Looking beyond Q2, rabi sowing in Q3 has so far been marginally lagging behind the acreage sown during the comparable period of the previous year. Precipitation since October has remained at around 13 per cent below the long period average (LPA). Major reservoirs, the main source of irrigation during the rabi season, were at 64 per cent of the full reservoir level vis-a-vis 67 per cent in the previous year. On the positive side, pulses sowing increased significantly as compared with a year ago, partly reflecting the impact of lifting of the export ban for all varieties of pulses.
12. Available high-frequency indicators suggest a mixed picture of industrial activity for Q3. Core industries’ growth was flat in October as all constituents barring steel and fertilisers slowed down sequentially. Coal mining, which revived strongly in Q2, slowed down too, while cement production contracted. In contrast, the Purchasing Managers’ Index (PMI) for manufacturing, which fell in October, rebounded in November, driven by output and new orders. Also, according to the Reserve Bank’s Industrial Outlook Survey (IOS), production is expected to pick up in Q3 as order books are rising.
13. Services sector activity has remained mixed in October. In the transportation sector, sales of commercial vehicles decelerated; those of passenger vehicles and two-wheeler turned into contraction mode. By contrast, domestic and international air passenger and freight traffic, and railway freight expanded robustly. The Reserve Bank’s survey suggests that sentiments on service sector activity for Q3 are upbeat and auto sales have rebounded in November. On the other hand, PMI for services moved into contraction zone in November.
14. Retail inflation measured by year-on-year change in the consumer price index (CPI) recorded a seven-month high in October, driven by a sharp uptick in momentum, tempered partly by some favourable base effects. Food inflation was volatile in the last two months – declining sharply in September and bouncing back in October – due mainly to vegetables and fruits. Milk and eggs inflation has shown an uptick, while pulses inflation remained negative for the eleventh successive month in October. Cereal inflation remained stable. Fuel group inflation, which has been on an upward trajectory since July, accelerated further due to a sharp pick-up in inflation in liquefied petroleum gas (LPG), kerosene, coke and electricity.
15. CPI inflation excluding food and fuel, which increased from July to September, remained steady in October. This reflected the softening of petroleum product prices on account of the reversal of taxes on petroleum products by the central and state governments. However, there was a hardening of housing inflation following the implementation of higher house rent allowances for central government employees under the 7th central pay commission award.
16. The Reserve Bank’s survey of households showed inflation expectations firming up in the latest round for both three months ahead and one year ahead horizons. Farm and industrial raw material costs rose in October. Firms responding to the Reserve Bank’s Industrial Outlook Survey expect to pass on the increase in input prices to their output prices. Turning to other costs, wage growth in the organised sector edged up, while rural wage growth weakened, particularly in agriculture.
17. Surplus liquidity in the system has continued to decline during October and November. Currency in circulation increased by `736 billion in Q3 (up to December 1, 2017) over end-September on festival demand. The Reserve Bank managed surplus liquidity through the conduct of regular variable rate reverse repo auctions of various tenors, ranging from overnight to 28 days. Net average daily absorption of liquidity under the LAF declined from `2,229 billion in September to `1,400 billion in October 2017 and further to `718 billion in November. The Reserve Bank conducted open market sales of `300 billion in October- November, taking the total absorption of durable liquidity during the financial year so far to `1.9 trillion, comprising `900 billion in the form of open market sales and `1 trillion of long- term treasury bills under the market stabilisation scheme. The weighted average call rate (WACR) traded 12 bps and 15 bps below the repo rate during October and November, respectively, as against 13 bps in September.
18. Merchandise exports declined by 1.1 per cent in October 2017 after showing positive growth for 14 consecutive months. A sustained increase in exports of engineering goods, petroleum products and chemicals during the month was outweighed by a sharp fall in shipments of gems and jewellery, ready-made garments, and drugs and pharmaceuticals. Imports continued to expand, though at a modest pace. Although gold imports rose sequentially in October, they moderated from their level a year ago. Consequently, the trade deficit widened again in October. Despite moderation in September, net foreign direct investment in H1 of 2017-18 was at the same level as a year ago. With the announcement of the recapitalisation plan for public sector banks, foreign portfolio inflows into equities resumed sharply in October, after recording outflows in the preceding month. India’s foreign exchange reserves were at US$ 401.94 billion on November 30, 2017. Outlook
19. The October bi-monthly statement projected inflation to rise and range between 4.2- 4.6 per cent in the second half of this year, including the impact of increase in house rent allowance (HRA) by the Centre. The headline inflation outcomes have evolved broadly in line with projections. Going forward, the inflation path will be influenced by several factors. First, moderation in inflation excluding food and fuel observed in Q1 of 2017-18 has, by and large, reversed. There is a risk that this upward trajectory may continue in the near-term. Second, the impact of HRA by the Central Government is expected to peak in December. The staggered impact of HRA increases by various state governments may push up housing inflation further in 2018, with attendant second order effects. Third, the recent rise in international crude oil prices may sustain, especially on account of the OPEC’s decision to maintain production cuts through next year. In such a scenario, any adverse supply shock due to geo-political developments could push up prices even further. Despite recent increase in prices of vegetables, some seasonal moderation is expected in near months as winter arrivals kick in. Prices of pulses have continued to show a downward bias. The GST Council in its last meeting has brought several retail goods and services to lower tax brackets, which should translate into lower retail prices, going forward. On the whole, inflation is estimated in the range 4.3-4.7 per cent in Q3 and Q4 of this year, including the HRA effect of up to 35 basis points, with risks evenly balanced (Chart 1).
20. Turning to GVA projections, Q2 growth was lower than that projected in the October resolution. The recent increase in oil prices may have a negative impact on margins of firms and GVA growth. Shortfalls in kharif production and rabi sowing pose downside risks to the outlook for agriculture. On the positive side, there has been some pick up in credit growth in recent months. Recapitalisation of public sector banks may help improve credit flows further. While there has been weakness in some components of the services sector such as real estate, the Reserve Bank’s survey indicates that the services and infrastructure sectors are expecting an improvement in demand, financial conditions and the overall business situation in Q4. Taking into account the above factors, the projection of real GVA growth for 2017-18 of the October resolution at 6.7 per cent has been retained, with risks evenly balanced (Chart 2).
21. The MPC notes that the evolving trajectory needs to be carefully monitored. First, two of the key factors determining the cost of living conditions and inflation expectations, i.e., food and fuel inflation, edged up in November. Inflation expectations of households surveyed by the Reserve Bank have already firmed up and any increase in food and fuel prices may further harden these expectations. Second, rising input cost conditions as reflected in various surveys point towards higher risk of pass-through to retail prices in the near term. Third, implementation of farm loan waivers by select states, partial roll back of excise duty and VAT in the case of petroleum products, and decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant implications for inflation. Fourth, global financial instability on account of the pace of/uncertainty over monetary policy normalisation in AEs and fiscal expansion in the US carry risks for inflation. The expected seasonal moderation in prices of vegetables, and fruits and the recent lowering of tax rates by the GST Council could mitigate upside pressures. Accordingly, the MPC decided to keep the policy repo rate on hold. However, keeping in mind the output gap dynamics, the MPC decided to continue with the neutral stance and watch the incoming data carefully. The MPC remains committed to keeping headline inflation close to 4 per cent on a durable basis.
22. In the MPC’s assessment, there have been several significant developments in the recent period which augur well for growth prospects, going forward. First, capital raised from the primary capital market has increased significantly after several years of sluggish activity. As the capital raised is deployed to set up new projects, it will add to demand in the short run and boost the growth potential of the economy over the medium-term. Second, the improvement in the ease of doing business ranking should help sustain foreign direct investment in the economy. Third, large distressed borrowers are being referenced to the insolvency and bankruptcy code (IBC) and public sector banks are being recapitalised, which should enhance allocative efficiency. However, the MPC notes that the impact of these factors can be buttressed by reducing the cost of domestic borrowings through improved transmission by banks of past monetary policy changes on outstanding loans.
23. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel were in favour of the monetary policy decision, while Dr. Ravindra H. Dholakia voted for a policy rate reduction of 25 basis points. The minutes of the MPC’s meeting will be published by December 20, 2017.
24. The next meeting of the MPC is scheduled on February 6 and 7, 2018. Voting on the Resolution to keep the policy repo rate unchanged at 6.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia No Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
25. Since the last review, headline inflation has inched up to 3.6 per cent. RBI’s quarterly projections of CPI inflation (including HRA) are based on crude prices being US $ 60 per barrel. Uncertainty because of geopolitical events could push up the price of crude higher than this value. As the Phillips Curve for the economy shifts up because of increases in crude prices, this poses an upside risk to the medium term inflation target of 4 per cent.
26. The increase in the wheat MSP by the government in October was the biggest increase in the past five years (both in absolute terms as well as percentage terms). My own research (with co-authors) shows how such procurement “shocks” can lead to a wage-price spiral ending up in generalized inflation. Separately, using the KLEMS database, I find that average annual total factor productivity (TFP) growth in agriculture in India between 1980 to 2011 is close to 1 per cent, with a very mild upward sloping (HP filtered) trend throughout the period. Stagnant agricultural productivity combined with a lopsided temporal distribution of rain like last year makes the agriculture sector continually vulnerable to price pressures that need to be carefully watched. Having said this, I am comforted by the fact that cereal inflation is lower with favourable base effects going forward. Kharif rice production is also consistent with production in the last five years. Pulses continue to face deflationary pressures, although base effects will be unfavourable in coming months. I see the 3-month and 1-year ahead inflationary expectations as stable but with an uptick. With the coming winter season, there will possibly be the usual seasonal moderation in vegetables. Inflation, excluding food, fuel, and housing till date is constant around 4.1 per cent which is somewhat comforting.
27. Compared to the last review, various risks are materializing around inflation becoming generalized and need to be watched carefully. The positive co-movement between the output gap and inflation excluding food and fuel since 2010-11 suggests that a closing output gap will generate demand-pull pressures on inflation as growth revives. The conquest of Indian inflation is certainly not a done deal!
28. As I mentioned in my last review, the weakness in growth drivers continues to worry me. While both GVA and GDP growth rebounded after sequential declines over the last 5 quarters, the growth revival lacks animal spirits. Consumption, the main stay of the Indian economy, at 54 per cent, exhibits a declining share of GDP. Consumer confidence is the lowest since September 2013. There has been a reversal of the commodity price cycle. Investment demand continues to be muted, despite a recent uptick in Q2 of 2017-18. While merchandise exports are likely to see a sustained recovery as GST disruptions fade, exports are far too volatile to be a reliable source of aggregate demand in the short term. The November 2017 PMI in services also turned into contraction mode. Various factors however bode well for the growth process (GST, favourable impact of global growth, incipient turn around in credit growth, pay commission, and bank recapitalization). More certainty on growth trends will be available in the next couple of months after the release of Advance GDP Estimates and the Union Budget, making it prudent to wait and watch.
29. Taking these considerations into account, I vote for a pause in the policy repo rate at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
30. Inflation as measured by the CPI recorded an uptick since the previous meeting of the MPC in early October 2017. This rise was driven by higher food inflation (mainly vegetables and fruits) and fuel prices. The effect of an increase in House Rent Allowance and the lingering impact of the goods and services tax (GST) also contributed towards the pressure on inflation. CPI inflation excluding food and fuel remained steady at 4.6 per cent.
31. Going forward, upside risks include expectations of high international prices of crude oil due to OPEC’s accord to extend production cuts till December 2018. The impact of House Rent Allowance and likely fiscal slippages may also continue to push inflation up. The seasonal decline in vegetable prices (especially onions and tomatoes) has also not yet materialised due to supply disruptions. Global financial instability on account of monetary policy normalisation in advanced economies also implies risks to inflation. Further, the latest round of RBI’s Households Inflation Expectations Survey shows inflation expectations firming up for both three-month- and one-year-ahead horizons. The Reserve Bank’s Industrial Outlook Survey shows that firms expect to pass on the increase in input prices to output prices. Offsetting factors include the reduction in GST rate of several commodities and services that may translate into lower retail prices for consumers, a more proactive supply management by the government, and a downward trend in prices of pulses.
32. India’s GVA growth accelerated in Q2 2017-18 after five consecutive quarters of slowing down. Although agriculture and services decelerated, there was a rebound in industrial activity, partly due to restocking after GST implementation.
33. Going forward, the Reserve Bank’s surveys indicate that performance in the services and infrastructure sectors is expected to improve in Q4 on account of increase in demand, financial conditions and the overall business situation. Further, recapitalization of public sector banks may help in sustaining the renewed credit flows. The recent reduction in GST rates may also provide a boost to the economy. The improvement in the ranking related to the ease of doing business may also provide an impetus to growth. In the coming months, downside risks to growth may arise from lower than projected sowing in the rabi season. Another major factor may be the recent increase in oil prices that will put pressure on margins of firms. The Consumer Confidence Survey conducted by RBI indicates deterioration in the outlook for the general economic situation and the employment scenario.
34. Furthermore, growth in the Economic Cycle Research Institute’s Indian Leading Index, a predictor of future economic activity, has been lacklustre in recent months.
35. Thus, in the current scenario, a wait and watch strategy is recommended, with continuous monitoring of data. Hence, I vote for status quo in the policy rate and maintenance of the neutral stance. Statement by Dr. Ravindra H. Dholakia
36. I am not in agreement with the assessment of the RBI for both the CPI inflation and the economic growth prospects in the near term. I also do not share its over-concerns for the upside risks on inflation and over-optimism on economic growth front. In my opinion, the inflation situation is under reasonable control and is likely to remain well within the acceptable range during the foreseeable future because after a couple of months favourable base effects will set in. The real cause of concern right now is the economic recovery and its slow pace. Fiscal space is more or less exhausted but the space for the monetary boost has fortunately been available now for a relatively long period. Had the policy rate been cut to 5.75 per cent in June 2017 as I had argued then, the economic recovery would have been far more rapid and we would have been in a much better position. Although we have missed the bus, it is still better late than never. In my opinion, we must cut the policy rate by at least 25 basis points to begin with if we want to be on conservative side, because enough space existed all along. The specific reasons for my recommendation are as follows: i) Although the recent most round of RBI’s household inflationary expectation survey shows an increase of about 60 basis points (bps) for inflation one year ahead, overall it shows a substantial decline of about 280 bps over the last year or so. A very consistent and more reliable result is obtained from the Indian Institute of Management Ahmedabad (IIMA) latest business expectation survey with more than 2100 responses that shows the headline CPI inflation expectation one year ahead to be 3.71 per cent – well below the RBI target of 4 per cent. The standard deviation for this estimate is also relatively low. Thus, inflationary expectations are very well anchored and inflation control does not seem to be a major issue in the near future, i.e. over next 6 to 12 months. ii) On the other hand, the RBI surveys show that consumer confidence on income, employment and overall economic environment is very low and declining in recent times. Companies still lack the pricing power and experience squeeze in their profit margins. iii) Better performing and financially sound companies according to the RBI surveys are investing more in financial assets than in physical assets. They behave more like savers than investors because the real rate of interest is too high to encourage long term investment. Even consumers would be discouraged to consume durable goods. It needs to be noted that the real rate of interest is the difference between nominal rate of interest and expected rate of inflation (and not the observed rate of inflation in the recent past). iv) Despite the marginal economic recovery, the capacity utilization in Indian industry according to the RBI surveys continues to be at low level of 72 per cent indicating persistent existence of output gap. Service sector PMI is also declining and in the pessimist zone. v) The growth recovery expectation of RBI during the June-September quarter of 2017 turned out to be a substantial overstatement. As against RBI’s expectation of 6.4 per cent, the growth of real GVA during the quarter turned out to be only 6.1 per cent. Yet, the RBI has not revised its growth forecast from the earlier 6.7 percent for the year 2017-18. This implies that RBI now expects a higher growth of 7.0 and 7.8 per cent respectively in the third and fourth quarters of 2017-18. This is highly improbable to be achieved without any policy rate cut because fiscal space is practically non-existent and the conditions described in points (ii) to (iv) above are posing a big challenge. Expecting an unrealistically higher growth rates during the 3rd and 4th quarters creates a false hope of the output gap closing on its own in near future so as to continue with the policy inaction. vi) On the contrary, since the recovery has been slow and the confidence low, I expect the growth during the year 2017-18 to be much lower at only 6.4 per cent, which implies a growth rate of 6.7 and 7.2 per cent respectively for the 3rd and 4th quarters. Moreover, unlike my colleagues on the MPC, I firmly believe that the output gap would not start narrowing unless the current growth rate exceeds 8 – 8.5 per cent. It means that, in my opinion, the output gap is going to expand till the middle of the next year. That, in itself, will put downward pressure on prices and neutralize several upside risks to inflation. Oil prices in my opinion are not likely to stay significantly higher than the current level for any longer time. Similarly, although the fiscal slippage is likely in percentage to GDP, it would not be substantial in absolute terms. The fiscal deficit as percentage of GDP may exceed the target because the nominal GDP would grow much slower than the assumed number (11.75 per cent) in the last budget on account of lower inflation and substantial slowdown in the real growth. However, the numerator that puts upward pressure on yield rates and prices is not likely to increase substantially in absolute terms and hence the inflationary impact would be limited. vii) It is important to recognize that the RBI’s expectation about the headline inflation in the remaining two quarters of 2017-18 is in the range of 4.3 to 4.7 per cent. If we exclude the pure statistical effect of revisions in the house rent allowance by the 7th Pay Commission for the government employees, the range of the RBI forecasts of both the headline and CPI excluding food and fuel show the relevant inflation rate hovering around 3.9 to 4.3 per cent over the rest of the year. Thus, there is a clear space for the rate reduction of at least 25 bps even without considering the output gap. viii) There are serious implications of keeping the real policy rate substantially higher than most other countries in the world. Currently, only eleven countries in the world have a positive real policy rate and several of them either are in some crisis or have recently emerged out of a crisis. Among the rest of the countries, India has the highest real rate. If the situation is not corrected soon, it has the potential to destabilize the financial markets at home by discouraging domestic investments and encouraging foreign investment in the debt market. It may involve substantial risks for future. On the other hand, by cutting the policy rate, the domestic corporate bond market, stock market and hence investment demand could be encouraged and growth can be accelerated to bridge the output gap.
37. Keeping all these points in mind, I vote for a 25 bps cut in the policy rate in December 2017. Statement by Dr. Michael Debabrata Patra
38. I vote for status quo.
39. All the upside risks to inflation cited in previous resolutions are materialising. Moreover, price pressures are no more confined to vegetables alone, as in previous readings; they are getting diffused across petroleum products, services (excluding housing, which is being pulled up independently by statistical effects of the house rent allowance for central government employees), and into underlying inflation. The risks of inflation getting generalised appear to have increased to a point where they could potentially overwhelm the softening effects of winter arrivals of vegetables and fruits. Projections indicate that inflation prints are likely to stay above target from here on.
40. Households’ inflation expectations have firmed up and are undermining consumer confidence. The pressure of input costs may soon force corporations to reflect them in selling prices as their margins get whittled down from absorbing these costs. Financial markets, especially the bond market segment, are scenting higher inflation in the air. The slosh of liquidity that marooned markets during the year so far is being steadily drained away by liquidity operations and a position of neutrality may emerge before the end of the financial year, abstracting maturing securities under the market stabilisation scheme and forex operations.
41. The current phase of accommodation in the monetary policy stance – reduction of the policy rate by 200 basis points - is one of the deepest barring the easing associated with the global financial crisis. Also, it has been more fully transmitted. In my view, this phase has matured; it is time now to signal its end and commence the withdrawal of accommodation, consistent with the evolving stance of liquidity management.
42. It is not that I am sanguine about growth; far from it. Rather than green shoots, my sense is that the upturn of Q2 occurred on the back of replenishment of inventories, and more incoming data are needed to tell us whether or not it is durable. The investment temper remains dormant, as evident in the persisting slump in the rate of capital formation. It awaits reforms that bite the bullet in terms of freeing up product and factor markets, removing barriers to entry and exit, and rekindling productivity and competitiveness all around. As growth regains solid ground, it could likely sustain inflation above the target.
43. The time has come for monetary policy to take guard and be ready to go on to the front foot. Statement by Dr. Viral V. Acharya
44. The global commodity cycle now seems to have turned with oil prices having also rebounded recently. This has created significant input cost pressures in the economy, which at some stage may get passed on to retail prices. Vegetable prices have also firmed up, creating uncertainty around the extent of seasonal winter moderation in prices. These factors have put headline inflation on a trajectory that will most likely cross the MPC target rate of 4 per cent rather soon and remain above the target in the medium term (even after excluding the HRA impact).
45. Oil price evolution remains a particular concern. The shale gas response notwithstanding, improving global demand appears to be playing an important role in shaping oil prices along with the extension of OPEC’s production cuts. This development poses difficult domestic policy challenges – countercyclical adjustment in cess would require fiscal balancing elsewhere, whereas lack of such adjustment would imply pressure on domestic inflation (temporarily latent, since the price pass-through at pumps has not been immediate).
46. The adverse change in overall terms of trade given the commodity cycle upturn has likely also weakened drivers of growth. Nevertheless, there has been some respite in the last quarter’s growth prints as well as some of the high frequency indicators of real economic activity in recent months. Our research team’s output gap estimates show some closure, attributable in part to improved credit growth and overall flow of financial resources to the commercial sector.
47. Output gap remains somewhat negative as reflected in present low capacity utilisation and high inventory. However, gradually improving credit metrics in several distressed sectors should pave way for improved investment over the next year. This process is expected to be further supported as cases referenced to Insolvency and Bankruptcy Code (IBC) resolve, facilitate consolidation, and restore pricing power. As public sector banks raise capital, receive recapitalisation from the government, and undertake reforms, credit flows to productive sectors of the economy should improve.
48. There seems little scope for accommodation or for change of stance at the present juncture. Hence, I vote to keep the repo rate at 6 per cent with neutral stance. Incoming data will be key to shape the policy going forward. I remain keen to (i) understand the impact of Goods and Services Tax (GST) on price levels as its rollout stabilises; (ii) assess in coming months the robustness of growth revival in GVA manufacturing; and (iii) track the impact of commodity prices on the Indian economy and markets. In parallel, the Reserve Bank is examining options to improve the transmission of its policy rate actions from banks to borrowers. Statement by Dr. Urjit R. Patel
49. The inflation scenario has evolved by and large along anticipated lines even as there was some unexpected firming up of food prices in October. (I say by and large because prints have been volatile throughout the year.) Inflation is now projected to be marginally higher, going forward, as the recent increase in oil prices is likely to sustain. Food inflation, led by vegetables, remains highly variable, while deflation in pulses continues. The impact of higher house rent allowance (HRA) of central government employees on housing inflation will peak in December.
50. There are several risks to the projected inflation trajectory. First, inflation expectations of households for both three-month ahead and one-year ahead periods in the latest round of the Reserve Bank’s survey moved up. The percentage of households expecting inflation to rise at a faster rate than the current level was the highest since end-2013. Second, rising input cost pressures across the board for both manufacturing and services have raised the risk of pass-through to output prices, especially because the growth momentum is projected to gain strength in the second half of the year. Third, fiscal slippage concerns linger on. Should this risk materialise, it would have implications for the inflation outlook. These risks to the inflation trajectory could, however, be alleviated to some extent by the expected seasonal moderation in vegetable prices and the pass-through of recent reduction in GST rates on certain goods and services to retail prices.
51. The acceleration in GVA growth in Q2:2017-18 (as projected in October) is comforting, especially because it was underpinned by a sharp increase in manufacturing. Growth in gross capital formation continued to recover. Going forward, lower rabi sowing and lower reservoir level pose a downside risk to agriculture activity. However, on the industrial front, the Reserve Bank’s industrial outlook survey points to an improvement in manufacturing sector business expectations in Q3. Various indicators of service sector activity, however, present a mixed picture. Financial conditions have improved significantly in the recent period as reflected in large capital raised from the primary capital market and a pick-up in bank credit growth. These perhaps may be indicating a long-awaited (modest) upturn in an investment cycle.
52. The macroeconomic situation has remained broadly unchanged since the last MPC meeting in October 2017. However, the recent upturn in crude oil prices has emerged as a source of concern. Several uncertainties, especially on the fiscal and external fronts, persist. It is, therefore, important to be vigilant. Hence, I vote for status quo in the policy rate, while maintaining the stance as neutral; this allows us the flexibility to respond appropriately to incoming data. Jose J. Kattoor Press Release : 2017-2018/1691 Chief General Manager
6. Since the MPC’s last meeting in December 2017, global economic activity has gained further pace with growth impulses becoming more synchronised across regions. Among advanced economies (AEs), the Euro area expanded at a robust pace, supported by consumption and investment. Economic optimism alongside falling unemployment and low interest rates are supporting the recovery. The US economy lost some momentum with growth slowing down in Q4 of 2017 even as manufacturing activity touched a multi-month high in December. The Japanese economy continued to grow as manufacturing activity gathered pace in January on strong external demand, providing fillip to the already bullish business confidence.
7. Economic activity accelerated in emerging market economies (EMEs) in the final quarter of 2017. The Chinese economy grew above the official target, driven by strong domestic consumption and robust exports. However, some downside risks to growth remain, especially from easing fixed asset investment and surging debt levels. In Russia, strong private consumption, rising oil prices and high exports are supporting economic activity, although weak investment and economic sanctions are weighing on its growth prospects. In Brazil, data on household spending and unemployment were positive in Q4. However, recovery remains vulnerable to political uncertainty, which has dampened consumer confidence. South Africa continues to face challenges on both domestic and external fronts, including high unemployment and declining factory activity.
8. Global trade continued to expand, underpinned by strong investment and robust manufacturing activity. Crude oil prices touched a three-year high as production cuts by the OPEC coupled with falling inventories weighed on the global demand-supply balance. Bullion prices touched a multi-month high on a weak US dollar. Inflation remained contained in most AEs, barring the UK, on subdued wage pressures. Inflation was divergent in key EMEs due to country-specific factors.
9. Financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy in view of January payrolls data showing rapidly accelerating wage growth and better than expected employment. The volatility index (VIX) has climbed to its highest level since Brexit. Equity markets have witnessed a sharp correction, both in AEs and EMEs. Bond yields in the US have hardened sharply, adding to the upward pressures seen during January, with concomitant rise in bond yields in other AEs and EMEs. Forex markets have become volatile as well. Until this episode of recent volatility, global financial markets were buoyed by investor appetite for risk, corporate tax cuts by the US, and stable economic conditions. Equity markets had gained significantly in January, driven by robust Chinese growth, uptick in commodity prices, and positive corporate sentiment in general. In currency markets, the US dollar had touched a multi-month low on February 1 on fiscal risks and improving growth prospects in other AEs.
10. On the domestic front, the real gross value added (GVA) growth as per the first advance estimates (FAE) released by the Central Statistics Office (CSO) is estimated to decelerate to 6.1 per cent in 2017-18 from 7.1 per cent in 2016-17 due mainly to slowdown in agriculture and allied activities, mining and quarrying, manufacturing, and public administration and defence (PADO) services.
11. Information available after the release of FAE by the CSO has, however, been generally positive. Manufacturing output boosted the growth of index of industrial production (IIP) in November. After a period of prolonged weakness, cement production registered robust growth in November-December, which along with continuing healthy growth in steel production led to acceleration of infrastructure goods production in November. The manufacturing purchasing managers’ index (PMI) expanded for the sixth consecutive month in January led by new orders. Assessment of overall business sentiment in the Indian manufacturing sector improved in Q3 as reflected in the Reserve Bank’s Industrial Outlook Survey (IOS). However, core sector growth decelerated in December due to contraction/deceleration in production of coal, crude oil, steel and electricity. Acreage in the case of wheat, oilseeds and coarse cereals was lower than last year. As a result, the shortfall in area sown for rabi crops increased to (-) 1.5 per cent as on February 2 as compared with (- ) 1.0 per cent on December 29, 2017.
12. In the services sector, some of the high frequency indicators improved. Commercial vehicle sales growth touched an eight-year high in December. Cargo carried by sea, rail and air also registered higher growth in November, but showed mixed performance in December. Other indicators such as domestic and international air passenger traffic and foreign tourist arrivals grew at a fast pace in November-December. The services PMI expanded sequentially in December and January on the back of higher business activity.
13. Retail inflation, measured by the year-on-year change in the consumer price index (CPI), increased for the sixth consecutive month in December on account of a strong unfavourable base effect. After rising abruptly in November, food prices reversed partly in December, reflecting mainly the seasonal moderation, albeit muted, in prices of vegetables along with continuing decline in prices of pulses. Cereals inflation moderated with prices remaining steady in December. However, inflation in some components of food – eggs; meat and fish; oils and fats; and milk – increased. Fuel and light group inflation, which showed a sharp increase in November, softened somewhat in December, driven by moderation in electricity, LPG and kerosene inflation.
14. CPI inflation excluding food and fuel increased further in November and December, largely on account of increase in housing inflation following the implementation of higher house rent allowances (HRA) for government employees under the 7th central pay commission (CPC) award. Inflation also picked up in health and personal care and effects. Reflecting incomplete pass-through to domestic petroleum product prices, inflation in transport and communication remained muted in December. Inflation also slowed down in clothing and footwear, household goods and services, recreation, and education.
15. Households’ inflation expectations, measured by the Reserve Bank’s survey of households, remained elevated for both three-month ahead and one-year ahead horizons even as inflation expectation for one-year ahead horizon moderated marginally. Firms responding to the Reserve Bank’s Industrial Outlook Survey (IOS) continued to report input price pressures and increase in selling prices in Q3. This is also confirmed by manufacturing and services firms polled by PMI. Organised sector wage growth remained firm, while the rural wage growth decelerated.
16. The liquidity in the system continues to be in surplus mode, but it is moving steadily towards neutrality. The weighted average call rate (WACR) traded 12 basis points (bps) below the repo rate during December-January as against 15 bps below the repo rate in November. On some days in December and January, the system turned into deficit due to slow down in government spending and large tax collections, which necessitated injection of liquidity by the Reserve Bank. During the two weeks beginning December 16, 2017, the Reserve Bank injected average daily net liquidity of ₹ 388 billion into the system. For December as a whole, however, the Reserve Bank absorbed ₹ 316 billion (on a net daily average basis). As the system turned into deficit again in the fourth week of January, the Reserve Bank injected average net liquidity of ₹ 145 billion. For January, on the whole, the Reserve Bank absorbed ₹ 353 billion (on a net daily average basis).
17. Merchandise exports bounced back in November and December. While petroleum products, engineering goods and chemicals accounted for three-fourths of this growth, exports of readymade garments contracted. During the same period, merchandise import growth accelerated sequentially with over one-third of the growth emanating from petroleum (crude and products) due largely to high international prices. Gold imports increased – both in value and volume terms – in December, after declining in the preceding three months. Pearls and precious stones, electronic goods and coal were major contributors to non-oil non-gold import growth. With import growth exceeding export growth, the trade deficit for December was US$ 14.9 billion.
18. Even though the current account deficit narrowed sharply in Q2 of 2017-18 on a sequential basis, it was higher than its level a year ago, mainly due to widening of the trade deficit. While net foreign direct investment (FDI) inflows moderated in April-October 2017 from their level a year ago, net foreign portfolio investment (FPI) inflows were buoyant in 2017-18 (up to February 1). India’s foreign exchange reserves were at US$ 421.9 billion on February 2, 2018. Outlook
19. The December bi-monthly resolution projected inflation in the range of 4.3-4.7 per cent in the second half of 2017-18, including the impact of increase in HRA. In terms of actual outcomes, headline inflation averaged 4.6 per cent in Q3, driven primarily by an unusual pick-up in food prices in November. Though prices eased in December, the winter seasonal food price moderation was less than usual. Domestic pump prices of petrol and diesel rose sharply in January, reflecting lagged pass-through of the past increases in international crude oil prices. Considering these factors, inflation is now estimated at 5.1 per cent in Q4, including the HRA impact.
20. The inflation outlook beyond the current year is likely to be shaped by several factors. First, international crude oil prices have firmed up sharply since August 2017, driven by both demand and supply side factors. Second, non-oil industrial raw material prices have also witnessed a global uptick. Firms polled in the Reserve Bank’s IOS expect input prices to harden in Q4. In a scenario of improving economic activity, rising input costs are likely to be passed on to consumers. Third, the inflation outlook will depend on the monsoon, which is assumed to be normal. Taking these factors into consideration, CPI inflation for 2018-19 is estimated in the range of 5.1-5.6 per cent in H1, including diminishing statistical HRA impact of central government employees, and 4.5-4.6 per cent in H2, with risks tilted to the upside (Chart 1). The projected moderation in inflation in the second half is on account of strong favourable base effects, including unwinding of the 7th CPC’s HRA impact, and a softer food inflation forecast, given the assumption of normal monsoon and effective supply management by the Government.
21. Turning to the growth outlook, GVA growth for 2017-18 is projected at 6.6 per cent. Beyond the current year, the growth outlook will be influenced by several factors. First, GST implementation is stabilising, which augurs well for economic activity. Second, there are early signs of revival in investment activity as reflected in improving credit offtake, large resource mobilisation from the primary capital market, and improving capital goods production and imports. Third, the process of recapitalisation of public sector banks has got underway. Large distressed borrowers are being referenced for resolution under the Insolvency and Bankruptcy Code (IBC). This should improve credit flows further and create demand for fresh investment. Fourth, although export growth is expected to improve further on account of improving global demand, elevated commodity prices, especially of oil, may act as a drag on aggregate demand. Taking into consideration the above factors, GVA growth for 2018-19 is projected at 7.2 per cent overall – in the range of 7.3-7.4 per cent in H1 and 7.1-7.2 per cent in H2 – with risks evenly balanced (Chart 2).
22. The MPC notes that the inflation outlook is clouded by several uncertainties on the upside. First, the staggered impact of HRA increases by various state governments may push up headline inflation further over the baseline in 2018-19, and potentially induce second-round effects. Second, a pick-up in global growth may exert further pressure on crude oil and commodity prices with implications for domestic inflation. Third, the Union Budget 2018-19 has proposed revised guidelines for arriving at the minimum support prices (MSPs) for kharif crops, although the exact magnitude of its impact on inflation cannot be fully assessed at this stage. Fourth, the Union Budget has also proposed an increase in customs duty on a number of items. Fifth, fiscal slippage as indicated in the Union Budget could impinge on the inflation outlook. Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation. Sixth, the confluence of domestic fiscal developments and normalisation of monetary policy by major advanced economies could further adversely impact financing conditions and undermine the confidence of external investors. There is, therefore, need for vigilance around the evolving inflation scenario in the coming months.
23. There are also mitigating factors. First, capacity utilisation remains subdued. Second, oil prices have moved both ways in the recent period and can potentially soften from current levels based on production response. Third, rural real wage growth is moderate.
24. Accordingly, the MPC decided to keep the policy repo rate on hold and continue with the neutral stance. The MPC reiterates its commitment to keep headline inflation close to 4 per cent on a durable basis.
25. The MPC notes that the economy is on a recovery path, including early signs of a revival of investment activity. Global demand is improving, which should help strengthen domestic investment activity. The focus of the Union Budget on the rural and infrastructure sectors is also a welcome development as it would support rural incomes and investment, and in turn provide a further push to aggregate demand and economic activity. On the downside, the deterioration in public finances risks crowding out of private financing and investment. The Committee is of the view that the nascent recovery needs to be carefully nurtured and growth put on a sustainably higher path through conducive and stable macro- financial management.
26. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of the monetary policy decision. Dr. Michael Debabrata Patra voted for an increase in the policy rate of 25 basis points. The minutes of the MPC’s meeting will be published by February 21, 2018.
27. The next meeting of the MPC is scheduled on April 4 and 5, 2018. Voting on the Resolution to keep the policy repo rate unchanged at 6.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra No Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
28. Since the last review, there has been a sharp increase in headline inflation (November, 4.9%; December, 5.2%). The latest reading is, worryingly, led by rising inflation in all major groups. Both food and fuel inflation have also increased, with the usual seasonal easing in food inflation getting delayed till December. Global demand – with world GDP projected to grow at approximately 3.9% in 2018 – could push oil prices higher. All measures of inflation have converged above 5%. Adverse supply side shocks could push the Phillips curve of the economy upward posing a strong risk to the medium-term inflation target of 4%.
29. Inflation, excluding food and fuel (December, 5.2%) is up although this is primarily due to the statistical boost from Centre’s HRA. Pricing decisions by firms may possibly be responding more to the recent increases in input costs, driven by a reversal of the international commodity cycle, rather than staff costs, driven by a tightening of the labour market, or higher capacity utilisation. This suggests that inflation excluding food and fuel may be increasing more because of cost-push factors, which will worsen the growth-inflation trade-off.
30. There are fewer mitigating factors to rising inflation compared to two months ago. Rural wage growth continues to be moderate but with an uptick, possibly reflecting a rise in construction activity. The deflation in pulses continues but could reverse with the new procurement policy announced in the Union Budget of 2018-2019. At the current juncture though, stripped of cereals and vegetables (volatile items), the increase in inflation net of volatile items, from its trough in June 2017, is less pronounced. Both 3-month and 1-year ahead inflationary expectations are also stable.
31. In my last review, I had flagged how increases in MSP by the government could lead to generalized inflation, and worsen monetary transmission, based on research (with co- authors). While details on the exact procurement policy are awaited, the enactment of a more elaborate procurement policy in the 2018-2019 Union Budget will put stress on state finances as well. Fiscal slippages in India are inflationary!
32. With respect to economic growth, data trends have largely been positive in the last few months, as suggested by many high frequency indicators. My main concern in the last few reviews was whether animal spirits in the economy will sustain GDP growth beyond the base effect induced increases in Q3 and Q4 2017-2018. This looks increasingly likely.
33. Profit margins in the manufacturing sector are improving, with sales being higher in real terms. The PMI in services increased in December and January. The RBI enterprise surveys also suggest a substantial improvement in demand conditions. Several high frequency activity indicators have picked up suggesting that the growth deceleration has troughed. The flow of financial resources by banks and non-banks is also picking up. It is highly possible however that current growth trends will make the economy accelerate into an inflationary phase. This needs to be watched with laser-like precision.
34. Ultimately, any durable increase in growth in GDP however will depend on investment demand. The figure below, using the KLEMS database, plots growth in output per worker against growth in capital stock per worker between 1980 and 2011. While the figure is merely suggestive, it does indicate that output per worker has tracked capital per worker fairly closely during this period, suggesting dynamics in output per worker in India in the medium term are described reasonably well by a Solow-Swan style model. Any durable increase in output per worker will only come about by increases in capital per worker. To that extent, the recent uptick in investment/GDP ratio is encouraging.
35. Taking these considerations into account, I vote for a pause in the policy repo rate at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
36. CPI inflation continued its upward trajectory in November and December 2017, climbing to a 17 month high of 5.2% in December, partly due to an unfavourable base effect. This increase was also driven by an increase in food prices, along with inflation in fuel due to a rise in global crude prices. CPI inflation excluding food and fuel also increased in December, partly due to housing inflation driven by the effects of house rent allowance for government employees under the 7th central pay commission.
37. Going forward, several upside risks to inflation remain. These include the possibility of an increase in global commodity prices and higher crude oil prices. Fiscal deficit slippage and the slower than expected fiscal consolidation as well as the staggered impact of house rent allowance by state governments may also exert pressure on inflation. The proposal in the Budget to link the minimum support prices (MSPs) for kharif crops with 1.5 times the cost of production, may also drive inflation up, although its impact cannot be ascertained as yet. The Union Budget has also proposed an increase in customs duty on several items. Further, the Industrial Outlook Survey (IOS) of the RBI suggests hardening of input prices which may be passed on to the consumers and lead to higher CPI inflation. Households’ inflation expectations, as per RBI’s survey of households, remain high for both three-month-ahead and one-year-ahead forecast horizons. Meanwhile, the Indian Future Inflation Gauge, a harbinger of inflation (constructed by the Economic Cycle Research Institute (ECRI), New York, with which the author is affiliated), has increased in recent months, indicating an uptick in inflation pressures.
38. At the same time, positive signs of economic growth are visible. To begin with, the implementation of the GST is stabilising. Other positive factors include the recapitalisation of public sector banks and steps towards NPA resolution under the insolvency and bankruptcy code. Credit growth has also increased in December. Steps have also been taken in the Union Budget to revive economic activity, with a focus on rural and infrastructure sectors.
39. However, growth in ECRI’s Indian Leading Index, a predictor of future economic activity, has eased lately, indicating fading economic growth prospects, Also, ECRI’s international leading indexes suggest that global growth will ease this year. Moreover, with growth in ECRI’s Indian Leading Exports Index, which anticipates the direction of exports growth, staying subdued, the Indian export growth outlook remains restrained.
40. There is also concern about global financial market volatility against the backdrop of rising global bond yields and uncertainty regarding the normalisation of monetary policy by major advanced economies.
41. Thus, with upside risks to inflation and lacklustre growth prospects, a wait and watch strategy with status quo in policy interest rate and a neutral stance is currently recommended. Statement by Dr. Ravindra H. Dholakia
42. Developments on inflation and growth fronts since the last meeting of MPC in December 2017 have been more or less on expected lines. Although the headline inflation was expected to rise in November and December 2017, the extent of increase was higher than I expected. However, it is likely to decline during the next 3-4 months on account of favourable base effect and seasonal factors. The expectation about recovery in the growth of GVA remained subdued in the Economic Survey 2017-18 in line with what I had anticipated in my statement in the last meeting of MPC. Capacity utilisation continues to be stubborn at around 72 per cent reflecting continued presence of excess capacity in manufacturing sectors. As I have been arguing, the output gap continues to be negative and expanding. Inflation expectations of households 12 months ahead show marginal decline over the previous round in spite of the headline inflation sharply picking up during the survey period. The latest Business Inflation Expectation Survey (BIES) conducted by the Indian Institute of Management Ahmedabad (IIMA) with more than 2500 respondents finds that their expectation about costs 12 months ahead has risen by 40 basis points but still remains at 3.7 per cent. Even the RBI’s forecast of the headline inflation 12 months ahead is around 4.5- 4.6 per cent.
43. However, inflation trends need to be watched carefully. Although the base effects are going to be favorable over the next 3-4 months, the oil price movements can create uncertainties and serious upside risks. The fiscal space to accommodate future higher oil price shocks seems to be absent given the slippage in the Union budget for 2018-19. Impact of the increase in customs duty and MSP proposed in the budget on the headline inflation is again uncertain. Although there is substantial fiscal slippage by the Centre, the fiscal performance of major states needs to be watched. Their revenues are now more certain and the Centre has provided for an increased transfer of tax revenues to states by 0.2 percentage points of GDP in the budget. As a result, the fiscal discipline by states is a critical factor to watch – whether it compounds or compensates for the fiscal indiscipline of the Centre. Moreover, the implementation of the HRA revisions by states and other bodies like universities and its likely impact on the headline inflation is again uncertain though its primary effect is only statistical.
44. Under all these uncertainties and conflicting trends, prudence lies in following the policy of wait and watch and allow clearer picture to emerge. Hence, I vote for maintaining the status quo on both the policy rate and neutral stance. Statement by Dr. Michael Debabrata Patra
45. In April last year, I expressed a preference for a pre-emptive policy rate increase, sensing that inflation is rising out of the demonetisation trough. I voted, however, for holding the rate unchanged through the June and August meetings to allow transitory effects to fully pass. My vote for status quo was maintained in August even though the Committee by majority decision reduced the policy rate by 25 basis points in that meeting.
46. By the October meeting, my stance had been vindicated. Looking ahead, I saw inflation stripped of house rent allowance effects exceeding the target by the end of the year. Worrying that a vicious spiral could be developing – input costs; domestic prices of petroleum products; inflation expectations – as the slowdown in growth troughed and geared to pick up in the second half of the year, I provided specific forward guidance.
47. My vote for status quo was conditioned to inflation staying within the target, with a readiness to raise the policy rate if inflation drivers strengthen. By the December meeting, the time had come to take guard, bringing to critical mass my stance articulated since April.
48. Circling back to the present, several drivers of inflation are firing at the same time – upward adjustments of domestic POL prices in response to the hardening of international crude prices, including catching up with withheld pass-through; imminent MSP increases; fiscal slippage; customs duty increases. Various measures of underlying inflation are converging to the headline at above 5 per cent. Expectations are elevated and volatile. Fixed income markets are telling us that we have fallen behind the curve.
49. In the near term outlook (up to mid-2018), inflation is likely to drift well above target. It is important to recognise that the expected easing of inflation in the outer months of the forecast horizon – between July 2018 and March 2019 – is largely statistical as the HRA effect wanes. The target is in danger of getting out of reach and over the next few months, the upper tolerance band is under threat. This could seriously dent the credibility of the Committee’s commitment to the target.
50. Turning to the state of the economy, a turnaround has likely begun in the third quarter of 2017-18 – sales are accelerating even as inventories are being drawn down; the capex cycle is starting up; and pricing power is returning. External demand is providing support as exports grow at ASEAN rates. Accelerating growth in non oil non bullion imports is reflecting domestic demand, including substitution effects, impatient with the sluggishness in the supply response.
51. The output gap is starting to turn up from a persistently negative state. If the professional forecasters’ consensus around 7 per cent plus growth for 2018-19 materialises, the output gap is expected to close going forward.
52. If the statistical reversal of the HRA effect is looked through, the real policy rate is below 1 per cent and could fall further absent policy action. This is completely misaligned with underlying fundamentals and the economy's prospects at a time when activity is picking up. In view of the prolonged period of status quo, a series of rate increases may be warranted to remove excessive accommodation. The time to begin is upon us.
53. I vote for an increase of 25 basis points in the policy rate to commence the withdrawal of accommodation. Statement by Dr. Viral V. Acharya
54. Headline inflation prints since last policy have been significantly above the target. While a part of this is statistical due to the Centre's HRA implementation, there has also been a rise in inflation sans HRA. A major concern has been the steep rise in oil prices coincidentally with (i) global rates and commodity cycles having turned up; and (ii) our fiscal deficit having overshot for this year and likely to do so next year too. Hence, even without factoring in the States’ staggered HRA implementation and MSP rises announced in the Union Budget, risks to inflation seem clearly tilted on the upside. Indeed, RBI's projections at 12-14 months in future put headline inflation by more than 50 basis points above the target (by then the statistical effect of Centre’s HRA implementation would have completely waned).
55. Such an inflation scenario would imply a raise in policy rates by a pure inflation- targeting central bank, in turn, implying a change in stance from "neutral" to "withdrawal of accommodation." However, two reasons induced me to pause.
56. First, an important factor determining inflation going forward is likely to be the shale gas production response to rising oil prices; while this response has been somewhat muted, its trigger out of dormancy could dampen oil prices swiftly. I would like to see whether this downside risk plays out in next few months to have a firmer grip on the medium-term inflation trajectory.
57. Second, for a flexible inflation targeting framework, the growth trajectory relative to potential output has to be considered too.
58. On this front, the output gap remains somewhat negative though it has been steadily closing. Structurally, the improving balance sheets of the banking system post recapitalisation package and the ongoing resolution of large stressed accounts have made the recent pick up in credit growth more sustainable. Real economic activity indicators also suggest a broad-based growth revival. While RBI growth projections for next year are in line with this buoyant activity of late, the recovery is nevertheless nascent and worthy of some support in the short run.
59. Given these trade-offs, I vote for a pause with no change in the neutral stance. The next few months of inflation and growth data will be key to determining the evolution of policy rates. If growth remains robust and inflation prints continue to project headline inflation a year ahead well above the target, then a change in stance from "neutral" to "withdrawal of accommodation" might have to be considered.
60. In the meantime, it would be good to focus on (i) pushing forward the work we have undertaken in improving the transmission of policy rate changes to the real sector; and (ii) taking the resolution framework for stressed assets to its logical conclusion. Statement by Dr. Urjit R. Patel
61. CPI inflation rose for the sixth consecutive month in December. Food inflation increased further even as pulses continued to deflate. Fuel group inflation rose sharply in November and remained elevated thereafter. With rising input prices, inflation is getting increasingly generalised. Inflation expectations have remained elevated.
62. Looking forward, inflation in the baseline scenario is projected to remain above the target of 4 per cent throughout 2018-19. There are several upside risks to inflation, especially from the staggered impact of HRA increases by various state governments (the direct effect on the CPI of the pure statistical adjustment has to be looked through, but not the second round effects driven by, say, expectations); policy for arriving at the minimum support prices for Kharif crops; and the fiscal slippage as indicated in the Union Budget, which also has attendant “crowding-out” implications with regard to the cost of private domestic credit. The evolving global macro backdrop is a concern. Tighter monetary policy by systemically important central banks, viz., the US Federal Reserve, combined with a looser US fiscal policy stance has the potential to imbue financial turbulence with concomitant consequences, especially for emerging markets. International crude oil prices increased significantly between December and early February, which is worrisome. However, oil prices could moderate if there is a strong supply response. Effective supply management by the government, as in the recent past, could help in keeping food inflation under check. Further, overall capacity utilisation in industry, according to surveys, is restrained.
63. Domestic economic growth impulses are strengthening. Manufacturing activity has picked up. The manufacturing purchasing managers’ index (PMI) expanded for the sixth consecutive month in January, led by new orders. There are also early signs of revival of investment activity. Many service sector indicators have shown robust growth such as commercial vehicle sales, domestic & international air passenger traffic, and foreign tourist arrivals. The services PMI expanded sequentially in December and January, supported by higher business activity. Credit growth is picking up and is also becoming broad-based. GVA growth in 2018-19 is forecast at 7.2 per cent, which will be a significant improvement over the current year.
64. Although inflation risks have increased in recent months, incoming data should provide greater clarity about the persistence of inflationary pressures. The economic recovery is also at a nascent stage and calls for a cautious approach at this juncture. I, therefore, vote for keeping the policy repo rate on hold while maintaining a neutral stance. Jose J. Kattoor Press Release: 2017-2018/2263 Chief General Manager
6. Since the MPC’s last meeting in February 2018, global economic activity has gathered further momentum, both in advanced and emerging market economies, though financial market volatility and potential trade wars pose a threat to the outlook. Among advanced economies (AEs), the US economy, which ended 2017 on a slightly weak note, appeared to have bounced back in Q1:2018; the unemployment rate remains low with hiring around multi-month highs. In the Euro Area, economic activity remained buoyant, although consumer spending and factory activity slowed down due to the strengthening of the euro, but a consistently falling unemployment rate and elevated consumer confidence continued to underpin the strength of the economy. The Japanese economy registered eight straight quarters of growth till Q4:2017; available data for 2018 point to a slower start to the year with weak machinery orders and an easing manufacturing Purchasing Manager’s Index (PMI) in February-March.
7. Economic activity remained robust in emerging market economies (EMEs) in Q1:2018. The Chinese economy started the year on a strong note; retail sales picked up pace indicating robust consumption, while industrial production also registered a strong increase in Q1:2018 on improved mining and manufacturing activity. In Brazil, economic activity is gaining momentum, driven by higher commodity prices. The Russian economy continued to recover in Q1; industrial production expanded in January-February, after two months of contraction, while exports grew at a robust pace. In South Africa, leading indicators, viz., the manufacturing PMI and business confidence, improved in Q1.
8. World trade volume growth is expected to have been robust in Q1, as gauged from the data on container trade throughput, air freight and export orders. Crude oil prices have become volatile in the recent period. After softening in February from multi-year highs on increased production in the US, crude prices hardened in the second half of March, driven by rebalancing of supply by OPEC and Russia, and drawdown of US inventories. Metal prices have come under selling pressure, with copper touching a three-month low in March on uncertainty stemming from global trade protectionism and US monetary policy. Gold prices, which touched a two- From this resolution onwards, growth in gross domestic product (GDP) will be used as the headline measure of economic activity. month low in March, have recently witnessed some uptick on fears of intensification of a trade war. Inflation remains below target in many key AEs and EMEs.
9. Financial markets turned volatile in February-March, triggered by uncertainty regarding the pace of normalisation of US monetary policy, and concerns surrounding global trade. Equity markets globally have shed most of the gains of the previous quarter in a heavy sell off in February-March, caused by optimistic US job reports and the US imposition of new tariffs on Chinese goods. Yields in the US traded sideways on weaker than expected inflation pressures and the anticipated rate hike by the Fed. Yields in other major AEs have fallen, while among EMEs, they have remained divergent on country-specific factors. In currency markets, the US dollar, which recovered somewhat in early March on an optimistic outlook of the economy, shed most of its gains in the latter part of the month on a less hawkish stance of the Fed and on anxieties surrounding a possible trade war. Among other major currencies, the euro continued to appreciate on an improving growth outlook for the region. Most EME currencies have retreated in the wake of the recent market volatility and the improving US economic outlook, though investors continued to discriminate on country-specific factors.
10. Turning to the domestic economy, the Central Statistics Office (CSO) released its second advance estimates for 2017-18 on February 28, revising India’s real gross domestic product (GDP) growth marginally upward to 6.6 per cent from 6.5 per cent in the first advance estimates released on January 5. GDP growth in 2017-18 at 6.6 per cent was lower than 7.1 per cent in 2016-17 and the deceleration was broad-based, but each component revealed intra-year turning points. Private consumption growth – whose contribution to GDP growth in 2017-18 was 68 per cent – moderated in the second half. Goods and services tax (GST) implementation had an adverse, even if transient, effect on urban consumption through loss of output and employment in the labour-intensive unorganised sector. Government expenditure provided sustained support to aggregate demand, with a pick-up in pace in the second half. Gross fixed capital formation turned around in Q2 and accelerated in the second half – markedly so in Q3 – reflecting the first signs of a sustained expansion in capital goods production and a modest revival of construction activity. Net exports dragged down aggregate demand in 2017-18 due to a surge in imports and deceleration in exports in Q3, the latter being driven in part by GST-related working capital disruptions.
11. For Q4, high frequency indicators point to a further strengthening of demand conditions. Private consumption seems to be improving on the back of strong growth in domestic air passenger traffic and foreign tourist arrivals, rising sales growth of passenger vehicles and a strong upturn in the production of consumer durables. The growth in sales of two-wheelers and tractors reflects buoyant rural consumption. Capital goods production registered a 19-month high growth in January 2018, indicative of the likely traction in investment demand. Housing loans extended by banks have increased significantly, which is a positive for residential investment. External demand remains a weak link. Merchandise import growth has slowed because of gold imports; simultaneously export growth has also weakened.
12. Turning to the supply side at a disaggregated sectoral level, the kharif foodgrains production for 2017-18 has been revised upward by 2.8 per cent in the second advance estimates released in February 2018 as compared with the first advance estimates released in September 2017. Total foodgrains production for 2017-18 is estimated at 277.5 million tonnes, up by 0.9 per cent from the level of 2016-17, with the production of rice, pulses and coarse cereals estimated to reach a record high. Wheat production is estimated to be lower than last year due to a decline in acreage and low soil moisture, but imports of 1.6 million tonnes and comfortable buffer stocks should cushion potential adverse effects. Horticulture production touched a new peak of 305.4 million tonnes in 2017-18, up by 1.6 per cent from last year.
13. For the year 2017-18 as a whole, the CSO estimates that value added in industry decelerated in relation to the previous year; in terms of quarterly performance, however, expansion set in by Q2 and was built upon in Q3 and Q4. This was mainly driven by the rebound in manufacturing. The manufacturing PMI remained in an expansionary mode for the eighth consecutive month in March, although there was some moderation in Q4. Assessment of overall business sentiment for manufacturing also improved in Q4 as reflected in the Reserve Bank’s Industrial Outlook Survey, driven by increasing output and new orders. Growth of value added in the services sector accelerated through the year, driven by trade, hotels, transport and communication and a significant pick-up in construction activity. Other high frequency indicators of services sector activity such as domestic air passenger traffic, international freight traffic, port traffic and commercial vehicles sales also expanded at a fair pace. The services PMI moved out of contraction and stabilised in March on a renewed increase in new business and strengthening expectations.
14. Retail inflation, measured by the year-on-year change in the CPI, fell from a high of 5.1 per cent in January to 4.4 per cent in February due to a decline in inflation in food and fuel. Excluding the estimated impact of an increase in the house rent allowances (HRA) for central government employees under the 7th central pay commission (CPC), the headline inflation for February was at 4.1 per cent. Food inflation declined by 120 bps in February, pulled down by a sharp decline in vegetable prices, especially of onions and tomatoes, along with continuing deflation in pulses. The fall in prices was also observed in other food components such as eggs, sugar, meat and fish, oils, spices, cereals and milk.
15. In the fuel and light group, inflation in respect of liquefied petroleum gas declined in line with international price movements. Furthermore, the rate of increase in prices of firewood and chips, and dung cake moderated.
16. CPI inflation excluding food and fuel remained unchanged at 5.2 per cent for the third consecutive month in February, after rising from its trough in June 2017. Among its constituents, housing group inflation rose significantly, reflecting the HRA increase for central government employees. Excluding the HRA impact, inflation in this group was estimated markedly lower at 4.4 per cent. Inflation in the transport and communication group increased in February on account of the rise in petroleum product prices and transportation fares. Inflation either eased or remained at a low level in February in other major sub-groups such as household goods and services, recreation and amusement, education, and personal care and effects.
17. Households’ inflation expectations, measured by the March 2018 round of the Reserve Bank’s survey of households, edged up for both three-month and one-year ahead horizons. Manufacturing firms covered in the Reserve Bank’s Industrial Outlook Survey reported input price pressures and an increase in selling prices in Q4:2017-18, which are expected to continue in Q1:2018-19. Manufacturing and services firms polled by PMI also showed a rise in input and output prices in Q4.
18. Liquidity in the system moved between surplus and deficit during February-March 2018. From a daily net average surplus of ₹ 272 billion during February 1-11, 2018, liquidity moved into deficit during February 12-March 1, reflecting a slowdown in government spending and large tax collections. After turning into surplus during March 2-15, the system moved into deficit again during March 16-22 mainly on account of quarterly advance tax outflows. Anticipating the seasonal tightening of liquidity at the end of March, the Reserve Bank conducted four additional longer tenor (24-31 days) variable rate repo operations aggregating ₹ 1 trillion, apart from the regular repo operations. In mid-March, additional liquidity of ₹ 1 trillion got released into the system through redemption of Treasury Bills issued under the Market Stabilisation Scheme (MSS) in April and May 2017. On the whole, the Reserve Bank injected ₹ 60 billion and ₹ 213 billion on a net daily average basis in February and March, respectively. The weighted average call rate (WACR) inched closer to the policy repo rate from 12 basis points below the policy rate in January to 7 bps in February, and 5 bps in March.
19. Merchandise export growth decelerated in January and February 2018, pulled down by a slowdown in exports of gems and jewellery, readymade garments and engineering goods. Import growth also moderated in February due to a decline in gold imports, lower growth in non- oil non-gold imports, and contraction in imports of transport equipment, vegetable oils and pulses. As import growth continued to exceed export growth in January-February, the trade deficit widened. The current account deficit increased in Q3:2017-18, primarily on account of the higher trade deficit. Net foreign direct investment moderated in April-January 2017-18 vis-à- vis the level a year ago. Foreign portfolio investors made net purchases in 2017-18, despite net sales in the wake of a global sell-off in February. India’s foreign exchange reserves were at US$ 424.4 billion on March 30, 2018. Outlook
20. The 6th bi-monthly resolution of 2017-18 in February projected CPI inflation at 5.1 per cent in Q4:2017-18; and in the range of 5.1-5.6 per cent in H1:2018-19 and 4.5-4.6 per cent in H2, including the HRA impact, with risks tilted to the upside. Actual inflation outcomes in January-February averaged 4.8 per cent, largely reflecting the sharp decline in vegetable prices and significant moderation in fuel group inflation. The available information suggests that vegetable prices continued to moderate in March as well. Accordingly, inflation in Q4:2017-18 is now projected at 4.5 per cent.
21. Several factors are likely to influence the inflation outlook. First, with the sharp moderation in food prices in February-March, the inflation trajectory in H1:2018-19 is expected to be lower than the projection in the February statement, despite a likely reversal in food prices in H1. Overall food inflation should remain under check on the assumption of a normal monsoon and effective supply management by the Government. Second, international crude oil prices have become volatile in the recent period, with a distinct hardening bias in the second half of March, even as the increase in shale production was more than expected. This has adversely impacted the outlook for crude oil prices. Third, on current assessment, Indian domestic demand is expected to strengthen during the course of the year. Fourth, the statistical impact of an increase in HRA for central government employees under the 7th CPC will continue till mid-2018, and gradually dissipate thereafter.
22. Taking these factors into consideration, projected CPI inflation for 2018-19 is revised to 4.7-5.1 per cent in H1:2018-19 and 4.4 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside (Chart 1). Excluding the impact of HRA revisions, CPI inflation is projected at 4.4-4.7 per cent in H1:2018-19 and 4.4 per cent in H2.
23. Turning to the growth outlook, several factors are expected to accelerate the pace of economic activity in 2018-19. First, there are now clearer signs of revival in investment activity as reflected in the sustained expansion in capital goods production and still rising imports, albeit at a slower pace than in January. Second, global demand has been improving, which should encourage exports and boost fresh investment. On the whole, GDP growth is projected to strengthen from 6.6 per cent in 2017-18 to 7.4 per cent in 2018-19 – in the range of 7.3-7.4 per cent in H1 and 7.3-7.6 per cent in H2 – with risks evenly balanced (Chart 2). 2
24. The MPC notes that there are several uncertainties surrounding the baseline inflation path. First, the revised formula for MSP as announced in the Union Budget 2018-19 for kharif crops may have an impact on inflation, although the exact magnitude will be known only in the coming months. Second, the staggered impact of HRA revisions by various state governments may push headline inflation up. While the statistical impact of the HRA revisions will be looked through, there is a need to watch out for any second round effects. Third, in case there is any further fiscal slippage from the Union Budget estimates for 2018-19 or the medium-term path, it could adversely impact the outlook on inflation. There are also risks to inflation from fiscal slippages at the level of states on account of higher committed revenue expenditure. Fourth, should the monsoon turn deficient temporally and/or spatially, it may have a significant bearing on food inflation. Fifth, firms polled in the Reserve Bank’s Industrial Outlook Survey expect input and output prices to rise, going forward. Sixth, recent volatility in crude prices has imparted considerable uncertainty to the near-term outlook.
25. Against the above backdrop, the MPC decided to keep the policy repo rate on hold and continue with the neutral stance. The MPC reiterates its commitment to achieving the medium- term target for headline inflation of 4 per cent on a durable basis. The implicit GDP growth projection in the 6th bi-monthly monetary policy statement was 7.4 per cent for 2018-19 – in the range of 7.4-7.5 per cent in H1 and 7.3-7.4 per cent in H2.
26. The MPC notes that growth has been recovering and the output gap is closing. This is also reflected in a pick-up in credit offtake in recent months. The large mobilisation of resources from the primary capital market should support investment activity further. While the domestic cyclical recovery is underway, the long-term growth potential is also expected to be reinforced by various structural reforms introduced in the recent past. On the downside, the deterioration in public finances risks crowding out private financing and investment. Furthermore, even as global growth and trade have been strengthening, rising trade protectionism and financial market volatility could derail the ongoing global recovery. In this unsettling global environment, it is especially important that domestic macroeconomic fundamentals are strengthened, deleveraging of distressed corporates and rebuilding of bank balance sheets persisted with, and the risk- sharing markets deepened.
27. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of the monetary policy decision. Dr. Michael Debabrata Patra voted for an increase in the policy rate of 25 basis points. The minutes of the MPC’s meeting will be published by April 19, 2018.
28. The next meeting of the MPC is scheduled on June 5 and 6, 2018. Voting on the Resolution to keep the policy repo rate unchanged at 6.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra No Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
29. My main concern in the last few reviews has been whether the ongoing cyclical recovery in growth will sustain, despite growing discomfort on the upside risks to the 4% inflation target in the medium-term.
30. The broad-based turnaround in growth continues to gather strength, although the turnaround is benefitting from a favourable base. Demand conditions improved in Q3 (2017- 2018). Capacity utilization, which tracks investment trends, has started to improve and is at the highest level now (at 74.3%) since Q2 2014-2015. Three-month average IIP growth (Nov 2017- Jan 2018) is 7.8% y-o-y; what is encouraging is that the high IIP growth is due to sequential gains and not base effects. Profitability in non-IT services has turned around. The sequential gains in the manufacturing sector are strong with the PMI-Manufacturing in expansion zone for the past 8 months. Credit growth continues to pick up, after lagging behind nominal GDP growth in the last two years. There is a risk that recent fraud in a public sector bank may make banks risk averse and slow lending.
31. Overall, growth signals are strong. Most indicators of the output gap suggest that it is closing. While consumption continues to be robust, investment is accelerating.
32. Food inflation continues to impart volatility to headline inflation and drive headline inflation momentum. Lower food inflation at 3.4% in February compared to 4.6% in January was the main driver of lower headline inflation (4.4%) in February. Inflation in vegetables is still elevated due to the adverse base in 2016-2017. Fuel inflation (at 6.8%) is much higher than all the other components. There was a marginal uptick in the 1-year ahead inflation expectations compared to the last round of the survey. Elevated and persistent inflation excluding food, fuel, and HRA adjustments is somewhat worrying. There is however a sustained moderation in cereals inflation, which is unusual. The total availability of pulses also appears to be well above demand estimates.
33. More than the cyclical drivers of food inflation, which for most items tends to be mean reverting, what worries me are the upside structural risks to inflation that impinge on the durability of the 4% inflation target in the medium term. In the past few reviews, I have flagged four such risks: (i) increases in minimum support prices (MSP), (ii) staggered implementation of the pay commission award by the States, (iii) slippages in the fiscal deficit in an election year, (iv) a sustaining of the price of oil at a high level.
34. Of these, my main concern at the current juncture is the possible simultaneous occurrence of adverse twin terms of trade shocks: internal (via a substantial upward revision of minimum support prices which would raise the relative prices of agricultural goods) and external (the price of oil sustains at a high level). Such twin terms of trade shocks would complicate inflation management and worsen the growth-inflation trade-off.
35. While details on what form the MSP policy will take are still awaited, my own research with co-authors shows that a one standard deviation net procurement shock not only increases inflation across all sectors, but after inflation rises for two quarters on impact, it remains positive for about six to seven quarters after that. As in an external terms of trade shock, which would push the Phillips curve of the economy upwards, compromising GDP growth and raising inflation in the medium term, an internal terms of trade shock via a rise in the MSP would do the same. The response to changes in the MSP would therefore need to be pursued in a systematic way to maintain durability of the medium-term 4% inflation target.
36. At this juncture, I would prefer to wait and watch as the data evolves.
37. I vote for a pause in the policy repo rate at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
38. Headline inflation eased to 4.4% in February after rising to a 17-month high of 5.2% in December, 2017. This fall was largely due to a significant seasonal drop in vegetable prices, along with other components of food. CPI inflation excluding food and fuel remained unchanged in February, having stayed at 5.2% since December, partly due to housing inflation driven by the direct effects of house rent allowance for government employees under the 7th central pay commission.
39. Despite the recent fall in headline inflation, several upside risks prevail. The proposed link between the minimum support prices (MSPs) for kharif crops with 1.5 times the cost of production may drive inflation up. Fiscal deficit slippage and the slower than expected fiscal consolidation, as well as the staggered impact of house rent allowance by state governments, may also exert pressure on inflation. The recent volatility in crude prices has also resulted in uncertainty regarding the inflation scenario. Further, the proposed increase in customs duty is likely to increase inflation. The outlook for inflation as per RBI’s survey of households undertaken in March 2018 signals high inflation expectations for both three-month-ahead and one-year-ahead horizons. Further, the Industrial Outlook Survey (IOS) of the RBI suggests hardening of input prices, which may be passed on to consumers and lead to higher CPI inflation.
40. On the output front, the estimated GDP growth is 6.6% for 2017-18, lower than 7.1% for 2016-17. Nevertheless, some positive signs of economic growth are visible, especially in revival of investment. Implementation of GST is stabilising and the recapitalization of public sector banks, as well as the steps towards NPA resolution under the insolvency and bankruptcy code, are expected to contribute to economic growth. On the other hand, banking sector risks can be an impediment to sustainable growth. Separately, the possibility of an escalating trade war is a growing risk factor.
41. Moreover, the Consumer Confidence Survey conducted by RBI in March 2018 presents a pessimistic outlook for General Economic Situation and Employment Scenario. This is supported by the languishing growth in the Economic Cycle Research Institute’s (ECRI) Indian Leading Index, a harbinger of future economic activity, indicating dull prospects for economic growth. Further, growth in ECRI’s 20-country composite Long Leading Index has eased, suggesting that global growth is likely to slow down. This has impacted growth in ECRI’s Indian Leading Exports Index, a predictor of the direction of exports growth, which is subdued, indicating that Indian export growth outlook remains restrained. Dimming growth prospects at the global level are also indicated in the drop in the composite Purchasing Managers’ Indexes covering services and manufacturing for various economies, including the Euro area, the U.K., China and Japan, since the end of 2017, and more recently in the U.S.
42. Thus, with upside risks to inflation and lacklustre growth prospects, a wait and watch strategy with respect to evolving risks, along with status quo in interest rates, is currently recommended. Statement by Dr. Ravindra H. Dholakia
43. The headline inflation in January and February 2018 showed a sharper decline than what MPC had expected in its previous meeting. It is likely to show a lower print even during March 2018. From April 2018, however, it is expected to increase on account of unfavorable base effect for the next 3-4 months before it again starts declining to reach the level of around 4 per cent by March 2019. Thus, in the baseline scenario, we are likely to be at or around the target rate of headline inflation 12 months down. There are, however, several uncertainties and concerns surrounding this forecast. These are: (i) There is a revival of economic growth but not to the level expected by RBI. Although the capacity utilization has improved to around 74 per cent, I feel, it is still far below the threshold required to induce substantial fresh investment. There is hardly any evidence on employment growth picking up to a level that would put upward pressure on the wage growth. Thus, continued existence of a negative output gap has to be considered. (ii) Fears of a trade war among major global players are turning increasingly realistic with likely adverse impact on our exports and costs of production. It may severely affect our growth recovery over the coming year. (iii) Oil prices have been fluctuating and both their direction and magnitude are difficult to predict for any possible impact on the headline inflation during the coming year. (iv) Concerns about the adequacy of monsoon rains and implementation of the revision in minimum support prices of different crops add another dimension to the inflation uncertainties. (v) Implementation of the revisions in HRA for employees of different states and related organizations (like universities, research institutes, municipal bodies, etc.) in line with the 7th CPC could raise the headline inflation substantially over time. Although it has to be seen through because it would be only statistical, it does impact CPI as well as CPI excluding food and fuel significantly for about a year. And if the implementation is staggered among states, it would take even longer. In this context, it is argued that the second round effects of such an increase have to be considered. My research shows that inflation dynamics have changed during the current decade making the second round effects less relevant. (vi) Slippage by the Centre from the fiscal consolidation path and its likely adverse impact on the headline inflation and the cost of borrowing are often raised as a major concern. In this context, as I had pointed out in the last MPC minutes, it is the combined (Centre and all States together) fiscal deficit that matters for the headline inflation. By now, 26 states have presented their budgets and their combined budgeted fiscal deficit is estimated to be 2.6 per cent of GDP. Thus, to a large extent, the fiscal slippage of the Centre is compensated by the fiscal discipline shown by the States. The net impact on the headline inflation on this count, therefore, is likely to be very limited. Moreover, there are expectations about the tax revenues exceeding the revised estimates for the year 2017-18, reducing the estimate of the fiscal slippage by the Centre. If the same buoyancy continues, it can substantially reduce the magnitude of the fiscal slippage next year. On the other hand, the slippage can occur for various reasons including the forthcoming elections in States and the Centre. (vii) The Business Inflation Expectations Survey (BIES) conducted by the Indian Institute of Management Ahmedabad (IIMA) during February 2018 shows that the expected headline inflation (CPI) 12 months down by the businesses is 4.1 per cent but is increasing of late. Similarly, the RBI survey of household inflation expectations also shows increasing trend.
44. On account of all such uncertainties of impacts on headline inflation in both the directions, it is prudent to wait and watch the events play out before any decisive change in policy stance and/or rate can be considered. I, therefore, vote for maintaining a status quo on the policy rate and neutral stance. Statement by Dr. Michael Debabrata Patra
45. I maintain my vote for a 25 basis points increase in the policy rate. Underlying macroeconomic developments impart some urgency to commencing the withdrawal of accommodation.
46. The ebbing of inflation in January and February will likely extend into the reading for March, given the continuing decline in prices of vegetables. Does it present a persuasive case for an easier/neutral monetary policy stance? In my view, that will be time-inconsistent and will push the achievement of the inflation target farther out in time, given the current assessment that the target is not likely to be achieved during the full course of 2018-19, absent policy action.
47. It is important to recognise that volatility in the prices of vegetables is obscuring a clearer evaluation of underlying inflation pressures. An unseasonal spike in November has given way to a delayed seasonal easing in February and March, which should reverse by April-May. Accordingly, this transient supply shock, however favourable it might be, has to be looked through while setting monetary policy so that the focus is on the real risks to food inflation looming over the horizon from (a) increases in minimum support prices announced in the union budget; and (b) the shortfall in wheat output and the implications for prices of cereals.
48. The main risks to the achievement of the target are festering in the category of CPI excluding food and fuel in which inflation has stubbornly risen above 5 per cent over the past three months. Over the course of 2018-19, inflation in this category is expected to peak close to 6 per cent in June and moderate in the rest of the year to settle at a little above 5 per cent. It is necessary, however, to adjust for the statistical impact of the HRA in assessing this trajectory. After the adjustment, the baseline path of inflation excluding food and fuel is one of monotonical hardening till the end of the year without the June peak. Meanwhile, upside risks in the form of international crude prices, rising raw material and other input prices, the slow return of pricing power among corporates, the spectre of trade wars and embedded tariff increases - which could turn out to be both inflationary and growth retarding – and bouts of global spillovers as markets re-price the normalization of monetary policy by systemic central banks have increased. Should the food situation turn adverse or overwhelm food management strategies, we will have to deal with inflation testing the upper tolerance limit of the inflation band. Households are reflecting these fears in their inflation expectations, and both bond and credit markets have been tightening interest rates well ahead of the MPC.
49. Impulses of growth are strengthening. The turnaround in the pace of investment is the defining feature of 2017-18 in contrast to the consumption-led growth in preceding years. Foodgrains and horticulture production are set to scale new records. Manufacturing is on an accelerating mode and the recovery is broadening and encompassing an increasing number of constituent industries in its ambit. It is supported by rising sales growth, an uptick in seasonally adjusted capacity utilization, drawdown of finished goods inventories and upbeat business confidence even as the regaining of pricing power is helping to shore up profit margins. There are also indications of the capex cycle gradually starting up. It is important that these drivers be nurtured to full strength and traction, and not be frittered away by allowing inflation to get out of hand in an environment of fiscal slippages at the central and state levels, a current account deficit that is modest but on the rise, and balance sheets of banks and corporates still fragile. Statement by Dr. Viral V. Acharya
50. In my minutes of the February 2018 Monetary Policy Committee (MPC) meeting, I had flagged two reasons that had induced me to pause from voting to begin the process of “withdrawal of accommodation”: first, the possibility of US shale gas response softening the oil price outlook, and two, growth recovery in the economy still being nascent. Uncertainty on these fronts has now receded.
51. In spite of the US shale gas response to rising oil prices being robust, inventories have continued to dwindle. The combination of OPEC supply cuts and strengthening global demand appear to be keeping international oil prices at a relatively high level, and the volatility of prices around the high level has been relatively low in the past three to six months. The dwindling stock of inventories implies that a supply side disruption to any one critical source, for instance, due to geopolitical risk, could have a sharp upward impact on prices. On the domestic front, the lack of fiscal space to go easy on fuel cesses implies that prices at the pump will likely mirror movements in international prices. Since global commodity prices as a group are refusing to budge, the overall outlook is not comforting from the standpoint of domestic inflation.
52. On the growth front, while we have not seen another print from the CSO since last policy, most real economic activity indicators, including the Purchasing Manager’s Index (PMI) data released during the week of MPC meeting, point to growing traction in the drivers underlying growth. In fact, RBI’s estimates suggest that output gap is closing; the finance-adjusted measure, which I personally prefer, shows near complete closure of the output gap due to the resilient credit growth over the past two quarters. This is further confirmed by high frequency data on rural and urban consumption, investment activity revival, and improvement in capacity utilisation. In my view, these healthy developments on the economic activity front are likely to remain durable due to steady progress in the time-bound resolution of twin balance-sheet problem affecting our banks and corporates.
53. In view of the above referred developments since the last MPC meeting, I have moved substantially closer to switching from the neutral stance to beginning the process of withdrawal of accommodation. This is in spite of the softening of inflation in recent prints. Let me explain in some detail.
54. An inflation targeting central bank needs to separate “signal” from “noise” in the data: • Recent prints have softened due primarily to easing of vegetable prices (contributing to over 90 per cent of softening of food inflation in February). Digging into specifics does not suggest that this is due to durable supply management in vegetables. Instead, reasonable conclusion is that vegetable prices continue to show seasonality over years, albeit with some variation in months in which the seasonality kicks in. This volatility is largely “noise” from an interest-rate setting perspective; this volatility is also not something amenable to monetary policy actions, and certainly not at short horizon of a few months at which it is likely to, and typically does, revert. • What concerns me is that the more persistent component of headline inflation, which is ex food and fuel, and which one can consider as the “signal” given its persistence, has strengthened steadily from a trough of 3.8 per cent last June to 4.4 per cent in February (excluding the estimated impact of Centre’s House Rent Allowance increase, i.e., ex HRA). This rise has been broad-based, consistent with the durability of a growth pick-up over this period, and also confirmed by input price pressures and selling price increases reported by firms in the Reserve Bank’s Industrial Outlook Survey. • The inflation trajectory over the entire twelve-month period is projected, despite the soft print in February, to remain above the MPC target rate of 4 per cent, on a quarter by quarter basis. Note that this is the case even after excluding the HRA impact. • Professional forecasters surveyed by the Reserve Bank also expect the inflation to stay over 4 per cent for much of 2018-19. • While there is inevitable uncertainty around these inflation projections, I view the risks as tilted significantly to the upside given the continuing rise in the ex-food-and-fuel inflation. Besides oil prices, my another primary concern is the risk of fiscal slippages, at both the Centre and State levels, especially in the form of: o A shift away from capital expenditures towards revenue expenditures, as is already being seen in state expenditure to accommodate farm loan waivers; and, o Food price-support measures, on which further clarity is needed, but which clearly induce an upside bias to potential inflation risks (estimates vary widely from 10 basis points to close to 100 basis points depending on what measures are adopted). • Finally, as the Indian economy is economically as well as financially integrated with the global economy, a faster normalisation of interest rates by systemic central banks can also pose a major challenge to the external sector.
55. I feel it is important to let some more hard data come in, especially on growth, and allow some more time to let the early skirmishes on the global trade front play out. I am, however, likely to shift decisively to vote for a beginning of “withdrawal of accommodation” in the next MPC meeting in June. Reinforcement of inflation-targeting credibility that such a shift would signal is crucial in my view for prudent macroeconomic management, on both the domestic and external sector fronts. Statement by Dr. Urjit R. Patel
56. CPI inflation moderated in January-February, led largely by a sharp decline in vegetable prices and continuing deflation in pulses. Fuel group inflation also moderated mainly on the back of a decline in liquefied petroleum gas inflation, reflecting softening in international prices. These developments, combined with the continued softening in vegetable prices in March, are expected to pull down the headline CPI inflation in Q4:2017-18 below the projection made in February. However, it is noteworthy that over the last three months (December-February), the monthly CPI headline inflation (year-on-year) adjusted for house rent allowance (HRA) revision has averaged 4.6 percent.
57. Going forward, the combined effects of the observed moderation in food inflation in January-February and the expected further softening in March are likely to result in lower headline inflation trajectory in the first half of 2018-19 vis-à-vis the February statement. This will be despite the likely seasonal reversal of food prices in the first half. Inflation expectations have firmed up, both for three-month and one-year ahead horizons. Input cost pressures are rising and the corporates are gradually regaining some pricing power. The outlook of inflation also faces several uncertainties emanating from: (i) the increase in minimum support prices for kharif crops; (ii) elevated and volatile crude oil prices, in part due to geo-political factors; (iii) the staggered impact of revision in HRA by various State Governments – the direct impact on inflation will be statistical in nature, which will be looked through; (iv) fiscal slippages by the Centre and the States; and (v) the performance of the monsoon.
58. Economic activity has been recovering, with the GDP growth in 2018-19 projected to be higher at 7.4 per cent (with balanced risks) as compared with 6.6 per cent in the previous year. There are clearer signs of revival of investment activity. The manufacturing sector is strengthening, which is also reflected in higher capacity utilisation. Improving global demand and trade should boost manufacturing and investment activity, going forward. Leading indicators also point to the strengthening of the services sector; purchasing managers’ index (PMI) for services moved into the expansion zone again in March. Credit offtake from the banking sector has continued to improve and it is becoming gradually more broad-based. The flow of funds from non-bank sources to the corporate sector has also been rising.
59. Even as inflation has moderated in recent months, several upside risks to inflation persist. Hence, I would like to wait for more data and watch how various risks to inflation evolve, going forward. I, therefore, vote for holding the policy repo rate at the current level and maintaining the stance as neutral. Jose J. Kattoor Press Release : 2017-2018/2783 Chief General Manager
6. Since the last meeting of the MPC in April, global economic activity has continued to expand, though there has been some easing of momentum. Among advanced economies (AEs), the US economy began the year on a weak note on soft private spending and reduced residential investment; however, there seems to be a rebound in Q2:2018 with strong retail sales and improved employment data. The Euro Area growth decelerated in Q1; recent industrial production data as well as weak consumer and business sentiment suggest a loss of pace. The Japanese economy contracted in Q1, though it is expected to turn around in Q2 as indicated by recent data prints on exports and the manufacturing purchasing managers’ index (PMI).
7. Economic activity in major emerging market economies (EMEs) remained largely resilient. The Chinese economy maintained a strong momentum in Q1; more recent data on industrial production and PMI suggest that growth is likely to hold steady in Q2. The Russian economy appears to have picked up in recent months after a soft end to 2017; both manufacturing and services PMI rose in April. In South Africa, growth prospects have improved with the return of political stability as reflected in consumer confidence, manufacturing PMI and retail sales. In contrast, a stream of poor data from Brazil on high unemployment and soft industrial production show that the effects of recession linger.
8. Global trade growth has continued to strengthen, though geo-political tensions have contributed recently to declining export orders and air freight. Crude oil prices rose sharply till May 24 on heightened geo-political tensions, but moderated thereafter on expectations of easing of supplies by the Organisation of Petroleum Exporting Countries (OPEC) and Russia. Base metal prices, especially aluminium, have risen on account of US sanctions on Russia. Gold has witnessed selling pressure on a stronger dollar, but the metal gained last week on political uncertainty in the Euro Area. Inflation pressures have emerged in some key advanced and emerging economies, driven in part by rising commodity prices.
9. Financial markets have been driven mainly by monetary policy expectations and geo- political developments. Equity market performance has varied across regions with modest gains in the AEs on strong Q1 earnings and abating of trade tensions, while stocks in major EMEs have faced sell offs on a rising dollar and expectations of further rate hikes by the Fed. The 10-year sovereign yield in the US crossed 3 per cent in mid-May on strong economic data as well as expectations of tighter monetary policy and fiscal expansion, but softened subsequently on safe haven demand; yields softened in other key AEs as well. In most EMEs, however, bond yields have risen on reduced foreign appetite for their debt due to growing dollar shortage in the global market and on prospects of higher interest rates in AEs. In currency markets, the US dollar touched its highest level in May since December 2017. The euro depreciated significantly against the dollar reflecting a combination of factors, including soft growth data for the Euro Area, which suggested that monetary policy normalisation by the European Central Bank could be delayed, and political uncertainty in its southern periphery. EME currencies have, by and large, depreciated against the US dollar.
10. On the domestic front, the Central Statistics Office (CSO) released on May 31 the quarterly estimates of national income accounts for Q4:2017-18 and provisional estimates for 2017-18. Gross domestic product (GDP) growth for 2017-18 has been estimated at 6.7 per cent, up by 0.1 percentage point from the second advance estimates released on February 28. This increase in growth has been underpinned by a significant upward revision in private final consumption expenditure (PFCE) due especially to improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure. Quarterly data suggest that the economy grew at 7.7 per cent in Q4:2017-18 – the fastest pace in the last seven quarters. Gross fixed capital formation (GFCF) growth accelerated for three consecutive quarters up to Q4.
11. On the supply side, estimates of agriculture and allied activities have been revised upwards, supported by an all-time high production of foodgrains and horticulture during the year. On a quarterly basis, agriculture growth increased sharply in Q4:2017-18. On April 16, the India Meteorological Department (IMD) forecast a normal south-west monsoon rainfall, which was reaffirmed on May 30. This augurs well for the agricultural sector.
12. Industrial growth also strengthened, reflecting the robust performance of manufacturing, which accelerated for three consecutive quarters in Q4. Capacity utilisation by manufacturing firms increased significantly in Q4:2017-18 as revealed in the latest round of the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS). The output of eight core industries accelerated in April on account of a sharp expansion in coal production, which reached a 42-month peak. Cement output also posted double-digit growth for the sixth consecutive month in April. However, electricity generation slowed down. As per the early results of the Reserve Bank’s April-June round of the industrial outlook survey (IOS), activity is expected to expand at a lower rate in Q1:2018-19 due to a significant rise in input prices and perceptions of softening domestic and external demand conditions. However, the manufacturing PMI remained in an expansionary mode for the tenth consecutive month in May on the back of new domestic orders and exports.
13. Although services sector growth was revised downwards on account of lower growth in some constituents such as trade, hotels, transport & communication, and financial services, it remained robust. Construction activity recorded the highest growth in Q4 in the new series (base 2011-12). Various high frequency indicators also suggest resilient performance of the services sector. Improving sales of tractors and two-wheelers suggest strengthening of rural demand. Commercial vehicle sales also accelerated in April. Revenue-earning freight traffic of railways picked up, driven by improved movement in coal, fertilisers, and cement. Growth in passenger vehicle sales accelerated but port traffic decelerated for the third successive month in April. Domestic air passenger traffic rose significantly in April. Two key indicators of construction activity showed improvement – cement production growth accelerated and steel consumption turned around. Services PMI moved slightly into contraction in May, reflecting decline in business activity and stagnation in new orders.
14. Retail inflation, measured by the year-on-year change in the CPI, rose sharply to 4.6 per cent in April, driven mainly by a significant increase in inflation excluding food and fuel. Excluding the estimated impact of an increase in house rent allowances (HRAs) for central government employees, headline inflation was at 4.2 per cent in April, up from 3.9 per cent in March. Food inflation moderated for the fourth successive month, pulled down by vegetables due to lower than the usual seasonal increase in their prices, and pulses and sugar which continued to experience deflation. However, within the food group, inflation increased in respect of cereals, fruits, prepared meals, meat and fish.
15. Fuel group inflation declined for the fifth month in a row in April mainly on account of a fall in the inflation of liquefied petroleum gas in line with international prices, and electricity. However, inflation in other major items of fuel such as firewood and chips, dung cake, kerosene and coal inched up. Inflation in the transport and communication sub-group accelerated due to the firming up of international crude oil prices, even though the domestic pass-through to petrol and diesel was incomplete. Inflation also picked up in clothing, household goods and services, health, recreation, education, and personal care and effects.
16. The May 2018 round of the Reserve Bank’s survey of households reported a significant rise in households’ inflation expectations of 90 basis points (bps) and 130 bps, respectively, for three-month and one-year ahead horizons. Manufacturing firms polled in the Reserve Bank’s IOS reported input price pressures and an increase in selling prices in Q1:2018-19. Firms polled for the manufacturing PMI in May also showed a sharp increase in input and output prices. Farm inputs and industrial raw material costs have risen sequentially. Wage pressures in the rural sector moderated; however, those in the organised sectors remained firm.
17. Liquidity in the system remained generally in surplus during April-May 2018. During April, the Reserve Bank absorbed surplus liquidity of ₹496 billion on a daily net average basis due to increased government spending, especially in the second half of the month. Reflecting easy liquidity conditions, the weighted average call rate (WACR) softened to 5.89 per cent in April (from 5.96 per cent in March). However, surplus liquidity in the system moderated considerably in the first half of May and the system moved into deficit in the third week of May mainly due to inflows on account of the goods and services tax (GST). The Reserve Bank conducted an open market operation purchase auction on May 17, 2018 to inject liquidity of ₹100 billion into the system. The system again turned into surplus in the last week of May reflecting mainly the payment of food subsidies. Surplus liquidity absorbed under the LAF on a daily net average basis declined to ₹142 billion in May. The WACR in May at 5.88 per cent remained broadly at the April 2018 level.
18. India’s exports grew in April 2018 after a marginal dip in the preceding month, supported mainly by non-oil exports, particularly engineering goods and chemicals. Import growth decelerated sequentially in April 2018; a significant decline in imports of gold as well as pearl and precious stones more than offset the impact of rising crude oil prices. Nevertheless, the trade deficit expanded in March and April from its level a year ago. External financing remained comfortable in 2017-18. While net foreign direct investment in 2017-18 was broadly comparable with the previous year, net foreign portfolio flows were stronger due to a sharp turnaround in debt inflows. However, foreign portfolio investors withdrew US$ 6.7 billion on a net basis from the domestic capital market in 2018-19 (up to June 4) reflecting volatility in global financial markets. India’s foreign exchange reserves were at US$ 412 billion on June 1, 2018. Outlook
19. The first bi-monthly resolution of 2018-19 in April projected CPI inflation in the range of 4.7-5.1 per cent in H1:2018-19 and 4.4 per cent in H2, including the HRA impact for central government employees with risks tilted to the upside. Excluding the impact of HRA revisions, CPI inflation was projected at 4.4-4.7 per cent in H1:2018-19 and 4.4 per cent in H2. Actual inflation outcomes since the April policy have evolved broadly on the lines of the projected trajectory. However, there has been an important compositional shift. While the summer momentum in vegetable prices was weaker than the usual pattern, there was an abrupt acceleration in CPI inflation excluding food and fuel. 19. On the other hand, food inflation has remained muted over the past few months and the usual seasonal pickup delayed, softening the projections in the short run. Taking these effects into account, projected CPI inflation for 2018-19 is revised to 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside (Chart 1). Excluding the impact of HRA revisions, CPI inflation is projected at 4.6 per cent in H1 and 4.7 per cent in H2.
20. The headline inflation outlook is driven primarily by two countervailing effects. On the one hand, CPI inflation excluding food and fuel rose sharply in April over March by 80 basis points to reach an ex-HRA level of 5.3 per cent, suggesting a hardening of underlying inflationary pressures. Furthermore, since the MPC’s meeting in early April, the price of Indian basket of crude surged from US$ 66 a barrel to US$ 74. This, along with an increase in other global commodity prices and recent global financial market developments, has resulted in a firming up of input cost pressures, as also confirmed in the Reserve Bank’s IOS for manufacturing firms in Q2:2018-19. The resulting pick-up in the momentum of inflation excluding food, fuel and HRA has imparted persistence into higher CPI projections for 2018-
21. Turning to the growth outlook, the CSO’s provisional estimates have placed GDP growth for Q4:2017-18 at 7.7 per cent – 70 basis points higher than that in Q3 – given the sharp acceleration in investment and construction activity. With improving capacity utilisation and credit offtake, investment activity is expected to remain robust even as there has been some tightening of financing conditions in recent months. Global demand has also been buoyant, which should encourage exports and provide a further thrust to investment. The sharp rise in petroleum product prices, however, is likely to impact disposable incomes. Consumption, both rural and urban, remains healthy and is expected to strengthen further. According to the early results of the Reserve Bank’s IOS, activity in the manufacturing sector is expected to moderate marginally in Q2:2018-19 on account of deterioration in the overall business situation and order book. On the basis of an overall assessment, GDP growth for 2018-19 is retained at 7.4 per cent as in the April policy. GDP growth is projected in the range of 7.5-7.6 per cent in H1 and 7.3-7.4 per cent in H2, with risks evenly balanced (Chart 2).
22. A major upside risk to the baseline inflation path in the April resolution has materialised, viz., 12 per cent increase in the price of Indian crude basket, which was sharper, earlier than expected and seems to be durable. Crude oil prices have been volatile recently and this imparts considerable uncertainty to the inflation outlook – both on the upside and the downside. Several other risks remain. First, global financial market developments have emerged as another important source of uncertainty. Second, the significant rise in households’ inflation expectations as gathered in the May 2018 round of the Reserve Bank’s survey could feed into wages and input costs in the coming months. However, the pass- through to output prices remains muted presently. Third, the staggered impact of HRA revisions by various state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is a need to watch out for any second round impact on inflation. Fourth, the impact of the revision in the MSP formula for kharif crops is not possible to assess at this stage in the absence of adequate details. Fifth, as forecast by the IMD, if the monsoon is normal and well-distributed temporally and spatially, it may help keep food inflation benign.
23. Against the above backdrop, the MPC decided to increase the policy repo rate by 25 basis points and keep the stance neutral. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis.
24. The MPC notes that domestic economic activity has exhibited sustained revival in recent quarters and the output gap has almost closed. Investment activity, in particular, is recovering well and could receive a further boost from swift resolution of distressed sectors of the economy under the Insolvency and Bankruptcy Code. Geo-political risks, global financial market volatility and the threat of trade protectionism pose headwinds to the domestic recovery. It is important that public finances do not crowd out private sector investment activity at this crucial juncture. Adherence to budgetary targets by the Centre and the States – which appears to be the case thus far – will also ease upside risks to the inflation outlook considerably.
25. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of the decision. The minutes of the MPC’s meeting will be published by June 20, 2018.
26. The next meeting of the MPC is scheduled on July 31 and August 1, 2018. Voting on the Resolution to increase the policy repo rate by 25 bps to 6.25 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
27. Since the adoption of flexible inflation targeting in India (de facto in 2014 and de jure in 2016), the “great-disinflation” experienced by the Indian economy is a major accomplishment. After several years of high inflation in the run-up to 2014, the March 2018 CPI headline inflation (ex-HRA) rate of 3.9% is a testimony to the successful conduct of monetary policy given its consistency with the 4 +/- 2 percent target recommended by the Urjit Patel Committee report in 2014 and enshrined in the Reserve Bank of India Act, 1934 in 2016. Both the Reserve Bank of India and the Government of India should be congratulated in calibrating a monetary-fiscal mix that has helped engender this disinflation. Good luck helped with this outcome but so did good policy.
28. Inflation targeting however can truly become successful if the inflation target and the inflation forecast become identical on a durable basis. Locking in the 4 percent medium target therefore requires continual vigilance.
29. Since the last review, demand conditions have continued to remain robust. Q4: 2017- 2018 headline growth of 7.7% was the highest in 7 quarters. While capacity utilization increased throughout 2017-18, the pick-up since Q3 (74.1%) appears to be decisive. The successful resolution of cases under the Insolvency and Bankruptcy Code will further assist capacity utilization without requiring new investment.
30. Despite the PMIs for services being somewhat fragile, overall corporate profits remain strong. While consumption (PFCE) growth remains tepid (the Q4 growth print was close to the average of the last 7 quarters), the strong revival of investment demand, manufacturing, and construction gives me more confidence about the durability of the growth recovery. Even though the high growth print of Q4:2017-2018 is pushed up by a base effect, I am more certain that the ongoing cyclical recovery in growth will sustain and this will lead to a faster closing of the output gap.
31. The revival of growth brings new inflationary risks that need to be carefully watched. The RBI’s enterprise surveys suggest that upward pressures in input and staff costs are being marked by an increase in selling prices. Staff costs in services increased by 6.6%, and 11.6% in manufacturing compared to the last round of the survey. Food inflation continues to be maverick with a 4th consecutive month decline: the usual seasonal uptick in April uncharacteristically surprised on the downside. CPI inflation ex food and fuel, which in April, sustained close to 6%, with strong momentum effects is worryingly becoming the main driver of inflation. Almost all components of CPI ex food fuel registered upticks suggesting that demand-pull forces are creeping into CPI headline inflation.
32. A major upside risk to the one-year ahead CPI projections has been the price of oil. This has been on a durable rise over the past six months, reflecting stronger global growth and the increasing costs of creating capacity in substitutes. While a strong dollar and the price of oil usually follows an inverse relationship, the usual “coupling” has been confounded by geo- political events in recent months. The volatility in the price of oil needs to be carefully watched, especially because higher fuel prices have helped harden inflationary expectations (both the 3- month ahead and 1-year ahead) to their highest level since September 2016.
33. The combination of cost-push and demand-pull factors at the current juncture has put one-year ahead inflation projections significantly above 4%. This warrants a monetary policy response. However, because of uncertainty surrounding the price of oil, and the nascent recovery of the economy, it would be opportune to take small steps.
34. I await details on the MSP policy. The outcome of a simultaneous twin terms of trade shock to the Indian economy as explained in my minutes of the April MPC meeting needs to be carefully watched.
35. I vote for an increase in the policy repo rate by 25 basis points at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
36. Headline inflation rose to 4.6% in April from 4.3% in March and 4.4% in February, despite subdued food inflation. This was primarily due to a broad-based hardening of inflation excluding food and fuel with inflation rising in transport and communication, housing, health, recreation, education and personal care and effects. Even after excluding the estimated impact of the HRA adjustment for central government employees, inflation showed an uptick between March and April.
37. Furthermore, both qualitative and quantitative responses from the May round of the Reserve Bank’s Inflation Expectations Survey of Households reflect a hardening of inflation expectations. In particular, the survey reports a rise in households’ inflation expectations for three-month and one-year horizons. The May round of the Consumer Confidence Survey also shows a deteriorating outlook with respect to the price situation. The Reserve Bank of India’s Industrial Outlook Survey (IOS) reports pressures in input costs and selling prices. Firms surveyed for the manufacturing Purchasing Managers’ Index also indicate an increase in input and output prices.
38. The upside risks to inflation include geopolitical risks associated with crude oil prices, increase in other global commodity prices, implementation of HRA revisions (state governments), increase in kharif minimum support prices, fiscal slippage and a weaker Indian rupee. The downside risks include forecast of a normal monsoon, and moderation in global commodity prices due to slowdown in global growth.
39. On the output side, the provisional estimates of GDP released recently show that the Indian economy grew at 6.7% in 2017-18 and the performance of the economy in Q4, 2017- 18 was strong with GDP growth at 7.7%, although this partly reflects a favourable base effect. Improving growth in the economy is also reflected in the rising capacity utilization of manufacturing firms as per the RBI’s Order Books, Inventories and Capacity Utilization Survey (OBICUS) as well as acceleration of growth in cement and steel production, upward revision of agricultural growth and resilience of the services sector. Industrial growth has also been robust, as is reflected in the strong performance in manufacturing for the past three consecutive quarters.
40. However, global growth is losing steam, as anticipated earlier by the long leading indexes of international growth maintained by the Economic Cycle Research Institute (ECRI), New York. In particular, quarter-over-quarter GDP growth turned negative in Japan, and declined in the Eurozone, the U.K. and the U.S. in the first quarter of 2018. While U.S. GDP growth is expected to improve in the current quarter, ECRI’s forward-looking indexes still point to fading global growth prospects. Also, the global manufacturing Purchasing Managers’ Index fell to a nine-month low in May, underscoring a moderating global industrial growth outlook. Furthermore, growth in ECRI’s Indian Leading Exports Index is in a deepening cyclical downswing, suggesting that Indian export growth will remain in a cyclical downtrend at least for the next couple of quarters. Moreover, India’s domestic growth outlook is lacklustre, at best, according to ECRI’s Indian Leading Index.
41. In the meantime, with underlying inflation pressures in a cyclical upswing, according to ECRI’s U.S. Future Inflation Gauge, U.S. inflation has also been on the rise, and is now at the Federal Reserve’s 2% inflation target. At the same time, the unemployment rate has dropped to an 18-year low, spurring the Fed to keep tightening monetary policy.
42. In India, with hardening of actual inflation, rising inflation expectations along with prevailing upside risks to inflation, I vote for an increase in the repo rate by 25 basis points while retaining the neutral stance. Statement by Dr. Ravindra H. Dholakia
43. After the last MPC meeting (5th April, 2018), several macroeconomic uncertainties have reduced and a clearer picture is emerging. However, some basic uncertainties still remain on geo-politics, international trade policies and ability of some advanced economies to pursue interest rate hikes. More specifically, I consider the following factors for the repo rate decision in the present policy: (i) Oil prices have further firmed up and geo-political developments indicate no respite likely on that count soon. For the next 12-18 months, the oil prices are likely to stay at higher level adding to the twin deficits (fiscal and current account) and inflationary pressures. (ii) RBI survey of households for inflationary expectations in the May 2018 round shows a significant increase of about 90 bps and 130 bps respectively for 3 months and 12 months ahead compared to the March 2018 round. We may note that the impact on consumers’ inflationary expectations of an oil price increase is almost 4 to 5 times higher than the similar increase in food prices and, therefore, we have to consider these numbers cautiously. (iii) RBI consumer confidence survey in April-May 2018 shows improvement in employment and household income outlook during the coming year. This indicates building up of demand pressures. (iv) IIM Ahmedabad survey of businesses in April 2018 also shows a substantial increase of about 60 bps in their expectation of headline CPI inflation 12 months ahead compared to February 2018 and is around 4.7 per cent. (v) Capacity utilization has increased substantially as revealed by different surveys. Growth in capital formation has also picked up. GDP growth at 7.7 per cent for 2017-18 Q4 assures that the Indian economy is firmly on the recovery path. All this indicates that the output gap has started closing. However, it has still not started exercising any pressure on unemployment and wage scenario and thereby on inflation. In this context, it is important to recognize that while the average growth during 2018-19 is likely to be around 7.4 per cent, in none of the quarters it is projected to exceed the 7.7 per cent mark observed in 2017-18 Q4. Growing protectionism around the globe and oil prices staying high can pose genuine downside risk to our growth. (vi) RBI’s latest inflation forecast considering the CPI prints up to April 2018 for 2018-19Q4 stands 30 bps higher than its last forecast based on CPI data up to February 2018. It is forcasted at 4.7 per cent for 2018-19Q4, which is the same as expected by the businesses and is, therefore, more credible. Inflation rate likely to stay consistently above 4 – 4.5 per cent is a cause of concern, particularly when there are some upside risks. It brings down the expected real policy rate in India that is substantially less than our comparator countries like Brazil, Mexico, China and South Africa though it is negative for most other G20 countries. Most of the advanced G20 countries where the real policy rates are negative are committed to rate hikes over the coming year. Now when the economic growth is firmly on the path of strong recovery in India, growing inflation concerns need to be addressed.
44. The upside risks to inflation such as MSP revision and HRA revision implementation by states are likely to be countered by reconfirmed normal monsoon forecasts and the lack of fiscal space in several states. Oil prices could turn on either side and hence present a genuine risk. There are chances that headline CPI prints in the coming months (H1) may turn out to be lower than expected by RBI (i.e. 4.8-4.9 per cent inflation) and in such a case, the inflation forecast 12 months ahead may come down. Although such possibilities are not ruled out, their chances are less. Under such circumstances, I believe that prudence lies in retaining the neutral policy stance, but increase the policy rate by 25 bps for now. Future course of action should depend on how the scenario on growth and inflation develops. Statement by Dr. Michael Debabrata Patra
45. This time, I would imbue urgency into my vote to raise the policy rate by 25 basis points and align the operating target.
46. In my view, the prolonged period of staying on hold is denting the credibility of the MPC's commitment to maintaining inflation at the centre of the target band. There is a rising risk that the public may start discounting this commitment: if it begins to believe that the MPC is willing to tolerate inflation in higher reaches, inflation expectations can be set adrift. The status quo is also dissipating the hard earned reputational bonus that accrued to the RBI for breaking the back of the high inflation episode of 2009-13. There was a lot of good luck then as international commodity prices collapsed, but good policy too as we set out a glide path of disinflation that took India out of the fragile five.
47. The major upside risks to inflation that the MPC has worried about in past resolutions are crystallising on an ongoing basis. Moreover, the early warning indicators – households' inflation expectations; professional forecasters' projections; input and selling prices captured in the RBI’s surveys and polled by purchasing managers; various input costs, farm and non- farm, including corporate staff costs; erosion in consumer confidence on the price situation – are all flashing amber or red. Markets and financial institutions are already getting ahead of the curve. Continuing policy inaction is running the danger of allowing inflation outcomes to slip away from the centre of the target band. The gains of macroeconomic stability that have defined the recent period as its greatest achievement could get frittered away.
48. Turning to growth, the economy is gathering speed. Buoyant sales growth, depleting inventories, rising capacity utilization and rising consumer optimism on spending, especially on discretionary items, all suggest that slack in the economy is being pulled in and the output gap is set to close. Consequently, demand-pull components are showing up in recent inflation readings. In this finely poised situation, inflation volatility can hamstring the new impulses of investment growth that have sprung up in recent quarters.
49. In my view, the time has come for the MPC to act unanimously to raise the policy rate by 25 basis points in a closing sliver of opportunity. This will demonstrate our resolve to return inflation to the centre of the target band. Monetary policy has to step in before it is too late and guide the economy along a non-accelerating inflation growth path. Statement by Dr. Viral V. Acharya
50. In the Minutes of the April 2018 Monetary Policy Committee (MPC) meeting, I had indicated my growing concern around underlying inflationary pressures. These pressures have been manifesting as a strengthening of Consumer Price Index (CPI) inflation excluding food and fuel even after adjusting for the impact of Centre’s House Rent Allowances (HRA). There has been a rise in input costs due to supply shocks such as the sharp oil price surge witnessed over the past nine months. The strengthening of inflation also reflects aggregate demand pressures, which are confirmed in the now almost-closed output gap, improved capacity utilization figures, and a significant pick up in credit growth. As a result, the projection for medium-term headline CPI inflation has become firmer on the upside; it has moved closer to 5% and away from 4%, the latter being the mandated target of the MPC.
51. The inflationary pressure also seems to be experienced by the common man. The Reserve Bank of India (RBI)’s Inflation Expectations Survey (IES) of households reveals a uniform picture of hardening of inflation expectations whichever way one looks at the data. Most notably, the 3-month ahead and 12-month ahead inflation expectations have increased sharply by 90 basis points (bps) and 130 bps, respectively, since the last survey. They are likely explained by the fact that petrol and diesel prices carry salience: fuel prices are in the face and generalise rapidly through transportation costs into prices of general goods and services.
52. A key uncertainty at present relates to the oil price development over medium-term horizon that monetary policy operates at. Robust global growth, OPEC and Russian supply cuts, supply shock in Venezuela, and geo-political uncertainty around the Iranian supply have all pushed international crude prices uncomfortably high in a short span of time. The shape of Brent futures curve (now in “backwardation”, i.e., buying oil forward is cheaper than buying it in spot) suggests the markets are pricing in the risk of a “stock out” – not having access to supply when it is needed. The US shale gas response appears to not have been enough as of yet to dampen this stock-out risk since some of the supply faces pipeline-infrastructure headwinds in reaching the markets.
53. The one respite for headline inflation prints has been the continuing benign food inflation where seasonal pickup has remained muted due to a collapse in the prices of onions and tomatoes. This has imparted a short-run softening to inflation projections keeping them contained in the first half of 2018-19 in spite of the rising momentum in CPI ex-food, fuel and HRA. However, if the seasonal pick-up does manifest in the first half at some point, then the headline prints will have little abatement from any of its constituents. Under such a scenario, any upward pressure on food prices such as through generous minimum support prices (MSPs) would exacerbate headline inflation pressures.
54. Factoring in these considerations, there is no alternative to raising the policy rate by 25 bps so as to signal concern about underlying inflation, manage inflation expectations, and guard proactively against a further increase in inflation. However, considerable uncertainties around oil and food prices as well as the playing out of trade wars and global financial market outcomes led me to keep the stance neutral. It will allow the MPC to determine in a flexible manner what further monetary policy response is warranted based on an ongoing assessment of the inflation situation, inflation expectations and growth prints in the coming months. Statement by Dr. Urjit R. Patel
55. A key risk to inflation cited in the MPC’s April 2018 resolution has since materialised; crude oil prices have risen sharply by over 12 per cent even as there was some moderation in recent days. On the positive side, food inflation has continued to be benign. On the whole, inflation in March and April has behaved more or less on the lines of the path projected in the April resolution. Two developments are noteworthy from the standpoint of price stability. First, inflation (CPI ex-HRA) has averaged 4.4 per cent since November 2017. Second, inflation expectations of households have risen significantly as reflected in the May 2018 round of the Reserve Bank’s survey.
56. Looking ahead, projected inflation for Q4:2018-19 (at 4.7 percent) is 30 bps higher than that in the April resolution. The baseline inflation path faces several uncertainties, viz., (i) the outlook for oil prices; (ii) continuing volatility in global financial markets; (iii) the risk of the significant rise in households’ inflation expectations feeding into wages and input costs, even as the pass-through to output prices has remained muted so far; (iv) the impact of the likely revision in the MSP formula; and (v) second round impact on inflation on account of the staggered impact of HRA revisions by various state governments, though the direct statistical impact of HRA revisions will be looked through. However, a normal monsoon, by keeping food inflation benign, could act as a mitigating factor.
57. Domestic growth has strengthened with the Q4:2017-18 print at a seven-quarter high and now appears to be on a sustainable path. Investment activity, in particular, has accelerated. There has also been a pick-up in manufacturing and this is manifested in an increase in capacity utilisation. The services sector has been resilient with several high frequency indicators continuing to show robust growth in recent months even as PMI services moved slightly into contraction in May. Bank credit growth has continued to improve. The recent increase in oil prices, by impacting disposable incomes, may have some adverse impact on private consumption. On the whole, however, economic activity continues to be resilient with GDP growth for 2018-19 projected at 7.4 per cent, same as in the April policy. Inflation risks have increased since the April policy. I, therefore, vote for an increase in the policy repo rate by 25 basis points. In view of prevailing uncertainties, it is apposite to maintain the neutral stance so as to respond to the evolving situation in a flexible manner. Jose J. Kattoor Press Release : 2017-2018/3320 Chief General Manager
6. Since the last meeting of the MPC in June 2018, global economic activity has continued to maintain steam; however, global growth has become uneven and risks to the outlook have increased with rising trade tensions. Among advanced economies (AEs), the US economy rebounded strongly in Q2, after modest growth in Q1, on the back of rising personal consumption expenditures and exports. In the Euro Area, weak growth in Q1 continued in Q2 due to subdued consumer demand, weighed down by political uncertainty and a strong currency. In Japan, recent data on retail sales, consumer confidence and business sentiment point to moderation in growth.
7. Economic activity in major emerging market economies (EMEs) has slowed somewhat on volatile and elevated oil prices, mounting trade tensions and tightening of financial conditions. The Chinese economy lost some pace in Q2, pulled down by efforts to contain debt. The Russian economy picked up in Q1; recent data on employment, industrial production and exports indicate that the economy has gained further momentum. South Africa’s economy contracted in Q1; though consumer sentiment has improved, high unemployment and weak exports pose challenges. In Brazil, economic activity suffered a setback in Q1 on nation-wide strikes; more recent data suggest that growth remained muted as industrial production contracted in May and the manufacturing purchasing managers’ index (PMI) declined.
8. Global trade lost some traction due to intensification of trade wars and uncertainty stemming from Brexit negotiations. Crude oil prices, which remained volatile and elevated in May-June on a delicate demand-supply balance, eased modestly in the second half of July on higher supply from Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC producers. Base metal prices have fallen on the general risk-off sentiment triggered by fears of an intensification of trade wars. Gold prices have softened on a stronger dollar. Inflation remained firm in the US, reflecting higher oil prices and stronger aggregate demand. Inflation has edged up also in some other major advanced and emerging economies, driven, in part, by rising energy prices and pass-through effects from currency depreciations.
9. Financial markets have continued to be driven mainly by monetary policy stances in major AEs and geopolitical tensions. Equity markets in AEs have declined on trade tensions and uncertainty relating to Brexit negotiations. Investors’ appetite for EME assets has waned on increases in interest rates by the US Fed. The 10-year sovereign yield in the US has moderated somewhat from its peak on May 17 on safe-haven demand, spurred by escalating trade conflicts. Yields have softened in other key AEs as well. In most EMEs, however, movements in yields have varied reflecting domestic macroeconomic fundamentals and tightening global liquidity. Capital flows to EMEs declined in anticipation of monetary policy tightening in AEs. In currency markets, the US dollar appreciated, supported by strong economic data. The euro strengthened in June on receding political uncertainty and taper talk by the central bank. However, the currency has traded soft thereafter on mixed economic data and the rising US dollar. EME currencies, in general, have depreciated against the US dollar over the last month.
10. On the domestic front, south-west monsoon has been recovering after a brief spell of deficiency in the second half of June. The cumulative rainfall up to July 31, 2018 was 6 per cent below the long-period average. In terms of spatial distribution, 28 of the 36 sub-divisions received normal or excess rainfall, whereas 8 sub-divisions received deficient rainfall as against three sub-divisions last year. The total sown area of kharif crops as on July 27 was 7.5 per cent lower than that a year ago. The live storage in major reservoirs as on July 26 was at 41 per cent of the full reservoir level compared with 36 per cent a year ago, which portends well for the rabi sowing season.
11. Industrial growth, measured by the index of industrial production (IIP), strengthened in April-May 2018 on a y-o-y basis. This was driven mainly by a significant turnaround in the production of capital goods and consumer durables. Growth in the infrastructure/construction sector accelerated sharply, reflecting the government’s thrust on national highways and rural housing, while the growth of consumer non-durables decelerated significantly. The output of eight core industries accelerated in June due to higher production in petroleum refinery products, steel, coal and cement. Capacity utilisation in the manufacturing sector remains robust. The assessment based on the Reserve Bank’s business expectations index (BEI) for Q1:2018-19 remained optimistic notwithstanding some softening in production, order books and exports. The July manufacturing PMI remained in expansion zone, although it eased from its level a month ago with slower growth in output, new orders and employment.
12. Several high-frequency indicators of services activity increased at a faster pace in May- June. Tractor and two-wheeler sales growth accelerated significantly, suggesting strong rural demand. Passenger vehicle sales growth, an indicator of urban demand, also strengthened. Commercial vehicle sales growth remained robust despite some deceleration. Domestic air passenger traffic – another indicator of urban demand – maintained double-digit growth. Construction activity indicators also improved with cement production sustaining double digit growth for the eighth consecutive month in June. Steel consumption also accelerated in May. The services PMI expanded to a twelve-month high in June, after a marginal contraction in May, supported by expansion in new business and employment.
13. Retail inflation, measured by the year-on-year change in the CPI, rose from 4.9 per cent in May to 5 per cent in June, driven by an uptick in inflation in fuel and in items other than food and fuel even as food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 per cent in May to 4.6 per cent in June. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation.
14. Fuel and light group inflation rose sharply, pulled up by liquefied petroleum gas and kerosene. Inflation in firewood and chips ticked up, while electricity inflation remained low. The pass-through of global crude oil prices impacted inflation in domestic petroleum products as well as transport services. Inflation also picked up modestly in respect of education and health.
15. The June round of the Reserve Bank’s survey of households reported a further uptick of 20 basis points in inflation expectations for both three-month and one-year ahead horizons as compared with the last round. Manufacturing firms polled in the Reserve Bank’s industrial outlook survey (IOS) reported higher input costs and selling prices in Q1:2018-19. The manufacturing PMI showed that input prices eased slightly in July, although they remained high. Input costs for companies polled in Services PMI in June also stayed elevated. Farm and non-farm input costs rose significantly. Notwithstanding some pick-up in February and March 2018, rural wage growth remained moderate, while wage growth in the organised sector remained firm.
16. Systemic liquidity remained generally in surplus mode during June-July 2018. In June, the Reserve Bank absorbed surplus liquidity of around ₹140 billion on a daily net average basis under the LAF even as the system migrated from net surplus to a net deficit mode in the second half of the month due to advance tax outflows. Interest rates in the overnight call money market firmed up in June reflecting the increase in the repo rate on June 6, 2018. The weighted average call rate (WACR) traded, on an average, 12 basis points below the repo rate – the same as in May. Systemic liquidity moved back into surplus mode in early July with increased government spending but turned into deficit from July 10 onwards; on a daily net average basis, the Reserve Bank injected liquidity under the LAF of ₹107 billion in July. The WACR in July, on an average, traded 9 basis points below the policy rate. Based on an assessment of prevailing liquidity conditions and of durable liquidity needs going forward, the Reserve Bank conducted two open market operation (OMO) purchase auctions of ₹100 billion each on June 21 and July 19, 2018.
17. Export growth picked up in May and June 2018 on a y-o-y basis, aided by engineering goods, petroleum products, drugs and pharmaceuticals, and chemicals. Import growth also accelerated largely due to an increase in crude oil prices. Among non-oil imports, gold imports declined due to lower volume, while imports of machinery, coal, electronic goods, chemicals, and iron and steel increased sharply. Double-digit import growth in May and June pushed up the trade deficit. On the financing side, net foreign direct investment (FDI) flows improved significantly in the first two months of 2018-19. With the tightening of liquidity conditions in AEs, growing geopolitical concerns and with the escalation of protectionist sentiment, net foreign portfolio investment (FPI) outflows from the domestic capital market have continued, albeit at an increasingly slower rate. India’s foreign exchange reserves were at US$ 404.2 billion on July 27, 2018. Outlook
18. In the second bi-monthly resolution of 2018-19, CPI inflation for 2018-19 was projected at 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside. Excluding the impact of HRA revisions, CPI inflation was projected at 4.6 per cent in H1 and 4.7 per cent in H2. Actual inflation outcomes have been slightly below the projected trajectory as the seasonal summer surge in vegetable prices has remained somewhat muted in comparison with its past behaviour and fruits prices have declined.
19. The inflation outlook is likely to be shaped by several factors. First, the central government has decided to fix the minimum support prices (MSPs) of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19. This increase in MSPs for kharif crops, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and second round effects on headline inflation. A part of the increase in MSPs based on historical trends was already included in the June baseline projections. As such, only the incremental increase in MSPs over the average increase in the past will impact inflation projections. However, there is a considerable uncertainty and the exact impact would depend on the nature and scale of the government’s procurement operations. Second, the overall performance of the monsoon so far augurs well for food inflation in the medium-term. Third, crude oil prices have moderated slightly, but remain at elevated levels. Fourth, the central government has reduced Goods and Services Tax (GST) rates on several goods and services. This will have some direct moderating impact on inflation, provided there is a pass-through of reduced GST rates to retail consumers. Fifth, inflation in items excluding food and fuel has been broad-based and has risen significantly in recent months, reflecting greater pass-through of rising input costs and improving demand conditions. Finally, financial markets continue to be volatile. Based on an assessment of the above- mentioned factors, inflation is projected at 4.6 per cent in Q2, 4.8 per cent in H2 of 2018-19 and 5.0 per cent in Q1:2019-20, with risks evenly balanced (Chart 1). Excluding the HRA impact, CPI inflation is projected at 4.4 per cent in Q2, 4.7-4.8 per cent in H2 and 5.0 per cent in Q1:2019-20.
20. Turning to the growth outlook, various indicators suggest that economic activity has continued to be strong. The progress of the monsoon so far and a sharper than the usual increase in MSPs of kharif crops are expected to boost rural demand by raising farmers’ income. Robust corporate earnings, especially of fast moving consumer goods (FMCG) companies, also reflect buoyant rural demand. Investment activity remains firm even as there has been some tightening of financing conditions in the recent period. Increased FDI flows in recent months and continued buoyant domestic capital market conditions bode well for investment activity. The Reserve Bank’s IOS indicates that activity in the manufacturing sector is expected to remain robust in Q2, though there may be some moderation in pace. Rising trade tensions may, however, have an adverse impact on India’s exports. Based on an overall assessment, GDP growth projection for 2018-19 is retained, as in the June statement, at 7.4 per cent, ranging 7.5-7.6 per cent in H1 and 7.3-7.4 per cent in H2, with risks evenly balanced; GDP growth for Q1:2019-20 is projected at 7.5 per cent (Chart 2).
21. Even as inflation projections for Q2 have been revised marginally downwards vis-à-vis the June statement, projections for Q3 onwards remain broadly unchanged. Several risks persist. First, crude oil prices continue to be volatile and vulnerable to both upside and downside risks. In particular, while geopolitical tensions and supply disruptions remain an upside risk to oil prices, the fall in global demand due to further intensification of protectionist trade policies could pull down oil prices. Second, volatility in global financial markets continues to impart uncertainty to the inflation outlook. Third, households’ inflation expectations, as measured by the Reserve Bank’s survey, have risen significantly in the last two rounds, which could influence actual inflation outcomes in the months to come. Fourth, manufacturing firms polled in the Reserve Bank’s industrial outlook survey have reported hardening of input price pressures in Q2 of 2018-19. However, if the recent softening of global commodity prices persists, it could mitigate some of the upward pressure on input costs. Fifth, though the monsoon has been normal temporally so far, its regional distribution needs to be carefully monitored in the context of key CPI components such as paddy. Sixth, in case there is fiscal slippage at the centre and/or state levels, it could have adverse implications for market volatility, crowd out private investment and impact the outlook for inflation. Seventh, uncertainty around the full impact of MSP on inflation will only resolve in the next several months once the price support schemes are implemented. Finally, the staggered impact of HRA revision by state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is need to watch out for any second- round impact on inflation.
22. Against the above backdrop, the MPC decided to increase the policy repo rate by 25 basis points. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis.
23. The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months. In addition, recent global developments raise some concerns. Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth.
24. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of the decision; Dr. Ravindra H. Dholakia voted against the decision. The minutes of the MPC’s meeting will be published by August 16, 2018.
25. The next meeting of the MPC is scheduled from October 3 to 5, 2018. Voting on the Resolution to increase the policy repo rate by 25 bps to 6.5 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia No Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
26. Since the last policy, demand conditions in the manufacturing sector have continued to improve. There is a significant improvement in the risk profile of the firms in most sub-sectors based on corporate results for H2:17-18. There is a noticeable improvement in consumer confidence, although the current situation index continues to be in the pessimistic zone. Organized sector wages – a proxy for pay inflation – continue to rise and need to be carefully watched. The increase in capacity utilization has coincided with better corporate performance. The Services PMI also expanded to a 12 month high in June.
27. On the expenditure side, private consumption (PFCE) continues to be the main driver of growth, and it will be further supported by a shift in the terms of trade towards agriculture, and the likelihood of a normal monsoon. Economic growth in the short run will also be buoyed by a political business cycle. The adverse implications of a political business cycle on fiscal consolidation should be carefully watched since fiscal consolidation is often a key feature of the adjustment required to contain trade imbalances. High frequency indicators on consumption suggest a mild tapering in the growth momentum since the last policy. Headline IIP also softened to 3.2% in May compared to 4.8% in April. Overall, I remain sanguine about current and medium term growth prospects.
28. One year projections of headline inflation (ex HRA) continue to durably persist above 4%, as in the last policy. CPI inflation ex food and fuel has continued to sustain above 6%, with strong momentum effects. On the positive side, this reflects a closing output gap. Favorable base effects will also prevail over a 12 month horizon for the ex food and fuel and ex HRA group, which will slow down CPI ex food and fuel and ex HRA inflation. Food inflation continues to be maverick. It ranged between 1.7% and 2.1% in Q1:18-19 and is the reason for the May-June 2018 undershoot of projections. Except food, all other groups contributed to an increase in headline inflation in the last few months. For instance, there is a tangible rise in price pressures in the miscellaneous sub-group (health, education, transport) in the last three months, possibly reflecting supply constraints in these sectors. Food inflation surprises continue to be one way, which is a puzzle. Crude prices have inched down, although the average price of crude remains elevated with risks persisting.
29. Both 3 month and 1 year ahead inflationary expectations have also hardened, which is worrisome. If inflationary expectations are well anchored, the 1 year ahead inflationary expectations should be less sensitive to “news” shocks (such as the recent elevated levels of the price of crude) compared to the 3 month level. The fact that median inflationary expectations (both 3 month and the 1 year ahead) in the last round increased roughly by the same amount (20 basis points) compared to the last policy suggests that much work lies ahead in making monetary policy more credible and anchoring inflationary expectations.
30. One more risk that has crystallized to the upside since the June review is the recent announcement of minimum support prices for Kharif crops for 2018. The weighted average increase in MSP, based on CPI weights, for 2018-2019 works out to 17%. Compared to this, the average increase in MSP for 2014-2015 to 2017-2018 was 3.6%. Higher MSPs of this magnitude have the potential of pushing headline inflation sustainably and significantly beyond the 4 percent target for headline inflation mandated in the RBI Act. While the final inflationary impact will depend on the exact procurement policy which is yet to be announced, given the magnitude of the MSP surprise, it is opportune to frontload a rate hike, somewhat akin to an “insurance policy”. In this regard, it will be crucial to watch how the twin terms trade of shocks – referenced to in my last few statements – play out on macroeconomic aggregates in the coming months.
31. For these reasons, I vote for an increase in the policy repo rate by 25 basis points at today’s meeting of the Monetary Policy Committee. Statement by Dr. Pami Dua
32. Headline inflation, as measured by the Consumer Price Index, rose to 5% in June 2018 from 4.9% in May due to a broad-based rise across its sub-indices. The pass-through of elevated global oil prices in the domestic economy directly affected prices of LPG, petroleum products and transport services. Inflation in education and health also increased modestly. Food inflation, however, declined marginally between May and June, partly due to a favourable base effect and also because of a decline in prices of fruits and soft inflation in vegetables. Inflation excluding food and fuel hovered above 6% and is a cause for concern. Moreover, high input costs and selling prices were reflected in the Reserve Bank’s Industrial Outlook Survey (IOS) for the first quarter of 2018-19. Companies covered in the Services PMI in June also highlighted high input costs as did those polled for the Manufacturing PMI in July.
33. Going forward, several upside risks to inflation remain. First, a larger than average increase in the minimum support prices (MSPs) for all kharif crops for the sowing season of 2018-19 is likely to have a direct impact on inflation in the food group as well as secondary effects through greater purchasing power in rural areas. However, the extent of impact will depend on the nature and scope of implementation of procurement by the government. The tapering impact of HRA revisions for central government employees and the staggered impact of HRA revisions by state governments may also push headline inflation up. Further, crude oil prices remain above $70 and future movements are expected to be volatile, depending on geopolitical events and their impact on global demand. Volatility in global financial markets also continues to impart uncertainty to the inflation outlook. Additionally, fiscal slippages by governments may have adverse implications for market volatility, and may crowd out private investment and impact the outlook for inflation. Moreover, the June round of RBI’s survey of households shows an increase in inflation expectations at the three-month and one-year horizons. Elevated input costs also pose a risk for further inflation in the coming months, although there is some potential for easing due to softening global commodity prices. Downside risks also include a normal southwest monsoon, which should help contain food inflation in the medium-term. Additionally, reduction in Goods and Services Tax (GST) rates may cool down inflation to the extent of a pass-through of reduced GST rates to retail consumers.
34. The use-based classification of the index of industrial production (IIP) shows that industrial growth has strengthened in recent months on account of growth in capital goods and consumer durables. Central government schemes concerning building of highways and rural housing have contributed towards acceleration of growth in the infrastructure and construction sectors. While the July manufacturing PMI remained in expansion mode, it eased relative to the previous month. The business expectations index (BEI) of RBI for Q1:2018-19 remained in optimistic zone. Further, the Reserve Bank’s Industrial Outlook Survey suggests that manufacturing sector activity is expected to remain robust in Q2. According to the June Round of the Consumer Confidence Survey conducted by the Reserve Bank of India, the Current Situation Index, an indicator of the current state of the economy, rose modestly after dropping in the previous two rounds. This rise was largely driven by an improvement in sentiment on the general economic situation and employment scenario as well as an increase in spending.
35. At the same time, the Future Expectations Index that depicts consumer outlook fell marginally in the June round. This was driven by a slight drop in sentiments on the one-year ahead general economic situation and the deterioration in the outlook on income. Downside risks to growth also include rising trade tensions that may hamper demand for India’s exports, aggravating the cyclical slowdown in exports signalled by the continued downswing in the growth rate of the Indian Leading Exports Index maintained by the Economic Cycle Research Institute (ECRI), New York. This is consistent with the global economic slowdown predicted earlier by ECRI's international leading indexes.
36. Thus, with hardening of actual inflation, rising inflation expectations along with prevailing upside risks to inflation, I vote for an increase in the repo rate by 25 basis points while retaining the neutral stance. Statement by Dr. Ravindra H. Dholakia
37. After the last meeting of the MPC in June 2018, the monthly headline inflation prints for May and June have turned out to be less than expected by the RBI and, as I had pointed out a possibility in my last statement, have resulted in lowering the forecast for Q4:2018-19. The current forecast of RBI does not show this decline and on the contrary shows an increase by about 20 bps only because it incorporates a remotely possible impact of MSP revisions on the headline inflation. Such an impact, on the other hand, is so uncertain even in its existence and definitely in magnitude that experts in the field advise to wait and watch till the revised MSP is implemented on ground by November 2018. There are so many well-known constraints on its implementation that prudence lies in not basing any policy rate decisions till clarity emerges on it. Once we take this crucial uncertain factor out, the rest of the developments do not warrant any change in the status quo even with a very conservative view. I, therefore, vote for the status quo both in the policy repo rate and the neutral stance. More specific reasons for my vote are: i) The argument of a pre-emptive consecutive rate hike at this stage pre-supposes: (a) complete failure of the rate hike effected in the June 2018 policy on impacting the inflationary expectations in the economy, and (b) headline inflation forecasts ex-house rent revisions a year ahead increasing further without any uncertainty. Neither of these two pre-suppositions is correct. Although the RBI survey of the household inflationary expectations shows an increase in its median quantum by 20 bps, the proportion of respondents expecting higher inflation 12 months ahead declined noticeably. Moreover, the IIMA Business Inflation Expectation Survey conducted in June 2018 (after the repo rate hike by 25 bps) shows a sharp decline in the headline CPI inflation expectation 12 months ahead from 4.67 percent in the April 2018 round to 4.16 percent in the June 2018 round. This survey covered more than 1600 companies and shows low standard deviation. There are several reasons why the second pre-supposition is incorrect. ii) The Central and State governments have shown reasonable commitment to the fiscal discipline in terms of bringing the fiscal deficit down. There is no reason to expect a substantial fiscal slippage this year despite the next year being an election year. iii) GST rate reductions on several items may reduce the inflation marginally. iv) Inflationary expectations of urban households have increased as per the RBI survey because two consecutive inflation readings (May and June 2018) increased. They are likely to fall when the next two consecutive readings (July and August 2018) would show a decline. Even RBI inflation forecasts point to this possibility on account of the strong base effects. If the actual fall in CPI inflation for July and August 2018 turns out to be larger than what RBI projected, their 12 month ahead inflation forecast may also show a reduction. Given the recent track record of RBI in terms of their near term forecasts, this possibility cannot be ruled out. v) Concerns about core inflation are misplaced on two counts: (a) the mandated target for our Committee is headline CPI inflation including food and fuel; and (b) my paper with a co-author in the Economic and Political Weekly (March 3, 2018) shows that inflation dynamics have changed during the last decade such that it is the core that adjusts to the headline and not vice-versa. vi) The oil prices have not further increased. If at all, they show a marginal decline from $75 in early June 2018 to $72.5 towards the end of July 2018. All these factors together would bring down the baseline inflation forecast for Q4:2018-19. Only the most uncertain impact of MSP revisions on food prices after 2 or 3 quarters can push the inflation forecast marginally higher. In my opinion, we should not consider such a highly uncertain impact for a rate hike decision. vii) On the other hand, there are disturbing signals and evidences pointing to likely slow down on the growth front. Capacity utilization seasonally adjusted has sharply fallen by 130 bps as per the RBI survey. It contradicts the RBI claim that output gap has closed. Actually, it is not getting closed, but is likely to widen creating downward pressure on wages and prices. viii) Corporate performance points to less investment in fixed and financial assets in H2:2017-18 and is also likely to fall during 2018-19 as revealed by the pipeline projects up to 2017-18. Bonds and debentures issues by the private sector declined in Q1:2018- 19. ix) Global growth is not likely to sustain. Our exports may not grow at the envisaged rate due to tariff wars and increased protectionism. x) Real policy rate is already positive and very high compared to most other countries. For businesses, it is well above +2 percent (since their inflation expectation 12 months ahead is only 4.16 percent). It is already adversely impacting capital formation. All these factors will put further downward pressure on inflation.
38. This is certainly not the time and environment to hike the policy rate. Nor is it the time to tinker with the policy stance. Prudence lies in maintaining status quo on both. Statement by Dr. Michael Debabrata Patra
39. I vote for raising the policy repo rate by 25 basis points and for accordingly aligning the operating target with the policy action.
40. First, inflation has hardened through the first quarter of the year, extending its upturn into the third consecutive month in June. The forecast – the intermediate target that provides a proximate view of how the goal variables are forming – suggests that inflation is likely to encounter a soft patch in the second quarter, but it will resume an upward trajectory in the second half of the year.
41. Second, the recent softening of international crude prices has afforded some respite from inflation pressures. The outlook, though, is clouded with uncertainty as to how geopolitical tensions, OPEC production commitments, global demand and inventory adjustments will play out. It is prudent to prepare for international crude prices remaining elevated and volatile for some time.
42. Third, the recent experience is suffused with global spillovers impacting the bond and forex markets in India. Apart from implications for growth and external sustainability, financial turbulence feeding into volatile inflation outcomes is a real and present risk.
43. Fourth, the inflationary consequences of MSP revisions remain an upside risk. The pass-through of the announced MSPs to retail inflation is conditioned by two big unknowns: (a) the scale and ambit of procurement operations when they commence in Q3; and (b) the pace of drawdown of stocks in the case of paddy, the main crop for effective procurement in the Kharif season. A fair assumption can be that it will not be business as usual in view of the size of increases in MSPs this year that fulfils the commitment given in the Union Budget, and the timing of the announcement.
44. That said, the inflation trajectory is expected to slant upwards in the third and fourth quarters of 2018-19 and in the first quarter of the next financial year. Households and professional forecasters are anticipating it, corporates are reporting rising input costs which could swiftly translate into pricing power as the output gap closes and demand pressures build up. Consumers are pessimistic about the future course of the price situation.
45. The risk of failing to achieve the inflation target, and of being perceived as willing to accommodate deviations over the remaining period for which the MPC is tasked, has increased significantly. This could unhinge inflation expectations, dent the credibility of the MPC and allow inflation outcomes to test the upper tolerance band. This evolving configuration warrants an adequate monetary policy response, so that inflation realigns with the target and inflation expectations remain anchored.
46. The economy is poised for an acceleration of growth in 2018-19 relative to 2017-18, but the drivers of growth are amorphous at this juncture. International crude prices and global spillovers from trade wars, monetary policy normalisation and geopolitical tensions present significant risks to growth prospects. In this highly volatile and unsettled international environment, stability has to be secured on an enduring basis to enable the drivers of growth to gain traction and to preserve external viability.
47. My preference, therefore, is to reinforce the policy action that commenced in June with another policy rate increase now and to allow the accumulated policy impulse to work its way through the economy, while vigil is maintained on the expected rising path of inflation going forward. The softer inflation prints expected in Q2 could likely lull inflation expectations, but abundant precaution and decisiveness in quelling risks to the target is warranted if the hard- earned gains in terms of macroeconomic stability and credibility have to be preserved. Statement by Dr. Viral V. Acharya
48. Since the Monetary Policy Committee (MPC) met last in June 2018, inflation prints have been somewhat softer than the Reserve Bank’s projections. Notably, vegetables and fruits prices have surprised on the downside. However, the underlying inflation as reflected in “ex food fuel” segment, especially in petrol and diesel, transportation (including fares), education fees, health services and clothing persists, and does not augur well for headline inflation going forward.
49. The last three rounds of the Reserve Bank of India (RBI)’s Inflation Expectations Survey (IES) of households reflect hardening of the 3-month ahead and 12-month ahead inflation expectations by 110 basis points (bps) and 150 bps, respectively. The input cost pressures faced by the corporate sector are also reported to be robust. These outcomes are not surprising given that headline inflation – even after adjusting for the statistical effect of the Centre’s increase in house rent allowances (HRA) – has remained above 4%, the MPC’s mandated target headline inflation rate, for seven out of the past eight months, with a mean as well as median of slightly over 4.5%.
50. Benign food inflation continues to act as a factor pulling forecasts down. It remains to be seen if the usual summer seasonal pickup in food inflation will simply be delayed by a month or two, or it is a feature of supply-driven soft food inflation prints. However, the major upside risk to food inflation that MPC had highlighted in its past resolutions, viz., the award of minimum support prices (MSPs), has materialised. There is now a concrete announcement detailing the targeted kharif crops and a much higher than the normal MSP increase. Though significant uncertainty remains regarding the exact rollout of the MSP program, inflation projections by the Reserve Bank include the impact of MSP under reasonable procurement assumptions.
51. Oil prices have moderated somewhat compared with two months back due to an increase in supply from some of the OPEC countries and Russia. Nevertheless, the price of the Indian crude basket remains at elevated levels and is just a throw away from levels that can cause domestic inflation to rise sharply. Hence, while the supply response has had some softening impact on the projections, oil price gyrations remain an important risk going forward.
52. Factoring in these considerations, I am more concerned about upside risks materialising compared to downside risks. This is especially so as most real-time indicators suggest that growth recovery is likely to be sustainable. As I have mentioned in the past few minutes, estimates suggest that the output gap has more or less closed.
53. In summary, since past several headline inflation prints have been above the target and projections suggest this will also be the case over the medium term, I vote to raise the policy rate by 25 basis points (bps) as a step towards fulfilling our inflation targeting mandate while paying attention to growth. The rate hike of June followed by another rate hike will help rein in demand pressures and manage inflation expectations. However, this transmission will occur with a lag. Since that is somewhat far and there is an important interim uncertainty in the form of tariff wars which can rock global growth, financial markets and inflation in abrupt and unexpected ways, I vote to retain the neutral stance of monetary policy. Statement by Dr. Urjit R. Patel
54. Inflation as measured by CPI ex HRA has risen for the third consecutive month in June 2018, driven by a broad-based increase in inflation in non-food goods and services. Continuing elevated crude oil prices have kept retail prices of petroleum products high; this has also resulted in higher inflation in transport services. Furthermore, inflation increased in education, health and clothing. In contrast, inflation in the food group remained benign due to a decline in prices of fruits and lower than the usual seasonal uptick in prices of vegetables. On the whole, actual inflation outcomes since the last MPC resolution of June 2018 have been slightly below the projected trajectory as food inflation has continued to surprise on the downside.
55. Going forward, excluding the HRA impact, CPI inflation is projected at 4.7-4.8 per cent in H2:2018-19; and 5 per cent in Q1:2019-20. These projections include the impact of an increase in minimum support prices (MSPs) for kharif crops announced by the central government over what was already assumed in projections in the June policy. The outlook for inflation, however, is faced with both upside and downside risks such as (i) considerable uncertainty around the full impact of MSP changes on inflation, which will be known only in the coming months when the procurement details are available and execution takes place; (ii) susceptibility of crude oil to both supply and demand shocks; (iii) continuing volatility in financial markets; (iv) a further rise in inflation expectations of households which has the potential to feed into wage & salary increases and induce cost-push pressures; (v) fiscal slippage at the centre and/or state levels; and (vi) second round effects on inflation on account of the staggered HRA revisions by various state governments, though the direct statistical impact of HRA revisions will be looked through.
56. Domestic growth impulses continue to be reasonably strong. The normal monsoon so far augurs well for the farm sector. Investment activity has remained broadly positive. The manufacturing sector has continued to be robust. Several high frequency indicators of services activity have expanded at a faster pace in recent months. However, rising trade protectionism may impact domestic investment and growth prospects by dampening India’s exports. Overall, economic activity appears to be buoyant with GDP growth for 2018-19 projected at 7.4 per cent, same as in the June policy; and 7.5 per cent for Q1:2019-20.
57. As inflation risks have continued to be elevated, I vote for an increase in the policy repo rate by 25 basis points; this action is a necessary step towards securing the mandated 4 per cent inflation target on a durable basis. However, in view of several uncertainties that are present, I maintain the neutral stance of monetary policy. Jose J. Kattoor Press Release : 2018-2019/409 Chief General Manager
6. The decision of the MPC is consistent with the stance of calibrated tightening of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment
7. Since the last MPC meeting in August 2018, global economic activity has remained resilient in spite of ongoing trade tensions, but is becoming uneven and the outlook is clouded by several uncertainties. Among advanced economies (AEs), the United States (US) economy appeared to have sustained pace in Q3:2018 as reflected in strong retail sales and robust industrial activity. In the Euro area, economic activity remained subdued due to overall weak economic sentiment, weighed down mainly by political uncertainty. The Japanese economy has so far maintained the momentum of the previous quarter, buoyed by recovering industrial production and strong business optimism.
8. Economic activity in major emerging market economies (EMEs) has been facing headwinds from both global and country-specific factors. In China, industrial production growth has moderated with slowing exports and the ongoing deleveraging of the financial system weighing on growth prospects. The Russian economy has been gathering steam with the manufacturing sector turning around, and the employment scenario remaining upbeat on rising oil prices. In Brazil, economic activity is recovering from the setback in Q2, supported by improving business and consumer sentiment, though weak domestic demand and the sluggish pace of recovery in manufacturing activity point to a slow revival. The South African economy slipped into recession in Q2:2018, pulled down by the negative contribution from agriculture on account of a strong unfavourable base effect.
9. Growth in global trade is weakening as reflected in export orders and automobile production and sales. Crude oil prices eased during the first half of August on concerns of reduced demand from EMEs due mainly to the spillover from country-specific turmoil, and accentuated by rising supplies. However, prices rebounded on expectation of reduced supplies due to sanctions on Iran and falling US stockpiles. Base metal prices witnessed selling pressure in anticipation of weak demand from major economies. Gold prices continued to slide lower on a strong US dollar, though they recovered somewhat on safe-haven demand from the mid-August lows. Inflation remained firm in the US, reflecting tightening labour market and elevated energy prices, while it persisted much below the central bank’s target in Japan. In the Euro area, inflation pressures have been sustained by elevated crude prices. Inflation in many key EMEs has risen on surging crude prices and currency depreciations, caused by a firm dollar and domestic factors.
10. Global financial markets continued to be affected by monetary policy stances in major AEs, the spreading of contagion risks from specific EMEs, and geopolitical developments. Among AEs, equity markets in the US touched a new high, driven by technology stocks, while in Japan, they were boosted by the weak yen. In contrast, stock markets in the Euro area suffered losses on signs of a slowdown and budget concerns in some member states. Sharp sell-offs have occurred on waning appetite of foreign portfolio investors for EME equities. The 10-year sovereign yield in the US has traded sideways, falling on dovish Fed guidance only to recover by end-September on robust economic data. Among other AEs, bond yields in the Euro area hardened in September on risk aversion following the sharp rise in financial market volatility in August. In contrast, bond yields in Japan moved in a narrow range, driven by the central bank’s yield curve management policy. In most EMEs, yields rose due to domestic factors and/or contagion effects from the stress in other EMEs. In currency markets, the US dollar witnessed selling pressures since August on reduced investor expectations of rate hikes by the US Fed. However, it recovered in the last week of September on a rate hike by the Fed and strong economic data. The euro remained in bearish territory due to fiscal risks in some member countries and expectations of weak growth. EME currencies continued to depreciate against the US dollar.
11. On the domestic front, real gross domestic product (GDP) growth surged to a nine- quarter high of 8.2 per cent in Q1:2018-19, extending the sequential acceleration to four successive quarters. Of the constituents, gross fixed capital formation (GFCF) expanded by double digits for the second consecutive quarter, driven by the government’s focus on the road sector and affordable housing. Growth in private final consumption expenditure (PFCE) accelerated to 8.6 per cent, reflecting rising rural and urban spending, supported by retail credit growth. However, government final consumption expenditure (GFCE) decelerated, largely due to a high base. The growth of exports of goods and services jumped to 12.7 per cent, powered by non-oil exports on the back of strong global demand. In spite of import growth continuing to surge, high exports growth helped reduce the drag from net exports on aggregate demand.
12. On the supply side, growth of gross value added (GVA) at basic prices accelerated in Q1, underpinned by double-digit expansion in manufacturing activity which was robust and generalised across firm sizes. Agricultural growth also picked up, supported by robust growth in production of rice, pulses and coarse cereals alongside a sustained expansion in livestock products, forestry and fisheries. In contrast, services sector growth moderated somewhat, largely on account of a high base. Construction activity, however, maintained strong pace for the second consecutive quarter.
13. The fourth advance estimates of agricultural production for 2017-18 released in August placed foodgrains production at a high of 284.8 million tonnes, 1.9 per cent higher than the third advance estimates (released in May 2018) and 3.5 per cent higher than the final estimates for the previous year. The progress of the south-west monsoon has been marked by uneven spatial and temporal distribution, with an overall deficit of 9 per cent in precipitation. However, the first advance estimates of production of major kharif crops for 2018-19 have placed foodgrains production at 141.6 million tonnes, 0.6 per cent higher than last year’s level. The live storage in major reservoirs (as on September 27) rose to 76 per cent of the full capacity, which was 17 per cent higher than last year and 5 per cent higher than the average of the last 10 years. This bodes well for the rabi sowing season.
14. Industrial growth, measured by the index of industrial production (IIP), accelerated in June-July 2018 on a year-on-year (y-o-y) basis, underpinned mainly by high growth in consumer durables, notably two-wheelers, readymade garments, stainless steel utensils, auto components and spares, and accessories. Growth in consumer non-durables also accelerated in July. The infrastructure and construction sector continued to show solid growth. Primary goods growth accelerated, driven by mining, electricity and petroleum refinery products. Growth in capital goods production spiked in June, but decelerated sharply in July. The output of eight core industries growth remained strong in July, driven by coal, petroleum refinery products, steel and cement, but moderated in August. Capacity utilisation (CU) declined from 75.2 per cent in Q4:2017-18 to 73.8 per cent in Q1:2018-19, while seasonally adjusted CU increased by 1.8 percentage points to the long-term average of 74.9 per cent. Based on the Reserve Bank’s business expectations index (BEI), the assessment for Q2:2018-19 improved, led by enhanced production, order books, exports and capacity utilisation. The August and September manufacturing purchasing managers’ index (PMI) remained in expansion zone; the September print rebounded close to the July level confirming robustness of manufacturing activity.
15. High-frequency indicators of services in July and August present a mixed picture. Indicators of rural demand, viz., growth in tractor and two-wheeler sales, slowed down. Passenger vehicle sales, an indicator of urban demand, declined possibly due to rising fuel prices. However, growth in air passenger traffic – another indicator of urban demand – remained robust. Transportation sector indicators, viz., commercial vehicle sales and port cargo, expanded at an accelerated pace. Steel consumption and cement production, indicators of construction activity, showed strong growth. The services PMI remained in expansion zone in August and September, though it decelerated from July, with slower expansion in new business and employment.
16. Retail inflation, measured by the y-o-y change in the CPI, fell from 4.9 per cent in June to 3.7 per cent in August, dragged down by a decline in food inflation. Some softening of inflation in items other than food and fuel also contributed to the decline. Adjusting for the estimated impact of an increase in house rent allowance (HRA) for central government employees, headline inflation was at 3.4 per cent.
17. Inflation in the food and beverages group declined sharply in the absence of seasonal uptick in prices of fruits and vegetables. Of the three key vegetables, the prices of tomatoes declined due to strong mandi arrivals, while those of onions and potatoes remained muted. Continued deflation in prices of pulses and sugar accentuated the decline in food inflation. Inflation in other items of food – cereals, meat and fish, milk, spices and non-alcoholic beverages – remained benign.
18. Inflation in the fuel and light group continued to rise on the back of a significant increase in liquefied petroleum gas prices, tracking international product prices. Kerosene prices rose as oil marketing companies reduced subsidies in a calibrated manner. While remaining elevated, CPI inflation excluding food and fuel moderated due to softening in inflation in housing; pan, tobacco and intoxicants; personal care; and transportation.
19. While the September round of the Reserve Bank’s survey of households reported a sharp uptick of 50 basis points in three-month ahead inflation expectations over the last round, one- year ahead expectations moderated by 30 basis points. Inflation expectations for both input prices and selling prices of manufacturing firms, polled by the Reserve Bank’s industrial outlook survey, firmed up in Q2:2018-19. The manufacturing and services PMIs also reported an increase in input costs and selling prices in Q2, reflecting a pass-through of higher costs to clients. On the other hand, growth in wages in the rural and organised manufacturing sectors remained contained. 19. However, higher net services receipts and private transfer receipts helped contain the current account deficit to 2.4 per cent of GDP in Q1:2018-19 from 2.5 per cent a year ago. On the financing side, net foreign direct investment (FDI) flows improved in April-July 2018. By contrast, foreign portfolio investors have been net sellers in both the equity and debt segments so far on a cumulative basis in 2018-19 due to higher US interest rates, risk-off sentiment in EMEs and escalation of trade wars. India’s foreign exchange reserves were at US$ 400.5 billion on September 28, 2018. Outlook
20. Systemic liquidity alternated between surplus and deficit during August-September 2018, reflecting the combined impact of expansion of currency in circulation, Reserve Bank’s forex operations and movements in government cash balances. From a daily net average surplus of ₹ 201 billion during August 1-19, 2018, liquidity moved into deficit during August 20-30. After turning into surplus during August 31-September 10 due to increased government spending, the system again moved into deficit during September 11-29 on the back of an increase in government cash balances and Reserve Bank’s forex interventions. Based on an assessment of the evolving liquidity conditions, the Reserve Bank conducted two open market purchase operations in the second half of September to inject ₹200 billion of durable liquidity. LAF operations absorbed, on a daily net average basis, ₹30 billion in August, but injected ₹406 billion in September. The weighted average call rate (WACR), on an average, traded below the repo rate by 15 basis points (bps) in August and by 4 bps in September.
21. Exports maintained double digit growth in July and August 2018, driven mainly by petroleum products (which benefitted from elevated crude oil prices), engineering goods, gems and jewellery, drugs and pharmaceuticals, and chemicals. However, imports grew faster than exports, reflecting not only a higher oil import bill, but also higher imports of gold, coal, electronic goods and machinery. This led to a widening of the trade deficit to US$ 35.3 billion in July-August 2018 from US$ 24.6 billion a year ago over and above the expansion in Q1:2018-
22. In the third bi-monthly resolution of August 2018, CPI inflation was projected at 4.6 per cent in Q2:2018-19, 4.8 per cent in H2 and 5.0 per cent in Q1:2019-20, with risks evenly balanced. Excluding the HRA impact, CPI inflation was projected at 4.4 per cent in Q2:2018-19, 4.7-4.8 per cent in H2 and 5.0 per cent in Q1:2019-20. Actual inflation outcomes, especially in August, were below projections as the expected seasonal increase in food prices did not materialise and inflation excluding food and fuel moderated.
23. Going forward, the inflation outlook is expected to be influenced by several factors. First, food inflation has remained unusually benign, which imparts a downward bias to its trajectory in the second half of the year. Inflation in key food items such as pulses, edible oils, sugar, fruits and vegetables remains exceptionally soft at this juncture. The risk to food inflation from spatially and temporally uneven rainfall is also mitigated, as confirmed by the first advance estimates that have placed production of major kharif crops for 2018-19 higher than last year’s record. An estimate of the impact of an increase in minimum support prices (MSPs) announced in July has been factored in the baseline projections. Secondly, the price of the Indian basket of crude oil has increased sharply, by US$ 13 a barrel, since the last resolution. Thirdly, international financial markets remained volatile with EME currencies depreciating significantly. Finally, the HRA effect came off its peak in June and is dissipating gradually on expected lines. Taking all these factors into consideration, inflation is projected at 4.0 per cent in Q2:2018-19, 3.9-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20, with risks somewhat to the upside (Chart 1). Excluding the HRA impact, CPI inflation is projected at 3.7 per cent in Q2:2018-19, 3.8 - 4.5 per cent in H2 and 4.8 per cent in Q1:2019-20.
24. Turning to the growth outlook, the GDP print of Q1:2018-19 was significantly higher than that projected in the August resolution. Private consumption has remained robust and is likely to be sustained even as the recent rise in oil prices may have a bearing on disposable incomes. Improving capacity utilisation, larger FDI inflows and increased financial resources to the corporate sector augur well for investment activity. However, both global and domestic financial conditions have tightened, which may dampen investment activity. Rising crude oil prices and other input costs may also drag down investment activity by denting profit margins of corporates. This adverse impact will be alleviated to the extent corporates are able to pass on increases in their input costs. Uncertainty surrounds the outlook for exports. Tailwinds from the recent depreciation of the rupee could be muted by the slowing down of global trade and the escalating tariff war. Based on an overall assessment, GDP growth projection for 2018-19 is retained at 7.4 per cent as in the August resolution (7.4 per cent in Q2 and 7.1-7.3 per cent in H2), with risks broadly balanced; the path in the August resolution was 7.5 per cent in Q2:2018- 19 and 7.3-7.4 per cent in H2. GDP growth for Q1:2019-20 is now projected marginally lower at 7.4 per cent as against 7.5 per cent in the August resolution, mainly due to the strong base effect (Chart 2).
25. While the projections of inflation for 2018-19 and Q1:2019-20 have been revised downwards from the August resolution, its trajectory is projected to rise above the August 2018 print. The outlook is clouded with several uncertainties. First, the government announced in September measures aimed at ensuring remunerative prices to farmers for their produce, although uncertainty continues about their exact impact on food prices. Secondly, oil prices remain vulnerable to further upside pressures, especially if the response of oil-producing nations to supply disruptions from geopolitical tensions is not adequate. The recent excise duty cuts on petrol and diesel will moderate retail inflation. Thirdly, volatility in global financial markets continues to impart uncertainty to the inflation outlook. Fourthly, a sharp rise in input costs, combined with rising pricing power, poses the risk of higher pass-through to retail prices for both goods and services. Firms covered under the Reserve Bank’s industrial outlook survey report firming of input costs in Q2:2018-19 and Q3. However, global commodity prices other than oil have moderated, which should mitigate the adverse influence on input costs. Fifthly, should there be fiscal slippage at the centre and/or state levels, it will have a bearing on the inflation outlook, besides heightening market volatility and crowding out private sector investment. Finally, the staggered impact of HRA revision by the state governments may push up headline inflation. While the MPC will look through the statistical impact of HRA revisions, there is need to be watchful for any second-round effects on inflation. The inflation outlook calls for a close vigil over the next few months, especially because the output gap has virtually closed and several upside risks persist.
26. Against this backdrop, the MPC decided to keep the policy repo rate unchanged. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis.
27. The MPC notes that global headwinds in the form of escalating trade tensions, volatile and rising oil prices, and tightening of global financial conditions pose substantial risks to the growth and inflation outlook. It is, therefore, imperative to further strengthen domestic macroeconomic fundamentals.
28. Regarding the policy repo rate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of keeping the policy repo rate unchanged. Dr. Chetan Ghate voted for an increase in the policy rate by 25 bps.
29. Regarding the stance, Dr. Pami Dua, Dr. Chetan Ghate, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Dr. Urjit R. Patel voted in favour of changing the stance to calibrated tightening. Dr. Ravindra H. Dholakia voted to keep the neutral stance unchanged. The minutes of the MPC’s meeting will be published by October 19, 2018.
30. The next meeting of the MPC is scheduled from December 3 to 5, 2018. Voting on the Resolution to keep the policy repo rate unchanged at 6.5 per cent Member Vote Dr. Chetan Ghate No Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
31. Anchoring inflationary expectations, which are shaped by the target, is extremely important in an inflation targeting regime. If there is substantial deviation of inflationary expectations in relation to the target, by failing to react with the policy interest rate, we will lose credibility and reduce our capacity to influence expectations.
32. While I am comforted by the decline in median inflationary expectations of households for the 1-year ahead horizon by 30 bps in the last RBI’s survey, the median 1-year ahead expectations are now higher by 180 basis points over the September 2017 round. Meanwhile, the three-month median inflationary expectations increased by 50 bps compared to the previous round, with a cumulative increase of about 220 basis points over the September 2017 round.
33. What makes these cumulative increases in inflationary expectations salient, is that they risk being unanchored by both the 7% nominal depreciation in the INR and the USD 13 a barrel increase in the price of oil, since the August 2018 policy. Another factor is the nature and scope of MSP implementation, details of which are still not clear. My own projections with the above variables suggest that these factors will push inflation beyond the Q1 FY19-20 projection of 4.8% made by the RBI. Doing so risks the possibility of the un-anchoring of inflationary expectations which will impair our ability to keep headline inflation durably at 4%.
34. There has been a slight moderation in CPI inflation, excluding food and fuel to 6.0% in August, from 6.2% in July, which is comforting. The elevated value of ex food and fuel inflation is consistent with a nearly-closed output gap which should be carefully watched.
35. On the growth front, the Q1 of 18-19 GDP growth at 8.2% was strong. GVA growth was also strong at 8% (compared to 7.6% in Q4 17-18). Sectoral growth patterns in agriculture, manufacturing, and services in Q1 of 18-19 numbers were robust. Capex good production remains resilient, and the growth in consumer non-durables, which was lack-luster before, has picked up.
36. These numbers are confirmed by RBI’s own surveys. Demand conditions in the manufacturing sector continued to improve with the latest round of the RBI industrial outlook survey (of 1095 manufacturing companies) showing strong sentiments on production and order books. The RBI’s enterprise survey, OBICUS, based on a survey of 994 companies, showed a seasonally adjusted increase in capacity utilization at a 20-quarter high. Firms expect demand conditions to improve in Q3 FY 18-19 on the back of improved business expectations. Higher inventories indicate that producers are stocking up in anticipation of higher demand in coming quarters. Upward pressure on input and staff costs continue to push up selling prices, posing a risk to headline inflation. The most recent PMI manufacturing corroborates this, showing an uptick in input prices and output prices, although the pass through is lower.
37. What worries me on the pick up in growth is the dismal consumer confidence numbers, with consumer confidence in Q2 FY 18-19 worsening. Ideally, in a growing economy, the durability of growth is better sustained if it is supported by growing consumer confidence. Notwithstanding this, I continue to remain sanguine about current and medium term growth prospects as in the last policy.
38. Despite the two hikes in the policy rate in the last two policies, the data since August risks impairing our ability to keep headline inflation durably at 4%. I say this fully cognizant of the trade-off facing the MPC: moving too quickly and needlessly shortening the growth turnaround or, calibrating the rate hikes too slowly, and risking an over-heating in an economy with a nearly closed output gap. Given the strong possibility of the un-anchoring of inflationary expectations for the reasons given above, the appropriate “risk-management approach” would be to act now. We should not allow the commitment to the 4% target to be flexible.
39. I vote for an increase in the policy repo rate by 25 basis points at today’s meeting of the Monetary Policy Committee. I also vote for a change in the stance from “neutral” to “calibrated tightening”. Statement by Dr. Pami Dua
40. Headline inflation softened to 3.7 per cent in August from 4.2 per cent in July and 4.9 per cent in June, mainly due to the drop in food inflation from 3.1 per cent in June to 1.7 per cent in July and 0.9 per cent in August. Headline inflation adjusted for the estimated impact of an increase in house rent allowance (HRA) of central government employees (as per RBI’s calculations) also moderated from 4.6 per cent in June to 3.4 per cent in August, while CPI excluding food and fuel and adjusted for the impact of an increase in HRA fell from 5.7 per cent in June to 5.4 per cent in August. At the same time, various surveys provide mixed signals regarding inflation expectations. The September round of the Reserve Bank’s Survey of Households points towards an increase of 50 basis points in three-month-ahead inflation expectations but a moderation of 30 basis points in one-year-ahead expectations. The July- September round of the Reserve Bank’s Industrial Outlook Survey indicates that manufacturing firms expect higher cost of raw materials, input prices and selling prices. The manufacturing and services PMIs also signal a similar trend.
41. Looking forward, the downside risks to the inflation outlook include benign food inflation. The recent cuts in excise duty on petrol and diesel are expected to moderate retail inflation. However, crude oil prices have escalated and the rupee has weakened considerably, with potential pass-through effects on inflation. Moreover, with EME currencies depreciating against the US dollar, volatility in global financial markets continues to impart uncertainty to the inflation outlook. Additionally, fiscal slippages by the government may have adverse implications for market volatility, and may crowd out private investment and impact the outlook for inflation. The upside risks associated with an increase in minimum support prices (MSPs) and the HRA still persist, although the latter has somewhat moderated. Risks due to an increase in state level HRAs and input prices also prevail. Thus, there is considerable uncertainty with respect to the inflation outlook.
42. On the output side, GDP growth in the first quarter of 2018-19 was strong, with robust growth in private consumption. However, downside risks to investment activity include an increase in input prices and crude oil prices and tightening of global and domestic financial conditions, including the recent developments in the non-banking sector. Despite a depreciating rupee, growth in exports may also be hampered due to geopolitical risks, trade war and slowing global economy.
43. Indeed, growth in the Indian Leading Export Index, a predictor of the direction of exports growth maintained by the Economic Cycle Research Institute (ECRI), New York, remains in the doldrums, indicating an unfavourable Indian export growth outlook. This is consistent with weakening growth in ECRI’s 20-country composite Long Leading Index, which still points to a global growth slowdown. However, growth in ECRI’s Indian Leading Index, a harbinger of future economic activity, has firmed lately, pointing to somewhat improved economic growth prospects.
44. In sum, while inflation has softened, upside risks to inflation remain, along with some downside risks to output growth. The policy repo rate has already been increased in the past two consecutive meetings of the MPC (June and August), each time by 25 basis points. Due to the transmission lags, the effects of these may take time to play out. It is therefore best to pause and wait and watch while maintaining a vigil on inflation. I therefore vote for keeping the policy repo rate unchanged. At the same time, given the upside risks to inflation, I also vote for a change in the stance from neutral to calibrated tightening. Statement by Dr. Ravindra H. Dholakia
45. In the last meeting of the MPC in August 2018, I had clearly mentioned that, if the RBI’s inflation forecast for July and August substantially exceeded the actual reading, its medium term forecast would also have to be revised downward substantially. As expected, this has happened. The RBI forecast for the headline CPI inflation in July and August 2018 turned out to be significantly higher than the actual readings. Similar deviations had occurred even for the RBI’s May and June 2018 headline inflation forecasts. RBI has, therefore, revised its short to medium term forecast of headline inflation significantly downward even after considering revisions in its baseline scenario of higher oil prices and exchange rate. As I had argued in the last meeting, moreover, the household inflationary expectations 12 months ahead have come down (by 30 bps) as per the latest RBI survey. The growth forecast for the Indian economy considering both the latest upside and downside risks has remained the same (7.4 percent) as during the previous meeting of MPC in August 2018 when the MPC decided by a 5-1 majority vote to hike the policy rate pre-emptively by 25 bps. Therefore, now there is no case for any hike in the policy rate this time. This is the time for a pause to allow the consecutive rate hikes to sink in the system and settle down. I, therefore, vote for status quo on both the policy rate and the neutral stance. More specific reasons for my vote are: i) While there is a considerable depreciation of Indian Rupee against US Dollar recently, the rate of depreciation is substantially lower in terms of trade weighted Nominal Effective Exchange Rate (NEER), because other currencies have also depreciated against US Dollar. It is the depreciation in NEER that affects headline inflation. As a result, its impact on inflation is not likely to be very substantial. ii) While the oil price increase has been substantial, the following two aspects need to be explicitly considered for its impact on the headline inflation: (a) it has a lagged effect on inflation depending on its effective pass-through including revisions in domestic taxes; and (b) productivity improvement or revised Input-Output ratios in the oil using productive activities could off-set to a considerable extent the adverse impact of price rise in oil. iii) The impact of House Rent Allowance (HRA) revisions as per the recommendation of 7th CPC in the central and state public sector enterprises, autonomous bodies, universities and other organizations that provide housing to their employees should ideally be seen through as we have been doing for the central government employees (because it is purely statistical). However, this impact has not been separated due to data problems. Since such households would form a significant proportion of the CSO sample households (almost similar to the one for the central government employees) for estimating housing CPI, there is a considerable overestimation of the effective inflation rate for the headline and more so for the CPI-ex-food and fuel. In short, the effective inflation forecasts for the short to medium term are much less than what RBI considers because of the lack of precise information. There is an urgent need to fix this problem so that right data inputs are considered for policy actions. However, till this statistical problem is fixed, I would not consider marginal upward deviations (of about 20-30 bps) of headline inflation forecast from the targeted 4 percent as a major concern requiring any rate action. iv) The US economy has almost peaked and is only likely to go down from there. Therefore, further rate hikes in US may not be as attractive to global investors as before. As far as the Indian economy is concerned, the real interest rate is significantly higher than 2 per cent even after considering the inflationary expectation of businesses 12 months ahead of about 4.36 percent as per the latest IIM Ahmedabad survey results for August 2018 or the RBI’s own inflation forecast 12 months ahead. There is no justification for increasing it further by a rate hike at this point. v) Finally, the headline inflation forecast 12 months ahead by RBI is on a higher side according to me. This is also because the extent to which RBI has considered the impact of MSP revision on inflation is unrealistically high in my opinion.
46. Considering all these points, status quo in both the neutral stance and policy rate at this point is the best option. Statement by Dr. Michael Debabrata Patra
47. In its third bi-monthly resolution of August, the MPC had expected inflation to ease in the second quarter of 2018-19 and had brought down its forecast for that quarter by 30 basis points relative to the projection in June. In my minutes in August, I anticipated the soft inflation readings that came in for July and August: “The forecast – the intermediate target that provides a proximate view of how the goal variables are forming – suggests that inflation is likely to encounter a soft patch in the second quarter, but it will resume an upward trajectory in the second half of the year.” I also warned that “the softer inflation prints expected in Q2 could likely lull inflation expectations, but abundant precaution and decisiveness in quelling risks to the target is warranted if the hard-earned gains in terms of macroeconomic stability and credibility have to be preserved.”
48. Thus, the projections turned out to be directionally correct, although they overestimated the levels of inflation in these months.
49. In view of the reasonable reliability of the forecasts in terms of direction, inflation appears to have troughed and is projected to rise from September, exceeding the target from the fourth quarter of 2018-19 and the first quarter of 2019-20 in an environment suffused with upside risks. Disconcertingly, global risks to inflation from crude prices and financial market turbulence are materialising on an ongoing basis. Corporate finances suggest that it is only a matter of time before firms pass through heightened input costs more aggressively into selling prices. Food inflation is imparting a downside under the influence of a deep cyclical downswing in the prices of some constituents and irregular downturns in others.
50. Meanwhile, aggregate domestic demand, as measured by GDP growth, appears to have quickened on to a higher trajectory (8 per cent) during January-June 2018. Slack has been pulled in and capacity utilisation is getting stretched. Rural and urban spend is strengthening to a point where aggregate demand, especially private consumption, is likely running ahead of the supply response, even as the outlook for agriculture, manufacturing and construction is brightening and a gradual upturn is taking hold in various services sectors.
51. The evolving macroeconomic configuration warrants an appropriate policy response. With the downward level shift in the projections relative to the August resolution, especially during January-June 2019, it is reasonable to keep the policy rate on hold in this meeting and to monitor the cumulative 50 basis points increase in June and August as it works its way through the economy. Stakeholders are anticipating this transmission – households have lowered their expectations of one year ahead inflation, while professional forecasters have revised downwards their outer forecasts of headline inflation. Yet, inflation is set to rise over the period ahead in an environment in which the balance of risks is shifting to the upside. Monetary policy needs to move to high alert, and this needs to be reflected in a pro-active policy stance. Overarchingly, monetary policy needs to stay focused on its mandate – the target of 4 per cent inflation, while keeping in mind the objective of growth – within the RBI’s overall policy framework that assigns appropriate instruments to goals in order to secure efficient policy outcomes.
52. I vote for status quo on the policy rate and a change in stance to “calibrated tightening”. Statement by Dr. Viral V. Acharya
53. Since the August policy, food inflation has surprised dramatically on the downside. Seasonal pickup in prices of vegetables and fruits in summer months was simply missing due to a combination of increased mandi arrivals, export policies and other supply management measures. This, coupled with a normal monsoon, has shifted RBI's food inflation projections significantly downward.
54. Elsewhere, fuel inflation continues its rapid upward march. While inflation excluding food and fuel has eased marginally due to lower momentum in certain goods and services, it remains at elevated levels. International crude oil prices keep surging as Iran sanctions approach, creating a difficult choice between pass-through to the pump prices and fiscal or quasi-fiscal absorption through excise cuts. The rising oil prices also coincide with the misfortune of weaker current account balance, inducing financial market volatility which raises imported inflation, though the direct impact of oil price on inflation via the consequent fare price impact is much larger. The worry is that this could generalise quickly through transportation and freight costs – input costs – that could get passed on to selling prices as capacity utilisation is improving and pricing power is returning to firms.
55. While there was mild softening in the 12-month ahead inflation expectations of households between the June 2018 and September 2018 rounds of RBI’s surveys, the 3-month expectations showed a sharp uptick. I am particularly concerned about the near 200 basis points increase in the 3-month and 12-month inflation expectations of households, based on the surveys of September 2017 to September 2018. Households are telling us that their inflation outlook has moved palpably upwards. Business expectations of headline inflation as well as input costs are showing similar trends, rising steadily in RBI's and other surveys.
56. As a result, headline inflation for Q1:2019-20 is projected at 4.8% vis-à-vis the mandated target of 4%, in spite of the benign food inflation outlook. Between the time the projections were finalised for the Monetary Policy Report (specifically, October 1) and today (October 5), oil prices have risen steeply, without any signs of durable supply adjustment amidst strong global demand.
57. Growth has been reasonably buoyant as evidenced by the real economic activity indicators for both the rural economy and the urban counterpart. Our estimates of the output gap suggest it has virtually closed as per the traditional measures; my preferred finance-neutral output gap measure has in fact turned positive due to asset price growth and especially non-food credit growth that is now in excess of the nominal GDP growth rate.
58. In such a milieu, the likelihood of oil prices remaining elevated rules out a rate cut anytime soon. Second round effects of the steep oil price rise can generalise causing inflation expectations to unhinge. Even if pass-through to pump prices is made less than one for one, inflation risk would generalise through fiscal slippage.
59. Given these factors, and given the flexible inflation-targeting mandate of the Monetary Policy Committee (MPC), it seems important to signal commitment to keeping to the mandate and move forward carefully at an appropriate time, allowing the economy to adjust to the past two back-to-back rate hikes while being vigilant of any emerging inflationary pressures.
60. Hence, I vote for not to raise the policy rate but change the stance of monetary policy to one of “calibrated tightening”. Statement by Dr. Urjit R. Patel
61. Headline inflation adjusted for the estimated impact of HRA for central government employees moderated significantly from 4.6 per cent in June 2018 to 3.8 per cent in July and further to 3.4 per cent in August, reversing the trend of previous three months. Food inflation continued to surprise on the downside, declining sharply from 3.1 per cent in June to 0.9 per cent by August in the absence of a seasonal pick up in prices of key vegetables and fruits in summer months. Inflation in items other than food and fuel also moderated due mainly to softening in housing, clothing and transportation. However, inflation in the fuel group increased reflecting higher international petroleum product prices. Overall, actual inflation turnouts in July and August were lower than the projections set out in the August resolution of the MPC.
62. Going forward, excluding the HRA impact, CPI inflation is projected at 3.7 per cent in Q2:2018-19, 3.8-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20. The outlook for inflation continues to face several upside pressures, which include: (i) uncertainty surrounding the impact of the increase in minimum support prices of kharif crops on food inflation; (ii) surge in crude oil prices; (iii) heightened volatility in financial markets of emerging economies; (iv) a further increase in inflation expectations of households at three-month horizon, which when combined with rising input costs, may impact price and wage setting behaviour, though it is comforting that one-year ahead inflation expectations have moderated; (v) the risk of fiscal slippage at the centre and/or state level; and (vi) second round effects on inflation on account of the staggered HRA revisions by various state governments, though the direct statistical impact of HRA revisions will be looked through.
63. The GDP growth print for Q1 of 2018-19 touched a high of 8.2 per cent, driven by robust private consumption and investment activity, suggesting that growth impulses, thus far, continue to be buoyant. The first advance estimates of production of major kharif crops are reassuring, considering spatially and temporally uneven monsoon. Going forward, consumption is expected to be sustained. Though rising oil prices and tightening of financial conditions may have a bearing on investment demand, overall economic activity is expected to be resilient with GDP growth for 2018-19 projected at 7.4 per cent (as in the August resolution). GDP growth for Q1:2019-20 is projected marginally lower at 7.4 per cent vis-à-vis 7.5 per cent in the August resolution.
64. The policy repo rate was raised by 25 basis points each in the last two consecutive meetings of the MPC in June and August. Moderation in inflation in the last two months has lowered the projected inflation trajectory. I vote for keeping the policy repo rate unchanged. Recognising that inflation risks have been persistent, and to reaffirm the commitment to securing the mandated 4 per cent inflation target on a durable basis, it is apposite to change the stance of monetary policy from “neutral” to “calibrated tightening”. “Calibrated tightening” means that in the current rate cycle, a cut in the policy repo rate is off the table, and we are not obliged to increase the rate at every policy meeting. Jose J. Kattoor Press Release : 2018-2019/924 Chief General Manager
6. Since the last MPC meeting in October 2018, global economic activity has shown increasing signs of weakness on rising trade tensions. Among advanced economies (AEs), economic activity appears to be slowing in the US in Q4:2018, after a buoyant Q3. The Euro area growth lost pace in Q3, impacted by weaker trade growth and new vehicle emission standards. The Japanese economy contracted in Q3 on subdued external and domestic demand.
7. Economic activity also decelerated in major emerging market economies (EMEs) in Q3. In China, growth slowed down on weak domestic demand. The ongoing trade tensions and the possible cooling of the housing market pose major risks to growth in China. The Russian economy lost some traction, pulled down largely by a weak agriculture harvest, though the growth was buttressed by strong performance of the energy sector. The Brazilian economy seems to be recovering gradually from the economic disruption in the first half of the year. The South African economy expanded in Q3, after contracting in the previous two quarters, driven by agriculture and manufacturing.
8. Crude oil prices have declined sharply, reflecting higher supplies and easing of geo-political tensions. Base metal prices have continued to decline on selling pressure following weak demand from major economies. Gold price has risen underpinned by safe haven demand triggered by political uncertainty in some geographies, though a strong dollar may stem the rise. The inflation scenario has remained broadly unchanged in the US and the Euro area. In many key EMEs, however, inflation has risen, though the recent retreat in energy prices, tightening of policy stances by central banks and stabilising of currencies may have a salutary impact, going forward.
9. Global financial markets have been driven mainly by rising policy rates in the US, volatile crude oil prices and expectations of a slowdown compared with earlier projections. Among AEs, equity markets in the US witnessed a selloff on the weakening outlook for corporate earnings caused by rising borrowing costs, while the European stock markets declined on political uncertainties. The Japanese stock market also shed gains on global cues and the gradual strengthening of the yen. EM stock markets have corrected on shrinking global liquidity, weak economic data in some key EMEs, and lingering trade tensions. The 10-year yield in the US, which surged on robust economic data at the beginning of October, softened subsequently on the unchanged Fed stance. Among other AEs, bond yields in the Euro area and Japan softened on weak economic sentiment and idiosyncratic factors. In most EMEs, bond yields have softened in recent weeks on falling crude oil prices and steadying currencies. In currency markets, the US dollar, which was strengthening on a widening growth differential with its peers, eased in the second half of November. The euro has weakened on Brexit and budget concerns in Italy, while the yen appreciated on safe haven buying in November. EME currencies have been trading with an appreciating bias, supported by a sharp decline in crude oil prices and conservative domestic monetary policy stances.
10. On the domestic front, gross domestic product (GDP) growth slowed down to 7.1 per cent year-on-year (y-o-y) in Q2:2018-19, after four consecutive quarters of acceleration, weighed down by moderation in private consumption and a large drag from net exports. Private consumption slowed down possibly on account of moderation in rural demand, subdued growth in kharif output, depressed prices of agricultural commodities and sluggish growth in rural wages. However, growth in government final consumption expenditure (GFCE) strengthened, buoyed by higher spending by the central government. Gross fixed capital formation (GFCF) expanded by double-digits for the third consecutive quarter, driven mainly by the public sector’s thrust on national highways and rural infrastructure, which was also reflected in robust growth in cement production and steel consumption. Growth of imports accelerated at a much faster pace than that of exports, resulting in net exports pulling down aggregate demand.
11. On the supply side, growth of gross value added (GVA) at basic prices decelerated to 6.9 per cent in Q2, reflecting moderation in agricultural and industrial activities. Slowdown in agricultural GVA was largely the outcome of tepid growth in kharif production. Within industry, growth in manufacturing decelerated due to lower profitability of manufacturing firms, pulled down largely by a rise in input costs, while that in mining and quarrying turned negative, caused by a contraction in output of crude oil and natural gas. Growth in electricity, gas, water supply and other utility services strengthened. Services sector growth remained unchanged at the previous quarter’s level. Of its constituents, growth in construction activity decelerated sequentially, but it was much higher on a y-o-y basis. Growth in public administration and defence services accelerated sharply.
12. Looking beyond Q2, rabi sowing so far (up to end-November) has been 8.3 per cent lower as compared with the same period last year due mainly to lower soil moisture levels resulting from a deficient monsoon and a delayed kharif harvest across states. Precipitation during the north-east monsoon as on November 28 was 49 per cent below the long period average. Storage in major reservoirs, the main source of irrigation during the rabi season, was at 61 per cent of the full reservoir level as on November 29.
13. Growth in the index of industrial production (IIP) slowed down to 4.5 per cent in September 2018. Capacity utilisation (CU), measured by the Reserve Bank’s Order Books, Inventories and Capacity Utilisation Survey (OBICUS), increased from 73.8 per cent in Q1 to 76.1 per cent in Q2, which was higher than the long-term average of 74.9 per cent; seasonally adjusted CU also increased to 76.4 per cent. Available high frequency indicators suggest that industrial activity has been improving in Q3. The growth in core industries recovered in October on the back of double-digit expansion in coal, cement and electricity. The purchasing managers’ index (PMI) for manufacturing touched an eleven-month high of 54.0 in November, supported by an expansion in output, and domestic and export orders. According to the assessment of the Reserve Bank’s Industrial Outlook Survey (IOS), the overall business sentiment in Q3 remained stable, with sustained optimism about production and exports.
14. High frequency indicators of service sector activity showed a mixed picture in September-October. Growth in tractors sales – an indicator of rural demand – turned negative in September. Growth in two-wheeler sales, another indicator of rural demand, rebounded in October, supported by a base effect. Growth in passenger vehicles sales – an indicator of urban demand – turned marginally positive in October, after three consecutive months of negative growth coincident with changes in mandatory long-term third-party insurance requirements and a sharp increase in fuel prices. Commercial vehicle sales growth remained robust in September-October, despite some deceleration. Railway freight traffic improved markedly in October to touch a five-year high growth. While domestic air passenger traffic sustained robust growth, international passenger traffic contracted. PMI for services registered a sharp uptick in November, driven by new business. The composite PMI output index touched a two-year high of 54.5 in November.
15. Retail inflation, measured by y-o-y change in CPI, declined from 3.7 per cent in September to 3.3 per cent in October. A large fall in food prices pushed food group into deflation and more than offset the increase in inflation in items excluding food and fuel. Adjusting for the estimated impact of an increase in house rent allowance (HRA) for central government employees, headline inflation was 3.1 per cent in October.
16. Within the food and beverages group, deflation in vegetables, pulses and sugar deepened in October. Among other items, there was a broad-based softening across food items, especially cereals, milk, fruits and prepared meals. Milk and milk products inflation softened caused by surplus supplies in the domestic market. Fruits inflation moderated, while prepared meals registered a price decline for the first time in the CPI series. Inflation, however, showed an uptick in meat and fish, and non- alcoholic beverages.
17. Inflation in the fuel and light group remained elevated, driven by liquefied petroleum gas prices in October, tracking international petroleum product prices. Kerosene prices also edged up, reflecting the calibrated increase in their administered price. However, electricity prices softened in October. Inflation in rural fuel items such as firewood and chips and dung cake also moderated.
18. CPI inflation excluding food and fuel accelerated to 6.1 per cent in October; adjusted for the estimated HRA impact, it was 5.9 per cent. Transport and communication registered a marked increase, pulled up by higher petroleum product prices, transportation fares and prices of automobiles. A broad-based increase was also observed in health, household goods and services, and personal care and effects. However, inflation moderated significantly in clothing and footwear, as also housing on waning of the HRA impact of central government employees.
19. Inflation expectations of households, measured by the November 2018 round of the Reserve Bank’s survey, softened by 40 basis points for the three-month ahead horizon over the last round reflecting decline in food and petroleum product prices, while they remained unchanged for the twelve-month ahead horizon. Producers’ assessment for input prices inflation eased marginally in Q3 as reported by manufacturing firms polled by the Reserve Bank’s IOS. Domestic farm and industrial input costs remained high. Rural wage growth remained muted in Q2, while staff cost growth in the manufacturing sector remained elevated.
20. The weighted average call rate (WACR) traded below the policy repo rate on 14 out of 21 days in October, on all 18 days in November and both days in December (December 3 and 4). The WACR traded below the repo rate on an average by 5 basis points in October, 9 basis points in November and 16 basis points in December. There was large currency expansion in October and especially during the festive season in November. Currency in circulation, however, contracted in each of the last three weeks in November. Liquidity needs arising from the growth in currency and the Reserve Bank’s forex operations were met through a mixture of tools based on an assessment of the evolving liquidity conditions. The Reserve Bank injected durable liquidity amounting to ₹360 billion in October and ₹500 billion in November through open market purchase operations, bringing total durable liquidity injection to ₹1.36 trillion for 2018-19. Liquidity injected under the LAF, on an average daily net basis, was ₹560 billion in October, ₹806 billion in November and ₹105 billion in December (up to December 4).
21. India’s merchandise exports rebounded in October 2018, after moderating in the previous month, driven mainly by petroleum products, engineering goods, chemicals, electronics, readymade garments, and gems and jewellery. Imports also grew at a faster pace in October relative to the previous month, contributed mainly by petroleum products and electronic goods. Consequently, the trade deficit widened in October 2018 sequentially as also in comparison with the level a year ago. Provisional data suggest a modest improvement in net exports of services in Q2:2018-19, which augurs well for the current account balance. On the financing side, net FDI flows moderated in April-September 2018. Portfolio flows turned positive in November on account of a sharp decline in oil prices, indications of a less hawkish stance by the US Fed and a softer US dollar. However, during the year, there were net portfolio outflows of US$ 14.8 billion (up to November 30). Non- resident deposits increased markedly in H1:2018-19 on a net basis over their level a year ago. India’s foreign exchange reserves were at US$ 393.7 billion on November 30, 2018. Outlook
22. In the fourth bi-monthly resolution of October 2018, CPI inflation was projected at 4.0 per cent in Q2:2018-19, 3.9-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20, with risks somewhat to the upside. Excluding the HRA impact, CPI inflation was projected at 3.7 per cent in Q2:2018-19, 3.8-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20. The actual inflation outcome in Q2 at 3.9 per cent was marginally lower than the projection of 4.0 per cent. However, the October inflation print at 3.3 per cent turned out to be unexpectedly low.
23. There have been several important developments since the October policy which will have a bearing on the inflation outlook. First, despite a significant scaling down of inflation projections in the October policy primarily due to moderation in food inflation, subsequent readings have continued to surprise on the downside with the food group slipping into deflation. At a disaggregated level, deflation in pulses, vegetables and sugar widened, while cereals inflation moderated sequentially. The broad-based weakening of food prices imparts downward bias to the headline inflation trajectory, going forward. Secondly, in contrast to the food group, there has been a broad-based increase in inflation in non-food groups. Thirdly, international crude oil prices have declined sharply since the last policy; the price of Indian crude basket collapsed to below US$ 60 a barrel by end-November after touching US$ 85 a barrel in early October. However, selling prices, as reported by firms polled in the Reserve Bank’s latest IOS, are expected to edge up further in Q4 on the back of increased demand. Fourthly, global financial markets have continued to be volatile with EME currencies showing a somewhat appreciating bias in the last one month. Finally, the effect of the 7th Central Pay Commission’s HRA increase has continued to wane along expected lines. Taking all these factors into consideration and assuming a normal monsoon in 2019, inflation is projected at 2.7-3.2 per cent in H2:2018-19 and 3.8-4.2 per cent in H1:2019-20, with risks tilted to the upside (Chart 1). The projected inflation path remains unchanged after adjusting for the HRA impact of central government employees as this impact dissipates completely from December 2018 onwards. Although recent food inflation prints have surprised on the downside and prices of petroleum products have softened considerably, it is important to monitor their evolution closely and allow heightened short-term uncertainties to be resolved by incoming data.
24. Turning to growth projections, although Q2 growth was lower than that projected in the October policy, GDP growth in H1 has been broadly along the line in the April policy when for the year as a whole GDP growth was projected at 7.4 per cent. Going forward, lower rabi sowing may adversely affect agriculture and hence rural demand. Financial market volatility, slowing global demand and rising trade tensions pose negative risk to exports. However, on the positive side, the decline in crude oil prices is expected to boost India’s growth prospects by improving corporate earnings and raising private consumption through higher disposable incomes. Increased capacity utilisation in the manufacturing sector also portends well for new capacity additions. There has been significant acceleration in investment activity and high frequency indicators suggest that it is likely to be sustained. Credit offtake from the banking sector has continued to strengthen even as global financial conditions have tightened. FDI flows could also increase with the improving prospects of the external sector. The demand outlook as reported by firms polled in the Reserve Bank’s IOS has improved in Q4. Based on an overall assessment, GDP growth for 2018-19 has been projected at 7.4 per cent (7.2-7.3 per cent in H2) as in the October policy, and for H1:2019-20 at 7.5 per cent, with risks somewhat to the downside (Chart 2).
25. Even as inflation projections have been revised downwards significantly and some of the risks pointed out in the last resolution have been mitigated, especially of crude oil prices, several uncertainties still cloud the inflation outlook. First, inflation projections incorporate benign food prices based on the realised outcomes of food inflation in recent months. The prices of several food items are at unusually low levels and there is a risk of sudden reversal, especially of volatile perishable items. Secondly, available data suggest that the effect of revision in minimum support prices (MSPs) announced in July on prices has been subdued so far. However, uncertainty continues about the exact impact of MSP on inflation, going forward. Thirdly, the medium-term outlook for crude oil prices is still uncertain due to global demand conditions, geo-political tensions and decision of OPEC which could impinge on supplies. Fourthly, global financial markets continue to be volatile. Fifthly, though households’ near-term inflation expectations have moderated in the latest round of the Reserve Bank’s survey, one-year ahead expectations remain elevated and unchanged. Sixthly, fiscal slippages, if any, at the centre/state levels, will influence the inflation outlook, heighten market volatility and crowd out private investment. Finally, the staggered impact of HRA revision by State Governments may push up headline inflation. While the MPC will look through the statistical impact of HRA revisions, it will be watchful of any second-round effects on inflation.
26. The MPC noted that the benign outlook for headline inflation is driven mainly by the unexpected softening of food inflation and collapse in oil prices in a relatively short period of time. Excluding food items, inflation has remained sticky and elevated, and the output gap remains virtually closed. The MPC also noted that even as escalating trade tensions, tightening of global financial conditions and slowing down of global demand pose some downside risks to the domestic economy, the decline in oil prices in recent weeks, if sustained, will provide tailwinds. The acceleration in investment activity also bodes well for the medium-term growth potential of the economy. The time is apposite to further strengthen domestic macroeconomic fundamentals. In this context, fiscal discipline is critical to create space for and crowd in private investment activity.
27. Against this backdrop, the MPC decided to keep the policy repo rate on hold and maintain the stance of calibrated tightening. While the decision on keeping the policy rate unchanged was unanimous, Dr. Ravindra H. Dholakia voted to change the stance to neutral. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis. The minutes of the MPC’s meeting will be published by December 19, 2018.
28. The next meeting of the MPC is scheduled from February 5 to 7, 2019. Voting on the Resolution to keep the policy repo rate unchanged at 6.5 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Dr. Urjit R. Patel Yes Statement by Dr. Chetan Ghate
29. In the October policy, I had highlighted the primacy of keeping inflationary expectations anchored – whether formed rationally or adaptively – durably at the 4% target. While the one-year ahead median inflationary expectations remained unchanged at 9.8% in the latest round, the three-month median inflationary expectations declined by 40 bps to 9%. The decline in the three-month inflationary expectations number, but unchanged one-year ahead expectations number probably indicates that households don’t expect the current decline in inflation to last. Notwithstanding this, these numbers bring some comfort.
30. In the October policy, I had also mentioned that two interlaced variables pose the potential of un-anchoring inflationary expectations, and thereby making it difficult to ensure price stability on an enduring basis: the nominal depreciation of the Rupee, and the increase in the price of oil. Since October, there was a substantial, though unanticipated, reversal in the price of oil, and by December, it was lower by over 29% compared to its October peak. There was also a strengthening of the Rupee by close to 4.6% (Dec 4 over Oct 5). Food inflation also fell to -0.1% in October. If oil and food prices stay lower for longer, this will help inflationary expectations taper. However, given the buoyancy in oil, and the risks of imported inflation from movements in the exchange rate, both variables need to be carefully watched.
31. The evolution of MSP-inflation dynamics also needs to be carefully watched, although this risk to inflation projections appears mitigated compared to a few months ago.
32. The elevated level of inflation excluding food and fuel (6.1%) at a 3-month high continues to be problematic. Most sub-groups of inflation excluding food and fuel, other than clothing and footwear, have registered upticks. The reversal in inflation excluding food and fuel needs to be carefully watched.
33. Since the last review, overall demand conditions in the manufacturing sector have continued to remain steady. Capacity utilization in Q2 crossed its long-term average (74.9%) and is expected to gather pace going forward. The sustained acceleration in investment activity is encouraging, and this will support rising capex and a higher investment/GDP ratio. There is an improvement in the overall business situation, as tracked by the BEI for manufacturing. Both leading and coincident economic indicators for Q3 growth look good at the current juncture. Organized sector nominal wage growth continues to be high suggesting input cost pressures.
34. Consumer confidence however worsened compared to the previous round suggesting pessimism about the present. Private final consumption expenditure growth momentum also fell in Q2. Merchandise export growth in Q2 however improved relative to Q1, although on the external front, the potential for escalation of tariffs or trade tensions may slow down global growth more than expected.
35. With both the inflation and growth numbers having developed “soft-spots”, the appropriate risk-management approach at the current juncture would be to “wait and watch.” This will allow the MPC to see how various risks to both inflation and growth evolve, and better assess the ability of flexible inflation targeting to absorb the impact of shocks that the economy is currently experiencing.
36. I therefore vote to keep the policy rate unchanged. I vote to keep the stance as calibrated tightening. Statement by Dr. Pami Dua
37. Headline inflation softened to 3.3 per cent in October from 3.7 per cent in September, primarily due to the drop in food inflation from 1 per cent in September to -0.1 per cent in October. Headline inflation adjusted for the estimated impact of an increase in house rent allowance (HRA) of central government employees (as per RBI’s estimates) also moderated from 3.5 per cent in September to 3.1 per cent in October, while CPI excluding food and fuel adjusted for the impact of an increase in HRA increased from 5.3 per cent in September to 5.9 per cent in October. At the same time, various surveys provide mixed signals regarding inflation expectations. Inflation expectations from the November round of the Reserve Bank’s Survey of Households softened by 40 basis points for three-month ahead expectations vis-à-vis the last round but did not change for one-year ahead expectations. The Reserve Bank’s Industrial Outlook Survey indicates moderation in input prices in the third quarter of 2018-19 as reported by manufacturing firms.
38. Looking forward, downside risks to the inflation outlook include continuing moderation in food inflation and a sharp fall in crude oil prices. At the same time, the slowdown in global growth may also lead to softening of crude oil prices. On the flip side, there is also the possibility of a rebound in crude oil prices due to supply factors. Additionally, fiscal slippages by the government may have adverse implications for market volatility and impact the outlook for inflation. Upside risks associated with an increase in minimum support prices (MSPs) still persist. Risks due to an increase in state level HRAs and input prices also prevail. Thus, there is considerable uncertainty with respect to the inflation outlook and movements in both food inflation and crude oil prices have to be watched closely.
39. On the output side, GDP growth in the second quarter of 2018-19 slowed to 7.1 per cent from 8.2 per cent in the previous quarter. Private consumption growth moderated possibly due to easing in rural demand that may have resulted from depressed farm prices and sluggish rural wage growth although investment growth was strong partly due to government spending in infrastructure projects. At the same time, the Purchasing Managers’ Index (PMI) for manufacturing rose to an eleven- month high in November reflecting an expansion in output, and orders (domestic and exports). PMI for services also rose due to new businesses. Forward looking indicators such as RBI’s Business Expectations Index for the manufacturing sector signal an improvement in the fourth quarter based on upbeat sentiments on production, order books, exports and capacity utilisation. Meanwhile, growth in the Indian Leading Index, a predictor of the direction of Indian economic growth maintained by the Economic Cycle Research Institute (ECRI), New York, has risen lately, indicating some improvement in economic growth prospects.
40. Downside risks to growth include lower sowing in the rabi season, financial volatility, global slowdown and trade war, while the drop in crude oil prices and rise in credit offtake augur well for growth prospects. As of now, net exports are a drag with growth in imports sharper relative to exports growth. However, growth in ECRI’s Indian Leading Export Index, a predictor of the direction of exports growth, has ticked up lately, indicating a slightly brighter Indian export growth outlook, despite languishing growth in ECRI’s 20-country composite Long Leading Index, which still points to a continued global growth slowdown.
41. In sum, while inflation has softened, upside risks to inflation remain. It is therefore best to pause and wait for incoming data while maintaining a vigil on inflation, especially with respect to food and crude oil. I therefore vote for keeping the policy repo rate unchanged. At the same time, given the uncertainty with respect to the inflation outlook, I also vote for maintaining the stance of calibrated tightening. Statement by Dr. Ravindra H. Dholakia
42. Drastic and sudden changes in external economic environment have taken place after the last meeting of MPC in October 2018. Should these changes evoke a response through an appropriate policy action? - yes, if they are not purely temporary and have reasonably long term impact on the economy. RBI’s own downward revision of the forecast of inflation 12 months ahead to a substantial extent in response to those developments, is a clear indication of their long-term impact on the economy. Thus, a policy response is called for. If there is no policy action in response to such a major favourable shock, MPC would run the risk of being considered neither current nor relevant! With inflation forecast coming down by around 120 basis points and quarterly growth forecasts marginally revised downward opening up output gap going forward, there is hardly any justification in retaining calibrated tightening stance. In my opinion, this would be the right time to cut the rate and bring the unduly high real interest rates in the country back to around 2 per cent. It was, however, unfortunate that in October 2018, MPC had changed its stance to calibrated tightening with 5:1 majority despite my unsuccessful persuasion to maintain neutral stance. As a result, any rate cut is off the table for now and any such action would not be advisable at this point. The best we can do under the circumstance is to hold the rate, but change the stance to neutral to take care of all possible uncertainties. We should not deny any possibility of either a rate cut or a rate hike in the near future depending on data coming in.
43. More specific reasons for my vote on the rate and the stance are: i) While the MPC resolution points largely to the upside risks to the RBI’s inflation forecasts, there are downside risks that cannot be overlooked: Oil price uncertainties are on both the directions; Qatar has opted out of OPEC and it can set a trend for others; OPEC meeting can go either way; the ultimate impact on oil prices would be determined by faithful implementation of its decision by all members; and role of USA in this matter cannot be ignored. ii) Similarly, Federal Reserve has practically changed its stance on rate hikes in future. Moreover, the USA economy is not likely to be very strong over time consistently. iii) Fiscal slippage is possible but the extent of it may not warrant any panic because its impact on inflation may not be significant and will be felt, if at all, with a considerable lag. iv) Real interest rate in the economy is very high. Even ignoring the issues concerning upward bias in the current measurement of inflation, it is substantially in excess of 200 basis points and is one of the highest in the world. v) Although the MPC resolution says that inflationary expectations one year ahead as per the latest RBI survey is constant compared to the previous survey, most of the 18 cities surveyed show a decline in the household inflationary expectation one year ahead. Only a few cities show an increase that neutralizes the decline observed in majority of cities. This brings to the fore the measurement issue for inflationary expectation in quantitative terms. We should be looking at the inflationary expectations of households not only in the urban cities but also in the smaller towns and the rural areas where inflation has come down significantly in recent times. In all likelihood, their inflationary expectation would be declining. Moreover, as I have argued elsewhere (EPW, Nov. 17, 2018), there is a need to consider expectation of businesses about the CPI headline inflation. The IIMA survey on them shows a marked decline of about 30 basis points. Thus, in the aggregate, the inflationary expectation in the country as a whole one year ahead seems to be declining and not remaining the same.
44. Under such circumstances, retaining the stance of calibrated tightening seems totally inconsistent and unjustified. All these points require a change in the stance from calibrated tightening to neutral to take care of several uncertainties on both sides so that a rate decision can be appropriately data driven in future. Statement by Dr. Michael Debabrata Patra
45. I vote for status quo on the policy repo rate and for maintaining the stance of calibrated tightening.
46. In its October 2018 meeting, the MPC anticipated the softening of headline inflation in the months ahead, revising its forecast down by 90 basis points in Q3: 2018-19 and by 30 basis points in Q4, and this sentiment was also reflected in individual minutes. The actual outturns for September and October undershot even the revised projections substantially, with prices of food unexpectedly sinking into deflation. In my view, the Indian economy is experiencing the onset of positive supply shocks as reflected in the sizable easing of prices of food and petroleum products, which could reverse. Accordingly, they should be looked through, while remaining alert to spillovers to the rest of inflation which is already elevated and rising. Households have ignored this unusual softening of inflation prints and have kept their 12-months ahead expectations unchanged, while professional forecasters have projected inflation to rise to 4.5-4.6 per cent in the first half of 2019-20. Consumers remain pessimistic about the price situation, citing it as the main factor influencing their perceptions of worsening general economic conditions. Corporates assess that input cost pressures will remain firm. Based on current reckoning, the MPC projects inflation to rise above the target in the first half of 2019-20. Taking these factors into account, I reiterate that although softer inflation prints could likely lull inflation expectations, abundant precaution and decisiveness in quelling risks to the target are warranted if the hard-earned gains in terms of macroeconomic stability and credibility are to be preserved.
47. Turning to growth, the CSO’s GDP estimates for Q2:2018-19 show a sequential moderation, but this needs to be caveated by the base effect driven bump in the previous quarter; on a year-on-year basis, though, there has been a marked acceleration in aggregate demand in the first half of 2018-19 and two main engines – investment and exports – are firing. Lead/coincident indicators for Q3 – order books; capacity utilisation in manufacturing; non-food credit growth; capital goods imports; railway and port freight traffic; construction activity – all point to the momentum of growth being sustained. Annual real GDP growth will likely accelerate in 2018-19 from its level a year ago. On the production side, the momentum of activity would be underpinned by buoyancy in manufacturing and some improvement in services sector performance.
48. With average inflation gradually converging to target, these growth impulses can be maintained by ensuring that the expansion remains sustainable. It is in this context that my preference is for keeping the policy rate unchanged. With inflation projected to rise above 4 per cent over the 12-month ahead horizon, it is apposite to persevere with the stance of calibrated tightening to head off inflation pressures from potentially corroding the foundations of the growth path that is evolving over the medium-term. Statement by Dr. Viral V. Acharya
49. Since the October 2018 Monetary Policy Committee (MPC) meeting, there have been two downward surprises to realised inflation.
50. First, food inflation has had an unexpectedly large collapse, again in vegetables and fruits, but somewhat more broad-based than the inflation decline in preceding months; the collapse has been sharper in rural inflation than in urban inflation.
51. Secondly, international crude oil prices that had been simmering to levels above $85 per barrel also crashed dramatically – by close to 30%. It appears that the “stock out” supply risk that was priced at the short end of the oil futures curve has subsided as the curve has flattened now compared to its sharp backwardation shape in early October. The oil price crash, in turn, has improved external sector prospects for India and caused the currency to strengthen appreciably, reducing the magnitude of imported inflation.
52. Together, these factors have resulted in an extraordinary downward revision in the Reserve Bank’s 12-month ahead inflation outlook. However, the past two months have also been extraordinarily volatile, making it difficult to make a complete sense of recent data. Let me elaborate.
53. First, it is not easy to ascertain fully at this stage the nature of the collapse of food inflation seen in recent months, particularly in terms of its implications for the food inflation outlook over the medium term. A clearer assessment is particularly clouded by divergence in the direction of price movements in data in key food items provided by the Department of Consumer Affairs (DCA) and realised food inflation for October. Such divergence in the direction is rarely observed. Further examination of data is necessary to understand with greater clarity the drivers of food deflation.
54. Secondly, market indicators of uncertainty in international crude oil prices remain high, reflecting the unexpectedly large gyrations in their movement this year and upcoming geo-political risks such as OPEC supply decision and trade war uncertainty’s impact on global demand. The implied volatility in crude oil options markets was around 25% per annum (p.a.) in October, which rose to around 45% p.a following the oil price crash. This is a rather high level of uncertainty embedded in expectations of market participants.
55. Thirdly, inflation excluding food and fuel remains persistently high. It is over 6% at present, with only 20-30 basis points attributable to the statistical impact of Centre’s House Rent Allowances (HRA).
56. Fourthly, the Reserve Bank’s Industrial Outlook Survey suggests that input cost pressures are still high for firms and expected to remain elevated (consistent with both closing of the output gap and improvement in capacity utilisation beyond the long period average). This is expected to result in cost pass-through to consumers in the coming months.
57. Fifthly, median household inflation expectations have softened at 3-month horizon by 40 basis points but remain unchanged for 12-month horizon. Over a 12- month period during which the Reserve Bank has raised the policy rate by 50 basis points (bps), median household expectations of inflation for 3-month horizon have risen by 150 bps and for 12-month horizon by 120 bps.
58. Finally, the risk of a fiscal slippage at the center and/or state levels appears to be considered within the realm of reasonable possibility. As such, the sharp decline in oil prices has provided an opportunity for fiscal consolidation.
59. In summary, even though the projections have been revised downwards significantly, several upside risks remain. In my view, it is better to understand data somewhat better over the next two months. Counter-factual exercises suggest that with headline inflation at 12-month horizon above the target (at 4.2% in Q2 of 2019- 20), a change in the stance at this stage, especially with heightened oil price volatility, would be premature. In other words, while the recent downward surprises to inflation have significantly reduced the extent of policy tightening required in future, they have not eliminated the requirement altogether.
60. Turning to growth, the outlook remains overall healthy, though there are some signs of emerging downside risks. On the positive front, investment has picked up and should be buoyed further by improving capacity utilisation. Composite PMI stands at its highest level in 24 months. Coincident and leading indicators, such as aggregate bank credit, are increasing above the nominal GDP growth rate. Oil price and external sector pressures have reduced which should ease financing conditions. On the negative front, there are some segments experiencing slowdown such as auto sales, but at least a part of this appears, in our research, to be linked to fuel price rise of past six months and regulatory revisions in mandatory third-party insurance requirements. The Q2 print for GDP growth was below the Reserve Bank’s expectation but the Q1 print was far above. Overall, due to change in macroeconomic conditions, the two-sided growth surprises have not led to revision in our growth forecast for next 12 months.
61. On balance, given the relatively short period of time over which inflation has softened, it is important to wait and watch, i.e., remain data-dependent as well as reliant on clear understanding of the drivers of recent data. I, therefore, vote for keeping the policy repo rate on hold and maintaining the stance of monetary policy as calibrated tightening. Statement by Dr. Urjit R. Patel
62. Headline inflation moderated significantly to 3.3 per cent in October from 3.7 per cent in August. Headline inflation adjusted for the estimated impact of HRA for central government employees also softened to 3.1 per cent in October from 3.4 per cent in August 2018. Food inflation continued to surprise on the downside; widening of deflation in pulses, vegetables, and sugar, along with broad-based moderation in other food items moved the food group into deflation. Inflation in fuel remained elevated, reflecting a rise in international prices of liquefied petroleum gas and calibrated increase in domestic administered prices of kerosene. Inflation in items other than food and fuel rose sharply (to more than 6 per cent) on account of transport and communication, health, household goods and services and personal care and effects. On the whole, actual CPI inflation prints, especially in October, turned out to be markedly lower than the projections set out in the October policy.
63. Going forward, inflation is projected at 2.7-3.2 per cent in H2:2018-19 and 3.8- 4.2 per cent in H1:2019-20, with risks tilted to the upside. Adjusted for the HRA impact also, the above projections remain unchanged as the impact will fade away completely in December. Though inflation projections have been revised downwards, several uncertainties continue to cloud the outlook in the form of : (i) the risk of a sudden reversal of the unusually low food prices; (ii) continuing uncertainty about the exact impact of MSP on food inflation; (iii) uncertainty of the oil price trajectory; (iv) volatile financial markets; (v) elevated inflation expectations; (vi) the likely staggered impact of HRA revisions by state governments; the direct statistical impact of HRA will be looked through while being mindful of the second-round effects; and (vii) the risk of fiscal slippages at the centre and/or state levels. With the general government (centre plus states) fiscal deficit budgeted at about 6 per cent of GDP in 2018-19, the extant national fiscal stance continues to be more akin to a “shock amplifier” rather than a “shock absorber” for our macroeconomy.
64. Gross domestic product (GDP) growth decelerated to 7.1 per cent in Q2:2018- 19, after four consecutive quarters of acceleration, driven mainly by a slowdown in private consumption. A sharper growth of imports relative to exports resulted in net exports pulling down aggregate demand. However, gross fixed capital formation expanded by double-digits for the third consecutive quarter. On the supply side, growth in manufacturing decelerated due to lower profitability of manufacturing firms. Low precipitation level during the north-east monsoon – 49 per cent below the long period average – may have negative impact on activity in the farm sector. However, on the positive side, the decline in crude oil prices could boost India’s growth prospects. Increased capacity utilisation in the manufacturing sector also augurs well for investment activity, especially because bank credit growth has continued to accelerate. Based on an overall assessment, GDP growth for 2018-19 has been projected at 7.4 per cent (7.2-7.3 per cent in H2) as in the October policy, and for H1:2019-20 at 7.5 per cent, with risks somewhat to the downside. All things considered, the time is apposite to further strengthen domestic macroeconomic fundamentals; fiscal discipline is critical to create space for and crowd in private investment activity.
65. Although the inflation trajectory has been revised downwards, several uncertainties persist, especially about the medium-term outlook of food inflation and oil prices. Incoming data should help clear the haziness and enable better assessment of the inflation outlook, especially regarding the permanence of the current softness in inflation prints. Hence, I vote for keeping the policy repo rate unchanged and retaining the stance of monetary policy as “calibrated tightening”. Should upside risks, as outlined above, not materialise on a durable basis in the coming months, there is possibility of space opening up for policy action in due course. Jose J. Kattoor Press Release: 2018-2019/1411 Chief General Manager
6. Since the last MPC meeting in December 2018, there has been a slowdown in global economic activity. Among key advanced economies (AEs), economic activity in the US lost some steam in Q4:2018. The outlook for Q1:2019 is clouded by the partial government shutdown, though the labour market conditions remain strong. In the Euro area, economic activity lost momentum on weak industrial activity. The Japanese economy is gradually recovering and an accommodative monetary policy stance is expected to buttress domestic spending.
7. Economic activity also slowed in some major emerging market economies (EMEs). In China, growth decelerated in Q4:2018. Economic activity in Russia lost pace, with soft oil prices posing a downside risk to growth. The Brazilian economy appeared to have ended 2018 on a firmer note, driven by improved domestic spending and exports, though industrial activity continued to struggle to recover from the disruptions of H1:2018. In South Africa, the economic recovery in Q4:2018 remained gradual, tempered by weak industrial activity and subdued exports.
8. Crude oil prices recovered from their December lows in early January on production cuts, but remain below their peak levels in October. Base metals, which witnessed selling pressures in December on persisting uncertainty over US-China trade frictions, recouped losses in January on expectations of thawing of trade disputes and production disruptions. Gold prices have risen, underpinned by safe haven demand in response to geo-political uncertainty and volatility in equity markets. Inflation edged lower in major AEs and many key EMEs.
9. Global financial markets began the year on a calmer note after a turbulent December. Among AEs, equity markets in the US recovered from a sharp sell-off in December, triggered by monetary policy tightening by the Fed, trade tensions and an impending shutdown. EM stock markets, which declined in December on a slew of soft economic data, registered some gains recently on expectations of accommodative monetary policy stances in major economies. The 10-year yield in the US, which fell to a multi-month low in December, rose in January on the edging up of crude oil prices and positive risk sentiment, though softening of the Fed stance restricted the gains. Among other AEs, bond yields in the Euro area and Japan eased on diminishing optimism about global growth. In most EMEs, bond yields have eased as well. In currency markets, the US dollar remained under pressure, though expectations of easing trade tensions provided some support. EME currencies appreciated on the pause in the rate hiking cycle by the Fed and expectations of a positive outcome from US-China trade negotiations.
10. Moving on to the domestic economy, on January 7, 2019 the Central Statistics Office (CSO) released the first advance estimates (FAE) for 2018-19, placing India’s real gross domestic product (GDP) growth at 7.2 per cent – the same level as in 2017-18 (first revised estimates). The FAE for 2018-19 featured an acceleration in gross fixed capital formation (GFCF) and a slowdown in consumption expenditure (both private and government). The drag from net exports is estimated to decline in 2018-19.
11. Some indicators of investment demand, viz., production and imports of capital goods, contracted in November/December. Credit flows to industry remain muted. Available data suggest that while revenue expenditure of the Centre, excluding interest payments and subsidies, contracted in Q3, that of States increased sharply, thus maintaining overall growth in government spending.
12. On the supply side, the FAE have placed the growth of real gross value added (GVA) at 7.0 per cent in 2018-19 as compared with 6.9 per cent in 2017-18. The estimates incorporated a slowdown in agricultural GVA growth and an acceleration in industrial GVA growth. Services GVA growth is set to soften due to subdued activity in trade, hotels, transport, communication and other services. Growth in public administration and defence services is also likely to moderate.
13. Rabi sowing so far (up to February 1, 2019) has been lower than in the previous year, but the overall shortfall of 4.0 per cent across various crops is expected to catch up as the season comes to a close. The lower rabi sowing reflects a deficient north-east monsoon (44 per cent below the long period average); however, storage in major reservoirs – the main source of irrigation during the rabi season – at 44 per cent of the full reservoir level (as on January 31, 2019) was marginally higher than in the previous year. The extended period of cold weather in this year’s winter is likely to boost wheat yields, which would partly offset the shortfall, if any, in area sown.
14. After exhibiting an uptick in the festive month of October, industrial activity, measured by the index of industrial production (IIP), slowed down in November. The year-on-year (y-o-y) growth in core industries decelerated to 2.6 per cent (y-o-y) in December, pulled down by a slowdown in the production of electricity and coal; and contraction in petroleum refinery products, crude oil and fertilisers output. Capacity utilisation (CU) in the manufacturing sector, as measured by the Reserve Bank’s order books, inventory and capacity utilisation survey (OBICUS), increased to 74.8 per cent in Q2 from 73.8 per cent in Q1; seasonally adjusted CU also improved to 75.3 per cent from 74.9 per cent. While the Reserve Bank’s business assessment index of the industrial outlook survey (IOS) for Q3:2018-19 suggests a weakening of demand conditions in the manufacturing sector, the business expectations index (BEI) points to an improvement in Q4. The manufacturing purchasing managers’ index (PMI) for January remained in expansion on the back of increased output and new orders.
15. High-frequency indicators of the services sector suggest some moderation in the pace of activity. Sales of motorcycles and tractors imply weakening of rural demand in December. Sales of passenger cars – an indicator of urban demand – contracted, possibly reflecting volatility in fuel prices and mandated long-term insurance premium payments. Commercial vehicle sales also shrank in December 2018 from a high base of the previous year. Lead indicators for the hotels sub-segment, viz., foreign tourist arrivals and air passenger traffic, point to softening in November-December. In the communication sub-segment, the telephone subscriber base contracted in October-November, while that of broadband continued to expand in October. The services PMI continued to expand in January 2019 despite a dip from the previous month. Indicators of the construction sector, viz., consumption of steel and production of cement, continued to show healthy growth, though growth in cement production inched lower in November 2018, reflecting a base effect.
16. Retail inflation, measured by y-o-y change in the CPI, declined from 3.4 per cent in October 2018 to 2.2 per cent in December, the lowest print in the last eighteen months. Continuing deflation in food items, a sharp fall in fuel inflation and some edging down of inflation excluding food and fuel contributed to the decline in headline inflation.
17. Five constituents of the food group – vegetables, sugar, pulses, eggs and fruits, accounting for about 30 per cent of food group – were in deflation in December. Inflation in respect of other major food sub-groups – cereals, milk, and oils and fats – was subdued. Within cereals, rice prices declined for the fourth consecutive month in December. Inflation in prices of meat and fish and non-alcoholic beverages showed an uptick, while it remained sticky for prepared meals.
18. Inflation in the fuel and light group fell from 8.5 per cent in October to 4.5 per cent in December, pulled down by a sharp decline in the prices of liquefied petroleum gas (LPG), reflecting softening of international petroleum product prices. Kerosene inflation continued to edge up due to the calibrated increase in its administered price.
19. CPI inflation excluding food and fuel decelerated to 5.6 per cent in December from 6.2 per cent in October, dragged down mainly by the moderation in the prices of petrol and diesel in line with the decline in international petroleum product prices. Housing inflation continued to edge down as the impact of the house rent allowance (HRA) increase for central government employees dissipated. However, inflation in several of the sub-groups – household goods and services; health; recreation and amusement; and education – firmed up in December, offsetting much of the impact of lower inflation in petrol, diesel and housing.
20. Inflation expectations of households, measured by the December 2018 round of the Reserve Bank’s survey, softened by 80 basis points for the three-month ahead horizon and by 130 basis points for the twelve-month ahead horizon over the last round, reflecting the continued decline in food and fuel prices. Producers’ assessment of inflation in input prices eased in Q3 as reported by manufacturing firms polled by the Reserve Bank’s industrial outlook survey.
21. Inflation in the prices of farm inputs and industrial raw materials remained elevated, despite some softening. Growth in rural wages moderated in October.
22. The weighted average call rate (WACR) traded below the policy repo rate on 12 out of 20 days in December, all 23 days in January and 4 days in February (up to February 6). The WACR was below the repo rate on an average by 4 basis points in December and 11 basis points each in January and February. Currency in circulation expanded sharply during December and January. The liquidity needs arising out of expansion in currency were met by the Reserve Bank through injection of durable liquidity amounting to ₹500 billion each in December and January through purchases under open market operations (OMOs). Accordingly, total durable liquidity injected through OMOs has aggregated ₹2.36 trillion during 2018-19 so far. Liquidity injected under the LAF was ₹996 billion in December on an average daily net basis, and ₹329 billion in January. In February, however, the average daily liquidity position turned into surplus with an average absorption of ₹279 billion.
23. Export growth on a y-o-y basis was almost flat in November and December 2018, primarily due to a high base effect and weak global demand. While growth in exports of petroleum products remained positive, non-oil exports declined, dragged down by lower shipments of gems and jewellery, engineering goods, meat and poultry. Import growth slowed in November and turned negative in December 2018. While imports of petroleum (crude and products) rose in line with the increase in import volumes, non-oil imports such as pearls and precious stones, gold, electronic goods and transport equipment, recorded declines. The merchandise trade deficit for April-December 2018 was a shade higher than its level a year ago. Net services exports picked up in October and November 2018, which combined with low oil prices, could have a salutary impact on the current account deficit in Q3. On the financing side, net FDI flows to India during April-November 2018 were higher than a year ago. Foreign portfolio flows turned negative in January 2019, after rebounding in November and December 2018. India’s foreign exchange reserves were at US$ 400.2 billion on February 1, 2019. Outlook
24. In the fifth bi-monthly monetary policy resolution in December 2018, CPI inflation for 2018-19 was projected in the range of 2.7-3.2 per cent in H2:2018-19 and 3.8-4.2 per cent in H1:2019-20, with risks tilted to the upside. The actual inflation outcome at 2.6 per cent in Q3:2018-19 was marginally lower than the projection. There have been downward revisions in inflation projections during the course of the year, reflecting mainly the unprecedented soft inflation recorded across food sub-groups.
25. Several factors will shape the inflation path, going forward. First, food inflation has continued to surprise on the downside with continuing deflation across several items and a significant moderation in inflation in cereals. Several food groups are experiencing excess supply conditions domestically as well as internationally. Hence, the short-term outlook for food inflation appears particularly benign, despite adverse base effects. Secondly, the moderation in the fuel group was larger than anticipated. Inflation in items of rural consumption such as firewood and chips, which had remained sticky and at elevated levels, has collapsed in recent months. Electricity prices also showed an unexpected moderation, providing a softer outlook for the fuel group. Thirdly, while inflation excluding food and fuel remains elevated, the recent unusual pick-up in the prices of health and education could be a one-off phenomenon. Fourthly, the crude oil price outlook remains broadly the same as in the December policy. Fifthly, the Reserve Bank’s surveys show that inflation expectations of households as well as input and output price expectations of producers have moderated significantly. Finally, the effect of the HRA increase for central government employees has dissipated completely along expected lines. Taking into consideration these developments and assuming a normal monsoon in 2019, the path of CPI inflation is revised downwards to 2.8 per cent in Q4:2018-19, 3.2-3.4 per cent in H1:2019-20 and 3.9 per cent in Q3:2019-20, with risks broadly balanced around the central trajectory.
26. Turning to the growth outlook, GDP growth for 2018-19 in the December policy was projected at 7.4 per cent (7.2-7.3 per cent in H2) and at 7.5 per cent for H1:2019-20, with risks somewhat to the downside. The CSO has estimated GDP growth at 7.2 per cent for 2018-19. Looking beyond the current year, the growth outlook is likely to be influenced by the following factors. First, aggregate bank credit and overall financial flows to the commercial sector continue to be strong, but are yet to be broad-based. Secondly, in spite of soft crude oil prices and the lagged impact of the recent depreciation of the Indian rupee on net exports, slowing global demand could pose headwinds. In particular, trade tensions and associated uncertainties appear to be moderating global growth. Taking into consideration the above factors, GDP growth for 2019-20 is projected at 7.4 per cent – in the range of 7.2-7.4 per cent in H1, and 7.5 per cent in Q3 – with risks evenly balanced.
27. Headline inflation is projected to remain soft in the near term reflecting the current low level of inflation and the benign food inflation outlook. Beyond the near term, some uncertainties warrant careful monitoring. First, vegetable prices have been volatile in the recent period; reversal in vegetable prices could impart upside risk to the food inflation trajectory. Secondly, the oil price outlook continues to be hazy. Thirdly, a further heightening of trade tensions and geo-political uncertainties could also weigh on global growth prospects, dampening global demand and softening global commodity prices, especially oil prices. Fourthly, the unusual spike in the prices of health and education needs to be closely watched. Fifthly, financial markets remain volatile. Sixthly, the monsoon outcome is assumed to be normal; any spatial or temporal variation in rainfall may alter the food inflation outlook. Finally, several proposals in the union budget for 2019-20 are likely to boost aggregate demand by raising disposable incomes, but the full effect of some of the measures is likely to materialise over a period of time.
28. The MPC notes that the output gap has opened up modestly as actual output has inched lower than potential. Investment activity is recovering but supported mainly by public spending on infrastructure. The need is to strengthen private investment activity and buttress private consumption.
29. Against this backdrop, the MPC decided to change the stance of monetary policy from calibrated tightening to neutral and to reduce the policy repo rate by 25 basis points.
30. The decision to change the monetary policy stance was unanimous. As regards the reduction in the policy repo rate, Dr. Ravindra H. Dholakia, Dr. Pami Dua, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted in favour of the decision. Dr. Chetan Ghate and Dr. Viral V. Acharya voted to keep the policy rate unchanged. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis. The minutes of the MPC’s meeting will be published by February 21, 2019.
31. The next meeting of the MPC is scheduled from April 2 to 4, 2019. Voting on the Resolution to reduce the policy repo rate by 25 bps to 6.25 per cent Member Vote Dr. Chetan Ghate No Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya No Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
32. In the last several reviews, I have highlighted the need for keeping inflationary expectations anchored durably at the 4% target. While the 3 month and 1 year ahead inflationary expectation numbers still remain elevated, the decline in median inflationary expectations in the most recent round for three months (by 80 basis points) and for 1 year ahead (by 130 basis points) is encouraging. This is the first time since the history of the survey that the change in inflationary expectations has been as large as it has from a “low” level.
33. Going forward, lower oil and food prices – if sustained – will help inflationary expectations further taper allowing for the durability of the 4% target.
34. Oil prices have declined by more than 30 percent since its peak in early October mainly reflecting increases and prospective increases in global supply. Food inflation was in deflation (-1.5%, Y-o-Y) in December. Few commodities (pulses, sugar) continue to have persisting deflation, although pulses deflation has reduced from double digits to a single digit. The existing glut in international markets for various food commodities will limit the scope for food exports keeping a lid on food commodities inflation in the months ahead. Inadequate procurement has also helped limit the pass through from higher MSP prices to headline inflation.
35. RBI’s projections for Q3 FY 19-20 headline inflation stand at 3.9%. These projections are however sensitive to the assumed momentum on food inflation. If, for instance, vegetable prices rebound in April-August in a stronger way, these projections will be easily breached. The bouncing back of vegetable prices is not an unreasonable assumption when seen from the perspective of the high weighted contribution of vegetables to food inflation in the last 6 years or so. Also, area under Rabi crops sown so far is lower. Factors like these make it opportune to wait and watch to see how the food price sub-index evolves in the next couple of months.
36. The elevated level of inflation ex food and fuel continues to be challenging, despite the fall from 5.8% in November to 5.6% in December. Offsetting base and momentum effects have kept inflation ex food and fuel sticky. The m-o-m seasonally adjusted annualised rate (saar) for inflation ex food fuel in December 2018 was elevated at 5.4 per cent.
37. Inflation has thus softened but not in a broad-based way.
38. I see the growth picture as robust despite the emergence of soft spots. Economic growth in the last four years (since the advent of inflation targeting) based on CSO’s latest revisions averaged 7.7%, which is consistent with elevated core inflation and a virtually closed output gap. While non-food bank credit (NFBC) growth has declined marginally in the last few months, it continues to be high (14.6% on January 18, 2019). Credit growth to Non-Banking Financial Companies (NBFCs) was also high at 55.1% in December 2018 according to RBI data. This level has been above 40% since July 2018. Both the service and manufacturing PMIs continue to be in expansion mode for the last several months. Seasonally adjusted capacity utilization rose for the 2nd consecutive quarter in Q2: 18-19 to 75.3%. There was also a significant improvement in consumer sentiment.
39. On the downside, the IIP fell to a 17 month low at 0.5% Y-o-Y, although this reflects the somewhat higher volatility typical of the October-December window because of festive holidays. Consumer durable goods production also contracted by 0.9 per cent in November 2018. Growth in a number of economies has slowed this year due to trade tensions and the associated uncertainty. This clouds India’s export outlook and should be carefully watched.
40. I also worry that India is not consolidating fiscally although the extra budgetary spending on social welfare and stimulative programs may not materialize (unless states match it with their own initiatives). The quality of fiscal expenditures after the election may also improve.
41. Given the above reasons, maintaining status quo on the rates would be consistent with sustainable growth in the economy and achieving the inflation target over the medium-term.
42. I vote, however, to change the stance to neutral from ‘calibrated tightening’. Statement by Dr. Pami Dua
43. Headline inflation softened to 2.2 per cent in December from 2.3 per cent in November and 3.4 per cent in October, primarily due to a drop in food inflation from -0.1 per cent in October to -1.7 per cent in November and -1.5 per cent in December. Inflation excluding food and fuel fell from 6.2 per cent in October to 5.7 per cent and 5.6 per cent in November and December, respectively. The impact of house rent allowance of central government employees has now faded, while there is an unusual spike in inflation in health and education. At the same time, there was also a moderation in inflation in transport and communication.
44. RBI’s projected trajectory of headline inflation has also somewhat softened to 2.8 per cent in Q4 of 2018-19 (down from 3.2 per cent in the last policy round) and 3.4 per cent in Q2 of 2019-20 (down from 4.2 per cent). Furthermore, various surveys signal moderation in inflation expectations. Inflation expectations in the December 2018 round of the Reserve Bank’s Survey of Households softened by 80 basis points and 130 basis points for three-month ahead and one- year ahead horizons, respectively, vis-à-vis the last round. The Reserve Bank’s Industrial Outlook Survey indicates moderation in input prices in the fourth quarter of 2018-19, as reported by manufacturing firms. The Purchasing Managers’ Index for January 2019 suggests that input costs and selling prices remain modest. The Economic Cycle Research Institute’s (ECRI) Indian Future Inflation Gauge, a harbinger of inflation, has also declined, signalling a moderation in future inflation. One-year-ahead Business Inflation Expectations also declined in December, as per the Business Inflation Expectations Survey conducted by IIM-Ahmedabad for the month of December.
45. Looking forward, downside risks to the inflation outlook include continuing moderation in food inflation. The slowdown in global growth may also lead to softening of crude oil prices and moderation in inflation. Upside risks include supply disruptions in crude oil and geopolitical tensions.
46. On the output side, although RBI lowered its growth projection, GDP is expected to grow by 7.2 per cent in the first quarter of 2019-20, rising to 7.5 percent in Q3. Consumer Confidence has improved in the December 2018 round, with the future expectations index close to the all- time high of the December 2016 round. Forward looking indicators such as RBI’s Business Expectations Index for the manufacturing sector signal an improvement in the fourth quarter based on upbeat sentiments on production, order books, exports and capacity utilisation. These movements are corroborated by the January PMI. Meanwhile, growth in the Indian Leading Index, a predictor of the direction of Indian economic growth maintained by the Economic Cycle Research Institute (ECRI), New York, has risen lately, indicating some improvement in economic growth prospects.
47. A major downside risk to growth is the continued global growth slowdown, along with trade tensions and associated uncertainties. Indeed, growth in ECRI’s Indian Leading Exports Index has weakened, dimming the exports growth outlook. According to ECRI’s leading indexes, U.S. economic growth is expected to continue to decelerate, while the inflation cycle is expected to remain in a downswing in the coming months, despite the Fed's abrupt U-turn. Furthermore, based on ECRI’s Chinese leading indexes, overall Chinese growth is expected to continue to languish for the time being, while Chinese industrial growth will stay in a downturn, in the months ahead. Eurozone economic growth prospects remain dismal, with Italy in recession and Germany and France getting closer to recessionary conditions. Thus, as per ECRI’s prognosis, overall global economic growth will continue to stay in a cyclical downswing, while inflation will decline in every major economy. This may not only halt central bank plans for policy "normalization", but also afford leeway for policy easing.
48. In light of the benign inflation outlook and a moderation in inflation expectations, as well as the likely headwinds due to the global growth slowdown, I vote for decreasing the policy repo rate by 25 basis points and changing the stance from calibrated tightening to neutral. Statement by Dr. Ravindra H. Dholakia
49. In the MPC meeting of December 2018, I had argued that given the sudden favourable changes in the macroeconomic environment during November 2018 and their magnitude, it was the most opportune time for the MPC to cut the policy rate. However, because the MPC had insistently changed its stance from neutral to calibrated tightening with a 5:1 majority vote only in the previous meeting of October stating explicitly that any rate cuts were off the table, it would not be appropriate to cut the rate in the December 2018 policy. My strong plea to change the stance to neutral was also not accepted by my other colleagues in the MPC, though it was made clear in the subsequent communication that in future the MPC could consider a rate cut if the upside risk to inflation did not materialize. The subsequent two prints of monthly CPI headline inflation for November and December 2018, which are now available, confirm that the upside risks have considerably subdued with the predicted inflation over the next 3-4 quarters coming down further. On the other hand, there are concerns about the GDP growth slowing down, which is reflected in the marginal reduction in the RBI’s growth forecast. Therefore, it would be appropriate to consider a rate cut not only to correct the past inaction but also provide impetus to growth without materially risking inflation beyond the targeted 4 percent. Under these circumstances, I think space has opened up for a substantial rate cut of about 50 to 60 bps going forward. There is, therefore, an immediate need to change the stance formally from calibrated tightening to neutral and cut the policy rate by 25 bps to begin with. More specific reasons for my vote are as follows: i) The implicit volatility in the oil prices was unusually high during November 2018, but now, during December 2018 and particularly January 2019, has significantly come down to almost its long-term average. There is an expectation of oil prices stabilizing at current levels of about $ 60 - $ 65 per barrel. The risks of significant overshooting on a sustained basis have substantially receded. ii) Food prices are likely to remain subdued over the next 3-4 quarters as per the detailed exercise of forecast undertaken by the RBI staff in consultation with the subject matter experts. iii) Inflation ex-food and fuel is also predicted to fall from its current level of about 5.9 percent in Q3 of 2018-19 to about 5.1 percent in Q3 of 2019-20. It may fall even more if the current spike in health and education price index turns out to be only one off phenomenon. Thus, the core (or ex-food and fuel) inflation also shows a declining trend. This is quite consistent with the finding of my study with a co-author published in EPW (March 03, 2018) that persistence of core inflation is coming down in India perhaps because the inflation targeting regime in India has resulted in anchoring of people’s inflationary expectations and as a result the core inflation is also declining. iv) As a result of all this, the headline inflation forecast one year ahead by RBI staff has turned out to be less than the target of 4 percent for the first time. With the policy rate of 6.5 percent, this implies the real policy rate of about 2.6 percent, which is one of the highest in the world as I have been arguing. 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 percent. v) It is important to note that the inflationary expectations in the economy have also been falling now at least for the last three survey rounds. Median household inflationary expectations 3 and 12 months ahead in the RBI surveys have shown considerable decline of about 120 and 130 bps and business expectations of headline CPI inflation 12 months ahead in the IIMA surveys have shown 53 bps decline. Moreover, the absolute number in the latter is 3.8 percent, which is almost the same as the RBI forecast. This provides more comfort for our quantitative assessment going forward. vi) Recently announced budget of the Central Government shows no fiscal slippage from the path of fiscal and debt consolidation during 2018-19 when we consider the first revised estimates of GDP published on 31st January 2019. The slippage during 2019-20 without additional resource mobilization (since it was an interim budget) also turns out to be less than 20 bps from the fiscal consolidation path. In all probability, in the regular budget to be presented after the general election, such a minor gap may be covered with additional resource mobilization. It may not, therefore, have any significant inflationary impact on the economy and a very limited impact on the real interest rates in the system. With the institutional reforms in the recent past, significant fiscal slippage from the states side taking place is also not very likely. vii) With the latest revisions in the GDP and unemployment estimates over the recent past there is a need to have a serious relook at the estimates of potential output and potential output growth in the economy. My views expressed earlier on the issue and estimates given by renowned scholars with rich policy making experience in the country need to be considered seriously. Accordingly, the potential output growth for the Indian economy going forward seems to be in the range of 8 to 8.5 percent and not 7 to 7.5 percent as was implicitly assumed now for quite some time. If we consider this more plausible estimate, the output gap is widening rather than closing. Generally, as the economic policy reforms are implemented, the potential output growth rises because it opens up new opportunities for productivity growth and efficiency. The current marginal downward revision in the growth forecast for the next 3-4 quarters, therefore, suggests that a substantial output gap is likely to open up exercising downward pressure on wage growth and inflation. viii) The experience of this MPC corroborates a negative correlation between the real policy rate (as measured by the excess of the actual policy rate over the projected inflation one year ahead at the time of the policy announcement) and the real GDP growth. One cannot reject the hypothesis that the recent slowdown in the real GDP growth in India is on account of high real policy rates among other factors. If so, now is the ripe time to correct the real interest rates and create policy space for future actions if required.
50. Given all these reasons, in my view this is the time to act decisively by changing the stance from calibrated tightening to neutral and cutting the policy rate by 25 bps to begin with. The future rate actions may be data driven particularly with respect to the target of 4 percent headline inflation sustaining over time and the direction and magnitude of output gap. Statement by Dr. Michael Debabrata Patra
51. My sense from recent readings is that inflation is troughing and its path over the 12- months ahead horizon is likely to be one that rises from current lows.
52. Given that inflation excluding food and fuel is elevated but sticky (fuel inflation is easing and its weight in the CPI is small relatively speaking), the future trajectory of headline inflation will be determined essentially by the momentum of food price changes, especially in the first half of 2019-20 when typically, there is a pre-monsoon firming up.
53. The critical judgment call is: will the momentum of food prices revert to the typical pattern from the unusually subdued pace observed in 2018-19 (April-August), or, will it take some time for large excess supplies in several food items to balance out before the usual momentum takes hold? My sense is the latter, given that the prices of some items like pulses and sugar are sluggishly emerging out of a deep cyclical downswing, while those of oils and fats are muted by the turning down of international commodity prices, and other prices such as those of fruits, vegetables and milk are experiencing irregular and unusual softness. The outlook for cereal prices has also turned benign, with prospects of drawing down of sizable excess buffer stocks in the months ahead.
54. Meanwhile, outside the food group, upside risks to the headline inflation path from crude prices have also ebbed considerably and the recent upsurges in prices of education and health could possibly be short-lived.
55. In an inflation targeting framework, the forecast becomes the intermediate target because it congeals all available information on the final goal variables – inflation and growth – which are invisible. The forecast indicates that headline inflation is likely to course below 4 per cent up to the third quarter of 2019-20, thus securing the target over a one-year ahead time horizon. Significantly, the path of inflation has been adjusted downwards by 40-80 basis points since the last meeting of the MPC in December 2018. This is consistent with the stylised evidence – surveyed households, businesses and professional forecasters have made sizable corrections in their inflation expectations over the next twelve months; consumers are more sanguine about the evolving price situation than before; and cost pressures are moderate with delayed and incomplete pass-through to selling prices. The key insight is provided by the direction of these adjustments, not their levels.
56. As the amended RBI Act enjoins us, if the primary target for headline inflation is achieved on a reasonably lasting basis, it opens up some headroom to address the objective of growth. The MPC will need to closely monitor the evolution of these disparately driven price movements and calibrate the monetary policy stance accordingly. If the momentum of food price changes in the next few months indicates that inflation is likely to rise above 4 per cent and persist in the upper reaches of the tolerance band, pre-emptive action will be warranted to ensure that the primary objective of maintaining price stability is defended and achieved lastingly.
57. Turning to the outlook for growth, domestic activity remains resilient, but it appears to be shedding some speed in the second half of 2018-19. Dark clouds seem to be gathering over the horizon. High frequency indicators suggest that the pick-up in investment in the first half of 2018-19 may have lost some strength in the second half and considerable uncertainty shrouds the prospects of an improvement in private investment – especially into new capacity addition – and capacity utilisation in manufacturing is straining above trend in view of the still weak capex cycle.
58. 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.
59. Accordingly, I vote for a 25 basis points reduction in the policy rate and a pre-emptive shift to a neutral policy stance. Statement by Dr. Viral V. Acharya
60. Since the December monetary policy meeting, food inflation prints have continued to be soft, mainly due to vegetables and fruits witnessing healthy domestic production combined with imports (in some cases). In fact, several food groups are now in deflation, continuing with the momentum of recent food inflation prints that were available at the time of the December policy. Fuel inflation has eased due to a drop in international Liquefied Petroleum Gas (LPG) prices. Headline inflation excluding food and fuel has moderated somewhat due to a fall in crude oil prices and complete waning of central government employees’ House Rent Allowance (HRA) effects; nevertheless, it remains at a highly elevated level, ranging between 5.6-6.2% over the past three prints, with inflation in health and education components showing a spike in December due to unexpected rise in prices of medicines and private tuition costs.
61. The RBI headline inflation projections were already revised substantially downward from October to December by between 40-80 basis points (bps) for different quarters over a 12-month projection horizon. The additional downside surprise relative to December projections has been small, around 10 bps on a quarterly basis. Inflation expectations of households as measured by RBI’s survey (IEH) reveal a softening by 80 bps at 3-month horizon and 130 bps at 12-month horizon, possibly reflecting the adaptive nature of household expectations in response to the softness of recent inflation prints; importantly, they too indirectly confirm the ground reality and revision in inflation perceptions, especially in food and fuel categories.
62. Based on these data and other considerations, RBI’s quarterly inflation projections over the next 12-month horizon have been further revised downward and imply headline inflation steadily rising but remaining below the target rate of 4%.
63. My understanding of composition effects and risks around these projections is as follows:
64. One, inflation excluding food and fuel remains elevated and persistent, so it seems crucial to understand if the sharp increase in momentum observed in health and education components is one-off or not. While it seems reasonable to treat it as one-off for now, if it does sustain then it could push inflation excluding food and fuel into uncomfortable territory. Unfortunately, there is no decisive way to resolve this issue other than to wait for and analyse a few more prints.
65. Second, international Brent crude prices have stabilised in the short run. Nevertheless, it is too early to forget or rule out the wild gyrations from geopolitical risks, as were observed over the past six months. Given our oil imports and the implied current account deficit effects, headline inflation responds particularly adversely to upside risk from crude oil prices.
66. Third, the recent low momentum in food prices is assumed to have a structural component over the next 12-month horizon as there appears to be a supply glut in several food items at both domestic and international levels. Vegetable prices, however, are vulnerable to sudden reversal from their deflationary momentum.
67. More importantly, the assumption of sustained low momentum in food prices leads to a consideration of the risk of agrarian distress. Such distress will necessitate a political-economy response in the form of fiscal support to the agrarian economy in the short run; effects of such fiscal support may play out partly over the next 12 months and partly beyond. Besides stimulating rural demand and restoring rural wages, such a response could get generalised into headline inflation; this could arise, for example, by aggravating the input cost push arising in the financing of the real economy from fiscal and quasi-fiscal financing, especially from national small savings fund (NSSF) into bank deposit rates and from fiscal/quasi-fiscal market borrowings into corporate bond yields. Our counterfactual exercises suggest that such upward pressure on headline inflation would require commensurate policy rate action over the next 12 months.
68. In other words, the assumption of particularly benign food inflation in the short run imparts significant upside risk to the inflation trajectory, at the short- and/or medium-term horizons, from the fiscal adjustments that would be necessary to address resulting agrarian distress and to boost rural demand.
69. Fourth, while inflation expectations have moved downward in the most recent survey, when compared to the December 2017 survey, they remain higher at 3-month horizon. In other words, anchoring of inflation expectations of households is still an ongoing process and it is somewhat early to assume its sustenance going forward based on the most recent adjustment.
70. On balance, I remain concerned about (i) the elevated level of inflation excluding food and fuel; (ii) upward risks that could emanate from oil prices and fiscal implications of sustained food deflation; and, (iii) lack of adequate and sustained downward adjustment in household inflation expectations over the past 12 months.
71. Turning to growth, concerns around global growth, especially in major advanced economies and emerging markets embroiled in tariff wars, have gathered momentum. In response, several central banks have decided to be patient with their rate hike plans and/or have revised growth projections downwards. My assessment is that unless these concerns turn into recessionary risks, they could in fact be positive for the Indian economy as a reduction in aggregate global demand keeps Brent crude oil prices under check.
72. Domestic indicators for economic activity are overall mixed. Overall corporate performance in Q3 of 2018-19 was stable; capacity utilisation – absolute or seasonally-adjusted – has remained robust and close to or above 75 for past two quarters; PMI manufacturing and services continue to remain in expansion mode at healthy levels; and consumer sentiment surveyed by the RBI has improved. The primary weak coincident economic indicators have been auto sales and production. Our internal research suggests that this weakness reflects in part the lagged impact of high fuel prices during Q2 and part of Q3 of 2018-19, an effect that should gradually reverse, as well as due to one-off policy changes such as in emission standards and third-party insurance requirement.
73. Traditional measures of the output gap suggest some opening up, i.e., realised output below the potential output; however, my preferred measure, the finance-neutral output gap, remains positive, i.e., realised output is slightly above the potential output, as it captures the healthy aggregate credit growth and stable stock market performance. This is also consistent with the elevated level of inflation excluding food and fuel.
74. Combining my inflation and growth assessments, and given the Monetary Policy Committee (MPC)’s mandate to target headline inflation at 4% on a durable basis while paying attention to growth, I prefer to “take off the helmet” but “stay within the crease”. That is, I 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%. 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% under these exercises turns out to be “just right” over the medium term.
75. In my view, a rate cut decision now would be heavily dependent on the assumption of sustained weak momentum of food prices all through the next 12 months, which, as I explained, must be viewed as coincident with significant upside risk from fiscal measures needed to address agrarian distress. It seems better to me, in times of presently healthy levels of growth, to wait till the next policy by when uncertainties I have highlighted, especially around one-off surprises in health and education inflation, oil prices, and global recessionary risks, could resolve. The growth print for Q3 would also be available by then for understanding any soft spots in the domestic real economy and their drivers.
76. Finally, recall that I did vote for a rate cut in August 2017; at that point of time, all components of inflation had experienced downward trends, upside risks to inflation had reduced, and growth was weaker. That constellation of parameters gave me greater comfort to cut the policy rate than at the present juncture. Should a similar situation evolve in the next two months, I would have greater clarity for future policy action. Statement by Shri Shaktikanta Das
77. The CPI inflation print of December at 2.2 per cent continued to surprise on the downside. The overall food group continued to remain in deflation with the decline in food prices becoming more broad-based. Five constituents of the food group – vegetables, sugar, pulses, eggs and fruits – were in deflation in December. Fuel inflation also decelerated significantly mainly due to a sharp decline in the price of liquefied petroleum gas (LPG). Inflation excluding food and fuel also moderated, dragged down mainly by the decline in the prices of petrol and diesel in line with the decline in international petroleum product prices. Housing inflation continued to edge down. However, inflation in household goods and services; health; recreation and amusement; and education firmed up in December 2018.
78. Going forward, the outlook for food inflation is expected to be benign in the backdrop of excess domestic supply conditions in many food items. The lower prices in the international markets in food items also limit the avenues for exports to address the domestic surplus. This will be an important factor in keeping the overall inflation low. Soft crude oil prices augur well for keeping the petroleum product inflation under check and this will help in containing the input costs for goods and services. Inflation expectations of households have declined significantly in the last round, which is a welcome development. CPI inflation is projected at below four per cent in the remaining four quarters – 2.8 per cent in Q4:2018-19, 3.2-3.4 per cent in H1:2019-20 and 3.9 per cent in Q3:2019-20 – with risks broadly balanced. Beyond the near-term, however, there is a need to guard against some uncertainties surrounding the inflation outlook such as (i) abrupt reversal in vegetable prices; (ii) haziness in the oil price outlook; (iii) the recent unusual spike in the prices of health and education, which calls for vigilance; and (iv) the impact of several budget proposals on the aggregate demand, though the full effect of the measures will materialise over a period of time.
79. Turning to the growth outlook, the CSO has placed India’s real GDP growth at 7.2 per cent in 2018-19. Looking further ahead, there are signs of domestic growth slowing down somewhat, compared to the Reserve Bank’s earlier projections. The more recent high frequency indicators point to investment demand losing some traction, with production of capital goods and import of capital goods contracting in recent months. High frequency indicators also suggest moderation in demand (passenger cars, consumer durables, motorcycles and tractor sales).
80. On the supply side, rabi sowing so far has been marginally lower than the previous year, with shortfall across crops. There is, however, an expectation that the acreage will increase in the remaining part of the sowing season. Extended winter conditions are also likely to have a positive impact on overall wheat productivity. High-frequency and survey-based indicators for the manufacturing and services sectors suggest some slowdown in the pace of activity. In the services sector, growth of foreign tourist arrivals and international air passenger traffic decelerated in recent months. However, indicators of the construction sector such as consumption of steel and production of cement continued to show healthy growth, though growth in cement production was lower in November 2018.
81. Overall financing conditions have been improving, with bank credit growth in double digits and the total flow of resources to the commercial sector significantly higher than a year ago. Credit flows to services (such as non-banking financial companies, transport operators and trade) and in the personal loans category, especially housing, have been robust. However, credit growth has yet to become broad-based. Credit flows to industry, in particular, have been anaemic; credit to micro and small industry contracted in December 2018, while credit to large industry expanded at a moderate pace.
82. Global growth is also losing traction amidst lingering trade tensions and uncertainty around Brexit. On the positive side, crude oil prices remain soft, though the benefit for net exports could be restricted due to slowing global demand. GDP growth for 2019-20 is projected at 7.4 per cent – in the range of 7.2-7.4 per cent in H1, and 7.5 per cent in Q3 – with risks evenly balanced.
83. 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. 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. Hence, I vote for a reduction in the policy repo rate by 25 basis points. I also vote for a change in the stance of monetary policy from calibrated tightening to neutral. This change in the stance has been largely factored in by market participants after the December MPC meeting and the post policy press conference. The neutral stance will provide flexibility and the room to address challenges to sustained growth of the Indian economy over the coming months, as long as the inflation outlook remains benign. Jose J. Kattoor Press Release: 2018-2019/2002 Chief General Manager
6. Since the last MPC meeting in February 2019, global economic activity has been losing pace. In the US, the subdued performance in the final quarter of 2018 appears to have continued into Q1:2019 as reflected in declining factory activity. The Euro area slowed down in Q4:2018 on soft domestic demand and contracting manufacturing activity. Of its constituents, the Italian economy contracted for two consecutive quarters in Q3 and Q4. In the UK, growth slowed down on Brexit uncertainty, with industrial production contracting during September-January. The Japanese economy rebounded in Q4 on increased domestic consumption expenditure and recovering investment spending. However, the latest data on manufacturing activity and business confidence suggest that growth lost momentum in Q1:2019. The monetary policy stances of the US Fed and central banks in other major advanced economies (AEs) have turned dovish.
7. Economic activity also slowed down in some major emerging market economies (EMEs). The Chinese economy decelerated in Q4:2018 on subdued domestic and global demand impacting industrial activity. Much of this weakness seems to have continued into 2019 as reflected in low factory output in Q1, though the purchasing managers’ index (PMI) moved into expansion zone in March after three months of contraction. In Q1, the Russian economy continued to be impacted by both domestic and external headwinds. The Brazilian economy ended 2018 on a weak note; going into 2019, available economic indicators for Q1 suggest that economic activity remained restrained by both weak domestic and external demand. The South African economy slowed down in the final quarter of 2018. Subdued industrial activity and worsening external demand point to a further loss in momentum in Q1.
8. Crude oil prices have risen on production cuts by OPEC and Russia as well as disruption in supplies due to US sanctions on exports from Venezuela. Gold prices weakened on expectations of positive outcomes of the China-US trade deal. Inflation continued to remain low in major AEs and many key EMEs due to slowing global growth and stable or falling commodity prices.
9. Financial markets continued to be driven by monetary policy stances of key central banks and movements in crude oil prices. In the US, the equity market witnessed some selling pressure in the last week of March on weak economic data. Equity markets in EMEs gained, benefitting from country-specific factors and easing of global financing conditions. Bond yields in the US softened, slipped into negative territory in Germany and dipped further into negative territory in Japan as central banks signalled softer stances. Bond yields in most EMEs have been falling in tandem with those in AEs and on the improving inflation outlook. In currency markets, the US dollar has traded with an appreciating bias in recent weeks. EME currencies have traded with a depreciating bias on country-specific factors and on fears of a weakening economic outlook in China. Domestic Economy
10. Turning to the domestic economy, the second advance estimates for 2018-19 released by the Central Statistics Office (CSO) in February 2019 revised India’s real gross domestic product (GDP) growth downwards to 7.0 per cent from 7.2 per cent in the first advance estimates. Domestic economic activity decelerated for the third consecutive quarter in Q3:2018-19 due to a slowdown in consumption, both public and private. However, gross fixed capital formation (GFCF) growth remained in double digits for the fifth consecutive quarter in Q3, with the GFCF to GDP ratio rising to 33.1 per cent in Q3:2018-19 against 31.8 per cent in Q3:2017-18, supported primarily by the government’s thrust on the road sector and affordable housing. The drag on aggregate demand from net exports also moderated in Q3 due to a marginal acceleration in exports and a sharp deceleration in imports led by a decline in crude oil prices.
11. On the supply side, the second advance estimates of the CSO placed the growth of real gross value added (GVA) lower at 6.8 per cent in 2018-19 as compared with 6.9 per cent in 2017-18. GVA growth slowed down to 6.3 per cent in Q3 due to a deceleration in agriculture output from the record level achieved in the previous year. Industrial GVA growth remained unchanged in Q3, with manufacturing GVA growth slowing somewhat. Services GVA growth also remained unchanged in Q3; while growth in construction activity accelerated, there was some loss of momentum in public administration, defence and other services.
12. Beyond Q3, the second advance estimates of foodgrains production for 2018-19 at 281.4 million tonnes were 1.2 per cent lower than the fourth advance estimates of 2017-18, but 1.4 per cent higher than the second advance estimates of 2017-18. According to the National Oceanic and Atmospheric Administration (NOAA) of the US, El Niño conditions strengthened during February 2019, which may affect the prospects of a normal south west monsoon.
13. Of the high frequency indicators of industry, the manufacturing component of the index of industrial production (IIP) growth slowed down to 1.3 per cent in January 2019 due to automobiles, pharmaceuticals, and machinery and equipment. The growth of eight core industries remained sluggish in February. Credit flows to micro and small as well as medium industries remained tepid, though they improved for large industries. Capacity utilisation (CU) in the manufacturing sector, however, as measured by the Reserve Bank’s order books, inventory and capacity utilisation survey (OBICUS), improved to 75.9 per cent in Q3 from 74.8 per cent in Q2 exceeding its long-term average; the seasonally adjusted CU rose to 76.1 per cent from 75.4 per cent. The business assessment index of the industrial outlook survey (IOS) points to an improvement in overall sentiments in Q4. The manufacturing purchasing managers’ index (PMI) remained in expansion zone for 20th month in March. The key indicators of investment activity contracted, viz., production of capital goods in January and imports of capital goods in February.
14. High frequency indicators of the services sector suggest significant moderation in activity. Sales of commercial vehicles contracted during February. Other indicators of the transportation sector, viz., port freight traffic and international air freight traffic, also contracted. However, indicators of the construction sector, viz., consumption of steel and production of cement, continued to show healthy growth. The hotels sub-segment showed some improvement in foreign tourist arrivals in January and international air passenger traffic in February. The services PMI continued to be in expansion zone for the tenth consecutive month in March 2019.
15. Retail inflation, measured by y-o-y change in the CPI, rose to 2.6 per cent in February after four months of continuous decline. The uptick in inflation was driven by an increase in prices of items excluding food and fuel and weaker momentum of deflation in the food group. However, inflation in the fuel group collapsed to its lowest print in the new all India CPI series.
16. Within the food group, deflation in four sub-groups – vegetables, sugar, pulses and fruits – continued in February. Egg prices moved into inflation after remaining in deflation in previous three months, while inflation ticked up in all other food sub-groups.
17. Inflation in the fuel and light sub-group collapsed from 4.5 per cent in December to 1.2 per cent in February. Prices of liquefied petroleum gas (LPG) declined sharply, pulled down by the lagged impact of the softening of international energy prices. The prices of firewood, with the second largest weight in the fuel group, also declined. Electricity slipped into deflation in January and February. Inflation in kerosene remained elevated, however, reflecting the impact of the calibrated increase in its administered price.
18. CPI inflation excluding food and fuel declined to 5.2 per cent in January, but rose to 5.4 per cent in February, driven by a broad-based pick-up in inflation in the personal care and effects, and recreation and amusement sub-groups. However, inflation in the clothing and footwear, and transport and communication sub-groups fell, the latter reflecting the reduction in petrol and diesel prices. Inflation in the health and education sub-groups remained elevated, even though it moderated markedly during January-February vis-à-vis December.
19. Inflation expectations, measured by the Reserve Bank’s survey of households, declined in the February round over the previous round by 40 basis points each for the three months ahead and for the one year ahead horizons. Firms participating in the Reserve Bank’s industrial outlook survey of manufacturing companies reported reduction in input price pressures, but they expected an increase in staff expenses in Q1:2019-20. Farm and industrial input costs increased at a slow pace in January-February 2019. Nominal growth in rural wages and staff costs in the organised manufacturing and services sectors remained muted in Q3:2018-19.
20. From a daily net average surplus of ₹27,928 crore (₹279 billion) during February 1-6, 2019, systemic liquidity moved into deficit during February 7 - March 31, reflecting the build-up of government cash balances. Currency in circulation expanded sharply in February- March. The liquidity needs of the system were met through injection of durable liquidity amounting to ₹37,500 crore (₹375 billion) in February and ₹25,000 crore (₹250 billion) in March through open market purchase operations (OMOs). Consequently, total durable liquidity injected by the Reserve Bank through OMOs aggregated ₹2,98,500 crore (₹2,985 billion) for 2018-19. Liquidity injected under the LAF, on an average daily net basis, was ₹95,003 crore (₹950 billion) during February (February 7-28, 2019) and ₹57,043 crore (₹570 billion) in March. The weighted average call rate (WACR) remained broadly aligned with the policy repo rate in February and March.
21. Anticipating the seasonal tightening of liquidity at end-March, the Reserve Bank conducted four longer term (tenor ranging between 14-day and 56-day) variable rate repo auctions during the month in addition to the regular 14-day variable rate term repo auctions. Furthermore, the Reserve Bank conducted long-term foreign exchange buy/sell swaps of US$ 5 billion for a tenor of 3 years on March 26, 2019, thereby injecting durable liquidity of ₹34,561 crore (₹346 billion) into the system.
22. Export growth remained weak in January and February 2019 mainly due to exports of petroleum products decelerating in response to a fall in international crude oil prices. Among non-oil exports, engineering goods, chemicals, leather and marine products recorded either sequentially lower or negative growth. As in the case of exports, lower international crude oil prices downsized the oil import bill. Non-oil non-gold imports declined sharply, dragged down by the subdued demand for pearls and precious stones, transport equipment, project goods and vegetable oils. The trade deficit narrowed in February 2019 – both sequentially and on a year-on-year basis – to its lowest level in 17 months. This, along with the increase in services exports and lower outgo of income payments, resulted in narrowing of the current account deficit sequentially. On the financing side, net FDI inflows were strong in April- January 2018-19. Foreign portfolio investors turned net buyers in the domestic capital market in Q4:2018-19. India’s foreign exchange reserves were at US$ 412.9 billion on March 31, 2019. Outlook
23. In the sixth bi-monthly monetary policy resolution of February 2019, CPI inflation was projected at 2.8 per cent for Q4:2018-19, 3.2-3.4 per cent for H1:2019-20 and 3.9 per cent for Q3:2019-20, with risks broadly balanced around the central trajectory. Actual inflation outcomes averaged 2.3 per cent in January-February.
24. The inflation path during 2019-20 is likely to be shaped by several factors. First, low food inflation during January-February will have a bearing on the near-term inflation outlook. Second, the fall in the fuel group inflation witnessed at the time of the February policy has become accentuated. Third, CPI inflation excluding food and fuel in February was lower than expected, which has imparted some downward bias to headline inflation. Fourth, international crude oil prices have increased by around 10 per cent since the last policy. Fifth, inflation expectations of households as well as input and output price expectations of producers polled in the Reserve Bank’s surveys have further moderated. Taking into consideration these factors and assuming a normal monsoon in 2019, the path of CPI inflation is revised downwards to 2.4 per cent in Q4:2018-19, 2.9-3.0 per cent in H1:2019-20 and 3.5- 3.8 per cent in H2:2019-20, with risks broadly balanced.
25. GDP growth for 2019-20 in the February policy was projected at 7.4 per cent in the range of 7.2-7.4 per cent in H1, and 7.5 per cent in Q3 – with risks evenly balanced. Since then, there are some signs of domestic investment activity weakening as reflected in a slowdown in production and imports of capital goods. The moderation of growth in the global economy might impact India’s exports. On the positive side, however, higher financial flows to the commercial sector augur well for economic activity. Private consumption, which has remained resilient, is also expected to get a fillip from public spending in rural areas and an increase in disposable incomes of households due to tax benefits. Business expectations continue to be optimistic. Taking into consideration the above factors, GDP growth for 2019- 20 is projected at 7.2 per cent – in the range of 6.8-7.1 per cent in H1:2019-20 and 7.3-7.4 per cent in H2 – with risks evenly balanced.
26. Beyond the near term, several uncertainties cloud the inflation outlook. First, with the domestic and global demand-supply balance of key food items expected to remain favourable, the short-term outlook for food inflation remains benign. However, early reports suggest some probability of El Niño effects in 2019. There is also the risk of an abrupt reversal in vegetable prices, especially during the summer months. Second, inflation in fuel group items, particularly electricity, firewood and chips saw unprecedented softening in H2:2018-19. There is, however, uncertainty about the sustainability of this softening in inflation in fuel items. Third, the outlook for oil prices continues to be hazy, both on the upside and the downside. On the one hand, continuing OPEC production cuts will reduce supplies. On the other hand, there is considerable uncertainty about demand conditions. Should there be a swift resolution of trade tensions, a pick-up in global demand is likely to push up oil prices. However, should trade tensions linger and demand conditions worsen, crude prices may fall from current levels, despite production cuts by OPEC. Fourth, inflation excluding food and fuel has remained elevated over the past twelve months with some pick up in prices in February. However, should the recent slowdown in domestic economic activity accentuate, it may have a bearing on the outlook for inflation in this category. Fifth, financial markets remain volatile reflecting in part global growth and trade uncertainty, which may have an influence on the inflation outlook. Sixth, the fiscal situation at the general government level requires careful monitoring.
27. The MPC notes that the output gap remains negative and the domestic economy is facing headwinds, especially on the global front. The need is to strengthen domestic growth impulses by spurring private investment which has remained sluggish.
28. Against this backdrop, the MPC decided to reduce the policy repo rate by 25 basis points and maintain the neutral stance of monetary policy.
29. Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted in favour of the decision to reduce the policy repo rate by 25 basis points. Dr. Chetan Ghate and Dr. Viral V. Acharya voted to keep the policy rate unchanged.
30. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Shri Shaktikanta Das voted in favour of the decision to maintain the neutral stance of monetary policy. Dr. Ravindra H. Dholakia voted to change the stance from neutral to accommodative.
31. The minutes of the MPC’s meeting will be published by April 18, 2019.
32. The next meeting of the MPC is scheduled during June 3, 4 and 6, 2019. Voting on the Resolution to reduce the policy repo rate by 25 bps to 6.0 per cent Member Vote Dr. Chetan Ghate No Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya No Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
33. Since the last review, the continual decline in both 3 month and 1 year ahead inflationary expectations of households is encouraging. Households’ current inflation perception is below 7%. The percentage of respondents expecting inflation below 6% for 3 month and 1 year ahead horizons has also been increasing over different survey rounds. It should be noted that although the 1 year ahead inflationary expectation declined by 40 bps to 8.1% compared to the previous round it is still only 50 bps below the March 2018 value (8.6%).
34. The elevated level of inflation ex food and fuel continues to be a concern, although I am more sanguine about its trajectory after the last few prints. My major concern with inflation ex food and fuel is that sequential gains continue to be strong. Inflation ex food fuel will only be buttressed by the rise in crude prices (USD 68.3 on April 2 versus USD 62.2 on February 7, equivalent to a 9.8% increase since the last review). Crude prices have also remained resilient despite lower projections for global growth. Oil is not a “Hotelling” good (constraints in different locations prevent supply responses that would otherwise help in mitigating overall price rises). This makes inflation management challenging.
35. Food prices continue to be subdued although the extent of disinflation is falling. The unusually low summer uptick in food inflation (3.2%) combined with a sharp decline in winter prices in FY 19 has kept food prices unexpectedly low. The shift in momentum of food in the last couple of prints indicates that low food inflation has possibly reached a nadir. I re-iterate my concern from the last review: RBI’s projections for Q4 2019-2020 headline inflation continue to be on the lower side because of an assumed low momentum for food. If vegetable prices rebound in April-August in a stronger way, RBI’s projections will be easily breached. What compounds problems this time is the rise in the price of crude, although there has been an off-setting impact because of the nominal appreciation of the rupee (3.3% since the last review). It wouldn’t hurt to wait for a couple of months to watch the momentum on food inflation and other variables before taking a call on further rate cuts.
36. The major question in this review is whether there is sufficient accumulation of downside risks on growth to warrant a monetary policy response. Are the drivers of growth fading?
37. My sense is that that the business cycle depicts “early cycle” weakness. At this juncture, I see sub 7% growth rates confined possibly to just two quarters: Q3 and Q4 FY 19. These will be our “kitchen-sink” quarters (i.e., quarters where the most adverse outcomes to the economy are realized). Looking at the momentum on GDP growth (Q-o-Q SAAR), there has also been an uptick in Q3 FY 19.
38. Various RBI surveys don’t depict an economy in collapse. PMIs in Manufacturing and Services continue to be in expansion zone for several months, capacity utilization in the manufacturing sector has gone up sequentially in the last four quarters (76.1% seasonally adjusted in Q3), adjusted non-food credit grew by 14.8% in March 2019 compared with 11.3% in the last fiscal year, and there has been a sharp uptick in consumer confidence (a positive “sentiment shock”) with the future expectation index at an all-time high.
39. Notwithstanding this, what is worrying is the performance of private final consumption expenditures (PFCE), about 59% percent of GDP. A variety of high frequency indicators look fairly weak which nowcast a loss in growth momentum.
40. What confounds this however is the fairly robust numbers for PFCE growth (8.4% Q3 FY 19 and 9.8% Q2 FY 19), (although admittedly, this is partly due to the outsized role that livestock had in the PFCE numbers for Q3 FY 19). Looking at data from April 2017 – January 2019 for consumer durables, out of 22 months, only 6 months showed negative growth. For non-durables, only 2 months out of 22 months showed negative growth. Consumer durables growth in Q2 was 8.1% in FY 19, and 6.0% in Q3. Consumer non- durables growth was 6.1% in Q2 FY 19 dropping to 4.6% in Q3 FY 19.
41. Various consumption indicators therefore look mixed.
42. In contrast, GFCF (gross fixed capital formation) has risen over the past few quarters to 33.1% of GDP in Q3: 2018-2019. RBI’s study on “Private Corporate Investment in India: Slow Recovery Underway” and enterprise surveys depict planned capex showing a turn- around in 2018-2019, with inventory ratios moving down in manufacturing.
43. Somewhat worrying though is that the machine and equipment component of GFCF is showing signs of stress.
44. In terms of consumption-investment linkages, somewhat more concerning is some preliminary econometric evidence, using data from 1996: Q2 to 2018: Q4 that PFCE growth (quarter on quarter, seasonally adjusted) drives GFCF growth with a lag of two quarters. Simple Granger causality tests also suggest that consumption demand drives investment demand and not vice versa. This suggests that subdued consumption growth may cause investment growth to taper, signs of which should be carefully watched.
45. I continue to view the elevated levels of the combined fiscal deficit and the on-going thrust towards competitive populism as jeopardizing the durability of inflation in the medium term. This should be carefully watched.
46. On the external front, while India’s overall growth rates have always been somewhat immune to our export performance, I view the muted performance of exports and imports over the last four months with concern.
47. Given the above reasons, maintaining status quo on rates at the current juncture would be consistent with sustainable growth in the economy and achieving the inflation target over the medium-term. Contrary to some of my colleagues in the MPC, I feel that frequent changes in policy rates and stance runs the risk of introducing uncertainty and volatility because of our own actions.
48. I will, however, carefully watch the incoming growth-inflation data and am open to a reassessment of my views.
49. I also vote to retain a neutral stance. Statement by Dr. Pami Dua
50. Headline inflation rose to 2.6% in February 2019 after four months of continuous decline. CPI inflation excluding food and fuel declined to 5.2% in January but increased to 5.4% in February, driven by an increase in personal care and effects, recreation and amusement sub-groups. On the basis of quarterly data, headline inflation fell from 4.8% in Q1: FY18-19 to 3.9% in Q2 and 2.6% in Q3. As per RBI projections, it is expected to decline to 2.4% in Q4 before rising to 2.9% in Q1: FY 19-20 and 3% in Q2. CPI excluding food and fuel has declined from 6.3% in Q1: FY 18-19 to 5.9% in Q3: FY 18-19. This softening in inflation is also exhibited in consumer and producer expectations.
51. Inflation expectations in the March 2019 round of the Reserve Bank’s Survey of Households softened by 40 basis points each for the three-month ahead and one-year ahead horizons, vis-à-vis the last round in December 2018. Further, the proportion of respondents expecting higher inflation declined. The gap between current inflation perceptions and expectations also narrowed, indicating anchoring of inflation expectations at a lower level. According to the January-March 2019 round of the Reserve Bank’s Industrial Outlook Survey, manufacturing firms expect a moderation in pressure in selling prices in Q1: 2019-20 with easing of input cost pressures. Salary costs, however, are expected to firm up. As per the Business Inflation Expectations Survey conducted by IIM-Ahmedabad in February 2019, businesses expect moderation in one-year-ahead CPI headline inflation from December 2018. The Economic Cycle Research Institute’s (ECRI) Indian Future Inflation Gauge, a harbinger of inflation, remains in a cyclical downswing, indicating that underlying inflation pressures are still subdued.
52. In the coming months, upside risks to inflation include a potentially weak monsoon; uncertainty in oil prices and how weaker global demand conditions may weigh against OPEC’s production decisions; volatility in financial markets; trade tensions; and the possibility of fiscal slippage. Downside risks include low food prices; moderation in inflation excluding food and fuel; and slowdown in global growth.
53. On the output side, RBI lowered its projection for GDP growth for 2019-20 from 7.4% in the February policy to 7.2%. Indicators paint a mixed picture, with weakening investment activity that is reflected in a slowdown in production and imports of capital goods. On the other hand, consumer confidence improved in the March 2019 round of RBI’s Consumer Confidence Survey, with an uptick in both current perceptions as well as future expectations, which is at an all-time high. This upward trajectory can be attributed to an improvement in sentiment with respect to general economic situation, employment scenario and price levels. According to RBI’s Order Books, Inventory and Capacity Utilization Survey (OBICUS), capacity utilisation in the manufacturing sector improved in Q3 from the previous quarter. The Business Expectations Index of RBI’s Industrial Outlook Survey, however, signals moderation in optimism in Q1: 2019-20. At the same time, the Purchasing Managers’ Index (PMI) remained in expansion zone for the twentieth month in March, while the services PMI continued in expansion zone for the tenth successive month in March 2019. Meanwhile, ECRI’s Indian Leading Index growth has increased in recent months, indicating an improved growth outlook. ECRI’s Indian Leading Exports Index growth continues to languish, however, suggesting that Indian exports growth will ease due to pessimistic prospects for global growth.
54. On the global front, ECRI’s international long leading indexes, including those for the U.S., Eurozone and China, are in continued cyclical downswings, pointing to a further slowdown in global growth. In fact, according to ECRI's 20-Country Long Leading Index, the global growth outlook is the worst it has been in three years. In the U.S., the Fed has not only doubled down on its abrupt about-face with regard to policy “normalization,” but also indicated that no rate hikes are planned this year, and only one rate hike is planned next year. As a result, the U.S. futures markets see no chance of a rate hike but some chance of a rate cut later this year, with some risk of recession. As expected, these cyclical prospects have resulted in an end to monetary policy “normalization” plans not only in the U.S., but also around the world, while opening up more room for policy easing. Meanwhile, ECRI’s international future inflation gauges, which are predictors of the direction of inflation, are pointing to the intensification of worldwide disinflation. Thus, the global prognosis is one of slow growth accompanied by benign inflation.
55. In view of the global growth slowdown and a benign global and domestic inflation outlook, I vote for decreasing the policy repo rate by 25 basis points and maintaining the neutral stance. Statement by Dr. Ravindra H. Dholakia
56. In the MPC meeting of February, 2019, I had explicitly stated that a space of 50 to 60 bps policy rate cut had opened up and that I would like to cut the repo rate by 25bps to begin with. Developments after the February MPC meeting have further opened up additional space of about 40 to 50 bps. The monthly headline CPI inflation prints of January and February 2019 have continued to undershoot the RBI projections substantially, forcing the RBI for further downward revision of headline inflation from 2.8 to 2.4 percent for Q4:FY 2018-19. Other developments on increase of USD 5 per barrel in crude oil prices, exchange rate appreciation, energy price revisions and monsoon expectations have all together led the RBI to revise its projections of the headline inflation trajectory downwards by 30-40 bps for the next 12 months. This is a very positive development on front of price stability in the economy and has opened up space for correcting the real interest rates in the system decisively. In my opinion, there are not even remote chances for the headline inflation to breach the medium term target of 4 percent substantially in foreseeable future for two consecutive quarters or even one quarter. On the other hand, there are serious concerns about the growth performance of economy. Global pessimism on growth and developments on domestic front have led the RBI to revise its growth projections downward for 2019-20. For 3 to 4 quarters in a row, from Q3:2018-19 to Q2:2019-20, the Indian economy is most likely to register a sub-seven percent real growth thereby substantially opening up an output gap exerting downward pressure on wage and price inflation. As per the mandate given to the MPC, under such circumstances, we need to give a sustained boost to the economy. I, therefore, vote for a change of stance from neutral to accommodative with a 25 bps cut in the policy repo rate, though I would have preferred to cut it by 35-40 bps this time. More precise reasons for my vote are as follows: i) Downward revision of the headline CPI inflation trajectory by RBI considers build up of substantial excess buffer stock of rice and wheat and prices of other food items like vegetables and fruits not experiencing the regular expected seasonal spikes reflecting structural corrections to control inflation in agri-commodities. ii) While the crude oil prices show volatility and a recent rising tendency, their sustainability at higher levels is doubtful. Moreover, their pass-through to domestic inflation has also not occurred to the fullest extent in recent times. In my opinion, it may not be a major cause of worry for domestic inflation till it breaches the level of USD 80 – 85 per barrel on a durable basis, which is unlikely. iii) Thus, oil prices, vegetable prices and fruit prices present volatile elements and any increase in them can at best be considered only temporary shocks as per our recent experience. They may not be considered durable shocks needing any policy response given the recent experience. iv) The energy prices including electricity which have been subdued of late are likely to remain so for the next 10-12 months because any substantial price revisions are not on cards. The inflation ex-food and fuel is also likely to show a sharper decline in coming months because the inflationary expectations are getting anchored. v) As per the RBI survey, the household inflationary expectations 3 months and 12 months ahead continued to decline for the fourth consecutive bi-monthly round sharply and this time by 40 bps each. Moreover, the gap between the household perception and their expectations about inflation is narrowing over recent rounds. The IIM Ahmedabad survey of Businesses also show a continuing decline in their headline CPI inflationary expectations 12 months ahead by 53 bps. Thus, the inflationary expectations are getting anchored as is usually expected with any inflation targeting policy implementation. Even the RBI projections of the headline CPI inflation 12 months ahead have been below the targeted 4 per cent for two consecutive policies. The core inflation (with whatever definition but theoretically correct concept) will no longer be sticky at high levels and will show tendency towards the medium term target sooner than later. vi) In this context, the concept and measurement of the output gap and more importantly its relationship with unemployment gap is crucial. On one hand, some economists argue that there is hardly any output gap (particularly if adjusted for financial factors); and on the other hand, several economists are emotionally arguing about existence of serious involuntary unemployment. These two contradictory views cannot be reconciled theoretically within the same macroeconomic model unless we consider measurement issues. Potential output and its growth in a rapidly developing emerging market economy like India needs to be measured differently than in a typical structurally stable and relatively slow growing advanced economy. Similarly, involuntary unemployment needs to be measured in such an economy avoiding all well-known limitations about disguised unemployment and underemployment. I have been consistently arguing that unless the real growth exceeds 8-8.5 percent per annum, the output gap reflecting the unemployment gap in the economy is not likely to close. Till that point, there would be downward pressure on the labour market and market determined wages and thereby on the so-called ‘core’ inflation. vii) The downward revision of real growth from 7.4 to 7.2 percent for the coming year 2019-20 by RBI, therefore, opens up the output gap reflecting the unemployment gap substantially and needs a policy response. This is all the more so, because there are significant downside risks to the growth projection in my opinion. Due to global slowdown and US trade actions, our exports are already suffering. Investment has not revived to reach its earlier peak. The fiscal policy is constrained because of the lack of fiscal space and impending general elections. It is, therefore, the monetary policy that needs to provide the boost since, as per the mandate given to MPC, inflation is well under control. Cutting the policy rate gradually over time would correct the real interest rate in the economy and encourage investments. In this context, it is also relevant to note that most of the Central Banks globally have changed their tone to dovish.
57. This is the right time to act decisively. When the pitch is favourable and no possibility of bouncers or googlies coming in, a well set batsman has to score and not miss the opportunity to build the total by defending unnecessarily. I would, therefore, continue to cut the policy rate by 25bps and change the stance to accommodative indicating that any hikes in the rates are off the table for the time being. Statement by Dr. Michael Debabrata Patra
58. As anticipated by the MPC, inflation turned up in February 2019, lifted by food prices emerging out of five months of deflation. Three features of the upturn are noteworthy.
59. First, the January and February readings of inflation that became available after the MPC met last in February have undershot the projection made in that meeting. It is reasonable to expect that the March reading - that will become available on April 12 - may reveal that food prices are out of deflation, but headline inflation is still softer than the February meeting projection. I belabour this point because it informs the error correction process that is concurrently taking place.
60. Second, the entire inflation projection path of the MPC's April 2019 meeting has shifted downwards by 30-40 basis points from its trajectory in the February meeting. This is important in a forward-looking sense because as intermediate variables that provide a first glimpse of monetary policy's unseen and moving targets, the projections are indicating that the primary mandate assigned to the MPC appears secured at this juncture – inflation will likely remain at or below target over the 12-month horizon for which forecasts are available.
61. Third, the one year ahead projection of inflation seems to be validated by incoming data. Survey results indicate that households, businesses and professional forecasters have become more optimistic on the inflation outlook than before over the same time horizon. In the case of households, there is also evidence of the anchoring of expectations. Consumer confidence in the inflation outlook remaining benign over the year ahead is rising. Signals extracted from all this information would argue that if the primary target for monetary policy is likely to be achieved on a durable basis, some space opens up for policy attention to the objective of growth as enjoined by the RBI Act.
62. Given this headroom, the dilemma is two-fold: (1) with growth expected to accelerate from 7 per cent in 2018-19 to 7.2 per cent in 2019-20, is policy support really needed? (2) even if the case is admissible, is it the right time to steer monetary policy in defence of growth? Why not exercise prudence and wait and watch for durable signs of underlying pressures on inflation other than food or fuel easing, and/or indications that the slowdown in growth is not a soft patch but a cyclical downswing? This may avoid wasting ammunition.
63. To speak to these questions, the baseline projection of growth is subject to downside risks. First, we are already living in a world in which India’s real GDP growth averaged 6.5 per cent in the second half of 2018-19, not 7 per cent. Even if the horizon is extended to incorporate the projections for the first half of 2019-20, real GDP growth is still expected to be sub-7 per cent. Second, the drivers of growth are fading. Data that have arrived since the MPC’s February meeting indicate that demand conditions in the manufacturing sector are slowing down, with the weakening of sales of fast moving consumer goods implying that consumption spending may be losing steam. Meanwhile, capacity utilisation in manufacturing is running above trend in the absence of investment in new capacity. This suggests that the current pace of growth could be difficult to sustain if the capex cycle does not start up soon. Given the limited fiscal space, the support from government final consumption expenditure (GFCE) that has held up growth – GDP growth excluding GFCE was 6.3 per cent in 2017-18 (as against the headline GDP growth of 7.2 per cent) and 6.8 per cent in 2018-19 (7.0 per cent) 1 – may not be available going forward. Exports have flattened, with the slowing down of global growth and trade imparting downside risks. Non-oil non-gold imports have contracted, indicative of weakening domestic demand.
64. Third, I continue to maintain the view that the biggest risks to growth are global. Some of these risks are already materialising. Global growth estimates and projections are being marked down as incoming data confirm the loss of momentum that is underway. Capital flows to EMEs have returned after a turbulent year gone by, but safe haven demand restrains a fuller resumption, and uncertainty in financial markets remains high. Crude prices are firming up, with financialisation of energy stocks adding upside. In 2015-16 and 2016-17, GFCE actually pulled down growth – ex GFCE, GDP growth was 8.1 per cent (8.0 per cent) and 8.4 per cent (8.2 per cent)
65. Monetary policy has a overarchingly domestic orientation. With inflation being quiescent and growth at risk, I vote for a reduction in the policy rate by 25 basis points while maintaining a neutral policy stance. I will, however, remain watchful about the upturn in food prices that usually precedes the onset of the monsoon. Statement by Dr. Viral V. Acharya
66. In the minutes of the February 2019 Monetary Policy Committee (MPC) meeting, I had provided several reasons for why I had voted to keep the policy rate at 6.5% and the stance at neutral.
67. Since then, the headline inflation prints have revealed further softening of inflation in January, followed by a pick-up in February. Notably, inflation excluding food and fuel softened unexpectedly in January, while reverting somewhat in February; nevertheless, it remains uncomfortably close to 5.5%. Food inflation, in contrast, has behaved more in line with the expectations; fuel inflation has remained unusually weak.
68. As per my assessment, these outcomes combined with a further softening of household inflation expectations and a marginal opening up of the output gap (traditional measure), would have justified a rate cut of 25 basis points from 6.5% to 6.25% at the April meeting. In particular, the softening of inflation excluding food and fuel gives greater durability to the inflation path remaining around the target rate of 4% in the medium term even if the policy rate were to be reduced from 6.5% to 6.25%. However, given that the MPC had already cut the policy rate to 6.25% at its February meeting, the relevant decision now for me was whether to reduce the policy rate further from 6.25%.
69. I vote for keeping the policy rate unchanged at 6.25% for similar reasons as echoed in my February meeting statement, with some additional uncertainties that I flag below.
70. First, oil prices have marched upwards by an additional 10% since the February policy. This rise has taken the Brent Crude price closer to $70 per barrel. Its momentum cannot be taken lightly given the uncertainty witnessed last year on oil prices and the pressure it puts on inflation, the external sector and financial markets. While the pass-through to consumers remains somewhat incomplete at present, it will eventually hit the pump prices and generalise through transportation fares into non-fuel components of headline inflation.
71. Second, food deflation has attendant fiscal risks, as I explained in detail in my February meeting statement. Fiscal responses to deal with agrarian distress resulting from low food prices can impart a significant upside risk to the inflation trajectory, an uncertainty that may get partly resolved in the coming months.
72. Third, let me reiterate that inflation excluding food and fuel remains uncomfortably close to 5.5%, i.e., at elevated levels as through most of the past twelve months. This is confirmed also in rising staff costs in the formal sector. Conversely, it is only the benign food inflation that is allowing the monetary policy to not respond to the discomforting elevated levels of inflation excluding food and fuel. An important observation on food inflation is in order; in all of recent years, even as the level of food inflation has trended downward, it has remained highly volatile within each year; peak-to-trough cycle in food inflation typically tends to be of around 8 months duration, and the month of February has already shown some seasonal uptick in prices of several food items. Hence, soft food inflation may not persist for long, a scenario in which the elevated level of inflation excluding food and fuel would steer the headline inflation away from the target rate of 4%. This can risk hardening of inflation expectations of households.
73. Fourth, professional forecasters are pegging inflation trajectory somewhat higher than that of the Reserve Bank; this is due to their factoring in some fiscal slippage for this year as well as post-election, as gathered from their qualitative responses. Dissaving induced by such fiscal slippage also creates a rather weak transmission of monetary policy to the private and household sectors of the economy as bank deposits compete with small savings and corporate bonds with government securities.
74. These factors, combined with mixed news regarding the prospects of a normal monsoon suggest to me that this is a particularly inopportune time to reduce the interest rate. In 2-4 months, several uncertainties as posed above are likely to be resolved, helping steer interest rates in a clear direction, upward or downward or simply staying put, depending on how the risks play out. In the meantime, efforts could be made to improve the financial system structurally for better transmission of monetary policy to the real economy, especially as there are headwinds to such transmission from the rise in overall public sector borrowing requirement.
75. On the growth front, signals from the domestic economy are mixed. Capacity utilisation continues to improve which augurs well for future investment, and services growth remains robust; however, consumption demand shows signs of weakness. Global growth is exhibiting a synchronised slowdown; as I have contended in my past statements, mild moderation of global growth benefits India through a downward pressure on oil prices; it is extreme moderation that hurts India and more so through the financial flows channel rather than the trade channel, the latter having been largely insensitive to external prospects in recent years.
76. Aggregate flow of financial resources to the commercial sector remains robust with banks substituting for the weak credit growth of non-banks; bank credit growth continues to be above nominal GDP growth; equity markets have been buoyant; foreign portfolio flows have reversed into India following the dovish stance of advanced country central banks; together, these imply that the finance-neutral output gap, my preferred measure of output gap which accounts for financial cycles, continues to remain closed.
77. On balance, therefore, notwithstanding signs of weakness in growth evinced in high frequency economic indicators, I am inclined to wait for some more time for incoming data to resolve several important uncertainties that will shape the Indian economy in the coming one or two years. The counter-factual exercises suggest that 6.25% policy repo rate is just “right” for achieving headline inflation target of 4% on a durable basis in the medium term; continuing oil price rise or fiscal impulses or seasonal uptick in volatile vegetable prices would likely require some tightening down the road; only a substantial collapse in global growth, which seems unlikely at present given proactive responses of central banks in advanced economies and China, would justify a rate cut at this point. Hence, I am erring on the side of caution, choosing to be patient, rather than supporting another rate cut on the back of MPC’s February decision to cut the rate. Statement by Shri Shaktikanta Das
78. Since the last policy in February 2019, there has been further weakening of domestic growth impulses, with global growth slowdown posing major headwinds to India’s exports. Inflation has continued to surprise on the downside. CPI inflation for January and February averaged 2.3 per cent as against projection of 2.8 per cent for the January-March quarter of 2019 in the February policy. Accordingly, inflation for Q4:2018-19 in all likelihood is set to be lower than that projected in the February policy.
79. CPI inflation excluding food and fuel moderated from 5.6 per cent in December to 5.4 per cent in February. The spike in prices in the health and education sub-groups in December proved to be a one-off phenomenon. The food group continued to be in deflation for the fifth consecutive month in February. Inflation in the fuel and light sub-group unexpectedly collapsed from 4.5 per cent in December to 1.2 per cent in February, with electricity prices remaining in deflation. Inflation expectations of households, measured by the Reserve Bank’s survey of households, declined in the February round over the previous round by 40 basis points each for the three-month ahead and the one-year ahead horizons. With this, inflation expectations have declined cumulatively by as much as 160 basis points for the three-month ahead and 170 basis points for one-year ahead horizons in the last four survey rounds.
80. In comparison with the February policy, CPI inflation projection is now revised downwards by 30-40 basis points to 2.4 per cent in Q4:2018-19, 2.9-3.0 per cent in H1:2019- 20 and 3.5-3.8 per cent in H2, with risks broadly balanced. This baseline inflation scenario, however, is subject to several uncertainties, especially from crude oil and food prices. More precisely, the uncertainties/risks include: (i) the highly uncertain outlook for oil prices, which are vulnerable to both upward pressure due to continuing OPEC production cuts, as well as downward pressure due to further slowing down of the global economy; (ii) the risk of an abrupt reversal in vegetable prices, which may get accentuated due to deficient monsoon should there be El Niño conditions; and (iii) inflation excluding food and fuel may soften further from the present levels if the recent slowdown in domestic economic activity intensifies. The fiscal situation at the general government level also needs a careful vigil. Given India’s large dependence on imports of crude oil, stability in international crude oil prices is critical for domestic macroeconomic stability.
81. Moving on to economic activity, high frequency indicators suggest a further loss of pace in growth. Private consumption has been weakening as reflected in deceleration in the growth of passenger car sales and domestic air passenger traffic, weak performance of consumer durables and non-durables, and continuing contraction in non-oil non-gold imports. Investment activity has also decelerated due to contraction in production of capital goods in January and imports of capital goods in February. On the supply side, industrial growth has weakened as reflected in deceleration in the growth of index of industrial production (IIP) for January; the growth of core industries for February remained sluggish. However, capacity utilisation (CU) in the manufacturing sector has improved and is also above the long-term average. In the services sector, sales of commercial vehicles, port freight traffic and international air freight traffic contracted during February. However, indicators of the construction sector, viz., growth in consumption of steel and production of cement, continued to show healthy growth.
82. Overall financing conditions have continued to improve as reflected in the total flow of resources to the commercial sector. However, bank credit flows to micro and small as well as medium industries remain extremely weak. GDP growth for 2019-20 has been revised downwards to 7.2 per cent – in the range of 6.8-7.1 per cent in H1:2019-20 and 7.3-7.4 per cent in H2 – with risks evenly balanced.
83. Investment demand is losing traction and a deceleration in exports may further impact investment activity. With the inflation outlook looking benign and headline inflation expected to remain below target in the current year, it becomes necessary to address the challenges to sustained growth of the Indian economy. Hence, I vote for reducing the policy repo rate by 25 basis points. I would like to state here that there is a need to consider interest rate adjustments, not necessarily in the conventional way of 25 bps or multiples thereof. This idea needs further debate and discussion. Further, with several uncertainties facing the economy, it is appropriate to maintain the neutral stance of monetary policy.
84. The RBI will continue to watch the evolving growth and inflation dynamics and shall act in time and act decisively while ensuring price stability on an enduring basis in pursuance of its mandate under the RBI Act. Yogesh Dayal Press Release : 2018-2019/2481 Chief General Manager
6. Global economic activity has been losing pace after a somewhat improved performance in Q1:2019, reflecting further slowdown in trade and manufacturing activity. Among advanced economies (AEs), economic activity in the US strengthened in Q1, supported by higher government spending, increase in private investment and a lower trade deficit. However, factory activity and retail sales moderated in April. Economic activity in the Euro area has remained weak due to muted industrial activity and weak business confidence. Leading indicators point to a further slowdown in the Euro area in Q2. In the UK, GDP growth for Q1 picked up on high retail sales and government expenditure. However, the outlook is clouded by uncertainty relating to Brexit. The Japanese economy accelerated in Q1 on net exports gains and increased public investment. In April, industrial production improved, while retail sales fell.
7. Economic activity has slowed in many emerging market economies (EMEs). In Q1:2019, the Chinese economy grew at the same pace as in the previous quarter, though slightly above consensus expectations. However, incoming data on industrial production and retail sales suggest that the growth momentum may weaken in Q2. The Russian economy, which had shown some signs of recovery in Q4:2018, weakened in Q1 on muted domestic activity and trade. Economic activity in South Africa contracted in Q1 pulled down mainly by a sharp decline in manufacturing activity. Brazil’s economy contracted in Q1 for the first time since 2016 and there are fears that it could return to recession.
8. Crude oil prices remained volatile, reflecting evolving demand-supply conditions underpinned by the production stance of the OPEC plus, rising shale output, weakening global demand and geo-political concerns. The strengthening of the US dollar had weakened gold prices; however, prices picked up since the last week of May on escalating trade tensions, reviving its demand as a safe haven asset. Inflation remains below target in several economies, though it has shown an uptick since March.
9. Financial markets have been driven by uncertainties surrounding US-China trade negotiations and Brexit. In the US, the equity market has experienced some selling pressures since early May on escalation of trade tensions with China and recently, with Mexico. Equity markets in most EMEs have lost steam due to the waning risk appetite on rising geo-political uncertainties and weakening global trade prospects. Bond yields in the US picked up in April on better GDP data for Q1, but declined in May on subdued economic data and expectations of a dovish monetary policy stance. Bond yields in Germany slipped into negative territory on weak economic data; in Japan, they remained negative on indications of sustained accommodation. In many EMEs, bond yields have been falling with central banks adopting accommodative monetary policy to boost economic growth. In currency markets, the US dollar strengthened on better than expected domestic economic data for Q1. Most EME currencies have depreciated against the US dollar. Domestic Economy
10. Turning to the domestic economy, on May 31, 2019 the National Statistical Office (NSO) released quarterly estimates of gross domestic product (GDP) for Q4:2018-19 and provisional estimates of national income for 2018-19. GDP growth for 2018-19 has been estimated at 6.8 per cent year-on-year (y-o-y), down by 20 basis points from the second advance estimates released on February 28, pulled down by a downward revision in private final consumption expenditure (PFCE) and moderation in exports. Quarterly data show that domestic economic activity decelerated sharply to 5.8 per cent in Q4:2018-19 from 6.6 per cent in Q3 and 8.1 per cent in Q4:2017-18. Gross fixed capital formation (GFCF) growth declined sharply to 3.6 per cent, after remaining in double digits in the previous five quarters. Private consumption growth also moderated. The drag on aggregate demand from net exports increased in Q4 due to a sharper deceleration in exports relative to imports. However, the overall slowdown in growth was cushioned by a large increase in government final consumption expenditure (GFCE).
11. On the supply side, agriculture and allied activities contracted, albeit marginally, in Q4:2018-19 due to a decline in rabi production. According to the third advance estimates, foodgrains production at 283.4 million tonnes for 2018-19 was lower by 0.6 per cent compared with the previous year mainly due to lower production of rabi rice, pulses and coarse cereals. However, there has been a catch-up in foodgrains production relative to earlier estimates. Foodgrains stocks at 72.6 million tonnes as on May 16, 2019 were 3.4 times the prescribed buffer norms. Growth in manufacturing activity weakened sharply to 3.1 per cent from 6.4 per cent in the previous quarter. Service sector growth, however, accelerated, supported by financial, real estate and professional services, and public administration, defence and other services. In contrast, construction activity slowed down markedly.
12. Moving beyond Q4, the India Meteorological Department (IMD) has predicted that south-west monsoon rainfall (June to September) is likely to be normal at 96 per cent of the long period average (LPA). The current weak El Niño conditions over the Pacific are likely to continue during the monsoon. However, currently prevailing neutral Indian Ocean Dipole (IOD) conditions may turn positive in the middle of the monsoon season and persist thereafter, which augur well for the rainfall outlook.
13. Growth in eight core industries decelerated sharply in April, pulled down largely by coal, crude oil, fertilisers and cement. Credit flows from banks to large industries strengthened, though they remained muted for micro, small and medium industries. Based on early results of the Reserve Bank’s order books, inventory and capacity utilisation survey (OBICUS), capacity utilisation (CU) in the manufacturing sector improved to 77 per cent in Q4 from 75.9 per cent in Q3; seasonally adjusted CU, however, slipped marginally to 75.2 per cent in Q4 from 75.8 per cent in Q3. The business assessment index (BAI) of the industrial outlook survey (IOS) in Q1:2019-20 remained unchanged at its level in the previous quarter. Imports of capital goods – a key indicator of investment activity – remained anaemic in April. However, the manufacturing purchasing managers’ index (PMI) edged up to 52.7 in May with strengthening of output, new orders and employment.
14. High frequency indicators suggest moderation in activity in the service sector. Sales of commercial vehicles, tractors, passenger cars, and three and two wheelers contracted in April. Railway freight traffic growth decelerated. Domestic air passenger traffic growth contracted in March, but turned around modestly in April. Two key indicators of construction activity, viz., cement production and steel consumption, slowed down in April. The PMI services index moderated to 50.2 in May on subdued growth of new businesses.
15. Retail inflation, measured by y-o-y change in CPI, remained unchanged in April, at its March level of 2.9 per cent, with higher inflation in food and fuel groups being offset by lower inflation in items excluding food and fuel.
16. The April food inflation print showed an increase to 1.4 per cent from 0.7 per cent in March. Within the food group, vegetables moved out of nine months of deflation. However, three sub-groups, viz., fruits, pulses and sugar, remained in deflation in April, though the extent of deflation moderated. Among other food sub-groups, inflation in prices of milk, oils and fats, spices, non-alcoholic beverages and prepared meals moderated, while inflation in meat, fish and eggs prices ticked up.
17. Inflation in the fuel and light group rose to 2.6 per cent in April from the February trough of 1.2 per cent, pulled up by prices of liquified petroleum gas due to an increase in international prices. Inflation in subsidised kerosene also rose, reflecting the impact of the calibrated increase in its administered price. Electricity prices moved out of three months of deflation in April. Prices of rural fuel consumption items – firewood, chips and dung cake – moved into deflation.
18. CPI inflation excluding food and fuel fell sharply to 4.5 per cent in April from 5.1 per cent in March – the largest monthly decline since April 2017. The moderation in inflation was broad-based, with household goods and services, and personal care and effects sub-groups registering the largest fall in April; housing inflation was the lowest since June 2017, reflecting softening in house rents in urban areas. Inflation in clothing and footwear also touched its historical low in the new all-India CPI series. Inflation in education, health and transportation and communication moderated as well.
19. Inflation expectations of households in the May 2019 round of Reserve Bank’s survey declined by 20 basis points for the three-month ahead horizon compared with the previous round, but remained unchanged for the one-year ahead horizon. However, manufacturing firms participating in the Reserve Bank’s industrial outlook survey expect input cost pressures to intensify on account of higher raw material costs and salaries in Q2. Input price pressures eased in both agricultural and industrial raw materials. Nominal growth in rural wages and in organised sector staff costs remained muted.
20. Liquidity in the system turned into an average daily surplus of `66,000 crore (`660 billion) in early June after remaining in deficit during April and most of May due to restrained government spending. The Reserve Bank injected liquidity of `70,000 crore (`700 billion) in April and `33,400 crore (`334 billion) in May on a daily net average basis under the LAF. It conducted two OMO purchase auctions in May amounting to `25,000 crore (`250 billion) and a US dollar buy/sell swap auction of US$ 5 billion (`34,874 crore) for a tenor of 3 years in April to inject durable liquidity into the system. The weighted average call money rate (WACR) – the operating target of monetary policy – remained broadly aligned with the policy repo rate: it traded above the policy repo rate (on an average) by 6 bps in April, but below the policy repo rate by 6 bps in May. The Reserve Bank has announced that it would conduct an OMO purchase auction of `15,000 crore (`150 billion) on June 13, 2019.
21. Transmission of the cumulative reduction of 50 bps in the policy repo rate in February and April 2019 was 21 bps to the weighted average lending rate (WALR) on fresh rupee loans. However, the WALR on outstanding rupee loans increased by 4 bps as the past loans continue to be priced at high rates. Interest rates on longer tenor money market instruments remained broadly aligned with the overnight WACR, reflecting near full transmission of the reduction in policy rate.
22. Exports were unable to sustain the growth of 11.8 per cent observed in March 2019; they grew by 0.6 per cent in April 2019 dragged down by engineering goods, gems and jewellery, and leather products. Imports grew at a somewhat accelerated pace in April 2019 relative to the preceding month, driven by imports of petroleum (crude and products), gold and machinery. This led to a widening of the trade deficit, both sequentially and on a y-o-y basis. Provisional data suggest that net services exports in Q4:2018-19 were broadly comparable to their level a year ago which bode well for the current account balance. On the financing side, net foreign direct investment flows were stronger in Q4:2018-19 than a year ago. After a sharp recovery in March 2019, net foreign portfolio inflows were relatively modest at US$ 2.3 billion in 2019-20 in April-May. While the equity segment received net inflows during this period, the debt segment witnessed net outflows. India’s foreign exchange reserves were at US$ 421.9 billion on May 31, 2019. Outlook
23. In the bi-monthly monetary policy resolution of April 2019, CPI inflation was projected at 2.4 per cent for Q4:2018-19, 2.9-3.0 per cent for H1:2019-20 and 3.5-3.8 per cent for H2:2019-20, with risks broadly balanced. The headline inflation outcome in Q4 at 2.5 per cent was largely in alignment with the April policy projections.
24. The baseline inflation trajectory for 2019-20 is shaped by several factors. First, the summer pick-up in vegetable prices has been sharper than expected, though this may be accompanied by a correspondingly larger reversal during autumn and winter. More recent information also suggests a broad-based pick-up in prices in several food items. This has imparted an upward bias to the near-term trajectory of food inflation. Second, a significant weakening of domestic and external demand conditions appear to have led to a sharp broad- based decline of 60 bps in inflation excluding food and fuel in April; this has imparted a downward bias to the inflation trajectory for the rest of the year. Third, crude prices have continued to be volatile. However, its impact on CPI inflation has been muted so far due to incomplete pass-through. Fourth, near-term inflation expectations of households have continued to moderate. Taking into consideration these factors, the impact of recent policy rate cuts and expectations of a normal monsoon in 2019, the path of CPI inflation is revised to 3.0-3.1 per cent for H1:2019-20 and to 3.4-3.7 per cent for H2:2019-20, with risks broadly balanced (Chart 1).
25. Risks around the baseline inflation trajectory emanate from uncertainties relating to the monsoon, unseasonal spikes in vegetable prices, international fuel prices and their pass- through to domestic prices, geo-political tensions, financial market volatility and the fiscal scenario.
26. In the April policy, GDP growth for 2019-20 was projected at 7.2 per cent – in the range of 6.8-7.1 per cent for H1 and 7.3-7.4 per cent for H2 – with risks evenly balanced. Data for Q4:2018-19 indicate that domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports. Weak global demand due to escalation in trade wars may further impact India’s exports and investment activity. Further, private consumption, especially in rural areas, has weakened in recent months. However, on the positive side, political stability, high capacity utilisation, the uptick in business expectations in Q2, buoyant stock market conditions and higher financial flows to the commercial sector augur well for investment activity. Taking into consideration the above factors and the impact of recent policy rate cuts, GDP growth for 2019-20 is revised downwards from 7.2 per cent in the April policy to 7.0 per cent – in the range of 6.4-6.7 per cent for H1:2019-20 and 7.2-7.5 per cent for H2 – with risks evenly balanced (Chart 2).
27. The MPC notes that growth impulses have weakened significantly as reflected in a further widening of the output gap compared to the April 2019 policy. A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern. The headline inflation trajectory remains below the target mandated to the MPC even after taking into account the expected transmission of the past two policy rate cuts. Hence, there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity, while remaining consistent with its flexible inflation targeting mandate.
28. Against this backdrop, all members of the MPC (Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Shri Shaktikanta Das) unanimously decided to reduce the policy repo rate by 25 basis points and change the stance of monetary policy from neutral to accommodative.
29. The minutes of the MPC’s meeting will be published by June 20, 2019.
30. The next meeting of the MPC is scheduled during August 5 to 7, 2019. Voting on the Resolution to reduce the policy repo rate by 25 bps to 5.75 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Dr. Viral V. Acharya Yes Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
31. Since the last review, there has been a further decline in the 3 month ahead inflationary expectations by 20 bps but with no change in the 1 year ahead inflationary expectations. Both the three month ahead inflationary expectations and the current perception of inflation have now declined in 4 consecutive rounds reflecting more benign inflation conditions. While inflationary expectations from RBI’s household survey may have bottomed out, I find it encouraging that the 58th round of the Survey of Professional Forecasters (SPF) indicates better anchoring of inflationary expectations to the medium target of 4 percent.
32. While headline inflation evolves in line with projections (April print was 2.92%, March print was 2.86%), food inflation has ticked up and doubled since the March print. I have been concerned that one year ahead headline inflation projections have been assuming lower food momentum, small deviations from which could easily make headline inflation projections breach the 4% target. More realistic baseline parameter assumptions used in current projections however rectify this, and suggest that 1 year ahead headline projections will undershoot the 4% medium target (average Q4 FY 20 values are 3.8%).
33. Inflation ex food fuel has precipitously dropped by 60 bps to 4.5% in April from 5.1% in March, which is the lowest print since September 2017. Even factoring in the latent pass through of the spike in crude that happened before the general election results were declared on May 23, the month-on-month SAAR rate for inflation ex food and fuel is still subdued in April 2019 (around 1.87%).
34. I see two risks here: first, the INR has depreciated more than other EME currencies in the last one year; second, crude prices tend to make the INR more vulnerable. I continue to remain watchful of the risk that the INR and crude will have on the trajectory of inflation ex food and fuel. Food inflation, however, will continue to normalize in the April-August period. It remains to be seen how strong the spillovers are from a cyclical seasonal movement, especially in vegetables, on inflation ex food and fuel. This should be carefully monitored.
35. On the growth front, compared to the last review, several indicators are flagging red. The crucial question is how deep is the cyclical downturn.
36. While RBI’s study on corporate performance for Q4 FY 19 indicates that demand conditions continued to moderate (proxied by nominal and sales growth of 1432 firms), this moderation was not broad-based. For instance, sales growth improved in sectors like food products and beverages, and remained steady and in double digits in cement and cement products and chemical and chemical products. Likewise, high double digit growth in sales was recorded in wholesale and retail trade and transport and storage services. Since new launches of private real estate continue to languish, it would appear that the stable growth in cement and steel could be driven by a government push in infrastructure building and affordable housing. A carefully done base-momentum decomposition analysis of seasonally adjusted Industrial GVA indicates that, during 2018-2019, barring the significant push to Industry GVA provided by the base effect in Q1, it is an unfavorable base effect which acted as a drag on industrial growth in the other quarters. Likewise, a decomposition of gross fixed capital formation (GFCF) into base and momentum effects indicates that investments during Q4: 2018-2019 were down primarily due to an adverse base effect, with some deceleration in momentum. Nominal GVA growth of listed private manufacturing companies however was dented by lower staff costs, which moved into single digit growth (6.4%) after many quarters, possibly reflecting lower employment creation.
37. There is a larger issue in my mind as to why RBI’s study on corporate performance paints a less drastic (or mixed) picture on the health of the economy when compared to say other indicators used in the national account statistics (NAS), or the IIP. It may possibly be because it samples a smaller universe of non-governmental non-financial (i.e., private sector) firms, although more analysis needs to be done. For instance, most consumption indicators in the IIP are now flashing red and have worsened since the last review. Consumer durable growth, reflecting stress in the auto sector, moved into contraction (-5.3%). Capital goods, reflecting the decline in machine and equipment, was also in contraction (-8.7%). Consumer non-durables growth, reflecting declines in discretionary income, was low (+0.3%).
38. These declines are reflected in a further widening in the output gap since the last review. The widening of the output gap is also in sync with a low print of Q4 FY 19 growth of 5.8%, and the virtual stalling of gross fixed capital formation growth in Q4 FY 19.
39. On the external front, the pace of activity has continued to slow down. The world output gap is more negative compared to a couple of months ago. I continue to view the consolidated fiscal deficit (as embodied in the public sector borrowing requirement) as jeopardizing the durability of the inflation target in the medium term. There are a few issues here.
40. One, our practice of fiscal policy where large swings in government final consumption expenditure in the final quarter of a fiscal year are required to meet fiscal deficit targets imparts substantial volatility to growth rates. This makes it difficult to design monetary policy. Second, fiscal ‘prestidigitation’ or sleight of hand may contribute to our own version of a “doom-loop”, i.e., by pushing expenditure off budget to meet deficit targets and then recourse to borrowing from the national small savings fund by state entities keeps administrative interest rates high to incentivise such savings. This impedes monetary transmission. Poor monetary transmission requires more active fiscal policy to compensate which breaches fiscal targets once again.
41. I also worry that the very nature of the Indian growth model, which requires excessive policy induced tinkering with the inter-sectoral terms of trade to meet both distributional objectives and demand push objectives makes fiscal-monetary coordination difficult.
42. The job of good monetary policy is to close gaps. A widening negative output gap and below target inflation warrants a monetary policy response. A rate cut at the current juncture would help both close the output gap and bring inflation back to target, a situation of “divine- coincidence”.
43. Going forward, I will remain data dependent, and will carefully watch the incoming growth and inflation data.
44. I vote to cut the policy rate by 25 basis points, and shift the stance to accommodative. Statement by Dr. Pami Dua
45. India’s Gross Domestic Product (GDP) growth in Q4:2018-19 decelerated sharply to a 20-quarter low of 5.8%, mainly due to a decline in the growth of gross fixed capital formation to 3.6% and moderation in growth of private consumption expenditure to 7.2%. While growth in government consumption expenditure was upbeat at 13.1% in Q4:2018-19, GDP growth for FY2019 was revised to a five-year low of 6.8%. Further, growth in agriculture turned negative (-0.1%) in Q4:2018-19 for the first time since Q3:2015-16, although services remained resilient. In addition, y-o-y growth in the Index of Industrial Production (IIP) decelerated in the months of January and February, followed by negative growth (-0.1%) in March. This was accompanied by negative growth in manufacturing (with 78% weight in IIP) in February and March. The use-based classification shows a declining trend in capital goods and consumer durables. Furthermore, high frequency indicators such as passenger vehicle sales, tractors and motorcycle sales suggest a slowdown in urban and rural demand. On the external front, growth in merchandise exports and imports has slowed, with exports witnessing a sharper deceleration, reflecting the slowdown in global demand, trade tensions and global uncertainties.
46. Meanwhile, the Purchasing Managers’ Index increased in May due to an expansion in output, new orders and employment. Further, RBI’s Business Expectations Index of the Industrial Outlook Survey for manufacturing anticipates modest improvement in Q2:2019-20. The OBICUS Survey (Order Books, Inventory and Capacity Utilisation Survey) conducted by RBI suggests a seasonal rise in capacity utilisation in Q4:2018-19. RBI’s Consumer Confidence Indices – Current Situation Index and Future Expectations Index – on the other hand, reflect a drop in the May round compared to the previous March round, implying lower current activity and a less optimistic outlook. On the brighter side, higher financial flows should enhance investment.
47. Headline inflation, measured by CPI inflation, remained at its March level of 2.9% in April, with increase in food and fuel inflation partly offset by the broad-based decline of CPI inflation excluding the food and fuel groups. Trends from surveys provided mixed signals. Inflation expectations of consumers, as captured through RBI’s Inflation Expectations Survey of Households, showed a decline for the three-month-ahead horizon by 20 basis points but were unchanged for the one-year-ahead horizon. At the same time, the Industrial Outlook Survey (IOS) showed an expectation of rising input costs in the upcoming quarter (Q2:2019- 20). Going forward, upside risks to inflation include continuation of the uptick in food price inflation, uncertainties relating to monsoon, volatility in international oil prices, materialization of industry expectations of cost pressures as per the IOS and lastly, potential fiscal slippage.
48. Looking at the international scenario, a revival in global economic growth remains elusive, with the Economic Cycle Research Institute’s (ECRI) 20-Country Long Leading Index growth rate staying near its lowest reading in almost three years. Also, US economic growth is set to slow, while an inflation cycle downturn is poised to persist, given the decline in ECRI’s U.S. Future Inflation Gauge (a harbinger of inflation) to its lowest reading in over three years. Meanwhile, with ECRI’s Global Leading Manufacturing Index growth staying near a seven-year low, the global industrial growth outlook remains dismal. Of particular concern is that growth in ECRI’s Chinese Leading Industrial Production Index, which leads Chinese PMI data, slipped in its latest reading toward its recent multiyear low. This is the cyclical context of the recent escalation of its trade war with the US.
49. The gloomy global scenario also highlights the fact that India cannot rely on external engines of growth in the current circumstances. Thus, an internal boost to demand would be the preferable option. In the last two MPC meetings (February and April), the repo rate was cut by 25 basis points in each meeting. The transmission of these policy rate cuts of 50 bps to the weighted average lending rate (WALR) was 21 bps on fresh rupee loans. On the other hand, the WALR on outstanding loans increased by 4 bps, since past loans are priced at high rates. At the same time, longer tenor money market instruments were generally aligned with the weighted average call money rate (WACR), implying reasonable transmission of the reduction in the policy rate. In other words, while the transmission is not complete, its impact is visible.
50. Thus, given the deceleration in growth and in the context of projected headline inflation remaining below the target in 2019-20, I vote for a rate cut of 25 bps. To reinforce this, in an attempt to boost sentiment, I also vote to change the stance from neutral to accommodative. Statement by Dr. Ravindra H. Dholakia
51. In the MPC meeting of April 2019, I had clearly stated that there was a considerable space of about 75 bps to cut policy rate further and voted for a 25 bps reduction with a change of stance from neutral to accommodative. Subsequent developments have further opened up the space by about 20-25 bps. Forecast by RBI 3-4 quarters ahead on headline inflation is down by 10 bps and on annual real GDP growth by 20 bps. Oil prices have remained broadly in my expected range and are softening of late. Inflationary expectations are getting anchored. As I had argued in my statement last time, the core inflation (by whatever definition) shows a declining trend and is no longer sticky at high levels. Recent inflation prints for March and April 2019 show a sharp decline in the core inflation across several goods and services. Real interest rates are very high in the economy adversely impacting costs and thereby our global competitiveness. In my opinion, we should continue correcting our real interest rates by bringing down our policy rate. I, therefore, vote for changing the stance to accommodative and reducing the policy rate further by 25 bps, although I would have preferred to cut it by 40 bps this time. More precise considerations for my vote are as follows: i) Recent developments on global slowdown in growth and international trade, pile up of inventory of oil in USA, and geo-political tensions indicate that oil prices are not likely to breach the band of $ 58 to $ 73 on a durable basis in the near future. Therefore, its adverse impact on headline inflation, if at all, is not likely to be significant. ii) Growth has seriously dipped and can recover relatively fast on the policy support though it is likely to remain well below the potential at least for next three-four quarters. This will lead to widening of the output gap already created. It would, therefore, put further downward pressure on wages and prices. iii) Core inflation (with whatever precise definition) is already on a declining trend and is likely to continue to fall over time because of the above reasons. In addition, the inflationary expectations in the economy are also coming down. iv) Food stocks are more than adequate and available predictions on monsoon are favourable. There is a possibility that food prices may not pick up to the extent predicted. If there are spikes in prices of some vegetables and fruits, they may be temporary and reversible over time. On the whole, there is a good chance that the food inflation and hence the headline inflation may undershoot the expectations. v) Central Banks all over the world have become more dovish in their tone and rate hikes are not only on hold but may reverse in some cases. This may generate additional space to correct our real interest rates. vi) The concern about first, the fiscal slippage at this stage and second, its adverse impact on inflation in my opinion is both misconceived and misplaced. With substantial slowdown in real growth on one hand and inflation rate consistently undershooting both on retail and wholesale basis, the growth of nominal GDP has declined significantly compared to the one assumed for the budget preparation. Under such a cyclical downturn, the fiscal deficit can overshoot the target even without any change in the fiscal policy parameters such as tax rates and expenditure rates. This should not be considered as a fiscal slippage; otherwise the fiscal policy would turn pro-cyclical if the policy makers become obsessed to achieve the observed fiscal deficit target by reducing expenditures or increasing taxes. It would only destabilize the system further rather than stabilizing it as expected of the policy. In order to take care of this anomaly with the observed fiscal deficit target, theory suggests evaluating fiscal performance through the concept of “full-employment budget deficit” or “the structural budget deficit”, which is not observed but has to be calculated taking potential output rather than actual (or observed) output. In practical terms, if the slippage in fiscal deficit is on account of revenue shortfall consequent on the decline in the nominal income growth, it should not be considered a genuine fiscal slippage. If, however, the slippage is because of increased expenditures by the government, it would be a genuine slippage. The current situation needs careful consideration before we conclude on fiscal slippage, because the slippage seems to be more due to revenue shortfall than expenditure increase. Secondly, in the face of a serious slowdown in the economy, a stabilization policy such as fiscal policy should be counter-cyclical and not pro-cyclical. Temporary “observed fiscal slippage” under such circumstances is neither undesirable nor damaging. The fear that it would derail the government from the path of fiscal consolidation and discipline amounts to distrusting the intentions of the government that has a clear and strong political mandate to perform. In my opinion, therefore, under present conditions, concerns about temporary fiscal slippage are misplaced. Moreover, with existence of deficient aggregate demand, minor fiscal slippage in the observed deficit would not be inflationary. vii) Finally, in most countries that matter to us in terms of trade and finance the real rates of interest are very low; or the real policy rate is barely positive. On the contrary, our real policy rate is in excess of 2 percent and our real interest rates are very high, making our production globally less competitive. We must bring it down to realistic levels of around 1.5 percent sooner than later. With expected inflation around 3.7 percent, there is a space of about 75-80 bps of rate cut.
52. It is prudent to create space for future policy action on either side when the conditions are good. When inflation is under reasonable control and upside risks are muted, this is the right time to correct the high real rates of interest. However, we have to be careful to avoid any knee-jerk reactions and proceed slowly but steadily. It is in this context that it is still not too late in my opinion to change the stance from neutral to accommodative by reducing the policy rate further by 25 bps. Statement by Dr. Michael Debabrata Patra
53. The formation of inflation over recent months is a story of compensating variations in components. But the sum of these parts has moved down over the twelve months ahead horizon on a trajectory that has itself been adjusted downwards four times successively (December 2018; February 2019; April 2019; and June 2019). Risks to the primary target of monetary policy are distinctly on the ebb. Inflation expectations are also better anchored than before. In fact, if one were to step back a little in time, it is evident that if the 2019-20 projections materialise, the MPC would have steered inflation at or below target on average for four years in a row in its five-year term of office.
54. The path of inflation in 2019-20 will likely encounter transient supply shocks such as pre-monsoon food price spikes, which monetary policy should look through and await their reversal. More importantly, this future path will also be conditioned by softening of more durable constituents, which perhaps mirrors the underlying state of the economy. And it is in this context that the conduct of monetary policy over the year ahead will get defined.
55. Lead and coincident indicators gleaned from surveys and other sources emit the following messages: i) weakening demand conditions facing manufacturing, which is also denting hiring intentions; ii) elevated capacity utilisation in the absence of investment in new capacity; iii) inventories of finished products in several sectors, including houses and automobiles; iv) still weak pricing power among corporates; v) dipping consumer confidence in the economic situation and the employment outlook; vi) professional forecasters expecting further moderation in private consumption, gross fixed investment, exports and imports.
56. I would submit that all this highlights the deterioration in the outlook for the economy in the year ahead. The recently released estimates of national income for Q4 2018-19 confirm the weakening of economic activity about which I have consistently expressed concerns in my minutes from February 2019. High frequency indicators for Q1 2019-20 point to a broad- basing of the slowdown.
57. Turning to the global economy, it is unlikely that global growth will be able to sustain the uptick in Q1 2019. Intensification of trade wars and geopolitical tensions amidst volatile crude prices and nervous financial markets render the outlook fraught with downside risks. India cannot afford to be complacent about the danger of the global slowdown deepening.
58. In my view, the evolving macroeconomic configuration imparts urgency to strong policy support for the flagging economy in pursuance of the goals set for the MPC. In fact, with inflation projected to remain below target, a higher weight needs to be assigned to growth relative to previous meetings.
59. Most important at this juncture: monetary policy by itself cannot bring about a reinvigoration of economic activity. Monetary policy is taking the lead as the first line of defence, but a coordinated full throttle effort by all arms of macroeconomic management is the need of the hour.
60. On these considerations, I vote for a 25 basis points reduction in the policy rate and a change in the stance of monetary policy to accommodation. Statement by Dr. Viral V. Acharya
61. “Why do old men wake so early? Is it to have one longer day?” wonders Santiago, the old fisherman, in “Old Man and the Sea” by Ernest Hemingway. I found myself preparing and writing these minutes early too, perhaps so I could have one longer drafting day!
62. Since the April 2019 meeting of the Monetary Policy Committee (MPC), inflation prints have been more or less consistent with RBI’s projections. Food inflation has risen more than expected, driven significantly by a seasonal summer uptick in vegetable prices. In contrast, inflation excluding food and fuel (ex-food-fuel) has registered a significant broad- based decline of 90 basis points (bps); this was both unexpected and unusually large in magnitude over a short period of two months. I have always put significant weight on ex- food-fuel inflation in my assessment of future inflation trajectory as it tends to be the more persistent component of headline inflation and it contains better signals about the underlying aggregate demand pressures. The signal conveyed by substantial softening of ex-food-fuel inflation has only been corroborated by the large negative surprise of the Q4:2018-19 GDP print, pulled down by a sharp deceleration in Gross Fixed Capital Formation (GFCF) growth to 3.6%, a 14-quarter low, explained possibly at least in part by a hysteresis effect induced by the pre-election uncertainty.
63. Altogether this led to the following considerations at my end regarding the inflation outlook: i) The broad-based decline in ex-food-fuel inflation is the primary contributor to softening of the inflation trajectory at the horizon of 12 months. While the level of ex- food-fuel inflation is presently at 4.5%, the fact that the level of food inflation is relatively low ensures that the headline trajectory over the next twelve months projected by the RBI staff remains below the MPC target of 4%, reaching 3.7% in Q4:2019-20. ii) Food momentum has picked up significantly; late monsoon and prevailing drought conditions in many states suggest this momentum may sustain beyond just vegetable prices. While vegetable prices show seasonality during April-August that tends to reverse partly during September-March, the reversal pattern is less clear for the food basket as a whole. Nowcast data suggest that momentum in food prices is broad-based in May too, though it has softened from the first fortnight to the second fortnight. Overall, this has imparted an upward push to the food inflation trajectory, more so in the short term. iii) Fuel prices had been rising internationally until the third week of May but have since corrected by over 10% due to the evolving trade war uncertainty and its implications for global demand in a scenario of more than expected supply response. The pass- through to domestic prices has, however, been incomplete. Hence, there is a latent inflation of around 15 basis points that will enter headline inflation if and when passed through; else, if it is absorbed by the government (through lower profits of public sector undertakings) then it will likely get generalised into headline inflation in due course through a higher fiscal deficit. Thus, even as the correction in fuel prices pulls the inflation trajectory down, the incomplete pass-through over the past few months negates some of the decline.
64. In summary, compared to the April 2019 policy, short-term headline inflation trajectory has risen but the 6-to-12-month trajectory has somewhat softened. For a change, I am not comparing this pattern to that observed in the revision of inflation expectations of households or in the survey of professional forecasters as these were received before the release of the Q4:2018-19 GDP print.
65. There is, however, an important upside risk to RBI’s projected inflation trajectory that I wish to highlight in particular – that of fiscal slippage.
66. Estimates of overall public sector borrowing requirement (PSBR) – which appropriately accounts for extra-budgetary resources and other off-balance sheet borrowings of central and state governments –have now reached between 8% and 9% of GDP 1. This is at a level similar to that in 2013 at the time of the “taper tantrum” crisis. Following are some salient implications: i) While the consolidated fiscal deficit of the center and states might have improved since 2013, the PSBR suggests otherwise. ii) PSBR has risen since 2014 even during high GDP growth years. The rise in PSBR in fact reflects a structural pattern of greater government expenditures and not just cyclical (such as due to weak tax collections from low growth). In other words, there is a significant aggregate demand push linked to government expenditure that needs to be recognised as a source of inflation; in particular, correct economic measurement of the fiscal slippage should factor in the implications of a rising PSBR rather than rely solely on the consolidated fiscal deficit figures. iii) Even the cyclical component of PSBR, such as that in the last year due to lower tax collections, raises the inflation trajectory through an increase in issuance of public debt and country risk premium that feed into imported inflation. iv) Further, PSBR impairs monetary policy transmission due to crowding out effects on market financing through public bonds and on bank deposits through small savings which continue to offer rates that are significantly higher than market yields. This channel bites particularly when the domestic savings rate is on a decline and increases economy’s reliance on external sources of funding.
67. The upcoming Union Budget is, therefore, key to understanding the inflation outlook, especially the response to ongoing distress in the agrarian economy, caused in part by low food prices and reflected in low rural inflation of less than 2% compared to urban inflation that remains above 4%. Would the response worsen the fiscal outlook for next year and beyond, or keep it contained through pursuit of much-needed reforms for the agricultural sector and reduction/rationalisation of other revenue expenditures? Equally importantly, the pattern of PSBR evolution during the rest of 2019-20 would also be critical for assessing the inflation outlook. Hence, the MPC needs to carefully watch out for these fiscal developments. Please see pieces by Sajjid Z Chinoy and Toshi Jain of J.P.Morgan: India’s interim budget tries to strike a balance, but the real story is off-balance sheet; RBI is a close-call next week; India in 2019: still waters run deep
68. Turning to growth, the Q4:2018-19 GDP print has widened the traditional measure of the output gap to be more negative. Several coincident economic indicators for Q1:2019-20, such as consumer durables and non-durables consumption as well as investment activity continue to remain weak. It is to be noted though that my preferred measure of the output gap – the finance-neutral output gap (FNOG) – remains closed as (i) aggregate credit growth remains above nominal GDP growth rate; (ii) the impact of past two policy rate cuts will provide fuller transmission to the real sector over the next year; and, (iii) the post-election reduction of financial market uncertainty has led to a softening of the bond yields and a rebound in equity markets in May. In other words, growth has slowed down but financial conditions have eased which should provide a tailwind to growth and help investment activity revive on the back of steadily improving capacity utilisation.
69. Nevertheless, on balance, I concluded that the mixed picture on economic growth has morphed into one where at least some aspects have weakened considerably over the past two quarters.
70. In the April 2019 policy, I had voted to keep the policy rate at 6.25%, whereas the MPC had cut the policy rate to 6%. Counterfactual exercises suggest that under the baseline projections of the RBI, the policy repo rate at 6% is just "right" in the short term to achieve MPC's mandated target of 4% headline inflation in the medium term. However, the large decline in ex-food-fuel inflation since the April policy implies some space in these counterfactual exercises to accommodate growth weakness with a policy rate cut of around 20 basis points sometime in the middle of 2019-20.
71. I do remain concerned about the following upside risks to inflation: i) The monsoon uncertainty imparting further spike in food prices and the possibility of vegetable price reversal in winter months turning out to be lower than expected. Not only would this worsen the inflation outlook directly, but potentially also indirectly via the fiscal channel as it would aggravate the agrarian distress. ii) The rise in implied volatility of international crude oil prices from 30% to 50% over the past month even as oil prices have corrected downwards. iii) The possibility of an upward level-shift in the price of the Indian crude basket due to a shift in its composition from Iran and Venezuela to other oil suppliers. iv) The fiscal undercurrents impacting the generalized inflation outlook. As also conveyed earlier, I worry especially about a worsening of the PSBR in conjunction with rising oil prices, say due to geopolitical tensions; such a coincidence creates a “twin deficit” – fiscal and current account deficits – scenario for imported inflation, a glimpse of which we have had only recently during H1:2018-19.
72. Let me elaborate on the last of these upside risks. The Indian economy appears to experience “twin deficit” related vulnerability on a regular basis when external shocks amplify domestic weaknesses. The key to dealing with such a scenario is the ability and the willingness of the central bank to maintain credibility of inflation targeting when imported inflation tends to rise steeply (e.g., due to rising oil prices, widening fiscal and current account deficits, and, in turn, depreciating currency). Since monetary policy response will cool down inflation only with substantive lags, some headroom needs to be maintained in the inflation trajectory below the mandated target so as to absorb the steep rise in imported inflation without the headline moving far away from the target. Similarly, headroom needs to be retained in the policy rate space so as to help revive growth with monetary accommodation once the economy has cooled off and twin deficits reined in. In my assessment, this is exactly the "robust" approach that the MPC had adopted during the last year 2.
73. Finally, a few words on the trade war uncertainty and India are in order. By not being a significant part of global supply chains in manufacturing, India’s direct exposure to the present correction in global growth is likely to be somewhat muted. Indeed, this consideration has led to India being perceived by investors as somewhat of a “safe haven” economy. Hence, it is my view that growth concerns for India based on moderate trade war concerns are somewhat overstated. A full-scale trade war blowout may, however, result in an emerging markets sell-off by foreign portfolio investors, engulfing India’s external sector and raising prospects of imported inflation, especially if it coincides with a worsening PSBR, and even more perversely, if instead of easing due to weak global growth, oil prices were instead to rise from geopolitical tensions.
74. Counterfactual exercises suggest that a fiscal slippage of 50 basis points (a conservative assessment based on the PSBR estimates) or an oil price increase of 10% leave no space to cut the policy rate below 6%.
75. How should I vote? I found that I was speaking to myself as Santiago, the old fisherman, in “Old Man and the Sea” by Ernest Hemingway: “It is better to be lucky. But I would rather be exact. Then when luck comes, you are ready.”
76. In spite of my dilemma, I vote – albeit with some hesitation – to frontload the policy rate cut from 6% to 5.75% (a 50 basis points rate cut from my April vote to keep the policy rate at 6.25%). This would provide an insurance to help prevent the output gap from widening further or the finance-neutral output gap (FNOG) from turning negative. The MPC will need to remain on guard and be prepared to provide such insurance in a symmetric manner if upside risks to inflation were to materialize.
77. I also vote to change the monetary policy stance from neutral to accommodative. This is because the uncertainty around the upside risks to inflation I have highlighted will resolve only gradually over the next few months and can be factored into future MPC decisions in a data-dependent manner, but seem highly unlikely to lead to a rate hike at the next policy. Statement by Shri Shaktikanta Das
78. Since the last MPC meeting in April 2019, greater clarity has emerged about the evolving macroeconomic situation. Overall, there is clear evidence of economic activity losing traction, with the GDP growth in Q4:2018-19 slowing down to 5.8 per cent. CPI inflation excluding food and fuel registered a 20-month low in April 2019 even as the headline CPI inflation evolved broadly along the projected lines. High frequency indicators suggest that the global economy could not sustain the improved performance in Q1:2019 in the face of a sharp slowdown in trade and manufacturing. Consequently, central banks in both advanced and emerging market economies have adopted an accommodative stance in monetary policy.
79. CPI inflation in April 2019 remained unchanged at the previous month’s level of 2.9 per cent, though there were significant compositional shifts. Inflation in the food group increased sharply to 1.4 per cent in April 2019 from 0.7 per cent in March, with vegetables Note also that this “robust” inflation-targeting approach is different from an interest-rate defense of the currency; the latter explicitly targets a level of the exchange rate and was ruled out by the MPC in the October 2018 policy. moving out of deflation after nine months. Inflation in the fuel and light group also rose to 2.6 per cent in April from the February low of 1.2 per cent, mainly due to an increase in the prices of liquified petroleum gas following increase in international prices. However, the increase in food and fuel inflation was entirely offset by a sharp decline in inflation in items excluding food and fuel to 4.5 per cent in April from 5.1 per cent in March – the largest monthly decline since April 2017. The moderation in inflation excluding food and fuel, reflecting weakening of demand conditions, was quite broad-based, spread across several groups like household goods and services, personal care and effects, education and housing. Inflation expectations of households in the May 2019 round of the Reserve Bank’s survey softened further by 20 basis points for the three-month ahead horizon as compared with the previous round, though they remained unchanged for the one-year ahead horizon.
80. Inflation projections have been revised to 3.0-3.1 per cent for H1:2019-20 (up by 10 basis points in comparison with the last policy) and to 3.4-3.7 per cent for H2 (down by 10 basis points relative to the last policy), with risks broadly balanced. There are, however, several uncertainties to the baseline inflation path – the progress of monsoon, unexpected spikes in vegetable prices, international petroleum product prices and their pass-through to domestic prices, volatility in financial markets, and the fiscal situation.
81. Turning to economic activity, the May 31, 2019 data release of the National Statistical Office (NSO) placed GDP growth for 2018-19 at 6.8 per cent, down by 20 basis points relative to its February 28, 2019 estimates. In Q4 of 2018-19, GDP growth decelerated sharply to 5.8 per cent from 6.6 per cent in Q3 and 8.1 per cent a year ago. Though the base effect played some part, growth momentum also slowed down. Investment activity, in particular, decelerated sharply. On the supply side, agriculture and allied activities contracted, while manufacturing activity weakened significantly. Service sector growth remained resilient, though construction activity decelerated markedly.
82. Looking ahead, the forecast of a normal south-west monsoon by India Meteorological Department (IMD) augurs well for agriculture. Even as the third advance estimates of foodgrains production for 2018-19 were lower (by 0.6 per cent) as compared with the previous year, adequate stocks of foodgrains (3.4 times the prescribed buffer norms) provide a backstop against any supply shocks. In the industrial sector, growth in eight core industries decelerated sharply in April. Credit flows from banks to large industries strengthened, though they remained muted for micro and small as well as medium industries. Seasonally adjusted capacity utilisation (CU) in the manufacturing sector slipped to 75.2 per cent in Q4 from 75.8 per cent in Q3. Growth in imports of capital goods – a key indicator of investment activity – remained weak in April. High frequency indicators suggest moderation in activity in the service sector. Sales of commercial vehicles, tractors, passenger cars, and two- and three- wheelers contracted in April. Cement production and steel consumption – the two key indicators of construction activity – slowed down in April. Overall imports in April grew at a much faster pace than exports. Projected GDP growth for 2019-20 is revised downwards from 7.2 per cent in the April policy to 7.0 per cent – in the range of 6.4-6.7 per cent for H1:2019- 20 and 7.2-7.5 per cent for H2 – with risks evenly balanced.
83. Over the last few years, the Central Government has by and large followed a policy of fiscal prudence. It has adhered to the fiscal deficit glide path in the last 5 years, though at a somewhat slower pace than committed earlier. Public sector borrowing includes several public sector enterprises which have their own revenue streams to service their debt and take care of their liabilities. Borrowings by such public sector enterprises are mostly for capital expenditure. Hence, such borrowings should be viewed differently.
84. Liquidity in the system turned into surplus in early June after a large injection of durable liquidity by the Reserve Bank in the previous months. The 10-year government securities benchmark yield has declined by about 40 basis points from its average in April 2019 to about 7 per cent. The transmission of the cumulative reduction of 50 bps in the policy repo rate in February and April 2019 to fresh rupee loans has been 21 basis points. However, the weighted average lending rate on outstanding loans has increased by 4 basis points. Going forward, the transmission is expected to improve, given the lags with which banks adjust their deposit and lending rates in response to changes in the policy rate. It is to be noted that quite a sizable part of loan portfolio of banks continues at the base rate, which impedes monetary transmission. Interest rates on small savings are also higher than the prescribed formula.
85. In sum, growth impulses have clearly weakened, while the headline inflation trajectory is projected to remain below 4.0 per cent throughout 2019-20 even after considering the expected transmission of the past two policy rate cuts. Keeping in view the evolving growth- inflation dynamics, there is a need for decisive monetary policy action. Hence, my vote is to reduce the policy repo rate by 25 basis points. My vote is also to shift the stance of monetary policy from neutral to accommodative to send a clear signal. Yogesh Dayal Press Release: 2018-2019/3001 Chief General Manager
6. Global economic activity has slowed down since the meeting of the MPC in June 2019, amidst elevated trade tensions and geo-political uncertainty. Among advanced economies (AEs), GDP growth in the US decelerated in Q2:2019 on weak business fixed investment. In the Euro area too, GDP growth moderated in Q2 on worsening external conditions. Economic activity in the UK was subdued in Q2 with waning consumer confidence on account of Brexit related uncertainty and weak industrial production. In Japan, available data on industrial production and consumer confidence suggest that growth is likely to be muted in Q2.
7. Economic activity remained weak in major emerging market economies (EMEs), pulled down mainly by slowing external demand. The Chinese economy decelerated to a multi-year low in Q2, while in Russia subdued economic activity in Q1 continued into Q2 on slowing exports and retail sales. In Brazil, the economy is struggling to gain momentum after contracting in Q1 on weak service sector activity and declining industrial production. Economic activity in South Africa appears to be losing pace in Q2 as the manufacturing purchasing managers’ index (PMI) contracted for the sixth month in succession in June and business confidence remained weak.
8. Crude oil prices fell sharply in mid-May on excess supplies from an increase in non-OPEC production, combined with a further weakening of demand. Consequently, extension of OPEC production cuts in early July did not have much impact on prices. Gold prices have risen sharply since the last week of May, propelled by increased safe haven demand amidst rising downside risks to growth and a worsening geo-political situation. Inflation remained benign in major advanced and emerging market economies.
9. Financial markets were driven by the monetary policy stances of major central banks and intensifying geo-political tensions. In the US, the equity market recovered most of the losses suffered in May, boosted by dovish guidance by the US Fed and some transient respite in trade tensions with China. EM stocks lagged behind their developed market counterparts, mainly reflecting the weak performance of Chinese and South Korean stocks. Bond yields in the US, which were already trading with a softening bias on increased probability of policy rate cuts, fell markedly in early August on escalation of trade tensions. Bond yields in some more member countries in the Euro area moved into negative territory as expectations of more accommodative monetary policy by the European Central Bank gained traction. In EMEs, bond yields edged lower on more accommodative guidance by systemic central banks. In currency markets, the US dollar weakened against major currencies in June on dovish guidance by the US Fed but appreciated in July. EME currencies, which traded with an appreciating bias in July, depreciated in early August on escalation of trade tensions. Domestic Economy
10. On the domestic front, the south-west monsoon gained intensity and spread with the cumulative rainfall 6 per cent below the long-period average (LPA) up to August 6, 2019. In terms of its spatial distribution, 25 of the 36 sub-divisions received normal or excess rainfall as against 28 sub-divisions last year. The total area sown under kharif crops was 6.6 per cent lower as on August 2 than a year ago. The live storage in major reservoirs on August 1 was at 33 per cent of the full reservoir level as compared with 45 per cent a year ago. Rainfall during the second half of the season (August-September) has been forecast to be normal by the India Meteorological Department (IMD).
11. Industrial growth, measured by the index of industrial production (IIP), moderated in May 2019, pulled down by manufacturing and mining even as electricity generation picked up on strong demand. In terms of the use-based classification, the production of capital goods and consumer durables decelerated. However, consumer non-durables accelerated for the third consecutive month in May. The growth in the index of eight core industries decelerated in June, dragged down by a contraction in petroleum refinery products, crude oil, natural gas and cement. Capacity utilisation (CU) in the manufacturing sector, measured by the order books, inventory and capacity utilisation survey (OBICUS) of the Reserve Bank rose marginally to 76.1 per cent in Q4:2018-19 from 75.9 per cent in Q3; seasonally adjusted CU, however, fell to 74.5 per cent in Q4 from 75.6 per cent in Q3. The Reserve Bank’s business assessment index (BAI) for Q1:2019-20 improved marginally, supported by a modest recovery in profit margins of the surveyed firms even as production and order books slowed. The manufacturing PMI rose to 52.5 in July from 52.1 in June, underpinned by a pick-up in production, higher new orders and optimism on demand conditions in the year ahead.
12. High frequency indicators of services sector activity for May-June present a mixed picture. Tractor and motorcycle sales – indicators of rural demand – continued to contract. Amongst indicators of urban demand, passenger vehicle sales contracted for the eighth consecutive month in June; however, domestic air passenger traffic growth turned positive in June after three consecutive months of contraction. Commercial vehicle sales slowed down even after adjusting for base effects. Construction activity indicators slackened, with contraction in cement production and slower growth in finished steel consumption in June. Import of capital goods – a key indicator of investment activity – contracted in June. The services PMI expanded to 53.8 in July from 49.6 in June on increase in new business activity, new export orders and employment.
13. Retail inflation, measured by y-o-y change in the CPI, edged up to 3.2 per cent in June from 3.0 per cent in April-May, driven by food inflation, even as fuel inflation and CPI inflation excluding food and fuel moderated.
14. Inflation in the food group rose to 2.4 per cent in June from 2.0 per cent in May and 1.4 per cent in April, caused by a sharp pick up in prices of meat and fish, pulses and vegetables. Inflation also edged up in cereals, milk, spices and prepared meals. However, inflation in eggs and non-alcoholic beverages softened. Prices of fruits, and sugar and confectionery remained in deflation in June.
15. Inflation in the fuel and light group moderated in June, with electricity moving into deflation. Fuels such as firewood and chips, and dung cake have been in deflation from April. Inflation in liquified petroleum gas (LPG) and subsidised kerosene prices, however, remained elevated.
16. CPI inflation excluding food and fuel fell by 50 basis points to 4.1 per cent in May from 4.6 per cent in April, and remained unchanged in June. The softness in inflation in this category was broad-based across clothing and footwear; household goods and services; transport and communication; and recreation and amusement. Housing inflation remained unchanged over the last three months. Despite some moderation, inflation in the health sub-group remained elevated. Inflation in personal care and effects edged up in June due to a resurgence in gold prices.
17. Inflation expectations of households remained unchanged in the July 2019 round of the Reserve Bank’s survey for the three months ahead horizon as compared with the previous round, but they moderated by 20 basis points for the one year ahead horizon. Input cost pressures from prices of agricultural and industrial raw materials continued to ease in May and June. Nominal growth in rural wages was muted, while growth in staff costs in the manufacturing sector eased in Q1. Manufacturing firms participating in the Reserve Bank’s industrial outlook survey expect input cost pressures to soften on account of lower raw material costs in Q2.
18. Liquidity in the system was in large surplus in June-July 2019 due to (i) return of currency to the banking system; (ii) drawdown of excess cash reserve ratio (CRR) balances by banks; (iii) open market operation (OMO) purchase auctions; and (iv) the Reserve Bank’s foreign exchange market operations. The Reserve Bank absorbed liquidity of ₹51,710 crore in June, ₹1,30,931 crore in July and ₹2,04,921 crore in August (up to August 6, 2019) on a daily net average basis under the LAF. Two OMO purchase auctions amounting to ₹27,500 crore were conducted in June, thereby injecting durable liquidity into the system. The weighted average call money rate (WACR) – the operating target of monetary policy – was aligned with the policy repo rate in June, but it traded below the policy repo rate on a daily average basis by 14 bps in July and 17 bps in August (up to August 6, 2019).
19. The transmission of policy repo rate cuts to the weighted average lending rates (WALRs) on fresh rupee loans of banks has improved marginally since the last meeting of the MPC. Overall, banks reduced their WALR on fresh rupee loans by 29 bps during the current easing phase so far (February-June 2019).
20. Merchandise exports contracted in June 2019, weighed down by the subdued performance of gems and jewellery, petroleum products, rice, engineering goods and cotton. After a modest increase in May, imports also contracted in June, impacted by falling prices of petroleum products and reduced imports of pearls and precious stones, transport equipment, machinery, metalliferous ores, chemicals and fertilisers. As the fall in imports was larger than that of exports, the trade deficit declined modestly during May-June on a y-o-y basis. Provisional data suggest a sequential decline in net services exports in May 2019. On the financing side, net foreign direct investment flows moderated to US$ 6.8 billion in April-May 2019 from US$ 7.9 billion a year ago. Net foreign portfolio investment (FPI) flows in the domestic capital market amounted to US$ 2.3 billion during the current financial year so far (up to August 5, 2019) as against net outflows of US$ 8.5 billion in the same period last year. India’s foreign exchange reserves were at US$ 429.0 billion on August 2, 2019 – an increase of US$ 16.1 billion over end-March 2019. Outlook
21. In the second bi-monthly monetary policy resolution of June 2019, CPI inflation was projected at 3.0-3.1 per cent for H1:2019-20 and 3.4-3.7 per cent for H2:2019-20, with risks broadly balanced. The actual headline inflation outcome for Q1:2019-20 at 3.1 per cent was in alignment with these projections.
22. The baseline inflation trajectory for the next four quarters will be shaped by several factors. First, the uptick in food inflation may be sustained by price pressures in vegetables and pulses as more recent data suggest. Uneven spatial and temporal distribution of monsoon could exert some upward pressure on food items, though this risk is likely to be mitigated by the recent catch up in rainfall. Second, despite excess supply conditions, crude oil prices may likely remain volatile due to geo-political tensions in the Middle-East. Third, the outlook for CPI inflation excluding food and fuel remains soft. Manufacturing firms participating in the industrial outlook survey expect output prices to ease in Q2. Fourth, one year ahead inflation expectations of households polled by the Reserve Bank have moderated. Taking into consideration these factors and the impact of recent policy rate cuts, the path of CPI inflation is projected at 3.1 per cent for Q2:2019-20 and 3.5-3.7 per cent for H2:2019-20, with risks evenly balanced. CPI inflation for Q1:2020-21 is projected at 3.6 per cent (Chart 1).
23. In the MPC’s June resolution, real GDP growth for 2019-20 was projected at 7.0 per cent – in the range of 6.4-6.7 per cent for H1:2019-20 and 7.2-7.5 per cent for H2 – with risks evenly balanced. Various high frequency indicators suggest weakening of both domestic and external demand conditions. The Business Expectations Index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q2, although a decline in input costs augurs well for growth. The impact of monetary policy easing since February 2019 is also expected to support economic activity, going forward. Moreover, base effects will turn favourable in H2:2019-20. Taking into consideration the above factors, real GDP growth for 2019-20 is revised downwards from 7.0 per cent in the June policy to 6.9 per cent – in the range of 5.8-6.6 per cent for H1:2019-20 and 7.3-7.5 per cent for H2 – with risks somewhat tilted to the downside; GDP growth for Q1:2020-21 is projected at 7.4 per cent (Chart 2).
24. The MPC notes that inflation is currently projected to remain within the target over a 12- month ahead horizon. Since the last policy, domestic economic activity continues to be weak, with the global slowdown and escalating trade tensions posing downside risks. Private consumption, the mainstay of aggregate demand, and investment activity remain sluggish. Even as past rate cuts are being gradually transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap. Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture while remaining consistent with the inflation mandate.
25. All members of the MPC unanimously voted to reduce the policy repo rate and to maintain the accommodative stance of monetary policy. Four members (Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Shri Bibhu Prasad Kanungo and Shri Shaktikanta Das) voted to reduce the policy repo rate by 35 basis points, while two members (Dr. Chetan Ghate and Dr. Pami Dua) voted to reduce the policy repo rate by 25 basis points.
26. The minutes of the MPC’s meeting will be published by August 21, 2019.
27. The next meeting of the MPC is scheduled during October 1, 3 and 4, 2019. Voting on the Resolution to reduce the policy repo rate Magnitude of policy Member Vote repo rate reduction (basis points) Dr. Chetan Ghate Yes 25 Dr. Pami Dua Yes 25 Dr. Ravindra H. Dholakia Yes 35 Dr. Michael Debabrata Patra Yes 35 Shri Bibhu Prasad Kanungo Yes 35 Shri Shaktikanta Das Yes 35 Statement by Dr. Chetan Ghate
28. Since the last review, while there has been no change in the three month ahead inflation expectations of households (7.6%), there has been a decline of 20 bps in the level of one year ahead inflationary expectations (to 7.9%). Households’ current perception of inflation also shows no change at (6.6%). What is noteworthy is that the proportion of respondents (both in the three month and one year buckets) expecting inflation to be less than 6% remains high. The moderation in the one year ahead level of inflationary expectations has happened in spite of rising food inflation in the past couple of months suggesting better anchoring of inflationary expectations.
29. Benign inflation conditions continue to be manifested in CPI-headline (3.2% in June) although it edged up marginally from 3.0% in May. Average inflation in Q1 FY 19-20 (3.1%) is more or less in line with RBI projections made in June (3 percent).
30. Food inflation however has inched up for the seventh consecutive month in June, and food momentum has picked up in April-June. As mentioned in the last Statement, I will remain watchful of how strong the spillovers are from a cyclical seasonal movement (in certain food sub-groups such as vegetables). The realization of such risks could eliminate the “inflation shortfall” currently being projected relative to the medium run target of 4%.
31. In contrast to food inflation, there has been a moderation in inflation ex food and fuel, which continues to be flat at 4.1% in June. The sequential momentum in inflation excluding food and fuel also remains weak. I expect the pick up in economic growth however to put a “floor” on inflation ex food and fuel.
32. Reflecting benign current and one year ahead inflation conditions in the last several months, the MPC has cut the policy rate by 75 bps (between February 2019 – June 2019) to close the output gap. I will call this our level policy. Because of previous downward revisions in our inflation and growth projections, our change in stance (in June to accommodative from neutral), and the tone of our resolution and minutes, there has also been a substantial flattening and shifting down of the yield curve. I will call this our slope policy. For instance, the 10 year government bond yield on July 22, 2019 was 6.42 per cent compared to 7.29 per cent on May 20, 2019. Likewise, the 91-day T-Bill rate on July 22 was 5.72% per cent compared to 6.33% per cent on May 20, 2019. Yield spreads on 5 year AAA rated corporate bonds over the 5 year G-Sec yield however increased during mid June and have remained high since then reflecting liquidity problems faced by a few players in the NBFC sector. Taken in unison, our level policy and slope policy already reflect substantial financial accommodation to address the sharp decline in economic growth (from 8.0% in Q1 to 5.8% in Q4) witnessed through FY 2019.
33. I should add that the MPC has enacted both “insurance-cuts” (to address current and future downside risks to growth) and “data-dependent” cuts (reflecting the evolving growth-inflation risk picture) in the February-June window.
34. The question then is: what incremental information since the last review warrants a need for further accommodation?
35. There are a few considerations here.
36. On the external front, growth in the global economy remains tepid. Trade tensions have worsened leading to some loss in our net export growth.
37. Domestically, a variety of growth indicators have weakened further.
38. Based on a sample of 843 manufacturing companies, the seasonally adjusted capacity utilization has weakened to 74.5%, which is marginally lower than the long term average and the last few readings. Demand conditions in the manufacturing sector – based on the Reserve Bank’s analysis of early corporate results of listed companies – weakened in nominal terms in Q1: 2019- 2020 relative to Q4: 2018-2019. Consumer driven industries also exhibit sluggish demand, with a piling up of inventories.
39. After the March 2019 surge in consumer confidence, this index has declined thereafter with the current situation index back in pessimistic territory. The Reserve Bank’s Business Expectation Index (BEI) expects to lose traction in Q2 2019:2020. IIP growth moderated to 3.1% in May compared to 4.3%. On a positive side though, consumer durable growth moved into positive territory (0.1%); capital goods also moved into positive territory (2.3%); while non durables increased by 7.7%. The output gap has also opened further up since the last review.
40. What is telling is that large swings in the Indian business cycle are still not a thing of the past, despite the adoption of inflation targeting in India.
41. I continue to worry that fiscal imbalances embodied in our large public sector borrowing requirement (roughly 8-9% of GDP) will lead to detrimental outcomes for the economy. While a fiscal glide path should be seen as a limit, once in place, it becomes a target. Convergence to the limit happens, and a form of “creative accounting” kicks in. Going forward, policy coordination between monetary and fiscal policy will be crucial for a healthier and more durable growth- inflation mix in the economy. For instance, if agents in the economy expect that the government will disregard the level of debt but the central bank follows the Taylor principle (i.e., insists that inflation is not allowed to rise), then the economy can go through a spiral of lower output, higher inflation, and higher debt.
42. I will carefully watch the evolving growth-inflation risk picture. Estimates of economic growth in India have unfortunately been subject to a fair degree of floccinaucinihilipilification. Notwithstanding this, growth is likely to pick up from Q2-Q3: 2019-2020.
43. It should also be highlighted that there has been inadequate monetary transmission given the quantum of past rate cuts: the WALR on fresh rupee loans in the banking system has come down by only 29 bps despite the MPC cutting rates by 75 bps in the February-June window. By a large cut (35 bps) I feel we will be burning through monetary policy space without much to show for it. While the real economy needs some support, we should wait for more transmission to happen.
44. Given the evolving growth-inflation risk picture, monetary policy should be used judiciously.
45. I vote to reduce the policy rate by 25 bps. I also vote to retain the stance as accommodative. Statement by Dr. Pami Dua
46. Headline inflation, measured by CPI inflation, rose to 3.2% in June 2019 from 3% in May. Food inflation also increased to 2.4% in June from 2% in the previous month, while CPI inflation excluding food and fuel moderated to 4.1%. Results from surveys provide mixed signals. Inflation expectations of households, as captured through RBI’s Inflation Expectations Survey of Households, remained unchanged from the last round in May for the three-month-ahead horizon but fell by 20 basis points for the one-year-ahead horizon. At the same time, the Industrial Outlook Survey (IOS) showed an expectation of easing of input cost pressures for Q2:2019-20. Upside risks to inflation include continuation of the uptick in food price inflation, uncertainties relating to monsoon, and volatility in international oil prices.
47. Industrial growth, as measured by the index of industrial production, moderated in May to 3.1%, down from 4.3% in the previous month, with manufacturing dropping to 2.5% from 4% and mining slowing to 3.2% from 5.1%. Electricity production, however, grew by 7.4%, up from 6% in April. On the basis of the use-based classification, growth in capital goods, intermediate and primary goods, and infrastructure/construction slowed in the month of May. Consumer durables also decelerated while consumer non-durables accelerated for the third consecutive month. High frequency indicators of rural demand – tractor and motorcycle sales – and of urban demand – passenger vehicle sales – continued to contract. Growth in the index of eight core industries fell to 0.2% in June due to a contraction in crude oil, cement, natural gas and petroleum refinery products.
48. Meanwhile, the manufacturing Purchasing Managers’ Index increased marginally in July due to an expansion in output, new orders and optimism on demand conditions. The services PMI also grew in July. RBI’s Business Expectations Index of the Industrial Outlook Survey for manufacturing showed modest softening in Q2:2019-20. The Order Books, Inventory and Capacity Utilisation Survey (OBICUS) conducted by RBI suggests a rise in capacity utilisation to 76.1% in Q4:2018-19, but a fall in the seasonally adjusted capacity utilisation to 74.5% in Q4 from 75.6% in Q3. RBI’s Consumer Confidence Indices – Current Situation Index and Future Expectations Index – reflect a drop in the July round compared to the previous May round, implying lower current activity and a less optimistic outlook. On the trade front, there was a broad based fall in exports (-9.7%) and imports (-9.1%) in June 2019, with import of capital goods dropping by 7.7%.
49. Looking forward, Indian exports growth prospects are fading, according to the Indian Leading Exports Index of the Economic Cycle Research Institute (ECRI). This is consistent with the worsening global industrial outlook underscored by ECRI’s Global Leading Manufacturing Index. Further, growth in ECRI’s U.S. Leading Manufacturing Index has dropped back to December’s seven year low. Growth prospects for U.S. consumer spending are also weakening. Further, ECRI’s U.S. Future Inflation Gauge remains in a cyclical downswing, indicating that the inflation cycle downturn that began in mid-2018 is poised to persist.
50. Further, concerns regarding the global slowdown and the trade tensions between U.S. and China still persist. The monetary policy stance of major central banks has recently been more dovish, tending towards easing of rates. On the domestic front, economic activity has softened due to muted consumption and investment activity, and inflation is benign. While considerable liquidity easing has already occurred and cumulative rate cuts of 75 basis points have been undertaken in the last three MPC meetings (between February and June 2019), along with a change in stance in June from neutral to accommodative, there is still policy space for a further cut in the policy rate, given the weak global and domestic economic scenario and a benign inflation outlook.
51. The weighted average call money rate (WACR) has remained broadly aligned with the policy rate, indicating transmission of the reduction in the policy rate. Policy rate reductions of 75 basis points to other money market rates and G-sec yield have also transmitted fully.
52. At the same time, though the transmission of the policy rate cuts to the weighted average lending rate (WALR) on fresh loans of banks has improved from 21 basis points in February and March to 29 basis points during February to June, it was partial, possibly due to transmission lags associated with monetary policy. Nevertheless, the significant monetary policy easing since February 2019, along with surplus liquidity, are likely to enable more transmission to lending rates, and eventually to the real economy. Further, in view of the shadow banking stress, the importance of surplus liquidity has increased. In this regard, measures taken by the government and the RBI to encourage flow of credit to shadow banks are important confidence building steps.
53. It is also important to recognize that, while monetary policy can impact cyclical factors, it has its limitations with respect to significantly impacting structural factors. Therefore, investment- focused fiscal policy and active continuation of structural reforms are imperative at this juncture to complement the already substantial easing that has been delivered since February 2019. In this context, the directional shift in the Budget towards a lower fiscal deficit target may also contribute towards lowering the cost of capital and boosting investment driven growth.
54. Overall, given that the headline inflation is projected to remain below target in 2019-20, I vote for a pre-emptive rate cut of 25 basis points to enhance consumer confidence and improve investor sentiment. On a cumulative basis, this denotes a policy rate cut of 100 basis points since February 2019, which is sufficient at this point in time. I also vote to keep the stance as accommodative. Statement by Dr. Ravindra H. Dholakia
55. After the last meeting of MPC in June 2019, several important events have occurred. Inflation readings for May and June 2019 were almost as per the RBI projections. While the Economic Survey 2018-19 provided a growth assessment very similar to the one by RBI, the Union Budget 2019-20 assumed a substantially higher growth rate for the current fiscal year. Monsoon is likely to be normal. Tariff war tensions have further escalated. Oil prices have continued fluctuating within the range I had mentioned in my earlier statements. Growth impulses are, however, weak on the whole and not significantly picking up for substantial revival. It is well recognized in the literature and reiterated by the Economic Survey 2018-19 that investment is a primary driver for economic growth and employment creation. In order to boost investment activities, positive sentiments and business-conducive environment need to be enhanced. It requires carrying out several economic reform measures in the land and labour markets, tariffs of electricity and other resources, and taxation of income and goods and services, besides urgently correcting prevailing high real interest rates in India. While most of these measures are not within the purview of the monetary policy, correction of high real interest rates to a certain extent is. Since I do not see any major threat to inflation in the foreseeable future, I would like to vote for a 35 bps cut in the policy repo rate to correct high real interest rates in order to enhance investment sentiments and revive growth impulses. More specific reasons for my vote are as follows: i) RBI surveys have found that the corporates are now investing more in the financial assets than in the physical assets. Thus, they are turning savers rather than investors. This provides indirect evidence of the adverse impact of high real interest rates prevailing in the economy. Economic reform measures would be more effective if the necessary incentives in terms of costs are there. ii) Fiscal slippage is not a matter of serious concern for the rest of the year, because the Union Budget has maintained the target given in the fiscal consolidation path and the state budgets put together are also not likely to show any serious divergence from the path. iii) The fiscal policy as indicated by the Union Budget 2019-20 on the contrary is on a tighter side rather than expansionary side. The budgeted fiscal deficit this year and projected for the next two years in the medium term strategy paper are very much on the fiscal consolidation path notwithstanding current slowdown and emergence of substantial negative output gap. As I had argued in my statement in the previous MPC meeting, adhering to the fiscal deficit target during a downturn of the business cycle amounts to a tight fiscal policy. It is also corroborated by the increased taxation and maintaining expenditure relative to GDP in the budget. The monetary policy has to, therefore, do its bit to provide the boost to the economy however short-lived it may be, because currently inflation does not appear to be a concern in the next 3-4 quarters at least. iv) Globally, central banks have not only been dovish in their stance but have also cut their policy rates. v) Inflationary expectations one year ahead by households have been declining and the latest round shows about a 20 bps fall over the previous round. If one outlier city is excluded, the fall is much larger. Similarly the business expectations about headline CPI inflation one year ahead by the IIMA survey shows the expectation of about 3.7 percent, which is very close to the RBI prediction as well. vi) Thus, there is enough policy space to cut the policy repo rate to correct the high real interest rate in the economy. The transmission of the policy rate cuts in the current cycle is likely to take some time because of the lags involved on account of the nature of the banking business. However, under prevailing circumstances, the immediate transmission should be considered not so much in terms of the bank deposit and lending rates but more specific rates influencing new investments such as housing loans, vehicle loans and long term bonds.
56. Given that there is a significant policy space to correct the real rate of interest and thereby helping the economic activities to recover, it is prudent in my opinion to cut the policy rate somewhat aggressively but cautiously keeping some space for future exigencies. As far as the general practice of taking 25 bps as a unit for cutting or raising the policy rate is concerned, there is no logic or scientific basis for it, particularly when we measure inflation rate, GDP growth rate, fiscal deficit percentage, etc. in single decimal. Ideally, there is a case for considering the unit to be 10 bps for cutting or raising the policy rate. I would, therefore, like to cut the policy rate by 40 bps, but I do not mind going with majority opinion of cutting the rate by 35 bps this time, and maintaining the accommodative stance. Statement by Dr. Michael Debabrata Patra
57. Since the MPC met in June, the macroeconomic outlook appears to have darkened, denting business and consumer confidence. This deterioration is getting reflected in inflation outcomes: (a) a pre-monsoon food price build-up was anticipated and it is tracking the seven-year average i.e., the history of the index, in spite of unfavourable base effects – this suggests that food prices are actually stabilising; (b) pressure points have opened up – pulses; dairy products; proteins; oils and fats – but there have been no unruly spikes; moreover, they fall in the remit of supply management policies, since they either reflect sectoral imbalances or cost push factors and nimble steps assume priority in order to prevent price pressures from accumulating; (c) the dynamics of inflation excluding food and fuel warrant concern, especially its broad- based and persisting softness because it seems to be mirroring the weakening of domestic demand.
58. In terms of the technology of monetary policy, the intrinsic link between underlying inflation and the output gap is stark – the Phillips curve is alive and well in India, notwithstanding some recent loss of faith. This validates the policy actions and a shift in the stance since February 2019.
59. Turning to the state of the economy, virtually every indicator of activity is turning down. Global growth flattered in Q1 of 2019 only to deceive in Q2. Global trade is in contraction. In India, high frequency indicators have focused the narrative on the slowdown in investment, the silence of the animal spirits embodied in the flattening of capital goods production, the absolute decline in capital goods imports and the deceleration in construction activity. What is worrisome though is that other components of aggregate demand could be joining investment in the loss of speed. Private consumption, the bedrock of domestic demand (57 per cent of GDP), is losing momentum in both urban and rural areas. Meanwhile, the deceleration in external demand on account of trade and geopolitical tensions has muted exports and sunk imports into contraction. The fiscal stimulus from the 7th Pay Commission award and one rank one pension (OROP) is fading (0.9 per cent of GDP in 2017-18 and 0.3 per cent in 2018-19); this was expected as the stimulus was in the form of revenue expenditure and the revenue multiplier in India is less than unity.
60. The key issue is: what is the extent of the downturn? This is hard to decipher at this stage – indicators of global economic activity are flashing amber or red, but there is no recession. Yet, projections of growth are being repeatedly marked down. The number of central banks that have either eased monetary policy or are getting ready to do so has increased, and ‘insurance’ cuts are becoming visible.
61. In India, negative gaps have opened up in respect of both output and inflation, warranting an appropriate policy response. The issue is: how is the policy headroom to be used? Monetary policy has been proactive and front-loaded as the first line of defence. From here on, the space for monetary policy action has to be calibrated to the evolving situation, especially as the nature and depth of the slowdown is still unravelling and elbow room may be needed if it deepens. A more broad-sided response involving all levers of policy acquires the highest priority now. The overarching goal is to reinvigorate domestic demand and the time to do it is now.
62. On these considerations, I vote for a 35 basis points reduction in the policy rate while persevering with the accommodative stance of monetary policy. Statement by Shri Bibhu Prasad Kanungo
63. The inflation trajectory has evolved since the June 2019 policy on the expected lines. Among the components, food inflation has turned up, while inflation excluding food and fuel has shown distinct moderation. Reflecting the weak demand conditions as well as lower input costs, the CPI inflation, excluding food and fuel, has seen a moderation of around 100 bps since March 2019. This moderation is broad based. Food inflation on the other hand registered a sharp increase to 2.4 per cent in June from 0.7 per cent in March largely due to a pick-up in prices of vegetables and pulses. Significant inflation pressures continued in meat and fish. Headline CPI inflation in Q1:2019-20 averaged 3.1 per cent, which was close to RBI’s projection of 3.0 per cent made in the June 2019 policy. The three-month ahead inflation expectations of households based on the Reserve Bank’s survey have remained unchanged vis-à-vis the previous round, while one-year ahead inflation expectations have moderated by 20 bps.
64. Global growth has weakened, and several central banks have adopted more accommodative stance of monetary policy. Domestic growth is also slowing down. A worrisome aspect of the recent growth slowdown is the moderation in private consumption which constitutes the largest segment of aggregate demand. Rural demand indicators like tractor and motorcycle sales continued to contract in May-June. Urban demand indicators, like passenger vehicle sales, contracted for the eighth consecutive month in June. Commercial vehicle sales also contracted during June. Construction activity indicators weakened with contraction in cement production and slower growth in finished steel consumption in June. Import of capital goods – a key indicator of investment activity – contracted in June. Q1 growth has been projected to slow down to 5.8 per cent – the second consecutive quarter of less than six per cent growth. The Business Expectations Index of the Reserve Bank’s industrial outlook survey, however, shows some moderation in demand conditions in Q2.
65. Cumulative repo rate reduction of 75 bps effected since February 2019 has so far resulted in 29 bps reduction in weighted average lending rate (WALR) of banks on fresh rupee loans. This is considered inadequate even though the transmission is expected to improve, going forward.
66. The projected inflation path suggests that headline inflation is expected to remain below 4 per cent for the next four quarters up to Q1:2020-21. GDP growth projection for 2019-20 has been successively revised down from 7.4 per cent (in February 2019) to 7.2 per cent (in April 2019), 7.0 per cent (in June 2019) and to 6.9 per cent in the 3rd bi-monthly policy of August 2019.
67. Given the benign inflation outlook that is expected to continue for the rest of the year and up to Q1:2020-21, I am of the view that there is a need for monetary policy action to support economic activity and close the output gap. I, therefore, vote for a reduction in the policy repo rate by 35 bps and also keep the stance of monetary policy as accommodative. Statement by Shri Shaktikanta Das
68. Economic activity has shown signs of further weakening since the last MPC meeting in June 2019. Several high frequency indicators have either slowed down or contracted in recent months. Headline CPI inflation has evolved broadly along the projected lines; CPI inflation excluding food and fuel continued to soften, while food inflation has edged up. Global economic activity has been losing pace, weighed down by intensifying trade tensions and geo-political uncertainty. GDP numbers for Q2:2019 in respect of some major advanced and emerging market economies have been subdued. Central banks in both advanced and emerging market economies have been increasingly resorting to more accommodative stances of monetary policy.
69. Headline CPI inflation rose to 3.2 per cent in June 2019 from 3.0 per cent in April-May. Food inflation rose by 100 bps in May-June, driven mainly by a pick-up in prices of meat & fish, pulses and vegetables. On the other hand, CPI inflation excluding food and fuel moderated for the fourth consecutive month to 4.1 per cent in June, caused by a broad-based softening across groups, particularly clothing and footwear; household goods and services; and transport and communication. This reflects subdued input cost pressures relating to both agriculture and industrial raw materials and further weakening of domestic demand conditions. Inflation in the fuel and light group also decelerated in May-June, despite the uptick in liquified petroleum gas (LPG) prices. Inflation expectations of households in the July 2019 round of the Reserve Bank’s survey moderated further by 20 basis points for the 1-year ahead horizon, though they remained unchanged for the 3-month ahead horizon. Cumulatively, inflation expectations of households have declined significantly by 180 basis points for the 3-month horizon and 190 basis points for the 1-year horizon in last five survey rounds. This suggests that inflation expectations of households are gradually getting better anchored. Overall, the inflation situation remains benign. CPI inflation has been projected at 3.1 per cent for Q2:2019-20 and 3.5-3.7 per cent for H2:2019- 20, with risks evenly balanced. CPI inflation for Q1:2020-21 has been projected at 3.6 per cent.
70. Turning to economic activity, total area sown under kharif crops was 6.6 per cent lower as on August 2 than a year ago, with significant catching up taking place in recent weeks. Industrial activity continued to be weak in May 2019, impacted mainly by manufacturing and mining. In terms of use-based classification, growth of capital goods and consumer durables decelerated. However, growth of non-durables accelerated in May. The index of eight core industries decelerated in June. Merchandise exports and imports contracted in June. Seasonally adjusted capacity utilisation moderated to 74.5 per cent in Q4:2018-19 from 75.6 per cent in Q3. Based on early results of listed companies, demand conditions in the manufacturing sector remained weak in Q1:2019-20, with sales of manufacturing companies contracting by 2.4 per cent (y-o-y), caused mainly by petroleum, automobile and iron and steel companies. On the positive side, the Reserve Bank’s business assessment index (BAI) for Q1:2019-20 improved marginally. The manufacturing PMI rose in July, supported by a pick-up in production, higher new orders and optimism on demand conditions in the year ahead.
71. Several high frequency indicators for May-June also suggest weakening of services sector activity. Two key indicators of rural demand, viz., tractor and motorcycle sales, continued to contract. Among indicators of urban demand, while passenger vehicle sales contracted in June, domestic air passenger traffic growth turned positive in June after three consecutive months of contraction. Two key indicators of construction activity, viz., cement production and steel consumption, also contracted/slowed down. Import of capital goods contracted in June, suggesting weakening of investment activity. The services PMI moved into expansion zone in July on increase in new business activity, new export orders and employment.
72. GDP growth for 2019-20 has been revised downwards from 7.0 per cent in the June policy to 6.9 per cent – in the range of 5.8-6.6 per cent for H1:2019-20 and 7.3-7.5 per cent for H2 – with some downside risks. GDP growth for Q1:2020-21 is projected at 7.4 per cent. The impact of monetary policy easing since February 2019 and favourable base effects are expected to support GDP growth, especially in the second half of the year.
73. Liquidity in the system has been in surplus since June 2019 with the surplus absorbed under the reverse repo window of the Reserve Bank being almost `2.0 lakh crore on August 6, 2019. The past policy rate cuts have been fully transmitted to financial markets. The weighted average lending rate (WALR) on fresh rupee loans of banks has declined by 29 bps during the current easing phase so far (February-June 2019). The transmission to bank lending rates has been inadequate, though it is expected to improve in the coming weeks and months. Credit growth has slowed down somewhat in the recent period; credit to micro, small and medium enterprises, in particular, remains anaemic.
74. Overall, there is clear evidence of domestic demand slowing down further. Investment activity has been losing traction. The weakening of the global economy in the face of intensifying trade and geo-political tensions has severely impacted India’s exports, which may further impact investment activity, going forward. Private consumption, which has been the mainstay of domestic demand, has also decelerated. The slowing down of domestic demand is also reflected in significant moderation in CPI inflation excluding food and fuel; and contraction in merchandise imports.
75. In view of weakening of domestic growth impulses and unsettled global macroeconomic environment, there is a need to bolster dwindling domestic demand and support investment activity, even as the impact of past three rate cuts is gradually working its way to the real economy. With headline inflation projected to remain within the target over the next one-year horizon, supporting domestic growth by further reducing interest rates needs to be given the utmost priority. Given the current and evolving inflation and growth scenario at this juncture, it can no longer be a business as usual approach. The economy needs a larger push. I am, therefore, of the view that a reduction in the policy repo rate by conventional 25 bps will be inadequate. On the other hand, a 50 bps rate cut might be excessive and indicate a knee jerk reaction. A policy rate adjustment of 25 bps or multiples thereof may not always be consistent with the evolving macroeconomic situation. Hence, at times it is apposite to calibrate the size of the conventional rate adjustment. Considering these aspects, I vote for reducing the policy repo rate by 35 basis points and for continuing with the accommodative stance of monetary policy. The calibration of the size of the rate cut is expected to reinforce and quicken the impact of (i) the past cumulative rate reduction of 75 basis points; (ii) change in the stance from neutral to accommodative; and (iii) injection of large surplus liquidity in the system. Yogesh Dayal Press Release : 2019-2020/489 Chief General Manager
6. Since the MPC’s last meeting in August 2019, global economic activity has weakened further. Heightened uncertainty emanating from trade and geo-political tensions continues to cloud the outlook. Among advanced economies (AEs), the slowdown in the US economy in Q2:2019 appears to have extended into Q3:2019, weighed down by softer industrial production. The Institute for Supply Management’s index for September indicates that manufacturing slipped further into contraction to touch its lowest reading in a decade; hiring by the private sector also slowed down. In the Euro area too, incoming data suggest that activity may have moderated further in Q3, with retail sales declining and manufacturing PMI remaining in contraction for the eighth consecutive month in September. The UK economy decelerated in Q2; the contraction in industrial production and soft retail sales in July suggest that the loss of speed has continued into Q3 as well. In Japan, the loss of momentum in Q2 spilled over into Q3, albeit cushioned by a fiscal stimulus and frontloaded consumer spending ahead of a planned sales tax hike.
7. The macroeconomic performance of major emerging market economies (EMEs) was weighed down by a deteriorating global environment in Q3. The Chinese economy appears to have slowed down in Q3 as well, with both retail sales and industrial production growth weakening in July-August and exports contracting in August; attention is now focussed on the efficacy of fiscal and monetary policy stimuli in averting a sharper deceleration. In Russia, economic activity ticked up in Q2, though still subdued consumer sentiment and weak industrial production may restrain momentum, going forward. Economic activity in both South Africa and Brazil rebounded in Q2, emerging out of contraction in the previous quarter; however, this nascent recovery faces both domestic and external headwinds.
8. Crude oil prices were pulled down by softer demand, amidst adequate supplies in early August. Prices remained range bound until mid-September when supply disruptions on account of an escalating geo-political conflict resulted in a spike which has abated faster than expected. Gold prices remained elevated on safe haven demand. Central banks became more accommodative with inflation remaining below targets across major AEs and EMEs.
9. Global financial markets have remained unsettled since the MPC’s early August meeting with bouts of volatility unleashed by protectionist policies and worsening global growth prospects. In the US, the equity market’s August losses were recouped by early September – investor sentiment was buoyed by signs of an easing in US-China trade tensions. Stock markets in EMEs fell, as the strong US dollar led to capital outflows, though they recovered partially in September. Bond yields in the US continued easing till August on growth worries, before a slight uptick was triggered in early September by better than expected US retail sales data and hopes of conciliatory trade negotiations between the US and China. In the Euro area, bond yields sank further into negative territory, propelled by the cut in the deposit rate by the European Central Bank (ECB) to (-) 0.5 per cent and the reintroduction of quantitative easing. In EMEs, bond yields exhibited mixed movements, driven by country-specific factors. In currency markets, the US dollar strengthened against currencies of other AEs. EME currencies, which were trading with a depreciating bias in August, appreciated in early September on country-specific factors and a revival of global risk-on sentiment. Domestic Economy
10. On the domestic front, growth in gross domestic product (GDP) slumped to 5.0 per cent in Q1:2019-20, extending a sequential deceleration to the fifth consecutive quarter. Of its constituents, private final consumption expenditure (PFCE) slowed down to an 18-quarter low. Gross fixed capital formation (GFCF) improved marginally on a sequential basis but remained muted as in the preceding quarter. Government final consumption expenditure (GFCE) cushioned the overall loss of momentum to some extent.
11. On the supply side, gross value added (GVA) growth decelerated to 4.9 per cent in Q1:2019- 20, pulled down by manufacturing growth, moderating to 0.6 per cent. Agriculture and allied activities were lifted by higher production of wheat and oilseeds during the 2018-19 rabi season. Growth in the services sector was stalled by construction activity.
12. Turning to Q2:2019-20, the initial delay in the onset of the south-west monsoon rapidly caught up from July. By September 30, 2019, the cumulative all-India rainfall surpassed the long period average (LPA) by 10 per cent. The first advance estimates of major kharif crops for 2019-20 have placed production of foodgrains 0.8 per cent lower when compared with the last year’s fourth advance estimates. Looking ahead at the rabi season, the live storage of water in major reservoirs was 115 per cent of the live storage of the corresponding period of the previous year on September 26, 2019 and 121 per cent of average storage level over the last ten years. Abundant rains in August and September have led to improved soil moisture conditions in most parts of the country, particularly central India, compared to the corresponding period of the last year. Overall, the prospects of agriculture have brightened considerably, positioning it favourably for regenerating employment and income, and the revival of domestic demand.
13. Industrial activity, measured by the index of industrial production (IIP), weakened in July 2019 (y-o-y), weighed down mainly by moderation in manufacturing. In terms of uses, the production of capital goods and consumer durables contracted. Consumer non-durables, led by edible oils, and intermediate goods, mainly mild steel slabs, posted sustained expansion and have emerged as potential growth drivers. Infrastructure/construction sector activity turned around to register a growth of 2.1 per cent vis-à-vis (-)1.9 per cent in the previous month. The output of eight core industries contracted in August, pulled down by coal, electricity, crude oil and cement. Capacity utilisation (CU) in the manufacturing sector, measured by the OBICUS (order books, inventory and capacity utilisation survey) of the Reserve Bank, declined to 73.6 per cent in Q1:2019-20 from 76.1 per cent in the previous quarter. However, seasonally adjusted CU rose to 74.8 per cent in Q1:2019-20 from 74.5 per cent in Q4:2018-19. Manufacturing firms polled for the industrial outlook survey (IOS) expect capacity utilisation to moderate in Q2:2019-20. The Reserve Bank’s business assessment index (BAI) fell in Q2:2019-20 due to a decline in new orders, contraction in production, lower capacity utilisation and fall in profit margins of the surveyed firms. The manufacturing purchasing managers’ index (PMI) for September 2019 was unchanged at its previous month’s level; new orders and employment improved, albeit marginally, and new export orders declined.
14. High frequency indicators suggest that services sector activity weakened in July-August. Indicators of rural demand, viz., tractor and motorcycles sales, contracted. Of underlying indicators of urban demand, passenger vehicle sales contracted in July-August, while domestic air passenger traffic accelerated in August. The sales of commercial vehicles, a key indicator for the transportation sector, contracted by double digits in July-August. Of the two indicators of construction activity, finished steel consumption decelerated sharply in August and cement production contracted. The services PMI moved into contraction in September 2019, dragged down mainly by a decline in new business inflows.
15. Retail inflation, measured by y-o-y changes in the CPI, moved in a narrow range of 3.1- 3.2 per cent between June and August. While food inflation picked up, fuel prices moved into deflation. Inflation excluding food and fuel softened in August.
16. Food inflation in August was elevated by a spike in the rate of increase in vegetables prices, a pick-up in pulses inflation and persistently high meat and fish inflation. On the other hand, softer increases in prices of eggs, oils and fats, non-alcoholic beverages and prepared meals, and deflation in prices of fruits and sugar cushioned the rise in overall food inflation.
17. Deflation in the fuel group deepened in August largely due to the pass-through from a sharp decline in international prices of liquified petroleum gas (LPG). Subsidised kerosene prices, however, have been rising in a calibrated manner as oil marketing companies continued a gradual reduction in subsidies.
18. CPI inflation excluding food and fuel increased in July, but its roots were largely confined to prices of personal care and effects – mainly bullion prices, and transport and communication, reflecting rise in prices of petrol and diesel. By contrast, there was moderation in August, which was spread across most of the sub-groups; however, gold prices spiked further on global uncertainties.
19. The Reserve Bank’s September 2019 round of inflation expectations survey indicates that households expect inflation to rise by 40 basis points over a 3-month ahead horizon and 20 basis points over a one-year ahead horizon, possibly responding adaptively to the rise in food prices in recent months. The Reserve Bank’s consumer confidence survey shows weak consumer sentiment and tepid consumption demand, especially relating to non-essential items. Manufacturing firms see weakening of demand conditions in Q2:2019-20 and Q3 and expect their output prices to soften, going forward, as the cost of finance and salary outgoes remain muted.
20. Overall liquidity remained surplus in August and September 2019 despite expansion of currency in circulation and forex operations by the Reserve Bank draining liquidity from the system. Net daily average absorption under the LAF amounted to ₹1,40,497 crore in August, essentially on account of spending by the government, which resulted in availment of ways and means advances (WMA) and intermittent overdraft facilities from the beginning of the month (till August 25, 2019). In September, with a steady build-up of cash balances, particularly with advance tax inflows around September 15, surplus liquidity moderated, and the Reserve Bank undertook daily net absorption of ₹1,22,392 crore in September. Reflecting easy liquidity conditions, the weighted average call rate (WACR) traded below the policy repo rate (on an average) by 8 basis points (bps) in August and by 6 bps in September.
21. Monetary transmission has remained staggered and incomplete. As against the cumulative policy repo rate reduction of 110 bps during February-August 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by 29 bps. However, the WALR on outstanding rupee loans increased by 7 bps during the same period.
22. Net exports had contributed to aggregate demand in Q1:2019-20 on account of a deeper contraction in imports relative to exports. In Q2, merchandise exports remained weak in July and August 2019, caused by lower shipments of engineering goods, petroleum products, gems and jewellery and cotton yarn. Imports contracted faster during the period mainly due to lower international crude oil prices downsizing the oil import bill and a large fall in the volume of gold imports. Non-oil non-gold imports were pulled down into contraction by coal, pearls and precious stones and transport equipment. These developments led to a narrowing of the trade deficit during July-August 2019. Higher net services receipts and private transfer receipts helped contain the current account deficit to 2.0 per cent of GDP in Q1:2019-20 from 2.3 per cent a year ago. On the financing side, net foreign direct investment rose to US$ 17.7 billion in April-July 2019 from US$ 11.4 billion a year ago. Net foreign portfolio investment (excluding the voluntary retention route) was of the order of US$ 3.3 billion during April-September 2019 as against net outflow of US$ 11.5 billion in the same period of last year. Net disbursals of external commercial borrowings rose to US$ 8.2 billion during April-August 2019 as against net repayments of US$ 0.2 billion during the same period a year ago. India’s foreign exchange reserves were at US$ 434.6 billion on October 1, 2019 – an increase of US$ 21.7 billion over end-March 2019. Outlook
23. In the third bi-monthly resolution of August 2019, CPI inflation was projected at 3.1 per cent for Q2:2019-20, 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1: 2020-21 with risks evenly balanced. The actual inflation outcomes for Q2 so far (July-August) at 3.2 per cent have been broadly in line with these projections.
24. Going forward, several factors are likely to shape the inflation trajectory. First, the outlook for food inflation has improved considerably since the August bi-monthly policy. Kharif production is estimated at close to last year’s level, auguring well for the overall food supply situation. Vegetable prices may remain elevated in the immediate months but are likely to moderate as winter supplies enter the market. Prices of pulses are expected to remain contained by adequate buffer stocks. Secondly, forward looking surveys conducted by the Reserve Bank point to weak demand conditions persisting, with indications of softening of output prices in Q3:2019-20. Accordingly, price pressures in CPI excluding food and fuel are likely to be muted. Thirdly, crude oil prices may remain volatile in the near-term; while global demand is slowing down, the persisting geo-political uncertainties pose some upside risks to the inflation outlook. Fourthly, three-month and one-year ahead inflation expectations of households polled by the Reserve Bank have risen in the current round reflecting near- term price pressures. Finally, financial markets remain volatile with currencies of several emerging market economies trading with a depreciating bias in the recent period. Taking into consideration these factors and the impact of recent policy rate cuts, the CPI inflation projection is revised slightly upwards to 3.4 per cent for Q2:2019-20, while projections are retained at 3.5-3.7 per cent for H2:2019- 20 and 3.6 per cent for Q1:2020-21, with risks evenly balanced (Chart 1).
25. Turning to the growth outlook, real GDP growth for 2019-20 in the August policy was projected at 6.9 per cent – in the range of 5.8-6.6 per cent for H1:2019-20 and 7.3-7.5 per cent for H2 – with risks somewhat tilted to the downside; GDP growth for Q1:2020-21 was projected at 7.4 per cent. GDP growth for Q1:2019-20 was significantly lower than projected. Various high frequency indicators suggest that domestic demand conditions have remained weak. The business expectations index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q3. Export prospects have been impacted by slowing global growth and continuing trade tensions. On the positive side, however, the impact of monetary policy easing since February 2019 is gradually expected to feed into the real economy and boost demand. Several measures announced by the Government over the last two months are expected to revive sentiment and spur domestic demand, especially private consumption. Taking into consideration the above factors, real GDP growth for 2019-20 is revised downwards from 6.9 per cent in the August policy to 6.1 per cent – 5.3 per cent in Q2:2019-20 and in the range of 6.6-7.2 per cent for H2:2019-20 – with risks evenly balanced; GDP growth for Q1:2020-21 is also revised downwards to 7.2 per cent (Chart 2).
26. The MPC notes that the negative output gap has widened further. While the recent measures announced by the government are likely to help strengthen private consumption and spur private investment activity, the continuing slowdown warrants intensified efforts to restore the growth momentum. With inflation expected to remain below target in the remaining period of 2019-20 and Q1:2020-21, there is policy space to address these growth concerns by reinvigorating domestic demand within the flexible inflation targeting mandate. It is in this context that the MPC decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
27. All members of the MPC voted to reduce the policy repo rate and to continue with the accommodative stance of monetary policy. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Shri Bibhu Prasad Kanungo and Shri Shaktikanta Das voted to reduce the repo rate by 25 basis points. Dr. Ravindra H. Dholakia voted to reduce the repo rate by 40 basis points.
28. The minutes of the MPC’s meeting will be published by October 18, 2019.
29. The next meeting of the MPC is scheduled during December 3-5, 2019. Voting on the Resolution to reduce the policy repo rate Magnitude of policy Member Vote repo rate reduction (basis points) Dr. Chetan Ghate Yes 25 Dr. Pami Dua Yes 25 Dr. Ravindra H. Dholakia Yes 40 Dr. Michael Debabrata Patra Yes 25 Shri Bibhu Prasad Kanungo Yes 25 Shri Shaktikanta Das Yes 25 Statement by Dr. Chetan Ghate
30. Since the last review, there has been a 40 bps increase in the three month ahead inflation expectations of households (now at 8%), and a 20 bps increase in the level of one year ahead inflationary expectations (to 8.1%). Households’ current perception of inflation also increased by 50 bps to 7.1%. The proportion of respondents (both in the three month and one year buckets) expecting inflation to be less than 6% has fallen. The uptick in inflationary expectations, while adaptively reflecting the uptick in food inflation, comes on the back of several rounds of declines, and therefore acquires salience.
31. The uptick in food inflation (3% in August) needs to be carefully watched. Vegetable prices have increased by 23.9% during April-August 2019 (compared to 15.7% in the same period last year), reflecting a stronger-than-usual summer uptick. The cumulative momentum in food prices during April-August was also higher (5.5%) compared to the same period last year (3.2%). Pulses inflation has turned positive for the first time since May 2019. The cumulative momentum on items like meat and fish has been higher than earlier occasions. The late exit of the monsoon will however be favorable for Rabi crop growing and should have a mitigating effect on the ongoing uptick in food inflation in the next couple of months.
32. Notwithstanding the uptick in food inflation, headline CPI inflation was almost flat at 3.2%. The August reading for inflation ex food and fuel was lower at 4.2% compared to 4.5% in July. The forward trajectory of inflation ex food and fuel will be influenced by several factors: the pace of growth, favorable base effects, lagged effects of the depreciation in the INR, the price of crude, and the pass-through of inflationary expectations into inflation ex food and fuel. These variables need to be carefully watched.
33. Since the last review, economic activity has continued to weaken.
34. This was manifest most poignantly in the weak Q1 FY19:20 growth numbers (5%) which slowed for a 5th consecutive quarter. Real GVA growth at 4.9% for Q1 FY 19:20 also continued to decline. Consumption demand grew at 3.1%, which is the slowest reading in 4 years. Investment grew at 4%, marginally higher than that in Q4 FY 18:19 which was 3.6%. Since the last review, the output gap has widened further.
35. External demand conditions have worsened. Geopolitical risks remain unresolved. There has been a resurgence of trade policy tensions, and global growth has continued to weaken. Exports contracted in Q1 FY19:20.
36. Domestically, sentiment remains weak. Consumer confidence fell for the 3rd consecutive round. Both the Current Situation Index (CSI) and Future Expectations Index (FEI) produced by the RBI have recorded lower readings compared to the previous round. Based on RBI’s survey of manufacturing activity, real sales growth across 1723 listed private manufacturing companies has become negative for the first time since Q1 FY 16:17. Capacity utilization has also fallen to 73.6% after growing consistently since Q1 FY 18:19. RBI’s Business Assessment Index (BAI) moved into a contraction zone. The Business Expectation Index (BEI) also dipped. However, sales growth remained steady for the non-IT services sector. I worry that weak sentiments may become self-fulfilling, which will complicate the job of monetary policy.
37. On the positive side, July IIP growth was higher at 4.3% compared to the June reading, largely driven by consumer non-durables and intermediate goods. The consumer non-durables segment, which typically proxies for fast moving consumer goods (FMCG), was strong at 8.3% (although influenced by a disproportionate jump in one-off items). However, capital goods contracted (-7.1%). Consumer durables also contracted (-2.7%). What mitigates this is the truncated IIP (i.e., taking out 2 per cent of most volatile components from both sides) which gives rise to a growth in the IIP of 2.4 per cent in July 2019. While there is a divergence in the year on year consumer durable growth number compared to its seasonally adjusted month on month momentum (7.5 % in July), this divergence has to be seen in the backdrop of high year on year growth of 14.1 per cent in July 2018.
38. FDI has picked up in April – July 2019 relative to 2018.
39. Compared to the last review, monetary transmission has become worse. The decline in the WALR on fresh rupee remained at 29 bps as in the last review. The WALR on outstanding rupee loans has however increased by 7 bps! This is despite the MPC cutting rates by 110 bps in the February- August window. The RBI should be commended for implementing a new set of norms on external benchmarking. This will help with monetary transmission. But as Milton Friedman said, monetary policy works with long and variable lags. In the Indian case, these lags are made worse by frictions in the banking system, complicating the MPC’s efforts to implement counter-cyclical policy.
40. I strongly feel that we need a more informed discussion of fiscal policy in India. While the government should be commended for implementing a new corporate tax rate regime, based on the discussion that I read, I find it premature, without a proper “dynamic scoring” analysis, to speculate on the impact of the tax cut on the fiscal deficit, what part of the economic effects will be on the demand side, and what part will be on the supply side.
41. In some of my own research with co-authors, we show that an impact of a corporate tax cut on GDP in an emerging market economy like India may not be very large. It leads to a rebalancing of the economy away from consumption and towards investment (which is why the GDP effects are muted). Overall, the tax cut leads to a decline in the fiscal deficit in the long run, although the size of this effect is negligible. The lowering impact on the fiscal deficit however depends on a very strong investment effect from the tax cut, which may not happen in the current economic climate.
42. Given the above, what is the appropriate path of monetary policy?
43. There is always a tension between pro-active risk management and being data dependent. Growth impulses however continue to be weak. Given this, the MPC has been pro-active in adjusting policy as reflected in the quantum of past rate cuts. Monetary policy however cannot be a permanent form of stimulus. As Lawrence Lindsey says in his book, The Growth Experiment Revisited (Basic Books, 2013) “Monetary policy should lean against the wind and help stabilize the business cycle. But it cannot become the wind itself, particularly one that blows at gale force.”
44. I vote to reduce the policy rate by 25 bps. I also vote to retain the stance as accommodative. I will remain data dependant, going forward; further monetary policy action will depend on the evolving growth-inflation dynamics. Statement by Dr. Pami Dua
45. Headline inflation, measured by CPI inflation, fell from 3.2% in June 2019 to 3.1% in July but rose back to 3.2% in August. Food inflation increased from 2.4% in June to 3% in August, mainly due to an increase in inflation in vegetables, pulses, and elevated inflation in meat and fish. Inflation excluding food and fuel rose from 4.1% in June to 4.5% in July, partly reflecting the increase in prices of petrol and diesel, but softened to 4.2% in August.
46. Looking forward, inflation expectations of households, as captured through RBI’s Inflation Expectations Survey of Households, increased in the September 2019 round, compared to the July round, by 40 basis points for the three-months-ahead horizon and by 20 basis points for the one-year- ahead horizon, possibly due to the recent increase in food prices. At the same time, the Industrial Outlook Survey (IOS) shows an expectation of selling prices of manufacturing being muted in Q3:2019-20. Further, according to Economic Cycle Research Institute’s (ECRI) Indian Future Inflation Gauge, which is a predictor of the direction of future inflation, inflation pressures remain contained.
47. Thus, while the actual inflation scenario and the outlook for inflation seem benign, some upside risks are prevalent, such as the possibility of supply disruptions in the global crude oil market.
48. On the output side, GDP growth fell for the fifth consecutive quarter to 5% in Q1:2019-20 from 5.8% in the previous quarter. Growth in private final consumption expenditure dropped to an 18- quarter low of 3.1% in the same period, while growth in gross capital formation remained muted at 3.7%. Growth in GVA also fell to 4.9% in Q1:2019-20 from 5.7% in Q4:2018-19, mainly due to a moderation in manufacturing growth and stalling of construction activity.
49. Industrial activity recorded moderate growth, with growth in IIP increasing from 1.2% in June to 4.3% in July, and with sub-indices for mining and quarrying, manufacturing and electricity registering positive growth, although growth in electricity slowed. Use based classification, however, indicates continuing deceleration in capital goods. Consumer non-durables accelerated for the fourth consecutive month, while for consumer durables, growth remained negative, although there was some improvement with growth rising from (-) 10.2% in June to (-) 2.7% in July. High frequency indicators of rural demand – tractor and motorcycle sales – and of urban demand – passenger vehicle sales – continued to contract. Growth in the index of eight core industries also fell in August.
50. Turning to survey data, RBI’s Order Books, Inventory and Capacity Utilisation Survey (OBICUS) suggests a drop in capacity utilisation in the manufacturing sector to 73.6% in Q1:2019-20 from 76.1% in the previous quarter, while seasonally adjusted capacity utilisation increased marginally to 74.8% in Q1 from 74.5% in Q4:2018-19. RBI’s Industrial Outlook Survey for the manufacturing sector shows a decline in the Business Assessment Index (a composite of demand indicators) for Q2:2019-20. The corresponding Business Expectations Index suggests that demand conditions are also expected to deteriorate in Q3:2019-20. According to RBI’s Consumer Confidence Survey, the Current Situation Index and the Future Expectations Index both dropped in the September round, implying lower current activity and a less optimistic outlook. Meanwhile, the manufacturing Purchasing Managers’ Index remained unchanged in September from the previous month, while the services PMI fell in September.
51. Thus, private consumption and investment activity are weak, and business and consumer sentiment are somewhat downbeat.
52. On the global front, the U.S. economic growth outlook is increasingly getting weaker, especially in manufacturing, and job growth prospects have dimmed. This boosts the probability of more Fed rate cuts this year. The overall global growth outlook also remains downcast, according to ECRI’s 20-Country Long Leading Index. In particular, Japan’s latest sales tax hike risks tipping the economy into its fifth recession since 2008. Meanwhile, Chinese economic growth is likely to languish. According to ECRI’s Chinese Leading Industrial Production Index, this is especially true in the industrial sector, hurting supplier countries like Germany, which is heavily reliant on exports to China. At the same time, industrial growth seems to have hit bottom in France and Italy earlier this year.
53. Nevertheless, in the context of largely gloomy international growth prospects, ECRI’s Indian Leading Exports Index growth rate remains in a cyclical downswing, suggesting that Indian export growth will stay weak. Thus, the global scenario is not likely to provide impetus to domestic growth.
54. With respect to transmission, between February and August 2019, the cumulative reduction in the policy repo rate has been 110 basis points, much of which is yet to be transmitted, although the financial markets have taken cognizance. While the importance of transmitting existing rate cuts before committing to fresh ones cannot be overstated, the recent linking of lending rates to external benchmarks is expected to expedite the process.
55. Of course, the policy heavy-lifting to reverse the growth slowdown has to be a multi-pronged approach. In this regard, there is a welcome delivery of a number of measures undertaken by the government since the last policy meeting with a focus on reviving growth. Among largely fiscal- neutral measures, the government has taken steps to relax norms for FDI, focus on seamless tax administration, improve ease of doing business, consolidate public sector banks, and encourage the flow of credit from the banking sector to the NBFCs and real economy sectors. The government has also undertaken fiscal stimulus in the form of a major overhaul in corporate income tax aimed at reducing the overall tax burden on corporates and in turn improving India's global competitiveness.
56. Given the measures undertaken by the government to address the growth slowdown, as well as the pending transmission of monetary policy, there is merit in a wait-and-watch approach to see how these measures pan out and impact real economy activity, going forward. At the same time, given the slowdown in growth on the domestic and global fronts, along with benign headline inflation and the expectation that it will remain below target, there is policy space to further cut the policy repo rate to boost domestic growth, within the flexible inflation targeting mandate.
57. Thus, on balance, the growth-inflation dynamics call for another 25 basis points cut, bringing the cumulative easing this year to 135 basis points. I therefore vote for a policy rate cut of 25 basis points. I also vote to keep the stance as accommodative. Statement by Dr. Ravindra H. Dholakia
58. Macroeconomic data coming in after the last meeting of MPC in August 2019 have further confirmed our serious concerns about the growth slow-down with continued benign inflation outlook. Compared to the expectation of 5.8% of real GDP growth during the first quarter of the current year 2019-20, the official estimate of the growth turned out to be far less at 5.0%. While we cannot rule out the possibility of the figure getting revised marginally upward by 10-20 bps, significant undershooting of the growth during Q1-2019-20 has to be recognized. In spite of late efforts by RBI and the Central Government to provide respectively the monetary and fiscal boost, it appears that growth recovery may take longer than expected. In fact, RBI has now revised its growth prediction for the current year 2019-20 substantially downward by 80 bps compared to the August meeting of MPC. Prediction about inflation rate, on the other hand, has been fairly stable and well below the target of 4%. As per the mandate given to the MPC by the Act under such circumstances, the growth concerns have to be addressed. In my opinion, we need to maintain accommodative stance with possible rate action till growth recovers provided the inflation remains within the target. At this juncture, I would like to act more aggressively by reducing the policy Repo Rate further by 40 bps so as to correct the real interest rates in the economy in due course. It would still leave some space for the rate action if required in future. More specific reasons for my vote are as follows – i) High frequency data on indicators for estimating quarterly growth suggest that the growth slow- down may continue in the second quarter of 2019-20. Any substantial recovery is likely only in the Q3 of 2019-20. This is because, the impact of corporate tax cut particularly for the new enterprises and good monsoon will be kicking off from the third quarter of the current year. As a result, the output gap would continue to be negative for at least next 3 to 4 quarters leading to downward pressures on the CPI excluding food and fuel. ii) Food inflation is likely to remain muted in the face of good monsoon with better Rabi season. While some vegetables and fruits may experience spikes during the year, they are not likely to result in permanent high prices. iii) Fuel prices also do not show an average expectation to rise substantially. In fact, all indications suggest fluctuating oil prices around $58-65 range on a sustained basis. iv) Thus, inflation rate crossing the mid-point target of 4% during the next year or so has very little probability. This is also supported by the inflationary expectation of businesses on the headline CPI inflation one year ahead of 3.70% as per the latest IIMA survey. Although RBI’s own survey of household inflationary expectation shows a rise of 20 bps one year ahead, it is likely to have been influenced by the food price hike before the survey. RBI’s own prediction of the headline inflation by Q1-2020-21 has remained the same at 3.6%. This generates substantial space for a rate cut to further correct the high real interest rate and encourage investment. v) The Economic Survey 2018-19 has argued with empirical support that, while the household savings in India are determined by the growth of income and demography and not so much by the high real interest rate, the private investment is significantly and negatively related to the real interest rate. In my opinion, this is an important finding for the current situation. Whereas most comparator countries have their real policy rates around zero percent, our real policy rate is around 1.8 to 2 percent. Correcting high real interest rates can go a long way to revive the economy from the slow growth. vi) In my opinion, concerns about likely slippage of the combined deficit during this year are misplaced as I have argued earlier. In any case, the overall impact of all current announcements on the combined fiscal deficit as per my calculation is likely to be hardly 10 to 20 bps assuming the GST revenues are as per the budgeted target. It should not have any serious adverse impact on the inflation.
59. External bench-marking of the lending rates by the banks would result in better transmission now. Corporate bond market reforms by allowing entry to corporates with lower rating than AAA; encouraging issuance of long term bonds and creating a proper yield curve for the government bond market to serve as a bench-mark can go a long way to deepen the market and improve the transmission. While such reforms are urgently required, they should not constrain the rate action by RBI. In my opinion, enough space exists as argued above for a 40 bps reduction in the policy repo rate now with space still existing for future till growth recovers. Hence, I vote for continuing with accommodative stance and cut the policy repo rate by 40 bps now. Statement by Dr. Michael Debabrata Patra
60. The GDP print for the first quarter of 2019-20, high frequency indicators for the second quarter up to August, the indicators that have become available for September such as auto sales of industry majors, bank credit, the lowest GST collections in 19 months, and the wide swathe of downgrades of projections suggest that the downturn in the economy, and especially in spending, may be deeper and more pervasive than expected. This justifies the pre-emptive accommodative stance adopted by the MPC since February 2019. Headwinds from the global slowdown are also stronger than initially envisaged, and broader in their impact on domestic activity: transmitted through trade, they seem to be active in muting industrial activity and investment across borders. Sensing this, business expectations for the third quarter and consumer confidence over a year ahead have moderated from their earlier readings. This pronounced cyclical downswing suggests that the state of the economy will likely get worse before it gets better.
61. Meanwhile, inflation continues to trail below target and is projected to remain so over the 12 months ahead horizon. Its underlying dynamics excluding food and fuel seem to be mirroring the growing slack in the economy, given the succession of soft readings and the broad-based nature of its ebbing. If one-off factors like gold prices are excluded, inflation excluding food and fuel falls below target. Although inflation expectations of households a year ahead have ticked up, they are essentially adapting to the firming up of food prices in the summer. Businesses are anticipating modest input cost pressures but still lack pricing power, rendering the outlook on selling prices benign.
62. The conduct of monetary policy requires as accurate as feasible a sense of the economy’s potential output, given that is unobservable. This enables an assessment of the state of the output gap – the difference between actual and potential output – so as to gauge where the economy is positioned on the business cycle. Accordingly, monetary policy can perform its stabilisation or countercyclical role that is appropriate to the situation. The lament of the monetary policy wielder has been that potential output is notoriously difficult to estimate. But, amidst the evolving configuration of macro- fundamentals in India, actual output itself and its future path are overcast with high uncertainty. Consequently, the extent of the slack in the economy due to deficient demand is obscure, although that input is vital for setting the monetary policy stance.
63. In this challenging environment, my call would be for prudence rather than being data- dependent. In its counter-cyclical role, monetary policy has to be pre-emptive in addressing the negative gaps – inflation below target, and output below potential – that seem to be developing some persistence. Available space for policy action has to be calibrated to secure the closure of the gaps.
64. The outlook is fraught with downside risks, but the prospects for agriculture have brightened and along with industry’s inventory restocking requirements in the festival season, scope opens up for reviving spending. In this endeavour, interest rate smoothing is the preferred approach: reinforcing the policy intent with successive steps so as to obviate monetary policy surprises; nudging transmission to bank deposit and lending rates with repetitive but calibrated policy actions in the same direction that also offset the risk premium that appears to be building up in several sectors of the economy.
65. In my minutes at the time of the June 2019 meeting of the MPC, I had emphasised that while monetary policy is taking the lead as the first line of defence, a full throttle effort by all arms of macroeconomic management is the need of the hour. Over recent weeks, monetary and fiscal actions have been undertaken, and it is important to buttress this coordinated endeavour.
66. Accordingly, I vote for a 25 basis points reduction in the policy rate while maintaining an accommodative policy stance until economic activity in India is reinvigorated and firmly on the path of recovery. Statement by Shri Bibhu Prasad Kanungo
67. GDP growth at 5 per cent for Q1 of 2019-20 was a surprise as it significantly undershot the Reserve Bank’s projection of 5.8 per cent. This is particularly a cause of concern because it was caused by a sharp slowdown in private consumption expenditure. Investment activity remained weak, and exports contracted reflecting weak global demand. Growth continued to lose momentum in Q2 as reflected in high frequency indicators. Industrial production growth moderated in July relative to the corresponding month of last year mainly due to sluggish manufacturing activity. Capacity utilisation in the manufacturing sector declined in the last round of the RBI’s survey. The core sector contracted in August. PMI manufacturing remained unchanged in September. Information gleaned through the forward-looking surveys of the RBI indicate deterioration in the industrial outlook in Q2 with downbeat expectations for Q3, especially relating to production, new orders and employment.
68. Most services sector indicators relating to rural and urban demand, transport and construction activity declined/contracted in July-August. PMI services slipped into contraction zone in September 2019 due to a decline in fresh orders.
69. The silver lining in the evolving growth dynamics was provided by agriculture, supported by a sharp catch up in rainfall after a delayed start. The first advance estimates of kharif crops are broadly comparable with those of the last year (fourth advance estimates). The live storage of water in major reservoirs at 121 per cent of the average storage level over the last ten years bodes well for agriculture and rural incomes.
70. CPI inflation remained soft in July-August, though there was a pick-up in food inflation, as expected. Food prices are likely to moderate once new kharif crops arrive in the market. Fuel inflation moved deeper into deflation reflecting the decline in prices of liquified petroleum gas (LPG) in the international market. CPI inflation excluding food and fuel continued to soften reflecting possibly the slowdown of economic activity. Inflation expectations of households increased during the latest round of RBI’s survey, in response to the recent rise in food inflation. CPI inflation projection has been revised marginally upwards for Q2 of 2019-20 at 3.4 per cent (as against 3.1 per cent projected at the time of the August 2019 policy) but has been retained for other quarters as in the August policy – 3.5- 3.7 per cent for the second half of 2019-20 and 3.6 per cent for the first quarter of 2020-21.
71. The cumulative repo rate reduction of 110 bps effected since February 2019 has resulted in 29 bps reduction in weighted average lending rate (WALR) on fresh rupee loans till August, which is much lower than expected. However, with the adoption of external benchmarking in pricing of loans by banks for lending to SME and personal loans effective October 1, 2019, monetary transmission is expected to improve.
72. To summarise, the slowdown of GDP growth in the recent period has been underpinned by deficient domestic demand. The recent measures initiated by the government should be helpful in supporting domestic demand, especially investment. While the impact of past policy rate cuts by the MPC is expected to transmit to the real sector gradually, there is a need to reinforce the past monetary policy measures and the recent steps taken by the government in supporting domestic demand. As inflation is projected to remain below the target of 4 per cent till the first quarter of 2020-21, policy space is available to support growth. I, therefore, vote for reducing the policy repo rate by 25 bps and continue with an accommodative monetary policy stance until the economy is on a revival path, within the mandate of flexible inflation targeting. Statement by Shri Shaktikanta Das
73. Economic activity has weakened further since the last MPC meeting in August 2019 with growth for Q1:2019-20 turning out to be 5 per cent. Various high frequency indicators show that economic activity remained weak in Q2. Inflation has evolved broadly along the projected lines and remains benign; while food inflation has edged up further in the last two months reflecting the sharper than expected increase in food prices, CPI inflation excluding food and fuel has moderated consistent with the slowing down of the economy. The global economy continued to lose traction with high frequency indicators in both the advanced and emerging market economies weakening further in Q3:2019, dragged down by escalating trade tensions and rising geo-political uncertainties. Central banks across the advanced and emerging market economies have adopted more accommodative stances of monetary policy to bolster their economies.
74. Headline CPI inflation edged up marginally in August, driven by an upward movement in food inflation reflecting the sharp summer uptick in prices of vegetables and a pick-up in pulses inflation. The increase in prices of vegetables this year was higher than that in last two years, but it was still in line with the long-term average. Fuel inflation moved further into deflation caused by a decline in prices of liquified petroleum gas (LPG). Inflation excluding food and fuel moderated in August, reversing the increase in the previous month; the moderation was broad-based, which more than offset the sharp increase in gold prices. CPI inflation excluding food and fuel moderated by around 90 bps between March and August 2019. Inflation expectations of households in the September round of the Reserve Bank’s survey increased by 40 basis points for a 3-month ahead horizon and 20 basis points for a 12-month ahead horizon. Overall, the near-term inflation scenario remains subdued; CPI inflation projections have been revised slightly upwards to 3.4 per cent for Q2:2019-20 but have been retained at 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1:2020-21, with risks evenly balanced.
75. Moving on to economic activity, real GDP growth moderated to 5 per cent in the first quarter of 2019-20 as against the projection of 5.8 per cent made in the August policy. Private consumption declined even as investment demand remained weak. The slowdown in industrial activity that began in Q2:2018-19 accentuated further in Q1:2019-20 with manufacturing growth moderating to 0.6 per cent. High frequency indicators suggest that economic activity remained weak in Q2:2019-20. Industrial production growth decelerated in July 2019 in comparison with the same month of last year, while the output of eight core industries contracted in August. The slowing domestic demand was also reflected in shrinkage in non-oil non-gold imports in July-August. The manufacturing PMI for September 2019 was flat. High frequency indicators suggest that services sector activity also remained weak in July- August. Key indicators of both rural demand, viz., tractors and motor cycles sales, and urban demand such as passenger vehicles sales contracted in July-August.
76. On the positive side, the first advance estimates of major kharif crops for 2019-20 are broadly in line with the last year’s fourth advance estimates. More importantly, the prospects for the rabi 2019-20 season have brightened with the improved position of the live storage of water in major reservoirs. This portends well for the farm sector, and the revival of rural demand. Seasonally adjusted capacity utilisation in the manufacturing improved marginally from 74.5 per cent in Q4:2018-19 to 74.8 per cent in Q1:2019-20 in the last round of the Reserve Bank’s survey. This was close to the long-term average, reflecting intensive use of existing capacities. Real GDP growth for 2019-20 has now been revised downwards from 6.9 per cent in the August policy to 6.1 per cent – 5.3 per cent in Q2:2019-20 and in the range of 6.6-7.2 per cent for H2:2019-20 – with risks evenly balanced; GDP growth for Q1:2020-21 has also been revised downwards to 7.2 per cent.
77. Overall liquidity in the system remained in surplus in August and September. However, monetary transmission has remained weak. As against the cumulative policy repo rate reduction of 110 bps during February-August 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by 29 bps. The WALR on outstanding rupee loans, in contrast, increased by 7 basis points. However, with the external benchmark framework coming into force from October 1, the transmission is expected to improve in the coming weeks and months.
78. Overall, domestic demand has moderated significantly. The weakening of private consumption, which for long has been the bedrock of aggregate demand, in particular, is a matter of concern. Private investment has also lost traction, with the corporate sector reluctant to make fresh investments even though capacity utilisation in the manufacturing sector has operated close to the long-term average in the recent period. The unsettled global environment in the face of rising trade tensions has impacted India’s exports, besides delaying the revival of private investment by creating uncertainty. In this environment, it is important to focus on strengthening domestic demand. The MPC has cumulatively reduced the policy repo rate by 110 basis points since the February 2019 policy and changed the stance from neutral to accommodative in the June policy. Systemic liquidity has been in surplus since June 2019. As stated earlier, the introduction of lending rates linked to an external benchmark should result in better monetary transmission.
79. The government has also initiated several measures in recent months which, together with monetary easing by the Reserve Bank, are gradually expected to work their way through the real economy. At the same time, continuing slowdown of the economy requires all out efforts to strengthen private consumption and investment. There is also a need to be watchful of the fiscal situation; however, the government has indicated that it would maintain the fiscal deficit. As the inflation scenario remains benign with headline inflation projected at below target in the remaining period of 2019-20 and Q1:2020-21, there is policy space to address growth concerns. Hence, I vote for reducing the policy repo rate by 25 basis points. With this, the policy repo rate would cumulatively stand reduced by 135 basis points in eight months. I also vote for persevering with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target. This enhanced forward guidance on the stance of monetary policy should strengthen monetary transmission and support the real economy. (Yogesh Dayal) Press Release: 2019-2020/987 Chief General Manager
6. Since the MPC’s meeting in October 2019, global economic activity has remained subdued, though some signs of resilience are becoming visible. Among the advanced economies (AEs), GDP growth in the US picked up in Q3 on strong private investment and personal consumption expenditure. More recent data, however, indicate that factory activity contracted for the fourth consecutive month in November, while retail sales and industrial production declined in October. In the Euro area, GDP growth remained stable in Q3 relative to the previous quarter on improved household consumption and government spending, although manufacturing activity continued to struggle with lingering geo-political uncertainties. With weak global demand pulling down exports, the Japanese economy lost momentum in Q3. Economic activity in the UK accelerated in Q3, primarily driven by the services sector and construction activity.
7. Among emerging market economies (EMEs), GDP growth in China decelerated further in Q3, reflecting weak industrial production and declining exports amidst trade tensions with the US. While retail sales edged lower in October, fiscal and monetary stimuli are expected to temper the slowdown. In Russia, GDP growth accelerated in Q3 on the back of an upturn in agricultural output and industrial activity. In South Africa, economic activity contracted in Q3, pulled down by slowing mining and manufacturing activity. In Brazil, GDP growth accelerated further in Q3, driven by agriculture, industry and business investment activity.
8. Crude oil prices have moved in a narrow range in both directions since the last meeting of the MPC, reflecting changing sentiments relating to progress in US-China trade talks. Gold prices traded sideways before falling in early November as a revival of risk appetite eased safe haven demand. Inflation remained benign in major AEs and EMEs in Q3, except in China where it firmed up to its highest level in eight years.
9. Global financial markets were buoyed in October by risk-on sentiment stemming from renewed optimism on a trade truce between the US and China and possibility of a Brexit deal. In the US, equity markets rallied in this environment, also supported by better than expected corporate earnings and strong jobs data. Stock markets in EMEs too registered gains in October before some selling pressure took hold in the second half of November on renewed fears of US-China trade talks stalling on the Hong Kong stand-off. Bond yields in the US firmed up from early October on risk-on sell-offs; however, they softened from mid- November on waning hopes of a near-term resolution of trade disputes. Bond yields in the Euro area remained negative, but expectations that a no-deal Brexit is less likely improved sentiment. In EMEs, bond yields showed mixed movements, driven initially by optimism on US-China trade talks and country-specific factors. In currency markets, the US dollar weakened against other major currencies, while EME currencies have been trading with an appreciating bias. Domestic Economy
10. On the domestic front, gross domestic product (GDP) growth moderated to 4.5 per cent year-on-year (y-o-y) in Q2:2019-20, extending a sequential deceleration to the sixth consecutive quarter. Real GDP growth was weighed down by a sharp slowdown in gross fixed capital formation (GFCF), cushioned by a jump in government final consumption expenditure (GFCE). Excluding GFCE, GDP growth would have been at 3.1 per cent. Growth in real private final consumption expenditure (PFCE) recovered from an 18-quarter trough. The drag from net exports eased on account of a sharper contraction in imports than in exports.
11. On the supply side, gross value added (GVA) growth decelerated to 4.3 per cent in Q2:2019-20, pulled down by a contraction in manufacturing. The slowdown in manufacturing activity was also reflected in a decline in capacity utilisation (CU) to 68.9 per cent in Q2:2019-20 from 73.6 per cent in Q1 in the early results of the Reserve Bank’s order books, inventories and capacity utilisation survey (OBICUS). Seasonally adjusted CU also fell to 69.8 per cent from 74.6 per cent during the same period. Growth in the services sector moderated, weighed down mainly by trade, hotels, transport, communication, broadcasting services and construction activity. However, growth in public administration, defence and other services accelerated in line with the surge in government final consumption expenditure. Agricultural GVA growth increased marginally, despite contraction in kharif foodgrains production in the first advance estimates.
12. Looking beyond Q2, rabi sowing is catching up from the setback caused by delay in kharif harvesting and unseasonal rainfall in October and early November. By November 29, it was only 0.5 per cent lower than the acreage covered a year ago. North-east monsoon precipitation was 34 per cent above the long-period average up to December 4. Storage in major reservoirs, the main source of irrigation during the rabi season, was at 86 per cent of the full reservoir level as on November 28 as compared with 61 per cent in the same period a year ago.
13. Contraction in output of eight core industries – which constitute 40 per cent of the index of industrial production (IIP) – extended into the second consecutive month in October and became more pronounced, dragged down by coal, electricity, cement, natural gas and crude oil. However, output of fertilisers rose sharply, reflecting expectations of robust sowing activity in the rabi season. According to the early results of the Reserve Bank’s industrial outlook survey, overall sentiment in the manufacturing sector remained in pessimism in Q3:2019-20 due to continuing downbeat sentiments on production, domestic and external demand, and the employment scenario. The purchasing managers’ index (PMI) for manufacturing increased from 50.6 in October to 51.2 in November 2019, driven up by an increase in new orders and output.
14. High frequency indicators suggest that service sector activity generally remained weak in October. Tractors and motorcycles sales – indicators of rural demand – continued to contract but at a moderated pace; however, passenger vehicle sales – an indicator of urban demand – posted a slender positive growth in October after 11 months of decline, reflecting festival season demand and promotional measures by auto companies. Commercial vehicle sales and railway freight traffic contracted. The PMI for services remained in negative zone in October (49.2) due to a decline in new export business and turning down of business expectations. However, it moved into expansion zone to 52.7 in November on a pick-up in new business.
15. Retail inflation, measured by y-o-y changes in the CPI, increased sharply to 4.6 per cent in October, propelled by a surge in food prices. Fuel group prices remained in deflation, while inflation in CPI excluding food and fuel moderated further from its level a month ago.
16. Turning to the drivers of CPI, food inflation spiked to 6.9 per cent in October – a 39- month high – pushed up by a sharp increase in prices of vegetables due to heavy unseasonal rains. Prices of onions, in particular, shot up by 45.3 per cent in September and further by 19.6 per cent in October. Inflation in several other food items such as fruits, milk, pulses and cereals also increased, reflecting diverse factors – the cost push of fodder prices in the case of milk; decline in production and sowing area of pulses; and minimum support price effects. Sugar and confectionery prices moved out of deflation in October as sugarcane output shrank on a y-o-y basis.
17. Fuel group prices remained weak for the fourth consecutive month in October due to deflation in prices of LPG, firewood and chips. Electricity prices, however, picked up in October following a rise in user charges by power distribution companies (DISCOMs) across 13 states as reflected in the CPI.
18. Inflation in CPI excluding food and fuel softened further from 4.2 per cent in September to 3.4 per cent in October, primarily due to favourable base effects. Price increases also moderated across several services as reflected in transportation fares, telephone charges, tuition fees and house rentals.
19. Households’ inflation expectations, measured by the Reserve Bank’s November 2019 round of the survey, increased by 120 basis points over the 3-month ahead horizon and 180 basis points over the 1-year ahead horizon as they adapted to the spike in food prices in recent months. Based on the Reserve Bank’s consumer confidence survey, spending on non-essential items of consumption has shrunk compared to a year ago; however, consumers expect their overall spending to remain unchanged going forward largely due to an increase in prices. Manufacturing firms polled in the industrial outlook survey of the Reserve Bank expect (i) weak demand conditions and reduced input price pressures in Q3:2019-20 and Q4; and (ii) muted output prices reflecting further weakening of pricing power.
20. Overall liquidity in the system remained in surplus in October and November 2019 despite an expansion of currency in circulation due to festival demand. Average daily net absorption under the LAF amounted to ₹1,98,566 crore in October. The Centre availed of ways and means advances (WMA) in the first week and the last three days of the month to fund its expenditure. In November, the average daily net absorption of surplus liquidity soared to ₹2,40,566 crore with more frequent and larger recourse to WMA by the Government. Consequently, the Reserve Bank decided to conduct longer-term variable rate reverse repo auctions with effect from November 4, 2019 in addition to overnight variable rate reverse repo auctions. So far, four longer term reverse repo auctions have been conducted – two auctions of 21 days tenor and one each of 35 days and 42 days tenor – absorbing ₹78,934 crore. Reflecting easy liquidity conditions, the weighted average call rate (WACR) traded below the policy repo rate (on an average) by 8 basis points (bps) in October and by 10 bps in November.
21. Monetary transmission has been full and reasonably swift across various money market segments and the private corporate bond market. As against the cumulative reduction in the policy repo rate by 135 bps during February-October 2019, transmission to various money and corporate debt market segments ranged from 137 bps (overnight call money market) to 218 bps (3-month CPs of non-banking finance companies). Transmission to the government securities market, however, has been partial at 113 bps (5-year government securities) and 89 bps (10-year government securities). Credit market transmission remains delayed but is picking up. The 1-year median marginal cost of funds-based lending rate (MCLR) has declined by 49 basis points. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 44 basis points, while the WALR on outstanding rupee loans increased by 2 basis points during this period. However, transmission is expected to improve going forward as (i) the share of base rate loans, interest rates on which have remained sticky, declines; and (ii) MCLR-based floating rate loans, which typically have annual resets, become due for renewal.
22. After the introduction of the external benchmark system, most banks have linked their lending rates to the policy repo rate of the Reserve Bank. The median term deposit rate has declined by 47 bps during February-November 2019. The weighted average term deposit rate declined by 9 bps in October as against a decline of just 7 bps in eight months during February-September. This augurs well for transmission to lending rates, going forward.
23. Exports contracted in September-October 2019, reflecting the persisting weakness in global trade. Excluding petroleum products, however, the decline in exports was less pronounced and, in fact, non-oil export growth returned to positive territory in October after a hiatus of two months. Imports contracted faster than exports, with lower international crude oil prices resulting in a decline in the oil import bill. A sharp contraction in the volume of gold imports kept outgoes on this account in check. Non-oil non-gold imports also contracted, pulled down by electronics, coal and pearls and precious stones. Reflecting these developments, the trade deficit narrowed in September-October. On the financing side, net foreign direct investment rose to US$ 20.9 billion in H1:2019-20 from US$ 17.0 billion a year ago. Net foreign portfolio investment was of the order of US$ 8.8 billion in April-November 2019 as against net outflows of US$ 14.9 billion in the same period of last year. In addition, net investment by FPIs under the voluntary retention route have amounted to US$ 6.3 billion since March 11, 2019. Net disbursals of external commercial borrowings rose to US$ 11.5 billion during April-October 2019 as against US$ 1.2 billion during the same period a year ago. India’s foreign exchange reserves were at US$ 451.7 billion on December 3, 2019 – an increase of US$ 38.8 billion over end-March 2019. Outlook
24. In the fourth bi-monthly resolution of October 2019, CPI inflation was projected at 3.4 per cent for Q2:2019-20, 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1:2020-21 with risks evenly balanced. The actual inflation outcome for Q2 evolved broadly in line with projections – averaging 3.5 per cent. The inflation print for October, however, was much higher than expected.
25. Going forward, the inflation outlook is likely to be influenced by several factors. First, the upsurge in prices of vegetables is likely to continue in immediate months; however, a pick-up in arrivals from the late kharif season along with measures taken by the Government to augment supply through imports should help soften vegetables prices by early February 2020. Second, incipient price pressures seen in other food items such as milk, pulses, and sugar are likely to be sustained, with implications for the trajectory of food inflation. Third, both the 3-month and 1-year ahead inflation expectations of households polled by the Reserve Bank have risen and these latent sentiment upsides are being reflected in other surveys as well. Fourth, domestic financial markets have exhibited volatility. Fifth, domestic demand has slowed down, which is being reflected in the softening of inflation excluding food and fuel. Sixth, crude oil prices are expected to remain range bound, barring any supply disruptions due to geo-political tensions. Taking into consideration these factors, the CPI inflation projection is revised upwards to 5.1-4.7 per cent for H2:2019-20 and 4.0-3.8 per cent for H1:2020-21, with risks broadly balanced (Chart 1).
26. Turning to the growth outlook, real GDP growth for 2019-20 in the October policy was projected at 6.1 per cent – 5.3 per cent in Q2:2019-20 and in the range of 6.6-7.2 per cent for H2:2019-20 – with risks evenly balanced; and 7.2 per cent for Q1:2020-21. GDP growth for Q2:2019-20 turned out to be significantly lower than projected. Various high frequency indicators suggest that domestic and external demand conditions have remained weak. Based on the early results, the business expectations index of the Reserve Bank’s industrial outlook survey indicates a marginal pickup in business sentiments in Q4. On the positive side, however, monetary policy easing since February 2019 and the measures initiated by the Government over the last few months are expected to revive sentiment and spur domestic demand. Taking into consideration these factors, real GDP growth for 2019-20 is revised downwards from 6.1 per cent in the October policy to 5.0 per cent – 4.9-5.5 per cent in H2 and 5.9-6.3 per cent for H1:2020-21 (Chart 2). While improved monetary transmission and a quick resolution of global trade tensions are possible upsides to growth projections, a delay in revival of domestic demand, a further slowdown in global economic activity and geo-political tensions are downside risks.
27. The MPC notes that economic activity has weakened further and the output gap remains negative. However, several measures already initiated by the Government and the monetary easing undertaken by the Reserve Bank since February 2019 are gradually expected to further feed into the real economy. Data on corporate finance and on projects sanctioned by banks and financial institutions suggest some early signs of recovery in investment activity, though its sustainability needs to be watched closely. The need at this juncture is to address impediments, which are holding back investments. The introduction of external benchmarks is expected to strengthen monetary transmission. In this context, there is also a need for greater flexibility in the adjustment in interest rates on small saving schemes. In the judgement of the MPC, inflation is rising in the near-term, but it is likely to moderate below target by Q2:2020-21. It is, therefore, prudent to carefully monitor incoming data to gain clarity on the inflation outlook. Similarly, the forthcoming union budget will provide better insight into further measures to be undertaken by the Government and their impact on growth.
28. The MPC recognises that there is monetary policy space for future action. However, given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture. Accordingly, the MPC decided to keep the policy repo rate unchanged and continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
29. All members of the MPC – Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Shri Bibhu Prasad Kanungo and Shri Shaktikanta Das – voted in favour of the decision.
30. The minutes of the MPC’s meeting will be published by December 19, 2019.
31. The next meeting of the MPC is scheduled during February 4-6, 2020. Voting on the Resolution to keep the policy repo rate unchanged at 5.15 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Michael Debabrata Patra Yes Shri Bibhu Prasad Kanungo Yes Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
32. Inflationary expectations are important in driving actual inflation. Since the last review, there has been a sharp spike in both the 3-month ahead (by 120 bps) inflationary expectations from 8% to 9.2% and 1-year ahead (by 180 bps) inflationary expectations from 8.1% to 9.9%.
33. Such a sharp increase has not been seen in the past three years. Even the 3- month ahead trimmed mean (from 8.7% to 9.7%) and one year ahead trimmed mean (8.6% to 9.9%) have increased. While these trends may be adaptively reflecting the rise in food inflation, they also may possibly reflect the rise in economic policy uncertainty in the current growth climate.
34. October food inflation printed at 6.9% which is a 39-month high. The cumulative momentum in food between April-October FY:19-20 is higher than that in the previous three financial years. Unseasonal rainfall has led to both a damage to Kharif output and to a delay in the sowing of the Rabi crop. This is building into price pressures. While some of the impulses could be idiosyncratic, it may also be that food surprises sustain going forward. For instance, the cumulative momentum of food excluding vegetables by October was higher this financial year. I have been concerned about the trajectory of food inflation in the last several reviews.
35. Headline inflation at 4.6% printed at a 16-month high. In contrast, inflation excluding food and fuel, moderated by 80 bps from 4.2% in September to 3.4% in October. Inflation excluding food and fuel still indicates relatively soft cumulative momentum so far in FY:2019-20, reflecting lacklustre demand in the economy. The price build up in services has also remained soft in groups such as housing, health, and education, which has helped contribute to low momentum in inflation excluding food and fuel. Low service sector inflation however is unlikely to sustain. This is because the service sector in India tends to be heavily supply constrained.
36. Economic growth continues to be lacklustre. Growth in Q2: FY19-20 fell further to 4.5%, the lowest in 26 quarters with investment growing at 1%. The Index of Industrial Production (IIP) continued to be in contraction in September (-4.3%) compared to -1.4% in August. The weakness in the IIP was manifest across all segments. The truncated IIP also contracted by -5.5% in September. Based on RBI’s Industrial Outlook Survey (IOS), demand conditions remained pessimistic in Q3: FY 19-20.
37. Despite lacklustre growth, and rising inflation, I think monetary policy is in a good place right now.
38. There are mitigating factors that would suggest that it is best to obtain greater clarity on the evolving growth-inflation risk picture.
39. First, counter-cyclical monetary policy has not been as effective as expected due to inadequate monetary policy transmission. Weak monetary transmission is one of the factors that has resulted in the poor macroeconomic equilibrium the economy is currently in and it could lead to excesses in the financial sector.
40. Transmission will no doubt improve with external benchmarking as the proportion of loans linked to the MCLR falls and more loans become linked to the external benchmark. Further, reducing risk aversion in the NBFC sector, problems in which have led to elevated term premia, is more in the domain of “macro-prudential policy”, rather than monetary policy.
41. Second, a few positive factors have emerged since the last review. This suggests that a wait and watch approach is appropriate.
42. First, the WALR on fresh rupee loans has fallen by 44 bps (from 29 bps in the last review). A large quantum of rate cuts has still not been transmitted, and the MPC loses nothing by waiting for a couple of months. Second, net FDI into India, at 20.9 Billion USD between April-September 2019 continues to be strong. Third, within exports, the share of sectors recording negative growth has reduced to 38.2% in October 2019. Fourth, in October, some high frequency indicators have begun to contribute to a positive momentum in growth, suggesting that it is best to wait for a few months to see whether the slowdown has bottomed out or not. Fifth, it is best to wait to see how the corporate tax cuts have impacted the economy. Since the tax cut was announced on September 20, and RBI’s analysis of corporate performance corresponded to the end of September, this data did not pick up the effects of the tax cut. Further, the corporate tax cut for new companies will only apply after October 1. Sixth, the large decline in capacity utilization (CU) to 68.9% in Q2: FY 19-20 based on early results of Order Books, Inventory and Capacity Utilisation Survey, needs further clarification. Importantly, using sentiments on CU in the IOS, Q3: FY 19-20 is forecasted to improve somewhat. Seventh, consumption expenditure (PFCE) growth has strengthened to a little over 5% in Q2: FY 19-20 from 3.1% in Q1: FY19-20 which is noteworthy notwithstanding the deflator effect. Eighth, the PMI in both manufacturing and services has strengthened in their most recent readings. Ninth, the risk environment in the global economy appears to have abated a bit suggesting that global recession risks seem to have waned.
43. I worry however that real wage growth in the organized sector has further weakened since the last review. In the rural sector, weak demand conditions add to the prospect of a “one-legged” recovery driven by the urban sector.
44. I vote to pause. I also vote to retain the stance as accommodative. I will remain data dependant, going forward; further monetary policy action will depend on the evolving growth-inflation dynamics. Statement by Dr. Pami Dua
45. Headline inflation, measured by CPI inflation, increased from 3.3% in August and 4% in September 2019 to 4.6% in October. Food inflation increased from 4.7% in September to 6.9% in October, mainly due to an increase in inflation in vegetables, fruits, pulses, milk and cereals. Inflation excluding food and fuel moderated to 3.4% in October from 4.2% in September, reflecting favourable base effects, as well as softening domestic demand.
46. Looking forward, inflation expectations of households, as captured through RBI’s Inflation Expectations Survey of Households, increased in the November 2019 round, compared to the September round, by 120 basis points for the three-month-ahead horizon and by 180 basis points for the one-year-ahead horizon, possibly due to the sharp increase in food prices. At the same time, the Industrial Outlook Survey (IOS) shows an expectation of subdued selling prices of manufacturing in Q4:2019-20, as well as reduced input cost pressures.
47. The increase in prices of vegetables is expected to continue in the near future, but moderate by February 2020 due to higher arrivals in the late kharif and subsequently from the rabi season, as well as measures taken by the government to augment the supply through imports.
48. On the output side, GDP growth fell for the sixth consecutive quarter to 4.5% (y-o-y) in Q2:2019-20 from 5% in the previous quarter. Growth in private final consumption expenditures was 5.1%, up from 3.1% in the previous quarter, and growth in government final consumption expenditure increased to 15.6%, while growth in gross capital formation slowed sharply. Excluding government final consumption expenditure, GDP growth is 3.1%, underlining the weakness in private domestic demand. Growth in GVA also fell to 4.3% in Q2:2019-20, pulled down by manufacturing sliding into contractionary territory, as well as moderation in services.
49. Turning to survey data, early results of RBI’s Order Books, Inventory and Capacity Utilisation Survey (OBICUS) suggest a drop in capacity utilisation in the manufacturing sector. The Business Assessment Index (a composite of demand indicators), based on the early results of the RBI’s Industrial Outlook Survey for the manufacturing sector, remained in the contractionary zone for Q3:2019-20. According to RBI’s Consumer Confidence Survey, the Current Situation Index and the Future Expectations Index both dropped in the November 2019 round, implying lower current activity and a less optimistic outlook. Meanwhile, the Manufacturing Purchasing Managers’ Index increased from 50.6 in October to 51.2 in November, reflecting an increase in new orders and output.
50. Thus, overall, private consumption and investment activity are weak, and business and consumer sentiment are somewhat downbeat. Further, exports growth has contracted by less than imports growth, indicating that the slowdown in domestic demand may be somewhat more acute than the weakness in global growth.
51. On the international front, some signs of a cyclical upturn in global industrial growth are now in sight. Industrial growth prospects have improved for both France and Germany, although the US industrial outlook remains subdued. The outlook for the Chinese economy remains constrained, while Japan is flirting with recessionary conditions. Overall, the global economy is expected to experience uneven improvement in economic growth in the next few months, according to Economic Cycle Research Institute’s (ECRI’s) international leading indexes. However, the world’s largest economies are in no position to act as locomotives to pull global growth out of the doldrums, and will therefore not be able to provide much impetus to the Indian economy. Thus, the drivers of growth for the Indian economy would have to be from within the economy. Meanwhile, growth in ECRI’s Indian Coincident Index looks to have bottomed, having improved modestly of late.
52. On the domestic front, from the monetary policy perspective, monetary transmission of the cumulative reduction in the policy repo rate by 135 basis points from February to October 2019 to the various money and corporate debt markets has been in the range of 137 basis points in the overnight call money market to 218 basis points in 3-month CPs of non- banking finance companies. Transmission to the government securities market has been partial at 113 basis points for 5-year government securities and 89 basis points for 10-year government securities. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks fell by 44 basis points during this period. Going forward, the recent linking of the lending rate to external benchmarking is expected to expedite the pending transmission, with most banks having linked their lending rates to the policy repo rate.
53. Further, to reiterate what I said in the last policy, the policy heavy-lifting to reverse the growth slowdown has to be a multi-pronged approach. In this regard, a number of measures have already been undertaken by the government with a focus on reviving growth. These include steps to relax norms for FDI, focus on seamless tax administration, improve ease of doing business, consolidate public sector banks, and encourage the flow of credit from the banking sector to the financial and real economy sectors. The government has also undertaken fiscal stimulus in the form of a major overhaul in corporate income tax aimed at reducing the overall tax burden on corporates and, in turn, improving India's global competitiveness. Such measures should help to improve the investment climate and attract more capital flows into India.
54. At the same time, lacklustre revenue collections, alongside lower nominal GDP growth rate add to the risk of fiscal slippage. Thus, at this juncture, it would be prudent to take a cue from the upcoming Budget on the government’s initiatives to revive growth.
55. Thus, with the pending monetary transmission expected to be realised in the near future, measures already undertaken by the government to address the growth slowdown expected to play out, and growth initiatives expected to be announced in the upcoming Budget, there is merit in a wait-and-watch approach to see how these measures pan out and impact real economic activity, including investment, going forward.
56. At the same time, while growth is slowing, headline inflation is projected to rise in the near-term, but moderate to below target by Q2:2020-21. At this juncture, it is, therefore, best to monitor incoming data on both inflation and growth.
57. I, therefore, vote to keep the policy rate unchanged and continue with the accommodative stance. Statement by Dr. Ravindra H. Dholakia
58. After the October 2019 meeting of MPC, the inflation readings of September and October 2019 turned out to be substantially higher, resulting in RBI’s forecast to be higher by 160 bps for the Q3 of 2019-20 with significant upward revisions in the forecast over the next year. Similarly, the estimate of the GDP growth for Q2 of 2019-20 has not only turned out to be 80 bps below but was also contrary to RBI’s assessment that the growth slowdown would bottom out in Q1 of 2019-20. As I had pointed out in my statement in October MPC minutes, the RBI’s forecast of 6.1% growth during the current year was on an optimistic side and would not materialize. Now the RBI has revised its expectation substantially downward to 5%, which seems plausible. The sharp spike in food inflation may continue for the next two- three months driving the headline inflation above the mid-point target and closer to the upper bound of the flexible target range. The forecast of inflation by RBI for the 4 quarters up to Q2 of 2020-21 is based on certain assumptions where considerable uncertainties are involved. I, therefore, take the RBI forecast of the headline inflation of 3.8% for Q2 of 2020-21 with some reservation at this point. Inflationary expectations that were reasonably anchored till recently can shoot up during this period as evident from the RBI Survey of Households and IIMA Survey of Businesses although the situation may not go out of control. Moreover, there are some green shoots of growth recovery during the third and fourth quarters of the current year perhaps in response to the counter-cyclical measures on the fiscal and monetary policy fronts, but they need to be confirmed with more data. I had argued for a 40 bps rate cut in the last policy and I still maintain that there is space for further rate cuts even now. The question is of the timing and magnitude. In my view, it is prudent to wait and watch out for clarity on growth – inflation dynamics and gain some more confidence at this juncture before taking a decisive action on the policy rate front. In the meantime, there is enough slack for the markets to adjust to the rate cuts already made. I, therefore, vote to hold the policy repo rate at 5.15% for now and continue with the accommodative stance. More specific reasons for my vote are as follows – i) While the current spike in the headline inflation is arguably due to the temporary supply shocks on the food front, the impact is not confined only to a few items. It is important to understand how much would be the impact and for how long. The household inflationary expectations as per the latest RBI survey showed a sharp increase by 120 bps and 180 bps for three months and twelve months ahead horizon. Thus, the surveyed households believe that the increased inflation is not a temporary phenomenon but can go on increasing over the whole of the year to come. On the other hand, IIM Ahmedabad Survey of Businesses shows an increase of only 10 bps in their inflationary expectation 12 months ahead indicating that the current spike is temporary. RBI’s own forecasts support the latter, but they are based on some crucial assumptions, which are surrounded by several uncertainties. Clarity on this with more data is important. ii) My own research with a co-author published in the Economic and Political Weekly on 3rd March 2018 shows that as per recent inflation dynamics the second round effects of an external shock (like food or fuel prices) on the core inflation are, if at all, quite weak. Unlike in the past, it is the headline inflation that now reverts to the core rather than the core reverting to the headline. RBI’s recent survey on consumer confidence provides some support to this argument. It has shown that in response to the sharp rise in the food prices, the consumption of the non-essential items has declined implying very low substitutability between food and non-food consumption. It may, therefore, be argued that inflationary expectations based largely on food inflation may not result in a rise in the core inflation. We may, however, need some more observations to confirm or contradict this argument. iii) Although the capacity utilization as per the early results of RBI survey has fallen substantially to less than 70% in Q2 of 2019-20, there are several green shoots of growth recovery in the economy. PMI in manufacturing as well as services has shown substantial increase with the latter turning into an expansionary mode from the earlier contraction. RBI survey has shown that corporates have turned investors from savers earlier. After a long time, corporates are increasing their physical assets and not financial assets. Transmission of rate cuts in the credit markets is picking up and with the policy of external benchmark for lending rates, it is likely to further pick up. RBI’s own forecast suggests that the growth slowdown has bottomed out in Q2 of 2019-20 and gradual recovery would take place in Q3 and Q4 and continue in the next year. High frequency data and advance estimates of GDP for the current year need to be watched carefully to examine the extent and speed of this recovery since it can have implications for the headline inflation. iv) Union Budget for 2020-21 and the Economic Survey for 2019-20 are due in the next couple of months. As I have argued earlier, the growth recovery has to be addressed fundamentally and durably by the fiscal policy with the monetary policy, if at all, playing only a facilitating role. The stance, content and commitment of the fiscal measures outlined in the Budget and the Economic Survey should, therefore, provide extremely useful guidance on the growth concerns. In my opinion, monetary policy should supplement those efforts provided inflation risks are contained within the given target range. In this context, I would like to repeat my earlier arguments on the concerns about fiscal slippage. When there is a cyclical downturn due to serious growth slowdown, it is logical to expect a fiscal slippage even without any change in the fiscal policy parameters. If the estimates of nominal income growth are seriously undershot, revenues are bound to fall short of the target. If under such circumstances, expenditures are cut to maintain the fiscal deficit target, it would amount to a contractionary fiscal policy during a downturn!! Generally, the stabilization policies like fiscal and monetary policies should be counter-cyclical and not pro-cyclical. The fiscal discipline target of 3% of GDP under such circumstances should not be overemphasized and can be temporarily ignored. Even though the N.K. Singh Committee has provided for a slippage by 50 bps under such exigencies, there is hardly any rationale for only 50 bps slippage. In my opinion, therefore, the slippage of more than 50 basis points may also be justified under the present circumstances. It is important in my opinion to wait for the clarity of the government’s commitment and action to tackle the growth slowdown before further action on the monetary front at present.
59. Given all these arguments, it is pragmatic to wait for more clarity to emerge for a firm action on policy rate. In the meantime, the expected better transmission of the past rate cuts will serve the purpose in any case. The stance should continue to be accommodative but in this policy, we should hold the repo rate at 5.15%. Statement by Dr. Michael Debabrata Patra
60. The configuration of macroeconomic and financial conditions facing the MPC in this meeting exerts conflicting pulls. Arguably, the slump in real GDP growth warrants accommodative monetary policy actions and stance whereas the upturn in headline inflation for the third month in succession after a quiescent phase of nine months calls for an opposite response or at least status quo until there is ground to infer that the food price spirals that are driving it are on the ebb.
61. In this context, two features of the recent upsurge in inflation weigh upon the monetary policy decision. First, it is prudent to expect higher than current readings over the next two or three months. This warrants a pause in the sequence of rate reductions that began in February 2019. Second, inflation pressures are rotating from vegetable prices to those of other elements of food and beverages. By current reckoning, vegetables prices can be expected to reverse by Q4:2019-20 as the supply situation improves. They can, therefore, be looked through while setting monetary policy. The key question is: will the upside in other food prices reverse or persist, especially those of pulses and milk? If it persists, will it spill over into non-food inflation? This too warrants close monitoring of incoming data over the next few months and, therefore, a pause.
62. Turning to the real economy, the weakness in overall activity may likely prolong into Q3, if not turn weaker. In particular, the sharp downturn in the growth of investment calls for urgent policy responses, reinforcing the actions already taken. The contribution of monetary policy in this endeavour can be to reduce the cost of capital. To bring about the turnaround, however, the net present value of future income streams from investment must exceed the cost of capital. This will hinge around a rekindling of animal spirits in a business-conducive environment, highlighting the importance of close and continuous policy coordination. Monetary policy has been pre-emptive in supporting growth and is committed to remaining in accommodative mode until growth revives. With 135 basis points of interest rate reductions and fiscal policy actions working their way into the economy, it is apposite in this meeting to allow this pass-through and be in readiness to back signs of traction with resolute and calibrated policy actions.
63. While voting for status quo in this meeting, it is important to note that headroom is available to act and arrest any further weakening of growth impulses. With this objective in the fore, I also vote for maintaining the accommodative monetary policy stance. Statement by Shri Bibhu Prasad Kanungo
64. Since the October policy, growth and inflation outcomes have deviated significantly from their paths projected by the RBI in the October policy. Real GDP growth at 4.5 per cent (y-o-y) in Q2:2019-20 turned out to be much weaker than 5.3 per cent projected earlier, despite a robust growth of 15.6 per cent in Government Final Consumption Expenditure (GFCE). While private consumption improved, fixed investment grew at a measly rate of 1 per cent. On the GVA side, industrial and services growth slowed down, while agriculture growth picked up slightly.
65. Beyond Q2, the index of eight core industries further contracted by 5.8 per cent during October 2019 to register the lowest growth in 2011-12 series after contracting by 5.1 per cent in September 2019. Among other high frequency indicators, cement production, international air cargo traffic and railway freight traffic contracted further in October. On the positive side, passenger vehicles sales and domestic air passenger traffic – indicators of urban demand - saw positive growth in October, while motor cycles sales – an indicator of rural demand – witnessed lower contraction vis-à-vis September. The PMI for manufacturing and services improved in November. Rabi sowing is catching up. Adequate reservoir levels augur well for the rabi prospects. Growth projection for 2019-20 has been revised downwards to 5 per cent from 6.1 per cent in the last policy.
66. On the inflation front, unseasonal rains in October and early November damaged certain crops and also disrupted the mandi arrival patterns. As a result, the temporary demand- supply imbalance led to price pressures in several vegetables, especially onion prices. During H1: 2020-21, food prices are projected to soften in response to rabi supplies. Inflation pressures in CPI excluding food and fuel have softened further on account of continuing moderation in demand conditions. Median inflation expectations of households, which are somewhat backward looking and also highly sensitive to food inflation, firmed up significantly from 8 per cent to 9.2 per cent for three months ahead horizon, and from 8.1 per cent to 9.9 per cent for one year ahead horizon.
67. The headline inflation path for H2: 2019-20 is projected to rise to 5.1 to 4.7 per cent now as against 3.5 to 3.7 per cent earlier. However, inflation will moderate gradually below the target in Q2:2020-21.
68. The cumulative repo rate reduction of 135 bps effected since February 2019 has resulted in 44 bps reduction in weighted average lending rate (WALR) on fresh rupee loans till October, which is lower than expected. It is, however, encouraging that there has been some improvement in transmission following the introduction of external benchmarking of new floating rate loans to the retail (housing, vehicle, education loans, etc.) and micro and small enterprises (MSE) sectors. After the introduction of external benchmarking system in October 2019, most of the banks have linked their lending rates to the policy repo rate. The weighted average term deposit rate (WATDR) declined by 9 bps in October, which bodes well for monetary transmission, going forward.
69. The MPC has cumulatively reduced the repo rate by 135 basis points, the impact of which will gradually be felt on the real economy. The current uptick in inflation driven by a sharp increase in food prices is expected to reverse. However, there exists considerable uncertainty on the food price trajectory, and the quantum of impact of unseasonal rains on kharif output would be known only early next year. The incoming data may also provide greater clarity on the growth outlook. I vote for a pause in the policy rate at this juncture. It is better to wait and watch for the incoming data. Even as space exists for future monetary policy action, a pause at this juncture would help calibrate the appropriate policy response in future. I also vote for persevering with the accommodative stance as long as it is necessary to revive growth while ensuring that inflation remains within the target. Statement by Shri Shaktikanta Das
70. Economic activity has continued to weaken with GDP growth decelerating for the sixth consecutive quarter for Q2:2019-20. Of the two main components of GDP, while investment activity weakened further, private consumption showed signs of recovery. CPI inflation has surged in last three consecutive months reflecting a spike in vegetable prices and price pressures in some other food items. However, inflation excluding food and fuel glided below four per cent, suggesting subdued domestic demand conditions. Global economic activity has remained weak, weighed down by continuing uncertainty relating to trade conflicts. Major central banks have maintained accommodative monetary policy stances.
71. Headline inflation rose sharply in September and further in October, driven up by a sudden spike in prices of vegetables as kharif crop was damaged due to unseasonal rains in many parts of the country; increase in prices of onion was particularly sharp. Prices of certain non-vegetable foods items such as pulses, cereals, fruits and sugar increased at a faster pace than in previous two years. On the whole, food group inflation was at a 39-month high in October. Fuel group inflation remained in deflation for the fourth consecutive month in October mainly due to continuing deflation in LPG prices. Electricity prices, however, picked up in many states.
72. CPI inflation excluding food and fuel moderated to an all-time low of 3.4 per cent in October. Apart from the strong favourable base effect, price increases also moderated in several services such as transport fares, telephone charges, tuition fees, recreation and amusement and house rentals. Inflation expectations of households polled in the last round of the survey conducted by the Reserve Bank, however, increased sharply for both the 3-month ahead and 12-month ahead horizons, possibly reflecting the sharp rise in food prices. CPI inflation is projected to rise to 5.1-4.7 per cent for H2:2019-20 before moderating to 4.0-3.8 per cent for H1:2020-21.
73. Turning to economic activity, GDP growth decelerated to 4.5 per cent for Q2:2019-20 from 5.0 per cent in Q1; the Reserve Bank had projected GDP growth for Q2 at 5.3 per cent in its October policy. Though growth in private consumption recovered to 5.1 per cent in Q2 from 3.1 per cent in Q1, it needs to be seen whether it will be sustained. Government final consumption expenditure surged to provide a strong support to economic activity, in the absence of which growth would have been still lower. On the supply side, manufacturing activity contracted. Early results of the order books, inventory and capacity utilisation (OBICUS) survey conducted by the Reserve Bank suggest that capacity utilisation in the manufacturing sector declined to 68.9 per cent in Q2:2019-20 from 73.6 per cent in Q1. Services sector activity also moderated, despite a pick up in growth in public administration, defence and other services (PADO).
74. Beyond Q2, however, some positive signs have emerged. Rabi sowing has caught up considerably from the setback caused by delay in kharif harvesting and unseasonal rainfall in October and early November. Storage in major reservoirs at 86 per cent of the full reservoir level as on November 28 was much higher as compared with 61 per cent a year ago. This augurs well for the rabi season. While the output of eight core industries contracted in October, PMI manufacturing increased to 51.2 in November from 50.6 in October. Certain high frequency indicators of the services sector showed positive growth in October/November vis-à-vis September. Passenger vehicle sales, domestic and international air passenger traffic, foreign tourist arrivals, and finished steel consumption showed higher growth in October in comparison with the previous month. Though commercial vehicle and two-wheeler sales contracted in October, the pace of contraction slowed down. The PMI for services, which was in contraction in October (49.2), moved into expansion zone to 52.7 in November. Real GDP growth for 2019-20 has been revised downwards from 6.1 per cent in the October policy to 5.0 per cent – 4.9-5.5 per cent in H2:2019-20; GDP growth has been projected at 5.9-6.3 per cent for H1:2020-21. While improved monetary transmission and a quick resolution of global trade tensions could push the growth above the projected trajectory, a delay in revival of domestic demand, a further slowdown in global economic activity and geo-political tensions could pull it down below the projected path.
75. Monetary transmission has been full and almost instantaneous across various money market segments and private corporate bond yields, while the transmission to the government securities market has been partial. Despite some improvement in the recent period, monetary transmission to lending rates of banks remains inadequate. The 1-year median marginal cost of funds-based lending rate (MCLR) declined by 49 basis points during February-November 2019. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 44 basis points during February-October 2019, while the WALR on outstanding rupee loans increased by 2 basis points during the same period. With the introduction of the external benchmark system, transmission is expected to improve going forward as the existing MCLR-based floating rate loans, which typically have annual resets, become due for renewal. Overall liquidity in the system remains in sizable surplus. The weighted average term deposit rate declined by 9 bps in October and 16 basis points during February-October 2019. This bodes well for transmission to lending rates.
76. Overall, several uncertainties cloud the growth-inflation outlook. First, the surge in food inflation in last three months, driven up by a spike in onion and other vegetable prices, could be transitory. It is likely to reverse gradually as late kharif output comes to the market. In view of this, even as current food price spike driven by vegetables can be looked through, there is a need for greater clarity as to how the overall food inflation path is going to evolve, as there is some uncertainty about the outlook of prices of certain non-vegetable food items such as cereals, pulses, milk and sugar. It is also not clear at this stage as to how the recent increase in telecom charges will play out even as CPI inflation excluding food and fuel has moderated.
77. Second, though domestic demand conditions have weakened, certain high frequency indicators have improved in the more recent period. There are also some indications that the capex cycle may be turning up as reflected in (i) an increase in the share of funds deployed in fixed assets to 45.6 per cent during H1:2019-20 from 18.9 per cent during H1:2018-19, based on the results of 1539 listed private manufacturing companies; and (ii) an increase in total cost of projects sanctioned in the private sector by banks/financial institutions to ` 79,525 crore in Q2:2019-20 from ` 45,781 crore in Q1. These are positive developments but need to be carefully assessed with incoming data for their sustainability.
78. Third, monetary transmission has improved in recent months. The impact of past policy rate reductions on monetary transmission, however, is still unfolding.
79. Fourth, the impact of recent counter-cyclical measures taken by the Government is playing out. The next budget is due for presentation in about two months and it will provide greater clarity about the further measures that the Government may initiate. It is imperative that monetary and fiscal policies work in close coordination.
80. Fifth, global financial markets have remained volatile caused by trade related uncertainties.
81. Considering all these aspects in their totality, on balance, I vote for keeping the policy repo rate on hold at the present level of 5.15 per cent in this meeting and for maintaining the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target. There is policy space, the use of which, however, needs to be appropriately timed for ensuring its optimal impact. (Yogesh Dayal) Press Release: 2019-2020/1465 Chief General Manager
6. Since the MPC met last in December 2019, global economic activity has remained slow-paced, but is getting differentiated across geographies. Among the key advanced economies (AEs), the US economy grew by 2.1 per cent in Q4:2019, the same pace as in Q3, with slack in consumer spending offset by government expenditure. In the euro area, economic activity slowed down in Q4 as France and Italy shrank unexpectedly amid waning consumer confidence. Growth momentum in the UK appears to have weakened in Q4 as reflected in a decline in industrial production and tepid retail sales. The Japanese economy was weighed down in Q4 by weak retail sales as reflected in subdued consumer spending in the wake of the sales tax hike in October. Industrial production in Japan was pulled down by muted global demand.
7. Among emerging market economies (EMEs), the Chinese economy slowed down to a 29-year low of 6.1 per cent in 2019, caused by sluggish domestic demand and prolonged trade tensions. In Russia, available indicators point to a loss of momentum in activity in Q4:2019 with industrial production easing, although private consumption may have provided some cushion. In Brazil, activity seems to have slowed down, as reflected in a contraction in industrial production and depressed retail sales. The South African economy recorded a growth of -0.6 per cent in Q3 and is likely to have also contracted in Q4 as industrial production slumped and household spending remained subdued amidst lingering consumer pessimism.
8. Crude oil and gold prices shot up in early January sparked by the US-Iran confrontation, but both softened from mid-January as geo-political tensions eased. By end-January, crude oil prices dipped sharply due to sell-offs triggered by the outbreak of the coronavirus. Gold prices, on the other hand, inched up towards end-January because of safe haven demand. International food prices have been rising on higher demand and supply disruptions from major exporting countries. Reflecting these developments, inflation has edged up in some major AEs and EMEs.
9. Global financial markets remained resilient in December 2019 and for the most part of January 2020 as thawing US-China trade relations and improved prospects of an orderly Brexit buoyed investors’ sentiment. Equity markets rallied across AEs and EMEs, turning bearish towards end-January with the outbreak of the coronavirus as markets braced up for the likely adverse impact on growth prospects, particularly in China. However, equity markets in most economies recovered some of the losses in early February. Bond yields, which had hardened in the US towards the end of 2019 as investors turned to riskier assets, softened in January 2020, especially after the US Fed left the policy rate unchanged and assured the extension of repo operations. In the euro area, bond yields sank further into negative territory in January. Yields also softened across several EMEs. In currency markets, the US dollar strengthened in January against major advanced economies in sympathy with factors impacting US bond markets. EME currencies, which were generally trading with an appreciating bias, have depreciated since the last week of January. Domestic Economy
10. Moving on to the domestic economy, the first advance estimates (FAE) released by the National Statistical Office (NSO) on January 7, 2020 placed India’s real gross domestic product (GDP) growth for 2019-20 at 5.0 per cent. In its January 31 release, the NSO revised real GDP growth for 2018-19 to 6.1 per cent from 6.8 per cent given in the provisional estimates of May 2019. On the supply side, growth of real gross value added (GVA) is estimated at 4.9 per cent in 2019-20 as compared with 6.0 per cent in 2018-19.
11. Turning to more recent indicators, both production and imports of capital goods – two key pointers of investment activity – continued to contract in November/December, though at a moderate pace compared with the previous month. Revenue expenditure of the Centre (excluding interest payments and subsidies) remained robust in Q3, indicative of the counter-cyclical buffer to domestic demand being provided by government final consumption. As per revised estimates given in the Union Budget, growth in revenue expenditure of the Centre (excluding interest payments and subsidies) is estimated to be lower in Q4 compared with Q3.
12. On the supply side, rabi sowing has been higher by 9.5 per cent up to January 31, 2020 compared with a year ago. The north east monsoon rainfall was above normal. Storage in major reservoirs – the main source of irrigation during the rabi season – was 70 per cent of the full reservoir level (as on January 30, 2020) as compared with 45 per cent a year ago. Based on the first advance estimates, horticulture production is estimated to have risen 0.8 per cent to a record level in 2019-20. Production of vegetables is estimated to have increased by 2.6 per cent in 2019-20 due to higher production of onions, potatoes and tomatoes.
13. Industrial activity, measured by the index of industrial production (IIP), improved in November after contracting in the previous three months. The output of core industries returned to positive territory in December after four months of contraction, buoyed by five out of eight of its constituents – coal; refinery products; fertilisers; steel; and cement. Capacity utilisation (CU) in the manufacturing sector, measured by the Reserve Bank’s order books, inventory and capacity utilisation survey (OBICUS), fell to 69.1 per cent in Q2 from 73.6 per cent in Q1; seasonally adjusted CU also eased to 70.3 per cent from 73.4 per cent. The Reserve Bank’s industrial outlook survey points to weak demand conditions facing the manufacturing sector in Q3:2019-20. The Reserve Bank’s business expectations index suggests an improvement in Q4. This is corroborated by the manufacturing purchasing managers’ index (PMI) for January 2020 which picked up sharply to 55.3 from 51.2 in November 2019 on the back of increased output and new orders.
14. Several high frequency indicators of services have turned upwards in the recent period, pointing to a modest revival in momentum, although the outlook is still muted. Amongst indicators of rural demand, while tractor sales grew by 2.4 per cent in December after ten months of a decline, motorcycle sales continued to contract. Domestic air passenger traffic – an indicator of urban demand – posted double digit growth in November, followed by a modest growth in December. Growth in three- wheeler sales and railway freight traffic has accelerated, while port traffic turned around in December. On the other hand, passenger vehicle sales continued to contract. The PMI services index improved to 55.5 in January 2020 from 52.7 in November 2019, boosted by a rise in new business and output.
15. Retail inflation, measured by year-on-year changes in the CPI, surged from 4.6 per cent in October to 5.5 per cent in November and further to 7.4 per cent in December 2019, the highest reading since July 2014. While food group inflation rose to double digits, the fuel group moved out of deflation. Inflation in CPI excluding food and fuel continued to edge up from its October trough.
16. CPI food inflation increased from 6.9 per cent in October to 12.2 per cent in December, primarily caused by a spike in onion prices due to unseasonal rains in October-November. Excluding onions, food inflation would have been lower by 4.7 percentage points and headline inflation by 2.1 percentage points in December. In addition, inflation in several other food sub-groups such as milk, pulses, cereals, edible oils, eggs, meat and fish also firmed up.
17. The CPI fuel group registered inflation of 0.7 per cent in December, reflecting an increase in prices of electricity and firewood and chips; and in administered prices of kerosene. Together they constitute 68 per cent of the CPI fuel basket. LPG inflation remained in negative territory despite a sharp recovery in prices in November-December.
18. CPI inflation excluding food and fuel rose from a low of 3.4 per cent in October to 3.8 per cent by December 2019, driven by an increase in inflation in mobile phone charges, petrol, diesel, transportation fares and clothing. Housing inflation moderated further in December reflecting subdued demand.
19. Households’ inflation expectations eased in the January 2020 round of the Reserve Bank’s survey – after a sharp pick-up in the previous round – with the 3- month ahead and 1-year ahead inflation expectations falling by 60 basis points (bps) and 70 bps, respectively. Based on the Reserve Bank’s consumer confidence survey, consumer spending on non-essential items of consumption contracted from a year ago; however, overall spending is expected to rise, going forward, reflecting an increase in prices. The December 2019 round of the Reserve Bank’s industrial outlook survey suggests that the input and output prices of manufacturing firms remained subdued in Q3:2019-20 and are likely to remain so in Q4.
20. Overall liquidity in the system remained in surplus in December 2019 and January 2020. Average daily net absorption under the liquidity adjustment facility (LAF) amounted to ₹2.61 lakh crore in December 2019. In January 2020, the average daily net absorption of surplus liquidity soared to ₹3.18 lakh crore. The Reserve Bank conducted four auctions involving the simultaneous purchase of long-term and sale of short-term government securities under open market operations (OMOs) for a notified amount of ₹10,000 crore each during December and January (December 23 and 30, 2019 and January 6 and 23, 2020). Reflecting these operations, the 10-year G-sec yield softened cumulatively by 15 bps between December 19, 2019 and January 31, 2020. During the intervening period, however, the yields fell by as much as 25 bps. The weighted average call rate (WACR) traded below the policy repo rate (on an average) by 10 bps in December and by 19 bps in January on easy liquidity conditions.
21. Monetary transmission across various money market segments and the private corporate bond market has been sizable. As against the cumulative reduction in the policy repo rate by 135 bps since February 2019, transmission to various money and corporate debt market segments up to January 31, 2020 ranged from 146 bps (overnight call money market) to 190 bps (3-month CPs of non-banking finance companies). Transmission through the longer end of government securities market was at 73 bps (5-year government securities) and 76 bps (10-year government securities). Transmission to the credit market is gradually improving. The 1-year median marginal cost of funds-based lending rate (MCLR) declined by 55 bps during February 2019 and January 2020. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 69 bps and the WALR on outstanding rupee loans by 13 bps during February-December 2019.
22. After the introduction of the external benchmark system, most banks have linked their lending rates for housing, personal and micro and small enterprises (MSEs) to the policy repo rate of the Reserve Bank. During October-December 2019, the WALRs of domestic (public and private sector) banks on fresh rupee loans declined by 18 bps for housing loans, 87 bps for vehicle loans and 23 bps for loans to micro, small and medium enterprises (MSMEs).
23. Export growth continued to contract in November-December 2019, reflecting the slowdown in global trade. Import growth slumped in November-December 2019, with contraction in both oil and non-oil non-gold imports. While the latter reflected the underlying weakness in domestic demand and was spread across categories such as transport equipment, coal, iron and steel and chemicals, outgoes on account of oil imports were lower due to a cut back in oil import volume. Gold imports also declined in December 2019. On the financing side, net foreign direct investment rose to US$ 24.4 billion in April-November 2019 from US$ 21.2 billion a year ago. Net foreign portfolio investment was of the order of US$ 8.6 billion in 2019-20 (up to February 4) as against net outflows of US$ 14.2 billion in the same period last year. In addition, net investments by FPIs under the voluntary retention route have aggregated US$ 7.8 billion since March 11, 2019. External commercial borrowings were higher at US$ 13.4 billion during April-December 2019 as compared with US$ 2.5 billion during the same period a year ago. India’s foreign exchange reserves were at US$ 471.4 billion on February 4, 2020 – an increase of US$ 58.5 billion over end-March 2019. Outlook
24. In the fifth bi-monthly resolution of December 2019, CPI inflation was projected at 5.1-4.7 per cent for H2:2019-20 and 4.0-3.8 per cent for H1:2020-21, with risks broadly balanced. The actual inflation outcome for Q2 at 5.8 per cent overshot projections by 70 bps, primarily due to the intensification of the onion price shock in December 2019 on account of unseasonal rains in October-November.
25. Going forward, the inflation outlook is likely to be influenced by several factors. First, food inflation is likely to soften from the high levels of December and the decline is expected to become more pronounced during Q4:2019-20 as onion prices fall rapidly in response to arrivals of late kharif and rabi harvests. Higher vegetables production, despite the early loss due to unseasonal rain, is also likely to have a salutary impact on food inflation. On the other hand, the recent pick-up in prices of non-vegetable food items, specifically in milk due to a rise in input costs, and in pulses due to a shortfall in kharif production, are all likely to sustain. These factors could impart some upward bias to overall food prices. Second, crude prices are likely to remain volatile due to unabating geo-political tensions in the Middle East on the one hand, and the uncertain global economic outlook on the other. Third, there has been an increase in input costs for services, in recent months. However, subdued demand conditions, muted pricing power of corporates and the correction in energy prices since the last week of January may limit the pass-through to selling prices. Fourth, domestic financial markets remain volatile reflecting both global and domestic factors, which may have an influence on the inflation outlook. Fifth, base effects would turn favourable during Q3:2020-21. Sixth, the increase in customs duties on items of retail consumption in the budget may result in only a marginal one-time uptick in inflation. Taking into consideration these factors, and under the assumption of a normal south west monsoon in 2020-21, the CPI inflation projection is revised upwards to 6.5 per cent for Q4:2019-20; 5.4-5.0 per cent for H1:2020-21; and 3.2 per cent for Q3:2020-21, with risks broadly balanced (Chart 1).
26. Turning to the growth outlook, real GDP growth for 2019-20 was projected in the December 2019 policy at 5.0 per cent – 4.9-5.5 per cent in H2. GDP growth for H1:2020-21 was projected at 5.9-6.3 per cent. For 2020-21, the growth outlook will be influenced by several factors. First, private consumption, particularly in rural areas, is expected to recover on the back of improved rabi prospects. The recent rise in food prices has shifted the terms of trade in favour of agriculture, which will support rural incomes. Second, the easing of global trade uncertainties should encourage exports and spur investment activity. The breakout of the coronavirus may, however, impact tourist arrivals and global trade. Third, monetary transmission in terms of a reduction in lending rates and financial flows to the commercial sector has progressed vis-à-vis the last policy, and this could spur both consumption and investment demand. Fourth, the rationalisation of personal income tax rates in the Union Budget 2020-21 should support domestic demand along with measures to boost rural and infrastructure spending. Taking into consideration the above factors, GDP growth for 2020-21 is projected at 6.0 per cent – in the range of 5.5-6.0 per cent in H1 and 6.2 per cent in Q3 (Chart 2).
27. The MPC notes that inflation has surged above the upper tolerance band around the target in December 2019, primarily on the back of the unusual spike in onion prices. Over the coming weeks and months, onion prices are likely to ebb as supply conditions improve. The salutary effects on headline inflation are, however, likely to be tempered by hardening of prices of other food items, notably those of pulses and proteins. Meanwhile adjustments to telecom charges are imparting cost- push pressures to CPI inflation excluding food and fuel. Going forward, the trajectory of inflation excluding food and fuel needs to be carefully monitored as the pass- through of remaining revisions in mobile phone charges, the increase in prices of drugs and pharmaceuticals and the impact of new emission norms play out and feed into inflation formation. The MPC anticipates that the combination of these factors may keep headline inflation elevated in the short-run, at least through H1:2020-21. Overall, the inflation outlook remains highly uncertain. Accordingly, the MPC will remain vigilant about the potential generalisation of inflationary pressures as several of the underlying factors cited earlier appear to be operating in concert.
28. At the same time, the MPC observes that the economy continues to be weak and the output gap remains negative. While some high-frequency indicators have turned around and point to a lift in the momentum of economic activity, there is a need to await incoming data to gauge their sustainability. Financial flows to the commercial sector have improved in recent months. The Union Budget 2020-21 has introduced several measures to provide an impetus to growth. While the emphasis on boosting the rural economy and infrastructure should help the growth momentum in the near-term, the corporate tax rate cuts of September 2019 should help boost the growth potential over the medium-term. The fiscal deficit of the Central Government for 2019-20 is placed at 3.8 per cent of GDP in the revised estimates as against 3.3 per cent of GDP in the budget estimates. The higher fiscal deficit in 2019-20 has not resulted in an increase in market borrowings compared to the budget estimates. The fiscal deficit is budgeted to decline to 3.5 per cent of GDP for 2020-21. Fresh gross market borrowings are budgeted to increase by ₹70,000 crore to ₹7.8 lakh crore in 2020-21 from ₹7.1 lakh crore in 2019-20. The MPC notes that while there is a need for adjustment in interest rates on small saving schemes, the external benchmark system introduced from October 1, 2019 has strengthened monetary transmission. These developments should amplify the effects of the cumulative policy rate reductions undertaken by the Reserve Bank since February 2019 and pull up domestic demand going forward.
29. The MPC recognises that there is policy space available for future action. The path of inflation is, however, elevated and on a rising trajectory through Q4:2019-20. The outlook for inflation is highly uncertain at this juncture. On the other hand, economic activity remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner. Given the evolving growth-inflation dynamics, the MPC felt it appropriate to maintain status quo. Accordingly, the MPC decided to keep the policy repo rate unchanged and persevere with the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target.
30. Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Janak Raj, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted in favour of the decision.
31. The minutes of the MPC’s meeting will be published by February 20, 2020.
32. The next meeting of the MPC is scheduled during March 31, April 1 and 3, 2020. Voting on the Resolution to keep the policy repo rate unchanged at 5.15 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Janak Raj Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
33. As in the last several reviews, I continue to track household inflationary expectations carefully. Surprisingly, since the last review, median 3- month ahead inflationary expectations have moderated from 9.2% to 8.6% (60 bps). One year ahead inflationary expectations have also moderated from 9.9% to 9.2% (70 bps).
34. While these drops adaptively reflect the decline in specific perishable food commodities, overall, I am “tentatively encouraged” by the relative stability of both the 3 month and 1 year ahead inflationary expectation series over the longer run. Post implementation of flexible targeting (post 2015), there is suggestive evidence of better anchoring of household inflationary expectations.
35. Post inflation targeting, inflation ex food and fuel has also not converged upwards towards headline CPI inflation as it did in the period prior to that suggesting the lack of second round effects. These factors will improve the short run output- inflation trade-off facing the MPC.
36. Headline CPI inflation in December spiked to 7.35% from 5.5% in November, and 4.6% in October. The sharp uptick in headline inflation was driven by a sharp uptick in food inflation. Onion inflation increased to 328%, which alone accounted for a 210 bps increase in headline inflation despite its small weight (0.64%) in the overall index. This is consistent with the significantly lower mandi arrival of onions in October-November due to unseasonal rains.
37. While some of the increase in the October–December 2019 food inflation (average 9.3%) relative to October–December 2018 inflation (average -1.2%) was due to a strong base effect, the cumulative momentum in food inflation in 2019-2020 so far has tracked the average momentum between 2012-13 and 2016-2017 much more closer than the cumulative momentum in the “outlier” years of 2017-2018 and 2018-2019. While this may be because of the significantly higher build up in vegetable momentum (food inflation ex vegetables however was also elevated at 5% y-o-y in December), it would be prudent to remain watchful of the outsized shocks to food.
38. Inflation ex food and fuel crept up marginally to 3.8% in December from 3.6% in November and 3.4% in October reflecting higher increases in telecom tariffs (which has elevated the transportation and communication sub-group inflation to 4.8% in December). However, all exclusion based measures of inflation (ranging from 3% to 3.8%) lie significantly below headline inflation.
39. In a testament to the success of flexible inflation targeting in India - helped also by good food management by the government - using data for the period January 2015 – December 2019, CPI headline inflation has averaged 4.2% – inflation ex food and fuel has averaged 4.8%, and food inflation has averaged 3.6%.
40. Economic growth is estimated to slow down to 5.0 per cent for 2019-20 by the NSO. The first advance estimate (FAE) for 2019-2020 puts Private Consumption Expenditure growth at a low 5.8% (compared to a 7.55% average growth between 2015-2016 and 2018-2019). Rural demand and rural wage growth continues to be weak.
41. Real sales of 286 listed private manufacturing companies in the manufacturing sector in Q3: 2019-2020 continued to weaken. Capacity utilization was lower at 69.1% in Q2: FY 19-20, consistent with low fixed investment and a negative output gap. Non-food credit growth continued with its declining trend since Q3: 2018-2019.
42. On the prospects for investment, what is disconcerting is that despite the enactment of the September 2019 corporate tax cut, there is no discernible increase in net profits in Q3:2019-20 across several firm types in RBI’s Industrial Outlook Survey (IOS). Profit margin expectations for Q4 also continue to be pessimistic across firm types. While it may still be early, the “impact effect” of the corporate tax cut appears to have been to accelerate the extent of corporate deleveraging rather than increase planned capex in an environment with weak demand. The impact of the corporate tax rate on investment, capital deepening, and wage growth will crucially depend on how the Jorgensonian cost of capital falls in response to the tax cut.
43. On the positive side, broader economic activity is beginning to show preliminary signs of a turn-around. This is encouraging.
44. Eight core industries grew in December (1.3 %) and the full IIP grew in November (+1.8%) after four and three consecutive months of contraction, respectively. Several high frequency indicators have turned and/or strengthened since the last review: PMI Services, PMI Manufacturing, the Manufacturing IIP, Consumer Non-Durables, High Rabi sowing, Vehicle registration, Rail freight, GST Tax collections, and Cement and Steel Production amongst others. Monetary transmission has also gathered pace. Since February 2019, the WALR on fresh rupee loans has fallen by 69 bps, and on outstanding loans by 13bps.
45. The government had an unenviable position of walking a fiscal tightrope in Budget 2020. I see the corporate tax cuts and the personal income tax rationalization in this budget as part of the same combined stimulus. Taking the budget estimates at face value, a rough calculation suggests that this amounts to a tax-stimulus of about 0.9% of GDP (26 USD Billion / 2.9 USD Trillion). The stimulus (in the form of reductions in various rates) from the GST since its implementation in July 2017 probably amounts to an additional 0.3 % of GDP. The combined tax stimulus therefore approximates 1.2 percentage of GDP given the initiatives in the 2020 budget.
46. If growth hasn’t revived with a 135 bps cut in the policy rate, and a tax stimulus amounting to 1.2% of GDP, then the need of the hour is more structural reform.
47. Having said this, fiscal deficit uncertainty may require the MPC to accept tighter than desired monetary conditions to ensure our commitment to the medium- term inflation target.
48. Real GDP growth during March 2015 – September 2019, has averaged 7.2%. This would suggest that the Indian economy has performed like a “7-4” economy (averaging roughly 7% growth and roughly 4% inflation) over the period of flexible inflation targeting. I find the growing chorus challenging the efficacy of flexible inflation targeting in India worrying. For those who advocate targeting an inflation rate higher than 4 per cent, I am sorry: 4-6% inflation is not price stability!
49. In sum, monetary policy continues to be well positioned. While I don’t see space for further cuts going forward, I remain data dependent. While the current spike in headline inflation is likely to lack persistence, the inflation numbers should be carefully watched.
50. Given the above reasons, I vote to pause. I also vote to retain the stance as accommodative. Statement by Dr. Pami Dua
51. Headline inflation, measured by CPI inflation, increased to 7.4% in December 2019 (highest since July 2014) from 5.5% in November and 4.6% in October, primarily due to a sharp rise in food inflation to 12.2% in December. This, in turn, was mainly due to an increase in onion prices, accompanied by a rise in inflation in milk, pulses, cereals, edible oils, eggs, meat and fish. At the same time, CPI inflation excluding food and fuel rose to 3.8% in December from 3.4% in October, driven primarily by an increase in inflation in the transport and communications sub-group.
52. Going forward, both survey data and model-based forecasts indicate a moderation in inflation. According to RBI’s Inflation Expectations Survey of Households, conducted in January 2020, inflation expectations eased by 60 and 70 basis points over three-month and one-year ahead horizons, respectively, possibly due to an expected moderation in food prices. As per the December 2019 round of RBI’s Industrial Outlook Survey, manufacturing firms expect subdued selling prices in Q4:2019-20 as input costs are also expected to remain muted. Further, projections made by RBI indicate that inflation is expected to moderate but remain at elevated levels (5% or above) through Q2:2020-21.
53. The future inflation trajectory is subject to various factors, including downside risks such as sharper than expected moderation in onion prices and larger correction in prices of other vegetables due to higher production. Upside risks include an increase in global food prices, rise in gold prices, fluctuations in oil prices due to geo- political tensions, and an increase in input costs for services. Disruptions in the supply of Chinese imports due to the spread of coronavirus may also exert pressure on prices of goods imported from China.
54. On the output front, industrial production grew by 1.8% y-o-y in November, a sharp turnaround from -4.0% in October. Growth in broad categories under the sectoral classification as well as the use-based classification either increased from the previous month or the extent of contraction eased (with the exception of intermediate goods that grew by double-digits though the pace moderated). Growth turned from negative to positive for the mining and manufacturing sectors, whereas the contraction in growth eased in electricity. The pace of contraction also eased for primary goods, capital goods, infrastructure and construction goods, and consumer durables, while it turned from negative to positive for consumer non- durables.
55. According to the first advance estimates released by the National Statistical Office (NSO), real GDP growth for 2019-20 is pegged at 5%, while GVA growth is estimated at 4.9%. The estimates indicate a deceleration in consumption and investment as well as a contraction in exports, with reduced demand for imports. Industrial growth is also expected to decline, while agricultural growth is expected to edge up – as rabi sowing has been higher than the previous year.
56. Turning to survey data, RBI’s Order Books, Inventory and Capacity Utilisation Survey (OBICUS) shows a drop in capacity utilisation in the manufacturing sector in Q2:2019-20 compared to Q1. The Business Assessment Index (a composite of demand indicator), based on the RBI’s Industrial Outlook Survey for the manufacturing sector, remained in the contractionary zone for Q3:2019-20. At the same time, the Business Expectations Index shows prospects of improvement for Q4. According to RBI’s Consumer Confidence Survey, the Current Situation Index fell to a new low in January 2020 due to weaker sentiment on general economic situation, price level and household income. On the other hand, the Future Expectations Index witnessed a marginal uptick due to improved outlook on employment and prices. Meanwhile, the Manufacturing Purchasing Managers’ Index increased from 51.2 in November to 55.3 in January 2020, reflecting an increase in new orders and output. The PMI Services Index also picked up during this period. A few high frequency indicators are also showing signs of revival, such as tractor sales, three-wheeler sales, railway freight traffic and domestic air passenger traffic.
57. Thus, there are some signs of a modest revival, although overall economic activity continues to remain weak. While the focus of the Union Budget is on sustainable growth within a framework of fiscal consolidation, it may provide some impetus to growth through the incremental rationalisation in personal taxes, focus on infrastructure and rural spending, emphasis on raising competitiveness in manufacturing and enhancing the overall ease of doing business. However, the full impact of these measures may percolate slowly to the economy with possibly only a small effect visible in the short-run.
58. Flow of credit to the commercial sector, that remained tepid till the MPC met last in December, picked up in the last two months. This should nurture growth impulses. The increase in the monetary transmission of the cumulative reduction in the policy repo rate by 135 basis points from February to October 2019 should also help in reviving economic activity. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks fell by 69 basis points from February to December 2019 (implying an additional 25 basis points in November and December). Since the introduction of the external benchmarking system, many banks have linked their lending rates for housing, personal and micro and small enterprises (MSEs) to the policy repo rate. From October to December 2019, the WALRs of public and private sector banks on fresh rupee loans fell by 18, 87 and 23 basis points for housing loans, vehicle loans, and loans to MSMEs, respectively. Thus, the external benchmarking system has improved the extent of transmission, although there is still scope for more.
59. Moving on to the international front, some signs of a cyclical upturn in global industrial growth are in sight. On the verge of the coronavirus outbreak, growth in the Economic Cycle Research Institute’s (ECRI’s) 21-Country Long Leading Index, a harbinger of global economic activity, entered a mild cyclical upturn consistent with global growth prospects posting patchy progress. Meanwhile, a nascent upswing in global industrial growth had already begun, following a modest upturn in the growth rate of ECRI’s Global Leading Manufacturing Index. In that context, it is notable that the coronavirus epidemic is not yet tipping global industrial growth into a fresh cyclical downturn. However, this has to be monitored closely to gauge the possible impact of the epidemic on global growth.
60. Aligned with the improvement in global growth prospects, growth in ECRI’s Indian Leading Exports Index, a predictor of Indian exports growth, has increased recently, anticipating a revival in Indian exports growth, which has dropped to a multi- year low. This bodes well for India’s exports, but has to be tracked closely in light of the recent epidemic. Therefore, as of now, it is not clear if economic growth in India can get a boost from global growth.
61. Thus, to address growth in the economy, there is merit in adopting a wait-and- watch approach. This will allow for the pending monetary transmission to be realised in the near future. Further, measures already undertaken by the government to address the growth slowdown are expected to play out, including the fiscal stimulus in the form of a major overhaul in corporate income tax aimed at reducing the overall tax burden on corporates and, in turn, improving India's global competitiveness. Moreover, growth initiatives announced in the Union Budget are also expected to pan out slowly. Additionally, the impact of global growth on the domestic economy would have to be examined in light of the recent epidemic.
62. At the same time, while growth is slowing, headline inflation has increased beyond the upper tolerance band and is expected to remain at elevated levels (5% or above) through Q2:2020-21. At this juncture, it is, therefore, best to monitor incoming data on both inflation and growth, given the evolving inflation-growth dynamics. I, therefore, vote to keep the policy rate unchanged and continue with the accommodative stance. Statement by Dr. Ravindra H. Dholakia
63. Since the last meeting of MPC in December 2019, several major events have occurred and new data is available. Greater clarity has emerged on several uncertainties perceived at that time, though some new uncertainties have arisen and assumed more importance. The latest two readings of monthly headline inflation for November and December 2019 have been significantly above the RBI forecast largely on account of the spikes in onion prices. While this is transitory and in all likelihood would reverse soon, it is most likely to lead to a breach of upper tolerance limit for the headline inflation for a quarter for the first time since the MPC is functioning. Given the high Rabi sowing, record level of water storage in reservoirs, prolonged growth slowdown leading to expanding negative output gap, favourable base effects and some international developments, the headline CPI inflation going forward is expected to show a declining trend for at least a year to come. Some new uncertainties have, however, emerged that could need some policy space for future. Moreover, the Union Budget for 2020-21, in my opinion, has presented a fiscal policy of the Centre that borders on being contractionary rather than expansionary on misplaced concerns about fiscal slippage in the face of a serious growth slow-down. Under such circumstances, in my view, the monetary policy should preserve policy space for any rate action at an appropriate time. I, therefore, vote to maintain status quo on both the policy repo-rate and the accommodative stance in this meeting. More specific reasons for my vote are as follows – i) Uncertainty regarding food and vegetable prices during the last meeting of the MPC has reduced and it is getting clear that these prices would gradually come down to their original level over the next two – three quarters. Fuel prices rising substantially in the short term is hardly a risk given the international developments. Union Budget for 2020-21 has been presented with no major impact on both growth and inflation in my opinion. As a result, there is no risk of output gap closing rapidly in the short to medium term. Global growth slow- down is confirmed by now. ii) New uncertainties have emerged from the likely spread of Coronavirus and its impact through trade and fuel prices. It can lead to sharp swings in fuel prices in both the directions over time. Run up to the US Presidential elections and its possible impact on the geopolitics can have substantial impact on the global economic environment. The response of various State Governments to the Union Budget 2020-21 in terms of their own budgets is a major uncertainty deciding almost the other half of the fiscal policy for the country. iii) Inflationary expectations of the households for 12 months ahead as revealed in the most recent RBI survey have declined by 70 bps compared to the previous round. This is, however, contradicted by an increase of 40 bps in the headline CPI inflation expectation by the businesses as revealed by the IIMA surveys. Thus, the picture is ambiguous on recent trends in inflationary expectations in the economy. RBI’s own assessment about the inflation forecast four quarters down is 3.2%. Thus, although there is uncertainty, some policy space for the rate action does exist. iv) The numbers presented in the Union Budget 2020-21 show that the fiscal slippage of 41 bps in the fiscal deficit to GDP ratio from the budgeted 3.34% in 2019-20 is accounted for by 36 bps due to cyclical factors and by only 5 bps of the genuine fiscal slippage. In a year of a serious growth slow-down, such an adherence to “fiscal discipline” not only shows misplaced emphasis and unjustified concerns but also a contractionary fiscal policy. The budgeted numbers for 2020-21 also continue along the same line and depict a contractionary fiscal policy. It is pro-cyclical rather than counter-cyclical. Moreover, the proportion of revenue deficit in the fiscal deficit in the budget for 2020-21 shows a substantial increase over 2019-20 (RE) that may not help crowding-in of the private investment. Immediate growth recovery may not be aided by the Union budget 2020-21. v) The growth slowdown may, therefore, be prolonged and the real growth may remain below 7.5% of the long-term trend for the next couple of years leading the negative output gap to expand. This is consistent with the capacity utilization rate of less than 70% presently observed in the RBI surveys. Thus, there would be downward pressure on the core inflation in the next few quarters. vi) Real rates of interest and policy rates globally are very low and negative in several comparator counties. Our real rates are high. Transmission of the past rate cuts is improving of late, which would continue to provide corrections to the real rates.
64. There is a definite space for policy rate action in the light of the above arguments. The question is – is this the right time? We need to wait for the other half of the fiscal policy given by the budgets of the States. While monetary policy is important for short run revival of aggregate demand, the long-term growth revival depends critically on the fiscal policy and structural reforms. When the long run revival is not seriously attempted, any substantial recovery in the short run is also likely to be elusive and the monetary policy stimulus that works only indirectly and with lags is also likely to be less effective. Under such circumstances, I would like to continue with status quo on both the policy repo-rate and the accommodative stance. Statement by Dr. Janak Raj
65. Headline inflation surged during last three months, driven mainly by an unprecedented spike in onion prices. Non-vegetable food prices such as pulses, milk, eggs, fish and meat also rose significantly, driven mainly by a shortfall in production due to unseasonal rains and a rise in input costs. While onion prices have already started reversing due to late kharif arrivals, the reversal is likely to be more pronounced once the rabi season harvest hits mandis in early March. However, the increase in inflation in non-vegetable food items is more likely to be sustained. Given this broad-based increase in food prices, there is a lot of uncertainty as to the level at which food inflation will stabilise even as onion prices normalise completely. Food inflation, therefore, needs a careful monitoring.
66. Inflation excluding food and fuel accelerated in recent months, driven mainly by cost push shocks such as increase in mobile phone charges. Rising input costs have transmitted to output prices, though weak pricing power of corporates due to deficient demand has limited its pass-through. Global commodity prices, especially of crude oil and metals, also declined sharply towards end-January in anticipation of slowdown in global demand due to the outbreak of coronavirus. This may help mitigate some of the input price pressures witnessed in the recent period. Though inflation expectations of households have moderated in the January 2020 round of the Reserve Bank’s survey, they are still elevated. Headline inflation is projected to remain at or above 5 per cent up to Q2: 2020-21, before moderating to 3.2 per cent in Q3.
67. Domestic economic activity has remained weak with GDP growth estimated at 5.0 per cent for 2019-20 being the lowest in last 11 years. Some of the major factors that have contributed to the growth slowdown are (i) ongoing deleveraging by the private corporate sector; (ii) continuing large inventory overhang in the residential real estate market; (iii) issues facing the auto sector; (iv) decline in income levels in rural areas due to low food prices in previous two years and deceleration in the growth of wages of agriculture and non-agricultural labourers; and (v) global uncertainties, especially trade tensions. All these factors have reduced aggregate demand by impacting investment and private consumption.
68. Some high frequency indicators such as consumer non-durables, tractor sales, port freight traffic, cement production and steel consumption have turned around in recent months. The index of industrial production (IIP) expanded in November 2019 despite contraction in the auto sector as well as eight core industries. Eight core industries, with a weight of 40 per cent in the IIP, also expanded in December. These are positive signs, though more data are needed to assess whether they are sustained. Several other indicators such as sales in commercial vehicles, passenger cars and motor cycles, and international air freight traffic have continued to contract. Credit flows continue to be tepid, though they are improving.
69. Overall, demand conditions remain weak. This is reflected in a variety of indicators such as non-oil non-gold imports, capacity utilisation in the manufacturing sector much below the long-term average even when there is hardly any addition of new capacities, and weak pricing power of corporates. Consumer confidence is also low.
70. Going forward, the recent rise in food prices should boost rural incomes and help strengthen rural demand. The stress in the auto sector seems to be gradually receding. The inventory overhang in the real estate sector remains high and it will take time before it comes to normal levels. The real estate sector has huge forward and backward linkages and it is critical for reviving growth. Though global uncertainties relating to trade tensions and Brexit have abated, a new uncertainty from coronavirus has arisen. It is expected that epidemic of coronavirus will be overcome soon. However, should it prolong and spread, it will have ramifications for the global economy and its net impact on the Indian economy might be negative even if oil and other global commodity prices decline.
71. The impact of monetary easing undertaken since February 2019 continues to unfold. Monetary transmission has strengthened in recent months and it is expected to be reinforced further as existing loans are repriced at reduced interest rates.
72. While current low growth is the outcome of deficient demand, high inflation is an upshot of a supply shock. These conflicting dynamics pose a challenge for monetary policy. Weak demand conditions warrant further monetary policy easing, while elevated inflation and the highly uncertain inflation outlook call for a cautious approach. More data are needed for greater clarity. Hence, I vote for keeping the policy repo rate on hold at the current level and for persevering with the accommodative stance. There is policy space, which could be used once the inflation outlook becomes clear. In a scenario of slowdown in growth, monetary policy has a role to boost aggregate demand consistent with the inflation objective. However, for strengthening the medium-term growth potential of the economy, the need is to step up investment and improve productivity through further structural reforms. In this context, corporate tax cuts announced in September 2019 and higher budgeted capital outlay for 2020-21 compared with the previous year bode well for strengthening India’s medium-term growth potential. Statement by Dr. Michael Debabrata Patra
73. As foretold in December 2019, the MPC has entered what I call the tunnel of testing trade-offs (TTT) and it may be a while before the light at the end of the tunnel is sighted.
74. Economic activity remains weak: there are indications of the momentum of growth stabilising, with sector-specific upticks underlying this guarded optimism, but they are far from gaining economy-wide traction. In some sectors, the slowdown is deep, and activity is stalled by sizable slack in demand. High frequency indicators are not offering definitive evidence yet that the downturn is bottoming out.
75. Global growth remains subdued. What seemed to be a synchronised downturn only a few months ago, is getting decoupled across jurisdictions. Until recently, emerging economies were cushioning the loss of pace in global growth. Now these economies are confronted with a downward slant in the balance of risks either from self-inflicted wounds or global spillovers. This is currently the big cloud on the outlook for the global economy. Overall, headwinds from the global economy continue to blow strongly, darkening the prospects for all economies, including India. The coronavirus outbreak has imparted new and uncertain risks in response to which the world is grappling to fashion a credible response. The implications for India are yet to unravel.
76. As in December, a monetary policy response to the state of the economy is stifled by higher than expected elevation in inflation. The breach in the upper tolerance band of the MPC’s inflation target band in the December print may well recur in the months ahead.
77. The pre-emptive easing of monetary policy since February 2019 is now turning out to be fortuitous. Over the 12 months ahead horizon, the forecasts are indicating some let-up in inflationary pressures, but it is not yet clear as to when and how the current inflation surge will bottom. Monetary policy has headroom to respond to the evolving macroeconomic configuration, but a good fix is needed on the shape of the inflation hump it has chosen to look through. Hardening prices of proteins and pulses and a range of cost pushes to core inflation are new and ominous risks to the inflation outlook if they persist.
78. Incoming data will have to be carefully parsed for this purpose. The endeavour now should be to improve transmission of the cumulative 135 bps rate reduction effected since February 2019 and seize the opportunity when it opens up to act judiciously and effectively to support the economy.
79. It is in this context that I vote for maintaining status quo on the policy rate and to persevere with the accommodative stance of monetary policy until growth revives on a durable basis.
80. The Union Budget has proposed several initiatives to revitalize the economy within the envelope of pragmatic fiscal prudence. These are significant positives for the medium-term growth and stability outlook. Monetary policy will complement the fiscal impulse and boost it going forward. Statement by Shri Shaktikanta Das
81. Since the last policy in December 2019, economic activity has slowed down further with the GDP growth estimated to moderate to 5 per cent for 2019-20. CPI inflation surged in December to its highest reading since July 2014, driven by a spike in food inflation, an uptick in fuel inflation and firming up of inflation excluding food and fuel from its October trough. Global economic activity has also slowed down and the prospects have weakened even further with the outbreak of coronavirus as China is the second largest economy and it is a key player in global supply chain. Central banks in several advanced and emerging market economies have held their policy rates.
82. Headline CPI inflation increased for the fifth consecutive month to 7.4 per cent in December 2019 as food prices, particularly those of vegetables, surged. Inflation in vegetables shot up to 60.5 per cent in December from 36.1 per cent in November largely due to a spike in onion prices, caused by damage to kharif crop from unseasonal rains. Inflation in onion swelled to 328 per cent in December. Excluding onions, CPI inflation was at 5.2 per cent in December and excluding vegetables, inflation was at 4.1 per cent. Inflation in several other items of food such as milk, pulses, cereals, edible oils, egg, meat and fish also edged up.
83. The fuel group moved out of deflation in December with a sharp increase in LPG prices in previous two months and a pick-up in inflation in electricity and firewood and chips.
84. CPI inflation excluding food and fuel edged up to 3.8 per cent in December from 3.6 per cent in the previous month, driven by a rise in inflation in mobile charges, petroleum product prices, transportation fares and clothing. Inflation expectation of households, as polled in the Reserve Bank’s January 2020 round of survey, moderated by 60 bps and 70 bps for 3-month and 1-year ahead horizons, respectively. CPI inflation is projected at 6.5 per cent for Q4:2019-20; 5.4-5.0 per cent for H1:2020-21; and 3.2 per cent for Q3:2020-21.
85. On the growth front, the first advance estimates released by the National Statistics Office (NSO) placed India’s real GDP growth for 2019-20 at 5.0 per cent due to slowdown in private final consumption expenditure and gross fixed capital formation. GDP estimates by the NSO for 2019-20 were in line with the projection set out in the 5th bi-monthly monetary policy.
86. Some green shoots are, however, visible. First, rabi sowing has been higher by 9.5 per cent. Horticulture production has also risen to a record level in 2019-20. This bodes well for farm incomes and boosting rural demand. Second, the index of industrial production (IIP) improved in November after contracting in the previous three months and growth of eight core industries also turned positive in December after four months of contraction. PMI manufacturing increased for January 2020. Business sentiment of manufacturing firms in Q4:2019-20, measured by the Reserve Bank’s business expectations index, also improved. However, capacity utilisation (CU) in the manufacturing sector, measured by the Reserve Bank’s order books, inventory and capacity utilisation survey, deteriorated to 69.1 per cent in Q2:2019-20 from 73.6 per cent in Q1. Third, in the services sector, some high frequency indicators have turned up. Amongst indicators of rural demand, tractor sales emerged out of ten months of contraction in December. Of indicators of urban demand, domestic air passenger traffic posted double digit growth in November. PMI services also rose sharply in January 2020, underpinned by the rise in new business and output. However, durability of such green shoots will be clearer in the coming months. At the same time, some other indicators such as commercial and passenger vehicle sales, and domestic and international air cargo traffic continued to contract. Going forward, real GDP growth is projected at 6.0 per cent for 2020-21 – in the range of 5.5-6.0 per cent for H1 and 6.2 per cent for Q3.
87. As regards credit flows, non-food credit growth of scheduled commercial banks moderated to 7.1 per cent in 2019-20 (up to January 17, 2020) from 14.6 per cent last year. However, it is noteworthy that non-food credit has increased by Rs. 2.77 lakh crore since mid-September 2019 in contrast to a contraction of Rs.0.83 lakh crore between end-March and mid-September. The total flow of credit from both banks and non-banks (domestic and foreign) to the commercial sector increased from Rs. 3.11 lakh crore during the period from end-March to mid-September 2019 to Rs. 8.43 lakh crore in 2019-20 so far (up to January 17, 2020), though they have been lower as compared with the increase of Rs.15.79 lakh crore in the corresponding period of the previous year.
88. The transmission of policy rate reductions has been full across various money and bond market segments; transmission to the longer end of the government securities market, however, has been partial. Transmission to the credit market has improved in the recent period. As against the cumulative reduction in the policy repo rate by 135 bps since February 2019, the 1-year median marginal cost-based lending rate (MCLR) has declined by 55 bps; the weighted average lending rate (WALR) on fresh rupee loans by 69 bps and the WALR on outstanding rupee loans by 13 bps. The external benchmark system has strengthened monetary transmission further. During October-December 2019, the WALR of domestic banks on fresh rupee loans declined by 18 bps for housing loans, 87 bps for vehicle loans and 23 bps for loans to MSMEs. These developments should amplify the effects of policy rate reductions since February 2019.
89. The Union Budget has sought to provide counter-cyclical support to the economy while broadly adhering to fiscal prudence. Monetary transmission and bank credit flows have improved, but they need to become stronger. While the macroeconomy needs further monetary stimulus, the inflation outlook continues to be uncertain. The seasonal winter softening of vegetable prices has been delayed, even as onion prices have begun to soften. Also, the prices of several other food items such as pulses, milk and edible oils have continued to rise. While demand conditions remain weak, there is uncertainty about the likely behaviour of inflation excluding food and fuel, given the recent cost push shocks, especially of mobile charges, prices of automobiles and essential medicines. Overall, the path of headline inflation is expected to moderate, but given the prevailing uncertainty, it is prudent to await more clarity based on incoming data.
90. Considering the overall evolving growth-inflation situation, it would be prudent to continue the focus on growth in the context of the expected moderation in inflation. This would indeed be in sync with the concept of flexible inflation targeting. Financial stability also requires revival of the growth trajectory. Considering all these aspects, I vote for keeping the policy repo rate on hold and for maintaining the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target. Barring the intensification of global risks, there is policy space that needs to be timed optimally and opportunistically to maximise its impact on growth. (Yogesh Dayal) Press Release: 2019-2020/1972 Chief General Manager
6. Global economic activity has come to a near standstill as COVID-19 related lockdowns and social distancing are imposed across a widening swathe of affected countries. Expectations of a shallow recovery in 2020 from 2019’s decade low in global growth have been dashed. The outlook is now heavily contingent upon the intensity, spread and duration of the pandemic. There is a rising probability that large parts of the global economy will slip into recession.
7. Financial markets have become highly volatile from January onwards due to the outbreak of COVID-19. Panic sell-offs have resulted in wealth destruction in equity markets across advanced and emerging economies alike. In the former, flight to safety has pulled down government bond yields to record lows with some hardening in recent days. In the latter, the rush to exit has rendered fixed income markets illiquid and resulted in firming up of yields. Emerging and advanced economy currencies are experiencing severe depreciation pressure on a daily basis because of fire sales due to extreme risk aversion. At this point, only the US dollar remains safe haven in a highly uncertain outlook. Japanese yen and gold – the other two safe havens till the early part of March – have given way to a flight to cash. International crude prices initially traded with a softening bias from January in anticipation of demand weakening due to the COVID-19 outbreak. Production cut disagreements among key oil producers, however, set off retaliatory supply scale-ups and a price war that plunged international Brent crude prices to a low of US$ 25 per barrel on March 18, 2020. These developments are likely to dampen inflation across advanced and emerging economies. Central banks and governments are in war mode, responding to the situation with several conventional and unconventional measures targeted at easing financial conditions to avoid a demand collapse and to prevent financial markets from freezing up due to illiquidity. Domestic Economy
8. The second advance estimates of the National Statistics Office released in February 2020 implied real GDP growth of 4.7 per cent for Q4:2019-20 within the annual estimate of 5 per cent for the year as a whole. This is now at risk from the pandemic’s impact on the economy. High frequency indicators suggest that private final consumption expenditure has been hit hardest, even as gross fixed capital formation has been in contraction since Q2:2019-20. On the supply side, the outlook for agriculture and allied activities appears to be the only silver lining, with foodgrains output at 292 million tonnes being 2.4 per cent higher than a year ago. A pick-up in manufacturing and electricity generation pulled industrial production into positive territory in January 2020 after intermittent contraction and/or lacklustre activity over the past five months; however, more data will need to be watched to assess whether the recent uptick will endure in the face of COVID-19. Meanwhile, most service sector indicators for January and February 2020 moderated or declined. Since then anecdotal evidence suggests that several services such as trade, tourism, airlines, the hospitality sector and construction have been further adversely impacted by the pandemic. Dislocations in casual and contract labour would result in losses of activity in other sectors as well.
9. Retail inflation, measured by the consumer price index, peaked in January 2020 and fell by a full percentage point in February 2020 to 6.6 per cent, as the ebbing of onion prices brought down food inflation from double digits in the preceding two months. Price pressures, however, remain firm across protein-rich items, edible oils and pulses; but the shock to demand from COVID-19 may weaken them going forward. While fuel inflation increased sharply in February on the back of the delayed domestic adjustment to international LPG prices, the plunge in international crude prices in March may bring a measure of relief to the extent it is allowed to pass-through. CPI inflation excluding food and fuel eased in February under the weight of softer prices of transport and communication, and personal care. Households’ inflation expectations a year ahead softened by 20 bps in the March 2020 round of the Reserve Bank’s survey.
10. Domestic financial conditions have tightened considerably, with equity markets facing massive sell-offs by foreign portfolio investors (FPIs). In the bond market too, yields have risen on sustained FPI selling, while redemption pressures, drop in trading activity and generalised risk aversion have pushed up yields to elevated levels in commercial paper, corporate bond and other fixed income segments. In the forex market, the Indian rupee (INR) has been under continuous downward pressure. Under these conditions, the Reserve Bank has endeavoured to keep financial markets liquid, stable and functioning normally. Systemic liquidity surplus, as reflected in net absorptions under the LAF, averaged ₹2.86 lakh crore in March (up to March 25, 2020). In addition, the Reserve Bank undertook unconventional operations in the form of auctions of what is called ‘operation twist’ involving the simultaneous sale of short-term government securities (of ₹28,276 crore) and purchase of long-term securities (of ₹40,000 crore), cumulatively injecting a net amount of ₹11,724 crore. The Reserve Bank also conducted five long term repo auctions of 1 year and 3 years tenors of a cumulative amount of ₹1.25 lakh crore so far to inject liquidity and improve monetary transmission. It also conducted two sell-buy swap auctions to inject cumulatively US dollar liquidity into the forex market to the tune of US$ 2.71 billion on March 16 and 23. Open market purchase operations of ₹10,000 crore on March 20 and ₹15,000 crore each on March 24 and March 26 have been conducted to bolster liquidity and smoothen financial conditions.
11. In the external sector, merchandise exports expanded in February 2020 after posting six consecutive months of contraction. Import growth also moved into positive territory after eight months of continuous decline. Consequently, the trade deficit widened marginally on a year-on-year basis although it was lower than its level a month ago. On March 12, the Reserve Bank released balance of payments data which showed the current account having moved to near balance in Q3:2019-20 with a deficit of only 0.2 per cent of GDP. On the financing side, net FDI inflows at US$ 37.8 billion during April- January 2019-20 were substantially higher than a year ago. Portfolio investment recorded net outflows of US$ 5.2 billion during 2019-20 (up to March 25), down from US$ 6.6 billion a year ago. India’s foreign exchange reserves reached a level of US$ 487.2 billion on March 6, 2020 – an increase of US$ 74.4 billion over their end-March 2019 level. Outlook
12. In the sixth bi-monthly resolution of February 2020, CPI headline inflation was projected at 6.5 per cent for Q4:2019-20. The prints for January and February 2020 indicate that actual outcomes for the quarter are running 30 bps above projections, reflecting the onion price shock. Looking ahead, food prices may soften even further under the beneficial effects of the record foodgrains and horticulture production, at least till the onset of the usual summer uptick. Furthermore, the collapse in crude prices should work towards easing both fuel and core inflation pressures, depending on the level of the pass-through to retail prices. As a consequence of COVID-19, aggregate demand may weaken and ease core inflation further. Heightened volatility in financial markets could also have a bearing on inflation.
13. Turning to growth, apart from the continuing resilience of agriculture and allied activities, most other sectors of the economy will be adversely impacted by the pandemic, depending upon its intensity, spread and duration. If COVID-19 is prolonged and supply chain disruptions get accentuated, the global slowdown could deepen, with adverse implications for India. The slump in international crude prices could, however, provide some relief in the form of terms of trade gains. Downside risks to growth arise from the spread of COVID-19 and prolonged lockdowns. Upside growth impulses are expected to emanate from monetary, fiscal and other policy measures and the early containment of COVID-19.
14. The MPC is of the view that macroeconomic risks, both on the demand and supply sides, brought on by the pandemic could be severe. The need of the hour is to do whatever is necessary to shield the domestic economy from the pandemic. Central banks across the world have responded with monetary and regulatory measures – both conventional and unconventional. Governments across the world have unleashed massive fiscal measures, including targeted health services support, to protect economic activity from the impact of the virus. To mitigate the economic difficulties arising out of the virus outbreak, the Government of India has announced a comprehensive package of ₹1.70 lakh crore, covering cash transfers and food security, for vulnerable sections of society, including farmers, migrant workers, urban and rural poor, differently abled persons and women. The MPC notes that the Reserve Bank has taken several measures to inject substantial liquidity in the system. Nonetheless, the priority is to undertake strong and purposeful action in order to minimise the adverse macroeconomic impact of the pandemic. It is in this context that the MPC unanimously votes for a sizable reduction in the policy repo rate, but with some differences in the quantum of reduction. Furthermore, the MPC also notes that the Reserve Bank has decided to undertake several measures to further improve liquidity, monetary transmission and credit flows to the economy and provide relief on debt servicing. It also underscores the need for all stakeholders to fight against the pandemic. Banks and other financial institutions should do all they can to keep credit flowing to economic agents facing financial stress on account of the isolation that the virus has imposed. Market participants should work with regulators like the Reserve Bank and the Securities and Exchange Board of India (SEBI) to ensure the orderly functioning of markets in their role of price discovery and financial intermediation. Strong fiscal measures are critical to deal with the situation.
15. All members voted for a reduction in the policy repo rate and maintaining the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target.
16. Dr. Ravindra H. Dholakia, Dr. Janak Raj, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted for a 75 bps reduction in the policy repo rate. Dr. Chetan Ghate and Dr. Pami Dua voted for a 50 bps reduction in the policy repo rate.
17. The minutes of the MPC’s meeting will be published by April 13, 2020. Voting on the Resolution to reduce the policy repo rate Magnitude of policy Member Vote repo rate reduction (basis points) Dr. Chetan Ghate Yes 50 Dr. Pami Dua Yes 50 Dr. Ravindra H. Dholakia Yes 75 Dr. Janak Raj Yes 75 Dr. Michael Debabrata Patra Yes 75 Shri Shaktikanta Das Yes 75 Statement by Dr. Chetan Ghate
18. In the last review, I had said “While I don’t see space for further cuts going forward, I remain data dependent”
19. In the last six weeks, the data has turned in a significant way.
20. Because of COVID-19, acute downside risks to growth have mounted. As lockdown measures kick-in, the economic cost of COVID-19 could become large as production declines in various sectors, and there is a permanent postponement of consumption expenditure plans.
21. A large decline in global growth will also affect our exports adversely. Growth in the service sector, the largest sector in the economy, will also be affected because discretionary spending will fall. It is important to understand that consumer services – retail, hotels, restaurants etc. – are a corollary of growth. In contrast, producer services – finance, IT, Real Estate, Transportation etc. - are producers of growth and also employment. COVID-19 will impact both, slowing the momentum on the growth turnaround that had set in in the last few months.
22. Unfortunately, there is no short-cut at the current juncture apart from the lockdown.
23. What should the monetary policy strategy be in this situation? There are three considerations.
24. First, monetary policy should minimize the fall in aggregate demand, i.e., we should minimize the extent of permanent damage done to growth by the COVID-19 shock. Hence, the required cut in the policy rate should be large given the severity of the shock. What is required is in the nature of an insurance cut.
25. In a demand deficient economy, a large rate cut, however, will be akin to pushing on a string. I have been raising this concern in several previous policy reviews justifying the need for more structural reforms. This concern prevents me from voting for an even larger cut in the policy rate this time.
26. Second, what is the appropriate division of labor between monetary policy, liquidity policy, social insurance policy, and fiscal policy in stimulating aggregate demand?
27. I see the current fiscal stimulus (1.7 lakh crore which is about 0.8% of GDP, announced on March 26, 2020) more in the nature or a relief measure (social insurance) rather than a stimulus. A relief is not a permanent fix. The idea of the measure announced by the government is to weather the storm so that no one has to go without food and spending on essential items. The effect of this measure will be to lead to a small rise in consumption in the short run, but the effect will dissipate quickly.
28. On liquidity policy, a large number of measures will be announced today which include prudential and forbearance measures. A series of liquidity measures have already been enacted (Forex swaps, LTROs, operation twist, OMOs). Combined, these measures amount to a “carpet-bombing” of the financial system with liquidity and will help flatten yields in those parts of the financial system where fire-sales have pushed up credit spreads. The stabilization of financial markets will help improve economic outcomes.
29. On fiscal policy, I await details on a second stimulus package that will possibly be announced by the government. The challenge will be this: estimates of the size of the government spending multiplier internationally across a wide variety of studies, unless the economy has a lot of slack or is stuck at the zero lower bound, tend to be small, and typically smaller than one (an increase in Government spending by 100 Rs. increases GDP by less than 100 Rs.). Tax multipliers, on the other hand, tend to be larger (greater than one). This suggests that the ideal fiscal stimulus to deal with COVID-19 should be loaded on the tax side rather than the government spending side. India however has limited tax penetration. This is going to be the main design challenge.
30. Finally, what is the threat to our medium term inflation aim because of the COVID- 19 shock?
31. While it is hard to assess -- in a precise manner -- the one year ahead level of inflation given the current situation, new disinflationary forces have emerged since the last review, namely, an outsized reduction in crude because of geo-political factors, and a possible acute slowdown in growth in FY: 20-21. Inflation ex-food and fuel could also fall with lower crude prices and with an opening up of the output gap.
32. I worry though that even though vegetable inflation has fallen sharply from 50% in January 2020, it is still elevated at about 30% in February. Unseasonal rains, if any, and COVID-19 related lasting supply side disruptions in the food sector also pose an upside risk to the inflation trajectory in 2020-21. These need to be carefully watched.
33. Taking monetary policy, fiscal policy, social insurance policy, and liquidity policy together, a 50 bps cut in the policy rate is appropriate at the current juncture.
34. As noted recently by former Fed Chairman Ben Bernanke in an AER article, monetary policy has never proved able to reverse large shocks. It only helps to mitigate the worse effects of shocks, and speeds up the recovery.
35. Once the COVID-19 pandemic subsides, is there likely to be a quick return to normal? I am hopeful because production capacity has not been destroyed. However, I will watch the incoming growth-inflation data carefully, and remain data dependent.
36. I also vote to retain the stance as accommodative. Statement by Dr. Pami Dua
37. The near nationwide lockdown due to the COVID-19 outbreak has brought economic activity to almost a standstill. The global economy has also been adversely impacted by the unprecedented economic and humanitarian crisis, the severity of which will depend on the depth, duration and diffusion of the evolving pandemic.
38. Depending on the severity of the situation and the duration of the lockdown, the crisis has ramifications for domestic growth stemming from supply side disruptions, contraction in demand, slowdown in global growth and a loss in consumer confidence as well as investor sentiment. The supply chain of key industries is likely to be disrupted due to restricted access to imported raw materials. The manufacturing sector is expected to drastically slow down due to closure of factories while consumer demand and investment spending are also likely to drop sharply. The services sector is expected to be impacted the most due to restrictions on travel, transport, hospitality, tourism, and professional and financial services. Construction activity is also expected to drop. Trade is expected to take a hit due to a fall in domestic demand and contraction in global growth. Since the shock to output is global, it is unlikely that any country can act as an engine of growth to pull the world out of this situation.
39. According to the second advance estimates of the NSO released in February 2020, GDP growth print for Q3: 2019-20 was 4.7% and is expected to be 5% for the full FY 2019-20. However, this may be difficult to achieve due to the negative impact of the coronavirus disease, which gained momentum in February in the country.
40. The slowdown in economic activity poses challenges for financial stability, especially in the wake of recent development in one private sector bank. Financial conditions have also become tight, with massive sell-offs by foreign portfolio investors in the debt and equity markets. For the same reason, the Indian rupee has also come under downward pressure. However, the Reserve Bank has done well to take various steps to inject large liquidity into the system and ensure stability in the financial markets.
41. On the inflation front, the trajectory of headline CPI inflation is heading downwards, with easing of food prices in the light of record foodgrains and horticulture production. The collapse in crude oil prices and weakening aggregate demand are expected to soften inflation further.
42. Thus, depending on the depth, duration and diffusion of the crisis, the risks to economic growth on both the supply and demand sides could be significant. Fortunately, in the current scenario, inflation is expected to remain soft and does not pose as a major challenge. The top-most priority, therefore, is to minimise the negative impact of the pandemic on economic growth. This necessitates a multi-pronged approach comprising monetary, fiscal and other policy measures, as well as steps to contain the spread of COVID-19.
43. The Reserve Bank has already taken several measures to inject substantial liquidity into the system. It is also widening the existing policy rate LAF corridor to incentivize banks to use funds for lending, instead of parking them with RBI. The Reserve Bank has also decided to undertake several measures to further improve liquidity, monetary transmission and credit flows to the economy, and provide relief on debt servicing. The Government of India has also announced a comprehensive fiscal package covering cash transfers and food security for vulnerable sections of society. Fiscal policy has a major role to play in combating the economic effects of the pandemic.
44. Given the extraordinary crisis, in order to revive growth and mitigate the economic impact of COVID-19, a sizable reduction in the policy repo rate is clearly warranted. Accordingly, I vote for cutting the policy rate by 50 basis points. In the current scenario, with heightened uncertainty and a near-standstill in economic activity, this may not necessarily lead to an increase in borrowing, but should raise consumer confidence and investor sentiment, going forward. It may be better to conserve some policy space for later, when those binding constraints are removed and the economy will require a further boost to recover from the pandemic. I also vote to maintain the accommodative stance as long as necessary to revive growth. Statement by Dr. Ravindra H. Dholakia
45. These are truly exceptional times. Health hazards created by the spread of COVID- 19 all over the globe are pushing the world economy into unprecedented recession. At the time of the previous meeting of MPC in early February 2020, the Indian economy was on the path of recovery from the growth slow down. Nobody expected that COVID-19 would hit India and so many other countries so soon and potentially so devastatingly that most of the production and economic activities would come to a grinding halt. Prolonged lock-down has seriously adverse economic and social implications. These external shocks are from both the supply and demand sides. Both producers and consumers, and hence investors and savers, are losing confidence and even hope. Under such unprecedented circumstances, governments in all countries have come up with policy measures on both fiscal and monetary fronts to provide a substantial booster dose, putting aside all other concerns like inflation and fiscal discipline. In any case, going forward, CPI inflation in India four quarters ahead is most likely to be well below the targeted 4 per cent. Therefore, remaining within the mandate given by the Act, this is the right time for MPC to act decisively and for RBI to provide a major booster dose to the economy basically to restore confidence of producers, consumers, investors and savers. In my opinion, there is enough space for a major rate cut and other liquidity and regulatory measures. I, therefore, vote for a 75 bps cut to begin with in the policy repo rate and maintaining the accommodative stance. More precise reasons for my vote are as follows i) The second advance estimate of GDP growth during 2019-20 by NSO published on 28th February 2020 has to be adjusted downwards because of the sudden adverse impact of COVID-19 from March 2020. In my opinion, the Q4:2019-20 growth would be around 3.5% instead of 4.7% and hence the GDP growth for the year 2019-20 is likely to be around 4.7% instead of 5% as predicted by the NSO. Although there are significant uncertainties about the impact of the Coronavirus, based on various scenarios, it is possible to have a conservative prediction range of GDP growth for the next year (2020-21). Accordingly I believe that GDP growth in the whole year 2020-21 would be less, but not substantially less, than the one observed during the current year and may be in the range of 4% to 4.5%. The output gap would, therefore, continue to expand and exert downward pressure on the inflation ex-food and fuel. ii) Looking to the international economic prospects in view of the devastating impact of COVID-19 and the response of the oil producers, the fuel prices are likely to remain depressed in the range of $25-40. Even when we consider that the entire fall may not get transmitted to the domestic market, the inflation in petroleum product prices may show a sharp declining trend over the next four quarters. iii) Rabi crop has been a bumper crop and assuming a normal monsoon next year, food prices are expected to show a sharp declining trend over the next four quarters. iv) Thus, headline CPI inflation by Q4:2020-21 is expected to be only around 2.5%. This makes the current real policy repo rate unduly high when the most of the comparator countries have cut their real policy rates to the zero or negative territory. It is time to correct our real policy rates substantially. v) Concerns about transmission of policy rate cuts are already addressed by the policy of external bench-marking of the lending rates by banks in respect of MSME, retail and housing loans. vi) The Central Government has already started providing fiscal boost and may continue doing so to revive the economy.
46. In my opinion, MPC and RBI must complement the efforts by providing a major boost. Fortunately, both have enough space on policy rates and liquidity and regulatory forbearance aspects for such exceptional times unlike several Central Banks of the West. This is the time for RBI to: reduce the Reverse Repo Rate further by widening the corridor thereby discouraging banks to park their excess liquidity with RBI and encouraging them to get into the corporate bond market; stop the clock for 3-4 months for recognition of defaults and downgrades to reduce panic and provide support; reduce SLR substantially to overcome liquidity crunch for credit expansion and such other measures. In order to provide a major boost through MPC, I vote to cut the policy Repo Rate by 75 bps this time. There is still enough space for the policy rate cut as and when required to support growth recovery going forward since inflation is likely to be under control. Statement by Dr. Janak Raj
47. In recent weeks, there has been a drastic change in the global and domestic macroeconomic scenarios. Coronavirus (COVID-19) has crippled global supply chains and disrupted economic activity in many countries. The outbreak of coronavirus initially began as a supply shock, but it soon also became a demand shock with restrictions on travel, tourism, and cut back in non-essential spending due to lockdowns. Reflecting the severe impact that the COVID-19 is expected to have on the global economy, financial markets have been witnessing turbulence.
48. The authorities in many countries, including central banks, have unleashed conventional and unconventional measures to mitigate the adverse macroeconomic impact of the pandemic. Despite massive easing by central banks, however, global financing conditions have tightened due to a flight to safety. That there has been so much flight for safety and demand for liquidity that there has been large selling even in gold, pulling down its prices, which normally rise in an uncertain environment.
49. Since the pandemic is still spreading and its impact deepening, the estimates for downward drag on global growth are continuously being revised. However, it is now clear that global growth in 2020 is likely to be much weaker than that in 2019. As the COVID- 19 pandemic has impacted advanced and emerging economies alike due to lockdowns and impaired supply chains, there is, in fact, a serious risk that the global economy will even slip into recession in 2020. In the face of slowing down of global growth, huge global debt accumulated after the global financial crisis may also pose serious threats to global financial stability.
50. Moving on to the domestic economy, economic activity appeared to have picked up some pace as reflected in several indicators in January/February such as growth in IIP, including manufacturing; railways freight traffic; tractor sales; and credit to micro and small industries. Both exports and imports also turned positive in February. PMI manufacturing in January and PMI composite in February were at eight-year high. However, these past data have become less relevant as the near-term outlook has turned highly uncertain caused by COVID-19, the spread, strength and length of which are unknown at this stage.
51. Various segments of the financial market have become extremely volatile and trading volumes have declined, pushing yields across the spectrum of yield curve. The domestic equity market has plummeted in the face of massive sell-offs by foreign portfolio investors. On the whole, domestic financial conditions have tightened and could seriously undermine monetary transmission, which otherwise improved in the more recent period.
52. While initially it was the civil aviation, hospitality and entertainment sectors which were hit by COVID-19, now with a 21-day nation-wide lockdown, most sectors will take a hit in Q4: 2019-20 and Q1:2020-21. The number of infected cases is relatively still low in India. And with the nation-wide lockdown if the spread is contained, life could slowly start returning to normalcy and the economy could also start recovering gradually. However, growth for the year as a whole is likely to be weak for three reasons. First, discretionary spending by households is likely to be curtailed in general even though there could be some pent-up demand in some sectors. Second, external demand will remain weak, impacting our exports. Third, weak domestic and external demand is likely to cause a delay in revival of investment activity. However, the increased government spending may cushion the slowdown.
53. Inflation declined by 100 bps in February, pulled down by vegetables, especially onion. However, with a lockdown, there may be some near-term pressure on prices in many food items. Beyond near-term, food inflation is expected to moderate on arrival of the bumper rabi harvest. Fuel group inflation is likely to decline significantly with a large fall in global LPG prices. CPI inflation ex food and fuel is expected to remain soft on account of two factors: (i) a slowdown in demand; and (ii) a sharp decline in international crude oil prices, which will not only have a direct impact on petroleum product prices, but also on input prices in many industries. However, the decline in domestic pump and LPG prices will occur only to the extent the pass-through takes place. On the whole, the inflation outlook appears to have become benign. Collection of comprehensive CPI data during the period of lockdown would be challenging, which may, therefore, hamper a clearer assessment of the price situation for immediate months.
54. On the whole, it has been hard to clearly assess the macroeconomic outlook at this point of time. The COVID-19 pandemic has led to a series of a priori indistinguishable shocks – a sharp slowdown in global demand, volatility in financial markets, a sharp fall in crude oil prices, and virtual freeze of global trade and travel. All these factors have generated unforeseen volatility in several macroeconomic and financial variables – identification of which for modelling purposes is practically impossible. Furthermore, assigning probabilities on outcomes in times of infrequent but high-impact events such as the COVID-19 pandemic for projection purposes is extremely daunting.
55. To sum up, there is an unprecedented uncertainty about the exact impact COVID- 19 will have on the near-term growth outlook. Though difficult to quantify, it is clear that aggregate demand will weaken significantly in the near future, which will impact the growth prospects for the year as a whole. Therefore, the main challenge for monetary policy at this juncture is to ensure that the adverse impact of COVID-19 on domestic demand is not amplified. It is also necessary to make sure that financial markets, which have been under stress with yields hardening across the maturity spectrum, do not intensify macroeconomic risks by impairing monetary transmission and giving rise to financial stability risks. Beyond the immediate future and once the situation starts normalising, domestic demand would need to be stimulated without any loss of time. The inflation outlook has improved significantly. Keeping in view these considerations, the need of the hour is to effect a sizeable reduction in the policy rate. I, therefore, vote for reducing the policy repo rate by 75 basis points. The reduction in the policy rate together with several other liquidity enhancing measures being separately announced by the Reserve Bank should ease financing conditions and address financial stability risks. I also vote for persevering with the accommodative stance as long as necessary to revive growth and to mitigate the adverse impact of COVID-19, while ensuring that inflation remains within the target. Statement by Dr. Michael Debabrata Patra
56. The corona virus’s danse macabre is taking a catastrophic toll on human lives. Economic dislocation is severe, and markets are in turmoil. Affected nations have taken wide-ranging health services support, stabilisation and regulatory measures to ease the conduct of financial and economic activity and try to alleviate the destruction wrought by the pandemic. Global growth projections are being slashed and the world economy appears to be staring at a deep recession, but the full effects of the losses incurred are still unknown, especially as expectations that the virus outbreak would be contained in the first quarter of 2020 have been belied.
57. India has locked down and a state of siege prevails. Several types of activity have come to a standstill with social isolation, supply disruptions, demand contraction and heightened anxiety. The outlook for the economy is highly uncertain and shifts with every incoming data on the impact of the virus. Prospects for the Indian economy now hinge around how pervasive and severe COVID-19 turns out to be, and how long it lasts.
58. In these challenging circumstances, monetary policy has to assume an avant garde role. Even as it fights the corrosive impact of COVID-19 on macroeconomic and financial conditions, monetary policy has to provide confidence and assuage fear. This involves easing financing conditions for people and institutions, keeping finance flowing to all agents in the economy, ensuring that markets do not freeze up, providing the assurance that the Reserve Bank of India is at the forefront in the war against COVID-19 and will use all instruments at its command to fight the virus and mitigate its fall out. It is important, however, to emphasise that COVID-19 is a global crisis and warrants action beyond the remit of monetary policy, within the country, and across the world.
59. In my minutes in February 2020, I had stated that “the coronavirus outbreak has imparted new and uncertain risks in response to which the world is grappling to fashion a credible response.” My sense at that time was that the MPC has entered a tunnel of testing trade-offs (TTT) and it may be a while before the light at the end of the tunnel is sighted. Today, as that prognosis materialises with disturbing intensity, I believe that the MPC is being called upon to rise beyond its mandate. The MPC must show the way with the powerful decision that it wields. By doing so, it will leverage and catalyse the Reserve Bank into the battlefront role that has to be undertaken for the greater common good. It is in this context that the rate decision of the MPC has to be significant enough to reach various troubled sectors and ease their financing constraints decisively as well as transmit positive announcement effects across the economy to dispel gloom and instil confidence.
60. Accordingly, I vote for a reduction in the policy rate and for maintaining an accommodative policy stance for as long as necessary to fight COVID-19 and revive growth. What should be the size of the reduction? Inflation has peaked and will likely ease well below the target in the second half of 2020-21. In the extreme scenario in which we are, however, the easing off of inflation may occur sooner and faster. In terms of the primary mandate given to the MPC, this outlook offers the scope for taking a calculated risk on current levels of inflation – which rule above the target – and focus on the 12 months ahead forecast. By this rule, there is space for policy action that is large in size relative to its past but still keeps the policy rate positive in real terms over a one year ahead horizon so as to see off any lingering or latent inflationary pressures. Meanwhile, the output gap is widening and may become pronouncedly negative as the situation evolves. In order to address these macroeconomic challenges, ease financial conditions substantially and infuse confidence, I vote for a cut in the policy rate of 75 basis points. COVID-19 is a global danger; our defence must be collective and coordinated even with social distancing. All stakeholders must muster inner strength and determination to stay the course and fight the scourge. Statement by Shri Shaktikanta Das
61. The global macroeconomic situation has abruptly worsened in the last fortnight or so and the authorities and central banks in many countries have deployed an extensive range of targeted policy instruments to deal with the macroeconomic fallout of COVID- 19, caused by lockdowns and social distancing. The outbreak of COVID-19 has seriously dented global growth prospects. Across the world, activity has come to a near standstill. There is a rising probability of a global recession, which may be deeper than the one experienced during the global financial crisis.
62. In India also, the near-term growth outlook has deteriorated sharply: initially reflecting global spillovers and the amplification of the impact of COVID-19; and thereafter, due to the much needed efforts mounted by the Government to contain the pandemic by declaring a nationwide lockdown of 21 days up to April 14, 2020. Prior to the outbreak, some high frequency indicators such as manufacturing, railway freight traffic, exports and imports in January/February had improved after several months of contraction/deceleration. With COVID-19, however, industry and service sector activities are likely to be severely impacted and the extent of the adverse impact would depend upon the intensity, spread and duration of COVID-19. The only silver lining is likely to be agriculture, which is expected to remain resilient, with foodgrains production for 2019-20 estimated (second advance estimates or SAE) at a record 292 million tonnes – 3.8 per cent higher than the SAE for 2018-19. The setback to economic activity could be cushioned, to an extent, by the collapse in crude oil prices; but there could be certain downsides in the form of decline in remittances from oil producing countries.
63. On the inflation front, the outlook has changed drastically. The inflation print for February 2020 softened by 100 basis points to 6.6 per cent from 7.6 per cent in January. Going forward, inflation outcomes are likely to be shaped significantly by COVID-19 and the sharp fall in oil prices. Food prices may also soften further on the back of record foodgrains and horticulture production. The usual uptick that begins in summer months may remain subdued if demand conditions take longer to normalise. The weakening of domestic aggregate demand may also help to contain core inflation.
64. The Reserve Bank has been proactively managing liquidity in the system. Overall liquidity in the system continued to remain in large surplus at close to ₹3.0 lakh crore on an average per day in February and March 2020 so far. With a view to facilitating monetary transmission, the Reserve Bank conducted five long term repo operations (LTRO) between February 17 and March 18, 2020 for one-year and three-year tenors aggregating ₹1.25 lakh crore. In order to ease financial conditions, which had tightened due to a sharp drop in trading volumes and consequent illiquidity, the Reserve Bank has taken several measures to inject further substantial liquidity in the system such as (i) conducting two 6-month US$ sell/buy swap auctions on March 16 and March 23, 2020 cumulatively injecting dollar liquidity of US$ 2.71 billion; (ii) injecting ₹40,000 crore through three open market operation (OMO) purchase auctions on March 20, 24 and 26, 2020; (iii) injecting ₹77,745 crore through two fine-tuning variable rate 16-day repos on March 23 and 24, 2020; and (iv) injecting ₹11,772 crore through one fine-tuning variable rate repo auction of 12-days maturity on March 26.
65. The COVID-19 pandemic is an invisible assassin which needs to be contained quickly before it spreads and wreaks havoc on valuable human lives and the macro economy. In this scenario, it is important to ensure that finance, which is the lifeline of the economy, keeps flowing seamlessly to various sectors of the economy. It is comforting that the macroeconomic fundamentals of the Indian economy continue to be sound, especially in comparison with the conditions that prevailed in the aftermath of the global financial crisis.
66. We are living through an extraordinary time and the situation currently facing the country is unprecedented. It, therefore, becomes imperative to make all-out efforts to protect the domestic economy from the adverse impact of the pandemic. The Government has announced several measures to protect the vulnerable sections of society. The Reserve Bank is undertaking measures almost on a daily basis to provide relief and financial accommodation to various segments of the economy. The path to normalisation of activity, however, is contingent on how India’s COVID-19 epidemiological curve evolves, amidst heightened uncertainty. Growth impulses face strong headwinds from sluggish aggregate demand and disruptions in supply of labour and key inputs, including imports. The erosion of consumer confidence and investment sentiment can operate in an adverse feedback loop to worsen the growth outlook even further. In this emerging scenario, monetary policy needs to proactively arrest any deterioration in aggregate demand, and thereby create enabling conditions for businesses to normalise production and supply chains as and when the situation becomes conducive for resumption of economic activity. The space for policy action has opened up in view of the disinflationary effects of deceleration in demand under the impact of COVID-19. Weaker overall demand outlook and lower crude oil prices should keep upside risks to inflation firmly contained, even in the face of temporary supply chain disruptions and scope for opportunistic use of pricing power. Arresting risks to the growth outlook and preserving financial stability should, accordingly, receive the highest priority. Considering all these aspects, I vote for reducing the policy repo rate by a sizable 75 basis points and maintaining the accommodative stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target. The substantial rate cut, along with several other regulatory and liquidity augmenting measures being announced as a part of developmental and regulatory policies today, convey the resolve of the Reserve Bank to deal with the macroeconomic fallout of COVID- 19 pre-emptively. The Reserve Bank will continue to remain vigilant and will not hesitate to use any instrument – conventional and unconventional – to mitigate the impact of COVID-19, revive growth and preserve financial stability. (Yogesh Dayal) Press Release : 2019-2020/2207 Chief General Manager
6. Since the MPC met in March 2020, global economic activity has remained in standstill under COVID-19 related lockdowns and social distancing. Among the key advanced economies (AEs), economic activity contracted in the US, Euro area, Japan and the UK in Q1:2020. Among emerging market economies (EMEs), the Chinese economy went into a pronounced decline and data on high frequency indicators suggest that activity may have also shrunk in other EMEs such as Brazil and South Africa.
7. Global financial markets calmed after a turbulent period in March, and volatility ebbed as swift and large fiscal and monetary policy responses helped to soothe sentiment. Equity markets recovered some lost ground, while government bond yields remained range-bound, although somewhat elevated in some EMEs due to country- specific factors. Portfolio flows to EMEs revived in April and the rush to safe havens eased. With the US dollar weakening, major EME currencies, which had experienced persistent downward pressure, traded with an appreciating bias. Crude oil prices firmed up modestly as oil producing countries (OPEC plus) agreed to cut production, and prospects for revival in demand improved on expectations of imminent easing of lockdowns. Gold prices remained elevated on hedging demand. CPI inflation remained subdued across major AEs and EMEs primarily due to a collapse in oil prices and compression in demand amidst lockdowns, while food inflation picked up due to supply disruptions. Domestic Economy
8. Domestic economic activity has been impacted severely by the lockdown which has extended over the past two months. High frequency indicators point to a collapse in demand beginning March 2020 across both urban and rural segments. Electricity consumption has plunged, while both investment activity and private consumption suffered precipitous declines, as reflected in the collapse in capital goods production and the large retrenchment in the output of consumer durables and non-durables in March. High frequency indicators of service sector activity such as passenger and commercial vehicle sales, domestic air passenger traffic and foreign tourist arrivals also experienced sizable contractions in March. The only silver lining was provided by agriculture, with the summer sowing of rice, pulses and oilseeds in the country progressing well, with total area sown under the current kharif season up by 43.5 per cent so far, and the rabi harvest promising to be a bumper as reflected in record procurement.
9. Retail inflation, measured by the consumer price index, moderated for the second consecutive month in March 2020 to 5.8 per cent after peaking in January. This was mainly due to food inflation easing from double digits in December 2019 – January 2020. In April, however, supply disruptions took a toll and reversed the softening of food inflation, which surged to 8.6 per cent from 7.8 per cent in March. Prices of vegetables, cereals, milk, pulses and edible oils and sugar emerged as pressure points 1.
10. The Reserve Bank remained in pro-active liquidity management mode, expanding its array of measures, both conventional and unconventional, to augment system-level liquidity as also to channel liquidity to specific sectors facing funding constraints. Systemic liquidity remained in abundance, with average daily net absorptions under the liquidity adjustment facility (LAF) increasing to ₹5.66 lakh crore in May 2020 (up to May 20) from ₹4.75 lakh crore in April. During 2020-21 (up to May 20), ₹1,20,474 crore was injected through open market operation (OMO) purchases and ₹87,891 crore through three targeted long-term repo operation (TLTRO) auctions and one TLTRO 2.0 auction. In order to distribute liquidity more evenly across the yield curve, the Reserve Bank conducted one ‘operation twist’ auction involving the simultaneous sale and purchase of government securities for ₹10,000 crore each on April 27, 2020. Furthermore, the Reserve Bank has provided ₹22,334 crore as refinance to National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and National Housing Bank (NHB) so far (as on May 21, 2020) and ₹2,430 crore to mutual funds through a special liquidity facility (SLF) with a view to easing liquidity constraints and de-stress financial markets. Since February 6, 2020 the Reserve Bank has announced liquidity augmenting measures of ₹9.42 lakh crore (4.6 per cent of GDP).
11. Reflecting the various liquidity management measures, domestic financial conditions have eased appreciably as reflected in the narrowing of liquidity premia in various market segments. Yields on government securities, commercial paper (CP), 91-day treasury bills, certificates of deposit (CDs) and corporate bonds have softened. The weighted average lending rates on fresh rupee loans of commercial banks declined by 43 bps in March 2020 alone. Though credit growth remains muted, scheduled commercial banks’ investments in commercial paper, bonds, debentures and shares of corporate bodies in this year so far (up to May 8) increased sharply by ₹66,757 crore as against a decline of ₹8,822 crore during the same period last year. There were net inflows into various schemes of mutual funds in April in contrast to large outflows in March.
12. In the external sector, India’s merchandise trade slumped in April 2020, with exports shrinking by 60.3 per cent and imports by 58.6 per cent (y-o-y), respectively. While imports contracted in all 30 commodity groups in April, exports contracted in 28 out of 30 groups. The trade deficit narrowed in April 2020 – both sequentially and on a year-on-year basis – to its lowest level in 47 months. On the financing side, net foreign direct investment inflows picked up in March 2020 to US$ 2.9 billion from US$ 0.8 billion a year ago. In 2020-21 so far (till May 18), net foreign portfolio investment (FPI) in equities increased to US$ 1.2 billion from US$ 0.8 billion a year ago. In the debt segment, however, there were portfolio outflows of US$ 3.8 billion during the same period as compared with outflows of US$ 1.4 billion a year ago. By contrast, net All India headline CPI was not released for April 2020 in view of limited transactions in non-food items due to the lockdown; data were released only for the food and housing groups. investment under the voluntary retention route increased by US$ 0.7 billion during the same period. India’s foreign exchange reserves have increased by US$ 9.2 billion in 2020-21 so far (up to May 15) to US$ 487.0 billion – equivalent to 12 months of imports. Outlook
13. The inflation outlook is highly uncertain. As supply lines get restored in the coming months with gradual relaxations in the lockdown, the unusual spike in food inflation in April is expected to moderate. The forecast of a normal monsoon also portends well for food inflation. Given the current global demand-supply balance, international crude oil prices are likely to remain low although they may firm up from the recent depressed levels. Soft global prices of metals and other industrial raw materials are likely to keep input costs low for domestic firms. Deficient demand may hold down pressures on core inflation (excluding food and fuel), although persisting supply dislocations impart uncertainty to the near term outlook. However, volatility in financial markets could have a bearing on inflation. These factors, combined with favourable base effects, are expected to take effect and pull down headline inflation below target in Q3 and Q4 of 2020-21.
14. Turning to the growth outlook, economic activity other than agriculture is likely to remain depressed in Q1:2020-21 in view of the extended lockdown. Even though the lockdown may be lifted by end-May with some restrictions, economic activity even in Q2 may remain subdued due to social distancing measures and the temporary shortage of labour. Recovery in economic activity is expected to begin in Q3 and gain momentum in Q4 as supply lines are gradually restored to normalcy and demand gradually revives. For the year as a whole, there is still heightened uncertainty about the duration of the pandemic and how long social distancing measures are likely to remain in place and consequently, downside risks to domestic growth remain significant. On the other hand, upside impulses could be unleashed if the pandemic is contained, and social distancing measures are phased out faster.
15. The MPC is of the view that the macroeconomic impact of the pandemic is turning out to be more severe than initially anticipated, and various sectors of the economy are experiencing acute stress. The impact of the shock has been compounded by the interaction of supply disruptions and demand compression. Beyond the destruction of economic and financial activity, livelihood and health are severely affected. Even as various measures initiated by the Government and the Reserve Bank work to mitigate the adverse impact of the pandemic on the economy, it is necessary to ease financial conditions further. This will facilitate the flow of funds at affordable rates and revive animal spirits. With the inflation outlook remaining benign as lockdown-related supply disruptions are mended, the policy space to address growth concerns needs to be used now rather than later to support the economy, even while maintaining headroom to back up the revival of activity when it takes hold.
16. Accordingly, all members voted for a reduction in the policy repo rate and maintaining the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target.
17. Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Janak Raj, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted for a reduction in the policy repo rate by 40 bps, while Dr. Chetan Ghate voted for a reduction by 25 bps.
18. The minutes of the MPC’s meeting will be published by June 5, 2020. Voting on the Resolution to reduce the policy repo rate Magnitude of policy Member Vote repo rate reduction (basis points) Dr. Chetan Ghate Yes 25 Dr. Pami Dua Yes 40 Dr. Ravindra H. Dholakia Yes 40 Dr. Janak Raj Yes 40 Dr. Michael Debabrata Patra Yes 40 Shri Shaktikanta Das Yes 40 Statement by Dr. Chetan Ghate
19. Since the last review, the outlook for the economy has deteriorated further.
20. Several high frequency indicators point to dire growth outcomes in the near term. On COVID-19, we haven’t achieved the first goal, which is flattening of the curve. The “tug of war” between economic and health costs has led to some opening up of the economy. The economy needs to be opened up smartly. The risk of prematurely opening the economy is that there could be a surge in new cases. It takes time for local epidemics to grow. The main growth challenge is that the top six industrialized states produce 62% of India’s GDP. These are also the worst affected states by COVID.
21. Despite the dire growth outcomes, why have I voted for a 25 bps cut, and not a larger amount?
22. First, it is not entirely clear to me that Covid-19 constitutes a large disinflationary shock. Inflationary pressures fall with economic slack (the output gap), but rise with expected future inflation and factors related to production costs.
23. Both 3-month ahead and 1-year ahead inflationary expectations have spiked sharply (by 190 bps and 120 bps respectively) in the latest round of RBI’s survey. This spike reverses a relatively flat trajectory for inflationary expectations over the past six rounds of surveys. It also reflects a sharp rise in food inflation in recent months. In April, food inflation rose to 8.6% from 7.8% in March, and will likely remain elevated in the coming months. This is worrisome. I continue to be concerned about declining market arrivals of food commodities because of COVID related supply side bottle- necks and their inflationary impact.
24. When the economy turns to the upside, the recovery in demand will be swift. There has already been a severe dislocation in domestic and global supply chains. It will take some time to for these to get resolved, and it is therefore likely that demand will recover faster than supply.
25. Currently, core inflation (inflation excluding food and fuel) continues to remain moderate, with the April readings (not released by the CSO) likely to have been similar to the March readings, or around 4%. Lower oil prices have not been passed on to consumers at the pump because of a sharp hike in Central excise duties and increases in VAT rates on petrol and diesel across States, cancelling out any beneficial effects of lower oil prices on core inflation.
26. Second, as I mentioned in the last review, in a demand deficient economy, a large rate cut is akin to pushing on a string.
27. For rate cuts to work, banks have to lend. Despite the large number of steps taken to improve the liquidity and functioning of credit markets, as of April 24 (the most recent data available), non-food credit growth on a y-o-y basis was at 6.5% on May 8, 2020, lower than 7.2% on April 10, 2020.
28. Third, rate cuts should be seen as part other measures that have already been taken with respect to liquidity policy, social insurance policy, and fiscal policy in dealing with the crisis.
29. Since the last review, a comprehensive fiscal stimulus has been announced, amounting to about 10% of GDP. The “Keynesian component” of the stimulus, i.e., the part that increases discretionary spending via fiscal policy is however around 1% of GDP.
30. An ambitious Keynesian fiscal stimulus was always going to have to navigate between Scylla and Charybdis: if the government spent too much on the discretionary part of the stimulus, the yield curve would have gotten thrashed, banks would have booked losses, and our credit rating would have gotten a downgrade. It would have also signalled that the government is giving up on its commitment to controlling inflation. If it spent too little, it risked a worsening of growth.
31. To navigate the middle path, the government has focussed on much needed structural reforms. This is prudent. The measured approach to the stimulus recognizes the government cannot spend its way to prosperity without implications for financial instability.
32. Despite the small Keynesian component of the stimulus however, taking into account the relaxation in state government borrowing limits, the combined state-centre fiscal deficit is still likely to rise to around 10-12% of GDP in FY 21. I doubt if the bond markets will shrug this off. That means transmission to credit markets will suffer, making a large rate cut pointless. What compounds this is the rising risk aversion in the financial system will get exacerbated by a looming spike in NPAs because of the loan and mortgage holidays announced. This will hinder transmission even more.
33. Fourth, since the last review, a variety of high frequency indicators have declined sharply. There has been a broad based and deep contraction in the March IIP (Index of Industrial Production) which fell to -16.7% from 4.6% in March. Passenger vehicle sales have plummeted. Consumer non-durables have fallen by -16%. Indicators of fixed investment have tanked: finished steel consumption has declined by -90.9%, and IIP Capital goods (which proxy for machinery and equipment) have also fallen by -35.6%. PMI manufacturing declined to 27.4 in April from 51.8 in March due to a sharp contraction in output and new export orders. The services PMI dropped to 5.4 in April from 49.3 in March due to a sharp fall in business activity. Exports have also fallen drastically by -60.3%.
34. While these have no doubt resulted in a large negative output gap, it is also true that potential output has also fallen.
35. The only silver lining is the agriculture sector. The current Rabi crop has done well. And the current summer sowing of crops (for rice, pulses, coarse cereals, and oilseeds) is higher by 43.7% over last year.
36. The strongest argument for a big rate cut would therefore be the dire growth outcomes because of COVID. However, such rate cuts should be saved for when the economy starts reviving, and not when we are in a lock-down. Rate cuts, assuming that there is transmission and banks lend, works most effectively when the economy is on the upside. The MPC should keep some gunpowder dry.
37. Fifth, the reverse repo rate has been cut thrice in succession to 3.35%. The idea behind the asymmetric cuts is to use the LAF corridor as an instrument of monetary policy. For all practical purposes the reverse repo rate is now the effective policy rate. I worry that the current quantum of liquidity will be difficult to unwind when things return back to normal. RBI’s liquidity policy has helped stabilize financial markets, but lender of last resort policies, as is widely recognised, are not useful outside a crisis, and thus should not be viewed as part of normal monetary policy.
38. Given the above reasons, I vote to cut the policy rate by 25 bps this time.
39. I will continue to watch the incoming growth-inflation data carefully, and remain data dependent.
40. I also vote to retain the stance as accommodative. Statement by Dr. Pami Dua
41. The nationwide lockdown over the past two months due to the COVID-19 pandemic has severely impacted domestic economic activity, yielding a grim prognosis for the economy. This unprecedented and extraordinary economic and health crisis has also gravely affected the global economy with acute intensity and spread.
42. On the domestic inflation front, headline CPI inflation fell from 6.6 per cent in February 2020 to 5.8 per cent in March. For the month of April, only partial information has been released, providing the numbers for food inflation, which rose from 7.8 per cent in March to 8.6 per cent in April, with prices of vegetables, pulses, edible oils, milk and cereals being the prime drivers. However, low crude oil prices, soft global prices of metals and other industrial raw materials, and weakening aggregate demand are expected to soften inflation, although supply disruptions may impact inflation adversely. Overall, headline inflation is expected to ease in the second half of FY:2020-21 and fall below target. This also conforms with the May 2020 round of the Inflation Expectations Survey of Households conducted by the Reserve Bank of India that shows higher inflation expectations for the three-months-ahead forecasts compared to forecasts for the one-year-ahead horizon.
43. On the domestic output front, the evolving pandemic has had serious ramifications for domestic growth, which is crippled by a near-standstill in economic activity due to the lockdown and social distancing, leading to demand compression as well as supply disruptions. High frequency indicators of urban consumption demand – passenger vehicle sales, domestic passenger air traffic and consumer durables – fell dramatically in March 2020. A similar dismal picture emerges in indicators of rural demand – tractors sales, motorcycle sales and consumer non-durables – that plunged sharply in the same period. Indicators of fixed investment also fell, with a sharp drop in finished steel consumption in April and cement production in March, reflecting a slowdown in construction activity. Moreover, capital goods production (as per the use- based classification of IIP) declined by 36 per cent in March, along with a significant drop in capital goods imports during March and April. While the data for the March print of IIP has been compiled with limited sample due to the institution of the lockdown from March 25, the preliminary data indicates a drop in IIP by almost 17 per cent, with manufacturing falling by more than 20 per cent, infrastructure/construction goods by almost 24 per cent and electricity by 6.8 per cent.
44. The Purchasing Managers’ Index (PMI) for manufacturing declined sharply to its lowest level of 27.4 in April from 51.8 in March, partly due to contraction in output and new exports orders. The PMI for services dropped dramatically to an unprecedented level of 5.4 in April from 49.3 in March, due mainly to a drop in business activity, new business orders and new export business. High frequency indicators of the services sector, in addition to those mentioned above (passenger vehicle sales, domestic passenger air traffic), and including foreign tourist arrival, railway freight traffic, and commercial vehicle sales, contracted in March/April.
45. Fortunately, growth in agriculture has held up, with the total area under summer crops including rice, pulses, coarse cereals and oilseeds up by 43.7 per cent as on May 10, 2020 over the corresponding period of last year. Further, as per the third advance estimates of crop production for 2019-20, production of foodgrains (kharif and rabi) in 2019-20 is 3.7 per cent higher than the final estimates of the previous year.
46. The Consumer Confidence Survey conducted by RBI in May 2020 also paints a grim picture, showing that the overall Current Situation Index is at a historic low, while the Future Expectations Index reflects high pessimism for the year ahead. Thus, consumer sentiment has plunged to abysmally low levels.
47. At the global level, the global manufacturing PMI plunged to an eleven year low in April 2020, while the global services PMI sharply declined to a record low. Accordingly, India’s merchandise exports and imports witnessed record contractions, with exports falling by 60.3 per cent in April 2020, while imports dropped by 58.6 per cent.
48. The economic situation is thus extremely gloomy. While the COVID-19 pandemic is a humanitarian and health crisis, the related lockdown has precipitated a collapse in economic activity, which has come to a near standstill. Other than in the agriculture sector, economic activity may continue to remain sluggish even after the lifting of the lockdown, due to social distancing and shortage of labour as a result of the migration of workers to their native places. In fact, GDP growth in FY:2020-21 is expected to remain in negative territory, with some respite in the second half of the fiscal year. The way forward in terms of restoration of economic activity thus depends on the speed with which the pandemic is contained, how quickly the Indian economy opens up, and how soon supply disruptions are repaired and demand revives. It will also depend on the impact of the combined stimulus from fiscal, monetary, social and administrative measures that have been implemented to create conditions conducive to survival in the crisis, as well as for revival in growth. Over time, some reprioritisation in government expenditure towards health infrastructure and capital expenditure may also be desirable for promoting economic revival.
49. The Government has outlined a comprehensive package in five tranches covering, amongst other measures, rural employment creation, infrastructure creation, focus on MSME sector and creation of an enabling business environment. The package also includes relief measures for poorer sections of society and for resource constrained state governments by increasing their borrowing limits. The measures also encompass a number of major structural reforms, which are more long-term in nature.
50. The Reserve Bank of India has used conventional monetary policy measures as well as unconventional monetary policy tools that supplement the conventional measures in order to ease financial conditions and stimulate growth in the economy. It has also undertaken several measures to improve liquidity, monetary transmission and credit flows to the economy, and provide relief on debt servicing.
51. Before the COVID-19 pandemic hit the Indian economy, the policy repo rate had already been reduced by 135 basis points between February and October 2019 in response to the slowdown in economic activity. Since the advent of the pandemic, the repo rate was further cut by 75 basis points in the March MPC meeting, amounting to a total cut of 210 basis points between February 2019 and March 2020. The monetary policy transmission to lending rates of banks has improved with a 90 basis points decline in the one-year median marginal cost of funds-based lending rate (MCLR) between February 2019 and May 15, 2020. The weighted average lending rate (WALR) on fresh rupee loans declined by 114 basis points between February 2019 and March 2020 with a fall of 43 basis points in March itself.
52. Given the severity and depth of the crisis, the macroeconomic impact of the pandemic is turning out to be more severe than initially anticipated. Thus, in order to revive growth and mitigate the economic impact of COVID-19, it is important to ease financial conditions further. Accordingly, I vote for cutting the policy rate by 40 basis points. This brings the total reduction in the policy rate since the start of the spread of the COVID-19 pandemic to 115 basis points with the magnitude of cut in the easing cycle that started in February 2019, (up to May 2020) being 250 basis points. In the current scenario, with heightened uncertainty and a near-standstill in economic activity, this may not necessarily lead to an immediate increase in borrowing, but should raise consumer confidence and investor sentiment, going forward. I also vote to maintain the accommodative stance as long as necessary to revive growth, while ensuring that inflation remains within the target. Statement by Dr. Ravindra H. Dholakia
53. Continuing lockdown in the geographical areas that contribute a major share in the Indian economy and worsening global economic situation due to COVID-19 has now created a distinct possibility of the real GDP growth in India during 2020-21 to be in the negative zone for the first time in the last 40 years. Even the nominal GDP growth may slip into the negative zone. There are all symptoms of a recession – fall in aggregate demand, negative real growth and high unemployment. The government has provided a major fiscal boost through a series of announcements. The role of the monetary policy under such circumstances should be to supplement and support the fiscal efforts to bring the economy out of the unprecedented crisis. Without exhausting all the space for policy rate cuts, in this meeting I, therefore, vote for a 40 bps cut in the policy Repo Rate and maintaining the accommodative stance. More specific reasons for my vote are as follows – i) Under the lockdown, measurement of consumer inflation and a survey of household inflationary expectations are likely to quite problematic. The samples would be truncated and undesirable biases may enter the estimates making them unreliable and non-representative. Under such circumstances, I feel, the model based forecasts provide a better guide. A very carefully carried out forecasting exercise provides an estimate of headline CPI inflation around 2.8 percent for Q4 2020-21. Even accounting for uncertainties, a very conservative estimate may be taken as 3.1-3.2 percent. Thus, inflation rising above the target of 4 percent does not seem to be any concern for the policy right now. ii) Although the real policy rate in most other comparator countries is zero or negative, in India it is not only positive but relatively very high at around 1.2 to 1.6 percent. I believe that the real policy rate needs to be kept positive but not so high under the present conditions. iii) The fiscal boost given by the Central government in several instalments is likely to result in further slippage of the fiscal deficit to GDP ratio of only 150 bps. Similarly, all states together may raise their fiscal deficit to GDP ratio by about 150 bps. Thus, the impact on the combined fiscal deficit to GDP ratio may be confined to about 300 bps, which in my opinion is quite prudent under such extreme conditions. It may not be inflationary and may result in growth recovery. iv) Once the situation returns back to normal and the fiscal and monetary boost measures start generating impacts, the recovering economy in my opinion may require some further boost. It is prudent to preserve some space for the future.
54. Considering all these factors, I vote for a 40 bps reduction in the policy repo rate and maintaining the accommodative stance. Statement by Dr. Janak Raj
55. The impact of COVID-19 on economic activity has turned out to be much more acute than initially expected with the nation-wide lockdown having been extended from initial 3 weeks to 9 weeks. There is still uncertainty as to when the epidemiological curve will flatten and this will continue to cloud the macroeconomic outlook for some more time. Be that as it may, we are staring at a huge negative growth in the current quarter and overall negative growth for the year as a whole. Both demand and supply sides of the economy have collapsed. However, I believe that supplies would recover much faster than demand. This is because capacity to produce goods and services by and large remains intact, though non-availability of labour may temporarily hamper production for a few months. On the other hand, however, there has been a substantial loss of demand. A large number of daily labourers/wage earners have been rendered jobless because of lockdown. Though a part of the unemployed work force will get back to work, still there are some sectors which have been hit hard and many people working in these sectors may have lost their jobs permanently. This will adversely affect private consumption. Otherwise also, consumer confidence has been dented and consumers are likely to cut down on discretionary spending.
56. Within aggregate demand, while private consumption is likely to slowdown from the pre-COVID-19 levels, what worries me more is investment demand, which is likely to be impacted severely for a variety of reasons. First, given the collapse in demand, excess capacity is likely to be created in many sectors. This, combined with huge uncertainty about future demand, both domestic and external, is likely to hamper new investments in the private sector. Second, financing of investment activity – from own sources due to a decline in profitability or by borrowing due to weak balance sheets – will also be a challenge. Third, the focus of government spending, both by the Centre and the States, will also be on revenue expenditure than on capital expenditure. For all these reasons, investment activity, which contracted in last two quarters, is expected to be severely hit, going forward.
57. Moving on to inflation, the NSO has released data only on the food and housing groups for April 2020. Food inflation rose to 8.6 per cent in April from 7.8 per cent in March. However, these numbers need to be interpreted with a caution as the rise in food prices in April was caused by a disruption in supply lines and is transitory. The wedge between CPI inflation and WPI inflation for food in April widened sharply by more than 500 bps. While CPI food inflation increased by close to 80 bps in April, WPI inflation declined by 190 bps from 5.5 per cent to 3.6 per cent, suggesting an increase in margins at a retail level due to supply bottlenecks. Should monsoon be normal, as it has been forecast, it should also have a salutary effect on food inflation. I, therefore, feel that risks to food inflation, other than in pulses, are minimal at this stage and overall food inflation is expected to resume its downward trajectory from May/June.
58. Though the print of CPI fuel inflation was not available for April, data from oil market companies suggest that domestic LPG and kerosene plunged in April in line with a decline in global prices.
59. Finally, we also do not have core inflation (excluding food and fuel) print for April. The fall in international crude oil prices has not been passed on to domestic pump prices of petrol and diesel. Though this makes domestic pump prices vulnerable to any rise in international prices, on the current demand supply balance, oil prices are likely to remain soft. Given the collapse in domestic demand, core inflation should soften significantly from the current levels over the medium term. Input cost pressures are also likely to ease due to a sharp decline in global commodity prices. Housing inflation at less than 4 per cent during March-April was the lowest in the series. Gold prices are expected to remain firm due to a flight to safety. On the whole, however, core inflation is expected to remain benign over the next few quarters. Even though there is expected to be a V shaped recovery, the economy will still be left with a considerable slack, which will keep core inflation under check.
60. To sum up, economic activity is expected to contract in 2020-21. While supply lines are likely to be restored as lockdown is relaxed, demand would take far longer to revive to pre-COVID levels. Even as some support will be provided by government expenditure, overall consumption is likely to slow down due to a slump in private consumption. More than private consumption, however, it is investment demand which is expected to be hit hard in this uncertain environment and may be a huge drag on economic activity in the near future with attendant implications for potential growth. Therefore, concerted efforts need to be made to revive investment demand. Overall, inflation over the medium term is expected to be benign. Monetary policy has been eased significantly since February 2019 and the Government has also taken several measures, which will help mitigate deleterious impact of COVID-19 on aggregate demand. However, an unprecedented collapse in demand calls for further easing of financing conditions. With the likely contraction in economic activity and the inflation outlook remaining soft, the policy space has opened up. I, therefore, vote for reducing the policy repo rate by 40 basis points and keeping the stance accommodative as long as it is necessary to revive growth, while ensuring that inflation remains within the target. Given the long transmission lags with which monetary policy operates, it is important to create enabling financing conditions so that economic activity takes off swiftly as soon as normalcy is restored. Should the inflation trajectory turn out as expected, some more policy space may open up, going forward. For monetary policy actions to transmit fully to the credit market, it is important that banks remain well capitalised. Only banks with strong balance sheets could be expected to support lending activity as and when credit demand picks up. Statement by Dr. Michael Debabrata Patra
61. In my view, the destruction of economic activity by COVID-19 and ensuing lockdowns is much more deleterious in terms of loss of basic livelihood, economic security, health and confidence than the range of estimates/projections of GDP and other macroeconomic aggregates suggest. In India, as in the rest of the world, external trade, investment, manufacturing, services involving people – hospitality, tourism, aviation and construction – and investment have been the worst hit. Private consumption is tenuously holding on to positive territory, but spending patterns have altered drastically away from the discretionary and to the essential. The large monetary stimulus and fiscal effort are striving to put a floor under the aggregate demand. At the current juncture, the all-out effort is to maintain and sustain, with the hope that when life is secure, resources, energy and time can be marshalled to rebuild and revive.
62. In fact, my view is that the damage is so deep and extensive that India’s potential output has been pushed down, and it will take years to repair.
63. In the deliberations of the MPC, my view is that the threats to growth have to be addressed frontally and aggressively, or risk a more dire outlook.
64. Meanwhile, the prolonged lockdown has thrown supply into disarray and interrupted the easing of inflation that had gotten underway after the January 2020 peaking. Contemporaneous information suggests that the momentum in the prices of several food items, especially perishables, may be ebbing, with favourable implications for the evolution of headline inflation going forward. This suggests that the food price spike has very little persistence and dispersion (except in April 2020 when the lockdown started producing wider effects), and can be looked through for policy purposes. The sustained loss of momentum of seasonally adjusted GDP growth over eight consecutive quarters is depressing the underlying momentum of core inflation, and this is likely to continue in the near term, as aggregate demand would take time to return to pre-COVID levels.
65. Relative prices tend to adjust within the budget constraint. For setting monetary policy, however, it is the absolute level of prices and its prospective movements that matter. This warrants a careful assessment of aggregate demand. Apart from the unidirectional loss of speed in real GDP growth, monetary conditions are also reflecting the fragile state of demand. While reserve money adjusted for the first round CRR effects is expanding substantially in relation to its pace a year ago, this essentially reflects the large monetary stimulus and the public’s flight to cash – currency in circulation expanded year-on-year by 18.4 per cent up to May 22, 2020 as against 14.9 per cent a year ago. In the current milieu in which banks are depositing sizeable balances with the Reserve Bank rather than lending/investing, the money multiplier at which this reserve money expansion translates into money supply, has to be adjusted to include LAF reverse repos, which are essentially (remunerated) excess reserves. With this adjustment, the money multiplier would have effectively declined from its normal level of 5.5 to about 4.5. This is showing up in the rate of money supply which has slowed below its secular trend; in fact, the negative money gap (actual rate of money supply minus its trend rate) has widened since 2019-20, especially from the second half. Both bank credit and investments are decelerating to multi-year lows, pointing to badly dented demand and risk aversion. On the other hand, bank deposits are growing faster than a year ago, driven by a precautionary savings instinct in these times of heightened uncertainty. It is important to break this recessionary loop, shore up the erosion in confidence, incentivise banks to invest and lend, and people to spend.
66. It is this context that should condition monetary policy actions and stance. The MPC has decided to remain accommodative as long as it is necessary to revive growth and mitigate the fallout of COVID-19. In keeping with this stance, the policy rate has been reduced by 75 basis points since February 2020 when the virus outbreak assumed pandemic proportions. In the evolving configuration of growth and inflation, monetary policy can inspire confidence among households and businesses to break the vortex of public preference for deposits over spending and banks’ aversion to lend and invest. Ahead of turning to mend broken areas of activity, it is important to nurture the green shoots that have become visible – as in agriculture and allied activities – so that they take root and grow. These considerations warrant backing up past actions and stance with another decisive reduction in the policy rate while persevering with the accommodative stance. The experience of central banks has been that monetary policy acts best when it is reinforced by policy actions and stance in the same direction repetitively till the desired objectives are achieved.
67. The size of the rate reduction needs to be calibrated to the space opened up by the inflation outlook, after allowing for margins of error in these fluid and uncertain times, while keeping in mind the ramifications of the size of the rate reduction for financial stability.
68. Accordingly, I vote for a reduction in the policy rate by 40 basis points while maintaining the accommodative stance of monetary policy that has been reflected in the resolutions of the MPC in the recent period. Statement by Shri Shaktikanta Das
69. The impact of COVID-19 on the domestic economy has turned out to be far more severe than initially anticipated. Lockdowns across major economies have also severely impacted economic activity across the globe. In the April WEO, the IMF projected the global economy to contract sharply by 3.0 per cent in 2020. GDP data for Q1:2020 and more recent high frequency indicators emanating from major advanced and emerging market economies, however, suggest that the contraction in global growth could be even deeper.
70. Domestic economic activity has been impacted severely by two months of lockdown which was imposed to contain the spread of the COVID-19 pandemic and save human lives. High frequency indicators for March-April 2020 suggest a collapse of demand. Industrial output, measured by the index of industrial production (IIP) for March, which included only seven days of the nation-wide lockdown, contracted by 16.7 per cent. The contraction was spread across sectors, with manufacturing shrinking by 20.6 per cent and capital goods production by 35.6 per cent. Private consumption, which has been the bedrock of domestic demand, also plummeted with the production of consumer durables falling by 33.1 per cent in March 2020 and that of non-durables by 16.2 per cent.
71. Limited data that are available for April suggest a further shrinkage in demand. India’s merchandise trade slumped in April 2020, with exports contracting by 60.3 per cent and imports by 58.6 per cent. While railway freight traffic shrank by 35.3 per cent in April, steel consumption declined by 90.9 per cent. PMI manufacturing and PMI services in April slipped to unprecedented levels of 27.4 and 5.4 respectively.
72. Bank credit growth continues to be tepid, suggesting weak demand. Non-food credit of scheduled commercial banks (SCBs) grew by 6.5 per cent (y-o-y) as on May 8, 2020 as compared with 13.0 per cent a year ago. During 2020-21 so far (up to May 8, 2020), however, banks’ investment in commercial paper, shares, bonds and debentures increased by ₹66,757 crore as against a decline of ₹8,822 crore during the same period last year, reflecting the impact of targeted long term repo operations (TLTROs) of the Reserve Bank.
73. The only silver lining has been the agriculture sector – the summer sowing is progressing well. As on May 10, 2020, summer sowing of all crops in the country was much higher by 43.7 per cent (37.9 per cent for rice, 74.8 per cent for pulses and 29.3 per cent for oilseeds) over last year’s acreage. The harvest of rabi crop is almost complete. The forecast of normal monsoon by the India Meteorological Department (IMD) augurs well for agriculture output and farm incomes.
74. On inflation, the headline consumer price index (CPI) for April 2020 was not available on account of nationwide lockdown. Among the major groups, for which indices were released, food group inflation edged up in April 2020 (to 8.6 per cent from 7.8 per cent in the previous month) due to a broad-based increase in inflation across the food sub-groups.
75. The Reserve Bank has been proactively managing liquidity. Since the MPC statement of February 6, 2020 the Reserve Bank has announced liquidity augmenting measures of ₹9.42 lakh crore (4.6 per cent of GDP). Monetary transmission has continued to improve with the weighted average lending rate (WALR) on fresh rupee loans declining by 43 bps in March; the decrease since February 2019, when the current cycle of rate cut began, being 114 bps.
76. Looking ahead, the growth outlook has deteriorated sharply. There is still uncertainty as to when the COVID curve will flatten. Even as the supply side is expected to ease gradually as the lockdown related restrictions are phased out, it is the demand side, which will continue to weigh heavily on economic activity for some time to come. The impact of the fiscal and contingent liability measures announced by the government on demand creation needs to be carefully watched. Quick implementation of various reform measures can also inject growth impulses into the Indian economy in the medium to long term. Economic activity, however, is expected to contract in the first half of the year before recovering gradually in the second half of 2020-21 on the back of various fiscal, monetary and liquidity measures undertaken in the recent period. Overall, the GDP growth in 2020-21 is estimated to remain in negative territory. The pace of recovery will be contingent upon the containment of the pandemic and how quickly social distancing/lockdown measures are phased out.
77. It has become challenging to assess the inflation outlook in the absence of complete information on CPI. Food inflation is expected to moderate in the coming months as transport impediments and supply lines get eased. This is also corroborated by data on 22 essential commodities released by the Department of Consumer Affairs, which show that prices of several food items have declined in this month so far from the April levels. The meltdown in demand is also likely to result in a significant easing of price pressures in core goods and services. Weak demand conditions in the presence of strong favourable base effects could result in headline inflation falling below the target rate during Q3 and Q4 of 2020-21.
78. Since the last off-cycle MPC meeting on March 27, 2020 macro-financial conditions have deteriorated rapidly. The fast evolving trade-offs between growth and inflation have underscored the need for intensifying the assessment of the macroeconomic outlook, and the preparedness to act pre-emptively to address the swiftly shifting underlying economic and financial conditions and what they portend for the path going forward. Delaying timely monetary policy response by two weeks, waiting for the bi-monthly MPC meeting schedule, could be costly and irreversible. In fact, such a delay in monetary policy action could potentially become a source of risk itself to the deteriorating growth outlook. Monetary policy is a rapid deployment instrument of public policy, and monetary authorities, forewarned by prescient assessment of the prevailing macroeconomic conditions, have to be nimble. It is in this context that the scheduled second bi-monthly meeting of the MPC was advanced from June 3 to 5, 2020 to May 20 to 22, 2020.
79. As pointed out in the foregoing paragraphs, the risks to growth have become far more severe than in our assessment at the end of March 2020. It is expected that this diagnosis will be validated by hard data over the next few months, even as the overall outlook continues to be highly uncertain. The key challenge for monetary policy at this stage is to resuscitate domestic demand to avoid any harmful effect on income and employment in the short run and potential growth over the medium term. For strengthening domestic demand, it is important to revive consumer and business confidence. The Government has already announced a variety of measures to provide economic support to various sectors of the economy and protect the interests of vulnerable sections of society. The Reserve Bank has also been proactively managing liquidity to ensure that funds flow to all productive sectors of the economy. RBI has also been easing monetary policy to reduce the cost of funds/capital to revive domestic demand. While all these measures should help support demand as and when the nation-wide lockdown is lifted, but given the enormity of a collapse in demand, the need is to move ahead full throttle to ease financing conditions further so as to revive consumption and revitalize investment. Since banks are the key players in financing consumption and investment, it is also imperative that they remain adequately capitalised. The benign inflation outlook that is expected for the second half of 2020- 21, coupled with the rising probability of a sharper loss of growth momentum in the near-term, has provided us with more policy space to ease financial conditions further and stimulate growth. Since the outbreak of COVID-19, the MPC has voted for front- loading its actions. In view of the deteriorating outlook, it is critical to reinforce these actions in sync with the space provided by the underlying conditions.
80. In assessing the magnitude of policy space, it is important to take into account the weak growth momentum, the need for prioritising growth in view of the less risky inflation outlook, and the need to assure benign financial conditions ahead of the recovery taking hold so that confidence is sustained. Considering all these factors, a reduction in the policy rate by 40 basis points would be appropriate. Accordingly, I vote for reducing the policy repo rate by 40 basis points from 4.4 per cent to 4.0 per cent. I also vote for persevering with the accommodative stance of monetary policy. The RBI remains watchful and shall not hesitate to use any conventional and unconventional tool in its toolkit to revive the macro economy and preserve financial stability while adhering to the inflation target. (Yogesh Dayal) Press Release: 2019-2020/2459 Chief General Manager
6. Since the MPC met in May 2020, global economic activity has remained fragile and in retrenchment in several geographies. While the uneasy and differently-paced withdrawal of COVID-19 lockdown restrictions in some countries enabled a sequential improvement in high frequency indicators during May-July, a renewed surge in COVID-19 infections in major economies and threats of a second wave of infections appear to have weakened these early signs of revival. Contractions in economic activity have been more severe in Q2:2020 than in Q1, and the near-term outlook points to a slow, uneven and hesitant recovery pushed into the second half of the year, with risks steeply slanted to the downside. Among advanced economies (AEs), output in the US and the Euro area underwent a deeper contraction in Q2:2020 than in the preceding quarter. Emerging market economies (EMEs) are expected to shrink in Q2 as reflected in high frequency indicators.
7. Global financial markets have rebounded since end-March 2020 with intermittent pauses, shrugging off the volatility and sharp correction recorded in Q1:2020. Portfolio flows returned to EMEs in Q2 after a massive reversal, though there was moderation in July from the previous month’s level. EME currencies have also appreciated in close co-movement, tracking weakening of the US dollar. Crude oil prices have remained supported on supply cuts by oil producing countries (OPEC plus) and improved demand prospects on the gradual easing of lockdown restrictions since May. Gold prices have rallied to an all-time high on August 5 on the back of safe haven demand. In AEs, benign fuel prices and soft aggregate demand have kept inflation subdued. In many EMEs, however, cost-push pressures arising from supply disruptions and demand revival have shown up in consumer prices in June 2020. Global food prices are elevated across the board. Domestic Economy
8. On the domestic front, economic activity had started to recover from the lows of April-May following the uneven re-opening of some parts of the country in June; however, surges of fresh infections have forced re-clamping of lockdowns in several cities and states. Consequently, several high frequency indicators have levelled off.
9. The agricultural sector has emerged as a bright spot. Its prospects have strengthened on the back of good spatial and temporal progress of the south-west monsoon. The cumulative monsoon rainfall was 1 per cent below the long-period average (LPA) up to August 5, 2020. Spurred by the expanding precipitation, the total area sown under kharif crops on July 31 was 5.9 per cent higher than the normal area measured by the average over the period 2014-15 to 2018-19. As on July 30, 2020, the live storage in major reservoirs was 41 per cent of the full reservoir level (FRL), which bodes well for the rabi season. These developments have had a salutary effect on rural demand as reflected in fertiliser production and sales of tractors, motorcycles and fast-moving consumer goods.
10. The pace of contraction of industrial production, measured by the index of industrial production (IIP), moderated to (-) 34.7 per cent in May from (-) 57.6 per cent a month ago, with the easing of lockdowns in different parts of the country. All manufacturing sub-sectors, except pharmaceuticals, remained in negative territory. The output of core industries in June contracted for the fourth successive month though with a considerable moderation. The Reserve Bank’s business assessment index (BAI) for Q1:2020-21 hit its lowest mark in the survey’s history. The manufacturing PMI remained in contraction, shrinking further to 46.0 in July from 47.2 in the preceding month.
11. High frequency indicators of services sector activity for May-June indicate signs of a modest resumption of economic activity, especially in rural areas, although at levels lower than a year ago. Notably, the decline in passenger vehicle sales moderated to (-) 49.6 per cent in June from (-) 85.3 per cent in May, indicative of tentative urban demand, and faster recovery of sales in rural areas. On the other hand, domestic air passenger traffic and cargo traffic continued to post sharp contraction. Construction activity remained tepid – cement production fell and finished steel consumption moderated sharply in June. Imports of capital goods – a key indicator of investment activity – declined further in June. The services PMI continued in contractionary zone in July to 34.2, although the downturn eased relative to the May and June readings.
12. The National Statistical Office (NSO) released data on headline CPI for the month of June 2020 on July 13, 2020, along with imputed back prints of the index for April and May 2020. This resulted in a sharp upward revision of food inflation for the month of April and May. During Q1:2020-21 food inflation moderated from 10.5 per cent in April to 7.3 per cent in June 2020. Meanwhile, fuel inflation edged up as international kerosene and LPG prices firmed up. Inflation excluding food and fuel was at 5.4 per cent in June, reflecting a spike in prices across most sub-groups. Inflation in transport and communication, personal care and effects, pan-tobacco and education registered significant increases in June. Headline CPI inflation, which was at 5.8 per cent in March 2020 was placed at 6.1 per cent in the provisional estimates for June 2020.
13. For the second successive round, households’ three months ahead expectations remained above their one year ahead expectations, indicating their anticipation of lower inflation over the longer horizon. Producers’ sentiments on input prices remained muted as their salary outgoes fell. Their selling prices contracted in Q1 in the April-June round of the Reserve Bank’s industrial outlook survey. The contraction in output prices is also corroborated by firms participating in the manufacturing PMI survey.
14. Domestic financial conditions have eased substantially and systemic liquidity remains in large surplus, due to the conventional and unconventional measures by the Reserve Bank since February 2020. Cumulatively, these measures assured liquidity of the order of ₹9.57 lakh crore or 4.7 per cent of GDP. Reflecting these developments, reserve money (RM) increased by 15.4 per cent on a year-on-year basis (as on July 31, 2020), driven by a surge in currency demand (23.1 per cent). Growth in money supply (M3), however, was contained at 12.4 per cent as on July 17, 2020. Average daily net absorptions under the liquidity adjustment facility (LAF) moderated from ₹5.3 lakh crore in May 2020 to ₹4.1 lakh crore in June as government spending slowed. In July, average daily net absorptions under the LAF moderated further to ₹4.0 lakh crore, as government spending remained subdued. During 2020-21 (up to July 31), ₹1,24,154 crore was injected through open market operation (OMO) purchases. In order to distribute liquidity more evenly across the term structure and improve transmission, the Reserve Bank conducted ‘operation twist’ auctions involving the simultaneous sale and purchase of government securities for ₹10,000 crore on July 2, 2020. Furthermore, the utilisation of refinance provided by the Reserve Bank to the National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and the National Housing Bank (NHB) increased to ₹34,566 crore on July 31, 2020 from ₹22,334 crore during the May policy.
15. The transmission to bank lending rates has improved further, with the weighted average lending rate (WALR) on fresh rupee loans declining by 91 bps during March-June 2020. The spreads of 3-year AAA rated corporate bonds over G-Secs of similar maturity declined from 276 bps on March 26, 2020 to 50 bps by end-July 2020. Even for the lowest investment grade bonds (BBB-), spreads have come down by 125 bps by end-July 2020. Lower borrowing costs have led to record primary issuance of corporate bonds of ₹2.1 lakh crore in the first quarter of 2020-21.
16. India’s merchandise exports contracted for the fourth successive month in June 2020, although the pace of fall moderated on improving shipments of agriculture and pharmaceutical products. Imports fell sharply in June in a broad-based manner, reflecting weak domestic demand and low international crude oil prices. The merchandise trade balance recorded a surplus in June (US$ 0.8 billion), after a gap of over 18 years. The current account balance turned into a marginal surplus of 0.1 per cent of GDP in Q4 of 2019-20 as against a deficit of 0.7 per cent a year ago. On the financing side, net foreign direct investment moderated to US$ 4.4 billion in April-May 2020 from US$ 7.2 billion a year ago. In 2020-21 (till July 31), net foreign portfolio investment (FPI) in equities at US$ 5.3 billion was higher than US$ 1.2 billion a year ago. In the debt segment, however, there were outflows of US$ 4.4 billion during the same period as against inflows of US$ 2.0 billion a year ago. Net investment under the voluntary retention route increased by US$ 0.9 billion during the same period. India’s foreign exchange reserves have increased by US$ 56.8 billion in 2020-21 so far (up to July 31) to US$ 534.6 billion – equivalent to 13.4 months of imports. Outlook
17. Supply chain disruptions on account of COVID-19 persist, with implications for both food and non-food prices. A more favourable food inflation outlook may emerge as the bumper rabi harvest eases prices of cereals, especially if open market sales and public distribution offtake are expanded on the back of significantly higher procurement. The relatively moderate increases in minimum support prices (MSP) for the kharif crops and monsoon are also supportive of benign inflation prospects. Nonetheless, upside risks to food prices remain. The abatement of price pressure in key vegetables is delayed and remains contingent upon normalisation of supplies. Protein based food items could also emerge as a pressure point, given the tight demand-supply balance in the case of pulses. The inflation outlook of non-food categories is, however, fraught with uncertainty. Higher domestic taxes on petroleum products have resulted in elevated domestic pump prices and will impart broad- based cost-push pressures going forward. Volatility in financial markets and rising asset prices also pose upside risks to the outlook. Taking into consideration all these factors, headline inflation may remain elevated in Q2:2020-21, but may moderate in H2:2020-21 aided by large favourable base effects.
18. Turning to the growth outlook, the recovery in the rural economy is expected to be robust, buoyed by the progress in kharif sowing. Manufacturing firms responding to the Reserve Bank’s industrial outlook survey expect domestic demand to recover gradually from Q2 and to sustain through Q1:2021-22. On the other hand, consumer confidence turned more pessimistic in July relative to the preceding round of the Reserve Bank’s survey. External demand is expected to remain anaemic under the weight of the global recession and contraction in global trade. Taking into consideration the above factors, real GDP growth in Q2-Q4 is expected to evolve along the lines noted in the May resolution. For the year 2020- 21, as a whole, real GDP growth is expected to be negative. An early containment of the COVID-19 pandemic may impart an upside to the outlook. A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks.
19. The June release of headline inflation after a gap of two months and imputed prints of the CPI for April-May have added uncertainty to the inflation outlook. The NSO has adopted best practices in producing these imputations for the purpose of business continuity in the face of challenges to data collection due to the nation-wide lockdown. The NSO has, however, not provided inflation rates for April and May. For the purpose of monetary formulation and conduct, therefore, the MPC is of the view that CPI prints for April and May can be regarded as a break in the CPI series.
20. The MPC noted that the economy is experiencing unprecedented stress in an austere global environment. Extreme uncertainty characterises the outlook, which is heavily contingent upon the intensity, spread and duration of the pandemic – particularly the heightened risks associated with a second wave of infections – and the discovery of the vaccine. In these conditions, supporting the recovery of the economy assumes primacy in the conduct of monetary policy. In pursuit of this objective, the stance of monetary policy remains accommodative as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy. While space for further monetary policy action in support of this stance is available, it is important to use it judiciously and opportunistically to maximise the beneficial effects for underlying economic activity.
21. At the same time, the MPC is conscious that its primary mandate is to achieve the medium-term target for CPI inflation of 4 per cent within a band of +/- 2 per cent. It also recognises that the headline CPI prints of April-May, 2020 require more clarity. At the current juncture, the inflation objective itself is further obscured by (a) the spike in food prices because of floods in eastern India and ongoing lockdown related disruptions; and (b) cost- push pressures in the form of high taxes on petroleum products, hikes in telecom charges, rising raw material costs reflected in upward revisions in steel prices and rise in gold prices on safe haven demand. Given the uncertainty surrounding the inflation outlook and taking into consideration the extremely weak state of the economy in the midst of an unprecedented shock from the ongoing pandemic, it is prudent to pause and remain watchful of incoming data as to how the outlook unravels.
22. Meanwhile, the cumulative reduction of 250 basis points since February 2019 is working its way through the economy, lowering interest rates in money, bond and credit markets, and narrowing down spreads. Financing conditions have eased considerably, enabling financial flows via financial markets, especially at a time when banks remain highly risk averse. Accordingly, the MPC decides to stay on hold with regard to the policy rate and remain watchful for a durable reduction in inflation to use the available space to support the revival of the economy.
23. All members of the MPC – Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted for keeping the policy repo rate unchanged and continue with the accommodative stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
24. The minutes of the MPC’s meeting will be published by August 20, 2020. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Chetan Ghate Yes Dr. Pami Dua Yes Dr. Ravindra H. Dholakia Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Chetan Ghate
25. Since the last review, the economy has seen a gradual rebound in economic activity. This is largely mechanical, as much of the lockdown in the economy is being undone as policy constraints on the supply side are removed.
26. Average CPI headline inflation has been above the target range’s upper bound (6 per cent) for the last 6 months (6.7 per cent between January – March 2020, 6.5 per cent between April-June 2020). While the NSO’s imputed estimates for April-May 2020 inflation require more clarity, it is clear that just looking at CPI headline inflation in March 2020 (5.8 per cent) and June (6.1 per cent) means that the trend is upwards. Inflation excluding food and fuel (i.e., core inflation) also rose to 5.4 per cent in June. Higher price momentum in most sub-groups of core inflation saw some increase in May and June suggesting that core inflation remains high and sticky.
27. On the other hand, after the April peak, food price momentum has subsided, which has largely been driven by the decline in cumulative momentum in vegetables. This however needs to be carefully watched. Both 3-month and 1-year ahead inflationary expectations increased marginally by 10 basis points to 10.4 per cent and 10.5 per cent respectively. The “levelling-off” of inflationary expectations from a steady increase since March 2020 is comforting.
28. The prospect of an “inflation whipsaw”, a phrase used by Markus Brunnermeir at Princeton, is probably the right way to look at inflation going forward, i.e., there are different inflation/deflation pressures that need to be watched carefully. On the upside, a perfect storm of cost push pressures, accommodative monetary policy, and adverse food supply shocks could lead to a pickup in inflation. On the downside, the paradox of thrift, i.e., forced saving pressure induced by a “de-facto” lock-down, could be a potent disinflationary force.
29. In terms of output losses, my assessment is that the worst is almost surely behind us (notwithstanding second waves of the pandemic etc.).
30. Economic crosscurrents however make it difficult to diagnose precisely the underlying damage because of the virus over the next year.
31. Real GDP growth in Q4 FY 20 based on provisional estimates produced by the NSO is now pegged at 3.1 per cent. This is the weakest print in the new data series that started in 2012-2013. The complete year FY20 real GDP growth is 4.2 per cent, which is also the weakest in the series. Netting out government expenditure’s contribution in Q4 FY20, private demand growth remains anaemic. Consumption growth, for instance, in FY 20 was 5.3 per cent compared to 7.2 per cent in FY 18-19 and 8.1 per cent in FY 16-17. In FY 21, these numbers will be compounded by idiosyncratic shocks to particular sectors because of Covid (aviation, tourism) where the policy response has not been adequate.
32. Credit growth continues to remain muted despite large rate cuts. I worry that a negative credit supply shock to the MSME sector may lead to a “credit-gap”, i.e., a reduction in the supply of credit to small firms, leading to small businesses to shift towards higher cost providers of credit. This will have a bearing on growth. Some of these issues have begun to be addressed in amendments to the recently announced ECLGS scheme by the government. I worry though that if credit continues to be expensive, these firms will become less capital intensive over time, leading to a lower marginal product of labour. The long run equilibrium for the economy will involve a negative impact on wages, and therefore demand.
33. Some high frequency indicators however have begun to turn in June. To name a few, the Index of Industrial Production (IIP), PMI services, PMI manufacturing, electricity output, some rural demand indicators like tractor sales, and GST collections have retreated from their earlier lows in April-May. A tentative global recovery is also happening. The distribution of rainfall has overall been positive. Monetary transmission has also improved. This is crucial given the close connection between sovereign yields and funding conditions in the economy. For instance, between March-July 2020, the policy repo rate was cut by 115 bps. The WALR for fresh rupee loans during this period declined by 91 bps. Despite this I worry though that given that there is a lot of uncertainty on the investment side, the option value of waiting will be big, which will delay the onset of investment spending.
34. There are other risks due to Covid that pose downside risks to growth in the medium run.
35. For instance, Covid is simultaneously a negative demand and a negative supply shock. Macro policy broadly must ensure that a temporary Covid type shock to the Indian economy does not become permanent. Economists call this hysteresis. In a post-Covid world, as Olivier Blanchard notes, hysteresis will be driven by human behaviour. Despite the economy opening up, people will still hesitate to go out and spend. This will limit the effects of unlocking the economy.
36. I continue to maintain that the major brunt of future fiscal stimuli should be tilted towards social insurance payments and on the taxation side, where the multipliers are larger. It is important to recognize that fiscal multipliers depend on country characteristics. They are smaller in countries with flexible exchange rate regimes, open to trade, and with high levels of public debt. India has all three. Fiscal multipliers may be larger at the zero lower bound, but India is not there yet. Prices are also more flexible in developing countries like India because of the presence of a large informal sector. This weakens the transmission of fiscal policy from financial markets to the real economy. Fiscal stimulus design will have to keep these factors in mind, and will have a strong bearing on the type of cyclical recovery that the economy experiences. Economic policy is a potent tool for equilibrium selection at the current juncture.
37. This should be a crisis that is not wasted. The government must continue to focus on much needed structural reforms. Some fiscal space should be reserved for later outbreaks.
38. Given the above reasons, it would be opportune to wait and watch to see how the growth-inflation numbers pan out over the next few months. I therefore vote to pause. I also vote to retain the stance as accommodative.
39. I should mention that I have been advocating a more cautious path for policy rate reductions since February 2019. However, I have been in a minority in the MPC. Inflation has now been above the upper band of 6 per cent for a number of months. Notwithstanding large rate cuts to spur growth over the last year and a half, growth has steadily declined despite 250 bps in cuts since February 2019. Future MPCs should not go soft on inflation. Going forward, monetary (and fiscal) policy will be needed to be used wisely with a clear understanding of what and what not they can achieve in terms of controlling inflation, smoothening out the business cycle, and limiting spurious economic volatility.
40. I have been contributing to the setting of monetary policy since February 2013 (first on the TAC, and now on the MPC). I want to thank the Reserve Bank of India and the Government of India for giving me this opportunity. Statement by Dr. Pami Dua
41. Since the last policy meeting, CPI headline inflation prints have been released for three months – April, May and June – of which the numbers for April and May are imputed. The provisional data for June shows headline inflation of 6.1 per cent compared to 5.8 per cent in March. Food inflation moderated somewhat from 7.8 per cent in March to 7.3 per cent in June, while rising in the interim to 10.5 per cent and 8.4 per cent in April and May, respectively. Fuel inflation rose slightly from 1.6 per cent in May to 2.7 per cent in June, reflecting the increase in international LPG and kerosene prices, although it was lower than the March level of 6.6 per cent. CPI inflation excluding food and fuel rose from 3.9 per cent in March to 5.4 per cent in June, portraying the increase in inflation in transport and communication, personal care and effects, pan-tobacco and education.
42. Going forward, a bumper rabi (winter) crop and a moderate increase in minimum support prices for the kharif crops, along with overall demand compression augur well for inflation. At the same time, however, upside risks to inflation include pressure on vegetable prices, continued supply chain disruptions, high taxes on petroleum products resulting in cost- push pressures, uncertainty regarding price changes in non-food categories, rising asset prices and volatility in financial markets. The headline print is expected to remain elevated in Q2:2020-21 and then moderate in the second half of FY: 2020-21 due to favourable base effects. This conforms with both the May and July 2020 rounds of the Inflation Expectations Survey of Households conducted by the Reserve Bank of India that show higher inflation expectations for the three-months-ahead forecasts compared to forecasts for the one-year- ahead horizon.
43. On the domestic output front, some signs of recovery were visible in June following the partial unlocking of some parts of the country. The ensuing increase in the number of new cases of COVID-19, however, forced the restitution of localised lockdowns, restraining growth in some high frequency indicators. Some indicators of urban consumption demand – passenger vehicle sales, domestic passenger air traffic and consumer durables – picked up slightly but continued to remain in deep contraction. On the other hand, some signs of recovery were evident in high frequency indicators of rural demand – tractor sales, motorcycle sales and production of consumer non-durables. High frequency indicators of investment demand remained weak, including consumption of finished steel, import of capital goods and capital goods production (as per the use-based classification of IIP), although the year-on-year contraction in cement production eased considerably in June. Contraction in IIP, year-on-year, moderated to (-) 34.7 per cent in May 2020 from (-) 57.6 per cent in the previous month due to the easing of lockdowns. Within manufacturing, only pharmaceuticals witnessed positive growth.
44. The Purchasing Managers’ Index (PMI) for manufacturing continued in the contraction zone, dropping to 46.0 in July from 47.2 in the preceding month. The PMI for services also continued in the contractionary zone while edging up to 34.2 in July, although contracting much less than in April and May. High frequency indicators of the services sector under construction and trade, hotels and transport – steel consumption, cement production, passenger vehicle sales, domestic passenger air traffic, railway freight traffic and commercial vehicle sales – contracted in June. Within financial and professional services, non-food credit growth remained muted.
45. Fortunately, growth in agriculture has held up, with the total area under summer crops (kharif) including rice, pulses, coarse cereals, oilseeds, cotton and sugarcane, up by 13.9 per cent as on July 31, 2020 over the corresponding period of last year and by 5.9 per cent over the normal area (5 years average).
46. The Consumer Confidence Survey conducted by RBI in July 2020 shows that the overall Current Situation Index is at a historic low, while the Future Expectations Index reflects some optimism for the year ahead.
47. On the external front, the pace of contraction of India’s exports growth slowed down in June to (-) 12.4 per cent from (-) 43 per cent during March to May. Imports growth, however, dropped by (-) 47.6 per cent in June.
48. At the global level, the global manufacturing PMI and the global services PMI increased to 50.3 and 50.5, respectively, in July, and moved back to the expansion zone.
49. The prognosis for the economic situation is thus highly uncertain. There are some signs of revival, but the restoration of economic activity depends on how soon supply disruptions are repaired and demand revives. This depends, amongst other factors, on the severity of the evolving pandemic in terms of its depth, duration and diffusion and the control of infections, as well as the development of a vaccine.
50. Clearly, it is important to revive the economy and mitigate the impact of the COVID-19 pandemic, in line with the objective of monetary policy – to maintain price stability while keeping in mind the objective of growth. It is thus prudent to continue with the accommodative stance of monetary policy. At the same time, the mandate of the MPC is to achieve the target of CPI inflation (combined) of 4 per cent with the upper tolerance limit of 6 per cent and the lower tolerance bound of 2 per cent.
51. In its attempts to revive the economy, the MPC has already front loaded cuts in the policy rate. In fact, before the COVID-19 pandemic hit the Indian economy, the policy repo rate was reduced by 135 basis points between February and October 2019 in response to the slowdown in economic activity. Since the outbreak of the pandemic, the repo rate was further cut by 75 basis points in the March MPC meeting and 40 basis points in the May meeting, amounting to a total cut of 250 basis points between February 2019 and May 2020 and 115 basis points between March and May 2020. The monetary policy transmission to lending rates of banks has also improved, with a 91 basis points decline in the weighted average lending rate (WALR) on fresh rupee loans between March and June 2020. However, at the present juncture, the outlook for inflation is also uncertain, with risks more on the upside. Some clarity is also required with respect to the imputation of the April and May prints. In this context, CPI inflation data for at least two or three more months will be crucial for clearly gauging the impact of supply side disruptions and demand conditions on prices.
52. Considering the above factors, at this juncture, it is best to adopt a wait and watch strategy and look forward to incoming data to assess the evolving macroeconomic situation. I therefore vote to keep the policy rate unchanged and to continue with an accommodative stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target, going forward. Statement by Dr. Ravindra H. Dholakia
53. After the last MPC meeting in May 2020, changes in the economic environment were along the expected lines except the official announcement about the headline CPI and implicit inflation numbers during April, May and June. These high inflation prints coupled with the apprehensions about GDP growth likely to be negative both in real terms and nominal terms would imply that the economy is not caught up in recession with deflation but in a deep stagflation, which occurs when the adverse supply shock is more severe than the demand shock. Under such circumstances, expansionary aggregate demand policies – both monetary and fiscal – would result first in fueling inflation further rather than output and employment expansion and growth recovery, which is expected under recession with deflation. I have strong reservations in accepting the implicit inflation numbers for April and May announced by the NSO. I would, therefore, like to wait and watch for more reliable and realistic estimates of the headline inflation before taking any decision on the policy rate. I vote for status quo both on the policy repo rate and the stance. More specific reasons for my vote are as follows – i) Price quotations collected for various items from the designated shops by NSO to measure inflation could not be collected during April and May because of the nation- wide lockdown. Even for June, the sample was not satisfactory to prepare the estimates for different states. Instead of leaving the gap in the CPI series, the NSO decided to impute the CPI values for April and May as suggested by the business continuity guidelines issued by a group of six international agencies that resulted in the implicit headline inflation of 7.2 percent for April and 6.3 percent for May from 5.8 percent for March. On the other hand, inflation based on the CPI for Industrial Workers released by the Labour Bureau (that has a very high degree of correlation with CPI-C prepared by NSO) for the months of March, April and May are respectively 5.50, 5.45 and 5.10 percent. Similarly, WPI – the index used to measure inflation in India till 2014 – based inflation rates for March, April and May are respectively 0.42, (-)1.57 and (-)3.21 percent. Thus, the imputed CPI and inflation rates implied by them do not seem to be consistent with the alternative measures not only in terms of the magnitude but also in the direction of change. ii) Moreover, I have been expressing serious concerns over the mismeasurement of inflation in our country (see The Report of the Sixth Central Pay Commission, 2008; and my article in Economic and Political Weekly, Nov.17, 2018) by the fixed base- weighted index with limited number of consumption items instead of the chain-base weighted index method followed in the developed countries. In an extreme situation created by the nation-wide lockdown for months, the consumption pattern in the country has significantly and substantially changed. This would simply not be reflected in the measurement of our headline inflation based on the fixed base-weighted index even if all price quotations were available; and would provide an unrealistic measurement of inflation. iii) Imputation of the headline inflation numbers ignoring all such limitations when used in forecasting models and policy simulation exercises may misrepresent and provide misleading signals. It is, therefore, prudent to ignore them and wait for more reliable measurements and estimates. iv) The household survey rounds for inflationary expectations carried out in May and July 2020 provide very interesting results. When the standard errors are considered, there was no statistically significant difference between May and July rounds of the survey in the three months ahead and one year ahead inflationary expectation of households. Similarly, in the July round of the survey, there is no statistically significant difference between the current perception of inflation and one year ahead inflationary expectations of the households, though the difference between three months ahead inflationary expectations and the current perception of inflation is statistically significant. This suggests that the (urban) households expect faster recovery of aggregate demand over the aggregate supply in the short run, but expect the supply to recover faster in the long run reducing the inflationary pressures. v) On the other hand, the RBI’s industrial outlook survey shows that manufacturing firms expect domestic demand to recover gradually from Q2:2020-21 and sustain through Q1:2021-22. Producers expected their input prices and costs to remain low and their selling prices actually contracted during April-June 2020. Similarly, the consumer confidence survey conducted by RBI also does not paint any optimistic picture.
54. Thus, there are high uncertainties and some contradictory evidences about the characterization of the current and future macroeconomic environment. I am sceptical about the deep stagflationary conditions prevailing in the country. Although the present circumstances are truly exceptional, the primary mandate given to MPC for inflation targeting at 4 percent with the upper tolerance limit of 6 percent has to be respected. In fact, the confusion and uncertainty created by the imputed CPI-C and implied inflation estimates needs to be cleared by more of regular readings on inflation rates. Since the transmission of the policy rate cuts to the money, bond and credit markets has been commendable but not complete, there is no harm in taking a pause at this juncture. In my view, the available space for policy rate should now be used prudently and opportunistically to optimize the impact on the economic recovery. Hence, I vote for a status quo on the policy stance and rate. Statement by Dr. Mridul K. Saggar
55. For purposes of transparent communication, it will be useful to explicitly recognise that monetary policy is being framed under considerable uncertainty at the current juncture. The depth of the gorge created by the unprecedentedly deep pandemic shock is difficult to measure. The underlying data is populated from incomplete and less reliable information due to missing data, larger sampling and non-sampling errors. Unusual revisions are likely down the line. Forecast uncertainty is compounded by the future course the pandemic might take. With medical solutions yet to be found, it is difficult to anticipate the output loss that might occur from further waves of infections even as path to normalisation has begun.
56. Growth estimates for 2020-21 are difficult to arrive at the current juncture, but there could be a downward bias to the present consensus estimates when the final data becomes available. Inflation, on the other hand, may have an upward bias. The recovery path is inextricably linked to the course the pandemic might take and complete normalisation will be difficult till pandemic is overcome. High frequency indicators of real activity show that contractions have turned smaller in May and still smaller in June as activity recovers from the severe lockdown in April. Recovery in GST, including through E-way bills, railway freight, port cargo, cement production and petroleum consumption has been particularly encouraging. However, with the notable exceptions of electricity and tractors, all other indicators remained in red in June with levels at least 15 per cent below that in February. Vehicle registrations, railway and airline passenger traffic remain abysmally low in face of travel restrictions. Anecdotal evidence from industry sources suggest that activity levels might improve only marginally in July. This signals that it may be hard to recover the last 10 per cent of the production given that the Covid-19 curve has not flattened yet. The disruption caused by it will leave hysteresis, implying some permanent damage to potential output even after pandemic recedes, although speedy policy action has contained this impairment. In these circumstances, the MPC has been rightfully mindful of growth as well within the flexible inflation targeting framework. It has taken actions with a view to prevent output collapse that could otherwise have had lasting impact.
57. Inflation statistics in the pandemic period have elements of fuzziness. Statistical authorities had to resort to imputation method in face of lockdown and had not released the headline inflation for the month of April and May. Item-level data is also not available for March-June. However, the June data shows that inflation is above the upper tolerance level when the markets coverage in price statistics had improved to 88 per cent of the usual coverage, up from 52 per cent in April. Quotations coverage could be relatively lower. It is not clear if the full coverage would have made a difference to the headline number. However, the best judgment that I can exercise with available information is that non-monetary factors may have led the headline inflation persisting above the acceptable band for most of the months since December, but monetary factors may also be contributing to the elevated inflation. Ex-food and fuel, inflation was at 5.4 per cent in June. However, this core component itself has been driven high by certain elements that may not be contributing to true inflation. For instance, gold that enters into personal care and effects segment may have contributed about 34 bps to the headline inflation if one were to proximate it by gold prices in the market. Ex-food, fuel and estimated gold, inflation was likely in the vicinity of 5.1 per cent. Consumption of gold had dropped but the CPI index is driven by Laspeyres or base-year consumption weights and not Paasche or current consumption weights. The bias on this count, however, could be non-material as high food inflation may have been accompanied by higher current consumption of food in the overall basket.
58. The question relevant for the policy is how long food inflation might stay high and are we seeing signs of generalisation. Food inflation should soften as food stock levels are well above norms, monsoon is shaping normal, reservoir levels are reasonable and kharif sowing has been brisk. However, the drivers of food inflation include protein-rich food sub-groups and as is evident from retail price data from the Department of Consumer Affairs, also tomatoes and potato. Price rise in protein-rich items has significant demand component. Moreover, rise in food prices, even though predominantly caused by supply disruption, runs the risks of generalisation to keep headline inflation higher than is being anticipated. The incipient signs of generalisation have also been aided by higher excise and VAT on petro- products. Higher diesel prices have implications for transportation costs. Risks to inflation arise from price stickiness and supply chain disruptions, high costs of rebuilding or modifying supply chains and less than competitive markets under lockdowns, translating into higher retail margins. As such, it remains to be seen how much inflation falls later in the year due to demand destruction, base effects and improved agriculture supplies.
59. In my view, with considerable policy rate reduction effected since February 2019 and liquidity and credit easing getting frontloaded since March 2020, a breather is necessary awaiting greater clarity. The transmission of rate cuts has picked up in the preceding quarter. Liquidity infusions have reduced financial market spreads on corporate paper of various tenors and credit quality, especially of corporate bonds whose issuance has risen. During July, the All-India financial institutions and Housing Finance Companies have been able to raise money through Commercial Papers at a weighted average rate below the reverse repo rate and corporates and NBFCs at below repo rate. Further rate reductions may come in the way of smoothening of interest rate movements unless durable reduction in path of inflation materialises. While markets and fundamentals seldom do a tango, a disconnect between the two carry the risks of disruptive market corrections. Policy needs to be mindful of the space that may be needed to deal with possibility of increased stress that may resurface later with loan defaults and recognition of bad loans. Impact of fiscal actions and space also need to be closely observed for demand management. Growth is at risk over the medium term if we sacrifice macro-financial stability for short-run expediency. Moreover, there is sound rationale that monetary policymakers should do less under uncertainty. While pausing, it is best to retain the accommodative stance as long as the baseline suggests that inflation will soften to well within the tolerance band keeping in view the need to avoid frequent directional changes even as policy remains data dependent. Also, confidence levels are currently fragile and monetary transmission of earlier rate reduction is still in pipeline.
60. Considering all of above, I vote for leaving the policy rate unchanged and maintaining accommodative stance as communicated in the resolution, that emphasises need for continued support to growth, while remaining watchful for a durable reduction in inflation to use the available space so as to ensure that inflation remains within the target going forward. Statement by Dr. Michael Debabrata Patra
61. From the time of the outbreak of the pandemic, the setting of monetary policy by the monetary policy committee (MPC) has involved the assignment of a more than proportionate weight to growth relative to inflation. The severe contractions in various sectors of the economy in the first half of 2020-21 so far vindicate this weighting scheme.
62. Disappointingly, however, inflation surprises of recent months are undermining the MPC’s actions and stymieing its resolve to do what it takes to revive growth and mitigate the impact of COVID-19 on the economy. The unanticipated concoction of imputations of the consumer price index (CPI) for April and May 2020, supply disruptions and unrelenting cost push interventions in price formation that have reared up outside the ambit of monetary policy has complicated its conduct, especially as the inflation levitation seems to show persistence.
63. Amidst the high uncertainty characterising the near-term outlook, two outcomes are possible, drawing from precedents alone. There can be a good outcome based on the 2016-17 experience when a combination of delayed market arrivals and risk-minimising supply management caused food inflation – which had risen to 8.0 per cent in July of that year – to fall off a cliff in the next month (August) itself. For the year as a whole, headline inflation averaged 4.5 per cent in spite of some hysteresis in core inflation. There can also be a bad outcome as in 2009-10 when, awash with stimulus, a build-up of domestic inflationary pressures and inflation expectations occurred on the back of surging food prices in the backdrop of a failed monsoon, and it spilled over into other components. Monetary policy action was delayed on the ground of nurturing nascent growth impulses; inflation became generalised and 13 consecutive policy rate increases could not excoriate inflation’s pernicious hold. The 2009 experience has striking similarities with what confronts us today. There is one important difference though – in 2009-10, India rebounded out of the global financial crisis and its real GDP growth was strong at close to 8 per cent. In 2020-21, India’s real GDP is widely expected to record its deepest contraction in history. There is also an important lesson from the 2009-10 experience – in India, food prices are the ‘true core’ of inflation dynamics. They can and do get persistent and generalised into wider macroeconomic instability.
64. At the current juncture, with inflation prints above the upper tolerance band, technical considerations under the monetary policy framework warrant a pre-occupation with dealing with the conditions of failure. All this, after a period of four years of uninterrupted success in keeping inflation well within the tolerance band and in fact, closely aligned with the target, which has earned the country credibility in monetary policy conduct, investor confidence and the anchoring of expectations! Consequently, monetary policy is forced into a standstill even when there is space available to persevere with its commitment to reinvigorate growth momentum and alleviate the effects of COVID-19. In fact, if inflation persists above the upper tolerance band for one more quarter, monetary policy will be constrained by mandate to undertake remedial action, including an immediate and more than proportionate response to head off the build-up of inflation pressures and prevent it from getting generalised. The question is: can the economy withstand it in this virus-ravaged, debilitated state? The MPC has already signalled its concern in its stance by resolving to ensure that inflation remains within the target going forward. It has also expressed the unanimous view that for the purpose of monetary formulation and conduct, CPI prints for April and May can be regarded as a break in the CPI series.
65. The outlook is grim; even when it improves, the expectation is one of slow, hesitant recovery, with the situation likely to worsen before it gets better. The upticks that easing of lockdowns yield are likely to be ephemeral and vulnerable to flattening out due to lack of underlying vigour. A durable revival of the economy depends on sustained policy support to resuscitate activity in various sectors, restore employment and livelihood to the displaced and dispossessed, continue to assure health support and pursuit of the vaccine, ease financial stresses facing households, businesses and financial intermediaries, instil confidence and anchor financial stability before it slips away. This underscores the urgency of unshackling monetary policy from extraneous non-pandemic constraints, emerging out of inadequate and lagged reactions in terms of supply management. In the absence of this coordinated strategy, monetary policy will be left with no option but to adhere to its primary mandate of the MPC, which is after all, achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.
66. At this juncture, therefore, I vote for status quo on the policy rate. I reiterate that, abstracting from the exogenous shocks to inflation mentioned earlier, the state of the economy warrants that the MPC should continue to maintain its accommodative stance, while ensuring that inflation returns to the target. Statement by Shri Shaktikanta Das
67. The outlook for the domestic economy remains extremely uncertain as the impact of COVID-19 is more severe than initial assessments and the global economy remains vulnerable to renewed surge in community infections and fears of a second wave. While the US and the Euro area registered record-setting contraction in output in Q2:2020, the emerging market economies (EMEs) also look set to see large declines in output. Even as high frequency indicators suggest some momentum in July, the near-term outlook remains uninspiring with large downside risks. In this backdrop, relatively buoyant global financial markets demonstrate not just a disconnect with underlying economic fundamentals, but also portend financial stability risks, particularly for EMEs.
68. Recent data releases on sale of automobiles (wholesale), electricity generation and issuance of e-way bills indicated that a moderate recovery was taking place in the domestic economy. Indicators relating to investment like cement and steel production saw some moderation in the pace of contraction to 6.9 percent and 33.8 percent, respectively, in June as compared to the previous two months (cement contracted by 21.4 per cent in May and 85.3 per cent in April, while steel contracted by 43.1 per cent in May and 78.7 per cent in April). Lately, however, it is seen that the nascent signs of recovery in June following the gradual resumption of activity in the country, have again slumped after a renewed spate of infections forced re-imposition of lockdowns in several states and cities. The agriculture sector remains a beacon of hope. The progress of the south-west monsoon in terms of wider coverage and intensity along with the significant increase in the total area sown under kharif crops augur well for the rural economy as reflected in fertiliser production and sales of tractors, motorcycles and fast-moving consumer goods. Robust agricultural production would not only have a salutary impact on rural demand but also should help easing of the inflationary pressure from food prices, going ahead.
69. The July 13, 2020 NSO press release on CPI, which published the imputed headline CPI index for April and May along with the provisional headline inflation number for June, brought about a significant change in assessment of the inflation trajectory for Q1:2020-21 and added uncertainty to the inflation outlook. Though the NSO has adopted best practices in imputing CPI for the months of April and May, the CPI prints for April and May obscure a realistic assessment of the inflationary momentum and can be regarded as a break in the CPI series for monetary policy formulation.
70. Imputed food inflation for April-May 2020 showed a sharp upward revision compared to earlier releases. The June 2020 CPI showed food inflation remaining at an elevated level. While vegetables inflation moderated, inflationary pressures in protein-based food items and cereals got entrenched. Further, price inflation in spices and oils and fats which was already elevated pre-lockdown, remained in double digits. Moreover, imputed CPI excluding food and fuel inflation during April-May surged by 90-100 bps from March readings. They were seen to accentuate further in June due to inflationary pressures in pan, tobacco and intoxicants, transportation and communication and personal care and effects sub-groups, among others. Consequently, headline inflation remained above 6 per cent in June. Inflation expectation of households, as polled in the Reserve Bank’s July 2020 round of survey, rose marginally by 10 bps for 3-month and 1-year ahead horizons. One year ahead expectations were, however, lower than the 3-month ahead expectations, suggesting lower inflation expectations over the longer horizon.
71. In the recent months, the major drivers of inflation have been supply-chain disruptions resulting from localised lockdown; increase in excise duty and VAT on petroleum products; price pressures in protein rich items and vegetables; and impact of statistical imputations. Looking ahead, headline inflation is expected to remain elevated in Q2:2020-21 due to inflationary pressures in both food as well as core inflation. Near-term price pressures in CPI excluding food and fuel continue due to cost-push factors and lock-down related production and supply-chain disruptions, even as aggregate demand conditions register sharp contraction in the post COVID-19 scenario.
72. The generalised inflationary pressures across food and CPI excluding food and fuel, in a situation where growth is expected to contract sharply, is a matter of serious concern. The survey-based measures of slack in the economy testify that there is little risk to inflation from demand side. Given that supply disruptions and bottlenecks in the post-COVID environment are key factors in engendering these inflationary impulses, the containment of it calls for proactive sector-specific supply-side measures. In case of edible oils this would entail augmenting imports to meet domestic shortfall and rationalisation of import duties. For pulses also, imports may have to be continued to the extent of domestic supply shortfall. Further, if open market sales and public distribution offtake of cereals are expanded on the back of significantly higher procurement, it would help in easing of cereal price pressures during the latter part of the year. As the economy recovers, some rebalancing of the duty structure on petroleum products can ease some of the cost-push pressures on the economy. Such timely policy intervention to ameliorate supply side concerns along with prospects of a normal monsoon and large favourable base effects could result in moderation in inflation during H2:2020-21.
73. Regarding growth outlook, the rural economy is expected to be robust while industrial and services activity may recover gradually. The recovery out of current slowdown, which is mainly conditioned by supply disruptions and compression of consumption demand especially on non-essential goods and services, would depend on the containment of Covid pandemic and unlocking of economic activities. Rural indicators led by good monsoon, higher kharif sowing and Government-led initiatives to provide employment in the rural areas have shown sharp revival which, if sustained, can provide support to demand going forward. High frequency indicators, however, suggest that private consumption which is the mainstay of aggregate demand remains subdued. Certain crucial sectors such as tourism, hospitality and entertainment will take some time to recover. Consumer confidence, as captured from the Reserve Bank’s July 2020 survey, is low; however, one year ahead expectations have improved and indicate some optimism. External demand is expected to remain frail. Manufacturing firms responding to the Reserve Bank’s industrial outlook survey, however, expect domestic demand to recover gradually from Q2:2020-21 and to sustain through Q1:2021-22. Low capacity utilisation amid subdued domestic and external demand is likely to delay early revival of investment demand. In view of the above, real GDP is likely to shrink in the first half of the year, and growth for the full year 2020-21 is estimated to be negative.
74. In an environment of extreme stress and uncertain outlook, the Reserve Bank’s proactive management of liquidity through both conventional and unconventional measures undertaken since February 2020 have cumulatively infused liquidity to the extent of ₹9.57 lakh crore (4.7 per cent of GDP) and have alleviated stress on the domestic financial conditions. Comfortable liquidity conditions, in turn, have helped improve monetary transmission in consonance with the MPC's accommodative stance and actions and borrowing costs in financial markets have plummeted to their lowest levels in a decade. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 162 basis points during February 2019-June 2020, of which 91 basis points transmission was witnessed during March-June 2020.
75. As I have been reiterating since October 2019, monetary policy is geared towards supporting the economic recovery process. Although there is headroom for further monetary policy action, at this juncture it is important to keep our arsenal dry and use it judiciously. I also feel that we should wait for some more time for the cumulative 250 basis points reduction in policy rate since February 2019 to seep into the financial system and further reduce interest rates and spreads. Given the uncertain inflation outlook, we have to remain watchful to see that the momentum in inflation does not get entrenched, which is also dependent on effective supply-side measures. As the economy continues to be in a fragile state, recovery in growth assumes primacy. It would be prudent at this stage to wait for a firmer assessment of the outlook for growth and inflation as the staggered opening of the economy progresses, supply bottlenecks ease and the price reporting pattern stabilises. Considering all these aspects, I vote for a pause on the policy rate at this moment while continuing with the accommodative stance. (Yogesh Dayal) Press Release: 2020-2021/214 Chief General Manager
6. Incoming data point to a recovery in global economic activity in Q3 of 2020 in sequential terms, although downside risks have risen with the renewed surge in infections in many countries. Global trade is expected to be subdued. The rebound could turn out to be stronger among advanced economies (AEs) than in emerging market economies (EMEs). Global financial markets remain supported by highly accommodative monetary and liquidity conditions. Soft fuel prices and weak aggregate demand have kept inflation below target in AEs, although in some EMEs, supply disruptions have imparted upward price pressures. Domestic Economy
7. On the domestic front, high frequency indicators suggest that economic activity is stabilising in Q2:2020-21 after the 23.9 per cent year-on-year (y-o-y) decline in real GDP in Q1 (April-June). Cushioned by government spending and rural demand, manufacturing – especially consumer non-durables – and some categories of services, such as passenger vehicles and railway freight, have gradually recovered in Q2. The outlook for agriculture is robust. With merchandise exports slowly catching up to pre-COVID levels and some moderation in the pace of contraction of imports, the trade deficit widened marginally sequentially in Q2.
8. Headline CPI inflation increased to 6.7 per cent during July-August 2020 as pressures accentuated across food, fuel and core constituents on account of supply disruptions, higher margins and taxes. One year ahead inflation expectations of households suggest some softening in inflation from three months ahead levels. Selling prices of firms remain muted, reflecting the weak demand conditions.
9. Domestic financial conditions have eased substantially, with systemic liquidity remaining in large surplus. Reserve money increased by 13.5 per cent on a year-on- year basis (as on October 2, 2020), driven by a surge in currency demand (21.5 per cent). Growth in money supply (M3), however, was contained at 12.2 per cent as on September 25, 2020. Banks’ non-food credit growth remains subdued. India’s foreign exchange reserves stood at US$ 545.6 billion on October 2, 2020. Outlook
10. Turning to the outlook for inflation, kharif sowing portends well for food prices. Pressures on prices of key vegetables like tomatoes, onions and potatoes should also ebb by Q3 with kharif arrivals. On the other hand, prices of pulses and oilseeds are likely to remain firm due to elevated import duties. International crude oil prices have traded with a softening bias in September on a weak demand outlook, but domestic pump prices may remain elevated in the absence of any roll back of taxes. Pricing power of firms remains weak in the face of subdued demand. COVID-19-related supply disruptions, including labour shortages and high transportation costs, could continue to impose cost-push pressures, but these risks are getting mitigated by progressive easing of lockdowns and removal of restrictions on inter-state movements. Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q2:2020-21, at 5.4-4.5 per cent for H2:2020-21 and 4.3 per cent for Q1:2021-22, with risks broadly balanced (Chart 1).
11. Turning to the growth outlook, the recovery in the rural economy is expected to strengthen further, while the turnaround in urban demand is likely to be lagged in view of social distancing norms and the elevated number of COVID-19 infections. While the contact-intensive services sector will take time to regain pre-COVID levels, manufacturing firms expect capacity utilisation to recover in Q3:2020-21 and activity to gain some traction from Q4 onwards. Both private investment and exports are likely to be subdued, especially as external demand is still anaemic. Taking into consideration the above factors and the uncertain COVID-19 trajectory, real GDP growth in 2020-21 is expected to be negative at (-)9.5 per cent, with risks tilted to the downside: (-)9.8 per cent in Q2:2020-21; (-)5.6 per cent in Q3; and 0.5 per cent in Q4. Real GDP growth for Q1:2021-22 is placed at 20.6 per cent (Chart 2).
12. The MPC is of the view that revival of the economy from an unprecedented COVID-19 pandemic assumes the highest priority in the conduct of monetary policy. While inflation has been above the tolerance band for several months, the MPC judges that the underlying factors are essentially supply shocks which should dissipate over the ensuing months as the economy unlocks, supply chains are restored, and activity normalises. Accordingly, they can be looked through at this juncture while setting the stance of monetary policy. Taking into account all these factors, the MPC decides to maintain status quo on the policy rate in this meeting and await the easing of inflationary pressures to use the space available for supporting growth further.
13. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted for keeping the policy repo rate unchanged and continue with the accommodative stance as long as necessary 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. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to continue with this accommodative stance at least during the current financial year and into the next financial year, with Prof. Jayanth R. Varma voting against this formulation.
14. The minutes of the MPC’s meeting will be published by October 23, 2020. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
15. 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.
16. The policy rates were left unchanged in the meeting of the MPC held on August 4-6, 2020 after a cumulative reduction of 115 basis points in rates between January and May 2020 in view of the prevailing modest GDP growth rate. The MPC policy statement of August 2020 reflected the concerns on the economic outlook as the COVID-19 pandemic began to take its toll.
17. The contraction in GDP in Q1: 2020-21, year-on-year basis, by 23.9 per cent, is a severe shock to the economy affecting employment and income. The decline in economic output is reflected in both production and expenditure accounts across most components. The Gross Value Added declined in all the non-farm sectors and in the case of demand, contraction in Private Final Consumption Expenditure and Gross Fixed Capital Formation was sharp. The only major component of demand that showed growth was Government Final Consumption Expenditure. Both exports and imports of goods and services declined, with imports declining more than the decline in exports. In the wake of COVID-19 pandemic, the extensive restrictions on the movement of goods and services barring the essential needs, imposed from the last week of March-May saw gradual relaxation from June onwards but a full economic recovery will require adjustments in the production and supply processes to control the spread of the disease. The recovery process will also be affected by the dynamic of the pandemic across the country as regional variations would also affect supply chains.
18. The present status of the impact of the pandemic suggests that there has been reduction in the daily new cases and mortalities due to COVID-19 towards the end of September but these numbers are large and the potential for an increase cannot be ignored. This would mean that relaxation of movement restrictions would help restore production, but the process would be gradual and subject to the measures that would be taken by the producers, providers of services and the consumers to control the spread of the virus.
19. Restoration of the supply side of the economy in a manner that is safe for the workers and the consumers is necessary for sustained economic recovery. There will be a need for changes in transportation and work places to mitigate the risks associated with the transmission of Covid 19.
20. The relative immunity of agriculture from the supply shocks may have been partly a result of the fact that the virus spread initially in urban areas and there were immediate efforts to limit the spread. The supply chains for the key food commodities were also exempted from transport restrictions, leading to sustenance of supply of these commodities.
21. There are indeed constraints that need to be addressed to restore the health of the firms that have lost revenues and returns. Access to credit to revive and expand production and markets is one of the essential factors in this regard. Bank lending rates to the productive sectors including housing have declined and a robust revival, however, would depend on the revival of demand. The weak demand conditions are also reflected in the decline in non-food bank credit upto September in 2020-21 over the previous year. Revival of consumer demand would require restoration of confidence in the safety in participation in normal economic activities and availability of health care. Public investment in improving infrastructure to achieve these goals would help build consumer confidence.
22. The current account balance, foreign capital flows and forex reserves position indicate relative stability in the external sector under a low demand equilibrium in both domestic and global markets. The depressed investment demand conditions are also reflected in the dampened state of demand for capital and weak growth in bank credit to non-food sector.
23. The fiscal position of the governments - both Centre and the States - is under pressure as the tax revenues have declined. The governments will be required to maintain their spending levels to meet the extraordinary demands to support livelihoods and lives in the present conditions.
24. Continued weakness in demand conditions would put greater stress on fiscal position and also the financial system.
25. The broad indicators of economic activity in the recent months suggest a revival from the sharp decline in Q1. Some of this improvement is on account of relaxation of movement restrictions, opportunities in sectors such as the pharma industry, and the requirement of critical inputs such as fertilisers. The more general pickup in activities is reflected in the expectation of improvement in capacity utilisation and perceptions of improved demand conditions in the recent surveys of enterprises reported by RBI.
26. 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. As indicated in the MPC Resolution, the GDP growth is expected to be positive in Q4: 2020-21, although for the year as a whole, the growth rate is projected to be -9.5 per cent over the previous year. The Survey of Professional Forecasters conducted by RBI in September 2020 yields a median forecast of -9.1 per cent for the year 2020-21 and an assessment by NCAER’s Quarterly Review of the Economy places the GDP growth for 2020-21 at -12.6 per cent. Going forward into Q2 to Q4: 2020-21 these projections imply recovery in the economic activities from the large initial negative shock in Q1.
27. On the price front, the CPI inflation has stayed above 6.5%, Y-o-Y basis during July-August 2020. This is above the tolerance band of the inflation target set for the monetary policy. The food inflation averaged 8.4% during the same period and CPI based inflation rate for items excluding food and fuel was 5.6%. The food inflation will remain a concern as it is often driven by the perishable produce like vegetables, which cannot be controlled in the short term except by removing bottlenecks in the supply chain upto the retail level or additional fresh supplies. As noted in MPC Resolution, inflation is expected to moderate in Q3 and Q4: 2020-21. Two of the main drivers of price inflation on the supply side now are food and fuel. In the case of food, the favourable monsoon rains support the prospects of good harvest and its moderating impact on food inflation. The global conditions for crude petroleum prices appear stable from here onwards till the end of 2020-21.
28. There are clearly uncertainties facing the growth and inflation projections. There is also uncertainty over the speed with which the Covid-19 pandemic is brought under control, which also affects growth and inflation scenarios in the next 2-3 quarters. Towards the end of Q2, there are indications of revival of the economy after the relaxation of restrictions on transportation and businesses across the country. As supply chains adapt to the new conditions, recovery is expected to be stronger and sustained. To achieve this outcome, an accommodative monetary policy is needed at this juncture. Moderation in upward cost pressures on prices and decline in food inflation rates would require a quick output recovery from the supply side measures.
29. The outlook for growth and inflation for the next 3-4 quarters suggests the need for a policy environment enabling recovery of output. The inflationary pressures are a concern but present assessment reflects moderating inflationary pressures in the remaining quarters of the year.
30. Therefore, I vote for retaining the current policy rates and continuation of accommodative stance of monetary policy as long as necessary 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. I also vote to continue with this accommodative stance at least during the current financial year and into the next financial year. Statement by Dr. Ashima Goyal
31. The MPC’s objectives are to meet its medium-run inflation target while supporting growth. Growth has fallen steeply while inflation is also above target. The question of what can revive growth as well as reduce inflation is best examined in the context of India’s macroeconomic structure.
32. COVID-19 led to crash in demand as well as disrupted domestic supply chains. As, under gradual unlocks, the latter revive while infections reduce, the supply-side is recovering. The heavy rains raised food prices but also promise a bountiful crop. Over the longer term, structural food surpluses, agricultural reforms and global changes in oil demand and supply can be expected to keep commodity prices soft. Reform is also reducing obstacles that raise production costs in India. Therefore, inflation can be expected to moderate. Research shows commodity price shocks and credible RBI guidance to be major determinants of inflation expectations.
33. India’s many youthful entrants to the labour force as well as migration to higher productivity jobs suggest it has an elastic supply curve but it is one that is subject to upward shocks 1. Apart from supply-side features that raise costs, shocks include inflation expectations and changes in exchange rates. Moderating these shocks is the most effective way to reduce inflation in India.
34. Monetary-financial conditions have a relatively greater impact on aggregate demand and output growth while the composition of government expenditure and taxation affects costs. 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. Necessary reforms over the last decade have improved the credit culture, governance, diversity and robustness in the financial system and conditions are ripe for a turnaround. COVID-19 creates an opportunity for a reversal of tight financial conditions2.
35. COVID-19 also creates uncertainty and precautionary hoarding of liquidity and savings. Therefore demand is now a greater constraint than supply. That inflation exceeds the MPC target when demand has crashed much below potential output suggests lockdown related shocks have pushed up the supply curve. This should reverse as lockdowns ease. That CPI inflation is much higher than WPI for the same items points to issues in retail supply. The CPI itself needs to be rebased to more accurately reflect the lower share of food in the consumption basket. Since the output gap is already so large, reducing demand and increasing the gap further cannot be the way to reduce inflation. Firms do tend to raise mark-ups to cover fixed costs when capacity utilization falls but reducing utilization further will only raise costs more.
36. 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. Fiscal deficits have risen countercyclically as tax revenues fell with the lockdowns. Even so, there is scope for further prudent expansion of government spending to boost demand and trigger private spending to raise growth. The expenditure should ideally be designed to relieve supply-side constraints. The ex-post fiscal deficit ratio falls as growth raises the denominator and rising tax revenues reduce the numerator.
37. Financing short-term rise in deficits requires keeping the cost of government borrowing low. Central banks worldwide are taking such actions. The monetary policy resolution committing to benign financial conditions for as long as it takes for revival will help both public and private borrowing and spending. Active and innovative steps, including counter-cyclical macro-prudential regulation, can improve incentives for appropriate action, allay fears, reduce risk aversion, make liquidity more widely available, improve transmission and bring down interest rate spreads.
38. Mitigating the impact of the unprecedented global health crisis has priority. It is important, however, there is neither over-reaction nor untimely reversal. Excess See Goyal, A. 2017. ‘Macroeconomic Policy for an India in Transition’, Economic and Political Weekly, 52(47): 31-37. Available at https://www.epw.in/journal/2017/47/perspectives/macroeconomic-policy-india-transition. html See Goyal, A. 2020. ‘Post Covid-19: Recovering and Sustaining India’s growth’. Indian Economic Review. Online publication: August 6. DOI: https://doi.org/10.1007/s41775-020-00089-z. 2020. stimulus after the global financial crisis resulted in excess tightening in the decade that followed. Policy should aim for balance and use available space when it would be most effective. Forward-looking actions are aiming to be state-contingent, carefully calibrated to the evolving situation and to incoming data. Early measures required during the lockdown have been successfully reversed. For example, moratoria given have ended without major adverse impacts on borrowers or the financial system. Banks now do risk-based lending and the credit guarantee from the government allows private banks also to lend to MSMEs. Targeted restructuring and freer movement of liquidity through the economy will help firms survive, so that persistent damage is avoided and the economy recovers faster.
39. Inflation is at present above the target band although it is expected to come down. Therefore no change in the policy rate itself is appropriate while awaiting the impacts of on-going supply-side improvement, as well as for uncertainty around COVID-19 to dissipate. I therefore vote to keep the policy repo rate unchanged and also 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, mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. The accommodative stance and the benign financial conditions it makes possible, together with the assurance it will not be reversed until the economy recovers, will support growth. The repo rate pause together with inflation guidance given will contribute to anchoring inflation expectations. Statement by Prof. Jayanth R. Varma
40. I have agonized a great deal about dissenting (in part) with a resolution on a narrow technicality when I am in agreement with the spirit of the resolution: am I making a mountain out of a molehill and creating unnecessary confusion? After prolonged deliberation, I have come to the conclusion that a dissent may be painful, but it is more consistent with the obligation of MPC members to express their views independently and candidly. Even when a disagreement is more philosophical than operative, it should not always be relegated to the individual statement; I see some merit in occasionally elevating it to a dissent.
41. My preferred formulation of the forward guidance would have been as follows: “The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. The MPC expects to maintain a low policy rate and an accommodative stance during the current financial year and well into the next financial year.”
42. It differs from the actual MPC resolution in two respects. First, in my formulation, the date based forward guidance is not a decision but an expectation. In a world that is full of unpleasant surprises, the MPC must of necessity be data driven. Covid-19 was an example of a totally unanticipated growth shock that came out of nowhere. If a similarly unforeseeable inflation shock were to hit the economy, I find it hard to believe that the MPC will remain accommodative. In practice, I suspect that the word “decided” only means an intention to remain accommodative as long as realized outcomes do not diverge drastically from what is currently expected. 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.
43. Second, my formulation is for a somewhat longer period and explicitly refers to interest rates. In my view, the principal motivation for the forward guidance is the fact that India has one of the steepest yield curves in the world. The Indian yield curve is extremely steep beyond a maturity of about a year: in the short term segment (1-2 years), the intermediate term segment (2-5 years) and the long term segment (5-10 years). However, in the money market segment (up to a maturity of nearly one year), the yield curve is close to the reverse repo rate of 3.35% (which is the effective policy rate today because of the liquidity support). 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.
44. One of the hallmarks of a credible inflation targeting regime is a substantial compression of the inflation risk premium. If the market expects inflation to average close to the target rate of inflation, then, by definition, inflation risk is low and consequently the inflation risk premium should also be very small. What remains is essentially the liquidity risk premium which cannot explain the extraordinary steepness of the Indian yield curve.
45. It appears to me that the steep yield curve reflects a lack of credibility of the MPC’s existing accommodative guidance. The introduction of dated guidance in the MPC resolution is an attempt to solve this problem, and my only difficulty with this solution is the word “decided”. Just as the brakes allow the car to travel faster, the MPC’s guidance will be more effective if it works alongside and not in conflict with its inflation fighting resolve. I prefer the word “expected” because it would preserve the commitment of the MPC to respond aggressively to inflation shocks that lie well above the upper band of the fan chart (Chart 1 of the Monetary Policy Statement).
46. I believe that excessively high long term rates are inflicting damage to the economy in two ways. First, a significant part of the easing of policy rates is not being transmitted to longer term rates that form the benchmark for corporate borrowing and investment decisions. Excessive long term rates exacerbate the collapse of investments in the economy. Second, high long term rates cause an appreciation of the real effective exchange rate by stimulating foreign capital inflows into our bond markets at a time when the collapse of investment has caused the current account to swing into surplus.
47. A sharp reduction in long term rates is therefore important. On the other hand, with short term rates already at 3.35%, the incremental benefits of a furthering lowering of this rate in the current macroeconomic environment are relatively low and not commensurate with the risks. So I support maintaining the policy rate at its current level. I also support the accommodative stance and liquidity support that drive short term rates towards the reverse repo rate rather than the repo rate. Statement by Dr. Mridul K. Saggar
48. At the time of the August MPC, while noting that monetary policy was being framed under large data and forecast uncertainties, I had also indicated that growth could fall more and, inflation less, than the consensus estimates that prevailed at that point. Market consensus has since moved significantly. Survey of Professional Forecasters now predicts 2020-21 growth at (-)9.1 per cent, down from (-)5.8 per cent in August and headline inflation to fall to 4.2 per cent in Q4:2020-21, up from 3.0 per cent. The baseline projections in the MPC resolution place growth at (-)9.5 per cent and headline inflation at 5.4-4.5 per cent in H2:2020-21 and 4.3 per cent for Q1:2021-22. The latest projections reaffirm that inflation will fall in line with the target, while growth has plummeted, thus decidedly shifting the growth-inflation policy trade- off in favour of supporting growth within the flexible inflation targeting paradigm.
49. During Q1:2020-21, the economy faced its deepest contraction ever, which was also the worst amongst G20 countries. Despite marked sequential improvements in high frequency indicators of real activity, many of them are yet to normalise to their pre-pandemic levels that were already sub-par as the economy had slowed to a 11-year low in 2019-20. The GDP is likely to contract close to double-digit mark in Q2:2020-21. A range of model-based exercises, as well as my judgment superimposed on these, suggest 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. Investment, that typically comprise about a third of real aggregate demand, contracted 47 per cent in Q1:2020-21. With seasonally adjusted capacity utilisation for surveyed manufacturing firms dropping to 48 per cent in Q1:2020-21, the large slack already visible in 2019- 20 has deepened further. As such, investment may take time to recover. 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.
50. Though inflation is currently above the upper tolerance band, it is not monetary in nature. Supply disruption in food, increase in taxes on fuel and liquor, and surge in gold prices catalysed by risk-off has lifted inflation. Ex-food, ‘fuel and light’, gold and ‘pan, tobacco and intoxicants’, inflation stands at 4.4 per cent, i.e. 2.3 percentage points lower than the headline inflation. In my view, headline inflation should start softening from October. Apart from favourable base effects, the unlocking has picked speed and would significantly reduce supply chain bottlenecks causing both agriculture and non-agricultural prices to correct. Monsoon risks to inflation have dissipated. Cumulative rainfall has been 9 per cent above long period average with its temporal and spatial distribution satisfactory. Area sown under Kharif has expanded by 4.8 per cent. Reservoir levels are 15 per cent above last 10-year average, lifting up Rabi prospects. The First Advance Estimates of Kharif point to substantial increase in output of crops like pulses, oilseeds and sugarcane that can have a salutary effect on food and processed food prices and leave enough margin of error for possible subsequent downward revisions in data. With marked increase in area sown under foodgrains, alongside the buffer of food stock at double the norms, prices should soften. Vegetable prices that have exhibited persistence at elevated levels due to weather-related disturbances should also correct starting December. With resumption of businesses by small poultry, high prices in protein items should witness some correction. As yet, there are no signs of generalisation of relative price shock from food items and agriculture and rural wage inflation has stayed muted.
51. The current high retail margins have prevailed as consumers avoid scouting for cheaper prices amidst social distancing. The phenomenon of such less competitive markets have been observed in past pandemics as well, such as the one that contributed to the Eisenhower recession in the United States. However, the unlock intensity now matches the lockdown stringency and with new confirmed Covid-19 cases starting to decline in recent weeks, unless there is strong second wave, supply chains should get near normalised as early as end of the current calendar year, setting off price corrections. However, demand will take time to normalise and weakness may persist into the next year. In these circumstances, corporate pricing power is unlikely to recover, though upside risks to inflation remain from possible collusive behaviour in less competitive industries, as also further unforeseen supply disruptions in food. As a baseline, headline should converge to core inflation, with both softening.
52. Three macro-financial risks currently concern me that have implications for monetary policy. First, if growth contractions stay for long, the hysteresis or scarring that has been substantially arrested by nimble-footed policy actions could stage a comeback creating renewed feedback loops within public, corporate and bank balance sheets that would impact the stock of debt as well as fiscal and saving- investment balances. If this happens, recovering potential output, some of which may be lost to hysteresis, will take longer. It will also push the neutral interest rate lower than before. Despite front-loaded action, monetary policy should, therefore, stay accommodative. The fiscal restraint observed so far provides some room for it. However, with term spreads already widening above historical levels in 2019-20 and in H1:2020-21 on back of widening fiscal gap that has necessitated larger government borrowing programmes, the unpleasant arithmetic is evident in supplies of papers more than doubling in two years. Consequently, the yield curve slope is hardly a predictor of growth or expected inflation. This is not unique to India and term spreads have been higher and have widened much more during current pandemic in many other emerging markets due to pro-cyclical nature of fiscal policies that leave little counter-cyclical space. As typically fiscal authorities have a first mover advantage in the game of chickens, monetary policy will naturally have to factor this in its stance to avert Nash equilibria as a pure strategy. In this milieu, monetary and liquidity easing in India has effectively kept government market borrowing costs at a 16-year low with attendant benefits for funding costs that are obvious but hard to quantify precisely in absence of counterfactual.
53. Second, 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. With retail fixed deposit rates currently ranging between 4.90-5.50 per cent for tenors of 1-year or more and the headline inflation prevailing above that for some months now, there has been a negative carry for savers. While expected future inflation is lower and leaves some policy room, it is prudent to hold policy rates for now.
54. Third concern relates to interactions between monetary policy and financial stability, which could intensify further, especially later into next year. Though low for long interest rates risk build-up of corporate and household leverage, unprecedented contraction entails policy-trade-offs imparting primacy to rebuilding consumer and business confidence over the next 2-3 quarters by taking some policy uncertainty out of their decisions. In this milieu, forward guidance can play an important role.
55. Considering all the above, I vote for leaving the policy rate unchanged. Further considering that output gap may close only towards the end of 2021-22 and that, going forward, the demand destruction caused by the pandemic, coupled with improvements in logistic networks of production and distribution, may exert significant downward pressure on headline and core inflation, I vote for the accommodative stance and the forward guidance provided in the resolution. Statement by Dr. Michael Debabrata Patra
56. The projections of real GDP growth for 2020-21 that are set out for the first time in the MPC’s resolution provide a sense of the wounds on the soul of the economy inflicted by COVID-19. 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. GDP is an aggregative indicator of economic activity and hides the extent of human misery and the loss of social and human capital caused by the health crisis. Nonetheless, 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. Changes in social behaviour and norms of commercial and workplace engagements may accentuate this structural change.
57. Progressive unlocking of the economy has brought people out of isolation and some high frequency indicators into the green. While this has raised optimism about the much-awaited recovery, perhaps, pragmatic caution is warranted. The COVID curve is arching inwards, from the cities where infections had hitherto festered, into interior regions. The fear of a second wave looms over India; already it has forced lockdowns across Europe, Israel and Indonesia, and India, with the second highest caseload of infections and over-stretched healthcare infrastructure, cannot be immune. 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. Exports could be a driver, but with the WTO’s latest projection of a decline in world trade volume by 9.2 per cent in 2020, the role of exports in powering a durable revival is likely to be circumscribed. This underscores the critical role of investment in engineering the turnaround in the economy and sustaining it over the medium-term. Depressed capacity utilisation in manufacturing, inventory overhang in residential housing, impaired balance sheets of corporates and financial institutions, and pervasive business pessimism are combining to create formidable drags on investment sentiment. Consequently, an investment-less recovery is doomed to be ephemeral. Policy intervention accordingly assumes a vital role. Illustratively, public investment can play both a gap-fill and crowding-in role. Monetary policy can engender favourable financing conditions by lowering the cost of capital and by narrowing risk spreads on financial instruments.
58. In the current milieu, however, both monetary policy and fiscal policy in India face tightening constraints, some idiosyncratic. For fiscal policy, it is the collapse of tax revenue – by 32 per cent in the first quarter; consequently, the centre’s revenue deficit during April-August is 121.9 per cent of budget estimates. For monetary policy, it is the persistence of headline inflation above 6 per cent for the third month in succession. Structural reforms to unlock growth impulses are needed, but may lack social traction in an atmosphere of depressed growth and employment, and high uncertainty.
59. In the context of headline inflation ruling above the upper tolerance limit of the target since June 2020, the role of monetary policy has come under scrutiny. It has been argued that while inflationary pressures may emerge from supply bottlenecks and cost pushes, inflation cannot become generalised and persistent unless it becomes a monetary phenomenon, i.e., it is accommodated by an increase in aggregate demand as reflected in an expansion of money supply or by a decrease in policy interest rates. Monetary policy has adopted an ultra-accommodative stance to revive growth and mitigate the effects of COVID-19. Liquidity operations in support of this stance have infused sizable liquidity into the system, reflected in reserve money expansion of 17.6 per cent adjusted for the first-round effects of cash reserve ratio changes. This has, however, not translated into a commensurate increase in money supply because of a money multiplier depressed by a sharp increase in the currency- deposit ratio, and remunerated reserves parked in reverse repo with the RBI over and above CRR requirements. Consequently, the rate of money supply is averaging 12 per cent in nominal terms and only 6 per cent in real terms. In terms of quarterly seasonally adjusted annualised rates, a negative money gap has opened up recently.
60. In a quarterly vector auto regression (VAR) framework, money supply and policy rate reductions together contribute only 4 per cent of the deviation of inflation from its target. The contribution of supply shocks from food and fuel prices account for 71 per cent of inflation deviations in the first half of 2020-21, followed by 28 per cent from unanchored inflation expectations (deviations of trend inflation from target). Changes in exchange rates and asset prices together contribute a little less than 12 per cent. Inflation is pulled down by 15 per cent by the negative demand shock from COVID-19.
61. Under these conditions, it is essential for monetary policy to remain accommodative and opportunistically exploit the headroom that opens up when inflation recedes, as it is projected in the second half of 2020-21. Three aspects need to be emphasised. First, it is important to separate false starts from durable growth drivers. In this context, all efforts need to be trained on the revival of investment. Second, in the evolving situation in which monetary policy is committed to an accommodative stance, it is necessary to monitor inflation dynamics closely for signs of generalization and persistence. For this purpose, all indicators of aggregate demand, including monetary and credit aggregates, warrant continuous examination for inflation impulses. Third, with unprecedented contractions in economic activity and elevated inflation posing a razor’s edge trade-off fraught with uncertainty, forward guidance has to be clear and decisive. The stance of policy conveys forward guidance on the future trajectory of short-term interest rates, which is well within the MPC’s remit. On this, therefore, communication has to be unambiguous and, given the evolving situation, specific in order to anchor expectations.
62. I vote to keep the policy rate unchanged and for retaining the accommodative stance of policy as set out in the MPC’s resolution. Statement by Shri Shaktikanta Das
63. After the sharpest contraction in economic activity in Q1:2020-21, a number of high frequency indicators of economic activity for Q2:2020-21 indicate a sequential improvement. The recovery in all likelihood would be led by rural demand. In urban areas too, there are indications of an uptick in consumption demand with passenger vehicles emerging out of contraction in August, rebound in GST e-way bills to pre- pandemic levels, sequential improvement in GST revenues in September and a steady improvement in PMI manufacturing and services.
64. Accordingly, the recovery is expected to be multi-speed depending on sectoral realities. Forward looking surveys conducted by the Reserve Bank are also indicating a sequential firming up of the recovery. Households expect an improvement in general economic situation, employment and income over a one year ahead horizon. Capacity utilisation saw some improvement in Q2:2020-21 and a further pick-up is expected from Q3 onwards. Manufacturers expect expansion in production volumes and new orders to continue through Q1:2021-22. Business Expectation Index (BEI) also suggests a move to expansion zone in Q3:2020-21.
65. There are, however, downside uncertainties that could put sand in the wheels of this nascent recovery. Primary among them is the risk of a second wave of COVID-19. Private investment activity is likely to be subdued, even as domestic financial conditions have eased significantly. External demand is expected to remain anaemic with sharp contraction in global economic activity and trade. Overall, we expect a likely reduction in the rate of contraction in GDP during Q2:2020-21 and a return to positive growth by Q4:2020-21. Despite sequential improvement in Q3 and Q4, the full year GDP is expected to contract by 9.5 per cent with a strong rebound next year.
66. 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. Adverse supply side factors along with increase in retail margins continue to impinge on food and non-food components of CPI. Food (with a weight of around 46 per cent in overall CPI) contributed disproportionately at around 60 per cent to the surge in inflation. In addition, costs of doing business have gone up due to additional sanitisation related expenditures, social distancing norms and labour shortfalls.
67. On the outlook for inflation, food inflation should moderate going forward on a combination of good kharif harvest and a favourable rabi season. Households polled by the Reserve Bank expect 3-month ahead inflation expectations to somewhat soften. As economic activity further normalises and supplies are restored, cost push price pressures faced by firms are likely to dissipate. However, should supply side shocks, especially to food persist, they can destabilise inflation expectations. Overall, in our assessment, headline inflation would moderate in H2 of the current year and further in Q1 of next fiscal year.
68. The Reserve Bank’s proactive management of liquidity through both conventional and unconventional measures, amounting to ₹12.3 lakh crore or 6.1 per cent of nominal GDP of 2019-20, has helped to keep systemic liquidity in abundance and easy financial conditions reflected in the narrowing of term and risk premia in various market segments. During March-August 2020, monetary transmission improved significantly reflecting the combined impact of surplus liquidity and enhanced coverage of the external benchmark-based pricing of loans. However, despite continued guidance of accommodative stance as long as necessary and ample surplus liquidity, the financial markets remained somewhat nervous and at variance with our expectations. The market participants were also concerned about the stance going forward.
69. Monetary policy works through financial markets which serve as the conduit of transmitting policy signals to the real economy. For seamless propagation of policy impulses, it is necessary that the monetary authority’s policy intent is clearly understood by market participants so that there are no expectational mismatches between the two. Accordingly, MPC should strengthen its forward guidance by indicating that the accommodative stance would continue 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. This enhanced guidance should strengthen and quicken the pace of transmission to longer-term yields and help support consumption and investment demand in the economy. Higher investment in conjunction with recent structural reforms measures by the government would help improve supplies and alleviate supply bottlenecks and also contribute to softening of inflation.
70. Monetary policy at this stage 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. With the supply side disruptions that are seen to drive the current inflationary pressures likely to be transient and wane out in months ahead as economy normalises, there is merit in looking through the current high levels of inflation and persevere with the accommodative stance for monetary policy as long as necessary to revive growth on a durable basis. Moreover, taking into account the projected moderation in inflation and the large output loss, I vote to keep the policy rate unchanged at present and continue with the accommodative stance, during the current financial year and into the next financial year, at the least. This would help to reduce uncertainty and market volatility. This would also enhance confidence in the monetary policy resolve to support the growth recovery process while ensuring that inflation remains within the target. 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. Meanwhile the ongoing transmission of past monetary policy actions would help ease financial conditions further. (Yogesh Dayal) Press Release: 2020-2021/533 Chief General Manager
6. The outlook for Q4 (October-December) of 2020 is overcast with a surge in COVID-19 infections in a second wave across Europe, the US and major emerging market economies (EMEs), with accompanying lockdowns. Progress on vaccine candidates has, however, generated some offsetting optimism. World trade recorded a rebound in Q3 as lockdowns were eased, but it is likely to slow in Q4 as pent-up demand is exhausted, inventory restocking is completed, and trade- related uncertainty is rising with the second wave. CPI inflation has remained muted across major advanced economies (AEs) while it picked up in some EMEs on firming food prices and supply disruptions. Global financial markets remain buoyant, supported by highly accommodative monetary policies and positive news on the vaccine. Domestic Economy
7. In India, the data release of the National Statistical Office (NSO) on November 27 showed a contraction of 7.5 per cent in real GDP in Q2:2020-21 (July-September). In Q3:2020-21, high frequency indicators point to a recovery gaining traction, with double digit growth in passenger vehicles and motorcycle sales, railway freight traffic, and electricity consumption in October, although there was moderation in some of these indicators in November. Riding on the favourable monsoon, the outlook for agriculture remains bright, with rabi sowing up 4.0 per cent from the acreage covered at this time last year under supportive soil moisture and reservoir conditions.
8. CPI inflation rose sharply to 7.3 per cent in September and further to 7.6 per cent in October 2020, with some evidence that price pressures are spreading. Food inflation surged to double digits in October across protein-rich items including pulses, edible oils, vegetables and spices on multiple supply shocks. Core inflation, i.e., CPI excluding food and fuel, also picked up from 5.4 per cent in September to 5.8 per cent in October. Both three months and one year ahead inflation expectations of households have eased modestly in anticipation of the seasonal moderation of food prices in the winter and easing of supply chain disruptions.
9. Domestic financial conditions remained easy in October-November and systemic liquidity continued to be in large surplus. Reserve money increased by 15.3 per cent (y-o-y) (as on November 27, 2020), driven by a surge in currency demand. Money supply (M3), on the other hand, grew by only 12.5 per cent as on November 20, 2020. A noteworthy development is that non-food credit growth accelerated and moved into positive territory for the first time in November 2020 on a financial year basis – hitherto, the large inflow of deposits into the banking system was being predominantly deployed in SLR investment. Corporate bond issuances stood at ₹4.4 lakh crore during April-October 2020 as against ₹3.5 lakh crore during the same period last year. India’s foreign exchange reserves were US$ 574.8 billion (as on November 27), up from US$ 545.6 billion on October 2 at the time of the MPC’s last resolution. Outlook
10. The outlook for inflation has turned adverse relative to expectations in the last two months. The substantial wedge between wholesale and retail inflation points to the supply-side bottlenecks and large margins being charged to the consumer. While cereal prices may continue to soften with the bumper kharif harvest arrivals and vegetable prices may ease with the winter crop, other food prices are likely to persist at elevated levels. Crude oil prices have picked up on optimism of demand recovery, continuation of OPEC plus production cuts and are expected to remain volatile in the near-term. Cost-push pressures continue to impinge on core inflation, which has remained sticky and could firm up as economic activity normalises and demand picks up. Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q3:2020-21, 5.8 per cent for Q4:2020-21; and 5.2 per cent to 4.6 per cent in H1:2021-22, with risks broadly balanced (Chart 1).
11. Turning to the growth outlook, the recovery in rural demand is expected to strengthen further, while urban demand is also gaining momentum as unlocking spurs activity and employment, especially of labour displaced by COVID-19. These positive impulses are, however, clouded by a possible rise in infections in some parts of the country, prompting some local containment measures. At the same time, the recovery rate has crossed 94 per cent and there is considerable optimism on successes in vaccine trials. Consumers remain optimistic about the outlook, and business sentiment of manufacturing firms is gradually improving. Fiscal stimulus is increasingly moving beyond being supportive of consumption and liquidity to supporting growth- generating investment. On the other hand, private investment is still slack and capacity utilisation has not fully recovered. While exports are on an uneven recovery, the prospects have brightened with the progress on the vaccines. Demand for contact-intensive services is likely to remain subdued for some time due to social distancing norms and risk aversion. Taking these factors into consideration, real GDP growth is projected at (-)7.5 per cent in 2020-21: (+)0.1 per cent in Q3:2020-21 and (+)0.7 per cent in Q4:2020-21; and (+)21.9 per cent to (+)6.5 per cent in H1:2021- 22, with risks broadly balanced (Chart 2).
12. The MPC is of the view that inflation is likely to remain elevated, barring transient relief in the winter months from prices of perishables. This constrains monetary policy at the current juncture from using the space available to act in support of growth. At the same time, the signs of recovery are far from being broad-based and are dependent on sustained policy support. A small window is available for proactive supply management strategies to break the inflation spiral being fuelled by supply chain disruptions, excessive margins and indirect taxes. Further efforts are necessary to mitigate supply-side driven inflation pressures. Monetary policy will monitor closely all threats to price stability to anchor broader macroeconomic and financial stability. Accordingly, the MPC in its meeting today decided to maintain status quo on the policy rate and 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.
13. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted for keeping the policy repo rate unchanged. Further, all members of the MPC voted unanimously 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.
14. The minutes of the MPC’s meeting will be published by December 18, 2020. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
15. The prevailing economic scenario has presented both positive developments and concerns. The positive developments have included better than expected GDP growth recovery in Q2: 2020- 21 and promise of vaccines for the Covid-19 becoming available in early 2021. The major concerns are the recent second wave of Covid-19 infections and deaths in Europe and the US leading to shutdowns and the continuation of inflation pressures.
16. The official data on GDP for Q2: 2020-21 released at the end of November 2020 indicates a year-on-year contraction by 7.5 per cent as against our October 2020 assessment of GDP contraction of 9.8 per cent. The positive growth in manufacturing output in terms of gross value added is a major positive indicator of revival of the economic activities. The imminent approvals for vaccines for the Covid-19 pandemic have raised the prospects of return to normal economic activities at the global level, subject of course to all the safety considerations until the vaccination programs cover all the population. The potential for the spread of the virus in the absence of critically vital safety precautions such as masks and social distancing cannot be ignored until the effective vaccination is achieved.
17. The headline CPI inflation rate for October is at 7.6 per cent, after the average inflation in Q2: 2020-21 at 6.9 per cent. The actual inflation rate for Q2 is slightly higher than our expected rate of 6.8 per cent in October.
18. The sustained recovery of the economy to bring back the lost employment and income to the workers remains crucial policy goal and maintaining moderate levels of inflation is equally important to sustain the recovery process. Experience of the previous quarter is an important guide for framing the monetary policy at this juncture.
19. The policy rates were left unchanged in October with Repo rate at 4 per cent and continuation of the accommodative monetary policy stance into the next year. This position appears to have supported a fairly broad based recovery process. This forms the context for my assessment of the economy and the view on the monetary policy resolution.
20. The output performance of the various sectors in Q2: 2020-21, measured in terms of gross value added (GVA) in constant prices, indicates broad based recovery. Year on year basis, Agriculture & allied activities sector registered a growth of 3.4%, Manufacturing 0.6%, Electricity and Utilities 4.4% and in the remaining 5 sectors, growth rate was negative but barring two sectors, the decline over the previous year was less steep than in Q1. In the case of Finance, Real Estate and Professional Services, and Public Administration and Defence & Other Services, the decline was steeper than in Q1. In the case of construction and Trade, Hotels, Transport, Communication and Broadcasting related services, which experienced a decline of close to 50% in Q1, the rate of decline in GDP in Q2 was less than 16%. The recovery of economic activity in Q2 over the level in Q1 is seen in all the sectors, except Agriculture & Allied and Mining & Quarrying. In both these cases, this may be a seasonal feature. For all sectors together, GVA in Q2 increased by 19.4% over Q1.
21. In terms of demand components of GDP, barring Inventory Change and Statistical Discrepancy, all the others show negative year-on-year growth. However, the YOY decline in Government Final Consumption Expenditure (GFCE) in Q2 has followed an increase in Q1. In all other cases, the rate of contraction in Q2 is less steep than in Q1. Gross Fixed Capital Formation (GFCF) and Private Final Consumption Expenditure (PFCE) have registered less steep YOY decline in Q2 than in Q1: 2020-21. Importantly, in all the cases, barring GFCE, the level of demand in Q2 is higher than in Q1. The improvement in the level of demand over Q1 along with lower contraction YOY basis signal sustained recovery.
22. Despite the overall improvement in the level of economic activities, there are concerns on the status of some of the sub-sectors and aspects of the economy. There are no clear indications of the extent to which the micro and informal sector enterprises have fared in this phase of recovery. In the case of registered or organised sector, the analysis of unaudited quarterly statements of 2570 listed non-financial private companies conducted by RBI shows that manufacturing firms have managed to achieve profits by reducing input costs and staff costs while facing cuts in value of production. In a scenario where output of the economy contracted by about 24%, recovery is not expected to be uniform across sectors both due to the differences in the nature of supply chains and demand conditions, often leading to ‘multi-speed recovery’ indicating the difficulties in achieving seamless recovery. Some of the sectors, termed ‘contact intensive sectors’ such as hospitality and tourism will take longer to recover. The corporate performance in Q2 cited above shows that non-IT services companies fared poorly compared to IT companies. Firms also face increased costs of operation unless the activities resume the pre-Covid pattern of operations. Firms also need to recoup the losses incurred. This will require both improved productivity and higher realisation from sales.
23. A reflection of the disruptions in the production processes is also seen in the rising price pressures. While the rising rate of food inflation is mainly a result of production setbacks, there is also some evidence of price pressures in other sectors. The firming up of commodity prices in the international markets affects domestic prices through either input costs or prices of competing domestic output. The large levels of indirect taxes on petroleum fuels has kept the transport costs high for all sectors.
24. The prospects of sustaining growth recovery through both expansion of growth across sectors and rising growth rates of output in the short term beyond Q2: 2020-21 are seen in some of the ‘expectations surveys’ and the indicators of economic activity for which data are available with much less time lag. Among the indicators from outlook surveys, RBI’s own survey of manufacturing companies indicates optimism on improved production, order books and employment and on turnover in the case of services and infrastructure sectors for Q3. The optimism is broad based and stronger on the output and employment conditions in 2021-22. RBI’s analysis of the findings of its sample survey of manufacturing companies, based on preliminary partial results, shows that capacity utilisation (seasonally adjusted) increased from 47.9% in Q1 to 62.6% in Q2, but well below the long term average of 74%, highlighting improvement in output but also a significant unutilised capacity either because of supply constraints or lack of demand.
25. Improvement in demand is clearly needed to accelerate production. Growth of agricultural and allied sector GVA by 3.4 per cent in both Q1 and Q2 YOY basis has supported rural demand. The festival season provided one stimulus to demand for consumer goods in Q2, but sustaining that will require both confidence in income stream and safety in work. The sequential pickup in GFCF in Q2 is a sign of pick up in consumption demand expected by the producers. The consumer confidence surveys by RBI reveal an improvement in the expected levels of spending one year ahead compared to the present in November 2020 relative to the findings in September 2020. However, this positive sentiment is yet to catch up with the level seen in pre-Covid period. The uncertainty about the prevailing income and employment conditions appears to be significant. The recovery in economic activities requires support from consumer spending.
26. The external demand conditions remain uncertain. While exports of goods and services show signs of recovery in terms of moderating YOY rates of decline in Q2 over Q1, they are still negative. The net investment inflows, however, have shown positive growth. The forex reserves have increased by $97 billion between November 27, 2020 and end of March 2020.
27. The economic growth momentum presently depends on domestic factors. Financial conditions that support investment are a critical factor in strengthening this link. Fiscal measures that support demand are also a critical factor in strengthening aggregate demand.
28. The prevailing monetary and fiscal conditions represent favourable financial conditions for investment. However, support for the consumer demand will require return of employment and income growth. While government borrowing to finance the fiscal deficit is at a high level, government spending to support investment and consumption are needed at this juncture.
29. Imbalances in the supply and demand conditions are impacting the price scenario as in the case of food inflation. The food inflation has been led by a few commodities, whether it is vegetables or pulses due to production shortfalls. Large price spikes due to sudden supply constraints have affected headline inflation. Arrival of winter crops in the market is expected to bring down the pressures on these commodities. In the present situation, the price pressures are also seen in other sectors, as firms manage lower capacity utilisation and higher costs emerging from the need for greater care to address risks of Covid infections. Firming up of international commodity prices, despite the projected low trade volumes is another indication of supply constraints. These pressures appear to be largely supply related but may be supported by improving demand conditions and are a concern.
30. The forecasts of growth and inflation suggest that economic recovery will continue in the remaining two quarters of 2020-21 and more strongly in the first half of 2021-22. The headline inflation is expected to remain well above 6 per cent in Q3 and below 6 per cent in Q4. The sustained economic recovery leading to a projected positive year- on- year GDP growth in Q3 and Q4 reflects the rising momentum of economic activities built up by the relaxation of restrictions on movement of goods and commerce as the Covid cases have reduced. But this reduction in Covid cases can be sustained only if the norms of social safety – the masks and social distance- are observed, until mass vaccinations are achieved. The adverse risks to sustained recovery remain on account of the potential for the rise of Covid infections and its impact on both supply and demand. The adverse risks on the price front are also emerging from the supply side considerations. The prevailing conditions require access to liquidity and financial conditions favourable to production and investment on the supply side. High inflation remains a risk but easing these pressures requires easing supply conditions.
31. On balance, the need to support relaxing the supply side constraints is a priority as this is also needed to address inflation concerns. Improvement in demand conditions requires both fiscal support and decline in Covid-19 threat.
32. I vote in support of the resolution to keep the policy repo rate unchanged and further 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. Statement by Dr. Ashima Goyal
33. Indian Q2 growth rate came in above expectations. One view attributes it to a temporary pent-up demand and festival driven surge. My own view is that just as the reversal of the liquidity drought had led to a revival of growth that was visible in the high frequency data for February 2020, the various measures to make liquidity available through the economy not only helped firms survive but have also revived demand. The bank credit growth figures show a turnaround but underestimate it. For example, reduction in precautionary liquidity hoarding leads to faster payments and unclogs the frozen economy. There are now other sources of market-based finance. Real estate inventory is beginning to move. Both households and firms have deleveraged, are cash rich, and ready to spend. There are early signs of firms beginning to invest. Even so, the kind of infrastructure boom we had in the 2000s will not occur. Moreover, it is not desirable.
34. India seems to have avoided a second Covid-19 peak and vaccines are around the corner. But we must remember growth is still negative. It will take at least a year to reach the earlier peak GDP level and more to recover lost growth. Jobs have been lost, some voluntary and some involuntary, especially in the lower middle class. The turnaround needs policy support until it is well established.
35. Headline CPI inflation has also exceeded expectations. But analysis suggests it is due to multiple supply shocks. Covid-19 and the lockdown was itself a massive supply shock, so much so that there was a break in the inflation series. The headline series being targeted now starts from Q2 (July-September), after the break in the lockdown months when it was not possible to even measure inflation.
36. Research shows household inflation expectations rise if inflation is high and persistent. Then headline inflation begins to affect core. Otherwise it is the reverse. To the extent inflation is due to a variety of supply-shocks coming on one after the other, intrinsic persistence may not have set in as yet.
37. The inflation expectations survey of households shows a sharp 100 basis points fall in current household inflation perceptions between September and November. There is also a mild softening of three month and one year ahead inflation expectations. Household inflation expectations are naive and normally exceed realized inflation. But the direction of change is informative. Professional forecasters all expect inflation to soften in H2 of this fiscal year.
38. Although the margin between consumer and wholesale prices remains high for specific goods suggesting retail supply chains are still disrupted, the fall in household inflation perceptions may be due to easier availability of goods. Fear of shortages makes the consumer willing to pay high prices, but the Indian consumer is price sensitive and will begin to search for lower price alternatives as mobility improves. Such searches may have started. There is a window for supply chains to stabilize. In August rural wages jumped up by 9.5% but since crops are plentiful possible second round rise in food prices may be limited.
39. Although October headline CPI inflation was 7.6%, WPI inflation was only 1.5%. Real rates remain positive for firms with respect to WPI inflation but are negative for households with respect to CPI inflation. There is still a chance CPI inflation may fall steeply in the next few months on supply-side action supported by favourable base effects. If inflation softens, such negative real rates will not persist. Also, the equilibrium policy rate is itself negative when growth rates are negative and output is much below potential, after a once in a century growth shock.
40. As long as the MPC stance is accommodative durable liquidity will be in surplus and short- term rates will not rise above the reverse repo rate. Rates have fallen below the reverse repo because of the combination of excess foreign inflows, intervention and reverse repo access limited only to banks. Even so, excess liquidity is still absorbed. Regulatory exposure norms can help prevent excess low rates driven short-term borrowing that creates risks.
41. The intervention that is raising foreign exchange reserves is required because over- valuation of the rupee can hurt exports, raise country risk and lead to a sharp depreciation later. Prolonged inflows can lead to over-valuation without intervention. Surges and sudden stops of capital flows to emerging markets due to advanced economy quantitative easing have hurt emerging market growth in the decade after the global financial crisis. There are many benefits from openness and from the availability of foreign savings but good management has to smooth shocks, reduce risks and protect the domestic growth cycle.
42. It is possible to sterilize excess durable liquidity from expansion in foreign exchange reserves, even while durable liquidity remains sufficiently in surplus to be able to absorb exogenous shocks such as outflows or changes in government cash balances. Giving greater access to reverse repo aids market development as well as short-term sterilization. Liquidity management tools can be used at any time. It is necessary to be watchful, however.
43. To the extent it is transient the contribution of excess liquidity to cost push inflation is limited. In an open economy import competition also caps price rise, especially with a rupee that is tending to appreciate, provided tariffs and taxes are moderated.
44. To continue the delicate balance between lowering inflation, anchoring inflation expectations yet strengthening the growth recovery, I vote to maintain the status quo in policy stance and rates. Statement by Prof. Jayanth R. Varma
45. At the outset, let me reiterate my disagreement with the use of the word “decided” in the forward guidance part of the resolution. My reasons for this disagreement have been articulated at length in my individual statement for the October 2020 meeting, and rather than repeat them ad nauseam, I would prefer to incorporate them by reference. I also indicated in the October statement that disagreements that are more philosophical than operative need not always be elevated to a dissent, and accordingly I choose not to dissent this time.
46. I wrote in my individual statement for the October 2020 meeting that “with short term rates already at 3.35%, the incremental benefits of a furthering lowering of this rate in the current macroeconomic environment are relatively low and not commensurate with the risks”. Since then, short term rates have fallen by a further 40 basis points. (The cutoff yield in the last 91-day T-bill auction before the October meeting was 3.36% while the corresponding yield for the last auction before the December meeting was 2.93% − a drop of 43 basis points). I believed then and believe now that this reduction of rates carries significant risks and very little rewards. The rewards are low because long rates are what are relevant for stimulating investments and supporting an economic recovery; a steepening of the yield curve by a reduction in short rates does not accomplish this. Also, a reduction in long rates that stimulates investment not only increases demand in the short run, but it also stimulates supply in the medium term as the new capacity becomes operational, and this new supply dampens inflationary pressures.
47. By contrast, the demand that is stimulated by a reduction in short rates is not accompanied by an offsetting supply boost, and therefore carries greater inflationary risks. A sub 3% short rate (corresponding to a negative real interest rate of −4.5%) risks encouraging speculative inventory accumulation and stoking inflationary buildup in sectors that are showing incipient anecdotal signs of cartelization and resurgence of pricing power. Anecdotal evidence suggests that in several sectors which are characterized by an oligopolistic core and a competitive periphery, the oligopolistic core has weathered the pandemic well and it is the competitive periphery that has been debilitated. Rising profits and profit margins, improving capacity utilization and lack of new capacity additions create ripe conditions for the oligopolistic core to start exercising pricing power. These are also the enterprises that are benefiting from borrowing at rates below the policy corridor through commercial paper issuance. I fear therefore that a sustained failure to defend the policy corridor could prove expensive in terms of creating inflationary pressures and inflationary expectations though, so far, low rates have been feeding into asset markets rather than goods price inflation. It is pertinent to note in this context that the IIM Ahmedabad’s business inflation expectations survey released just before the MPC meeting reported an increase in inflation expectations.
48. Turning to the resolution, I indicated in my individual statement for the October 2020 meeting that monetary policy must remain accommodative “as long as realized outcomes do not diverge drastically from what is currently expected.” It must be admitted that realized growth and inflation have both drifted towards the edge of the fan charts while remaining within them. Nevertheless, it is my considered view that the balance of risk and reward at the current juncture is still in favour of monetary accommodation. Therefore, I support maintaining the policy rate at its current level. I also support the accommodative stance and liquidity support that drive short term rates towards the reverse repo rate rather than the repo rate, while being wary of a drop below the corridor. The MPC must continue to be data driven and must continue to monitor future developments carefully. Statement by Dr. Mridul K. Saggar
49. Central banking has not been usual once the pandemic set in. Supporting growth was a natural priority given the cliff effects of pandemic on aggregate demand and supply. Monetary policy is now entering into a more complex zone. While growth is recovering faster than earlier anticipated, it has not yet taken sustainable roots. It remains to be seen how it might respond ahead as pent-up demand wanes while animal spirits remain anaemic. Furthermore, fiscal impulse has weakened since Q2:2020-21 and, therefore, despite inflation persistence, pulling back the monetary support to aggregate demand will not be an apt choice at this juncture. High inflation has persisted longer than predicted at the time of the preceding MPC meeting in early October. This was mainly due to unseasonal rains that caused vegetables price spike. As a base case, inflation should still start correcting in near months and fall below the upper-tolerance levels by December 2020. The upside risks, however, remain with some evidence that price pressures are starting to get distended.
50. Notwithstanding the remarkable improvement in activity levels, as also captured by normalisation of several high frequency indicators, there are several reasons to believe that growth will stay below trend for the rest of the year, even though positive terrain may be reached before close of the current fiscal year. The sharp recovery seen in indicators relating to auto sales cannot be interpreted as being reflective of the underlying trend in aggregate demand or supply conditions as pent-up purchases were being delayed, first on account of transition to stricter emission standards that kicked in since April and then on account of pandemic related lockdowns. Services sector accounted for 63 per cent of the gross value added and contributed 78 per cent to the overall growth over preceding two years. Several services continue to be deeply affected by the pandemic. These include hospitality, construction, real estate, trade, and several types of transport, even though railway freight movement has normalised. Investment demand which had significantly contributed to overall growth in 2017-18 and 2018-19 had dropped off in 2019-20 and was the main driver of the growth contraction during Q1:2020-21 and despite remarkable sequential improvement in Q2 is likely to stay weak, with capacity utilisation rate likely staying below 70 per cent against long-term average of 74.0 per cent. Non-food credit, a leading indicator for growth stays muted, though in the fortnight ended November 6, 2020, it jumped to 5.7 per cent year-on- year from 5.1 per cent in the preceding fortnight. It could be the turning point in credit offtake but is not clear at this stage and, in any case, it has not yet acquired strength to alter the growth-inflation trade.
51. Furthermore, in Q2:2020-21, government final consumption expenditure contracted by 22.2 per cent and public administration, defence and other services by 12.2 per cent, dragging the growth down in terms of weighted contribution to growth by 2.9 percentage points from the demand-side and 1.7 percentage points from the supply-side, respectively; lower supply-side contraction essentially reflected improvement in ‘other services’. The fiscal support to growth has nevertheless come from automatic stabilisers that have been stronger than in many emerging markets but remain weaker than in advanced economies, especially as they act through fall in tax revenue but have no automaticity to increase spending. The discretionary fiscal policies, therefore, become important but policy space has been limited by largely procyclical fiscal policies followed for years. In this backdrop, fiscal policy has attempted restrained counter-cyclical support since 2019-20. Going forward, growth is likely to get some support from fiscal spending in the remaining months of this fiscal year when bulk of the on-budget stimulus is likely to be spent. Given that fiscal multipliers are higher during large downturns and also that investment multipliers distinctly exceed revenue spending multipliers, the growth-targeting investment measures announced as part of additional stimulus in October and November are likely to complement monetary policy support to growth in a measured way.
52. Though monetary policy so far has provided a bungee cord to the growth, its tensile strength depends on how inflation evolves ahead. The nature of inflation still remains predominantly supply driven but with addition of some elements of cost-push inflation that can get a further fillip if three is a feedback from recent increased rural wage inflation. Cost-push inflation, even when arising from factors such as increasing food and energy prices, especially crude oil, and higher direct taxes, can start below the natural rate of unemployment if monetary accommodation is large and sustained. The Great Inflation episode after the oil price shock of 1973 bears testimony of these risks to which one needs to be mindful, even though recent flattening of Phillips curve has diminished correlation between core inflation and output. A decade back, post- global financial crisis, pushing demand continually, did result in resurgence of inflation in India. These risks are not imminent at this point. Since February 2020 policy, RBI has announced liquidity measures adding to about Rs 12.7 trillion. A significant portion of this liquidity has been parked back at central bank window. Therefore, it has not had a perverse effect on inflation so far. Through the interest rate, credit and confidence channels it prevented credit from dropping as steeply as nominal GDP. It also helped in maintaining total flow of resources to commercial sector at about last year’s level with the help of 58 per cent higher corporate bond issuances by non- financial entities during April-October 2020 compared with same period in the preceding year. So, this large liquidity infusion served a very important role in preventing meltdown of markets in Q1 of 2020, reversing the spike in financial spreads observed in March, averting acute credit crunch, thwarting tightening of financial conditions that could have plummeted economy into a deep recession with its domino effects on financial stability that could have further complicated policy choices.
53. The money supply growth so far this year has been reasonable. It has accommodated the shock to growth and substantially compensated for the steep drop in velocity of money that saw demand for currency to spike in Q1. However, going forward, at a point when expansion of activity takes firmer roots, recalibration of policies will become essential. In my assessment, given that output gap will close only in H2 of 2021-22, there is time to normalise monetary policy. As the pandemic shock created a huge negative output gap, even with high weight to core inflation along with lower weights to headline inflation and output gap, the projected path of these variables leaves time before policy rate hikes will become necessary. This is simply because the pandemic shock has left a huge negative output gap. If output gap closes faster than anticipated, core CPI inflation surges on back of observed momentum in some WPI inflation components or more supply-side shocks lead to generalisation of inflation, policy will need to respond appositely. I am labouring to explain this point because accommodative monetary policy has been misread by some as demise of inflation targeting. Quite to the contrary, current policies are consistent with the flexible inflation targeting mandate and hard empirical calculations of how monetary policy needs to react to projected path for key variables. The framework itself has delivered unambiguous gains in disinflating the economy and lowering inflation expectations.
54. Monetary policy under the inflation targeting strategy requires policy to be informed by economic analysis. Liquidity, credit and monetary aggregates will need to be closely monitored in this context with an eye on macro-financial stability that can be enervated when short-term borrowing costs fall below the operational policy rate. If this results in persistence of negative real rates for too long, it can adversely affect savings, lend support to mispricing of financial asset prices and encourage excessive leveraging. As such, other policies outside the flexible inflation targeting framework, such as macroprudential and strengthening the instruments of sterilisation in view of surge in capital inflows in recent months may be needed to mitigate these risks.
55. Considering the growth and inflation projections and other considerations enumerated above, I vote to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 4.0 per cent. I also vote for retaining the accommodative stance and accompanying forward guidance. Statement by Dr. Michael Debabrata Patra
56. I vote for status quo on the policy rate at this juncture and to maintain the accommodative stance of policy as articulated in the October 2020 resolution: 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.
57. The preponderant weight assigned by the monetary policy committee (MPC) to growth relative to inflation since the outbreak of COVID-19 appears to be yielding dividends – a much shallower than anticipated contraction in the economy in Q2:2020-21; strengthening incoming data in Q3 so far. A Beveridge-Nelson type trend cycle decomposition of real GDP (seasonally adjusted) indicates that the economy is perched on the shoulder of the recovery phase of the underlying cycle. Investment, followed by exports and private consumption, are the drivers of the recovering demand momentum, offsetting the drag from the decline in government spending. In terms of trends, government spending and exports remain stable, but private consumption and investment are on a downward trajectory.
58. As for the proximate indicators of aggregate demand embodied in the monetary aggregates – seasonally adjusted and smoothed by 5-year annualised averages – currency in circulation is still on the upswing and driving up reserve money, but the broader measures of deposits, bank credit and money supply are stabilising from a prolonged decline that started in 2010. In fact on a financial year basis, credit growth turned positive for the first time in 2020-21 in November. Key Monetary Aggregates: 5-year Annualised Growth Rate per cent Oct-96 Oct-97 Oct-98 Oct-99 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 Oct-20 Apr-96 Apr-97 Apr-98 Apr-99 Apr-00 Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 Currency with the Public Aggregate Deposits Bank Credit Reserve Money Money Supply (M3)
59. On the supply side, manufacturing, followed by construction and trade services, are leading the cyclical upturn. Business optimism is also reflected in the buoyancy in order books and the pick-up in capacity utilization of manufacturing and services firms.
60. With growth gaining cyclical momentum, the window available to the MPC to look through inflation pressures is narrower than before. The wedge of 6.1 percentage points between WPI and CPI inflation in the October 2020 readings is elevated relative to the historical record – an average of 3.0 percentage points between 2015 and 2019, and 4.3 percentage points in February 2020 before COVID struck. More than half of this divergence is due to a combination of retailer margins in food prices (amplified by its higher weight in CPI than in the WPI), the sharp increase in taxes on petroleum products and alcoholic beverages in the post-COVID period (which are not captured in the WPI), and high prices of non-traded services such as healthcare, transport and personal services. Depressed input costs are widening the gap on the downside. Costs of sanitisation, social distancing, and of doing business have contributed to the higher retail mark- ups in goods and services, and thereby to the difference between WPI and CPI inflation.
61. Elevated inflation has checked in and may be here to stay. With retailers striving to recover lost incomes, it is unlikely that margins will ease in the near-term. Meanwhile, households recouping lost incomes may work towards keeping the supply price of services elevated. Returning cyclical demand, backed by improving business and consumer expectations, may allow a higher pass-through of input prices into selling prices as businesses endeavour to preserve profit margins. This is also reflected in expectations of surveyed manufacturing firms and persisting pessimism among consumers on the price situation.
62. Economic activity is recovering but hesitantly and unevenly. This warrant continuing policy support till it is set on a firm trajectory of self-sustaining expansion. At the same time, the confluence of forces determining inflation outcomes and their likely persistence imparts downside risks to growth, unless contained early. Amidst this high uncertainty, the MPC’s dilemma around its window of accommodation has become more acute than at the time of its last meeting. Statement by Shri Shaktikanta Das
63. Over the last two months it has become increasingly clear that the recovery underway is faster than what was anticipated at the time of the October policy, although it must also be noted that overall activity is still below its level a year ago. Meanwhile, inflationary pressures have continued unabated, posing challenges for monetary policy.
64. The Q2:2020-21 contraction in GDP turned out to be lower than projected at the time of October 2020 policy. In Q3:2020-21 so far, various high frequency indicators also suggest further strengthening of the momentum in economic recovery. Rural demand continues to be the main driver of growth with rabi sowing progressing well due to congenial soil and reservoir conditions. Urban demand is also showing signs of turning a corner. The Reserve Bank’s consumer confidence survey of urban areas has registered a marginal uptick in November 2020 from its trough in September. Optimism on early vaccine availability has also boosted economic sentiments.
65. As per my assessment, the recovery is multi-speed as more sectors are showing an upturn, though the improvement is not steady and continuous yet. In October, there was a double-digit growth in passenger vehicles and motorcycle sales, railway freight traffic, and electricity consumption. Demand conditions in the manufacturing sector, according to the Reserve Bank’s industrial outlook survey, improved notably during Q3:2020-21 over Q2:2020-21, driven by easing of lockdowns and re-opening of businesses. Early results of order books, inventories and capacity utilisation survey suggest that the capacity utilisation (CU) in the manufacturing sector is recovering, increasing to 61.7 per cent in Q2:2020-21 from 47.3 per cent in Q1:2020-21, although still lower than its long-term average. The expansion of the production-linked incentive (PLI) scheme to 10 more sectors is expected to boost manufacturing and exports.
66. Investment demand in the economy is still to gain traction even as the transmission of policy rate actions has been sharper and quicker. Corporate bond yields have seen a significant reduction. Investment-related indicators such as imports and production of capital goods and consumption of steel and cement posted some sequential improvement in October. Corporate finances in Q2:2020-21 indicated some signs of recovery in demand conditions with profit margins rising due to savings in expenditure. Debt servicing capacity for manufacturing companies, measured by interest coverage ratio, improved in Q2:2020-21 with rise in profits. While investment in fixed assets is muted, increased cash holdings, reduced leverage and improved profitability suggest that investment activity could rebound quickly as conditions normalise with the flattening of the COVID curve and the availability of vaccines.
67. Non-food credit growth in November 2020 accelerated and moved into positive territory on a financial year basis for the first time in 2020-21. Total flow of resources to the commercial sector from banks and non-banks is also running close to last year, thus creating enabling domestic financial conditions to sustain and strengthen the recovery process. Since February 6, 2020 the Reserve Bank has announced liquidity augmenting measures of ₹12.7 lakh crore (6.3 per cent of nominal GDP of 2019-20). Reflecting the various liquidity management measures and the supportive market operations undertaken by the Reserve Bank in fostering market confidence and strengthening financial stability, there has been a narrowing of term and risk premia in various market segments. Yields on government securities, commercial paper (CP), 91-day treasury bills, certificates of deposit (CDs) and corporate bonds have softened appreciably. Corporate bond spreads have broadly receded to pre-COVID levels.
68. The fiscal measures announced so far are a balanced mix of consumption, liquidity and investment measures, which have been sequenced as per the evolving situation. A calibrated shift in focus from consumption expenditure under Pradhan Mantri Garib Kalyan Package (PMGKP) to liquidity support under AatmaNirbhar 1.0 to investment expenditure under AatmaNirbhar 2.0 and 3.0 is clearly visible. On the whole, it is expected that the calibrated stimulus provided by the government is likely to flow through the economy through multiple channels - private consumption, fixed capital formation and push from the supply side. Increase in government expenditure during the remaining part of the year will provide further impulses to growth. Given the large multipliers for capital spending, the recent trend of cuts in States’ capital outlays needs to be reversed. As strong capex multipliers for both central and state capital expenditure kick in, crowding in of private investment could take place, all of which is critical during a revival phase. Overall, the recovery is likely to gain further traction in Q3:2020-21 and Q4: 2020-21.
69. On inflation front, a combination of cost-push factors including supply side disruptions, sharp increase in international commodity prices, high retail margins and elevated taxes on petroleum products by both Centre and States have kept inflation above the upper tolerance band of the inflation target. The October 2020 CPI surprised on the upside, both in terms of the extent and depth of price pressures.
70. Going forward, stronger measures to address the supply side issues and the winter moderation in vegetable prices should result in some softening in inflation from its current levels. Continuing demand supply mismatches in protein-based food and edible oils would require active supply side measures. The Reserve Bank is constantly engaged with the concerned authorities for undertaking supply-side measures to contain inflation. The improved prospects of a bumper kharif harvest and favourable rabi season should also keep cereal prices in check. The inflation expectations survey of households indicates a modest softening in both three-month and one-year ahead inflation expectations, though median inflation expectations continue to remain at elevated levels.
71. Overall, the persistence of inflation at elevated levels constrains monetary policy at the current juncture. At the same time, though recovery is underway, there is still continuous need to nurture and support growth to make it broad based and durable. A premature roll back of the monetary and liquidity policies of RBI would be detrimental to the nascent recovery and growth. The overall situation needs to be monitored carefully, both in the sides of growth and inflation. On balance, therefore, I vote to keep the policy rate unchanged and 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. We need to monitor closely all threats to price stability and possible spill overs to broader macroeconomic and financial stability. The Reserve Bank will continue to respond to global spill overs to secure domestic stability with our liquidity management operations. The various instruments at our command will be used at the appropriate time, calibrating them to ensure that ample liquidity is available in the system. (Yogesh Dayal) Press Release: 2020-2021/804 Chief General Manager
6. The global economic recovery slackened in Q4 (October-December) of 2020 relative to Q3 (July-September) as several countries battle second waves of COVID-19 infections, including more virulent strains. With massive vaccination drives underway, risks to the recovery may abate and economic activity is expected to gain momentum in the second half of 2021. In its January 2021 update, the International Monetary Fund (IMF) has revised upward its estimate of global growth in 2020 to (-)3.5 per cent from (-) 4.4 per cent and increased the projection of global growth for 2021 by 30 basis points to 5.5 per cent. Barring some emerging market economies, inflation remains benign on weak aggregate demand, although rising commodity prices carry upside risks. Financial markets remain buoyant, supported by easy monetary conditions, abundant liquidity and optimism from the vaccine rollout. Global trade is also expected to rebound in 2021, with services trade on a slower recovery than merchandise trade. Domestic Economy
7. The first advance estimates of GDP for 2020-21 released by the National Statistical Office (NSO) on January 7, 2021 estimated real GDP to contract by 7.7 per cent, in line with the projection of (-)7.5 per cent set out in the December 2020 resolution of the MPC. High frequency indicators – railway freight traffic; toll collection; e-way bills; and steel consumption – suggest that revival of some constituents of the services sector gained traction in Q3 (October-December). The agriculture sector remains resilient - rabi sowing was higher by 2.9 per cent year-on-year (y- o-y) as on January 29, 2021, supported by above normal north-east monsoon rainfall and adequate reservoir level of 61 per cent (as on February 4, 2021) of full capacity, above the 10 years average of 50 per cent.
8. After breaching the upper tolerance threshold of 6 per cent for six consecutive months (June-November 2020), CPI inflation fell to 4.6 per cent in December on the back of easing food prices and favourable base effects. Food inflation collapsed to 3.9 per cent in December after averaging 9.6 per cent during the previous three months (September-November) due to a sharp correction in vegetable prices and softening of cereal prices with kharif harvest arrivals, alongside supply side interventions. On the other hand, core inflation, i.e. CPI inflation excluding food and fuel remained elevated at 5.5 per cent in December with marginal moderation from a month ago. In the January 2021 round of the Reserve Bank’s survey, inflation expectations of households softened further over a three month ahead horizon in tandem with the moderation in food inflation; one year ahead inflation expectations, however, remained unchanged.
9. Systemic liquidity remained in large surplus in December 2020 and January 2021, engendering easy financial conditions. Reserve money rose by 14.5 per cent y-o-y (on January 29, 2021), led by currency demand. Money supply (M3), on the other hand, grew by only 12.5 per cent as on January 15, 2021, but with non-food credit growth of scheduled commercial banks accelerating to 6.4 per cent. Corporate bond issuances at ₹5.8 lakh crore during April-December 2020 were higher than ₹4.6 lakh crore in the same period of last year. India’s foreign exchange reserves were at US$ 590.2 billion on January 29, 2021 – an increase of US$ 112.4 billion over end-March 2020. Outlook
10. With the larger than anticipated deflation in vegetable prices in December bringing down headline closer to the target, it is likely that the food inflation trajectory will shape the near-term outlook. The bumper kharif crop, rising prospects of a good rabi harvest, larger winter arrivals of key vegetables and softer egg and poultry demand on avian flu fears are factors auguring a benign inflation outcome in the months ahead. On the other hand, price pressures may persist in respect of pulses, edible oils, spices and non-alcoholic beverages. The outlook for core inflation is likely to be impacted by further easing in supply chains; however, broad-based escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices could impart upward pressure. Furthermore, there could be increased pass-through to output prices as demand normalises as indicated in the Reserve Bank’s industrial outlook, services and infrastructure outlook surveys and purchasing managers’ indices (PMIs) and firms regain pricing power. International crude oil prices may remain supported by demand build up on optimism from vaccination and continuing production cuts by OPEC plus. The crude oil futures curve has become downward sloping since December 2020. Taking into consideration all these factors, the projection for CPI inflation has been revised to 5.2 per cent in Q4:2020-21, 5.2 per cent to 5.0 per cent in H1:2021-22 and 4.3 per cent in Q3: 2021-22, with risks broadly balanced (Chart 1).
11. Turning to the growth outlook, rural demand is likely to remain resilient on good prospects of agriculture. Urban demand and demand for contact-intensive services is expected to strengthen with the substantial fall in COVID-19 cases and the spread of vaccination. Consumer confidence is reviving and business expectations of manufacturing, services and infrastructure remain upbeat. The fiscal stimulus under AtmaNirbhar 2.0 and 3.0 schemes of government will likely accelerate public investment, although private investment remains sluggish amidst still low capacity utilisation. The Union Budget 2021-22, with its thrust on sectors such as health and well-being, infrastructure, innovation and research, among others, should help accelerate the growth momentum. Taking these factors into consideration, real GDP growth is projected at 10.5 per cent in 2021-22 – in the range of 26.2 to 8.3 per cent in H1 and 6.0 per cent in Q3 (Chart 2).
12. The MPC notes that the sharp correction in food prices has improved the food price outlook, but some pressures persist, and core inflation remains elevated. Pump prices of petrol and diesel have reached historical highs. An unwinding of taxes on petroleum products by both the centre and the states could ease the cost push pressures. What is needed at this point is to create conditions that result in a durable disinflation. This is contingent also on proactive supply side measures. Growth is recovering, and the outlook has improved significantly with the rollout of the vaccine programme in the country. The Union Budget 2021-22 has introduced several measures to provide an impetus to growth. The projected increase in capital expenditure augurs well for capacity creation thereby improving the prospects for growth and building credibility around the quality of expenditure. The recovery, however, is still to gather firm traction and hence continued policy support is crucial. Taking these developments into consideration, the MPC in its meeting today decided to continue with an accommodative stance of monetary policy till the prospects of a sustained recovery are well secured while closely monitoring the evolving outlook for inflation.
13. All members of the MPC – Dr. Shashanka Bhide; Dr. Ashima Goyal; Prof. Jayanth R. Varma; Dr. Mridul K. Saggar; Dr. Michael Debabrata Patra; and Shri Shaktikanta Das – unanimously voted for keeping the policy repo rate unchanged at 4 per cent. Furthermore, all members of the MPC voted 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.
14. The minutes of the MPC’s meeting will be published by February 22, 2021.
15. The next meeting of the MPC is scheduled during April 5 to 7, 2021. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. The First advance estimates (FAE) of GDP for 2020-21 released by the National Statistical Office (NSO) on January 7, 2021 place the annual growth of GDP in constant prices at -7.7 per cent over the previous year. The NSO notes that these estimates are likely to see sharp revisions in view of the limitations of the data used, in the context of the Covid-19 pandemic. The official estimates of GDP for Q3: 2020-21 are expected to be available only in the last week of February along with the Second Advance Estimates for 2020-21.
17. The sectoral level breakup of annual output growth reveals that the steepest decline in FY 21 is in the services (including construction) by 9.2% followed by a decline of 8.5 per cent in industry over the previous year. Agriculture & Allied Sectors GVA increased by 3.4 per cent as per FAE. Key to projected sustained recovery in output performance in FY21 after the sharp decline in Q1 remains with (1) sustained growth of agriculture and allied activities and (2) output of industry and services in H2: FY21 reaching close to the levels of H2: FY20.
18. The pattern of growth recovery across sub-sectors of the economy points to the emergence of sustained recovery, although there are risks associated with the nascent nature of the recovery, which requires support from both its internal dynamics and exogenous factors. Internal dynamics refers to the interlinkages across sectors and the supply chains including global linkages and translation of improving supply conditions to investment decisions. As many of the external restrictions on movement and activities due to the pandemic are now lifted, the impact of such liberalisation is evident in many indicators available for Q3: 2020-21. The indicative results on sales or turnover for a sample of 445 listed non-financial private companies indicate positive growth in the case of manufacturing and IT firms. In the case of non-IT services firms, sales growth in Q3 is negative but less contractionary than Q2: 2020-21. A survey of manufacturing companies by RBI shows improved capacity utilisation for Q3: 2020-21. High frequency data for the months of October-December show high year on year growth rates for railway freight e-way bills, and trade transactions reflected in the GST collections. In the case of e-way bills and GST collections the growth rates are slightly lower in January 2021 but remain high. The important concerns relate to the demand conditions. The rise in demand in the ‘festival season’ played its part in catalysing consumer demand during September-November period and sustaining this demand requires restoration of household income and employment.
19. The surveys of business sentiments and outlook indicate improvement in the business conditions from the severe shock in Q1: 2020-21. The RBI’s survey of enterprises (Industrial Outlook Survey) shows improvement in demand conditions in Q3: 2020-21 in the case of manufacturing, services and infrastructure. Demand conditions are expected to improve further in Q4: 2020-21 and in the first two quarters of 2021-22. Business sentiments are clawing back to the levels seen just before the onset of lockdowns due to the pandemic. Enterprise survey indicates that firms are planning to hire more workers and the staff costs in the case of organised sector show increase in Q3: 2020-21 year-on-year basis, compared to the decline in the previous quarter. The overall picture that emerges is one of improving business conditions and expectations of sustaining this trend into the next few quarters.
20. One of the pre-requisites of sustained economic recovery is the control over the pandemic. The recent data suggests that the incidence of new infections has declined. However, the experience in several countries suggests that there is need to be cautious on this score and the decline in new infections and mortality cannot be taken for granted, especially in view of the new strains of the Corona virus. Availability of vaccines has provided much needed confidence that the pandemic would give way to restoration of normal economic life, even if gradually. The ongoing recovery, based on the perceptions of decline of new infections, will require all measures to sustain this decline in reality. Accelerated progress of vaccinations and access to the key health services to battle new infections would be a crucial factor in maintaining the confidence of producers and consumers in the economy.
21. The cautious consumption expenditure outlook is reflected in the findings of RBI’s Consumer Confidence Surveys. The improvement in Consumer Confidence reflected in the assessment of expenditure is significant in the longer one-year horizon than the present situation. The improvement seen in November 2020 dropped marginally in January 2021 survey, both in the current period and one year ahead. As per the FAE, the government final consumption expenditure rose by 5.8 per cent in FY21 as a whole, while the private final consumption expenditure declined.
22. While measures to address the local and domestic conditions related to both the economy and the pandemic have borne fruit, the global conditions appear diverse as far as the pandemic is concerned. While the vaccinations are making progress in the Advanced Economies, there has been a rise in Covid infections in the winter months. The World Economic Outlook by IMF has projected the world output to rise in 2021 by 5.5 per cent after the decline by 3.5 per cent in 2020. The output growth in 2021 after the decline in 2020 is projected for both Advanced Economies and Emerging Market Economies. Among the major economies, only China has managed to show a positive output growth in 2020. The World Trade Volumes of goods and services are also expected to recover from the steep decline in 2020. The global demand scenario has become optimistic but will face the challenge of restoring the disrupted supply chains.
23. Recovery in investment demand is a key factor in sustaining the economic recovery. As per the FAEs, the Gross Fixed Capital Formation (GFCF) declined by 14.5 per cent in FY 21, year on year basis. The GFCF had also decreased, year on year basis, in 2019-20 based on provisional estimates for 2019-20. The IIP for capital goods increased in October 2020, year-on-year basis, for the first time after December 2018. The IIP for infrastructure and construction goods, linked to investment spending has also shown positive growth in the two consecutive months, September and October 2020. Part of the explanation for the weak investment demand appears to be weak capacity utilisation in industry. Therefore, sustaining the on-going improvement in the demand conditions to restore capacity utilisation levels is necessary to catalyse investment demand. The strong FDI inflows in April-November 2020, surpassing the levels in the same period a year back point to the attractiveness of investment in the country but revival of the broader domestic investments is yet to be realised.
24. The Union Budget 2021-22 has laid out a number of growth orientated policies and programs, that include increased expenditure in specific sectors and also capital expenditure. Given the sharp reduction in revenues in FY21, the fiscal consolidation path now sets the fiscal deficit target below 4.5 per cent of GDP by 2025-26 from 9.5 per cent in FY21 and budget estimate of 6.8 per cent for FY22. High rates of economic growth sustained over the medium term will be needed to achieve fiscal consolidation.
25. The need for revival of economic activities back to the pre-pandemic levels and then at a pace that is consistent with income and employment goals remains prominent in the present economic policies. As the supply side restrictions are lifted, revival of demand in terms of consumption, investment and exports is needed to sustain economic recovery.
26. The recovery of economic activity from the pandemic shock has also been accompanied by relatively high rates of retail inflation. Between June and November 2020, the inflation rate has ranged between 6.2 and 7.6 per cent, in each month. The rate declined in December 2020 to 4.6 per cent. While the recent rise and decline in the inflation rate were amplified by food inflation, the core inflation has remained between 5.4-5.9 per cent during July - December 2020. The prospect of good rabi crop harvest is expected to exert downward pressure on the agricultural commodity prices in the coming months. Easing of the pressures in the non-food sector will require easing of some of the key input costs such as transportation services and energy, both by improved supply conditions and productivity. Easing the price pressures in the non-food sector will be required to achieve revival of consumer demand as well.
27. The present scenario reflects continued revival of the economy after the severe decline in GDP in Q1: 2020. For the financial year 2020-21 as a whole, the FAE by NSO estimate GDP to decline by 7.7 per cent over the previous year, indicating the severity of the shock in Q1. The economy is expected to reach the GDP level of Q3 of 2019-20 by the third quarter of 2020-21. The sustained economic recovery will require continued decline in the number of Covid infections to regain consumer confidence with successful roll out of vaccinations being a key strategy to achieve this.
28. Accommodative monetary policy stance is needed to strengthen ongoing economic recovery enabling expansion of both output and demand.
29. I vote in support of the resolution to keep the policy repo rate unchanged at 4 per cent and further 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. Statement by Dr. Ashima Goyal
30. In the months since the December 2020 MPC meeting growth has exceeded market expectations and headline inflation has also come in below expectations, falling within the MPC tolerance band after 6 months. The country has done well in avoiding a second peak until now under a well-sequenced gradual unlock, careful testing and tracing. Its vaccination drive has begun. New more deadly variants of the virus remain a risk, however, requiring continuing care and acceleration of vaccination.
31. Although growth has turned positive, output levels remain below 2019 levels. Excess capacity continues, supply chains have room to normalize much further, and unemployment rates have increased despite a recovery in employment, because of the rise in labour participation rates as willingness to work rose with the waning of Covid-19 fears. While corporate India has done well, and consumer confidence is reviving, reliable data is still awaited on the resilience of the informal sector.
32. The timing and sequence of policy support has been crucial over the last year. Early liquidity support, moratorium and government warranties were vital for survival. Some of these measures have been reversed yet the financial sector remains healthy. Banks are reporting much lower than expected NPA growth as well as restructured loans as the early revival has enabled repayment.
33. Short term rates have risen to the reverse repo rate reducing risks, US Treasury bill rates are also moving up yet Indian long term rates, more important for demand, remain low and plentiful liquidity continues to sustain activity. Excess liquidity with the financial system is absorbed at the Reverse Repo window, or using other instruments, implying risk created is minimal. Money supply growth remains moderate, even as there is some rise in credit growth through diverse instruments. Quick response and very gradual withdrawal is a mantra that works for macroeconomic policy as well as for India’s response to Covid-19.
34. Supply chains improved after unlock 4 in September 2020, which prevented states from imposing arbitrary restrictions on inter-state travel, in time for the festival demand stimulus. Public spending could take a backseat in Q2 and has revived in Q3. In Q4 and over the next year it has sought to increase the share of investment, which has a larger multiplier since it also improves the supply-side, thus lowering inflation and enabling monetary support through lower interest rates 1. The budget stimulus is largely through better quality spending, while the deficit itself reduces moderately. This relative fiscal conservatism also enables monetary policy flexibility to keep borrowing costs low.
35. Inflation presents a mixed picture. Prices of many food products have softened bringing down headline inflation. Profiteering in retail supply has not been able to withstand excess supply, although data shows only the beginning of reduction in retail margins.
36. Core inflation, however, remains near the upper band. The severe winter Covid-19 second spikes in many countries have kept global supply chains disrupted and raised prices of many intermediate goods and commodities. As demand revives local firms are able to pass on the rise in costs. But this is likely to be temporary, although uncertainty remains about the timeline. Rapid vaccination is already moderating spikes abroad making room for the supply response to improve. Oil has a much faster supply response now because of shale oil as well as green substitutes, capping future rise in prices. Gold prices that impact Indian core inflation are falling as vaccination spreads.
37. For the last so many years manufacturing inflation has been low in India—a factor responsible for the wide gap between WPI and CPI inflation. One reason is India is a very competitive price sensitive market. Manufacturers pricing power is temporary and will not survive the full resumption of supply it will attract. Many firms have reduced costs over the last year, which also gives them the ability to absorb some rise in input prices. Mark-ups tend to be counter- cyclical, falling as capacity utilization rises and fixed costs are spread.
38. The fall in short-term household inflation perceptions shows that households are observing improvements in retail supply—as yet more for perishables. Sustained double-digit one year ahead inflation expectations seem to be due to higher uncertainty since the dispersion across households’ expectations has risen. There is evidence of some success in anchoring expectations in the inflation See Goyal, Ashima and Bhavya Sharma. 2018. ‘Government Expenditure in India: Composition, Cyclicality and Multipliers’. Journal of Quantitative Economics, 16(1): 1-39. DOI: https://doi.org/10.1007/s40953-018-0122-y. targeting period 2. That inflation has returned within the tolerance band even in the very difficult Covid-19 period should further improve its credibility and reduce uncertainty.
39. The current macroeconomic configuration and its expected future evolution as outlined above implies there is space for the MPC to continue to support the revival of the economy with inflation remaining in the target band. Therefore, I vote to maintain the status quo in policy rate and stance. Statement by Prof. Jayanth R. Varma
40. I support maintaining the policy rate at its current level and I also support the accommodative stance as these decisions are consistent with the forward guidance provided by the MPC in its last two meetings (October and December 2020). With both inflation and growth outcomes being well within the range of expectations of the MPC, and short term interest rates being within the corridor defined by the repo and reverse repo rate, there is nothing to be done and there is nothing to be said as of now. The MPC must of course continue to be data driven and must continue to monitor future developments carefully. Statement by Dr. Mridul K. Saggar
41. The MPC call to hold policy rates despite inflation staying elevated above the upper tolerance level during H2 of 2020 was based on the assessment that inflation will recede going forward. This was a difficult call given the observed persistence in inflation. It enabled the monetary policy to afford a countercyclical support to growth in a rather critical period that could otherwise have resulted in extensive scaring of big and small businesses and a large hysteresis in aggregate output. Had this happened, India’s growth trajectory would have been pulled down for a long time to come.
42. There was recognition of risks while taking this call, especially as there was some evidence that price pressures were starting to get distended with elements of cost-push pressures emerging. Nevertheless, when CPI data was available only till August, in my statement at the October MPC I stated that vegetable prices should correct starting December. Vegetable prices dropped 15.7 per cent month-over-month in December, bringing headline inflation down from 6.9 per cent to 4.6 per cent - within the tolerance band for the first time in seven months. This inflation correction bears testimony to careful projections and judgment that by keeping policy accommodative, enabled avoiding what could have been a costly policy mistake.
43. Since monetary policy is forward-looking, there is little point in looking back except for the limited purpose of drawing lessons. Given the long and variable transmission lags, we now need to focus on carefully assessing not just the baseline inflation trajectory but also the risks to it, the nature of inflation and its internals going forward.
44. Two things are noteworthy. First, bulk of the food-price correction in CPI has already happened. From the DCA data till January it looks that food prices are at near bottom and though they may start firming up from Q1:2021-22 with some price build up aided partly from firming food and non-food international commodity prices, high food inflation like last year is unlikely to See Goyal, Ashima and Parab Prashant 2020. What Influences Aggregate Inflation Expectations of Households in India? Journal of Asian Economics, Available online November 20, https://www.sciencedirect.com/science/article/abs/pii/S1049007820301408 be repeated. However, cost-push increases may come from higher crude oil prices that will feed into costs, especially fertiliser prices and as they get factored in MSPs.
45. Second, some upside risk to inflation comes from core inflation stickiness and its persistence at elevated levels that may make the task of keeping the headline at the 4 per cent target a challenging one. There is evidence that firms are able to pass on cost push increases by raising retail prices. Early corporate results for Q3:2020-21 suggests that margins are rising steeply in automobiles and components, metals, chemicals, capital goods, health care services, telecommunication and real estate. Not all of this is through cost saving. Price hikes have been reported in items of iron ore, steel, automobiles, yarn, textiles, chemical and chemical products, rubber products besides oilseeds and edible oils, some of which may get reflected in next three months in WPI and CPI indices. Mineral oil prices have also witnessed increases.
46. There is a significant probability that global oil prices may turn out to be markedly higher than the current prevailing prices given the possibility of a large US dollar depreciation this year and signals sent last month by the largest OPEC oil producer by announcing additional supply restraint. Even though the relationship between dollar movements and oil prices has relatively weakened in recent years, the large dollar invoicing of global commodities trade can not only cause an upswing in commodity prices but through financial market interdependencies may cause ripple effects in asset prices, inflation and business cycles. Effect on equities of changes in global nominal and real bond yields and financial market spillovers to EMEs may particularly cause macroeconomic shifts. How the challenges of trilemma amid capital flow volatility are handled with less than corner solutions will influence the monetary policy and inflation outcomes, though a weaker dollar ceteris paribus also means stronger rupee, which will somewhat offset the effect of firmer global oil prices.
47. However, one can draw considerable comfort from the fact that the core inflation stickiness is embedded in our baseline projections and fully accounts for the trend in momentum. Also, empirical exercises suggest that while the passthrough from 1 per cent change in WPI non-food manufactured products inflation to CPI core goods inflation is likely to be about 0.20 per cent, the passthrough is much less for overall CPI core inflation and even lesser to headline CPI inflation. However, this passthrough is time varying and depends on output gap. When IIP output gap is positive, the passthrough on an average is about double that when it is negative. Though strong momentum in core goods CPI has taken its inflation to 6.9 per cent, some solace comes from the fact that ex-gold, petrol. diesel and liquor, the core goods inflation is only at 4.9 per cent. Also, as contact services may take long to normalise, core services inflation is unlikely to surge in near term. So, as of now the risks of headline inflation coming back are, therefore, contained in line with our projections.
48. So, let me turn to growth. I will just make two points. First, faster than anticipated, most manufacturing and rural high frequency indicators have already normalised past pre-pandemic levels. However, services sector indicators such as commercial vehicle sales, registration of transport vehicles, three-wheeler sales, domestic and international air passenger traffic, international cargo, railway passenger traffic, retail and recreation and foreign tourist arrivals are languishing much below those levels. Second, hysteresis is visible to some degree with anecdotal evidence of some micro-enterprises and informal unincorporated household enterprises having permanently closed production shops. Quantitative estimates using a range of methods show that even without further disruptions, output gap is unlikely to close before 3Q:2021-22 and more likely only by the end of the next fiscal year. As growth is still fragile, support to it need to be extended into Q1:2021-22 and longer if necessary, though with risk of a re-calibration in some scenarios such as one in which core inflation momentum picks up further. Since this is not the baseline and the announced exit dates for various measures are planned at a very gradual pace, the process of change in policy can be non-disruptively achieved.
49. In my October statement, I had stated that as fiscal authorities have a first mover advantage in the game of chickens, monetary policy will naturally have to factor this to avert Nash equilibria. With the second successive year of very large gross market borrowing, this is even more important. Monetary policy will need to lean against the wind to keep interest rates low to the extent possible. If central bank open market operation purchases are moderate, it entails the risk of crowding out of private investment; if they are large, it carries risk of reengineering inflation. However, with capacity utilisation rate currently at 63 per cent in Q2:2020-21 and likely to be about 70 per cent by end of the year, capex funding need of private sector are currently limited and the monetary- fiscal coordination to support a larger public investment that can crowd-in private investment can work so long as it is followed by an unflinching commitment to strong fiscal consolidation thereafter.
50. In conclusion, going forward, while efforts should continue to extend output expansion and close output gap, a necessary concomitant for monetary policy is to secure price stability. With headline inflation having already corrected as supply shocks have substantially faded, keeping inflation around the target is the best contribution monetary policy can make to fortify and sustain growth. In my statement, I have focussed more on risks than the baseline. In my view, the baseline is still consistent with supporting growth through accommodative policy stance in near term. Therefore, I vote to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 4.0 per cent. I also vote for retaining the accommodative stance and accompanying forward guidance. Statement by Dr. Michael Debabrata Patra
51. Macroeconomic configurations have shifted and brightened the outlook. Estimates/projections indicate that GDP growth may have attained positive territory in the second half of 2020-21, mainly on the back of a surge in government expenditure but contractions in private consumption spending are also easing and net exports are finally emerging out of a long retrenchment. Foreign investment flows are already scenting the imminent upturn. On the supply side, agriculture and allied activities are clearly demonstrating resilience in the face of the pandemic, and manufacturing activity is gradually limping back to growth on the back of recovery in sales. This is also evident in rising capacity utilization. With stronger demand conditions and still moderate costs, operating profits are improving across the board. Some categories of services such as information technology, construction, real estate, finance, domestic trade and transport are slowly healing from the deep scars left by the virus but several other categories of services remain deeply wounded due to their contact-intensity. Consumer and business confidence is either cautiously returning to expansion or already in it. These developments vindicate the stance of monetary policy.
52. The most heartening feature of the recent shifts is the large fall in inflation, taking it closer to the target after 6 months of persisting outside the tolerance band. If the sharp disinflation in vegetable prices extends into the spring, headline inflation can ease further, empowering the conduct of monetary policy. Meanwhile, mending of supply chains and normalization of activity is underway, especially recouping of lost incomes by both households and businesses, and that is keeping mark-ups and blue-collar wages elevated. It is worthwhile to note that households have internalised this outcome in their near-term inflation expectations polled in January 2021 – while current inflation perceptions and expectations three months ahead have declined, those for a year ahead remain flat amidst considerable uncertainty.
53. Upside risks to the outlook for inflation persist. First, core inflation remains stubborn and will warrant close monitoring as it has the potential to render the recent fortuitous improvements in the macroeconomic outlook stillborn. Second, rising international commodity prices are being watched the world over with concern as heralding the return of inflation. For India, the relentless hardening of international crude prices is worrisome, especially as their impact on inflation is amplified by disproportionately high excise duties. Third, crude and other commodity prices are translating into higher inputs costs, especially in an environment in which demand is recovering. Pricing power could gain bite as normal demand flows gather traction. Fourth, the flush of capital flows favouring emerging market economies, including India, has imparted volatility to asset prices and increased the risks of imported inflation.
54. Overall, the near-term outlook for inflation appears less risky than the near-term challenges for growth which warrant continuing policy support, at least until the elusive engine of investment fires and consumption, the mainstay of aggregate demand in India, stabilizes. Trade- offs facing the conduct of monetary policy may become sharper in the near-term, however. First, shocks to economic activity from the winding down of exceptional pandemic measures will have to be balanced against the persuasive incentive to continue with them but with the risk of becoming immobilized in liquidity traps. Second, concerns about financial stability have risen. The recent new highs scaled by equity markets could be driven by irrational exuberance; it is difficult to tell in an environment of exceptionally low interest rates all around, large corporate profits but still no capex to write home about, and high levels of market borrowings. Banks have stronger capital buffers than during the global financial crisis, but stress in the financial sector’s balance sheets could intensify as the camouflage of moratorium, asset classification standstill and restructuring fades. Capital infusion and innovative ways of dealing with potential loan delinquencies need to occupy the highest policy attention so that the embryonic recovery in credit growth can be nurtured into a more durable trajectory that also fuels the macroeconomic recovery. Strong complementarities are emerging between financial and macroeconomic stability. The best results will obtain when monetary policy ensures that the nominal anchor is firmly moored.
55. Against this backdrop, I vote for keeping the policy rate unchanged and for maintaining the accommodative stance of policy. Statement by Shri Shaktikanta Das
56. The macroeconomic environment – in terms of both growth and inflation – turned out to be better than anticipated since the December 2020 meeting of the MPC. These outcomes, along with the sharp reduction in COVID-19 infections in the country and the rollout of the vaccination programme, have brightened the outlook even though some uncertainties remain. The Union Budget 2021-22 has given further impetus through a qualitative shift in expenditure which will boost overall investment with multiplier effects on growth. Foreign direct investment and foreign portfolio investment to India have surged in recent months, reposing faith in an impressive recovery of the Indian economy.
57. On the global economy front, the International Monetary Fund (IMF), in its January 2021 update, has revised upward its projection of global growth for 2021 which augurs well for our external demand and exports.
58. High frequency indicators suggest that the economic recovery is normalising fast in both rural and urban areas. The agricultural sector has been resilient throughout the pandemic and its prospects appear bright in view of higher rabi sowing and comparatively better reservoir levels. Manufacturing activity is picking up. Although initial revival was propelled by pent-up demand, indications are that growth impulses are now being driven by pick-up in activity across manufacturing and services. Forward looking surveys conducted by the Reserve Bank signal greater optimism from manufacturing with the expectation of an expansion in production volumes and new orders in Q4:2020-21 and the following two quarters. The purchasing managers’ index for manufacturing is in expansionary zone and was above its long-period average in January 2021.
59. Trends in railway freight traffic, toll collection, goods and service tax collections, e-way bills and steel consumption suggest that services sector activity is also recovering. The purchasing managers’ index for services is in the expansion territory. Services and infrastructure sector reported increase in turnover in Q3 and expected further improvement through Q2:2021-22 as reported by firms participating in the Reserve Bank’s services and infrastructure survey.
60. The multiple dimensions of normalisation of economic activity, as reflected in the movement of coincident and proximate high frequency indicators, suggest that in 2021-22 the Indian economy will expand by about 10.5 per cent over 2020-21. These projections are based on the assessment of multispeed recovery which is underway, wherein some sectors are witnessing smart recovery, while consumption in contact intensive sectors, being discretionary in nature, could be postponed in near to medium-term.
61. Inflation which remained above the upper tolerance threshold of 6 per cent consecutively since June 2020, registered a larger than anticipated softening to 4.6 per cent in December, a drop by 2.3 percentage points from the November reading of 6.9 per cent. Around 90 per cent of this fall in headline inflation in December was on account of sharp movement of vegetables into double-digit deflation as prices crashed from highly elevated levels supported by robust winter arrivals and favourable base effect. This trend is likely to be further buttressed by an expected bumper kharif harvest and the rising prospects of a good rabi crop. Further softening in food inflation – both substantial and durable – would, however, be dependent upon the abatement of price pressures that are currently seen in pulses, edible oils, spices, and non-alcoholic beverages.
62. CPI inflation excluding food and fuel remained elevated at 5.5 per cent in December, due to inflationary impact of rising crude oil prices and high indirect tax rates on petrol and diesel, and pick-up in inflation of key goods and services, particularly in transport and health categories. Proactive supply side measures, particularly in enabling a calibrated unwinding of high indirect taxes on petrol and diesel – in a co-ordinated manner by centre and states – are critical to contain further build-up of cost-pressures in the economy.
63. Domestic financial conditions continued to remain accommodative to help nurture the recovery. The liquidity provision of ₹12.9 lakh crore (comprising 6.3 per cent of nominal GDP of 2019-20) since February 6, 2020 has kept systemic liquidity in surplus mode with average daily net absorptions under the liquidity adjustment facility (LAF) at around ₹5.9-6.0 lakh crore in December-January. Reflecting the various liquidity management measures, domestic financial conditions have eased considerably as reflected in the narrowing of term and risk premia in various market segments. Reserve money rose by 14.5 per cent y-o-y (on January 29, 2021), while money supply (M3) grew by only 12.5 per cent as on January 15, 2021.
64. The RBI’s liquidity operations, together with credible communication and explicit forward guidance have been important elements of our strategy during recent times. Explicit forward guidance goes a long way in soothing market apprehensions, particularly when sentiments are frayed during uncertain times. While “state-based” forward guidance or data contingent forward guidance was used occasionally by the MPC in the pre-COVID period, since October 2020 the MPC has started to offer “time-based” forward guidance. The commitment to keep accommodative stance “during the current financial year and into the next financial year” is reflective of a time- based guidance; whereas on the other hand, the expression “to revive growth on a durable basis” characterises a state-based guidance; i.e., guidance contingent on the state of the economy. Going ahead, market participants need to factor in the forward guidance with respect to the two-phase normalisation of the cash reserve ratio (CRR) which opens up space for a variety of market operations to inject additional liquidity through instruments like open market operations (OMOs), among others.
65. Consistent with the accommodative stance of the monetary policy, the Reserve Bank remains committed to ensure the availability of ample liquidity in the system to foster congenial financial conditions for the recovery to gain traction.
66. Growth, although uneven, is recovering and gathering momentum, and the outlook has improved significantly with the rollout of the vaccine programme in the country. The growth momentum, however, needs to strengthen further for a sustained revival of the economy and for a quick return of the level of output to the pre-COVID trajectory. The sharp correction in food inflation has improved the near-term headline inflation outlook, although core inflation pressures persist. Given the sharp moderation in inflation along with a stable near-term outlook, monetary policy needs to continue with the accommodative stance to ensure that the recovery gains greater traction and becomes broad-based. On balance, I vote to keep the policy repo rate unchanged and 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. (Yogesh Dayal) Press Release: 2020-2021/1134 Chief General Manager
6. Since the MPC’s meeting in February, lingering effects of the slowdown in the global economy in Q4 of 2020 have persisted, although recent arrivals of high frequency indicators suggest that a gradual but uneven recovery may be forming. The much anticipated boost to economic activity from the vaccination rollouts is being somewhat held back by new mutations of COVID-19, second and third waves of infections across countries and unequal access to vaccines more generally. World trade activity improved in Q4:2020 and January 2021. There are, however, concerns due to COVID-19-related fresh lockdowns and depressed demand in a few major economies, escalation in shipping charges and container shortages. Inflation remains benign in major advanced economies (AEs), although highly accommodative monetary policies and large fiscal stimuli have added to concerns around market-based indicators of inflation expectations, unsettling bond markets globally. In a few emerging market economies (EMEs), however, inflation is ruling above targets, primarily driven by firming global commodity prices. This has even prompted a few of them to raise policy rates. Equity and currency markets have been turbulent with the increase in long-term bond yields and the steepening of yield curves. More recently, however, calm has returned and major equity markets have scaled new peaks in March, while currencies are trading mixed against a generally firming US dollar. With the bond markets sell- offs, EME assets came under selling pressure and capital outflows imposed depreciating pressures on EME currencies in March. Domestic Economy
7. The second advance estimates for 2020-21 released by the National Statistical Office (NSO) on February 26, 2021 placed India’s real gross domestic product (GDP) contraction at 8.0 per cent during the year. High frequency indicators – vehicle sales; railway freight traffic; toll collections; goods and services tax (GST) revenues; e-way bills; and steel consumption – suggest that gains in manufacturing and services activity in Q3:2020-21 extended into Q4. Purchasing managers’ index (PMI) manufacturing at 55.4 in March 2021 remained in expansion zone, but lower than its level in February. The index of industrial production slipped into marginal contraction in January 2021, dragged down by manufacturing and mining. Core industries also contracted in February. The resilience of agriculture is evident from foodgrains and horticulture production for 2020-21, which are expected to be 2.0 per cent and 1.8 per cent higher respectively than the final estimates of 2019-20.
8. Headline inflation increased to 5.0 per cent in February after having eased to 4.1 per cent in January 2021. Within an overall food inflation print of 4.3 per cent in February, five out of twelve food sub-groups recorded double digit inflation. While fuel inflation pressures eased somewhat in February, core inflation registered a generalised hardening and increased by 50 basis points to touch 6 per cent.
9. System liquidity remained in large surplus in February and March 2021 with average daily net liquidity absorption of ₹5.9 lakh crore. Driven by currency demand, reserve money (RM) increased by 14.2 per cent (y-o-y) as on March 26, 2021. Money supply (M3) grew by 11.8 per cent as on March 26, 2021 with credit growth at 5.6 per cent. Corporate bond issuances at ₹6.8 lakh crore during 2020-21 (up to February 2021) were higher than ₹6.1 lakh crore during the same period last year. Issuances of commercial paper (CPs) turned around since December 2020 and were higher by 10.4 per cent during December 2020 to March 2021 than in the same period of the previous year. India’s foreign exchange reserves increased by US$ 99.2 billion during 2020- 21 to US$ 577.0 billion at end-March 2021, providing an import cover of 18.4 months and 102 per cent of India’s external debt. Outlook
10. The evolving CPI inflation trajectory is likely to be subjected to both upside and downside pressures. The bumper foodgrains production in 2020-21 should sustain softening of cereal prices going forward. While the prices of pulses, particularly tur and urad, remain elevated, the incoming rabi harvest arrivals in the markets and the overall increase in domestic production in 2020-21 should augment supply which, along with imports, should enable some softening of these prices going forward. While edible oils inflation has been ruling at heightened levels with international prices remaining firm, reduction of import duties and appropriate incentives to enhance productivity domestically could work towards a better demand-supply balance over the medium- term. Pump prices of petroleum products have remained high. Reduction of excise duties and cesses and state level taxes could provide some relief to consumers on top of the recent easing of international crude prices. This could slow down the propagation of second-round effects. The impact of high international commodity prices and increased logistics costs are being felt across manufacturing and services. Finally, inflation expectations of urban households one year ahead showed a marginal increase than over the three months ahead horizon according to the Reserve Bank’s March 2021 survey. Taking into consideration all these factors, CPI inflation is now projected as 5.0 per cent in Q4:2020-21; 5.2 per cent in Q1:2021-22, 5.2 per cent in Q2, 4.4 per cent in Q3 and 5.1 per cent in Q4, with risks broadly balanced (Chart 1).
11. Turning to the growth outlook, rural demand remains buoyant and record agriculture production for 2020-21 bodes well for its resilience. Urban demand has been gaining strength on the back of normalisation of economic activity and should get a fillip with the ongoing vaccination drive. The fiscal stimulus from increased allocation for capital expenditure under the Union Budget 2021-22, expanded production-linked incentives (PLI) scheme and rising capacity utilisation (from 63.3 per cent in Q2 to 66.6 per cent in Q3:2020-21) should provide strong support to investment demand and exports. Firms engaged in manufacturing, services and infrastructure polled by the Reserve Bank in March 2021 were optimistic about a pick-up in demand and expansion in business activity into 2021-22. Consumer confidence, on the other hand, has dipped with the recent surge in COVID infections in some states imparting uncertainty to the outlook. Taking these factors into consideration, the projection of real GDP growth for 2021-22 is retained at 10.5 per cent consisting of 26.2 per cent in Q1, 8.3 per cent in Q2, 5.4 per cent in Q3 and 6.2 per cent in Q4 (Chart 2).
12. The MPC notes that the supply side pressures on inflation could persist. It also notes that demand-side pull remains moderate. While cost-push pressures have risen, they could be partially offset with the normalisation of global supply chains. On imported inflation from global commodity prices, urgent concerted and coordinated policy actions by Centre and States can mitigate domestic input costs such as taxes on petrol and diesel and high retail margins. The renewed jump in COVID-19 infections in certain parts of the country and the associated localised lockdowns could dampen the demand for contact-intensive services, restrain growth impulses and prolong the return to normalcy. In such an environment, continued policy support remains necessary. Taking these developments into consideration, the MPC decided to continue with the accommodative stance as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
13. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted for keeping the policy repo rate unchanged. Furthermore, all members of the MPC voted to continue with the accommodative stance as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
14. The minutes of the MPC’s meeting will be published on April 22, 2021.
15. The next meeting of the MPC is scheduled during June 2 to 4, 2021. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. The Second Advance Estimates by the National Statistical Office place the GDP at constant prices lower by 8 per cent in 2020-21 over the previous year, slightly steeper decline than decline of 7.7 per cent as per the First Advance Estimates. Source of deeper contraction in GDP has been the lower net taxes on products as the GVA decline was lower at 6.5 per cent in the second advance estimates compared to 7.2 per cent in the First Advance Estimates. These estimates are subject to further revisions but the order of decline in output contraction in FY 21 has been sharp and the present estimates of GVA or GDP are lower than in 2018-19. This pattern holds for private final consumption expenditure and gross fixed investment and, exports and imports of goods and services. The pace of recovery of output needed to offset the negative impact of the Covid 19 shock to the economy in terms of growth in income and employment will be substantial and sustained over many years.
17. The rise in GDP quarter over quarter, since the initial sharp decline in Q1:FY21 provides a basis for more robust future growth. After a massive decline in GVA in Q1:FY21, manufacturing sector registered positive year on year growth in Q3 and implicitly in Q4, based on projected GVA for Q3 and full year FY21 in the Second Advance Estimates. Year on year growth in Construction and Financial and Real Estate and Professional Services sectors turned positive in Q3:FY21 after two quarters of decline.
18. An important source of growth of output during the pandemic phase of FY21, has been agriculture and allied activities sector, as the rural areas appear to have been relatively less affected by the pandemic, allowing production related operations uninterrupted. The GVA from agriculture increased by 3 per cent over the previous year, the only sector among the major sectors to register growth of over 1 per cent.
19. Although there is a positive growth in Q3:FY21, the gross fixed investment in expected to register a decline for the year as a whole over the previous year. The private final consumption expenditure is projected to be lower in Q3:FY21 compared to Q3:FY20. The exports and imports of goods and services for Q3:FY21 and FY21 as a whole are projected to be lower than in the previous year. These indicators reflect the subdued demand conditions in FY21.
20. The indicators such as improvement in capacity utilisation in manufacturing; turnover of business for the firms in the services, particularly in the IT services; and infrastructure sectors available from RBI’s enterprise surveys; bank credit and GST revenue do point to the pickup of economic activities in Q3 and ahead in the non-agricultural sectors. However, RBI’s March 2021 survey of consumer confidence, suggests that a large proportion of the respondents assess the prevailing economic conditions and income to have worsened compared to a year ago. The forward looking consumer expectations also reflect weakened sentiments compared to the previous quarter.
21. The revival of economic activities in Q3:FY21 points to the resilience in the economy but a broad based recovery covering all the production sectors and the micro, small and medium enterprises and employment to support consumption demand is needed to sustain this revival.
22. The improvement in growth performance in the final two quarters in FY21, therefore, is fragile and will require strong policy support for broadening and sustaining positive momentum. The external demand conditions also point to uncertainty although growth in some of the advanced economies is expected to improve. The measures put in place during FY21 to support growth such as the production linked incentives and the push for capital expenditure and infrastructure in the Central budget 2021-22 provide a positive push to economic activity.
23. The sustained growth will also depend on an effective control over the pandemic that would permit economic activities. As the rise of Covid infections and resulting local restrictions on the movement of people in March shows, controlling the spread of infections in essential for sustained economic recovery. Going forward, success of vaccinations, universal adoption of preventive measures to severely limit the chances of transmission of the virus and investment in health services to assure access to health care will define the course of economic recovery. As many have noted, the critical factor affecting sustained revival of the economy will be the victory in the battle over the Corona virus.
24. The headline inflation dropped below the upper tolerance limit of 6 per cent for monetary policy for three consecutive months from December 2020. The drop is mainly on account of easing of food inflation. There is hardening of consumer price inflation for fuel and light and particularly the core inflation. The international commodity prices for food, energy and metals show upward trend partly reflecting the global economic recovery. In the domestic market, the producer prices for manufactured products, reflected by WPI show significant rise in prices since December 2020. RBI’s March 2021 Inflation Expectations Survey of Households, points to expectations of higher inflation rate for three months ahead and one year ahead as compared to the expectations held in the previous survey.
25. The CPI inflation rate in the short run is projected at less than 5.3 per cent for the four quarters of FY22, although the risks to the projected trajectory from external sector, type of the south-west monsoon and the pattern of recovery of the domestic economy remain.
26. Expansion of supply of goods and services in public and private spheres will require new investments and access to funds. The monetary policy environment so far has provided support to sustaining economic activities and recovery of growth. Such policy environment is needed to strengthen and broaden the ongoing recovery process.
27. I vote in support of the resolution to keep the repo rate under the liquidity adjustment facility (LAF) unchanged at 4 per cent and also to continue with the accommodative stance as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
28. Growth uncertainty has increased with the second wave in Covid-19 in some states. RBI surveys show consumer confidence to be lower in March 2021 compared to January, although corporate confidence was still intact. Exports have increased as some countries recover. Second waves in many countries have been sharp but short. The effect on growth could be marginal if complete lockdowns and bans on interstate movement are avoided. The nature of the virus and its ability to mutate imply too much unlocking can create a surge. Large gatherings are especially dangerous.
29. Tightening should be gradual, however, not reversing for long beyond the unlock 4 in September 2020 that forbade restrictions on interstate movements and led to a sustained revival of economic activity. Compared to past pandemics we have the advantage of fast creation of vaccines, but it will take some months for vaccination to reach a critical mass. In the interim, people have learnt to live and keep working with the virus, with technology creating some substitutes for high contact activities. The surge is a warning, however, to raise the level of care and precaution. The medical infrastructure can come under severe strain.
30. Even the above ten per cent growth most analysts still expect for 2021-22, however, will barely take us to the level we had reached in 2019. We have to also make up for lost time; alleviate widespread job loss and income stress. Expected growth is high because of the base effect and does not imply sustained growth at potential. Only when we reach the latter will true recovery have taken place.
31. While banks do not see turnaround in investment as yet there is a rise in alternative financing for manufacturing and a response to government incentives. A new investment cycle, however, will not be like the infrastructure boom of the 2000s, but will build up slowly. In the rest of the world credit leads investment, in India it follows and credit ratios are very low by world standards. With easier financing conditions and a healthier financial sector, there is a chance of a credit-led cycle this time. To the extent investment rises, potential growth will also rise with it.
32. While headline inflation is expected to remain well within the MPC’s tolerance band over this year, core inflation has been rising. Perishables supply chains resolved faster under the pressure of fresh supplies. Something similar will happen with manufactured goods, although it will take more time, since global factors are involved. Oil prices have already come off the boil and there are several factors that are working towards reducing them. Imported commodities have a large weight in WPI. Rising WPI is a temporary Covid-19 related digression, although the new surge may cause some delay in reversion to normal. Historically, wholesale inflation has ruled much lower than consumer price inflation. The base effect, however, will also raise WPI inflation over the next few months.
33. Despite all the emphasis on cost pressures, many firms have undertaken cost cutting measures. RBI’s analysis of the corporate sector in Q3 2020-21 shows a sharp rise in profit before tax. Rise in raw material and staff cost was not material, and margins were steady—there is space to absorb a temporary rise in costs and firms will do it as restoration of supply chains increases competition.
34. Urban retail margins rose somewhat in March 2021. But households do not expect this rise to last. The survey of household inflation expectations showed a rise in current and 3 month inflation expectations but 1 year ahead expectation remained almost the same. The monsoon is expected to be normal.
35. Transmission of low rates set by the MPC remained robust in the banking system. While real short rates are negative, real longer-term rates are positive. Transmission faltered in markets over the last 2 months. Taylor rules, estimated assuming negative output gap and headline inflation at 5 per cent above the 4 per cent target, suggest short rates should range from 3.2 to 3.65 per cent. But some short rates had risen above this. This is incompatible with low overnight rates, an accommodative stance and durable liquidity in clear surplus.
36. The spread of the 10-year G-Secs over short rates was 60 basis points over 2011-17 before rising sharply in 2018. The current spread of over 200 basis points, despite large OMO support, points to markets being caught in an irrational trap. They did not respond to positives such as government borrowing less than announced as well as better tax revenues. Bond markets are subject to disruption where they expect rates to rise and do not buy, so that rates rise, debt becomes unsustainable and fears are self-fulfilling. This is one reason why many central banks around the world have announced explicit support for a temporary Covid-19 related rise in borrowing requirements. Indian markets also need firm and clear guidance. Once market fears recede interventions required would reduce.
37. India’s cautious approach to capital account convertibility means that volatile fixed income flows are still capped at 6 per cent of outstanding stocks of G-Secs. Large foreign exchange (FX) reserves, acquired during surges in inflows, are sufficient to counter outflows due to rising US G- Sec rates, without having to raise domestic rates. Sale of FX stocks will release space on the RBI’s balance sheet to buy more Indian government securities consistent with its target for creation of durable liquidity. RBI has the space to smooth volatility.
38. In view of expected growth and inflation trends in the context of continued Covid-19 related stresses, I vote for keeping the policy repo rate unchanged and the stance accommodative. Greater uncertainties require more flexibility for the MPC. Therefore, I also support a move from time-based to data-based guidance with the understanding that in view of the unprecedented situation, supporting a full recovery is paramount. Statement by Prof. Jayanth R. Varma
39. The economic recovery after the pandemic shock of 2020 remains uneven and incomplete, and the renewed jump in COVID-19 infections in certain parts of the country has increased the downside risk to the growth momentum. On the other hand, inflation rates have been consistently well above the mid point of the target zone and is forecast to remain elevated for some time. This is a difficult situation, but I believe that the balance of risk and reward is in favour of monetary accommodation. Therefore, I support maintaining the policy rate at its current level, and I also support the accommodative stance.
40. The question that remains is about the time based forward guidance (first provided in October 2020) that is expiring now as we have already entered the new financial year. From my perspective, the principal motivation for the forward guidance was to reduce long term yields in the backdrop of an excessively steep yield curve. Unfortunately, forward guidance has failed to flatten the yield curve, and I see little merit in persisting with it any more. As the popular quote (often misattributed to Albert Einstein) says: insanity is doing the same thing over and over again and expecting different results. A flattening of the yield curve remains an important goal but, I think it must be pursued using other instruments which largely lie outside the remit of the MPC.
41. There is another reason why time based forward guidance is no longer appropriate. Experience of the last several months indicates that in the aftermath of the pandemic, forecasting has become more difficult. It is apparent that some economic and statistical relationships have tended to break down in the current exceptional environment. Consequently, model risk has now become an important issue as evidenced both in large realized forecast errors and in the dispersion of forecasts from different models. Model risk presents a far less tractable problem than the well defined statistical prediction error of any single model. In this situation, I think it is not prudent to repose excessive faith in forecasts. Instead, the MPC must have the agility and flexibility to respond rapidly and adequately to whatever surprises new data may bring in future. Time based guidance is inconsistent with this imperative.
42. Both these considerations weigh in favour of state contingent guidance that reaffirms the MPC’s commitment to continue to mitigate the impact of COVID-19 on the economy so as to sustain growth on a durable basis while ensuring that inflation remains within the target going forward. Statement by Dr. Mridul K. Saggar
43. The Central Government, in consultation with the Bank, retained the inflation target and the tolerance bands for the next five years. At the outset, I wish to acknowledge this, both from the viewpoint of the sage counsel exercised and the accountability it imposes on the MPC going forward. Over the first five-year period of practicing inflation targeting, the headline inflation averaged 4.3 per cent compared with the situation when the CPI inflation was averaging around double digits for six years before this framework was conceived. 1 The retention of the target will go a long way in preserving the macro-economic stability and the credibility of the framework. However, the success of this framework has not been unfettered. The volatility of inflation has remained high as manifested in higher coefficient of variation. However, this is largely reflection of supply disruptions during the pandemic period at a time where the growth collapse warranted monetary policy to prop up demand. Better supply management and greater recognition that growth-inflation trade-offs dissipate in long-run can help lower inflation volatility ahead.
44. Let me now turn to business at hand. The five significant differences since we last met in early February are: (i) the sudden resurgence of the Covid-19 infections; (ii) emergence of incipient signs that the recovery is beginning to lose some steam; (iii) return of inflation after a short-lived decline to the target; (iv) asset prices facing resistance after a runaway rally from the pandemic lows a year ago; (v) some indications of the path of fiscal consolidation going forward that still needs further clarity. The current account has also slipped back into a small deficit, but I will not judge this as material to our decision in this policy. Let me briefly discuss all of these.
45. After a remarkable decline in Covid-19 incidence during mid-September 2020 to mid- February 2021, daily new confirmed cases have spiked back to about 100 thousand. More than half of these new cases have come from Maharashtra that accounts for about 9.0 per cent of the country’s population and 14.6 per cent of its output. The economic recovery can come under risk if this new wave of infections is not flattened soon. This is especially so as monetary and fiscal policies have already used most of their space to considerably limit loss of economic capital, though expansion of policy toolkits can still afford additional comfort. While the countrywide dispensation is still quite supportive of production activity, this can change if the virus spread, hitherto contained to few States, might transmit across country. Learning effects on calibrating stringency of restrictions may keep economic costs of the second wave much lower than the first but still retard full normalisation by a quarter or two. Ramping up vaccination, testing and treatment holds the key to protecting economic recovery and health policies have become the first line of defence. Monetary and fiscal policies can only play a second fiddle.
46. Going forward, the GDP growth in Q4: 2020-21 is likely to surpass its implied growth in the full year’s NSO’s Second Advance Estimates. The economy is then set for a growth rebound in 2021-22 with a baseline projection of 10.5 per cent; but this high growth will essentially be on account of an all-time low base. The realisation of the projected growth will translate to only a meagre average growth rate of 0.85 per cent in two years following 2019-20. This provides justification for the monetary policy’s continued support to growth. Both consumption and investment need to be stimulated. Capacity utilisation rate at 66.6 per cent in the latest RBI survey is well below the long-term average of 73.6 per cent and though there is evidence of some small ticket investments reflected in pick up in short cycle capital goods, an upturn in capex cycle will require larger public investments that can crowd in private investments. Consumption needs support from removing credit frictions and more redistributive policies.
47. Recovery is beginning to lose some steam. The IIP returned to the contraction zone in January and will remain so in February. The output of the eight core industries, in February, 1 Headline inflation measured by All Groups combined CPI averaged 4.3 per cent for the period October 2016 to February 2021 (with March 2021 data awaited). The average excludes the two months – April and May 2020 – for which headline inflation was not computed and imputed back-prints were made available later. The annual average CPI-Industrial Workers inflation had touched double digits or stayed just underneath for the last six years 2008-09 to 2013-14, prompting Reserve Bank to revise and strengthen its monetary policy framework. registered its most negative growth since September 2020 and the largest month-on-month contraction since April 2020. However, this fall has been exacerbated by the month’s peculiarity. But for the extra day in leap year 2020, the contraction would have been smaller with growth at (-)1.2 per cent instead of (-)4.6 per cent. Extrapolating February output for 31-days as in January, the month-on-month growth would have been (+)2.0 per cent instead of (-)7.8 per cent. The sequential improvement in high frequency indicators of real activity witnessed some loss of momentum in January with bulk of normalisation getting completed. In February, almost half of the indicators did not improve. This again may have lot to do with the peculiarity of the February month, but the second wave can entrench this trend.
48. Inflation rose back to 5.0 per cent in February after receding close to target at 4.1 per cent in January 2021. The momentum was somewhat above average, especially driven by core and fuel. Furthermore, the momentum in WPI was markedly above average. In each of the last four months, WPI prices have increased for larger number of commodities than ever in any of the months since October 2013. Therefore, momentum pressures for CPI may exacerbate in near term if producers hitherto absorbing a large part of cost push pressures decide to passthrough the price pressures to retail level. So far, this is not much seen in the CPI with lower-than-average CPI items witnessing price increases over last three months. Global commodity prices, both energy and non-energy, have surged since June 2020. The increases have been marked in case of crude oil, metals and food. The FAO food price index is higher by 27.5 per cent, while that for edible oils by 89.4 per cent. Imported commodities have a weight of about 22 per cent in CPI. Some price pressures may arise as a rise in global non-food commodity prices by 10 per cent is expected to increase CPI core goods inflation up to 50 bps. However, the passthrough to headline inflation is low. Therefore, despite the emerging risks and price pressures it should be possible to keep inflation within the band.
49. Asset prices are seemingly facing resistance after a runaway rally from the pandemic lows a year ago. Mundell has just left us, but his legacy will continue to haunt monetary policy as it manages the impossible trinity through surges and stops of capital flows. During February and March, EM equities have weakened slightly as global bonds faced a sell-off with US 10-year yield hardening 67 basis points. Benchmark yields in most emerging markets rose more sharply over the same period but in India the rise was contained to 26 bps. Indian rupee till now has remained stable and bucked the global trend of depreciating EM currencies. There is risk in too much focus on asset prices in the conduct of monetary policy. Credit channel that works in tandem with interest rate channel is far more important than the asset price channel for effective monetary transmission. Countries have certainly relied on negative nominal or real rates in an attempt to avert deep recessions. In part they have helped limit job losses and scarring. However, these benefits have to be weighed against the low interest rates fuelling K-shaped recoveries with increased inequalities and inflicting financial repression for savers. Also, there are added macroeconomic risks for countries where inflation is not as dampened as in Advanced Economies that are resorting to unconventional policies.
50. It is equally important to understand that while increasing fiscal space to the extent possible is desirable, any revision in fiscal targets should be consistent with medium-term debt sustainability and should not impinge on conduct of monetary policy, such as requiring direct monetisation that has been eschewed even by countries with low inflation. Lastly, the current account deficit in small size as expected is least of a worry, but going forward, with wide fiscal gaps, large twin deficits must be avoided over the medium term.
51. While we had moved towards calibrated exit from extra-ordinary supportive measures to mitigate the impact of Covid-19 as the curve was flattening, we have already made considerable adjustments in exit dates for these measures. The extant priority is now to continue supporting growth from the possible shock from the second wave. I, therefore, vote for retaining the policy rate at present level and continue with the accommodative stance as spelled out in resolution. I borrow what Marie Curie said, “Nothing in life is to be feared, it is only to be understood. Now is the time to understand more, so that we may fear less.” It is in this spirit that we act appropriately as per judgment based on scientific facts. Statement by Dr. Michael Debabrata Patra
52. I vote to keep the policy rate unchanged and to maintain an accommodative stance as articulated in the MPC’s resolution.
53. Risks to the recovery have become accentuated since the MPC’s February meeting – new waves of infections and the inexorably slow pace of vaccinations; moderation in several high frequency sentiment indicators; global risks and spillovers. Monetary policy has to remain supportive of the economy until the recovery is more sure footed and its sustainability assured. Meanwhile, inflation middled the tolerance band in December and January and aligned with the target; although it has risen in February, it is expected to remain within the corridor over a 12- month horizon. Longer term inflation expectations remain broadly stable in spite of high volatility in food and fuel prices. Demand pull is still weak. The inflation print of February reflects pandemic effects in the form of input cost pressures – though still muted in translating into selling prices – retail margins and increased costs of doing business as supply chains are still mending. Accordingly, I would continue to look through the recent elevation in inflation and remain focused on reviving the economy on a path of strong and sustainable growth. An integral part of this approach would be to insulate domestic financial markets from global spillovers and volatility so that congenial financial conditions continue to support growth. Statement by Shri Shaktikanta Das
54. Economic activity and inflation developments over the past two months have been largely along the anticipated lines. The curve of active cases of COVID-19, which was on a downward trend till mid-February, has changed its course with a surge in several parts of the country. Experience of other countries suggest that this new surge can be more infectious due to several mutations of the virus. Rapidly rising cases of COVID-19 is the single biggest challenge to ongoing recovery in the Indian economy. Learnings of last one year should, however, help us in managing the crisis as it unfolds.
55. Global growth is gradually recovering, even though it remains uneven across countries, reflecting the substantial differences in the infections trajectory, the speed of vaccination drives, and the size of fiscal stimulus. International organisations are gradually scaling up their global growth outlook for 2021. The improving global outlook would support India’s exports and investment demand. At the same time, global financial markets have turned volatile over inflation fears in advanced economies and rising commodity prices, posing risks to the domestic outlook.
56. In the domestic economy, there are clear signs of revival of growth. The agricultural sector has been resilient throughout the pandemic period. Manufacturing and services activities continue to normalise as reflected in key high frequency indicators such as mobility data; issuance of e- way bills; GST revenue; wholesale dispatches of automobile; registrations of passenger vehicles and construction equipment vehicles; rail and water cargo; highway toll collections; and electricity generation. These indicators represent a wide range of sectors that are maintaining their pace, which we had noticed in the previous round of MPC deliberations as well. While there was a slight dip in industrial production during January, PMI manufacturing remained resilient. Manufacturing companies assessed further strengthening of production, order books and employment during Q4:2020-21 according to a survey conducted by the RBI. Forward looking surveys suggest further improvement in production and overall business situation during 2021-22. Capacity utilisation of the manufacturing sector recovered further.
57. A revival in real estate and residential construction activity also seems to be underway as reflected in stamp and registration duty collections in select states in February 2021, backed by lower cost of financing, stable prices and support from the Government. This, coupled with higher financial savings, show that the aggregate balance sheet of the household sector – the resource surplus sector of the economy – could provide support to demand recovery. Signs of incipient revival in domestic demand were discernible in the current account balance which swung into deficit in Q3:2020-21 after reporting surplus for three consecutive quarters. India’s exports and imports have attained their pre-pandemic levels in Q4:2020-21. Foreign direct investment flows have been running higher than the previous year. While strong domestic fundamentals and healthy level of foreign exchange reserves shall bode well for the external sector, the speed of domestic vaccination drive will be key in containing short-term risks to domestic economic recovery and mitigating spillovers from global shocks.
58. All these indicators suggest that the real GDP is evolving on the lines of the February MPC resolution. Improving demand conditions, investment enhancing measures by the Government and improving external demand impart an upside to growth prospects. The recent jump in COVID-19 infections and its impact on economic activity, however, needs to be watched carefully.
59. Headline inflation registered significant softening in January 2021 to move close to the target rate from levels that were substantially above the upper tolerance threshold. A sharp correction in food inflation helped to bring about this rapid disinflation. In February, however, headline inflation increased to 5.0 per cent from 4.1 per cent in January, primarily due to volatility imparted by adverse base effects. On the other hand, core inflation remained elevated. Going ahead, sustenance of key factors like the bumper foodgrains production in 2020-21; mitigation of price pressures through timely supply-side measures on key food items such as pulses and edible oils; and coordinated reduction in taxes on petroleum products by centre and states can help assuage cost pressures on inflation. On the other hand, a combination of high international commodity prices and logistics costs may push up input price pressures across manufacturing and services. The projection of inflation rate at 5 per cent for the full year 2021-22, with 5.2 per cent for the first half and 4.8 per cent for the second half, takes into account both the upside and the downside pressures.
60. The April 2021 MPC meeting was the first after the Government notification of March 31, 2021 retaining the inflation target at 4 per cent with the lower and the upper tolerance levels of 2 per cent and 6 per cent, respectively, for the next five years (April 2021-March 2026). The successful implementation of the flexible inflation targeting (FIT) framework since 2016 has resulted in better anchoring of inflation expectations, especially those of financial market participants, around the 4 per cent target rate. It has also improved transparency of monetary policy process. The resultant increase in monetary policy credibility has helped the MPC to respond effectively to the growth-inflation trade-offs posed by an exceptional shock like the COVID-19.
61. In the recent period, the RBI’s policy strategy has been a combination of liquidity operations, support to targeted sectors, credible communication and explicit forward guidance. In sync with the MPC’s accommodative stance guidance, the RBI maintained ample surplus liquidity through conventional as well as unconventional measures which have helped to ease domestic financial conditions; reduce borrowing costs; improve transmission; and facilitate the successful completion of central and state government borrowing programmes in 2020-21. It has also led to significant amount of private borrowing through corporate bonds, commercial paper and debentures. As part of the liquidity management strategy for 2021-22, the Reserve Bank’s objective would be to ensure orderly evolution of the yield curve and to avoid volatility in G-sec market. This would help create pre-conditions in financial markets that support a durable economic recovery. The secondary market G-sec acquisition programme or G-SAP 1.0, where the RBI has committed upfront a specific amount of open market purchases of government securities is a step in this direction to ensure congenial financial conditions for the recovery to gain traction. Going forward, the RBI would continue to ensure ample surplus systemic liquidity and the system would remain in surplus even after meeting the requirements of all financial market segments and the productive sectors of the economy.
62. The MPC’s forward guidance over the past year has been helpful in anchoring market expectations; navigating the recovery from the crisis; and strengthening the pace of monetary transmission. The forward guidance provided by the MPC – to remain in accommodative stance as long as necessary to sustain growth on a durable basis – lays out the future course of monetary policy. Given the uncertainties and the fact that we are in the beginning of a new financial year, it is too early to give explicit time-based forward guidance. The forward guidance in terms of securing a sustainable growth on a durable basis itself testifies to our commitment to continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target, going forward.
63. The need of the hour is to effectively secure the economic recovery underway so that it becomes broad-based and durable. The renewed jump in COVID-19 infections in several parts of the country and the associated localised and regional lockdowns add uncertainty to the growth outlook. In such an environment, monetary policy should remain accommodative to support, nurture and consolidate the recovery. We need to continue to sustain the impulses of growth in the new financial year 2021-22. I vote to keep the policy rate unchanged and to continue with the accommodative stance as long as necessary to sustain growth on a durable basis, while ensuring that inflation remains within the target going forward. The RBI would take all steps, as needed, to ensure orderly conditions in the financial markets and to preserve financial stability. (Yogesh Dayal) Press Release: 2021-2022/91 Chief General Manager
6. Since the MPC’s meeting in April, the global economic recovery has been gaining momentum, driven mainly by major advanced economies (AEs) and powered by massive vaccination programmes and stimulus packages. Activity remains uneven in major emerging market economies (EMEs), with downside risks from renewed waves of infections due to contagious mutants of the virus and the relatively slow progress in vaccination. World merchandise trade continues to recover as external demand resumes, though elevated freight rates and container dislocations are emerging as constraints. CPI inflation is firming up in most AEs, driven by release of pent-up demand, elevated input prices and unfavourable base effects. Inflation in major EMEs has been generally close to or above official targets in recent months, pushed up by the sustained rise in global food and commodity prices. Global financial conditions remain benign. Domestic Economy
7. Turning to the domestic economy, provisional estimates of national income released by the National Statistical Office (NSO) on May 31, 2021 placed India’s real gross domestic product (GDP) contraction at 7.3 per cent for 2020-21, with GDP growth in Q4 at 1.6 per cent year-on- year (y-o-y). On June 1, the India Meteorological Department (IMD) has forecast a normal south- west monsoon, with rainfall at 101 per cent of the long period average (LPA). This augurs well for agriculture. With the rise in infections in rural areas, however, indicators of rural demand – tractor sales and two-wheeler sales – posted sequential declines during April.
8. Industrial production registered a broad-based improvement in March 2021. While mining and electricity output surpassed March 2019 (pre-pandemic) levels, manufacturing did not catch up. The output of core industries registered a double digit y-o-y growth in April 2021, propelled by a weak base. Although GST collections were at their highest during April 2021, there are indications of moderation in May as reflected in lower E-way bills generation. Other high- frequency indicators – electricity generation; railway freight traffic; port cargo; steel consumption; cement production; and toll collections – recorded sequential moderation during April-May 2021, reflecting the impact of restrictions and localised lockdowns imposed by states with exemptions for specific activities. The manufacturing purchasing managers’ index (PMI) remained in expansion in May although it moderated to 50.8 from 55.5 in April due to a slowdown in output and new orders. The services PMI, which was 54.0 in April, entered into contraction (46.4) in May, after seven months of sustained expansion.
9. Headline inflation registered a moderation to 4.3 per cent in April from 5.5 per cent in March, largely on favourable base effects. Food inflation fell to 2.7 per cent in April from 5.2 per cent in March, with prices of cereals, vegetables and sugar continuing to decline on a y-o-y basis. While fuel inflation surged, core (CPI excluding food and fuel) inflation moderated in April across most sub-groups barring housing and health, mainly due to base effects. Inflation in transport and communication remained in double digits.
10. System liquidity remained in large surplus in April and May 2021, with average daily net absorption under the liquidity adjustment facility (LAF) amounting to ₹5.2 lakh crore. Reserve money (adjusted for the first-round impact of the change in the cash reserve ratio) expanded by 12.4 per cent (y-o-y) on May 28, 2021, driven by currency demand. Money supply (M3) and bank credit grew by 9.9 per cent and 6.0 per cent, respectively, as on May 21, 2021 as compared with growth of 11.7 per cent and 6.2 per cent, respectively, a year ago. India’s foreign exchange reserves increased by US$ 21.2 billion in 2021-22 (up to May 28) to US$ 598.2 billion. Outlook
11. Going forward, the inflation trajectory is likely to be shaped by uncertainties impinging on the upside and the downside. The rising trajectory of international commodity prices, especially of crude, together with logistics costs, pose upside risks to the inflation outlook. Excise duties, cess and taxes imposed by the Centre and States need to be adjusted in a coordinated manner to contain input cost pressures emanating from petrol and diesel prices. A normal south-west monsoon along with comfortable buffer stocks should help to keep cereal price pressures in check. Recent supply side interventions are expected to ameliorate the tightness in the pulses market. Further supply side measures are needed to soften pressures on pulses and edible oil prices. With declining infections, restrictions and localised lockdowns across states could ease gradually and mitigate disruptions to supply chains, reducing cost pressures. Weak demand conditions may also temper the pass-through to core inflation. Taking into consideration all these factors, CPI inflation is projected at 5.1 per cent during 2021-22: 5.2 per cent in Q1; 5.4 per cent in Q2; 4.7 per cent in Q3; and 5.3 per cent in Q4:2021-22; with risks broadly balanced (Chart 1).
12. Turning to the growth outlook, rural demand remains strong and the expected normal monsoon bodes well for sustaining its buoyancy, going forward. The increased spread of COVID- 19 infections in rural areas, however, poses downside risks. Urban demand has been dented by the second wave, but adoption of new COVID-compatible occupational models by businesses for an appropriate working environment may cushion the hit to economic activity, especially in manufacturing and services sectors that are not contact intensive. On the other hand, the strengthening global recovery should support the export sector. Domestic monetary and financial conditions remain highly accommodative and supportive of economic activity. Moreover, the vaccination process is expected to gather steam in the coming months and should help to normalise economic activity quickly. Taking these factors into consideration, real GDP growth is now projected at 9.5 per cent in 2021-22, consisting of 18.5 per cent in Q1; 7.9 per cent in Q2; 7.2 per cent in Q3; and 6.6 per cent in Q4:2021-22 (Chart 2).
13. The MPC notes that the second wave of COVID-19 has altered the near-term outlook, necessitating urgent policy interventions, active monitoring and further timely measures to prevent emergence of supply chain bottlenecks and build-up of retail margins. A hastened pace of the vaccination drive and quick ramping up of healthcare infrastructure across both urban and rural areas are critical to preserve lives and livelihoods and prevent a resurgence in new waves of infections. At this juncture, policy support from all sides – fiscal, monetary and sectoral – is required to nurture recovery and expedite return to normalcy. Accordingly, the MPC decided to retain the prevailing repo rate at 4 per cent and continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
14. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 4.0 per cent. Furthermore, all members of the MPC unanimously voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
15. The minutes of the MPC’s meeting will be published on June 18, 2021.
16. The next meeting of the MPC is scheduled during August 4 to 6, 2021. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
17. The strong recovery in economic activities registered in Q4: FY2021 raised expectations that the adverse impact of the Covid 19 pandemic is now behind us. The Provisional Estimates brought out by National Statistics Office (NSO) for 2020-21 on May 31 now place the real GDP growth at -7.3 per cent over the previous year, a lower rate of contraction than provided in the Second Advance Estimates. The year-on-year growth rates of key components of aggregate demand, Private Final Consumption and Government Final Consumption Expenditures, Exports and Gross Fixed Capital Formation registered substantial recovery in Q4 compared to the performance in the previous quarter. On the production side, construction sector registered double digit growth rate, year-on-year, in Q4. Data available on the performance of the corporate sector in Q4: FY2021 also shows improvement in sales realisations and Gross Value Added, particularly in the case of manufacturing sector. However, the subsequent second steep surge of the Covid 19 infections seen during April-May, led to far greater fatalities than in the previous wave and some disruptions of economic activities in the first two months of Q1: FY2022, which in turn have required re-assessment of the growth prospects in the immediate term.
18. The second wave of infections led to restrictions on the movement of people at a local level unlike the national level lockdown imposed during the first wave in 2020. But the fact that extent of the spread of the disease was large in many of the large cities also meant that commercial activities were disrupted in a significant manner. The rural areas were not insulated from the second wave to the extent it was the case during the first wave.
19. While data on the impact of the second wave of the pandemic is limited, qualitative data emerging from the surveys of households and enterprises suggest significant dent in the consumer and business sentiments. The survey of Consumer Confidence conducted by RBI in the last week of April and up to May 10, 2021 in 13 major cities in the country reveals a sharp rise in the percentage of respondents who perceive the current general economic conditions to be worse than a year back, compared to a similar survey conducted two months back. Importantly, 51.5 per cent of the respondents also say that they believe the general economic conditions would be worse a year-ahead. Early results of the quarterly Industrial Outlook Survey of the RBI for June 2021, show that in the case of the manufacturing sector, the summary index of current business conditions has declined for Q1: FY2022 and the index of expectations also has declined for Q2: FY 2022. These perceptions of business conditions point to the adverse economic conditions compared to the sentiments at the end of Q4: FY2021.
20. Further evolution of the economy would be affected by the decline in the spread of the disease on the back of adoption Covid appropriate behaviour by the population that increases protection from new infections. Acceleration in the vaccination program and availability of health care would be a key to boost the confidence of the consumers, workers and producers in the resumption of their economic lives. The projection of near-term economic growth, therefore, is conditioned by this unexpected shock from the second wave of the pandemic.
21. The global economic conditions in 2021 have been projected to be more favourable to trade and investment than in 2020, as the Advanced Economies are expected to regain the growth momentum. The Covid 19 pandemic is seen to be coming under control combined with fiscal stimulus measures to revive demand. However, the shadow of threat of the new strains of the virus and the slow progress of vaccinations globally will also limit the economic revival.
22. The initial impact of the second wave of the pandemic on the economy has been incorporated in the revised assessment of the GDP growth for FY2022 by many organisations and agencies. The median estimate of GDP growth for FY2022 from RBI’s Survey of Professional Forecasters carried out during May 2021 has declined to 9.8 per cent over the previous year from 11.0 per cent forecast in March 2021.
23. While the uncertainty over the short-term growth prospects has increased, there are also the positive triggers. The improved global demand conditions are expected to support the sustained improvement in export performance. The focus on improving capital expenditure in the central government budget also provides a stimulus to domestic demand. Agriculture is expected to contribute to economic growth based on a favourable monsoon. Response to these triggers by improvement in private consumption and investment spending will require the sustained reduction in the Covid 19 infections.
24. In this backdrop the projected growth of GDP in 2021-22 at 9.5 per cent, revised downward from the 10.5 per cent, projected in April 2021 will require continued fiscal and monetary policy support, besides other measures to enable expansion of economic activities and keeping the population safe from the pandemic.
25. The headline inflation rate for April 2021 is at 4.3 per cent, although fuel price index rose sharply by 7.9 per cent, year on year basis. The index of prices reflecting core inflation (excluding food and fuel) – which includes the effect of food and fuel prices indirectly through input linkages and that of transportation prices directly - increased by 5.4 per cent in April compared to 5.9 per cent in March 2021. The rising prices of fuel and global commodity prices push up the cost of production and distribution across supply chains. Besides the resumption of production across sectors that also create competitive pressures, easing of these price pressures will require more efficient operation of trade and logistics infrastructure, supported by easing of movement restrictions. Based on present trends, the projected headline inflation rate in 2021-22 at 5.1 per cent, is marginally higher than the projections in April 2021.
26. At this juncture, providing a policy environment supportive of sustained economic recovery from the second shock of the pandemic is necessary.
27. I vote in favour of keeping the policy repo rate unchanged at 4.0 per cent. I also vote in favour of continuing with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
28. The human cost is incalculable in the country’s battle with the fearsome second wave of more infectious coronavirus variants. The economic cost, however, is likely to be limited. Compared to last year, the fall in demand far exceeds that in supply because of the decentralized structure of lockdowns that largely maintained inter-state goods movement and make possible calibrated, differentiated re-opening. Since vaccination in hot spots such as large cities and for corporates is likely to reach a critical mass by July-August normalization will be rapid. Although uncertainties remain regarding a possible third wave, vaccination cover in dense clusters will reduce its probability. The second wave peak in rural areas was in the slack season and is past. Sowing is likely to be normal with a good monsoon. Migrant labour is also available for work.
29. There are two major implications for monetary policy. First, since the fall in demand exceeds that in supply the output gap should widen, reducing demand side pressures on inflation. Second, a healthier supply-side combined with weak demand may damp firms pricing power and pass through, despite more concentration that increases it. In the past quarters output prices have risen with input prices and together with global commodity price rise and a low base, pushed WPI inflation into double digits. Firms have actually raised profit margins, even in a pandemic year. This may be partly due to low capacity utilization. They have not passed on a fall in wages and many other costs such as travel. Moreover, since normally the pass through from WPI to CPI headline is low and lagged, wage increases may remain muted, preventing persistent second round rise in inflation. The dominant current view is global price pressures are temporary and expected to reduce as supply chain disruptions and congestion are overcome. Moreover, uneven global recovery and uncertainties may somewhat restrain demand, despite the unprecedented stimulus given in a few major countries. Headline CPI, therefore, is widely predicted to remain within the MPC’s tolerance band, although seasonal and lockdown related spikes may occur.
30. But can the rise in household inflation expectations compared to March create persistence in inflation? Note, however, current surveys were conducted over 29th April to 11th May. Fresh coronavirus cases peaked at above 4 lakhs on 7th May. This was the period of highest fear and uncertainty that very likely affected consumer responses. A number of inconsistencies in responses also support this hypothesis. For example, inflation is expected to soften for all non-food groups, but is expected to increase in the aggregate. In the consumer confidence survey inflation is expected to reduce, albeit the level remains high. Therefore, robust inferences have to await surveys taken in more normal times.
31. The slump in consumer confidence in the second wave is slightly more than that in the first wave. It had, however, recovered to July 2019 levels in January 2021, and may show a similar V- shape this time. It is not yet clear if higher risk-aversion will dampen consumer demand more now or there will again be a desire to make up for forced abstention. But income and job loss, more indebtedness and impoverishment surely will shrink demand.
32. The MPC has moved to data-based guidance from time-based guidance. In times of such uncertainty, expectations and forecasts are less reliable. It is important, therefore, while remaining pre-emptive and forward looking, to wait for data on actual outcomes, watching for first signs of second round pass through in inflation as well as for alleviation on the supply-side. Over-reaction has to be avoided to minimize risks if expectations prove incorrect. Adjustment, therefore, has to be gradual but not too gradual as monetary policy acts with long lags.
33. At this juncture, since the output gap has widened and inflation is largely predicted to remain within the tolerance band, macroeconomic policy clearly has to further stimulate demand. The short-term real interest, however, is already negative and may be close to equilibrium levels, so it is liquidity that has to make additional contributions. Targeted schemes can smooth kinks in the yield curve ensuring that funds reach wherever required. Low demand is keeping credit growth low, with the excess durable liquidity parked by banks in the reverse repo so that broad money supply growth remains low at 9.9 per cent. The risk of excess money growth fuelling inflation is therefore minor as yet.
34. In the circumstances, I vote for keeping the policy repo rate unchanged and the stance accommodative as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while remaining watchful to ensure that inflation remains within the target going forward.
35. There is room for a supportive limited countercyclical rise in government deficits. This together with visibly better tax performance will prevent spikes in risk premium and help monetary policy keep real interest rates at levels that sustain the growth recovery. Growth rates that exceed the real interest rate bring down debt ratios over time 1.
36. Recovering global growth has buoyed Indian exports supporting demand. But the asymmetric global recovery carries a potential threat of a recurrence of the taper tantrum. The beginnings of US exit from stimulus may provoke outflows from emerging markets. But India has the reserves to suit its interest rate policy to its domestic cycle instead of being forced to follow the US cycle. Moreover, at present there is some softening of US bond yields and the dollar is weakening, suggesting the exit may be smooth. A rise in inflation above the 2 per cent Fed target for a few months is unlikely to destabilize long run inflation expectations if inflation ruling below 2 per cent for many years after the global financial crisis could not do so. Moreover, there is the post taper learning that bond markets are less destabilized during exit if the Fed’s balance sheet is allowed to shrink very slowly as securities mature, while interest rates are raised only gradually with data that shows the recovery to be well established. Statement by Prof. Jayanth R. Varma
37. The economic recovery that was visible in the early months of 2021 was arrested by the second wave of the pandemic which has been catastrophic in terms of lives lost. But the economic impact appears to have been less severe, and high frequency indicators provide some reason to hope that the economic recovery will resume soon as the second wave now appears to be well past its peak. However, ever since the onset of the pandemic, nowcasts and forecasts of economic growth have not been highly reliable. Moreover, there is a fear that the health shock is inducing high levels of precautionary savings that could depress demand for several quarters to come. All of this point to a need for monetary accommodation at this juncture to support economic recovery.
38. Turning to inflation, Indian inflation rates have been consistently well above the mid point of the tolerance zone for an extended period and are forecast to remain elevated for some time. Moreover, survey data and other indicators show that businesses have no difficulty in passing on cost increases to consumers, and are able to maintain (and even expand) their margins. The only source of comfort is that all the evidence at the moment suggests that inflation is being driven not by domestic demand, but by supply side factors including the global surge in commodity prices. See Goyal, A. 2021. Using the snowball effect in Indian post Covid-19 paths to fiscal consolidation. IGIDR Working paper no. WP-2021-016. Available at: http://www.igidr.ac.in/pdf/publication/WP-2021-016.pdf. This could change as the recovery gathers steam, and the MPC must be sensitive to the risk that inflation expectations could become entrenched if inflation remains elevated for too long. The MPC has been able to maintain monetary accommodation in the face of above-target inflation mainly because of its hard-earned credibility for successful inflation targeting. To maintain and enhance this credibility, the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future.
39. Turning to the current policy statement, I believe that the balance of risk and reward continues to be in favour of monetary accommodation. Therefore, I support maintaining the policy rate at its current level, and I also support the accommodative stance. Statement by Dr. Mridul K. Saggar
40. Let me provide an assessment of growth and inflation before discussing some policy trade- offs in the backdrop of decision at hand.
41. After a spike, daily new infections are now back at the levels that prevailed at the time of the last MPC meeting. Judging by the epidemiological models the wave will be flattened by end- June. Economic recovery is likely to ensue. With unclear probabilities and timings of any further waves, they are best kept as a risk factor rather than a baseline assumption.
42. The solace is that growth has not fallen off the cliff in Q1 as it did a year ago. Work-related Google and Apple mobility indicators, GST E-way bills issuances and wholesale and retail digital payments, despite sequential drops, have stayed much higher on a year-on-year basis than last year. This lends support to the Q1 growth projection that implies a smaller quarter-over-quarter decline of 18.0 per cent compared with 29.7 per cent a year ago. It is possible that that initial GDP estimates do not provide full visibility and the impact on informal and unorganised economy may be deeper. Also, if the economy does expand by 9.5 per cent this year, the output level in 2021-22 will be just 1.6 per cent higher than in the pre-pandemic year 2019-20. These are two reasons against pulling out policy support to growth prematurely. However, while monetary and fiscal policies can lend counter-cyclical support, a sustained revival will ultimately depend on health policies and how the limited fiscal space is used to augment potential output by tagging spending to capex and structural reforms.
43. World economy is picking steam and global growth beyond 6 per cent is possible powered by the strong bounce back in the U.S. and steady acceleration in the euro area. If the expected slowdown in China in the sequential quarters is arrested through policy interventions the global growth momentum can turn breathtaking. However, this would also carry the risk of increased passthrough from global inflation. Upside on net exports may also be limited by worldwide container shortages, though some moderation in capesize freight rates in May shows that efforts to decongest ports are working. Government directly produces about a fifth of the GDP and its’ spending will matter for growth. This year’s budget aims to shift spending further from consumption to investment. This augurs well for growth from a multi-year perspective given its much higher multiplier. Lastly, monsoon forecast at 101±4% of LPA, with a reasonably good spatial and temporal distribution, has diminished the downside risks though a clearer picture will be known only by the next MPC meeting in August.
44. Coming to inflation, the baseline suggests that inflation will stay within the tolerance band, though consistently above target. It may remain close to the upper tolerance level till August but recede thereafter if Kharif crop shapes well and if global commodity price pressures subside by then. Risks of elongated commodity pressures exist in face of piping-hot global economy but demand substitution across commodities supported by the ESG push might change relative prices thus halting or reversing the rising prices of crude oil, iron ore and steel. While prices of crude oil, pulses, edible oils and cotton are likely to put pressure on domestic inflation they can be contained by quick fiscal or supply-side responses.
45. Let me come to some policy trade-offs we face. First, as a baseline, inflation is expected to stay elevated from the target but below the upper tolerance level through the year. However, the probability distribution indicated in the fan chart shows that risks of breaching the upper tolerance level are not insignificant. But for the extra-ordinary circumstances that prevail, we would have moved to a neutral stance long back. I had earlier in my statements starting October 2020 stated that output gap will close towards the end of 2021-22. The second wave is likely to push back normalisation a bit but not a lot. A range of filtering techniques still suggest closure of output gap as a ratio of level of potential GDP by the end of this year but we cannot rely on them mechanically as these techniques have high dependence on the end points. Therefore, we need to make some allowance for the uncertainty around that. We can continue to support growth for now as the flexible inflation targeting framework allows temporary deviation from the target so long as inflation is expected to be within tolerance bands. There are risks to inflation as there have been general price pressures at the WPI level and its inflation as well as its momentum is at its highest for the index with the current base. However, the passthrough of cost-push inflation at the retail level has stayed muted amid demand deficiency. Also, credit growth remains anaemic and nominal broad money growth as well as money multiplier adjusted for reverse repo remain low. So, support to growth can continue at this juncture. In my view, clear signs of generalisation in CPI inflation setting in could be a tipping point where growth-inflation dynamics could alter. Also, with a further rise in elevated inflation expectations, policy may need to respond if these expectations are becoming unhinged. While the odds are that we can avert this as inflation softens back in H2, the uncertainties ahead provide a rationale to avert any time-based guidance, especially as transmission lags exist.
46. Secondly, we need to consider the policy trade-off between leaving policy rate unchanged and correcting it at some point for the negative real rates that have persisted for a spectrum of interest rates thus taxing savers. The frontier of the macroeconomics, especially in terms of Heterogenous Agents New Keynesian (HANK) models provide a good reason to think that not all savers may necessarily be worse off when central banks push down the interest rates. These models capture additional effects that are heterogenous. As demand increases with monetary expansion, firms ramp up production. This improves their survival rate amid a deep shock like the pandemic. It also protects job losses and pushes more wages and salaries in the hands of households most of whom may get more than compensated for a drop in their interest incomes on saving. With a large proportion of low income and other liquidity constrained households in India, these indirect second-round effects could turn very significant. Furthermore, low interest rates create space for fiscal action in support of growth. These multiplier effects are the raison d’etre for extant monetary and liquidity accommodation. My judgment is that the policy has worked well in dampening scarring, limiting job losses, generating wealth effects from higher asset prices, thus supporting incomes and consumption under some very difficult circumstances. Its continuation for long, though carries the hazard of unintended consequences as incomes may instead fall in real terms worsening its distribution as well. Monetary accommodation, when coordinated with expansionary fiscal policy has a greater impact on output gap but may also cause slope of the Phillips curve to turn steeper over time.
47. Nevertheless, retail inflation is not yet predominantly demand-driven and to accept output sacrifice at this stage may not be the best policy choice. Taking full cognisance of these policy trade-offs, I judge that withdrawing support to growth at this stage may be premature as it may dampen second-round effects. I, therefore, vote for retaining the policy rate at present level and continue with the stance as spelled out in resolution. Statement by Dr. Michael Debabrata Patra
48. I vote to maintain status quo on the policy rate and on the stance of policy.
49. The growth-inflation trade-off and consequently, policy choices have shifted towards increasing accommodation. High frequency indicators for April and May 2021 point to a stalling of the recovery that was underway from the second half of 2020-21. Unlike in the first wave, supply conditions have remained relatively resilient in the second wave, but aggregate demand barring net exports has been dented and needs counter-pandemic policy support. Even the turnaround in net exports is fragile and heavily dependent on the strength of the vaccination- propelled revival in external demand, which may be partially offset by the terms of trade loss on account of the rise in international commodity prices, particularly crude oil.
50. April’s inflation afforded a window of respite, and more recent information suggests that price pressures on some constituents of the food category may remain benign in the near-term in spite of the usual pre-monsoon upturn. Input pressures will work towards keeping core inflation elevated, while some food prices will reflect persisting demand-supply imbalances, but in the absence of strong demand, the pass-through to retail inflation is likely to be incomplete and delayed, especially with respect to prices of services. The outlook for energy inflation is the main upside risk, especially as the timing and magnitude of reflation of global demand to pre-pandemic levels is uncertain. This warrants close and continuous watching, with preparedness to take countervailing action in the form of duty/tax reductions. The recent initiative of a Group of Ministers monitoring supply conditions with greater intensity is a welcome step in the right direction and should be matched by proactive actions as necessary to deflect imported input costs from adding to inflationary pressures.
51. The MPC has created the necessary conditions for supporting growth by maintaining the policy rate at its lowest level ever. It has also provided credible forward guidance matched by actions, committing to a path for future short-term interest rates that should re-engineer the recovery that was dented by the impact of the second wave of COVID-19, given the limited headroom from inflation remaining aligned with the target in April and forecast to stay within the tolerance band going forward. The onus is on the Reserve Bank to operationalize the MPC’s guidance on an ongoing basis by ensuring congenial financial conditions across the system as well as for specific sectors, instruments and institutions. With credit growth remaining subdued despite monetary transmission being reasonably full, the Reserve Bank is galvanising market-based channels of financing as well as off-market channels such as refinancing institutions. It is also proactively engaged in operations that convey the monetary policy stance directly across the term structure of interest rates. By keeping the policy rate unchanged and by persevering with the accommodative stance in this meeting, the MPC creates the space for further easing of financial conditions by the Reserve Bank. Statement by Shri Shaktikanta Das
52. When we last met in early April, the second wave of COVID-19 infections had started increasing but was still restricted to a few states. In the subsequent weeks, however, the surge in new infections turned severe and broad-based both in its spread across states and in the intensity of the increase, putting enormous pressure on the health system with heavy toll on human lives. The lockdown restrictions and containment measures undertaken by the states have led to a significant moderation of new infections and active cases; at the same time, it has taken some toll on the economy, as reflected in high-frequency economic and mobility indicators. We have now started seeing a phased relaxation of the restrictions in some states and can expect activity across the country to normalise from the beginning of July, if this trend persists.
53. The indicators of rural as well as urban demand suggest that economic activity was normalising and gaining a strong foothold in Q4:2020-21 with broad-based recovery driven by revival in real estate, manufacturing, construction and trade and financial services. With decline in infections, there were nascent signs of revival in the capex cycle during Q4:2020-21 as reflected in indicators like steel consumption; cement production; imports and production of capital goods. The recovery also got reflected in the strong print of the real gross value added (GVA) growth for the same quarter. This momentum in activity got abruptly disrupted with the onset of the second wave.
54. The infection containment efforts this time around were localised and calibrated, which allowed manufacturing and industrial activity to operate in varying degrees across states during this period. At the same time, businesses and supply chains have increasingly adapted to working in the pandemic and restricted environment. Also, the reverse migration of labour to villages has been muted relative to last year and inter-state movement of goods continues smoothly. Overall, it is expected that the loss in momentum of activity could be temporary and restricted to the first quarter of 2021-22.
55. Going forward, agriculture is expected to be the bright spot in the current year as well after remaining the fulcrum of growth during 2020-21. The upward revision of monsoon forecast with good spatial distribution augurs well for this expectation. Further, exports have exhibited resilience in recent months and with global recovery strengthening, especially in India’s key export destinations, it is anticipated that net exports would remain a propellant of growth in the current year. Enhanced and targeted policy support to exports can buttress this process further. The central government capex, which is budgeted to expand at a robust pace for 2021-22 (overall capital expenditure is budgeted to increase by 30.5 per cent within which capital outlay is budgeted to increase by 63.4 per cent) along with infrastructure pipeline, should reignite investment cycle once restrictions are eased. As the vaccination coverage expands, the pent-up demand for contact- intensive services is likely to rebound sharply. They should also get a leg up from the on-tap liquidity window from the Reserve Bank for these sectors. Domestic monetary and financial conditions remain highly accommodative and are expected to continue to be so in view of the MPC’s forward guidance. Taking all these factors into account, economic activity can be expected to recover from Q2:2021-22 onwards and gather pace in H2:2021-22 (October-March). For the full year, however, with the dent in activity during Q1:2021-22, the projected growth for 2021-22 is 9.5 per cent instead of 10.5 per cent projected earlier.
56. Over the last two months, inflation evolved broadly in line with our expectations. Headline inflation moderated to 4.3 per cent in April from 5.5 per cent in March. Large base effects played a crucial role and inflation sobered across food as well as core groups. A softening inflation print provides some relief and policy space enabling the Reserve Bank to step up liquidity infusion into the system to provide further support to the weak domestic economy in line with the MPC’s stance of reviving and sustaining growth on a durable basis. Moreover, the fragile demand conditions could help limit the pass-through of input cost pressures across manufacturing and services to output prices. Going forward, CPI inflation for 2021-22 is projected to be at 5.1 per cent, which is well within the mandated tolerance band of 2-6 per cent; however, we would need to keep a close watch on the evolving trajectory considering the uncertainties, both on the upside and downside, to the baseline path. Given the predominant role of supply side factors in the recent inflation movements, active and timely supply side policy measures with regard to petrol and diesel, edible oil and pulses, among others, would be critical to bring about a durable softening of price pressures.
57. Overall, the second wave of COVID-19 has altered the near-term outlook, and policy support from all sides – fiscal, monetary and sectoral – is required to nurture recovery and expedite return to normalcy. The dent on economic activity due to the second wave of the virus has necessitated the continuation of monetary measures to support the process of economic recovery to make it durable. I therefore vote for a pause on the repo rate. At the same time, there is a need to strengthen forward guidance by stressing the aspect of revival of growth. Thus, the emphasis should be to continue with accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. In this context, the phrase ‘to revive’ needs to be brought in so as to strengthen the forward guidance and demonstrate the unambiguous commitment of the MPC to revive and sustain the growth process. In fact, focus on revival and sustenance of growth is the most desirable policy option while of course remaining watchful of the inflation trajectory.
58. Going forward, the pace of vaccination and the speed with which COVID-19 second wave can be brought under control will have considerable bearing on the evolving growth as well the inflation trajectory. The Reserve Bank remains committed to undertake pro-active conventional and unconventional measures and to effectively channelling the systemic liquidity to alleviate stress of critical sectors which have borne the brunt of the second wave. In addition to liquidity provided under G-SAP operations, the Reserve Bank will continue to conduct other regular market operations to ensure that liquidity and financial conditions remain congenial, consistent with the accommodative stance of the monetary policy. (Yogesh Dayal) Press Release: 2021-2022/390 Chief General Manager
6. Since the MPC’s meeting during June 2-4, 2021 the pace of global recovery appears to be moderating with the resurgence of infections in several parts of the world, especially from the delta variant of the virus. In June and July, global purchasing managers’ indices (PMIs) slipped from the highs scaled in May. The growing consensus is that the recovery is occurring on a diverging two-track mode. Countries that are ahead in vaccination and have been able to provide or maintain policy stimulus are rebounding strongly. Growth in other economies remains subdued and vulnerable to new waves of infections. There has been a slowing of momentum in global trade volumes in Q2:2021, with elevated shipping charges and logistics costs posing headwinds.
7. There has been a considerable hardening of commodity prices, particularly of crude oil. The latest agreement within the Organisation of Petroleum Countries (OPEC) plus to raise oil production for a likely restoration of output to the pre- pandemic levels by September 2022 imparted transient softening to spot and future crude prices from the recent peak in early July. Headline inflation has ratcheted up in several advanced economies (AEs) as well as most emerging market economies (EMEs), prompting a few central banks in EMEs to tighten monetary policy. In contrast, sovereign bond yields have softened across AEs as markets seem to have acquiesced to the views of central banks that inflation is largely transitory. In EMEs, bond yields remain relatively high on inflation concerns and country-specific factors. In the foreign exchange market, EME currencies have depreciated in the wake of portfolio outflows since mid-June as risk appetite ebbed, while the US dollar has strengthened. Domestic Economy
8. On the domestic front, economic activity picked up pace in June-July as some states eased pandemic containment measures. As regards agriculture, the south- west monsoon regained intensity in mid-July after a lull; the cumulative rainfall up to August 1, 2021 was one per cent below the long-period average. The pace of sowing of kharif crops picked up in July along with some high frequency indicators of rural demand, notably tractor and fertiliser sales.
9. Reflecting large base effects, industrial production expanded in double digits year-on-year (y-o-y) in May 2021 on top of the massive jump in April, but it was still 13.9 per cent below its May 2019 level. The manufacturing purchasing managers’ index (PMI) that had dropped into contraction to 48.1 in June for the first time in 11 months, rebounded well into expansion zone with a reading of 55.3 in July. High- frequency indicators – e-way bills; toll collections; electricity generation; air traffic; railway freight traffic; port cargo; steel consumption, cement production; import of capital goods; passenger vehicle sales; two wheeler sales –posted strong growth in June/July, reflecting adaptations to COVID related protocols and easing of containment. Services PMI remained in contractionary zone due to COVID-19 related restrictions, though the pace eased to 45.4 in July from 41.2 in June 2021. Initial quarterly results of non-financial corporates for Q1:2021-22 show healthy growth in sales, wage growth and profitability led by information technology firms.
10. Headline CPI inflation plateaued at 6.3 per cent in June after having risen by 207 basis points in May 2021. Food inflation increased in June primarily due to an uptick in inflation in edible oils, pulses, eggs, milk and prepared meals and a pick-up in vegetable prices. Fuel inflation moved into double digits during May-June 2021 as inflation in LPG, kerosene, and firewood and chips surged. After rising sharply to 6.6 per cent in May, core inflation moderated to 6.1 per cent in June, driven by softening of inflation in housing, health, transport and communication, recreation and amusement, footwear, pan, tobacco and other intoxicants (as the effects of the one- off post-lockdown taxes imposed a year ago waned), and personal care and effects (due to sharp reduction in inflation in gold).
11. System liquidity remained ample, with average daily absorption under the LAF increasing from ₹5.7 lakh crore in June to ₹6.8 lakh crore in July and further to ₹8.5 lakh crore in August so far (up to August 4, 2021). Auctions for a cumulative amount of ₹40,000 crore in Q2:2021-22 so far under the secondary market government securities acquisition programme (G-SAP) evened liquidity across illiquid segments of the yield curve. Reserve money (adjusted for the first-round impact of the changes in the cash reserve ratio) expanded by 11.0 per cent y-o-y on July 30, 2021 driven by currency demand. As on July 16, 2021, money supply (M3) and bank credit by commercial banks grew by 10.8 per cent and 6.5 per cent, respectively. India’s foreign exchange reserves increased by US$ 43.1 billion in 2021-22 (up to end-July) to US$ 620.1 billion. Outlook
12. Going forward, the revival of south-west monsoon and the pick-up in kharif sowing, buffered by adequate food stocks should help to control cereal price pressures. High frequency indicators suggest some softening of price pressures in edible oils and pulses in July in response to supply side interventions by the Government. Input prices are rising across manufacturing and services sectors, but weak demand and efforts towards cost cutting are tempering the pass-through to output prices. With crude oil prices at elevated levels, a calibrated reduction of the indirect tax component of pump prices by the Centre and states can help to substantially lessen cost pressures. Taking into consideration all these factors, CPI inflation is now projected at 5.7 per cent during 2021-22: 5.9 per cent in Q2; 5.3 per cent in Q3; and 5.8 per cent in Q4 of 2021-22, with risks broadly balanced. CPI inflation for Q1:2022-23 is projected at 5.1 per cent (Chart 1).
13. Domestic economic activity is starting to recover with the ebbing of the second wave. Looking ahead, agricultural production and rural demand are expected to remain resilient. Urban demand is likely to mend with a lag as manufacturing and non-contact intensive services resume on a stronger pace, and the release of pent- up demand acquires a durable character with an accelerated pace of vaccination. Buoyant exports, the expected pick-up in government expenditure, including capital expenditure, and the recent economic package announced by the Government will provide further impetus to aggregate demand. Although investment demand is still anaemic, improving capacity utilisation and congenial monetary and financial conditions are preparing the ground for a long-awaited revival. Firms polled in the Reserve Bank surveys expect expansion in production volumes and new orders in Q2:2021-22, which is likely to sustain through Q4. Elevated levels of global commodity prices and financial market volatility are, however, the main downside risks. Taking all these factors into consideration, projection for real GDP growth is retained at 9.5 per cent in 2021-22 consisting of 21.4 per cent in Q1; 7.3 per cent in Q2; 6.3 per cent in Q3; and 6.1 per cent in Q4 of 2021-22. Real GDP growth for Q1:2022-23 is projected at 17.2 per cent (Chart 2).
14. Inflationary pressures are being closely and continuously monitored. The MPC is conscious of its objective of anchoring inflation expectations. The outlook for aggregate demand is improving, but still weak and overcast by the pandemic. There is a large amount of slack in the economy, with output below its pre-pandemic level. The current assessment is that the inflationary pressures during Q1:2021-22 are largely driven by adverse supply shocks which are expected to be transitory. While the Government has taken certain steps to ease supply constraints, concerted efforts in this direction are necessary to restore supply-demand balance. The nascent and hesitant recovery needs to be nurtured through fiscal, monetary and sectoral policy levers. Accordingly, the MPC decided to keep the policy repo rate unchanged at 4 per cent and continue with an accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID- 19 on the economy, while ensuring that inflation remains within the target going forward.
15. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 4.0 per cent.
16. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma, voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
17. The minutes of the MPC’s meeting will be published on August 20, 2021.
18. The next meeting of the MPC is scheduled during October 6 to 8, 2021. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The revival of economic activity seen in Q4: FY2020-21 was disrupted in the first two months of Q1: FY2021-22 by the surge of second wave of the Covid-19 pandemic. Sharp rise in infections and fatalities due to the pandemic during April-May 2021 compared to the same period in the previous year also led to imposition of restrictions on economic activities across states. As the second wave began to subside, some of the high frequency indicators of the economic activity have also shown revival in June and July 2021.
20. While pick-up in the pace of vaccinations against the disease enables return to more stable working conditions, uncertainties are highlighted by the continued potential for the emergence of new infections as the economic activity picks up unless the people’s Covid appropriate behaviour becomes a norm. Likelihood of emergence of new variants of the virus and its impact is also posing a challenge to achieve sustained recovery of the economy.
21. The global experience so far has highlighted the need for faster vaccination coverage and adoption of preventive measures by the population to achieve greater control over the spread of the disease. In the economies of the US and UK where the activity bounced back in 2021, sustaining the pace of this recovery has come under pressure with the rise in the Covid infections.
22. Impact of the pandemic on the nature and extent of economic recovery has been illustrated by the experience of the past two waves. The resilience of formal sector on the supply side and higher income segment on the demand side appear to be greater than the informal or lower income segment. Recovery of the contact intensive sectors of the economy – such as travel by public transport, hospitality and tourism - is slow and weak. Both – staying afloat and recovery – have required accommodative monetary, fiscal and financial sector policy support. These interventions are critical in restoring business and consumer confidence.
23. The negative impact of the pandemic in Q1: FY 2021-22 has been significant. The outlook surveys by the RBI covering manufacturing, services and infrastructure enterprises conducted during April-June 2021 find the perceptions of overall business conditions to be unfavourable in all three sectors. The survey of industry finds that a larger proportion of manufacturing enterprises experienced decline in capacity utilisation in Q1: FY 2021-22 than those who experienced rise in capacity utilisation. However, the survey finds that enterprises expect the situation to improve in Q2: 2021-22 with respect to capacity utilisation. The production levels, employment and financing conditions are also expected to improve in Q2: FY 2021-22 compared to the assessment for Q1, consistent with the expectation of improvement in capacity utilisation in Q2: FY 2021-22. Expectation of improvement in profit margins is more widely shared among the respondents in Q2: FY 2021-22 in all the sectors compared to the assessment for Q1. Overall, firms in the manufacturing, services and infrastructure sectors expect improvement in demand conditions in Q2: FY2021-22. Moreover, the investment intentions remain muted for the current financial year with fewer firms planning fresh investments as compared to the previous year.
24. The consumer confidence survey by RBI polled during June 28-July 9 in the major urban centres of the country shows lesser pessimism in the perception of general economic conditions compared to the findings of the survey of May. On the other hand, the expectations for one-year ahead are also characterised by larger proportion of the respondents who do not expect the general conditions to improve compared to those who expect otherwise. Household income situation is seen to have deteriorated in July compared to the assessment in May 2021. However, one- year-ahead income situation is expected to improve but the optimism is yet to reach the level seen in January 2021. Expectations on overall spending recover slightly, with improvement in spending on ‘essential items’. Improvement in household income following the recovery of employment conditions is necessary to spur consumer sentiments.
25. In the case of industry, based on IIP data, while manufacturing output has shown high growth year-on-year basis in April-May 2021, on a low base in which the national level movement restrictions were effected, on month over month basis, there was a decline in growth rate. In the case of mining and electricity pattern is the same.
26. The high frequency indicators such as domestic air passenger traffic, passenger vehicle sales, motor cycle sales, tractor sales and consumption of finished steel and production of cement point to improvement in economic activity in June over the levels in May. In the case of GST collections and e-way bills, the year-on- year growth rate during May-June 2021 remains strong but over a weak base. The unemployment rate and labour participation rate, broader indicators of the economic activity tracked in the CMIE’s household surveys, show improvement in the level of economic activity in June and July, with data available up to the week of 21 July 2021. Merchandise exports show sequential growth during the period April-June 2021. However, the year-on-year growth of non-food credit, another indicator of the economic activity at a broader level, was 6.2 per cent in early July not significantly higher than the growth seen a year ago.
27. The South-West monsoon, a key determinant of the performance of agriculture, has not been close to the long-period average in the current year up to July across all the different regions. The area sown in the Kharif season up to July 30th was 4.7 per cent lower than in the previous year, with cotton, oilseeds and coarse cereals areas declining at a higher rate than the overall crop area. The reservoir levels are, however, reported to be higher than in the previous year, leaving potentially improved availability of water for irrigation that supports improved crop yields.
28. The overall picture that emerges points to signs of nascent stage of recovery from the initial shock of the second wave of the pandemic during April-May 2021.
29. Recent assessment of the year-on-year growth of GDP at constant prices in FY2021-22 by a number of professional forecasting organisations, which were made in the month of July, has ranged from 8.8 to 10 per cent. Further, the median real GDP growth forecast of Survey of Professional Forecasters (SPF) conducted by RBI in July 2021 is 9.2 per cent. The SPF assessment of GDP growth is a downward revision from 9.8 per cent obtained by the survey carried out in May 2021, which itself was a downward revision from 11.0 per cent from the earlier round of March 2021. The successive reductions in the recent two rounds reflect the impact of the second wave of Covid-19. An important upward revision in the July 2021 SPF is in the external sector: merchandise exports and merchandise imports are projected to increase at a higher rate than in the May 2021 round of the survey.
30. Taking into the various factors, the projected GDP year-on-year growth rate of 9.5 per cent for FY 2021-22 is within the range of forecasts available in July including the SPF July 2021. The present projections are unchanged from the overall GDP growth projection in the June meeting of MPC, although quarterly projections of 21.4% (Q1), 7.3% (Q2), 6.3% (Q3) and 6.1% (Q4) reflect an upward revision in Q1 and downward revisions in the remaining three quarters.
31. Even as there are signs of economic recovery from the disruption to the growth momentum achieved in Q4: FY2020-21, the conditions impacting inflation are a concern. The global commodity prices impact the overall domestic price situation. One of the key drivers of present inflation is the fuel prices. The year-on-year inflation in CPI for fuel is up from 4.4 per cent in March 2021 to 12.7 per cent in June 2021. The sharp rise in the prices of fuels used for transportation, feed into the core inflation through transportation services prices. Similar is the impact of other prices affected by international commodity price rise such as the metals. While these may be one-time effects, prices would remain elevated unless the external shock is reversed. Although the sequential month-on-month momentum has moderated in June in the case of food and fuel and declined in the core components, the inflation rate remains elevated. In the case of CPI food, the year-on-year rate has remained above 5 per cent in May and June. Vegetables and edible oils are contributing to the sequential momentum and going forward, prospects of Kharif output would affect the price pattern. Finally, price adjustments to account for pandemic induced altered supply-side conditions may also emerge as the demand conditions improve. These may be one-time effects on prices. The households’ expectations captured in the RBI’s Inflation Expectations Survey of urban households conducted during June 28- July 9, 2021 reflect an increase of 0.5 percentage points in inflation expectations 3- months ahead. The pace of increase is lower than that observed in the previous survey of May 2021.
32. The projected year-on-year CPI inflation rate for the Q2-Q4 quarters of FY 2021-22 at 5.9, 5.3 and 5.1 per cent is higher than the projections in June, mainly on account of the higher fuel and items other than food and fuel. The FY 2021-22 CPI inflation is projected at 5.7 per cent.
33. With faster expansion of vaccination program, better health care infrastructure and measures by the public to prevent the spread of Covid infections, the rise in consumer sentiments can be expected to be sustained and supportive of the expansion of supplies. All policy measures are needed to achieve normalisation of economic activities and moderation of inflationary pressures.
34. I vote in favour of keeping the policy repo rate unchanged at 4.0 per cent. I also vote in favour of continuing with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
35. A global conviction seems to have firmed up that the inflation spike is due to Covid-19 related supply bottlenecks and therefore is temporary. US ten year G-secs rates have softened. Research finds inflation to be more in Covid-19 affected products.
36. Oil, global commodity and semi-conductor prices are actually showing signs of reversal. Domestic inflation has also marginally fallen in June compared to May, and its momentum softened considerably, as second wave lockdowns were eased. There may be more reversals in future. Signs of second-round inflation pass through are still limited. The August RBI inflation forecasts may be an overestimate.
37. The MPC has a difficult job as it battles both the slowdown and the inflation Covid-19 has triggered. Even so, marginal moderation in inflation has twice this year provided just in time relief—pointing again towards supply-side causation and volatility.
38. Advanced economy central banks emphasize the dangers of premature tightening: ECB plans to maintain its stimulus in the form of ultra-low interest rates until inflation durably reaches its 2% target. The US fed is targeting average inflation and wants it to rise above target to compensate for being below for long; in India the aim should be to provide support until the investment cycle starts durably. As long as inflation is in the tolerance band, it can gradually be brought down to target.
39. According to Taylor rules estimated for India a persistent rise in expected inflation above the tolerance band or rise after closing of output gap, require policy rates to rise. But optimal policy can differ. No mechanical formula is adequate, especially in these unusual times. Output gap is especially difficult to measure under the Covid-19 shock—there is a requirement to recreate jobs, alleviate sectoral distress as well as pull out of a decade long investment slowdown. There is uncertainty regarding a possible third wave and global slowdown as delta and other variants spread, or of the reverse—an aggressive revenge spending and export boom.
40. Moreover, currently we have a fiscal contraction, contrary to most countries. But here monetary policy is not at the zero bound and has space to keep real interest rates low. The equilibrium real rate does become negative under temporary output shocks. But real rates should not fall below the equilibrium rate. Wholesale price inflation is higher than consumer inflation giving lower real rates to firms, but it helps them less if the inflation is due to cost shocks.
41. If, however, indirect taxes impart persistence to inflation, this could de-anchor inflation expectations and pose challenges for monetary policy. Research shows that while temporary commodity spikes are looked through, a persistent rise tends to affect inflation expectations. The volatility of Indian fuel prices is much lower than international and average rise is more, since taxes are not decreased as much when international oil prices rise, as they are increased when oil prices fall. A persistent rise in Indian fuel prices is at odds with inflation targeting.
42. Although household inflation expectations are naive and much in excess of realized inflation, the direction of change is instructive. While household 3-month and 1-year inflation expectations continue to increase, current perceptions are stabilizing. The latter fell in September 2020 as the first wave clearly moderated. Expectations also fell later in November. This cycle may repeat, since the uncertainty associated with expectations rose sharply in May 2020 with the onset of Covid-19 and has remained high since.
43. These aspects and the June softening in inflation momentum indicate it is better to wait and watch inflation, inflation expectations and growth outcomes. Inflation has been above target for many months but the rise is due to multiple supply shocks associated with the prolongation of Covid-19. Sustained rise above the tolerance band has not yet exceeded the three quarters time given to the MPC. The reputation and responsiveness of an inflation targeting regime, as well as supply-side support from the government, may be adequate to prevent de-anchoring of inflation expectations despite these multiple shocks.
44. Therefore, I vote for status quo on the repo rate and policy stance.
45. Whenever normalization starts, it should be very gradual and aligned to growth recovery and inflation paths. Since stance affects only repo rate actions, other normalization can start even in an accommodative stance. This is only my view—the MPC does not vote on liquidity actions. In 2009 it was decided to first reduce excess liquidity and this is what markets expect. But in its normalization, the US Fed stopped balance sheet expansion, announced on October 29, 2014, but did not reverse its size—this worked well in keeping markets calm after the taper-on shock and in helping recovery. Since excess liquidity is absorbed at the reverse repo, M3 growth cannot be excessive unless demand revives. A rise in the price of money can restrain its growth. The definition of the stance is consistent with some durable liquidity surplus continuing in a tight/neutral stance.
46. India had excessively tight financial conditions in much of the past decade. Some slack is required to lubricate the economy so payments percolate to low income segments. Banks are now unable to adequately supply the needs of an increasingly diverse financial sector, so schemes targeting liquidity to different sectors need to continue. Moreover, India is subject to large negative liquidity shocks from rise in currency holding, government cash balances and foreign capital outflows 1. Surplus durable liquidity can help to absorb and counter these, especially as the US Fed exits accommodation.
47. Some G-SAP support may also have to continue until fiscal consolidation is adequate. But this consolidation is happening faster than expected as tax revenues are buoyant. Despite a rise in short-rates, long-term spreads may still fall with less than anticipated government borrowing and as there is more conviction on the inflation target. Government cash balances are already large. If, however, expected inflation raises G-secs rates by 1%, and the public debt GDP ratio is about 100%, government interest payments will rise by 1% of GDP. Compared to that, a cut in fuel taxes would sacrifice about 0.5% of GDP in revenues and have many other benefits such as anchoring inflation expectations, reviving demand as well as enabling a fair sharing of the burden of oil price shocks. Statement by Prof. Jayanth R. Varma
48. In the last several meetings, my statements have expressed the belief that the balance of risk and reward is in favour of monetary accommodation. As the pandemic continues to mutate, it appears to me that the balance of risk and reward is gradually shifting, and this merits a hard look at the accommodative stance.
49. First, Covid-19 is beginning to look more and more like tuberculosis which kills a very large number of people every year without inflicting major damage to the economy; in other words, it is beginning to resemble a neutron bomb. The ability of monetary policy to mitigate a human tragedy of this nature is very limited as compared to its ability to contain an economic crisis. Related to this is the lengthening of the time horizon of the pandemic. Global experience (particularly countries like Israel which are witnessing rising case counts despite very high levels of vaccination) suggests that vaccination is insufficient to stamp out the pandemic though it might reduce its severity. The possibility that Covid-19 will haunt us (though with lower mortality) for the next 3-5 years can no longer be ruled out. Keeping monetary policy highly accommodative for such a long horizon is very different from doing so for what was earlier expected to be a relatively short crisis.
50. Second, monetary policy has very broad effects on the entire economy, and this was appropriate in the early phase of the pandemic which caused generalized economic distress. More recently, however, the ill effects of the pandemic have been concentrated in narrow pockets of the economy. At the industry level, contact intensive services have suffered heavily, while many other industries are now operating above pre-Covid levels. At the firm level, MSMEs have suffered severely, while large businesses have prospered. At the household level, the pandemic has been devastating for weaker sections of the society, while the affluent have weathered it reasonably well. Geographically also, the pandemic has done its worst damage in around 100-200 districts spread across a relatively small number of states. Monetary policy is much less effective than fiscal policy for providing targeted relief to the worst affected segments of the economy. Indeed, monetary accommodation appears to be stimulating asset price inflation to a greater extent than it is mitigating the distress in the economy. 1 See Charmal, V. and Goyal, A. 2021. ‘Liquidity management and monetary transmission: empirical analysis for India’, Journal of Economic Studies, Published online ahead-of–print July 13. https://doi.org/10.1108/JES-07- 2020-0359
51. Third, inflationary pressures are beginning to show signs of greater persistence than anticipated earlier. There are indications that inflationary expectations may be becoming more widely entrenched. Most worrying of all, there is now a reduced degree of confidence that demand side inflationary pressures would remain quiescent. After averaging above 6% in 2020-21, inflation is forecast to be well above 5% in 2021-22, and is not expected to drop below 5% even in the first quarter of 2022-23 according to RBI projections. While there is some comfort that inflation is forecast to be below the upper end of the tolerance band, it is important to emphasize that the inflation target for the MPC is 4% and not 6% or even 5%. The tolerance band is designed to allow for forecast errors, implementation shortfalls and measurement issues. Treating 5% as the target would significantly increase the risk of inflation targeting failures. (While I have seen some commentary suggesting that there may be a case for raising the inflation target during the pandemic, that decision clearly lies with the government and not with the MPC.)
52. In this context, I believe that the current level of the reverse repo rate is no longer appropriate. I am conscious of the fact that the MPC’s mandate is supposed to be restricted to the policy rate or the repo rate. Unfortunately, the monetary policy statement of this meeting (as in the past several meetings) contains the line: “Consequently, the reverse repo rate under the LAF remains unchanged at 3.35 per cent”. I have for some time now being arguing that if the reverse repo rate does not fall within the remit of the MPC, then the announcement of this rate should be in the Governor’s statement and not in the MPC’s statement, but this view has not found favour with the rest of the MPC. Hence, I have no choice but to express my disagreement with the level of the reverse repo rate. A gradual normalization of the width of the corridor is warranted. In my view, a phased normalization of the corridor would increase the ability of the MPC to keep the repo rate at 4% for a longer period, and this should in my view be a greater priority for the MPC than maintaining an ultra- low reverse repo rate for some more time.
53. At a time when the economic recovery is still nascent, it is extremely important that monetary policy serves as an anchor of macroeconomic stability. That would reduce the inflation risk premium as well as the term premium and help stabilize long term interest rates. As I have argued in my past statements, a low long term interest rate is more important for inducing an investment led growth than a low short term rate. In this light, I fear that the forward guidance and monetary stance are becoming counter productive. By creating the erroneous perception that the MPC is no longer concerned about inflation and is focused exclusively on growth, the MPC may be inadvertently aggravating the risk that inflationary expectations will be disanchored. In that scenario, rising risk premia could cause long term rates to rise. Easy money today could lead to high interest rates tomorrow. On the other hand, by demonstrating its commitment to the inflation target with tangible action, the MPC will be able to anchor expectations, reduce risk premia, and sustain lower long term interest rates for longer thereby aiding the economic recovery. For these reasons, I am not in favour of the decision to keep the reverse repo rate at 3.35%, and vote against the accommodative stance.
54. On the other hand, I vote for maintaining the repo rate at 4% for the following reasons. Economic growth was unsatisfactory long before the pandemic, and even if the economic ill effects of the pandemic abate to some extent, substantial monetary accommodation is warranted. Persistent high inflation means that the monetary accommodation has to be somewhat restrained, and, therefore, I argued above for raising money market rates towards the repo rate of 4% from the current ultra-low level of 3.35%. The repo rate of 4% corresponds to a negative real rate in the range of 1-1.5% based on forward looking inflation forecasts. In my view, this level of rates is currently appropriate for reviving economic growth without excessive risk of an inflationary spiral. Needless to say, the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future. Statement by Dr. Mridul K. Saggar
55. The policy trade-offs that I highlighted at the June MPC meetings are no less relevant today. However, the policy balance needs to be reviewed after appraising the recent information on inflation and growth.
56. The trepidation reflected in my June MPC statement, when I stated that the risks of breaching the upper tolerance level are not insignificant, materialised in its dreaded form when May inflation data was released in June. There were three important facets of that data. First, the headline inflation crossed the upper tolerance level, raising the prospects that inflation could stay above the tolerance band for most part of the year. Second, the momentum in May was high with 1.65 per cent month- over-month (m-o-m) increase being about 2½ times of what can be considered normal for the month. Third, price increases were generalised across commodities that month. Of the 299 commodities for which item-level price data is made available by NSO on a monthly basis, as many as 240 commodities witnessed price increase during the month, which was the highest ever for the flexible inflation targeting period.
57. The latest available CPI numbers for June released in July, however, turned out to be antithetical, telling a very different story. First, the headline inflation surprised on the downside and stayed at 6.3 per cent with price levels dropping for several groups. It showed that May price spike may have been caused by fresh supply-side disruptions in the second wave and the month’s inflation number may have been biased upwards contaminated by data collection difficulties. Second, the momentum in June with a m-o-m increase of just 0.56 per cent was distinctly below the average momentum seen for the month. Third, the general increase in prices seen in May did not sustain in June and fewer items witnessed price increases during the month than is witnessed on an average. Moreover, the momentum in WPI that was exceptionally high during February-April 2021 has also receded during May-June 2021 reducing the risks of high passthrough ahead by producers to consumers at a retail level.
58. Interpreting inflation trends have turned difficult with these mixed trends and some fuzziness in data. However, going forward, three considerations are important. First, in terms of baseline forecast, post the correction in price levels witnessed in June, inflation is projected to stay above the target, but within the tolerance bands. Second, with inflation averaging 6.23 per cent since December 2019 and breaching the upper tolerance level in 13 of those 19 months, inflation persistence remains a concern even though the supply-side shock in May could have large transitory component. Even though the nature of inflation is cost-push, persistence of inflation is worrisome, especially as inflation expectations are getting impacted partly by the adaptive expectations but also in part due to inertial element in this inflation that needs to be closely watched. The third aspect, that can have an overriding consideration in policy decision at hand, is that this inflation is not from the demand side. Aggregate demand remains sub-normal and fragile. The extended price pressures are emanating from second round effects of a very large cost-push shock which to a sizable part has been passthrough from global commodity prices across energy, metal and mineral space, though mineral prices have seen a sharp correction over last two weeks. The effects have been magnified as on May 6, 2020, excise duty on petrol and diesel was hiked by 44 per cent and 69 per cent, respectively and has not been reversed in face of fiscal constraints. Model based estimates suggest the excise duty hike itself may have pushed headline inflation higher by 60-80 bps, adding to cost push inflation.
59. Growth recovery remains fragile accentuated by the dent caused by the second wave and continued uncertainties about pandemic driven by distance to herd immunity and virus mutations. Risks that recovery can falter ahead remain on number of counts. First, at the start of our meetings, cumulative rainfall deficiency in monsoon, has been just 1 per cent. However, the spatial and temporal distribution of monsoon this season has been sub-par. While sowing deficiency that was large in early July has been largely bridged, some adverse impact on yields and outturn can emerge. These risks can magnify if climate changes cause a repeat of weather disruptions as has often happened of late with unseasonal rains affecting some horticulture crops. Second, the IIP in Q1 of 2021-22 is likely to remain below the pre- pandemic average for fiscal year 2019-20 as is already known to be the case for the output level of eight core industries with its June levels still 3.8 per cent below the pre-pandemic fiscal year average for 2019-20. Third, the high frequency indictors also have similar story. Over two-thirds of high frequency indicators remain below pre-pandemic levels. Fourth, services sector is particularly vulnerable. Services PMI at 45.4 in July remains in contraction zone implying two months after the second wave, services activity is still perceived to be falling m-o-m. Fifth, informal sector particularly requires policy support, with emerging evidence of added scaring from the second wave. Sixth, capacity utilization rates are still abysmally low with OBICUS seasonally adjusted capacity utilisation rate of 67.6 per cent in Q4 not only being markedly lower than the long-term average (from start of the survey in Q1:2008-09 till the pre-pandemic period ending Q4:2019-20) of 74.6 but is also below the all-time pre-pandemic low. In Q1:2021-22, the second wave of Covid-19 infections would have again brought the capacity utilisation rates further down from this low as is also the indication from the Industrial Outlook Survey.
60. It is not unusual for central banks to set policies based more on current conditions than forecasts in times of crisis or extreme uncertainties. Currently, risk of policy errors on either side remains given the large uncertainty on growth and inflation as well as policy trade-offs attached to it. Relying exclusively on forward- looking policies increases these risks, especially with extant wide probability distribution attached to inflation forecasts and lack of good information on distributional aspects of growth that affects the bottom of the pyramid disproportionately, the importance of which I explained in my last MPC statement. Inflation is currently elevated above target and as a baseline is expected to recede. However, the probability distribution of the projections over a one-year horizon, as provided in the resolution fan charts, even at 50 per cent confidence level leaves the possibility of inflation breaching the upper tolerance level or falling below the lower tolerance level. In these circumstances, policy can respond with agility should need arise. If newer supply-side disturbances or elongation of imported commodity price inflation occurs it can impel a reassessment. However, currently these risks seem to have diminished, though not waned, with Kharif sowing deficiency getting bridged and global commodity price cycle showing signs of thawing on back of anticipated cyclical slowdown of the Chinese economy and possibility that the US economy, dented by the third wave, may not overheat. On the other side, the possibility of prolonged disinflationary impulse on back of sustained demand weakness cannot be ruled out altogether.
61. The MPC’s current mandate is to set the policy repo rate and the stance of the monetary policy. Getting the timing and sequence of policy change wrong and inviting policy reversals later can result in costly increase in output and inflation volatility. Therefore, at this stage status quo would be better option awaiting further clarity from near-term incoming data. Changing repo rate at this stage will not be effective and apt from sequencing viewpoint. So, I vote for keeping repo rate unchanged and continuing the accommodative stance.
62. Policy focus to revive growth on a durable basis needs to continue and should entail consideration to avoid inflation risks that may emanate when credit demand improves, likely ahead of output gap closing. This arduous task needs to be carried without endangering sustainable recovery in growth. Narrative economics plays an important role in difficult times as even animal spirits are characterised by fat tails and can produce endogenous business cycle movements. However, averting markets becoming opiated to slush liquidity designed as temporary crisis measure is critical to facilitate unwinding when the time comes. Gradual adjustments that are non-disruptive are possible within the accommodative stance. Therefore, I vote with the resolution. Statement by Dr. Michael Debabrata Patra
63. With infections plateauing and vaccination underway on a national scale, people are stepping out of isolation and workplaces are filling up. Power consumption is recovering, freight traffic has shown pandemic-proofing, air travel is rebounding, and all payment modes have registered an uptick in volumes. In my opinion, these indicators are foretelling a revival of business and consumer confidence. This window must be utilised to reinvigorate the interrupted recovery even while preparing for a possible third wave. Absorptive capacity of the economy is rising again, and this is reflected in higher imports and utilisation of capital flows from abroad to supplement domestic saving and push up the investment rate - gross capital formation has risen to 31.3 per cent in January-March 2021, with two-thirds of net foreign capital inflows received by India during that quarter being absorbed domestically. Yet, even as near- term prospects have brightened, aggregate demand conditions are taking more time to heal.
64. Amidst the extreme uncertainty encircling the path of the pandemic, monetary policy authorities have sought to impart some certainty by a commitment to a stance of accommodation extending into the future. With the upsurge of inflation worldwide, this effort to anchor expectations is under scrutiny. In some countries, markets have acquiesced with the authorities’ view that inflation pressures are transitory and do not warrant a change in the policy stance. In others, central banks have pre-emptively tightened the policy stance despite assessing inflation as transitory. This is a razor’s edge dilemma and responding to it, in my view, involves a judgment call that puts both foresightedness and inflation fighting credibility on the line.
65. My vote in this meeting is to maintain the policy rate at 4 per cent and continue with the accommodative stance as adopted so far. In my view, monetary policy has an inherently domestic orientation and the stance of policy is predominantly shaped by country-specific exigencies. In India, my assessment is that headline inflation may persist at current elevated levels at least through the second quarter of 2021-22 before easing in the third quarter when the kharif harvest arrives in markets. There are demand-supply mismatches as in the case of protein-rich food items, edible oils and pulses, which are being addressed by specific supply measures, and there are indications that these price pressures are softening. On the other hand, underlying or core inflation may remain stubborn for longer due to disruptions caused by the pandemic, overlaid with increases in margins and taxes. The high flux in elevated international crude prices remains a risk to inflation and to the terms of trade. It is important to cushion the economy from this volatility through policy interventions.
66. The economy is struggling to regain the momentum that had gathered in the second half of 2020-21. As mentioned earlier, a solidly entrenched increase in aggregate demand is yet to take shape. Although it seems meaningful to compare progress with a pre-pandemic year, it needs to be noted that in 2019-20, a cyclical downturn had matured over 2 and a half years, taking down real GDP growth to its lowest in the 2011-12 based series of national accounts. Thus, there is substantial slack in resource utilisation in the economy which needs to be drawn in to get economic activity back to normalcy. The highest priority now is to revive growth along a sustainable trajectory that becomes compatible with the inflation target as the pandemic recedes. The price that has to be paid for this policy choice is inflation in the upper reaches of but within the tolerance band in this exceptional, pandemic ravaged year of 2021-22, as against the overshoot above the upper tolerance band in 2020-21. So far, inflation outcomes are tracking this projected path. Statement by Shri Shaktikanta Das
67. Since the outbreak of the pandemic, all the meetings of the MPC have been held under challenging circumstances. This one was no less, given the nuancing required at this critical juncture – to continue to foster growth which is nascent even as there is a sharp spike in inflation almost across the globe.
68. The MPC has prioritised revival of growth and mitigation of the impact of the pandemic while ensuring that inflation expectations remain anchored, as its guiding principle. Last year, when inflation rose sharply to 7.3 per cent in September and further to 7.6 per cent in October 2020, our assessment pointed to exogenous and largely temporary supply shocks driving the inflation process. Under these conditions, the MPC decided to moderate irrational expectations building up at that time of a possible reversal of the monetary policy stance through time-specific guidance. The MPC took a call to look through the supply shocks driven inflation and sought a convergence of expectations all around that monetary policy would continue to remain accommodative in support of growth and not respond to the supply side pressures on inflation. In hindsight, our prognosis turned out to be correct as inflation ebbed to around 4.1 per cent by January 2021 and was at an average of 4.9 per cent in Q4:2020-21. The forward guidance given during October-February 2020-21 was helpful in anchoring market expectations; navigating the recovery from the crisis; and strengthening the pace of monetary policy transmission.
69. The resurgence in inflation in May and June above the upper threshold has reignited the debate on the appropriate monetary policy response. The gains in monetary policy credibility since the adoption of inflation targeting have helped the MPC to respond effectively to growth-inflation trade-offs posed by an exceptional shock like the COVID-19 pandemic. The flexible inflation targeting (FIT) framework allows adequate flexibility to the MPC to deal with unanticipated shocks to the economy in the conduct of its monetary policy. The Reserve Bank’s whatever it takes approach, bolstered by careful guidance on all aspects in the conduct of monetary policy, has been an important facilitator for the cusp of recovery that we are witnessing at the present juncture.
70. Our own assessment of the resurgence in inflation in India since the June 2021 policy is that it is driven largely by adverse supply-side drivers impinging on food, fuel and core groups due to multifarious disruptions caused by the pandemic. Many of current price shocks are likely to be one-off or transitory. Weak demand conditions and low pricing power are limiting the extent of their pass-through to output prices.
71. The inflation forecast given by the MPC shows that headline inflation will remain within the tolerance band – albeit closer to the upper tolerance level. The economy is slowly returning back to normalcy from the biggest shock in 100 years. The MPC’s projection of 9.5 per cent GDP growth for the current year would mean that the size of the economy in 2021-22 will be moderately higher than 2019-20. There is still considerable slack in the economy. Domestic demand is picking up, but at a slow pace. Several supply side measures have been taken by the Government to deal with the inflationary pressures; however, more needs to be done. The daily new COVID-19 infections are sticky at around 40,000 cases per day. Possibility of a third wave looms somewhere in the horizon. On the whole, the economy still requires support in terms of maintaining congenial financial conditions and fiscal boosters. At such a critical juncture, can we really pull the rug and the let the economy tumble? The need of the hour is twofold: first, continue the monetary policy support to the economy; and second, remain watchful of any durable inflationary pressures and sustained price momentum in key components so as to bring back the CPI inflation to 4 per cent over a period of time in a non-disruptive manner.
72. Managing the economy and the financial markets since the beginning of the pandemic has thrown up several challenges with crosscurrents and conflicting objectives. Under such circumstances, macroeconomic policies have to be carefully nuanced by making judicious policy choices. Continued policy support with a focus on revival and sustenance of growth is indeed the most desirable and judicious policy option at this moment. I, therefore, vote to keep the policy rate unchanged and continue with the accommodative stance as spelt out by the MPC in its June 2021 meeting. In parallel, close monitoring of the inflation dynamics will have to continue so as to anchor the inflation expectations. (Yogesh Dayal) Press Release: 2021-2022/722 Chief General Manager
6. Since the MPC’s meeting during August 4-6, 2021, the momentum of the global recovery has ebbed across geographies with the rapid spread of the delta variant of COVID-19, including in some countries with relatively high vaccination rates. After sliding to a seven-month low in August, the global purchasing managers’ index (PMI) rose marginally in September. World merchandise trade volumes remained resilient in Q2:2021, but more recently there has been a loss of momentum with the persistence of supply and logistics bottlenecks.
7. Commodity prices remain elevated, and consequently, inflationary pressures have accentuated in most advanced economies (AEs) and emerging market economies (EMEs), prompting monetary tightening by a few central banks in the former group and several in the latter. Change in monetary policy stances, in conjunction with a likely tapering of bond purchases in major advanced economies later this year, is beginning to strain the international financial markets with a sharp rise in bond yields in major AEs and EMEs after remaining range-bound in August. The US dollar has strengthened sharply, while the EME currencies have weakened since early-September with capital outflows in recent weeks. Domestic Economy
8. On the domestic front, real gross domestic product (GDP) expanded by 20.1 per cent year-on-year (y-o-y) during Q1:2021-22 on a large favourable base; however, its momentum was dragged down by the second wave of the pandemic. The level of real GDP in Q1:2021-22 was 9.2 per cent below its pre-pandemic level two years ago. On the demand side, almost all the constituents of GDP posted robust y-o-y growth. On the supply side, real gross value added (GVA) increased by 18.8 per cent y-o-y during Q1:2021-22.
9. The rebound in economic activity gained traction in August-September, facilitated by the ebbing of infections, easing of restrictions and a sharp pick-up in the pace of vaccination. The south-west monsoon, after a lull in August, picked up in September, narrowing the deficit in the cumulative seasonal rainfall to 0.7 per cent below the long period average and kharif sowing exceeded the previous year’s level. Record kharif foodgrains production of 150.5 million tonnes as per the first advance estimates augurs well for the overall agricultural sector. By end-September, reservoir levels at 80 per cent of the full reservoir level were above the decadal average, which is expected to boost rabi production prospects.
10. After a prolonged slowdown, industrial production posted a high y-o-y growth for the fifth consecutive month in July. The manufacturing PMI at 53.7 in September remained in positive territory. Services activity gained ground with support from the pent-up demand for contact-intensive activities. The services PMI continued in expansion zone in September at 55.2, although some sub-components moderated. High-frequency indicators for August-September – railway freight traffic; cement production; electricity demand; port cargo; e-way bills; GST and toll collections – suggest progress in the normalisation of economic activity relative to pre-pandemic levels; however, indicators such as domestic air traffic, two-wheeler sales and steel consumption continue to lag. Non-oil export growth remained strong on buoyant external demand.
11. Headline CPI inflation at 5.3 per cent in August softened for the second consecutive month, declining by one percentage point from the recent peak in May- June 2021. This was primarily driven by an easing in food inflation. Fuel inflation edged up to a new high in August. Core inflation, i.e. inflation excluding food and fuel, remained elevated and sticky at 5.8 per cent in July-August 2021.
12. System liquidity remained in large surplus in August-September, with daily absorptions rising from an average of ₹7.7 lakh crore in July-August to ₹9.0 lakh crore during September and ₹9.5 lakh crore during October (up to October 6) through the fixed rate reverse repo, the 14-day variable rate reverse repo (VRRR) and fine- tuning operations under the liquidity adjustment facility (LAF). Auctions of ₹1.2 lakh crore under the secondary market government securities acquisition programme (G- SAP 2.0) during Q2:2021-22 provided liquidity across the term structure. As on October 1, 2021, reserve money (adjusted for the first-round impact of the change in the cash reserve ratio) expanded by 8.3 per cent (y-o-y); money supply (M3) and bank credit grew by 9.3 per cent and 6.7 per cent, respectively, as on September 24, 2021. India’s foreign exchange reserves increased by US$ 60.5 billion in 2021-22 (up to October 1) to US$ 637.5 billion, partly reflecting the allocation of special drawing rights (SDRs), and were close to 14 months of projected imports for 2021-22. Outlook
13. Going forward, the inflation trajectory is set to edge down during Q3:2021-22, drawing comfort from the recent catch-up in kharif sowing and likely record production. Along with adequate buffer stock of foodgrains, these factors should help to keep cereal prices range bound. Vegetable prices, a major source of inflation volatility, have remained contained in the year so far and are likely to remain soft, assuming no disruption due to unseasonal rains. Supply side interventions by the Government in the case of pulses and edible oils are helping to bridge the demand supply gap; the situation is expected to improve with kharif harvest arrivals. The resurgence of edible oils prices in the recent period, however, is a cause of concern. On the other hand, pressures persist from crude oil prices which remain volatile over uncertainties on the global supply and demand conditions. Domestic pump prices remain at very high levels. Rising metals and energy prices, acute shortage of key industrial components and high logistics costs are adding to input cost pressures. Weak demand conditions, however, are tempering the pass-through to output prices. The CPI headline momentum is moderating with the easing of food prices which, combined with favourable base effects, could bring about a substantial softening in inflation in the near-term. Taking into consideration all these factors, CPI inflation is projected at 5.3 per cent for 2021-22; 5.1 per cent in Q2, 4.5 per cent in Q3; 5.8 per cent in Q4 of 2021-22, with risks broadly balanced. CPI inflation for Q1:2022-23 is projected at 5.2 per cent (Chart 1).
14. Domestic economic activity is gaining traction with the ebbing of the second wave. Going forward, rural demand is likely to maintain its buoyancy, given the above normal kharif sowing while rabi prospects are bright. The substantial acceleration in the pace of vaccination, the sustained lowering of new infections and the coming festival season should support a rebound in the pent-up demand for contact intensive services, strengthen the demand for non-contact intensive services, and bolster urban demand. Monetary and financial conditions remain easy and supportive of growth. Capacity utilisation is improving, while the business outlook and consumer confidence are reviving. The broad-based reforms by the government focusing on infrastructure development, asset monetisation, taxation, telecom sector and banking sector should boost investor confidence, enhance capacity expansion and facilitate crowding in of private investment. The production-linked incentive (PLI) scheme augurs well for domestic manufacturing and exports. Global semiconductor shortages, elevated commodity prices and input costs, and potential global financial market volatility are key downside risks to domestic growth prospects, along with uncertainty around the future COVID-19 trajectory. Taking all these factors into consideration, projection for real GDP growth is retained at 9.5 per cent in 2021-22 consisting of 7.9 per cent in Q2; 6.8 per cent in Q3; and 6.1 per cent in Q4 of 2021-
15. Inflation prints in July-August were lower than anticipated. With core inflation persisting at an elevated level, measures to further ameliorate supply side and cost pressures, including through calibrated cuts in indirect taxes on petrol and diesel by both Centre and States, would contribute to a more durable reduction in inflation and anchoring of inflation expectations. The outlook for aggregate demand is progressively improving but the slack is large: output is still below pre-COVID level and the recovery is uneven and critically dependent upon policy support. Compared to pre-pandemic levels, contact intensive services, which contribute around two-fifth of economic activity in India, still lag considerably. Capacity utilisation in the manufacturing sector is below its pre-pandemic levels and an early recovery to its long-run average is critical for a sustained rebound in investment demand. Even as the domestic economy is showing signs of mending, the external environment is turning more uncertain and challenging, with headwinds from slowing growth in some major Asian and advanced economies, steep jump in natural gas prices in the recent weeks and concerns emanating from normalisation of monetary policy in some major advanced economies. Against this backdrop, the ongoing domestic recovery needs to be nurtured assiduously through all policy channels. The MPC will remain watchful given the uncertainties surrounding the outlook for growth and inflation. Accordingly, keeping in mind the evolving situation, the MPC decided to keep the policy repo rate unchanged at 4 per cent and continue with an accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
16. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 4.0 per cent.
17. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma, voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
18. The minutes of the MPC’s meeting will be published on October 22, 2021.
19. The next meeting of the MPC is scheduled during December 6 to 8, 2021. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
20. A number of indicators now point to recovery of economic activity from the severest shock of the second wave of the Covid 19 pandemic the country suffered in the first two months of the present financial year. The estimates of GDP for Q1: 2021- 22 by the National Statistical Office (NSO) point to year-on-year (yoy) increase of 20.1 per cent in this period of the second wave. This sharp rise in GDP reflects a substantially smaller economic impact of the second wave than in the first wave as relative to Q1: 2019-20, GDP in the first quarter of the current financial year is lower by 9.2 per cent compared to the decline of 24.4 per cent in Q1: 2020-21 during the first wave. These patterns highlight the extent of the negative impact of the pandemic and the challenge of rebuilding the economy considering the fact that some sectors have suffered far more than others.
21. At a disaggregate level, all major components of GDP, the private final consumption expenditure (PFCE), gross fixed investment (GFCF) and exports have increased sharply by 19.3 per cent, 55.3 per cent and 39.1 per cent, respectively, in Q1: FY 2022, year on year basis. As in the case of aggregate GDP, PFCE and GFCF are below their pre-pandemic levels in Q1: 2019-20. The Government Final Consumption Expenditure (GFCE) declined in Q1: 2021-22 over the same period in 2020-21, as it had increased substantially in the latter period. Exports are now above the pre-pandemic level seen in Q1: 2019-20. Imports rose sharply in Q1: 2021-22 but remained below the level seen in Q1: 2019-20.
22. Real GDP growth for Q1:2022-23 is projected at 17.2 per cent (Chart 2). 22. The supply side disruptions during the second wave of the pandemic were slightly less stringent from the first wave as these disruptions were not at the national level but state level or even more localised. This helped reduce the constraints on the supply side but the demand side weakness remained slower to overcome due to the significant income and employment losses. Some of these differences in the nature of economic recovery are reflected in the present uneven pattern of growth.
23. While return to the pre-pandemic level of economic activity is to be expected when the restrictions on the supply side are liberalised, pace of this return to normalcy would depend on the factors affecting supply as well as demand. On the supply side, in the presence of adequate demand, expansion may be constrained by the supply of inputs, rise in the prices of inputs besides the need for new investments to do business in the new environment. If the pace of this recovery is slower on the supply side, prices would rise if demand grows more quickly. If the supply rises more quickly, price rise may be muted, although in both the cases, the exogenous price shocks from the external sector including crude oil and commodity markets impart upside risks to the outlook.
24. Excluding the data for April 2021, for which the yoy growth rates were exceptionally high, the Index of Industrial Production (IIP-General), while registering double digit growth rates in May and June of 2021, was still below the level of 2019 for the same two months. However, in July 2021, the IIP was above the level two years back in the case of mining and electricity and the IIP-General was only 0.3 per cent below the level in July 2019. The trend is clearly one of catching up with the pre- pandemic levels of industrial activity. There are patterns that also suggest weaker output growth in certain sectors. In July 2021, IIP for Consumer goods was lower than in July 2019, particularly for Consumer durables; it was marginally higher than the pre-pandemic levels of July 2019 for primary and capital goods; between 2 and 2.5 per cent in the case of intermediate goods and infrastructure/ construction sectors.
25. It is also important to recognise sectors in the non-IT services that are in the early stages of recovery. The MSME and informal sector enterprises face greater challenges in operating in conditions in which input price pressures are significant and consumer demand is still recovering.
26. While rural demand is expected to be buoyant in the light of higher Kharif crop output projected in the First Advance Estimates for 2021, the sales of tractors and motor cycles – proxies for rural demand conditions - show divergent pattern for April- August 2021 over the levels seen in 2019 for the same period. Tractor sales have increased sharply and motor cycle sales show a negative growth. In the case of urban demand, domestic air passenger traffic, passenger vehicles sales and consumer durables sales show divergent trends. While some of this pattern is related to supply side restrictions (air traffic) or supply chain disruptions (automobile sector), the recovery of overall consumption demand to the pre-pandemic levels is uneven.
27. RBI’s Consumer Confidence Survey for September 2021 shows that a larger proportion of the respondents reported improvement in the general economic situation compared to the July 2021 survey. But a large majority of the respondents - more than 72 per cent - perceive the overall situation to have worsened compared to a year back. A larger proportion of the respondents expect improvement in the overall economic situation a year ahead, as compared to the results of the July 2021 survey. But this proportion is lower than the survey results a year back. The concerns exhibited in the consumer sentiments appear to mirror the assessment of employment and income conditions. A larger proportion of respondents are now spending more now than a year back, but the improvement is in spending on ‘essentials’ as compared to ‘discretionary spending’. A positive pattern is the decline in unemployment rates and increase in the labour force participation rates in the rural and urban areas from the peak levels seen in May 2021, as brought out by the surveys of the Centre for Monitoring Indian Economy (CMIE).
28. Investment activity has picked up over the levels seen 2020-21 but yet to reach the 2019-20 levels. Accelerated progress in vaccinations and a number of economic policy initiatives to open up opportunities for investment are among the factors constituting positive stimulus to fresh investments. Some of the positive investment sentiments are reflected in the strong FDI inflows and successful IPOs in the current financial year. The survey of enterprises conducted by the RBI mainly in August-September 2021 shows sharp improvement in demand conditions compared to the decline in the previous quarter, especially in the manufacturing sector. The demand conditions are expected to improve steadily in the next two quarters of the current financial year. Input cost pressures remain the main concern for the enterprises, leading to higher selling prices to achieve profitability. Overall business situation is expected to improve in Q3: 2021-22 and remain robust in Q4 and Q1: 2022-23, particularly for manufacturing and services.
29. The indicators such as the PMI were in expansionary zone in July-September 2021 in the case of manufacturing and August-September 2021 for services. A number of high frequency indicators point to recovery in economic activities, from the trough seen during July-August 2020. Air passenger traffic and consumption of transportation fuels show significant growth in July-August 2021, year on year basis. Broader recovery in economic activity is reflected in the steady rise in railway freight traffic, pickup in port traffic, air cargo, e-way bills and GST collections. Non-food credit has continued modest expansion although below the rate of expansion in bank deposits. The overall trends point to emerging growth momentum, some of it from the relaxation of administrative restrictions imposed in the face of the pandemic as vaccination drive is gaining acceleration across the country and reduction in the number of active cases of infection.
30. One of the key drivers of the aggregate demand in 2021-22 so far has been the exports, both merchandise and services. Imports have also increased reflecting pick-up in domestic demand. Revival of external demand on the back of pick-up of economic growth in the advanced economies has been an important factor supporting export performance. The supply chain constraints and persistence of pandemic conditions globally, particularly in some of the advanced economies are a concern.
31. With the present growth momentum, GDP in 2021-22 is expected to exceed the level achieved in 2019-20. The uneven pace of ongoing recovery across sectors highlights that the protection against the Covid infections through vaccination, practice of Covid appropriate behaviour and availability of health services to mitigate any fresh wave of the infections would be essential to achieve a broad based sustained growth.
32. Revival of economic growth has also been accompanied by inflationary pressures. Sources of inflation include price pressures from international markets and also domestic markets. Restricted supply conditions have added to the price pressures in the domestic markets. Sharp price increases in a few critical items of production and consumption also have cascading effects. The present outlook for CPI inflation has been driven by the rise in petroleum fuel prices, and international commodity prices leading to increase in raw material costs, transportation costs and energy costs, even when the recovery in demand conditions has been modest. The fiscal and administrative measures to ease infrastructure constraints by the government have helped in reducing the potential impact of price impulses from external markets. But fuller capacity utilisation, new investments to improve productivity are needed to meet the rising aggregate demand without further price pressures. Monetary and fiscal measures to support supply response to the rising demand would be needed at this crucial juncture.
33. The headline CPI inflation (yoy) during June-August 2021 averaged 5.7 per cent, well below 6.5 per cent seen during June-August 2020. Drivers of inflation were indeed different between the two years. In June-August 2020, it was food inflation and in the same period in 2021, it has been fuel inflation. The CPI for fuel rose by 12.6 per cent during June-August 2021 compared to 2.1 per cent in June-August 2020; CPI for food rose by 4.6 per cent in June-August 2021 and in the same period of 2020, the increase was 8.2 per cent. Core CPI inflation in June-August 2021 was 5.9 per cent and 5.5 per cent in the same period in 2020. Besides the spill over effects from food and fuels, core inflation is affected by the prices of transport fuels and transport services that are directly affected by the crude oil price shocks. Improving efficiency of logistics services and reduction in indirect taxes would play an important role in easing such exogenous shocks on the cost of transport services and overall inflation.
34. Going forward, external factors such as international commodity prices including petroleum crude would play an important role in the evolution of CPI. Improved demand conditions would also mean upward pressure on the price front unless supply expands with improved productivity. The projected CPI inflation rate for Q2, Q3 and Q4 in FY 2021-22 are 5.1, 4.5 and 5.8 per cent, respectively, with an average of 5.3 per cent for FY 2021-22 considering the actual rate of 5.6 per cent for Q1. This projected inflation rate for 2021-22 is lower by 40 basis points compared to the projected 5.7 per cent in August, still above the target but within the tolerance band of the inflation target. RBI’s Survey of Professional Forecasters (SPF) for September 2021 provides a median forecast of 5.3 per cent for FY 2021-22, taking actual rate of 5.6 per cent for Q1. A clear driver of this decline in projections is the food inflation. Reduction in the core CPI inflation rate from the present level will require, inter alia, reduction in petroleum fuel prices.
35. Taking into account the recent trends in output the GDP growth for FY 2021- 22 has been retained at 9.5 per cent. The projections of yoy GDP growth for Q2 have been revised upward from 7.3 per cent in the MPC meeting of August to 7.9 per cent, Q3 from 6.3 to 6.8 per cent, with the Q4 growth remaining unchanged at 6.1 per cent. The SPF for September 2021 provides a median forecast for FY 2021-22 of 9.4 per cent, revised upward from its July survey.
36. The projected moderation in the headline inflation rate and unchanged GDP growth rate for FY 2021-22 reflect improving underlying macroeconomic conditions. However, in the context of the uncertainties in the external demand and price conditions and an uneven sectoral growth pattern an accommodative monetary policy stance and broader policy support are necessary at this juncture for strengthening the growth momentum and reducing inflation pressures.
37. Accordingly, I vote in favour of keeping the policy repo rate unchanged at 4.0 per cent. I also vote in favour of continuing with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
38. We have navigated a difficult year well so far with strong recoveries. Headline inflation is also softening towards the target.
39. The theory that temporary Covid-19 related supply shocks are largely responsible for inflation seems to have held out well, although repeated commodity price shocks are an issue. There is some pass through to other items but it is not generalized as yet. In addition to oil prices, inflation is higher for electronic goods and consumer durables affected by Covid-19 global shortages and supply chain issues; retail perishables supply chains were able to resolve faster. Inflation, as well as household and business inflation expectations rose during peak waves and fell thereafter. Global price shocks have turned out to be more persistent, contributing to sticky core inflation. Tax cuts on petroleum products are essential to break the upward movement that could impart persistence to domestic inflation. Government initiatives have contributed to the fall in food inflation. This, and relative fiscal conservatism, enables monetary policy to remain accommodative, keeping the real interest rate well below the growth rate, stimulating the recovery and reducing public debt ratios. The transmission to output growth from low real rates combined with surplus liquidity is well established.
40. Causality is normally from core inflation to headline but this need not be so if rise in core inflation is due to reversible supply shocks. There is large uncertainty built into current prices because of the speculative element that seeks to profit from aggravated shortages. Large sudden falls are therefore possible. Oil prices have shown high volatility. The climate change activism that is partly responsible for current spikes will also reduce oil demand in the future. There are signs of container prices softening as exports from China reduce. Policy has to be data based, since inflation may fall faster than guidance, or supply-side issues may cause new spikes.
41. Demand is also uncertain beyond pent up demand and the festival season. Some slowdown in global growth and more surprises from Covid-19 are possible, although vaccination is progressing well. Data lags mean we do not as yet know the extent of scarring in small and medium enterprises (SMEs), contact intensive services and in employment.
42. The current situation warrants that monetary-financial conditions remain accommodative. In times of great uncertainty it is important that policy remains steady and supportive. Therefore, a pause in the repo rate and an accommodative stance is required and I vote for these. Even so, policy has to continuously adapt in line with changing circumstances. Over-stimulus as after the global financial crisis, with delay resulting in sharp adjustment, has to be avoided.
43. What is the quantity of excess liquidity required? Large inflows have led to a rise in liquidity over the past two months. In advanced countries exit normally starts by stopping fresh injections of liquidity although existing levels are only allowed to reduce slowly and naturally as securities mature. The experience is markets react well to transparent changes in policy rates that follow the data. For example, if rates rise as growth is well-established, stock markets continue to do well.
44. India, however, has an informal sector as well as a modern sector that are differently served by existing arrangements for short term liquidity. Only banks have access to repo and reverse repo windows. There are also large shocks from foreign flows, government cash balances and currency leakages. Therefore, liquidity needs to be kept in sufficient surplus to absorb these shocks even as the excess is reduced allowing the reverse repo to rise gradually and arrangements for non-banks remain in place. A higher fixed reverse repo rate for banks could be linked to raising their interest rates on deposit accounts. The ECB has done this.
45. With some growth recovery, but more to go, and one year ahead inflation expected at about 5%, a real policy rate of about -1% is appropriate.
46. As the LAF band was widened last year short rates fell much more than long rates. Spreads widened for 10-year G-secs, although rates fell to their lowest in many years. Market expectations in current forward rates see short rates rising over the next year with little change in 10-year G-secs rates. As uncertainty reduces, the inflation target is well internalized, and government borrowing requirements reduce, spreads should fall further. Long rates are important for investment and as benchmarks for private borrowing. The yield curve is likely to flatten, although oil price uncertainty is a risk.
47. Given India’s foreign exchange reserves and strong external fundamentals, India is well placed to absorb any volatility as advanced economy central banks begin their exit or if financial shocks spread from China. It is important that policy remains aligned to the domestic cycle and any external shocks are smoothed. Statement by Prof. Jayanth R. Varma
48. Several of the arguments that I made in my August statement continue to be valid, and I will summarize them quickly without repeating the detailed analysis underpinning them. First, the Covid-19 pandemic has mutated into a human tragedy rather than an economic crisis, and monetary policy is not the right instrument to deal with this. Second, the ill effects of the pandemic are now concentrated in narrow pockets of the economy, and monetary policy is much less effective than fiscal policy for providing targeted relief to the worst affected segments of the economy. Third, inflationary pressures are beginning to show signs of greater persistence than anticipated earlier.
49. Since August, I have become increasingly concerned about two other risks that have become salient globally in recent weeks. The first is that the ongoing transition to green energy worldwide poses a significant risk of creating a series of energy price shocks similar to that in the 1970s. This means that the upside risks to long term inflation and to inflation expectations are now more aggravated. My second recent concern is about the tail risk to global growth posed by emerging financial sector fragility in China reminiscent of Japan of the late 1980s. Both of these risks - one to inflation and the other to growth - are well beyond the control of the MPC, but they warrant a heightened degree of flexibility and agility. A pattern of policy making in slow motion that is guided by an excessive desire to avoid surprises is no longer appropriate.
50. For these reasons, I am not in favour of the decision to keep the reverse repo rate at 3.35%, and vote against the accommodative stance. Raising effective money market rates quickly towards 4% would demonstrate the MPC’s commitment to the inflation target, help anchor expectations, reduce risk premia, enhance macroeconomic stability, and allow lower long-term interest rates to be sustained for longer thereby aiding the economic recovery.
51. On the other hand, I vote for maintaining the repo rate at 4% for the following reasons. Economic growth was unsatisfactory long before the pandemic, and even if the economic ill effects of the pandemic abate to some extent, substantial monetary accommodation is warranted. The repo rate of 4% corresponds to a negative real rate in the range of 1-1.5% based on forward looking inflation forecasts. In my view, this level of rates is currently appropriate for reviving economic growth without excessive risk of an inflationary spiral. Needless to say, the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future. Statement by Dr. Mridul K. Saggar
52. Since we last met, real economic activity is on track to gradual normalisation, inflation spike has turned out to be transitory, fiscal position appears to be back on budgetary track and external balance remains under control. In short, macroeconomic conditions have improved and the economy looks stable. However, this should not lull us into assuming a goldilocks scenario. Significant headwinds have started blowing from the shifting global macro-economic conditions. Rising geopolitical risks complicate the scenario further. The expectations of a red piping-hot recovery have been belied. Global growth expectations are getting scaled down on account of likely taper, China slowdown, scaling back of US fiscal stimulus on back of uncertainties surrounding infrastructure bill and debt ceiling and adverse impact on activity of gas and energy shortages in Europe and elsewhere. These can have significant spillovers and spillbacks running through trade, financial and market expectations channels. They can alter the domestic macroeconomic balances and cause spells of volatility clustering over a year or more, even though the buffers so assiduously built in the recent past are likely to see the economy through without any growth collapse.
53. How do we frame monetary policy in the backdrop of the emerging new challenges? First and foremost, we need to remain data dependent. Financial markets are characterised by multiple equilibria. Capital flows can turn volatile in either direction if taper paths come with surprises. Within the flexible inflation targeting framework, we need to be conscious about exchange rate dynamics originating from exogenous shocks and incorporate those in risks though not in baseline. Amid these uncertainties, policies will need to respond with alacrity and should be untangled from any pre-commitments. If at all some guidance is needed at this stage, it has to be a soft one; with the Reserve Bank preparing markets that while policy stance is likely to remain accommodative till growth is revived on a durable basis, liquidity levels will be adjusted dynamically to appropriate lower levels that are still consistent with accommodative stance. Second, we need to reinforce our commitment to the assigned inflation target guided by data inflows on growth, inflation and other parameters. The central bank needs to remain committed to goal dependence and instrument independence as it has a statutory foundation and is also consistent with general worldwide practice amongst inflation targeting central banks. Third, we need now to focus more on risks to both inflation and growth and calibrate policies as the situation evolves. Considerable uncertainty about output gap in pandemic times remains, with filtering techniques guiding much faster closure than structural models that capture scarring better. However, in my judgement, if no new disruptions to growth emerge, output gap will close sometime in 2022-23 and monetary policy should start to gradually reposition to lowering underlying inflation and inflation expectations next year, especially if inflation edges up from the energy and services side amid sticky goods core inflation. Fourth, an Arjuna’s eye needs to be kept on commodity prices and we need to consider different scenarios according to which we can calibrate our policies. I will explain this point in some details later.
54. Let me now revisit growth and inflation landscape for the next 12-months. Growth recovery after the second wave remains nebulous and there is anecdotal evidence that the wave deepened scarring on small businesses. Of the industries at NIC 5-digit level, 55 per cent of the 404 industries for which data is available, are operating at below 2019-20 levels and 63.4 per cent are operating at below 2018-19 levels, indicating need for not only to support demand revival and ameliorate pandemic supply disruptions but also address the structural malaise that appears to be causing an industrial stagnation. After an encouraging sequential improvement in high frequency indicators in July, there was a loss of momentum in August, when only about three-fifths of the indicators registered improvement over the preceding month. As of now, only about half the indicators have normalised to pre-pandemic levels and only a fifth of indicators to levels achieved in March 2021 before the second wave derailed the normalisation process. However, the activity levels can normalise faster in H2:2021-22 and reach pre-pandemic levels before fiscal year-end on back of vaccinations ramp-up and considerable re-opening of the economy with removal of most Covid-related movement restrictions.
55. Investment intentions, as revealed by the phasing details of projects financially assisted by the financial intermediaries or funded through oversees borrowings or equity raising, show investment retrenchment in 2020-21 and a rather weak pipeline for 2021-22 with a 47.5 per cent year-on-year drop. Seasonally adjusted capacity utilisation rate that was at 66.6 per cent in Q4:2020-21 had dipped to 61.7 per cent in Q1:2021-22 marred by the second wave, but the dip was much lower than in the first wave when the rate had dropped to 48.9 per cent. Investment demand is lagging consumption demand but has started to look up. Net responses of Industrial Outlook Survey (IOS) shows that capacity utilisation rebounded in Q2:2021-22 and further improvement is expected. While in recent years capex has been essentially led by power and roads, there are signs that true investment may be getting somewhat understated given the recent spurt in intangible investments that are not getting fully reflected in national accounts. There are also signs that on the back of PLI scheme investment will get more broad-based in near-term. Monetary policy has already lowered the hurdle rates since 2019-20. Fiscal policy has cut the effective corporate tax rates by nearly 39 per cent in September the same year. This means that the user cost of capital has dropped markedly. However, investment has not responded much till now because of huge pandemic related uncertainty that has affected consumer and business confidence, depressed aggregate demand and posed execution and cash flow difficulties. Corporates chose to deleverage, and their investment intentions have fallen. Consumer confidence improved sequentially in Q2:2021-22 but remains gap down compared to normal levels pre-pandemic. Debt/Equity ratio of corporates has already declined from above 60 per cent in 2015- 16 to around 35 per cent in 2020-21. Once structural policies work and animal spirits revive on back of reduced uncertainties, investment will turnaround. In the interim, the current accommodative policy is helping in shoring up consumption demand. With rising global uncertainties, at this juncture, it important that we preserve macro- financial stability, so as to be able to nurture growth rebound.
56. Coming to inflation, while one expects further disinflation in near months, the baseline reverses thereafter despite base effects being moderately on the favourable side. The momentum is expected to pick up in H2:2021-22 and there are upside risks and stickiness of core that warrant attention. In my assessment, the probability that oil prices may touch or cross US$85/barrel before the year ends and could average US$80/barrel or more in H2 are not insignificant. It can have significant impacts that are hard to precisely quantify due to non-linearities and uncertainties but, on a ballpark from the baseline, can be expected to raise inflation by 15-20 bps, lower growth by 13-15 bps, have negligible effects on fiscal subsidies and widen CAD by about 0.25% of GDP. Unless cooperative solutions are found, the underlying gas shortages in Europe are going to get worse in the winters and as they might enervate climate change commitments. The increased dependence on fossil fuels can structurally lift energy inflation and its passthrough to general price level. High imported coal prices are already affecting power generation in some coastal plants in India. Chips delivery time has gone up to 21 weeks from 12 weeks in the pre- pandemic period. Automakers are compelled to cut down production. Container freight rates are still on the rise having risen 2-8 times on various global routes. In general, supply constraints persist and if demand revives fast, it can add to inflation. So, managing supply side will be critical. While there are some signs that price rise broadened during August CPI, the spread is moderate at best and not reflective of generalisation of price rise. Inflation expectations remain high but are not unanchored yet and have dampened by 50-60 bps in the latest round. While this does afford solace, further dampening of inflation expectations will be needed as output levels gets normalised. Interestingly, some recent research from an influential central bank has casted scepticism over long-run inflation expectations being an important factor driving inflation dynamics. To my view, introducing such new paradigms in monetary policy is playing with fire and carry dangers that central banks will lose control over inflation as the economies recover.
57. In sum, we have broadly been right in averting premature tightening and allowing economy to recover. With complementary actions in calibrating liquidity, negative real rates to savers can now be corrected in period ahead. Considering the above, I vote for keeping the stance unchanged and for keeping policy rate unchanged in line with the resolution. Statement by Dr. Michael Debabrata Patra
58. The assessment made in August 2021 that inflation would ease in the third quarter of 2021-22 has been happily overtaken by actual outcomes in the form of a decline in food inflation. Looking ahead, specific supply measures are working to address demand-supply mismatches in this category. With agricultural production prospects looking bright, further easing of food inflation may take down the headline in the third quarter more than initially expected. On the other hand, the formation of inflation is being buffeted by repeated shocks that have taken fuel inflation to an all- time high and turned core inflation persistent, with risks to the upside. Accordingly, it is important to remain on guard about second order effects from these transitory perturbations that gives these components of inflation a resistant character by their recurring incidence. At this time, however, pressures from wages and rentals remain muted. Staff costs in the organised sector are rising again as hiring and normal work processes resume. There is also some evidence forming that cost pressures may not be able to be absorbed any longer and selling prices may turn up. Thus, while the trajectory of inflation may undershoot the projections made in August, it is likely to be uneven, sluggish and prone to interruptions.
59. Beginning in August, various indicators are suggesting that the economy is negotiating a potential gravitational swing-by from the retarding forces unleashed by COVID-19. Pre-pandemic levels of output are being sighted. Agriculture and allied activities look set to achieve and even exceed last year’s record production; manufacturing – the laggard among the components of industry – is just short of 2019-20 levels; and contact-based services are healing fast. Exports can become a force multiplier that accelerates the pace of growth. They provide the avenue for the economy to break out of the limits imposed by the size of the domestic market which is still struggling with pent-up demand becoming more durable. By the end of September, the half-way mark of an ambitious export target for the year is about to be crossed.
60. Even as domestic macroeconomic configurations are improving, the risks from global developments are rising and warrant a close watch as they could stifle the recovery that is underway in India. Exports are directly at risk from logistics bottlenecks, shortages of containers and personnel in international shipping, and elevated freight rates. Policy interventions, including coordinated multilateral efforts, are needed urgently to prevent global trade from choking. More broadly, global growth is losing steam, circumscribing the strength of the recovery with shortages of key intermediates such as chips and semi-conductors. And inflation is now everywhere and raging, with implications for the revival of consumption demand. This is precipitating diverse monetary policy actions which are accentuating the fissures in the global economy. Recent financial developments amidst a sea of froth highlight the excesses of indebtedness and the potential contagion for the real economy, especially if financial conditions tighten. In my view, the biggest risks to India’s macroeconomic prospects are global and they could materialise suddenly.
61. In this milieu, I vote to maintain the policy rate and the accommodative stance of policy unchanged, awaiting stronger evidence on demand-led inflationary pressures. Until then, congenial financial conditions need to be in place. Statement by Shri Shaktikanta Das
62. The COVID-19 pandemic, an unprecedented crisis, that led to record output and employment losses combined with bouts of financial market volatility and supply disruptions, has rendered the job of central bankers across the globe even more challenging. In India also, we had to deal with sharp meltdown in growth, rise in inflation and threat to financial stability, all at once. Given the complexity of the challenges, the policy responses had to be geared not just towards short-term stabilisation, but also to potential long-term implications. During the last eighteen months, therefore, our priority has been to revive growth and preserve financial stability, even as we remain steadfastly committed to keep inflation closer to the target.
63. The global economy now is on a more difficult tangent of slowing growth momentum with entrenching inflationary tendencies. As the classical trade-off that central banks face between slowing growth and higher inflation is getting edgier, their actions have been in response to their domestic macroeconomic circumstances. India’s policy has also been driven by domestic factors.
64. As per our assessment, while the recovery is gaining traction and aggregate demand is rebounding, the economy still operates below the pre-pandemic level. Despite the projected 9.5 per cent GDP growth for 2021-22, there is still slack in the economy as the level of GDP will only be moderately above its pre-COVID level of 2019-20 GDP. In fact, the recent data release of GDP on August 31, 2021 suggests that the real GDP in Q1:2021-22 was well below the Q1:2019-20 level as well as the Q1:2018-19 level. We expect to exceed the pre-pandemic level of output only in Q3:2021-22. The second wave amplified the impact of COVID-19 pandemic on contact-intensive activities and the informal sector. With increased pace of vaccination, however, contact-intensive activities which were earlier lagging in recovery are now catching up. Informal sector is likely to take even longer to recoup as the impact of the second wave on this sector was relatively more pronounced. The demand for MGNREGA – notwithstanding the sequential moderation in September – remains high partly reflecting persisting weakness in the informal sector. Durable recovery in manufacturing and services sectors should support revival in the informal economy. The future trajectory of growth, however, is strewn with many challenges, most notably from how the pandemic will evolve. Overall, growth remains critically dependent on policy support and needs nurturing for sustained recovery.
65. In its August 2021 meeting, the MPC was faced with the challenges posed by headline inflation exceeding the upper tolerance threshold for the second successive month. The MPC then judged the inflation spike during May-June as transitory, driven largely by pandemic-induced supply bottlenecks and elevated commodity prices, and expected it to ease in the subsequent months. The actual inflation outcomes for July- August, with inflation registering a substantial moderation to move within the tolerance band, have vindicated the MPC’s outlook and monetary policy stance. The MPC was faced with a similar dilemma in September-October last year due to food price shocks; and its judgement to see them as transitory and to look through it had proved to be right. Such an approach has been contributing significantly to the economic recovery and stability in the financial markets. Thus, the medium-term focus of the MPC has successfully moderated undue expectations of a possible reversal of the monetary policy stance and is helping anchor expectations in the right direction, while navigating the economic recovery from the crisis.
66. The more than expected softening of inflation in July and August this year was underpinned by the significant lowering in food price momentum, especially in August. Several factors have contributed to this. The summer seasonal vegetable price build-up this year was unusually low, close to a third of historical patterns. Supply side measures announced by the Government in recent months to meet the demand-supply gaps have helped to stabilise food prices. Core inflation, i.e., CPI excluding food and fuel, however, remained elevated and sticky primarily on account of persistent inflationary pressures in transport and communication, health, clothing and footwear.
67. Going forward, if there are no spells of unseasonal rains, food inflation is likely to register significant moderation in the immediate term, aided by record kharif production, more than adequate food stocks, supply-side measures and favourable base effects. Volatile crude oil prices, particularly the resurgence since mid- September, is pushing pump prices to new highs, raising risk of further spillover of high transportation cost into retail prices of goods and services. On balance, the outlook on inflation has improved and inflation projection for 2021-22 has been revised downward by 40 bps to 5.3 per cent.
68. Against this backdrop, it is felt that continued monetary support is necessary as the economic recovery process even now is delicately poised and growth is yet to take firmer roots. The external environment, which had been supportive of aggregate demand over the past few months, may lose momentum for a variety of reasons such as – surge in infections; the persistence of pandemic-related supply bottlenecks; a binding shortage of key inputs like semi-conductors; and the spike in gas prices. Given an ever evolving and dynamic environment, with the outlook overcast by several uncertainties including the fact that the pandemic is far from over, we need to ensure that the nascent revival of economic activity shows signs of durability and sustainability. At this critical juncture, our actions have to be gradual, calibrated, well- timed and well-telegraphed to avoid any undue surprises. We are reaching the shore after sailing through a very turbulent journey, and we cannot afford to rock the boat at this crucial stage. We must ensure that we reach safely to begin the journey beyond the shore. I, therefore, vote to keep the policy rate unchanged and to continue with the accommodative stance as spelt out by the MPC in its August 2021 meeting. In parallel, we remain laser-focused to bring back the CPI inflation to 4 per cent over a period of time in a non-disruptive manner. (Yogesh Dayal) Press Release: 2021-2022/1086 Chief General Manager
6. Since the MPC’s meeting during October 6-8, 2021, surges of infections across geographies, emergence of the Omicron variant, the persistence of supply chain disruptions and elevated energy and commodity prices continue to weigh on global economic activity. Global merchandise trade is slowing after a sharp rebound from the pandemic due to the disruptions in port services and turnaround time, elevated freight rates and the global shortage of semiconductor chips, which could dampen future manufacturing output and trade. The composite global purchasing managers’ index (PMI), however, improved to a four-month high in November, with services continuing to perform better than manufacturing for eight consecutive months.
7. Commodity prices remain elevated across the board, though there has been some softening since late October and further drop towards end-November following uncertainties from the new COVID-19 variant, among others. Headline inflation in several advanced economies (AEs) and emerging market economies (EMEs) has soared, prompting a number of central banks to continue tightening and others to bring forward policy normalisation. With the US Federal Reserve commencing tapering of its monthly asset purchases and the possibility of faster taper, renewed bouts of volatility and heightened uncertainties have unsettled global financial markets. Bond yields which had risen in most countries, responding to inflation and monetary policy actions, eased from the last week of November. The US dollar has been trading higher in recent weeks against both AE and EME currencies. Domestic Economy
8. On the domestic front, data released by the National Statistical Office (NSO) on November 30, 2021 showed that real gross domestic product (GDP) expanded by 8.4 per cent year-on-year (y-o-y) in Q2:2021-22, following a growth of 20.1 per cent during Q1:2021-22. With the recovery gaining momentum, all constituents of aggregate demand entered the expansion zone, with exports and imports markedly exceeding their pre-COVID-19 levels. On the supply side, real gross value added (GVA) increased by 8.5 per cent y-o-y during Q2:2021- 22.
9. Available data for Q3:2021-22 indicate that the momentum of economic activity is gaining further traction, aided by expanding vaccination coverage, the rapid subsiding of new infections and release of pent-up demand. Rural demand exhibited resilience – tractor sales improved in October over the same month of 2019 (pre-pandemic level), while motorcycle sales are slowly inching towards their pre-pandemic levels. Continued direct transfers under PM Kisan scheme are supporting rural demand. The demand for work under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) moderated in November from a year ago, suggesting a pickup in farm labour demand. Supported by favourable soil moisture content and good reservoir storage levels, rabi sowing was 6.1 per cent higher than a year ago as on December 3, 2021.
10. Urban demand and contact-intensive services activities are rebounding on improving consumer optimism, supported by festival demand. High-frequency indicators such as electricity demand, railway freight traffic, port cargo, toll collections, and petroleum consumption registered robust growth in October/November over the corresponding months of 2019. Automobile sales, steel consumption and air passenger traffic still remained below 2019 levels even though they gained momentum in October as supply side shortages eased. Investment activity is exhibiting modest signs of improvement – production of capital goods remained above pre-pandemic levels for the third month in a row during September, while import of capital goods in October rose at double-digit pace over its level two years ago. Prints of manufacturing and services PMIs for November 2021 suggested continued improvement in economic activity. Exports grew in November for the ninth month in a row, along with a surge in non-oil non-gold imports on the back of reviving domestic demand.
11. Headline CPI inflation, which has been on a downward trajectory since June 2021, edged up to 4.5 per cent in October from 4.3 per cent in September on account of a spike in vegetable prices – due to crop damage from heavy rainfalls in October in several states, and fuel inflation – driven up by international prices of liquefied petroleum gas and kerosene. In fact, fuel inflation at 14.3 per cent in October surged to an all-time high. Core inflation or CPI inflation excluding food and fuel remained elevated at 5.9 per cent during September-October with continuing upside pressures stemming from clothing and footwear, health, and transportation and communication sub-groups.
12. Liquidity conditions remained in large surplus, with daily absorptions through the fixed rate reverse repo and the variable rate reverse repo (VRRR) operations under the liquidity adjustment facility (LAF) averaging ₹8.6 lakh crore in October-November. Reserve money (adjusted for the first-round impact of the change in the cash reserve ratio) expanded by 7.9 per cent (y-o-y) on December 3, 2021. Money supply (M3) and bank credit by commercial banks grew y-o-y by 9.5 per cent and 7.0 per cent respectively, as on November 19, 2021. India’s foreign exchange reserves increased by US$ 58.9 billion in 2021-22 (up to December 3, 2021) to US$ 635.9 billion. Outlook
13. The inflation trajectory, going forward, will be conditioned by a number of factors. The flare-up in vegetables prices due to heavy rains in October and November is likely to reverse with the winter arrivals. Rabi sowing is progressing well and is set to exceed last year’s acreage. Recent pro-active supply side interventions by the Government continue to restrain the pass- through of elevated international edible oil prices to domestic retail inflation. Crude prices have seen a significant correction in recent period. Cost-push pressures from high industrial raw material prices, transportation costs, and global logistics and supply chain bottlenecks continue to impinge on core inflation. The slack in the economy is muting the pass-through of rising input costs to output prices. Taking into consideration all these factors, CPI inflation is projected at 5.3 per cent for 2021-22; 5.1 per cent in Q3; 5.7 per cent in Q4:2021-22, with risks broadly balanced. CPI inflation for Q1:2022-23 is projected at 5.0 per cent and for Q2 at 5.0 per cent (Chart 1).
14. The recovery in domestic economic activity is turning increasingly broad-based, with the expanding vaccination coverage, slump in fresh COVID-19 cases and rapid normalisation of mobility. Rural demand is expected to remain resilient. The spurt in contact-intensive activities and pent-up demand will continue to bolster urban demand. The government’s infrastructure push, the widening of the performance-linked incentive scheme, structural reforms, recovering capacity utilisation and benign liquidity and financial conditions provide conducive conditions for private investment demand. The Reserve Bank’s surveys point to improving business outlook and consumer confidence. On the other hand, volatile commodity prices, persisting global supply disruptions, new mutations of the virus and financial market volatility pose downside risks to the outlook. Taking all these factors into consideration and assuming no resurgence in COVID-19 infections in India, the projection for real GDP growth is retained at 9.5 per cent in 2021-22 consisting of 6.6 per cent in Q3; and 6.0 per cent in Q4:2021-22. Real GDP growth is projected at 17.2 per cent for Q1:2022-23 and at 7.8 per cent for Q2 (Chart 2).
15. The impact of the recent spike in vegetables prices on food inflation prints is expected to dissipate as the usual softening of prices in the winter sets in. The partial roll back of Central excise and State Value Added Taxes (VAT) on petrol and diesel in November have eased retail selling prices and will have second round effects over a period of time. Crude oil has seen some correction but remains volatile. Core inflation will need to be closely monitored and held in check. For a sustained lowering of core inflation, continuing the normalisation of excise duties and VATs alongside measures to address other input cost pressures assume critical importance, more so as demand improves. The domestic recovery is gaining traction, but activity is just about catching up with pre-pandemic levels and will have to be assiduously nurtured by conducive policy settings till it takes root and becomes self-sustaining. In particular, private investment has to lead the revival of the economy, along with the strong impetus being provided by exports. Private consumption, despite strong recovery in Q2:2021-22, remains below its pre-pandemic level and demand for contact-intensive services could potentially face headwinds if authorities take pre-emptive steps to contain the fallout of Omicron. Downside risks remain significant rendering the outlook highly uncertain, especially on account of global spillovers, the potential resurgence in COVID-19 infections with new mutations, persisting shortages and bottlenecks and the widening divergences in policy actions and stances across the world as inflationary pressures persist. A tightening of global financial conditions poses risks to global economic activity and to India’s prospects as well. Against this backdrop, the MPC has judged that the ongoing domestic recovery needs sustained policy support to make it more broad-based. Considering it appropriate to wait for growth signals to become solidly entrenched while remaining watchful on inflation dynamics, the MPC decided to keep the policy repo rate unchanged at 4 per cent and to continue with an accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
16. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 4.0 per cent.
17. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma, voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
18. The minutes of the MPC’s meeting will be published on December 22, 2021.
19. The next meeting of the MPC is scheduled during February 7-9, 2022. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
20. The quarterly GDP estimates by NSO for July-September 2021 point to a continued expansion of the economy, YOY basis, with GDP at constant prices rising by 8.4%, following the increase of 20.1% in Q1FY22. The Q2FY22 GDP estimates are higher than 7.9% projected in the October meeting of MPC. The GDP estimate also reflects growth of 10.4% over the previous quarter. While these are significant positive trends, there are new concerns on the growth front on account of the implications of the emergence of the new variants of the Corona virus and uncertainty of global growth and inflation scenarios.
21. In terms of the return of the economy to the pre-pandemic level, progress has been significant but sustained improvement of this performance is critical to the economy. In this context, GDP growth in Q2FY22 is only 0.3% over the pre-pandemic Q2FY20. The improvement needed to return to the pre-pandemic levels is also reflected in the estimates of final consumption expenditure and investment. Although Private Final Consumption Expenditure grew by 8.6% in Q2FY22 YOY basis in constant prices, it was 3.5% below Q2FY20 level. The Gross Fixed Capital Formation, in constant prices, increased YOY basis by 11% in Q2FY22 and rose only 1.5% over Q2FY20. The quarter- on- quarter improvements in PFCE and GFCF in Q2FY22 are indicators of momentum in the economy that needs to be sustained for achieving further expansion of the economy leading to employment and income growth.
22. At a broad level, output levels of the various sectors in Q2FY22 measured by GVA at constant prices are above Q2FY21. But there is also unevenness in growth performance reflecting sectoral and other structural variations in the adjustments taking place in the economy in the ongoing recovery process. In the case of ‘Trade, hotels, transportation, communications and broadcasting services’, which had a share of 20.3% in total GVA in 2019- 20, the gap from Q2FY20 is 9.2%. In general, the pace of output recovery in contact-intensive sectors is likely to be affected by both supply side constraints and weak demand, conditions which may abate only with further relief from the pandemic. The slower output growth is also contributed by supply disruptions as in the case of semiconductor chips affecting particularly production of passenger cars and the travel restrictions affecting the aviation sector and the related businesses. The IIP for manufacturing has shown only a modest YOY growth of 3.1% in September 2021. The overall weak demand conditions are reflected in the RBI’s Consumer Confidence Survey for November 2021, in which a large majority of the urban respondents presently remain cautious on ‘incurring non-essential consumption expenditure’. 22. As corporates get ready to invest, congenial financial conditions need to be in place to boost business sentiment.
23. The private investment, an important component of aggregate demand would be a key to sustaining the momentum of GDP growth. RBI’s enterprise survey for November 2021 points to improvement in business outlook for Q3FY21 but majority of the respondents remain cautious. NCAER’s Business Confidence Index based on a survey conducted in September registered improvement QOQ basis and also over Q2FY2020. The financial performance of the private corporate sector in Q2FY2022 suggests a steady growth in sales in Q2FY22 but investment indicators reflect a subdued investment activity. A key factor influencing the private investment in the manufacturing sectors appears to be the level of capacity utilisation, which is still below the long-term average reflecting both demand and supply constraints. While there are positive drivers such as FDI, the uncertainty surrounding the relief from the pandemic and global growth scenario are the other factors affecting caution in investment decisions.
24. Agricultural sector is expected to be supportive of the overall GDP growth in FY 2021- 22, with normal rainfall conditions although they were also marked by uneven rainfall.
25. The export growth in October-November 2021 has continued to support overall GDP growth. The NSO estimates of rupee value of exports of goods and services at constant prices in Q2FY22 are 19.6% higher on YOY basis, following an increase of 39.1% in Q1FY22. The merchandise exports in dollar value during April-November 2021-22 is 262.5 billion compared to 174.2 billion in the same period of 2020-21. Imports have also increased sharply YOY basis in H1FY22 partly indicating the rising domestic economic growth but also reflecting the price increase in some of the critical imports such as the petroleum imports. The global uncertainty on economic growth, resulting from fresh surges of Covid infections is a challenge in sustaining export performance in the short term. In its October 2021 World Economic Outlook, IMF lowered world GDP growth projections for 2021 compared to its projections in July 2021. Going further, the projected growth in 2022 is one percentage point lower than in 2021.
26. A number of high frequency indicators of the economy do point to revival of the growth momentum in Q2FY22 and the subsequent months of October and November 2021. PMIs, cement production, GST collections, E-way bills, domestic and international air traffic, housing launches, housing sales, Google mobility indices show robust performance YOY basis. The government revenue expenditure in Q2FY22 for the Centre and States registered double digit growth YOY basis. Indicators such as railway freight, motor spirits consumption show improvement YOY basis and remain above 2019-20 levels or catching up with them. Some of these indicators also show some deceleration in YOY growth in the recent months. Port traffic data shows moderate growth and has reached 2019-20 level in October 2021. The key financial sector indicators, deposit and commercial credit by the banking sector, have shown steady improvement during 2021-22.
27. RBI’s Survey of Professional Forecasters for November 2021 provides a median forecast of YOY GDP growth for FY2021-22 at 9.5%, a slight upward revision from the September 2021 forecast of 9.4% with significant improvement in the growth of industrial output balanced by slower services growth. Based on the present trends and patterns of indicators of growth, and actual growth estimates for Q1 and Q2, the YOY GDP growth for 2021-22 has been retained at 9.5%. The growth rates for Q3 and Q4 for the present financial year are projected at 6.6% and 6.0%, respectively.
28. Achieving these growth projections in the face of concerns over the new variants of Corona virus and the return from accommodative monetary policy in the advanced economies suggest a need for policy measures supportive of growth drivers.
29. The inflation pressure measured in terms of YOY headline CPI in October is at 4.5 per cent, slightly higher than 4.3 per cent in September. CPI Food, YOY basis is at 1.8%, fuel at 14.3% and CPI core (excluding food and fuel) is at 5.9%. In the case of Food and Fuel, the YOY increase in October is higher than in September 2021 and remains more or less at its level in September and October 2021 in the case of core inflation. Between July and October 2021, the core inflation has remained at 5.8-5.9% in each month. CPI Fuel increased by 12.4% in July 2021 YOY basis, rising steadily reaching 14.3% in October. Food inflation dropped from 4.5% in July to 1.8% in October 2021. While the retail prices of fuel are affected by the various taxes and subsidies, it may be noted that average YOY increase in Brent crude oil prices in dollar value during October 2021 exceeded 100%. The rising fuel prices are clearly driving the cost of energy and transportation costs in every other sector. In the RBI’s enterprise surveys of October-December 2021 covering manufacturing, services and infrastructure sectors, a large majority of the respondents report cost increase and also increase in selling prices. The pickup in economic activity has also increased demand for inputs leading to higher prices to the consumer.
30. Taking into account the patterns of changes in prices in different components of CPI, the headline inflation rate for Q3 and Q4 is now projected at 5.1% and 5.7%, respectively and 5.3% for FY2021-22 as a whole. The high level of core inflation is a concern that affects both consumption expenditure and profitability of firms. Sustained improvement in output will require reduction in inflation rate achieved through easing of supply constraints and productivity improvement to revive consumer and investment demand. While there is ample liquidity in the system, bank credit to commercial sector as a ratio to money supply (M3) remains below the levels seen during 2019-20. Full transition from the two major disruptions inflicted by the pandemic on the supply and demand systems to normalcy will require policy support to both output growth and ease inflation pressures.
31. In view of the projected growth and inflation rates and the emerging uncertainty from the renewed surge of Covid infections and macroeconomic adjustments at a global level, I vote in favour of keeping the policy repo rate unchanged at 4.0 per cent. I also vote in favour of continuing with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
32. Global risks are rising with the Omicron variant as well as with expectations of an earlier Fed taper. Markets are volatile as are oil prices. In such circumstances it is better for the MPC to remain steady and watchful through the next couple of months. International oil prices may fall further after the winter season. Their high volatility means collapse is possible. Some analysts expect an unwinding of demand because excess inventories were built for festival demand.
33. While US inflation is now expected to be less temporary because of the large fiscal stimulus and withdrawal from the labour force, these conditions do not hold in India. The differential between Indian and US real rates is high because of higher US inflation, so some Fed tightening in future does not necessarily require our policy rates to rise.
34. Indian household inflation expectations have fallen steeply in end November compared to their rise in early November following governments’ cut in fuel taxes and softening of international oil prices. The expectations are at or below their September levels. Firms’ price expectations have also somewhat reduced. Although core inflation is elevated the major share in the rise comes from transport and communication. Transport at least may soften with oil prices. There are signs of cost push in more commodities, but the contribution of services such as household goods and services, personal care and effects and education, which are demand driven remains low.
35. Government’s critical and just in time supply-side side action has enabled monetary policy accommodation. In the post Covid-19 world of supply shocks and high government debt monetary-fiscal coordination has become acceptable in advanced economies (AEs), while earlier it was regarded as compromising monetary policy independence. But a flexible inflation targeting regime has to respond to demand-side inflation and to supply-side inflation that has second round effects. This ensures central bank independence and contributes to anchor inflation expectations. Coordination is consistent with central bank independence since low rates are conditional on supply-side action.
36. In India, moreover, coordination normally does better because supply shocks dominate inflation and can be better influenced by state action. Monetary policy has more space to affect demand, while high debt and interest payments constrain fiscal spending. Policy rates can adjust more easily to appropriately fine-tune demand, watching to see if exports and pent-up demand moderate, or if there is overheating and persistent inflation.
37. Research shows that monetary transmission to output is effective in Indian conditions 1. A semi-structural estimation with gap variables obtains an interest elasticity of aggregate demand (-0.21) as high as in AEs. This is intuitive because consumer durable and housing loan demand is interest elastic and induces demand for working capital and investment funds. Covid-19 naturally led to postponement of projects, as uncertainty increased and consumer confidence fell, so that time is required for revival. Even so investment in specific sectors did rise in 2020 itself, following softer monetary-financial conditions. By October 2021 there was a perceptible rise in credit. Although credit growth to overall industry was only 4%, that to medium industries was 48.6%. Large industries are deleveraged, cash rich and have access to the corporate bond market. Credit to MSMEs and personal loans grew above 11%, with that to consumer durables at 44%.
38. Q2 GDP data also shows signs of investment revival. Aggregate GDP has passed 2019 levels, but consumption and stressed sectors remain below it pointing to income loss that still has to be made-up. Excess capacity and unemployment continues to be high. Potential output is difficult to measure in the Indian context 2 and is best defined by a persistent rise in inflation above the tolerance band, which is not the case at present, implying the output gap is negative. Real rates are less negative, to the extent one year ahead inflation projections have softened.
39. Estimated Indian aggregate supply shows a mixture of backward and forward looking behaviour. When there are some lags, stability requires monetary policy to respond early but slowly 3. There is steady progress in fine-tuning and control of liquidity since early this year. Since the share of VRRR has gone up, the weighted average reverse repo rate is higher and some other short rates have risen. Additions to durable liquidity have stopped. But the next step is to decrease excess durable liquidity itself. Some of this will be absorbed as growth rises. Banks are already raising some deposit rates in anticipation of a rise in credit. Even as excess aggregate liquidity reduces, RBI policies targeting liquidity at stressed sectors must continue.
40. In view of these considerations I vote to continue with the current stance and repo rate. Goyal, A. and S. Arora (2016) ‘Estimating the Indian Natural Interest Rate: A semi-structural approach’. Economic Modelling. 58: 141–153. November. doi:10.1016/j.econmod.2016.05.023. Goyal and Arora (2013) ‘Inferring India's Potential Growth and Policy Stance’. Journal of Quantitative Economics, 11(1 & 2): 60-83. January-July. Goyal, A. and S. Tripathi, (2014) ‘Stability and Transitions in Emerging Market Policy Rules’, Indian Economic Review. XLIX (2): 153-172, July-December 2014. Statement by Prof. Jayanth R. Varma
41. My views have not changed much since the August and October statements. I believe that monetary policy is no longer the right instrument to deal with the Covid-19 pandemic whose economic effects (as opposed to its health effects) have diminished greatly and become more concentrated in narrow pockets of the economy. There is no evidence so far to suggest that the Omicron variant of the Covid-19 virus would change the picture materially.
42. Economic activity appears to have surpassed its pre-pandemic level, continued recovery is likely during the rest of 2021-22, and the prognosis is for healthy growth in 2022- 23 as well. On the other hand, there is increasing evidence of inflation becoming persistent in the upper region of the tolerance band, though it is projected to remain within the band.
43. In this environment, it is no longer appropriate to stick to the monetary policy stance first adopted in May 2020 when the adverse economic effects of the pandemic were at their peak. I am therefore not in favour of the decision to keep the reverse repo rate at 3.35%, and vote against the accommodative stance. Raising effective money market rates quickly towards 4% would demonstrate the MPC’s commitment to the inflation target, help anchor expectations, reduce risk premia, enhance macroeconomic stability, and allow lower long-term interest rates to be sustained for longer thereby aiding the economic recovery.
44. On the other hand, I vote for maintaining the repo rate at 4% for the following reasons. Economic growth was unsatisfactory long before the pandemic, and even if the economic ill effects of the pandemic abate to some extent, substantial monetary accommodation is warranted. The repo rate of 4% corresponds to a negative real rate in the range of 1-1.5% based on forward looking inflation forecasts. In my view, this level of rates is currently appropriate for reviving economic growth without excessive risk of an inflationary spiral. Needless to say, the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future. Statement by Dr. Mridul K. Saggar
45. At the October MPC, I had cautioned on the likelihood of significant headwinds from the shifting global macro-economic conditions. The Fed start of taper last month was at an envisaged pace as guided by it in September and as expected by the financial markets. However, there were three surprises since our last meeting. First, inflation in the US and across the globe surprised on the up indicating that inflation may persist longer than what may be traditionally viewed as “transitory”. Second, supply-side disruptions seem to be elongated and spilling over to several geographies running through oil, gas, minerals and metals and, together with climatic factors, is lately spilling over to agro-space in a significant manner reflected in food and fertiliser prices climbing up. Third, these two factors have combined to contribute to higher inflation and lower growth prospects, raising spectre of stagflationary impulses globally.
46. The uncertainties regarding each of these factors have risen markedly in recent period. Equities markets may see more of volatile adjustments of the type seen in the last week of November as analysts adjust multiples to the changed macroeconomic environment. Bonds steepening trades in the belly of the curve will contribute to flattening of the yield curve but will also generate cross-border trades which can cause portfolio outflows. These volatilities can spillover to exchange rates. Markets are already turbulent trying to price risks emanating from the high transmissibility and spike mutations of Omicron variant, some of which are already materialising in the form of fresh travel bans and intensified protocols to contain its spread. The risk to global growth in my view has already surfaced from the rapid rise in new Covid infections in Europe and the U.S, with the 7-day Moving Averages of daily new confirmed Covid-19 cases standing in the vicinity of 3.70 lakh and 1.20 lakh, respectively. The situation remains alarming. It is clear, that the pandemic is far from over yet, though learning effects and vaccinations will help us cope with it better. So, where is the global economy headed? In my view the risk of a return to stagflation of the 1970s is rather remote. However, global growth is slowing once more and central banks, including ours, will need to confront the inflation challenge with careful calibration and avoid impulses that may kindle or deepen stagflationary impulses. In my judgement, these impulses should be mild one but could turn into a moderate one if monetary policy is not well-calibrated. Policy errors in either direction on the part of the central banks at this stage are laden with serious risks.
47. Let me turn to India. Growth is picking up. The Q2:2021-22 GDP and GVA were 0.3 per cent and 0.5 per cent above the pre-pandemic Q2:2019-20. On the demand side, PFCE was slightly less (-3.5%) than pre-pandemic Q2, while gross capital formation was 7.8 per cent above it. On the supply side, agriculture and allied activities and all three sectors of industry were above the pre-pandemic levels, while services sector (including construction) was only 2.2 per cent below pre-pandemic Q2. Only trade, hotels, transport, communication and broadcasting services remained markedly below pre-pandemic Q2 (-9.2 per cent). Information from business sources suggests that hotel occupancy and restaurant utilisation rates, though improving, are just half of the pre-pandemic levels. Tourism and travel are faring even worse. This is also an indicator to suggest that informal sector faces an uphill task in normalising production.
48. Overall, out of the 59 high frequency indicators that have become available for October out of 67 that I track, 88 per cent of the indicators exhibited month-on-month improvement after a somewhat weak August and September. The momentum towards normalisation has picked up significantly, but a third of indicators have yet to cross their pre-pandemic levels. Moreover, the stress in informal sector is not adequately captured by these indicators.
49. On the consumption side, trade reports suggest that Diwali sales jumped 71 per cent this year compared with 17 per cent, 20 per cent and 16 per cent in the preceding three years. On the investment side, partial information for Q2 and informal feedback obtained from corporates and banks suggest that capacity utilization rates in manufacturing have improved and is likely to have crossed 70 per cent mark but will likely remain slightly below trend levels in Q3:2021-22. Though the pipeline investment from last year is weak, there is anecdotal evidence of new projects that are or can soon get into financial closures. The road sector stands out, but some investment is also seen in cement, iron and steel, textiles, solar power, chemical and chemical products.
50. On the inflation, the momentum in October was strong. CPI increased 1.4 per cent month-on-month in October, which is more than double the normal momentum. Seasonally adjusted annualised rate of CPI inflation touched 10.0 per cent and item level data indicates pickup in diffusion. Passthrough from WPI inflation will need to be closely watched with October momentum reaching an all-time high at 2.3 per cent month-on-month. Diffusion of price rise was also high at the wholesale price level. Core inflation remains elevated and sticky. In this milieu, we need to be eagle-eyed for the passthrough of producer prices to retail levels and be ready to act should the need arise. If growth improves further, we should use the opportunity to nudge inflation and inflation expectations down.
51. I finally turn to decisions at hand in this meeting. With inflation having bottomed out, the real interest rate adjustment assumes added importance. Macroeconomic adjustments of saving-investment balance will be critical as global interest rate cycle changes in face of tapers and lift offs. While we are very close to growth having revived, its durability is still not entirely clear. On the other hand, inflation has come back below upper tolerance level for the last four months and while the upside risks exist, the baseline affords some comfort that inflation should stay mid-way between the target and the upper tolerance band in H1:2022-23. If one were certain about a broad-based durable growth revival, monetary policy could have acted now to pre-empt the possibility of inflation resurgence. However, the key question is whether the economy can entail the output sacrifice it may bring at a time when the recovery is nascent. Therefore, it will be best not to risk strengthening stagflationary impulses that already are being propped up by supply disruptions mentioned upfront in my statement. Small moves towards policy normalisation may be sufficient now and one can decide to shift to a tightening monetary policy cycle at a point when it is clear that demand revival has acquired resilience and pandemic risks to growth have diminished or alternatively if inflation diffusion persists in near months which then can result in inflation getting generalised and persist next year, especially if inflation expectations get unanchored. Short-run Phillips curve can shift up and turn steeper in this case. Yet, at this juncture, it looks India will be able to contain inflationary pressures through better supply-side responses.
52. One month’s data suggesting strong growth and inflation momentums is not sufficient to change rate cycles or policy stance. This guiding rule has helped us avert the mistake of premature tightening on at least two earlier occasions. This, however, does not mean status quo. Central bank has an armoury of tools to calibrate monetary and financial conditions. The Pascal’s principle for transmission of fluid pressures very much holds and appropriate liquidity levels are key to monetary adjustment at this stage. This is also important to address unintended effects reflected in asset prices inflation, income inequalities and future risks of macro-financial imbalances. Keeping in view the Swiss knife-like policy tools the central bank possesses to deal appropriately with the emerging trends, I vote to leave the repo rate unchanged at 4.0 per cent and also vote for retaining the stance. Statement by Dr. Michael Debabrata Patra
53. Suddenly, the global outlook has darkened. Three fundamental questions about Omicron have put national authorities on high alert – is it more transmissible than other variants? Can it evade immunity conferred by previous infections or vaccination? Does it cause more severe disease?
54. As countries race to contain Omicron with travel restraints and new quarantine and social distancing measures, the global recovery and the inflation outlook are at risk again.
55. Even before Omicron, the momentum of the global recovery and of world trade has been ebbing in the second half of 2021, including in countries with relatively high vaccination rates. With GDP prints coming in lower for several countries, estimates suggest that global GDP growth is slowing by a full percentage point in the second half of 2021 on a sequential seasonally adjusted annualised basis. In some countries, the level of GDP may have reached pre-pandemic levels, but that is of little comfort as activity worldwide had been slowing since 2018. In many other countries, negative output and employment gaps are still too wide, and that is sapping global aggregate demand. The path of the recovery is still being shaped by the pandemic and its second order effects. The question that is uppermost is: Has the global recovery peaked prematurely, leaving behind the scars of the pandemic?
56. Fears about the new variant triggered the biggest Black Friday plunge on record in global equity markets on November 26, 2021. Even earlier, financial market volatility had surged in recent weeks on fears of a policy pivot towards faster normalisation. Clearly, financial conditions are highly fragile, vulnerable to volatile shifts and not conducive to a strong and broad-based recovery.
57. The pretext underlying financial market volatility – what I term the cynicism of bonds and the ‘fomo’ of equities – is that inflation has checked in as if it is here to stay. In some countries, the dogs of second order transmission have begun to bark – wages; rents; education fees; transportation costs. The world helplessly stares at what have become household terms - supply and logistics disruptions, shortages and bottlenecks – but the need of the hour is coordinated action. Consequently, markets and analysts get increasingly certain that inflation may remain elevated through the greater part of 2022 and growth will slow further absent policy action to unclog supply bottlenecks.
58. Yet, it is important to be cognisant of the bullwhip effect – when shortages turn into surpluses. Some evidence of this happening is already there. Finished goods inventories are piling up as shown in PMIs of several advanced countries and promises of discounts, sales and faster deliveries are getting louder. When these inventories will be wound down, they will reduce new orders and economic activity will slow. An excess of finished goods may also lead to weak pricing power, which will moderate inflation. It is likely that this will happen in the first half of 2022. Meanwhile, final private consumption expenditure seems to be weakening in individual countries’ data releases. India’s November 30 release was no exception.
59. As far as the emerging markets as an asset class are concerned, the ebbing of yields globally during April-June this year seemed to suggest that markets had priced in the inevitability of monetary policy normalisation by systemic central banks, but the recent volatility has dispelled that comfort. Most emerging market currencies have depreciated, with retrenchment in capital flows amplifying the downswing. As macroeconomic conditions diverge further across countries, monetary policy actions and stances are getting dissonant, tightening global financial conditions and putting the global recovery further at risk.
60. The Indian economy has been treading a trajectory that diverges from the global situation. Bank credit is picking up, tax revenues are buoyant, exports are growing robustly and the current account balance is set to swing into a deficit on the back of strong import demand, but there are limits to decoupling. There are vulnerabilities too. The level of GDP in Q2:2021- 22 is barely at the so-called pre-pandemic level of Q2:2019-20, which itself grew at the slowest pace in 6 years preceding it. Consumption spending is held back by households hesitant to incur discretionary expenditure. Private investment remains timid and is yet to participate in the recovery. Contact-intensive services are still convalescing from the wounds of the pandemic. In November, several high frequency indicators have slowed, suggesting that the second half of 2021-22 may not be the same as the first half and moderation in the recovery could set in.
61. On inflation, food inflation may ease with the usual winter softening, but core inflation will keep us awake, especially with the likely cost push from recent upward revisions of telecom tariffs and GST rates on clothing and footwear, the safe haven upswing in gold prices and the increasing likelihood of selling price revisions in respect of consumer durables, automobiles and the like by January 2022. India’s inflation developments reflect a scissor effect – rebound in demand colliding with supply bottlenecks; but shipping delays, delivery lags and semi-conductor shortages cannot last indefinitely and should certainly improve in the second half of 2022, as predicted by the IMF. The surge of pent-up demand should also normalise by then. Accordingly, elevated levels of inflation will persist till then, whether we like it or not, but not longer. By the projections, inflation in India will peak in the last quarter of this year and from there, it will moderate.
62. India is being lashed by global spillovers. The main conduit has been financial markets so far but the channels themselves are diversifying. The biggest risk of contagion is now from the new variant. Unless a clearer picture emerges on the near-term outlook, we must take guard and resume battle readiness again. In this highly unsettled environment, my vote for status quo on the policy rate and the accommodative stance as articulated in the resolution is fait accompli. Statement by Shri Shaktikanta Das
63. Since the previous meeting of the MPC (October 6-8, 2021), domestic growth and inflation have unfolded broadly on projected lines, while the global environment has turned febrile. Risks stalking the global economy have amplified with rapid spread of the virus mutations, including the Omicron variant, leading to countries scrambling for restrictions. Concomitantly, sharp escalation in inflationary pressures across several major advanced economies is prompting their central banks to hasten winding down of their ultra- accommodative policies, which may impart volatility to the financial markets with associated spill overs for emerging market economies (EMEs) like India. These developments certainly have two major takeaways for central bankers. First, uncertainty is emerging as the only certainty with which central bankers will have to deal with in the period ahead. Second, since monetary policy is at an inflection point, the journey of monetary policy which is hardly smooth in the best of times, is going to get more challenging. These two factors necessitate judicious policy choices amidst trade-offs. Against this backdrop, let me set out my assessment.
64. The Indian economy is facing several headwinds emanating from global factors – some old ones getting prolonged compared with the initial assessment, coupled with new ones. The supply disruptions and other bottlenecks which were earlier anticipated to resolve by end of this year have gained additional shelf life stretching into 2022. Global trade, after rebounding strongly in the first half of 2021, is losing momentum on the back of stretched supply chain and logistics issues, shortages of key components and slowdown in key regions. The emergence of the Omicron variant may cast some shadow on the momentum of contact-intensive services that were just showing signs of recovery in recent months. The threat of Omicron is also imparting additional volatility to the financial markets.
65. While the Indian economy is on its way to achieve the projected growth of 9.5 per cent in 2021-22, there are still significant areas of concern. Private consumption – the mainstay of aggregate demand with a share of around 55 per cent – is languishing below its level recorded two years ago, suggesting that we still have a distance to go in nurturing a more durable recovery. Private sector capex remains sluggish even though pre-conditions for its acceleration have been engendered by increasing capacity utilisation, deleveraging of balance sheets and improved profitability of corporates. Based on the early results, capacity utilisation in the manufacturing sector increased to 68.8 per cent in Q2:2021-22 from 60.0 per cent in Q1:2021-
66. As regards inflation, headline CPI after moderating sharply in September to 4.3 per cent, edged up in October to 4.5 per cent. On the domestic front, October saw unusually heavy rains, which led to loss of kharif crops as well as delayed harvest. This resulted in a flare up of vegetables prices. CPI fuel inflation continued to be in double digits with domestic LPG and kerosene prices being raised in response to increase in international prices. These price pressures in food and fuel resulted in a pick-up in CPI inflation in October despite large favourable base effects. Core inflation remained elevated.
67. Going forward, the heavy rainfalls in November are likely to keep vegetables prices elevated in the near-term; however, prices thereafter are expected to register seasonal declines on fresh winter arrivals. The recent supply side interventions by the Government would continue to restrain the pass-through of elevated international edible oil prices to domestic retail inflation. The outlook on cereals and pulses is also favourable with healthy progress of rabi sowing. Retail selling prices of fuel eased somewhat in early November with reduction in excise duty and VAT on petrol and diesel, which should lead to a durable reduction in inflation through both direct and indirect effects. This should also be supported by the fall in international crude oil prices observed towards end-November, albeit to the extent that it is passed on to the retail pump prices. The revision in mobile tariffs, however, would be an additional source of price pressures on core inflation from December 2021. Looking ahead, inflation is expected to moderate to 5.0 per cent in H1 of next financial year, remaining well within the tolerance band.
68. We, however, need to remain vigilant to incipient cost-push pressures to inflation as well as to the uncertainty imparted by Omicron. Its implication for inflation, going forward, are two-fold. First, increase in restrictions, if any, on activity and commerce to stymie COVID- 19 spread could translate to continuing supply chain and logistics disruptions. Second, if the Omicron variant results in the onset of new waves of infection globally, this could derail the ongoing demand recovery. On the whole, at this stage it is too premature to gauge as to how the effects of the Omicron variant would pan out in the weeks and months ahead in terms of its effect on growth and inflation.
69. To sum up, there is growing uncertainty regarding the evolving global macroeconomic outlook. In the domestic front, even as the prospects for economic activity are improving, there is still a slack with key drivers like private consumption remaining well below their pre- pandemic levels. Given these uncertainties, continued policy support is warranted for a durable, broad-based and self-sustaining rebound, especially to nurture revival in sectors which are lagging and to safeguard those which are exposed to the evolving headwinds. In this scenario, it would be prudent to watch out for growth signals becoming well entrenched while remaining vigilant on inflation dynamics. There is also a necessity to have a firm understanding of the impact of the Omicron variant. The calibration and timing of a monetary policy response and preventing build-up of financial stability risks are very important in such an uncertain environment. Thus, I vote to keep the policy repo rate unchanged at 4 per cent and to continue with the same accommodative stance as spelt out by the MPC in its October 2021 meeting. (Yogesh Dayal) Press Release: 2021-2022/1402 Chief General Manager
6. Since the MPC’s meeting in December 2021, the rapid spread of the highly transmissible Omicron variant and the associated restrictions have dampened global economic activity. The global composite purchasing managers’ index (PMI) slipped to an 18 month low of 51.4 in January 2022, with weakness in both services and manufacturing. World merchandise trade continues to grow. There are, however, headwinds emanating from persistent container and labour shortages, and elevated freight rates. In its January 2022 update of the World Economic Outlook, the International Monetary Fund (IMF) revised global output and trade growth projections for 2022 downward to 4.4 per cent and 6.0 per cent from its earlier forecasts of 4.9 per cent and 6.7 per cent, respectively.
7. After reversing the transient correction that had occurred towards end- November, commodity prices resumed hardening and accentuated inflationary pressures. With several central banks focused on policy normalisation, including ending asset purchases and earlier than expected hikes in policy rates, financial markets have turned volatile. Sovereign bond yields firmed up across maturities and equity markets entered correction territory. Currency markets in emerging market economies (EMEs) have exhibited two-way movements in recent weeks, driven by strong capital outflows from equities with elevated uncertainty on the pace and quantum of US rate hikes. The latter also led to an increasing and volatile movement in US bond yields. Domestic Economy
8. The first advance estimates (FAE) of national income released by the National Statistical Office (NSO) on January 7, 2022 placed India’s real gross domestic product (GDP) growth at 9.2 per cent for 2021-22, surpassing its pre-pandemic (2019-20) level. All major components of GDP exceeded their 2019-20 levels, barring private consumption. In its January 31 release, the NSO revised real GDP growth for 2020-21 to (-) 6.6 per cent from the provisional estimates of (-) 7.3 per cent.
9. Available high frequency indicators suggest some weakening of demand in January 2022 reflecting the drag on contact-intensive services from the fast spread of the Omicron variant in the country. Rural demand indicators – two-wheeler and tractor sales – contracted in December-January. Area sown under Rabi up to February 4, 2022 was higher by 1.5 per cent over the previous year. Amongst the urban demand indicators, consumer durables and passenger vehicle sales contracted in November-December on account of supply constraints while domestic air traffic weakened in January under the impact of Omicron. Investment activity displayed a mixed picture – while import of capital goods increased in December, production of capital goods declined on a year-on-year (y-o-y) basis in November. Merchandise exports remained buoyant for the eleventh successive month in January 2022; non-oil non-gold imports also continued to expand on the back of domestic demand.
10. The manufacturing PMI stayed in expansion zone in January at 54.0, though it moderated from 55.5 in the preceding month. Among services sector indicators, railway freight traffic, e-way bills, and toll collections posted y-o-y growth in December-January; petroleum consumption registered muted growth and port traffic declined. While finished steel consumption contracted y-o-y in January, cement production grew in double digits in December. PMI services continued to exhibit expansion at 51.5 in January 2022, though the pace weakened from 55.5 in December.
11. Headline CPI inflation edged up to 5.6 per cent y-o-y in December from 4.9 per cent in November due to large adverse base effects. The food group registered a significant decline in prices in December, primarily on account of vegetables, meat and fish, edible oils and fruits, but sharp adverse base effects from vegetables prices resulted in a rise in y-o-y inflation. Fuel inflation eased in December but remained in double digits. Core inflation or CPI inflation excluding food and fuel stayed elevated, though there was some moderation from 6.2 per cent in November to 6.0 per cent in December, driven by transportation and communication, health, housing and recreation and amusement.
12. Overall system liquidity continued to be in large surplus, although average absorption (through both the fixed and variable rate reverse repos) under the LAF declined from ₹8.6 lakh crore during October-November 2021 to ₹7.6 lakh crore in January 2022. Reserve money (adjusted for the first-round impact of the change in the cash reserve ratio) expanded by 8.4 per cent (y-o-y) on February 4, 2022. Money supply (M3) and bank credit by commercial banks rose (y-o-y) by 8.4 per cent and 8.2 per cent, respectively, as on January 28, 2022. India’s foreign exchange reserves increased by US$ 55 billion in 2021-22 (up to February 4, 2022) to US$ 632 billion. Outlook
13. Since the December 2021 MPC meeting, CPI inflation has moved along the expected trajectory. Going forward, vegetables prices are expected to ease further on fresh winter crop arrivals. The softening in pulses and edible oil prices is likely to continue in response to strong supply-side interventions by the Government and increase in domestic production. Prospects of a good Rabi harvest add to the optimism on the food price front. Adverse base effect, however, is likely to prevent a substantial easing of food inflation in January. The outlook for crude oil prices is rendered uncertain by geopolitical developments even as supply conditions are expected to turn more favourable during 2022. While cost-push pressures on core inflation may continue in the near term, the Reserve Bank surveys point to some softening in the pace of increase in selling prices by the manufacturing and services firms going forward, reflecting subdued pass-through. On balance, the inflation projection for 2021-22 is retained at 5.3 per cent, with Q4 at 5.7 per cent. On the assumption of a normal monsoon in 2022, CPI inflation for 2022-23 is projected at 4.5 per cent with Q1:2022-23 at 4.9 per cent; Q2 at 5.0 per cent; Q3 at 4.0 per cent; and Q4:2022-23 at 4.2 per cent, with risks broadly balanced (Chart 1).
14. Recovery in domestic economic activity is yet to be broad-based, as private consumption and contact-intensive services remain below pre-pandemic levels. Going forward, the outlook for the Rabi crop bodes well for agriculture and rural demand. The impact of the ongoing third wave of the pandemic on the recovery is likely to be limited relative to the earlier waves, improving the outlook for contact- intensive services and urban demand. The announcements in the Union Budget 2022-23 on boosting public infrastructure through enhanced capital expenditure are expected to augment growth and crowd in private investment through large multiplier effects. The pick-up in non-food bank credit, supportive monetary and liquidity conditions, sustained buoyancy in merchandise exports, improving capacity utilisation and stable business outlook augur well for aggregate demand. Global financial market volatility, elevated international commodity prices, especially crude oil, and continuing global supply-side disruptions pose downside risks to the outlook. Taking all these factors into consideration, the real GDP growth for 2022-23 is projected at 7.8 per cent with Q1:2022-23 at 17.2 per cent; Q2 at 7.0 per cent; Q3 at 4.3 per cent; and Q4:2022-23 at 4.5 per cent (Chart 2).
15. The MPC notes that inflation is likely to moderate in H1:2022-23 and move closer to the target rate thereafter, providing room to remain accommodative. Timely and apposite supply side measures from the Government have substantially helped contain inflationary pressures. The potential pick up of input costs is a contingent risk, especially if international crude oil prices remain elevated. The pace of the domestic recovery is catching up with pre-pandemic trends, but private consumption is still lagging. COVID-19 continues to impart some uncertainty to the future outlook. Measures announced in the Union Budget 2022-23 should boost aggregate demand. The global macroeconomic environment is, however, characterised by deceleration in global demand in 2022, with increasing headwinds from financial market volatility induced by monetary policy normalisation in the systemic advanced economies (AEs) and inflationary pressures from persisting supply chain disruptions. Accordingly, the MPC judges that the ongoing domestic recovery is still incomplete and needs continued policy support. It is in this context that the MPC has decided to keep the policy repo rate unchanged at 4 per cent and to continue with an accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.
16. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 4.0 per cent.
17. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma, voted to continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
18. The minutes of the MPC’s meeting will be published on February 24, 2022.
19. The next meeting of the MPC is scheduled during April 6-8, 2022. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
20. The First Advance Estimates (FAE) released by NSO place the GDP growth in 2021-22 at 9.2 per cent over the previous year, lower than the projected 9.5 per cent in the December MPC statement. However, the First Revised Estimates (FRE) for 2020-21 released subsequent to the FAE point to slightly higher level of GDP than the Provisional Estimates used for calculating the FAE for 2021-22 implying lower projected growth rate for 2021-22. Overall, GDP in 2021-22 is likely to exceed the level achieved in 2019-20 by less than 2 per cent highlighting the need for accelerating the pace of economic recovery.
21. The FAE for 2021-22 show that the private consumption expenditure, the largest component of GDP, is yet to reach the pre-pandemic 2019-20 level. Two other components - government final consumption expenditure and gross fixed capital formation in 2021-22 are projected to exceed the 2019-20 levels. Exports and imports of goods and services are projected to rise in 2021-22 above their 2019-20 levels.
22. Even as the pace of growth appeared to be on track at the end of November, with the Covid situation again turning uncertain, policy measures have become crucial to sustain the growth momentum. The dominant impact of the latest state of the pandemic, directly or indirectly, has emerged from the global scenario. The direct impact is the significant caseload across countries and the restrictions on economic activities to contain the disease spread. The indirect impact follows as the spill overs of the initial impact through the supply chains, inflation and monetary policy tightening to contain inflation are realised. The YOY rate of growth of the world economy in 2022 is now projected by IMF in its January 2022 update of the World Economic Outlook at 4.4 per cent, compared to 4.9 per cent in October 2021. Going forward, growth is projected at 3.8 per cent in 2023. Globally, inflationary pressures from fuel and food are expected to abate during 2022-23. The January 2022 update by IMF also projects the World trade volume - goods and services - to grow in 2022 at a lower rate than the previous October 2021 projections. The projections also recognise the downside risks to growth related to the spread of Covid.
23. The global economic environment is also affected by the continued geopolitical risks that may in turn affect trade, prices and capital flows.
24. The domestic economy has shown strong recovery from the impact of the second wave of the pandemic in Q1: 2021-22. The growth recovery, however, has been incomplete so far, particularly with respect to private consumption expenditure. RBI’s bi-monthly Consumer Confidence Survey conducted in the major urban areas across the country in January, reflects continued weakness in consumer sentiments compared to the survey in November 2021. Majority of the respondents report increased spending now compared to a year back, with ‘essential expenditure’ driving the increase and ‘discretionary expenditure’ remaining weak. The pattern is the same for expectations of one-year-ahead situation. Although slightly higher proportion of respondents now find improvement in the prevailing general economic conditions compared to a year back, majority find that the situation has worsened. The one year ahead assessment by the respondents reflects decline in positive ratings, probably due to the impact of rise in the infections from the Omicron variant during December 2021. Perceptions of the prevailing employment and income conditions also reflect weak sentiments. The mixed picture on consumer spending is also reflected in the pattern of Index of Industrial Production (IIP). The IIP for consumer durables is yet to rise above the 2019-20 levels in a significant way. The IIP for consumer nondurables has just reached 2019-20 level. Overall, boost to the consumption spending would require sustained improvement in employment and income conditions.
25. The Gross Fixed Capital Formation is projected to increase by 17.4 per cent in 2021-22 (FAE) over the previous year. The significant increase is over a decline of 10.4 per cent in the previous year highlighting again the need for sustaining this momentum. The latest estimates of IIP for Capital Goods for October and November in 2021 are lower than the levels in 2020 for the same months. The Business Expectations Survey conducted by NCAER in December 2021 (https://www.ncaer.org/data_details.php?dID=21), reports improvement in Business Confidence in Q3 2021 over the previous quarter, although pace of improvement slowed and the index based on responses in the last week of the survey was lower than the first three weeks of December drawing attention to the impact of rising Omicron cases. RBI’s latest Industrial Outlook Survey shows decline in the Business Expectations Index for Q4: 2021-22 from Q3: 2021-22 after its steady increase since Q2: 2020-21 even as it indicates expansion. Capital goods imports, one of the key indicators of investment conditions, has increased consistently above the 2019-20 levels during September-December 2021. To sustain the positive trends in investment demand, improvement in the overall demand conditions would be crucial. The proposed increase in capital expenditure in the Union Government Budget for 2022-23 will be one of the positive drivers for investment spending, besides continuation of the buoyant export growth seen in 2021-22.
26. While the current wave of Covid infections has affected consumer and business sentiments, there are also indicators that suggest underlying positive growth trends. GST collection has registered double digit growth in December 2021 and January 2022, although at a much slower pace than in October-November 2021. Non-food bank credit expanded by 9.3 per cent in December 2021, year on year basis and by 8.1 per cent as on January 14, 2022. These are the highest rates of growth in the last 12 months. The PMI for manufacturing and services, while declining from the levels of previous month, remain in expansion zone for the month of January 2022.
27. The growth momentum of domestic economy is expected to pick up as the impact of the current wave of the pandemic subsides. The vaccinations and continued adherence to Covid protocols to prevent any further spread of the virus are essential for achieving sustained growth in employment and household income.
28. Based on the assumption of a normal monsoon, and the present trends in the key indicators of economic activity, GDP growth for 2022-23 is placed at 7.8 per cent, YOY basis. The quarterly growth trajectory is projected as Q1:2022-23 at 17.2 per cent; Q2 at 7.0 per cent; Q3 at 4.3 per cent; and Q4:2022-23 at 4.5 per cent, YOY basis. The Survey of Professional Forecasters, conducted by RBI in January 2022 provides a median GDP forecast of 7.7 per cent for 2022-23. Applying the forecast of 7.8 per cent on 2021-22 FAE value for GDP, implies an increase of 9.6 per cent over the Second Revised Estimates for 2019-20 or an average annual growth of 3.2 per cent for the three years ending 2022-23. This highlights the need for supportive policies for achieving a sustained higher growth momentum.
29. The CPI headline inflation rate for the first three quarters of 2021-22 has come at 5.6, 5.1 and 5.0 per cent YOY basis. The non-Food and non-Fuel Core CPI inflation rate for the same periods has been at 6.0, 5.8 and 6.0 per cent. The CPI core measure, which includes the prices of petrol and diesel as well as the prices of transportation services, captures the cost of retail selling prices of petrol and diesel as well as its cost passed on in the prices of the other products in the consumption basket. The double-digit growth of prices in the petroleum products, therefore, is one of the key drivers of the Core inflation as well. Going forward, the trajectories of food and petroleum product prices would impact the prices of the other sectors, besides the other sector-specific factors. The Inflation Expectations Survey of Households conducted by the RBI in the first two weeks of January 22 shows a decline in the median of expected inflation rate on three months ahead and one-year ahead horizons. Perceptions of current inflation rate also declined. Although the perceived inflation rates are high compared to the actuals, changes in these perceived rates point to expectations of moderation in inflation rate. Taking into account the present trends, and the favourable impact of the Rabi crop conditions, the inflation projection for 2021-22 is retained at 5.3 per cent. The projected inflation rate for Q4 is at 5.7 per cent, the same as in the December 2021 projections. The median forecast of CPI inflation rate in the Survey of Professional Forecasters for Q4: 2021-22 is 5.8 per cent. With a normal monsoon and easing of supply conditions with the decline of the Covid infections, the headline CPI inflation for 2022-23 has been projected at 4.5 per cent by the RBI. The quarterly estimates are Q1 at 4.9 per cent; Q2 at 5.0 per cent; Q3 at 4.0 per cent; and Q4 at 4.2 per cent. There are indeed factors that may change this scenario, particularly the impact of geopolitical tensions affecting international commodity prices and trade, and the impact of macroeconomic policies of the advanced economies.
30. To strengthen the positive growth trends in the economy, the need for favourable monetary and financial conditions has remained a critical condition. Pickup in momentum of consumption and investment expenditure would require access to financial resources to both consumers and firms. The inflation rates are projected to moderate and stay below the upper level of the tolerance band of the inflation target at this juncture. With these factors in view, I vote in favour of keeping the policy repo rate unchanged at 4.0 per cent. I also vote in favour of continuing with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Statement by Dr. Ashima Goyal
31. To arrive at a voting decision I take up issues of global risks facing the economy, factors determining its expected inflation path and growth recovery, as well as the type and the impact of guidance.
32. Global risks include high oil prices, rising inflation and interest rates in major countries and possible volatility in foreign capital outflows.
33. Indian headline CPI inflation, however, is expected to soften after Q4. Oil prices are high currently but are volatile and unlikely to stay at current levels, lowering WPI, which will also ease as adverse base effects fade. The dominance of food price inflation in second round inflation in India makes CPI inflation affect WPI inflation more than the reverse, although normally it is producer prices that are expected to affect consumer prices 1. Therefore, high WPI need not raise CPI. Household inflation expectations have also moderated.
34. Moreover, the food items dominating headline CPI are more amenable to government action. The government is taking active measures to lower domestic commodity inflation, apart from longer term supply-side measures such as reducing logistics and other costs of doing business. Monetary-fiscal coordination on this is excellent.
35. Spillover to CPI from high inflation in advanced economies (AEs) is unlikely since the structure of consumption is very different—imported consumer goods are 12.1% of the Indian consumption basket but 37% for US. Inflation propagation mechanisms such as high wage growth and labour shortages in AEs are not at work here, firms’ pass through of input costs shows moderation yet their profit margins are constant. A combination of cost restructuring and better scale economies may account for this. Container costs have been declining since October.
36. That M3 and credit growth has remained in single digits since the pandemic struck, despite surplus durable liquidity, indicates that aggregate demand is low. In an IT regime the liquidity adjustment facility makes money supply endogenous 2, any excess durable liquidity is absorbed in the remunerated reverse repo. Money growth reflects the current state of demand rather than creating demand.
37. Although the third wave of the pandemic seems to have passed with less economic cost, consumption continues at below pre-pandemic levels pointing to loss of income and demand. A future corona variant remains a possibility although we seem to have learnt to handle it better.
38. The budget has reduced deficits only marginally but improved the composition of government spending, which will lower future inflation. Expenditure commitments have been reasonably met, but the proposed rise in capex will take some time to stimulate demand further, even though some construction activities create jobs with little delay. Goyal, A. and S. Tripathi. 2011. ‘New Keynesian Aggregate Supply in the Tropics: Food prices, wages and inflation’ International Journal of Monetary Economics and Finance. 4(4): 330-354. Indeed, one reason for shifting to the interest rate as an instrument is that money demand becomes unstable, and money supply endogenous, with near money substitutes that financial institutions can create. See Goyal, A. and S. Dash. 2000. ‘The Money Supply Process in India: Identification, Analysis and Estimation’, Indian Economic Journal, Vol. 48(1), July-September.
39. Export growth is high and is expected to continue despite some softening of world growth, but since imports exceed exports, largely because of commodity imports, net contribution of trade to domestic demand is negative.
40. Another indicator of low demand is high unemployment. Many have lost jobs in the pandemic. Inflation targeting theory tells us that output sacrifice is required to reduce inflation when it is caused by supply shocks and the sacrifice can be very high if supply is elastic as in India. It would not be wise to create even more unemployment in order to reduce inflation, especially when inflation itself is expected to reduce towards the target. Despite continuing uncertainty there are signs of credit growth and investment picking up in some sectors. This needs to be supported in order to sustainably reverse the decade long slowdown in private investment.
41. It follows it is necessary for the MPC to continue to stimulate demand at present. But not as much as earlier, because some recovery has taken place compared to last year. Since one year ahead expected inflation is at 4 per cent and the weighted reverse repo is near 4 per cent, the real policy rate has risen from negative to near zero.
42. Markets, however, have priced in steeply rising policy rates and spreads have risen. This seems to be an over-reaction to the expected rise in Fed rates and of government borrowing requirements. It could also be due to equating Indian inflation incorrectly with US inflation. The Fed has yet to start normalization although inflation has exceeded their target for some time now. But Indian policy started rebalancing excess durable liquidity from early 2021 with the re-introduction of the VRRRs and the reversal of the CRR cut while communicating that ample liquidity will be ensured and conditions remain supportive. Gradual adjustment already undertaken, together with the expected inflation path, implies a sharp rise in Indian policy rates is unlikely to be required. In uncertain times policy is more data driven but the reaction function should be well understood.
43. The interest differential with the US is large. Their real rates remain highly negative. Since interest sensitive foreign flows are still a small percentage of Indian markets, potential outflows are a minuscule portion of India’s large foreign exchange reserves. Sustained equity outflows are unlikely in view of India’s growth potential. Moreover, some outflows will give more space to support government borrowing without raising durable liquidity. In any case room has been created to rebalance any rise or fall in liquidity, as required, with existing instruments in the LAF.
44. The current account deficit remains manageable and the overall balance of payments in surplus with a rising share of foreign direct investment. In 2013 and 2018 following Fed tightening had upset Indian growth and other macros. This time there is space to align policy to the needs of the domestic cycle.
45. In view of expected trends in inflation and growth and in order to moderate market over-reaction, I vote to continue with the current stance and repo rate. Statement by Prof. Jayanth R. Varma
46. As the third Covid-19 wave peters out in India, the time has come to think of the objectives of monetary policy in much broader terms than “mitigate the impact of COVID-19 on the economy”. Of course, a fourth wave cannot be ruled out, but the third wave has shown that the economy is no longer hostage to the pandemic, and in fact, as we meet, geopolitical tensions have become a bigger risk to the global economy than the virus.
47. Monetary policy acts with lags, and it is important to set policy looking at the expected state of the economy 3-4 quarters from now and not in terms of where it is today. The RBI projections presented in the fan charts (Chart 2) show growth running out of steam after an initial burst of decent growth in the first couple of quarters. In other words, the pre-pandemic situation of an economy growing below potential is expected to re-assert itself. According to Chart 1, inflation is expected to drop close to the 4% target towards the end of 2022-23. Going by these projections, it appears to me that while real interest rates need to be remain low, they do need to become mildly positive during 2022-23. The projections also suggest that though a significant part of the normalization of real interest rates would happen through the expected decline in inflation, there would be a need for a modest rise in nominal interest rates.
48. The fan charts also reveal a very large range of uncertainty on both inflation and growth. Robust growth coupled with sticky inflation could necessitate larger rises in nominal rates, while weak growth accompanied by benign inflation could open up the space for a more accommodative monetary policy. With risks appearing to be balanced on both sides, the policy stance needs to be neutral.
49. I find it instructive to compare the situation today (February 2022) with that at the last pre-pandemic MPC meeting (February 2020) in terms of projections three quarters ahead (Q3 of 2022-23 and Q3 of 2020-21 respectively). Compared to then, (i) three-quarter ahead growth expectations are about 2% lower, (ii) three-quarter ahead inflation expectations are about 1% higher, and (iii) the real policy rate (based on three-quarter ahead inflation expectations) is now about 2% lower. This comparison also suggests a neutral policy stance.
50. Taking all this into account, I vote in favour of maintaining the policy rate at 4% while voting against the policy stance on two counts. First, a switch to neutral stance is now long overdue. Second, the continued harping on combating the ill effect of the pandemic has become counter productive and deflects the focus of the MPC away from the core issue of addressing the recessionary trends that go back at least to 2019.
51. I have in the past expressed my reservations about the abnormal width of the policy corridor, but with all money market rates having moved close to the upper end of the corridor, the persistence with a low reverse repo rate has now become a somewhat harmless fetishism, and I will therefore not dwell on it. Statement by Dr. Mridul K. Saggar
52. The contours of shifting macroeconomic conditions, visible since October 2021, have got elevated further since we last met in early December. Let me dwell into these shifts and their implications.
53. First, the global interest rate cycle is decidedly changing. The benchmark 10- year JGB yield is at its highest since 2015, while the 10-year German bunds yields have moved into positive terrain in February crossing early 2019 levels with spreads widening in the euro area periphery. The US treasury yields have surged above pre- pandemic levels. On current indications, the Fed is on path to complete taper and start lift off by March and quantitative tightening a few months later. Markets have moved to expecting five rate hikes by the Fed, two by ECB and three more by BoE this year in addition to the two already effected over last two months. CPI inflation for December 2021 in the US came at 7% (highest since June 1982) and the PCE inflation at 5.8% (highest since July 1982). Headline inflation for the euro area as per flash estimates for January 2022 was ruling at 5.1% (highest since 1997 when index recording began) and in UK at 5.4% in December 2021 (highest since March 1992). With inflation in these geographies witnessing wide gaps over their 2% inflation targets, their central banks have little choice but to raise rates sooner than later. The situation in India is not similar. While CPI inflation at 5.6% in December 2021 is higher than the target, it is still within the tolerance band and is projected to recede in 2022-23 allowing monetary authorities to remain accommodative. However, the changing global monetary policy cycle implies that emerging market economies like ours will do well to brace for tighter financial conditions ahead even if domestic monetary policy stays accommodative.
54. Moreover, as interest differential narrows and current account widens, macroeconomic dynamics will come into play. How should our monetary policy react to this; and will inflation targeting hamper exchange rate management in these conditions? Low for long interest rates will certainly bring in macroeconomic imbalances and it is expedient that policy rate should be raised as soon as growth is judged to recover on a durable basis or inflation is seen to be turning endemic. In the interim, the good part is that we have built buffers against possible capital outflows. There is evidence to suggest that in small open economies that face imperfect substitution between domestic and foreign financial assets, the exchange rate management greatly enhances the efficacy of inflation targeting. These economies are able to avoid macroeconomic fluctuations which can be driven by self-fulfilling expectations. Sterilised interventions can be a key strategy should the need arise.
55. Typically, in case of sudden stops, rise in global interest rates prompts corporate sector to deleverage. Indian corporates have already deleveraged significantly and also reduced stock of external commercial borrowings in US dollar terms, which at end-September 2021 was 7.3% lower than at end of 2019. The ‘original sin’, a situation in which a country cannot borrow abroad in their own currency has been the bug bear for emerging markets during upturn cycles in global interest rates. However, the original sin has somewhat weakened in recent years with the development of local currency bond markets. With high foreign reserves, exchange rates may turn less sensitive to global factors such as the US VIX. India having moved to inflation targeting regime should benefit from lower local currency spreads as well as lower exchange rate risk premia. However, it will be important to maintain credibility by aiming to maintain inflation on a sustained basis at or near the target as soon as real economy conditions normalise.
56. Second, Omicron variant, along with continued port congestions and supply shortages has started to drag down global growth. This, in turn, may act in accordance with Bernoulli’s principle on fluid pressure, making the growth pipe narrower with falling external demand acting to dampen price pressures that have turned elevated from the supply-side. Omicron wave has pushed the broad-based recovery further down the time, even though the disruptions caused by this third wave have been smaller compared to the first and even the second wave. Three points are noteworthy: (i) in India, the 7-day Moving Average of daily new confirmed COVID-19 cases during this wave has dropped 60% from its peak on January 25 but is still 14 times the number when the first Omicron case was detected in India; (ii) though the mortality incidence in India is currently about a fourth of the peak seen during the second wave, the daily new deaths have risen three times since the onset of the Omicron wave and currently matches the peak deaths seen during the elongated first wave and so, hard statistics do not yet afford the comfort that we can overlook the pandemic and focus beyond; (iii) vaccinations have certainly contributed to mitigating the severity of disease outcomes. However, with continuous mutations, there is lack of clarity on enduring vaccine efficacy.
57. Third, uncertainties about energy prices have risen considerably. Indian crude oil basket is up nearly 25% in the previous two months. The current geopolitical stress in Europe is a significant risk and if it translates into oil and gas prices spiking, we will need to adjust macro-economic policies suitably.
58. Fourth, it is a no-brainer that the fiscal impulse needs to be factored in our monetary policy calculations. The pace of fiscal consolidation this year has been balanced by consideration to preserve Keynesian stimulus and to continue spending support for those disproportionately affected by the pandemic. The size of the gross market borrowing at ₹14.3 lakh crore is large. Therefore, monetary-fiscal coordination remains important to avoid inferior outcomes. In this backdrop, smooth rebalancing of liquidity assumes critical importance for inflation management.
59. This, however, does not mean that monetary policy should no longer support growth. While the capex push in the latest budget will support growth, monetary policy still has a complementary role to play. Uncertainty remains on account of whether States and PSUs will keep capex high this year and whether execution will remain on track.
60. Let me now briefly sum up how growth and inflation scenarios might unfold and my view on the decisions at hand. High frequency indicators, after impressive sequential improvements during June-October 2021 lost momentum in November but bounced back in December. Early information on select high frequency indictors now available for January 2022 exhibit renewed loss of momentum in January on account of Omicron spread. Electricity demand met has decelerated to a 2.1% m-o-m increase in January 2022 from 9.9% in December 2021. Vehicle registrations, E-way bills and toll collection volumes contracted m-o-m by 7.9%, 3.9% and 4.6%, respectively in January 2022. Overall, automobile sales, crude oil production, railway and air passenger traffic are yet below the 2019-20 levels. While the unemployment rate fell in January 2022 to 6.6% from 7.9% in December, it was mostly due to a marked sequential fall in Labour Force Participation Rate (LFPR) by 1-percentage point to 39.9%. Employment rate worsened in January 2022 to 37.2% and was the lowest since August 2021 and LFPR was the lowest in last seven months.
61. On inflation, the headline inflation is projected to ease to the vicinity of 5.0% mark in H1:2022-23 and then recede further to the target of 4.0% by Q3:2020-23. However, monsoon outturn and oil price dynamics will need to be closely watched. While for decision at hand, both the baseline and the risks are important, the incremental data since the December meeting affords some comfort as it suggests that the fears that price increases may get generalised are not materialising. At the item-level, while 80% of the items registered a sequential increase in October 2021, the number dropped to 73% in November and further to only 66% in the latest reading for the month of December, which is in line with the pre-pandemic average for the inflation targeting period. Similar trend of a lower diffusion is also seen in the case of WPI, with the index falling in December for the first time in 19-months.
62. Considering the above, I vote for keeping the policy rate unchanged and retaining the accommodative stance, while emphasising the need to maintain appropriate financial conditions with evolving situation. Statement by Dr. Michael Debabrata Patra
63. The global outlook is sombre. Consumption spending is dented by the Omicron-driven wave of the pandemic. Labour and production disruptions continue. Consensus forecasts suggest that a global deceleration has commenced in the first quarter of 2022. Multilateral institutions project global growth losing up to 2 percentage points of speed during 2022 and 2023. In other words, a prolonged slowdown looms and there are risks that it could tip over into a recession.
64. Inflation may take longer to slow – perhaps the greater part of 2022 – but slow it will. Already there are indications that supply chain pressures are peaking and getting set to ease. In corroboration, the UNCTAD nowcasts merchandise trade volume to have picked up pace in the last quarter of 2021 from the quarter before. This cannot happen without port decongestion and supply chain pressures easing.
65. In my view, the pandemic inflation surge is not being driven by excess demand but by supply constraints. It is turning out to be harder to bring supply capacities on stream than for demand to restart, partly due to the fact that supply capacities are in the wrong places. For instance, the pandemic caused a shift in consumer spending away from services and towards goods. The result is supply bottlenecks in goods producing sectors and spare capacities in services. Consequently, inflation is driven ever higher even though economic activity is yet to fully recover to its potential.
66. Monetary policy is an instrument of stabilisation. Its role is to align demand with supply, not the other way round. When inflation is driven by demand, monetary policy can stabilise inflation and growth. Monetary policy cannot play its stabilization role when inflation is the result of supply constraints. So central banks have a choice: either accept higher inflation for some time or be prepared to be accountable for destroying demand.
67. The reality, however, is that in terms of the policy responses, the biggest economies in the world are pulling in opposite directions. Monetary policy authorities in several parts of the world look at inflation in the rear-view mirror in which objects can look bigger than they are and they prepare to normalise and tighten. If they looked forward, they would sight a falling trajectory of inflation. Other countries have to brace up for shock waves from spillovers. Geo-political tensions and climate transition challenges complicate the outlook. Overall, I regard monetary policy chasing inflation instead of anticipating it as the main factor weighing down on global growth prospects.
68. The Indian economy is encountering headwinds as well as cross currents. First the headwinds: (1) even though we allow ourselves cautious optimism about the recent decline in infections, it is important to keep in mind that India has the second highest caseload of Covid-19 in the world and it is important to be cognisant of the scarring; (2) a mutation of Omicron - Ba2 - is showing up around the world and spreading fast - India has already reported cases of this sub-variant; and (3) more than a billion vaccinations have been achieved but only 56 per cent of the total population is fully vaccinated; the next billion will be back breaking.
69. Turning to cross currents, mobility of people has exhibited a sequential moderation in January, but movement of goods remains robust as evident in freight volumes, toll collections and GST revenues. Aggregate demand conditions are facing similar conflicted pulls. Power and fuel consumption is rising, but there is a broad- based decline in vehicle registrations, primarily due to shortage of semiconductors amidst global supply chain disruptions. Consumer confidence has improved, sales of fast moving consumer goods has been inching up and in the top 7 cities, housing sales jumped in 2021. On the hand, labour participation is falling. All in all, very divergent pulls.
70. There are several positives too which have withstood the pandemic’s waves. First, India’s merchandise exports are on course to reach an ambitious target for 2021-22. Second, services exports are also doing well. These developments should work towards keeping the current account deficit within sustainable limits. Third, foreign direct investment into India has held up well, moderating slightly from last year’s level. Fourth, India’s total external debt is more than covered by the stock of international reserves. In fact, India’s international assets cover three-fourth of all international liabilities. Thus, the external sector, which will bear the brunt of shocks from abroad, remains robust and resilient enough to withstand the tidal waves of global spillovers. Fifth, the agriculture outlook is bright, with both foodgrains and horticulture heading towards new records.
71. The projections indicate that headline CPI inflation (year-on-year) may test the upper tolerance band in January 2022. There will be public consternation on February 14 when the CPI for January will be released, but what may escape public notice is that this will essentially be because of an unfavourable base effect which may camouflage a welcome decline in the momentum of key food prices that has set in since October 2021. There has also been some let-up in input cost pressures.
72. To sum up, economic activity in India appears to have resiliently withstood the third wave, but messages from incoming high frequency indicators are mixed. It is prudent to assume that the recovery may have lost some momentum during Q4: 2021-22 and Q1: 2022-23. Inflation appears to be approaching an inflection point after which it is projected on a downward path through all of 2022-23. Accordingly, I vote for maintaining the policy rate and the accommodative stance of policy unchanged. Statement by Shri Shaktikanta Das
73. This MPC meeting takes place in the backdrop of global headwinds turning more adverse. Perceptible slowdown in growth together with elevated inflation in several countries characterise the global economy at present. The trajectories of growth and inflation, however, continue to diverge between countries. This has impelled some central banks to embark on aggressive policy tightening to quell inflation risks, while a few others, mostly emerging market economies (EMEs), continue to maintain accommodative policies. The adverse spillovers from such divergent policy responses could materialise quickly on the global and domestic outlook. Policy making is getting increasingly complex in this environment.
74. In the domestic front, rapid spread of the Omicron variant in conjunction with the fading of festive and pent-up demand has tempered economic activity in the near- term as reflected in several high-frequency indicators. Going forward, the current wave is showing signs of waning and with the return of normalcy, the pace of economic activity is likely to be bolstered by buoyant Rabi prospects, robust export demand, accommodative monetary and liquidity conditions, improving credit offtake, and the continued push in capital expenditure and infrastructure in the Union Budget 2022-23. On the downside, slowing global growth could impact exports while demand for contact intensive services would remain contingent on the trajectory of COVID-19 infections. High commodity prices and supply side shortages could weigh on corporate profitability amid weak pricing power and unfavourable base effects during 2022-23. The global financial market volatility associated with monetary policy normalisation process in the advanced economies could further complicate the situation.
75. As regards inflation, there has been considerable improvement in the outlook for food prices since the last bi-monthly review. Vegetable prices, after the spike of October-November, have seen significant seasonal correction which is likely to continue on fresh winter crop arrivals. In addition, the December CPI print saw price corrections in edible oils and pulses coming from the supply side interventions by the Government. The record Rabi acreage, propelled by a significantly higher acreage of oilseeds and pulses, along with prospects of higher yields for wheat, augur well for a bumper harvest of key food items. Further, considering the advance estimates of a robust kharif harvest, and on the assumption of a normal monsoon, there is room for considerable optimism on the food inflation trajectory over the next financial year.
76. The renewed surge in international crude oil prices, however, requires close monitoring. We need to remain watchful of the risks to domestic inflation arising from rise in international commodity prices due to exogenous factors including geo-political developments. While core inflation remains elevated, demand-pull pressures are still muted, given the slack in the economy. On balance, inflation is likely to peak in Q4: 2021-22 and thereafter soften to around 5.0 per cent in H1:2022-23 and further closer to the target in H2:2022-23 with an average inflation rate of 4.5 per cent for the entire financial year.
77. Amidst growing divergence in policy responses on the global front, our monetary policy should remain attuned to the evolving domestic inflation and growth dynamics. Despite recovery in 2021-22, real GDP is only marginally higher than the pre-pandemic level with private consumption still trailing its 2019-20 level. Inflation pressures in India continue to emanate largely from supply side factors, and the recent print also reflects adverse base effects. The expected moderation in inflation trajectory over the next financial year provides room for monetary policy to remain accommodative. At the same time, economic recovery from the pandemic remains incomplete and uneven and continued support from various policies remains crucial for a sustained recovery.
78. In this period of prolonged uncertainty, it would be wise to remain agile and respond in a gradual, calibrated and well telegraphed manner to the emerging challenges. Taking into consideration the outlook for inflation and growth, in particular the comfort provided by the improving inflation outlook, the uncertainties related to Omicron and global spillovers, I vote for status quo in the repo rate. I also vote to continue with our forward guidance of accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. (Yogesh Dayal) Press Release: 2021-2022/1763 Chief General Manager
6. Since the MPC’s meeting in February 2022, the global economic and financial environment has worsened with the escalation of geopolitical conflict and accompanying sanctions. Commodity prices have shot up substantially across the board amidst heightened volatility, with adverse fallouts on net commodity importers. Financial markets have exhibited increased volatility. Crude oil prices jumped to 14- year high in early March; despite some correction, they remain volatile at elevated levels. Supply chain pressures, which were set to ease, are rising again. The broad- based jump in global commodity prices has exacerbated inflationary pressures across advanced economies (AEs) and emerging market economies (EMEs) alike causing a sharp revision in their inflation projections. The global composite purchasing managers’ index (PMI) eased to 52.7 in March from 53.5 in February with output growth slowing in both manufacturing and services sectors. World merchandise trade momentum has weakened.
7. Several central banks, especially systemic ones, continue to be on the path of normalisation and tightening of monetary policy stances. Resultantly, sovereign bond yields in major AEs have been hardening. Bullion prices had buoyed to near 2020 highs on safe haven flows, with some recent correction as bond yields rose. Global equity markets fell, although more recently they have recovered some ground. In recent weeks, strong capital outflows from the EMEs have moderated thus curbing the downward pressures on their currencies, even as the US dollar has strengthened. Overall, the global economy faces major headwinds from several fronts, including continuing uncertainty about the pandemic’s trajectory. Domestic Economy
8. The second advance estimates (SAE) for 2021-22 released by the National Statistical Office (NSO) on February 28, 2022 placed India’s real gross domestic product (GDP) growth at 8.9 per cent, 1.8 per cent above the pre-pandemic (2019- 20) level. On the supply side, real gross value added (GVA) rose by 8.3 per cent in 2021-22, with its major components, including services, exceeding pre-pandemic levels. GDP growth in Q3:2021-22 decelerated to 5.4 per cent.
9. In Q4:2021-22, available high frequency indicators exhibit signs of recovery with the fast ebbing of the third wave but the picture is mixed. Urban demand reflected in domestic air traffic rebounded in March and the pace of contraction in passenger vehicle sales moderated in February. On the other hand, rural demand mirrored in two-wheeler and tractor sales contracted in February. Import of capital goods increased robustly in February, although domestic production continued to contract. Merchandise exports remained buoyant and clocked double-digit growth for the thirteenth successive month in March 2022 and reached US$ 417.8 billion in 2021-22 surpassing the target of US$ 400 billion. All categories of imports, however, have risen even faster, leading to merchandise trade deficit at a record annual level of US $ 192 billion in 2021-22 or 6.1 per cent of GDP.
10. On the supply side, foodgrains production touched a new record in 2021-22, with both kharif and rabi output crossing the final estimates for 2020-21 as well as the targets set for 2021-22. The manufacturing PMI remained in expansion zone in March, although it moderated somewhat to 54.0 from 54.9 in February. Services sector indicators – railway freight; e-way bills; GST collections; toll collections; fuel consumption; and electricity demand – were in expansion in February-March. The services PMI continued in expansion mode, inching up to 53.6 in March from 51.8 in the preceding month.
11. Headline CPI inflation edged up to 6.0 per cent in January 2022 and 6.1 per cent in February, breaching the upper tolerance threshold. Pick-up in food inflation contributed the most in headline inflation, with inflation of cereals, vegetables, spices and protein-based food items like eggs, meat and fish being the key drivers. Fuel inflation moderated on continuing deflation in electricity and steady LPG prices. Core inflation, i.e., CPI inflation excluding food and fuel remained elevated, though there was some moderation from 6.0 per cent in January to 5.8 per cent in February primarily due to the easing of inflation in transport and communication; pan, tobacco and intoxicants; recreation and amusement; and health.
12. Overall system liquidity remained in large surplus, with average daily absorption (through both the fixed and variable rate reverse repos) under the LAF at ₹7.5 lakh crore in March, marginally lower than ₹7.8 lakh crore in January-February 2022. Reserve money (adjusted for the first-round impact of the change in the cash reserve ratio) expanded by 10.9 per cent (y-o-y) on April 1, 2022. Money supply (M3) and bank credit by commercial banks rose (y-o-y) by 8.7 per cent and 9.6 per cent, respectively, as on March 25, 2022. India’s foreign exchange reserves increased by US$ 30.3 billion to US$ 607.3 billion in 2021-22. Outlook
13. Looking ahead, the inflation trajectory will depend critically upon the evolving geopolitical situation and its impact on global commodity prices and logistics. On food prices, domestic prices of cereals have registered increases in sympathy with international prices, though record foodgrains production and buffer stock levels should prevent a major flare up in domestic prices. Elevated global price pressures in key food items such as edible oils, and in animal and poultry feed due to global supply shortages impart high uncertainty to the food price outlook, warranting continuous monitoring.
14. In this scenario, pro-active supply management is critical to contain inflation. International crude oil prices remain volatile and elevated, with considerable uncertainties surrounding global supplies. With the broad-based surge in prices of key industrial inputs and global supply chain disruptions, input cost push pressures appear likely to persist for longer than expected earlier. Their pass-through to retail prices, though limited till now given the continuing slack in the economy, needs to be monitored carefully. Manufacturing sector firms polled in the Reserve Bank’s industrial outlook survey expect higher input and output price pressures going forward. Taking into account these factors and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 100 per barrel, inflation is now projected at 5.7 per cent in 2022-23, with Q1 at 6.3 per cent; Q2 at 5.8 per cent; Q3 at 5.4 per cent; and Q4 at 5.1 per cent (Chart 1).
15. Going forward, good prospects of rabi output augur well for rural demand. With the ebbing of the third wave and expanding vaccination coverage, the pick-up in contact-intensive services and urban demand is expected to be sustained. The government’s thrust on capital expenditure coupled with initiatives such as the production linked incentive (PLI) scheme should bolster private investment activity, amidst improving capacity utilisation, deleveraged corporate balance sheets, higher offtake of bank credit and congenial financial conditions. At the same time, the escalation of the geopolitical situation and the accompanying surge in international crude oil and other commodity prices, tightening of global financial conditions, persistence of supply-side disruptions and significantly weaker external demand pose downside risks to the outlook. The future course of the pandemic and the uncertainties about the pace of monetary policy normalisation in major advanced economies also weigh on the outlook. Taking all these factors into consideration, the real GDP growth for 2022-23 is now projected at 7.2 per cent, with Q1 at 16.2 per cent; Q2 at 6.2 per cent; Q3 at 4.1 per cent; and Q4 at 4.0 per cent, with risks broadly balanced (Chart 2).
16. The MPC is of the view that since the February meeting, the ratcheting up of geopolitical tensions, generalised hardening of global commodity prices, the likelihood of prolonged supply chain disruptions, dislocations in trade and capital flows, divergent monetary policy responses and volatility in global financial markets are imparting sizeable upside risks to the inflation trajectory and downside risks to domestic growth.
17. Given the evolving risks and uncertainties, the MPC has decided to keep the policy repo rate unchanged at 4 per cent. The MPC also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
18. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate at 4.0 per cent.
19. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Mridul K. Saggar, Dr. Michael Debabrata Patra and Shri Shaktikanta Das unanimously voted to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
20. The minutes of the MPC’s meeting will be published on April 22, 2022.
21. The next meeting of the MPC is scheduled during June 6-8, 2022. Voting on the Resolution to keep the policy repo rate unchanged at 4.0 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Mridul K. Saggar Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
22. At the beginning of February 2022, a number of indicators reflected an environment of sustained overall growth for the economy. The economic impact of the rise in Omicron variant of the coronavirus appeared limited. However, there were also concerns relating to the global economic outlook with the rise in Covid cases, supply chain disruptions and rising inflation pressures. For India, with a strong growth in agricultural output in FY 2021-22, going forward, adequate policy support for investment and consumer spending was expected to strengthen the growth momentum. The scenario, however, has been reshaped by the Russia-Ukraine war, the economic fallout of which has affected the overall global growth and price conditions sharply.
23. The prolonged duration and scale of destruction in the conflict and the wide ranging economic sanctions by the Western countries on Russia that followed the beginning of the conflict have had global implications. The supply chain disruptions aggravated an already stressed global supply system on account of the Covid pandemic and led prices of a number of commodities in the international markets to rise sharply and turn volatile. Energy prices and prices of some of the food commodities in particular have increased sharply compared to February. Crude oil prices rose by about 30 per cent in the international markets in February-March 2022. Prices of edible oils and wheat also increased sharply during the period.
24. Even before the Russia-Ukraine war, the monetary policy response to the rising inflationary pressures in the advanced countries had begun with the increase in policy rates and measures to tighten the easy liquidity conditions created to manage the adverse impact of the Covid pandemic. The monetary policy tightening in the advanced countries is expected to continue in order to bring down the inflation rates, but it would also have a significant impact on trade and investment flows for the developing world.
25. Given the three successive large negative shocks to growth and employment during the Covid pandemic conditions, the MPC has chosen to maintain conditions favourable to revival of growth on a sustained basis while maintaining inflation rate within the tolerance limits of the target. The sustained recovery seen in the growth conditions in Q3:2021-22 was nevertheless incomplete. On the positive side, there were indications of moderating pattern of inflation rate in 2022-23 on the basis of the ongoing recovery, assumption of a normal monsoon and moderation on international commodity price pressures. The sharp changes in the broader global economic environment that have now unfolded require a reconsideration of the economic outlook and the policy responses.
26. As the shocks to the price conditions are essentially on the supply side, emanating from external sector, unless the potential of the reviving domestic demand conditions to sustain higher prices is reduced, inflation pressures would rise further. While finding alternative international supply sources for imports and markets for exports is necessary, domestic inflationary pressures will not be relieved effectively unless the external supply constraints in the form of restrictions on movement of goods and finances are removed. Global coordination in easing these constraints would have major benefits in minimising the adverse effects of supply disruptions. Limiting the spill over from the rising energy and food prices in the international markets to the domestic markets would also reduce pressures on the external and fiscal imbalances.
27. The Second Advance Estimates of GDP released by the National Statistics Organisation at the end of February 2022 reflect the substantial gap in output growth needed to restore the high growth momentum after the setbacks in the last two years. While the YOY basis real GDP growth of 8.9 per cent in FY 2022 represents a rebound from its contraction by 6.6 per cent in FY 2021, the incomplete nature of the growth recovery is reflected in the growth rates of its components, especially when compared to the pre-pandemic scenario. In comparison to FY 2020, real GDP increased marginally by 1.8 per cent, the private final consumption expenditure increased by 1.2 per cent, gross fixed capital formation by 2.6 per cent. Exports and imports increased by 9.9 and 11.9 per cent in FY 2022 over FY 2020. In terms of value added, the divergence in performance is reflected in the growth rates of 0.4 per cent in the case of Services and 9.8 per cent in manufacturing. Real GDP in Q3:FY 2022 increased by 5.4 per cent over the same period in the previous year.
28. The available data on a wide range of indicators of output and demand conditions for January and February point to an on-going recovery. Year on year growth in GST collection has maintained its strong growth and Non-food Bank Credit has maintained its higher pace of YOY growth since December 2021. Exports for the year have exceeded the record target for $400 billion set by the government. RBI’s survey of Order Books, Inventories and Capacity utilisation in companies conducted in January-March 2022, reveals increase in capacity utilisation rate in the manufacturing sector in Q3:2021-22, moving closer to its long-term average. PMI for manufacturing in March 2022 shows a drop by 0.9 point from February, while PMI for services increased by 1.8 points, both remaining in expansion zone. RBI’s enterprise surveys [Industry Outlook (IOS) and Services and Infrastructure Outlook (SIOS)] conducted during January-March 2022 indicate that the firms are less optimistic about overall business conditions. This may reflect the conditions relating to the abating impact of the Omicron variant on the positive and the apprehensions about the fallout of the Russia-Ukraine war on the negative side of the business environment. The consumption expenditure indicators show a mixed picture. RBI’s Consumer Confidence Survey conducted in the early part of March 2022 indicates that as compared to the findings of the same survey in January 2022, a significantly larger proportion of respondents report higher spending than a year back but this increase is mostly driven by ‘essential spending’. The proportion of respondents reporting reduction in ‘non-essential spending’ has, however, declined. The IIP for consumer durables and non-durables in January 2022 is below the level seen in 2019-20 in the same period.
29. What has changed clearly for the consumers and producers in March 2022 is the price rise for fuels and some food items in what appears to be a first round impact with the full pass through of the rise in the international prices yet to be complete. The input cost pressures are reported in the RBI’s enterprise surveys, particularly in the services and infrastructure.
30. The uncertainty on the evolution of both growth and inflation in next 3-4 quarters has increased considerably. The prolonged war and its fall out may have accentuated the adverse impact of monetary policy tightening that has begun in several countries, especially on the growth front. The Covid related growth disruptions in China also have adverse impact on global demand.
31. The upturn of CPI inflation rate in February 2022 at 6.1 per cent is the second successive monthly reading at or above 6 per cent. Among the major sub-categories of the headline inflation, ‘fuel & light’ and ‘miscellaneous’ registered rates of increase above 6 per cent in both these months, with the fuel & light at 9.0 per cent and Miscellaneous at 6.5 per cent, YOY average for January-February 2022. Although ‘Food & beverages category’ registered an increase of 5.8 per cent, Oils & Fats registered an increase of 17.6 per cent and within Miscellaneous, CPI inflation for Household Goods & Services, Health, Transport & Communications, Recreation & Amusement sub-categories exceeded 6 per cent for the two-month period. The global supply chain disruptions since late-February as a result of Russia-Ukraine war and their impact on energy and food commodity prices on domestic prices have now added to more generalised cost push pressures.
32. Consequent to the above changes in growth and inflation scenarios, the projected GDP and CPI inflation rates for FY 2023 are as follows: GDP growth rates (YOY%) - Q1: 16.2, Q2: 6.2, Q3: 4.1 and Q4: 4.0 with the financial year projection at 7.2 per cent. CPI inflation rates (YOY%): Q1: 6.3, Q2: 5.8, Q3: 5.4 and Q4: 5.1 with the financial year average of 5.7 per cent. The revised projections reflect the impact of both supply disruptions and moderating demand conditions leading to lower GDP growth and higher inflation rate. RBI’s Survey of Professional Forecasters (SPF) carried out during March 2022 provide a median GDP growth forecast of 7.5 per cent and inflation forecast of 5.5 per cent for FY 2023. The SPF assessment has also shown downward revision in GDP growth and upward revision in inflation forecasts for FY 2023.
33. The present situation reflects improving conditions with respect to managing the Covid threat, with the scaled-up vaccinations and an understanding of measures to control any further outbreak of infections. However, improved demand conditions in the face of fresh global supply constraints may lead to increased inflation affecting the growth recovery itself. Response to the evolving price conditions and broad- based policy measures to effectively bring down inflationary pressures without disrupting the favourable environment for sustaining growth are now needed.
34. Accordingly, I vote to keep the policy repo rate at 4.0 per cent.
35. I also vote to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
36. The Ukraine war has lasted more than a month, uncertainties continue, oil prices are volatile, supply disruptions will raise inflation but also reduce demand; the continued high impact of Covid-19 in major countries will have similar effects.
37. The typical household response to inflationary supply shocks is to decrease consumption. Moreover, falling wage share will also decrease their demand.
38. Although household inflation expectations remain high, they have risen only marginally in the last two months, despite the rise in international oil prices—this points to the salience of domestic oil prices, of government action that affects these prices and of RBI guidance for households. Expectations fell when the government cut fuel excise in November 2021. The absence of any rise in dispersion points to some anchoring. One-year-ahead business inflation expectations, however, recently crossed 6%.
39. Capacity utilisation, especially in some sectors and for large firms has reached pre-Covid-19 levels; unemployment shows signs of falling. The non-oil non-gold current account is also in deficit, although the rising share of financial savings should reduce the need for foreign savings. Credit growth is higher and the PMI continues to be in the expansionary zone. But Q3 shows some softening—the recovery is still not strong. Firms facing low demand have limited their pass through yet profit margins have remained largely constant due to falling wage share and interest costs—firms still have scope to absorb rise in costs. Second round effects have yet to set in. Cost- push is still coming from primary but multiple supply shocks.
40. Covid-19 is waning in India. Current trends suggest there is more physical as well as economic immunity. Signals are mixed, yet clearly crisis level of stimulus is no longer required.
41. As pressures on oil prices persist, pump prices began rising steeply in end March. RBI consumer headline inflation estimate for the year is raised to 5.7 per cent, which implies the real rate has fallen further and is now too negative.
42. With some recovery and high commodity prices it will not be necessary to cut repo rates further. Future policy will either pause or raise rates. Rebalancing of liquidity started in 2021, and has now reached a level, with new facilities to absorb liquidity, that is compatible with raising policy rates. Short rates are set to rise to make the repo rate the operational policy rate again.
43. Research as well as Indian experience in the 2000s shows an early and gradual rise works better. Rebalancing of liquidity began early. It is time now to withdraw crisis time accommodation in terms of moving towards the equilibrium or neutral real rates consistent with non-inflationary growth. As long as rates remain below this, it is still not a tightening regime. When rates are below neutral because of excess crisis related accommodation, the initial rise only takes them towards neutral.
44. Exit should be balanced avoiding the over-stimulus after the global financial crisis and the consequent over-tightening in the 2010s. A rate rise that responds to excess demand, as well as to persistent inflation, so that the real rate adjusts smoothly and does not deviate too far from equilibrium will best be able to anchor inflation expectations yet sustain the growth recovery while minimising market volatility and output sacrifice.
45. Supply-side action has a major role in anchoring inflation expectations in order to sustain consumer confidence and the recovery. In April 2019 domestic petrol prices exceeded international prices by ₹40 per litre. The gap widened in the Covid- 19 years as international prices fell but domestic taxes were not reduced. These were an essential revenue-source then as other sources had collapsed with activity. In February 2022 the gap was back to ₹40 as international prices had risen. The difference now is that direct and indirect taxes are buoyant, 30 to 40% higher than their levels in 2019. There is room to cut fuel taxes to mitigate the pass through of international prices to consumers. Excise duty could go back to 2019 levels that were high enough to limit oil consumption, even as other efforts to substitute towards renewable sources continue.
46. The extent of nominal rate and borrowing cost rise required will depend on supply-side action. Even under rising rates, fiscal stress will reduce over time as long as real rates are kept smoothly below growth rates helping lower deficit and debt ratios over time. Outflows under US Fed tightening give more room for supporting government borrowing consistent with the required growth in reserve money. Such support is the most effective in moderating rise in long-term nominal rates in Indian conditions 1. There is room for spreads to fall since the historical spread between the repo and the 10-year G-sec was only 60 basis points.
47. Excess inflows are accumulated as reserves. Therefore, excess outflows or a temporary balance of payments deficit requires some of these reserves to be used to moderate excess rupee volatility. Limiting rupee depreciation will also reduce inflation and the oil bill. When inflation expectations are well-anchored terms of trade shocks can be looked through but it is better to avoid adding such shocks at a time of other multiple supply shocks. The real exchange rate is at competitive levels since exports are doing well. Moreover, Indian structural reform has reduced the cost of doing business and this time Indian inflation is less than international.
48. Both fiscal and monetary policy must use the space available to smooth international shocks, while taking unavoidable hits. In the last decade emerging markets as a group grew more slowly because such shocks had persistent effects. Costs of adjusting to the global financial crisis were passed on to them. Countries that have reformed suitably and built buffers may be able to protect themselves better this time.
49. In view of these considerations I vote to keep the repo rate unchanged and to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Exit of accommodation is proceeding but its pace awaits future developments. Statement by Prof. Jayanth R. Varma
50. The geopolitical situation has worsened considerably since the February meeting, and consequently inflation projections have risen sharply. However, I would like to point out that the hostilities in Europe have imparted an adverse shock not only to inflation, but also to growth. While the inflation shock is more clearly and immediately visible, the growth shock cannot be ignored. There is at least anecdotal evidence that businesses are becoming reluctant to pass on input cost increases to the customers because of concerns about demand compression.
51. I refrain from discussing whether, on balance, the changed situation warrants immediate action on the policy rate for the simple reason that the forward guidance given in the last meeting effectively precludes such action. It is important to maintain See Goyal, A. 2019. ‘Government Securities Market: Price Discovery, Monetary Management and Government Borrowing’, Economic and Political Weekly, 54(13): 44-58. 30 March. Available at https://www.epw.in/journal/2019/13/money-banking-and- finance/government-securities-market. html the credibility of monetary policy communications, and deviation from prior forward guidance should be made only under truly exceptional circumstances. In this backdrop, maintaining the policy rate at the current level is the only sensible choice, and I therefore vote to keep the policy repo rate at 4.0 per cent.
52. I have been arguing for the normalization of the policy corridor for several months now, and I welcome this action which forms part of the MPC statement.
53. Coming to the “stance”, I think it is wholly appropriate that this word has been dropped from the resolution. In the extremely uncertain situation that prevails today, it is very important for the MPC not to issue any forward guidance that would tie its hands. It is necessary to communicate clearly that in future meetings, the MPC would consider itself completely free to take any action on the policy rates that may be warranted by the data that becomes available in the coming weeks. With inflation projected to breach the upper tolerance limit for several months, it is imperative for the MPC to communicate its resolve to ensure that inflation remains within the target going forward. It is also necessary to prepare the markets for the withdrawal of the post pandemic monetary accommodation. I therefore vote to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Mridul K. Saggar
54. The world is changing in many important ways. The anticipated global and domestic macroeconomic trajectories that were shaping will get reset in slope and intercept. In my statement in February, I had stated that “the current geopolitical stress in Europe is a significant risk and if it translates into oil and gas prices spiking, we will need to adjust macro-economic policies suitably”. The contingent risk has materialised calling for policy shifts. We are witnessing an entrenched conflict. While it remains unclear how long it may last, it looks that even on its de-escalation, the supply chain disruption and elevated prices of energy, agro-products and minerals and metals may last for at least a year. With some ratchet, it will leave permanent effects on price levels, making it necessary for the monetary policy to deal with its second-round effects so that inflation is not elevated as a multi-year phenomenon. The War will also have significant detrimental effects on growth. In my statement in December last, I had cautioned on the building global stagflationary impulses. The Ukraine shock will further slow the global recovery, risks of a global recession are still small and predicated on war spreading over to the rest of the continent or beyond, thus remaining a tail risk event.
55. To add to the shock, the Fed kept tryst with the lift off in mid-March and indicated a quantitative tightening (balance sheet reduction) starting May. The baseline looks like the Fed will consciously entail a significant growth sacrifice and go ahead with aggressive rate hikes in the rest of the year in a bid to tame high inflation. However, global inflation is here to stay for the rest of the year at least. Against their 2% inflation targets, CPI inflation in the U.S., euro area and UK inflation are set to cross 8% in near term, which is four times their targets. Notwithstanding the difficulties in measuring potential output amid extreme shocks, wide array of measures suggests that the output gaps in the U.S. and the U.K. economies have not just closed but turned positive, though due to shallow cyclical recovery and the war retrenchment the same cannot be said of the euro area. So, the advanced economies face a big inflation gap and a closed output gap, thus justifying aggressive tightening based on the central bank reaction functions. Even in many emerging markets, inflation is ruling at multi-year highs. In contrast, inflation in India is not yet in inertial motion. Nevertheless, considering that we face elevated inflation that is projected, on an average, to be 1.7 percentage point above target and a likely closed output gap in my assessment later this year, it is important to take measured policy actions.
56. Let me now cover the growth and inflation assessment and the trade offs involved. The level of GDP in 2021-22 crossed the pre-pandemic 2019-20 level not just in aggregate but in all components of aggregate demand. In terms of quarterly GDP, it has stayed above corresponding pre-pandemic quarter of 2019 since Q2 of 2021-22 and in Q3 it had exceeded pre-pandemic levels for all components. On the supply-side, the GVA data shows that in 2021-22 the output of all sectors, except the ‘trade, transport, communication and broadcasting services’ had surpassed the 2019- 20 level. In terms of quarterly data, output had exceeded pre-pandemic level in aggregate since Q2 of 2021-22 and in Q4 is likely to do so for all sectors, including ‘trade, transport, communication and broadcasting services’. High frequency indicators have shown distinct month-on-month improvements since December 2021. By February 2022, almost all indicators have moved above pre-pandemic levels, except a few, mainly automobile related, where activity has relapsed due to semi- conductor shortages. So, it is safe to assume that output has recovered now, though the improvements from hereon may remain moderate given the expected growth deceleration on account of war.
57. On inflation, it has breached the upper tolerance level and is expected to remain so in Q1 of 2022-23. There are upside risks that cannot be ignored. Global crude oil prices have been highly volatile of late and can move in either direction from here. The uncertainty on this account has large ramifications for projection of any macroeconomic variable. If the war ends and global recovery sustains, oil prices can move up again later this year once the effects of release of strategic reserves wane in 6 months. Gas prices can rise further if Russia cuts supplies to Europe or Europe implements plans to reduce dependence on Russian gas. However, energy prices can fall from here if war ends soon and no sanctions are levied by EU in this sector. The current upsurge in energy prices is masking the potential impact of the likes of EV hummers that portend a trend shift downwards in oil prices over the medium- term. Also, if oil prices persist at current high levels, it can trigger ramping up of tight oil. The expected easing of food prices even if monsoon is normal, runs the risk from elevated input costs, especially of fertilisers and diesel that can result in jacking up of floor that is set by minimum support prices (MSPs). Global food prices have already gone up substantially and supply shortages may persist for more than a year as sowing in war torn Ukraine will be impacted. More importantly, in my assessment, core inflation is expected to stay above 6% through 2022-23 as the price shock from the war in Ukraine will be transmitted through mineral and metals as soaring coal prices and Palladium group and other metal shortages seep through to retail levels. They will also bring down growth and the resultant demand destruction may put some lid on surging commodity prices.
58. The global shock can have large spillovers to India through multiple channels. First, accentuated supply chain disruptions will result in longer episode of cost-push inflation. Second, this will erode purchasing power and slow down the economy. Third, the CAD will rise, especially if negative real rates persist and impact domestic savings. The median rate on fresh rupee term deposits has a negative carry of about 2% in real terms. Fourth, while fiscal policies have scope to limit the pass-through of imported inflation, it will need to be balanced off in a manner that twin deficits remain sustainable. Fifth, the interest rates and exchange rates can have profound effects on growth and inflation through contesting channels, in which the capital flow channel could be the most important. Even as these risks amplify, India has strong buffers to withstand these shocks. There aren’t too many fissures and once markets quickly price the shifts, the dynamics could turn favourable again.
59. So, what are the policy options in this backdrop? As the slowdown and inflationary impulses have hit us with monetary policy already being very accommodative, there is not enough room to pump prime growth. If output levels fall again, the negative output gap may help soften high inflation as the pass-through to retail levels may remain contained. However, lack of contestability and collusive behaviours have been seen in the past and the price rises can follow to protect margins. It is important to keep a sense of scarring and fall in potential output as large scarring will also mean an early closing of output gap causing inflationary pressures to accentuate. Recovering to pre-pandemic trend should not guide monetary policy at this stage and policy should focus on non-inflationary sustainable growth in the economy. A close watch on inflation expectations is necessary. If expectations are rising, especially if they turn unhinged and start rising faster than even actual inflation, monetary policy would have to reign in expectations to prevent a self-sustained inflationary spiral. Headline inflation has stayed elevated for long and has tested our tolerance. Even though the current high inflation is not primarily a monetary phenomenon it is critical to ensure that economic agents place the use of flexibility in the context of extra-ordinary circumstances that were prevailing and do not perceive an implicit upward drift in inflation target. Such a slip can affect inflation expectations. The best way to support growth on a durable basis is to have a strong commitment to low and stable inflation. I wish to sign off with this note.
60. Considering the emergence of a different growth-inflation trade-off, it is best to start withdrawing monetary accommodation through liquidity and rate actions that can begin with raising the floor and normalising the corridor. The policy will still stay accommodative as rates, even after lifting nominal rates, will stay below real neutral rate for foreseeable future. Monetary policy is not a rocket science, but the timing of the launch of the rocket is nevertheless important as monetary policy transmits to its final goals with long and variable lags. With a flatter Phillips curve, tackling inflation becomes that much harder as it may call for larger output sacrifice. So, a deft policy- mix is needed. We have varied tools and with right cross fertilisation of these tools it should be possible to bring back inflation closer to the target later without much growth sacrifice and without a very high terminal rate. It is important to note that the labour markets in India are yet to heat up and this is reflected in muted wage and house price pressures, below trend labour force participation rate and flattish unemployment levels.
61. Considering the above, I vote for leaving policy rate unchanged and for staying accommodative, while focusing on withdrawal of accommodation as indicated in the resolution. Statement by Dr. Michael Debabrata Patra
62. In a world in which deglobalisation seems imminent, one thing has become globalised and that is the alarm about inflation. With 60 per cent of developed countries facing inflation above 5 per cent – unheard of since the 1980s – and more than half of developing countries experiencing inflation above 7 per cent, the climb in prices is testing societal tolerance levels.
63. The view that increasingly occupies centre-stage is that irrespective of whether supply bottlenecks are the driver or pent-up demand, it will become more difficult to tame inflation the longer the fight is delayed. To quote an influential view, it will make central banks unpopular, but they have been there before. The rationale underlying this point of view is that whether the jump in oil and other commodity prices will be short-lived or not is not known; but if these prices ignite and levitate the prices of other goods and services sympathetically, the fear will gain ground amongst the public that inflation is going to stay high for a while, and this can end up becoming a self-fulfilling prophecy. Hence financial markets race ahead of central banks in foretelling what they should do, by how much and by when.
64. Supply disruptions, soaring commodity prices and ensuing financial market turbulence no more tell about fears of the shape of future inflation – the worst fears are already materialising. Instead they darken the outlook for growth. Macroeconomic conditions are the toughest for developing countries, with acute shortages of even essentials showing up alongside spiralling prices. On the one hand, the cost of foreign currency debt for EMEs is rising and on the other, they are forced to drain currency reserves in order to shore up exchange rates. Higher commodity prices could also complicate the situation for governments that have been striving to mitigate the impact of the pandemic by offering food and energy subsidies to households.
65. The key question is: will it be a goldilocks moment? Will central banks deliver the perfect disinflation, the so-called soft landing? Or will they overshoot the runway and precipitate an unwanted recession on a world weary with pandemic woes, war and worn and torn supply chains? In fact, the view gaining ground is that inflation is at heights that have shattered glass ceilings and the only way to excoriate it is to force a recession - the so called hard landing. The dilemma is even sharper for central banks with dual mandates – will their remits allow them to kill the economy for price stability?
66. Geopolitical risks appear overwhelming at this juncture and over the foreseeable near-term. The RBI has been preparing for tail risks in either direction. First, out of the pandemic-related liquidity overhang, an amount of ₹2.94 lakh crore has been withdrawn from the system with the lapse of measures/repayments on due dates. Second, open market sales and forex operations during the year have withdrawn liquidity of the order of ₹2.3 lakh crore. Third, market-based auctions with a menu of maturities have been conducted with a view to get market participants attuned to the alignment of money market rates with normal liquidity management procedures.
67. The RBI is in the process of completing the migration to a fully fledged liquidity management framework that is perfectly symmetrical – standing facilities at the upper and lower bounds with the policy rate at the centre; access on all days of the week, throughout the year; and restoration of the corridor to its pre-pandemic width and operation. During the course of 2022-23 and up to April 2023, all pandemic-related extraordinary measures will cease.
68. These actions empower the RBI at a moment of reckoning. If, as the projections show, inflation persists in high reaches, the drainage of liquidity already achieved and planned for the year ahead will reduce risks of excess liquidity fanning inflationary pressures and posing threats to financial stability. It will also facilitate the transmission of policy impulses across market segments and the interest rate structure. If, on the other hand, risk sentiment improves globally and India receives large volumes of capital flows, the standing deposit facility expands the capability of the RBI to undertake full and seamless sterilisation without running out of instruments. This will help to keep monetary expansion consistent with the outlook on inflation and growth.
69. Accordingly, I vote for status quo on the policy rate. I also vote for the stance as formulated in the MPC’s resolution. Statement by Shri Shaktikanta Das
70. The Monetary Policy Committee (MPC) meets at a time when tectonic shifts in geopolitical environment are materially affecting the global and domestic outlook on both inflation and growth. Just as the global economy seemed to be on the cusp of returning to normalcy from the pandemic, the war in Europe and subsequent sanctions have further clouded the outlook. The war-induced price spikes in food, oil, gas, fertiliser and several key industrial inputs, together with continued supply chain bottlenecks, are posing major upside risks to inflation which has already scaled multi- decadal highs in several countries. At the same time, the war poses major downside risks to global growth in the wake of trade restrictions, sanctions, elevated uncertainties and the flare up in the prices of food and energy. Global financial markets are on tenterhooks reacting to the toxic mix of supply and demand shocks and the varying pace of monetary policy normalisation in advanced countries. Most emerging market economies are caught in the vortex of risk-off sentiments marked by capital outflows and rising bond yields. To say that the world is going through extremely volatile times would be an understatement.
71. These developments are likely to have significant long-term implications for the global economy caused by supply chain reconfigurations, trade and technology fragmentation, and defence and energy security considerations. Emerging market economies find themselves in a much more difficult situation as their economic recovery from the pandemic remains incomplete even as inflation continues its ascent. Central banks in these economies face the difficult trade-off between containing inflation and nurturing growth. The situation is particularly challenging for net oil importing countries like India.
72. The domestic inflation outlook presented in the February 2022 MPC meeting has undergone a significant upward shift since the start of the war on February 24, 2022, with the escalation of conflict and subsequent turmoil in global commodity markets. The increase in crude oil price and its direct and indirect effects on CPI contributed to around 60 per cent of the upward revision in projections with the other major contributor being the spillovers coming from the global food price shocks on wheat, edible oil and feed cost pressures impacting on poultry, milk and dairy product prices. In the current scenario, continuation and further deepening of supply side measures would alleviate food price pressures and also mitigate cost-push pressures across manufacturing and services.
73. Emerging from the Omicron wave, India’s economic recovery remains on track, although there are weak spots – private consumption and investment are still subdued and contact-based services, although catching up, are yet to recover fully. There is also a risk that the ongoing recovery, which is already strained by the current crisis, may get undermined if there is rapid tightening of financial conditions. In these circumstances, policy making has to be nuanced and nimble.
74. Consistent with the strategy of focusing on withdrawal of accommodation, the Reserve Bank intends to gradually withdraw surplus liquidity over a multi-year period, keeping in mind the evolving macroeconomic and financial developments and the stance of monetary policy, while maintaining adequate liquidity to meet the productive requirements of the economy. Signalling this intent, the Liquidity Adjustment Facility (LAF) corridor is being normalised to a width of 50 bps that was prevailing before the pandemic. The liquidity rebalancing operations of the RBI have prepared the market for this normalisation of the LAF corridor.
75. The current geopolitical situation has led to an upward revision of our inflation projections for 2022-23. The estimates now point to inflation remaining above the upper tolerance band in the near-term even as growth projections have undergone downward revisions. These are indicative of the sheer magnitude of the adverse exogenous supply and price shocks. While the risks to domestic growth call for continued accommodative monetary policy, inflationary pressures necessitate monetary policy action. The circumstances warrant prioritising inflation and anchoring of inflation expectations in the sequence of objectives to safeguard macroeconomic and financial stability, while being mindful of the ongoing growth recovery. There is also a need to avoid undue disruptions in the financial markets. Given this delicate balance between inflation and growth, I vote for retaining the repo rate at 4.0 per cent and maintaining the accommodative stance while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. The situation is dynamic and fast changing, and we should constantly re-assess the situation and tailor our actions accordingly. (Yogesh Dayal) Press Release: 2022-2023/103 Chief General Manager
6. Since the MPC’s meeting in April 2022, disruptions, shortages and escalating prices induced by the geopolitical tensions and sanctions have persisted and downside risks have increased. The International Monetary Fund (IMF) has revised down its forecast of global output growth for 2022 by 0.8 percentage point to 3.6 per cent, in a span of less than three months. The World Trade Organization has scaled down projection of world trade growth for 2022 by 1.7 percentage points to 3.0 per cent. Domestic Economy
7. Domestic economic activity stabilised in March-April with the ebbing of the third wave of COVID-19 and the easing of restrictions. Urban demand appears to have maintained expansion but some weakness persists in rural demand. Investment activity seems to be gaining traction. Merchandise exports recorded double digit expansion for the fourteenth consecutive month in April. Non-oil non-gold imports also grew robustly on the back of improving domestic demand.
8. Overall system liquidity remained in large surplus. Bank credit rose (y-o-y) by 11.1 per cent as on April 22, 2022. India’s foreign exchange reserves declined by US$ 6.9 billion in 2022-23 (up to April 22) to US$ 600.4 billion.
9. In March 2022, headline CPI inflation surged to 7.0 per cent from 6.1 per cent in February, largely reflecting the impact of geopolitical spillovers. Food inflation increased by 154 basis points to 7.5 per cent and core inflation rose by 54 bps to 6.4 per cent. The rapid rise in inflation is occurring in an environment in which inflationary pressures are broadening across the world. The IMF projects inflation to increase by 2.6 percentage points to 5.7 per cent in advanced economies in 2022 and by 2.8 percentage points to 8.7 per cent in emerging market and developing economies. Outlook
10. Heightened uncertainty surrounds the inflation trajectory, which is heavily contingent upon the evolving geopolitical situation. Global commodity price dynamics are driving the path of food inflation in India, including prices of inflation sensitive items that are impacted by global shortages due to output losses and export restrictions by key producing countries. International crude oil prices remain high but volatile, posing considerable upside risks to the inflation trajectory through both direct and indirect effects. Core inflation is likely to remain elevated in the coming months, reflecting high domestic pump prices and pressures from prices of essential medicines. Renewed lockdowns and supply chain disruptions due to resurgence of COVID-19 infections in major economies could sustain higher logistics costs for longer. All these factors impart significant upside risks to the inflation trajectory set out in the April statement of the MPC.
11. As regard the outlook for domestic economic activity, the forecast of a normal southwest monsoon brightens the prospects for kharif production. The recovery in contact-intensive services is expected to be sustained, with the ebbing of the third wave and the growing vaccination coverage. Investment activity should get an uplift from robust government capex, improving capacity utilisation, stronger corporate balance sheets and congenial financial conditions. On the other hand, the worsening external environment, elevated commodity prices and persistent supply bottlenecks pose formidable headwinds, along with volatility spillovers from monetary policy normalisation in advanced economies. On balance, the Indian economy appears capable of weathering the deterioration in geopolitical conditions but it is prudent to continuously monitor the balance of risks.
12. Against this background, the MPC is of the view that while economic activity is navigating the vortex of forces confronting the world with resilience on the strength of underlying fundamentals and buffers, the risks to the near-term inflation outlook are rapidly materialising, as reflected in the inflation print for March and the developments thereafter. In this milieu, the MPC expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects. Accordingly, the MPC decided to increase the policy repo rate by 40 basis points to 4.40 per cent. The MPC also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
13. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to increase the policy repo rate by 40 basis points to 4.4 per cent.
14. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das unanimously voted to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
15. The minutes of the MPC’s meeting will be published on May 18, 2022.
16. The next meeting of the MPC is scheduled during June 6-8, 2022. Voting on the Resolution to increase the policy repo rate to 4.4 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
17. In its meeting of April 6-8, the MPC had noted the building up of the inflationary pressures, not anticipated in February. As a result, the projected outlook for FY 2023 reflected an average inflation rate above the assessment provided in February. The year-on-year CPI inflation rate of 6.3 per cent was projected for Q1FY2023 in the April meeting, well above 4.9 per cent projected in the February meeting.
18. It was also seen that overall GDP growth recovery, while significant, was incomplete, especially in terms of consumption demand. The growth environment was also subject to significant uncertainty in the short-term, given the supply chain interruptions in the global markets. GDP growth rate for FY2023 was projected at 7.2 per cent in April, below the 7.8 per cent projected in February.
19. The emerging need for policy response in the context of inflationary pressures was clearly recognised. But the uncertainty of both growth and inflation trajectories as a consequence of global economic conditions was also a significant consideration.
20. The CPI inflation rate for March 2022 that became available a week after the April meeting, showed a sharp increase in the headline number and the price rise was widely spread across all the main consumption items. The headline inflation rate was above 6 per cent for the third successive month in 2022. The inflationary pressures, while substantially emanating from the external developments - Russia- Ukraine war and the sanctions from the Western countries leading to supply disruptions - there are additional concerns in the form of ban on palm oil exports by Indonesia and the restrictions on economic activities in China as a result of emergence of new Covid 19 cases.
21. These external price and supply shocks have led to inflationary pressures both directly at the retail level and also indirectly through cost pressures on domestic supplies. The energy and food price increases in the international markets have impacted domestic prices. The external market conditions also have implications for trade and current account deficits and in turn, prices. The accommodative monetary conditions now in place to support growth are also not moderating transmission of price rise impulses through the supply chain.
22. On the growth front, the improvements are reflected in the broader indicators such as bank credit and GST collections and specific indicators such as PMI for manufacturing and services for the month of April 2022. Exports have been a driver of aggregate demand through FY 2022. However, uncertainty over growth trajectory is also significant in the context of expectations of slower world GDP and trade growth in 2023.
23. Given the present assessment of the inflation and economic growth conditions, monetary policy measures to break the inflation dynamics have become necessary. While the impact of such monetary policy measures may affect growth momentum adversely in the short-term, the overall external conditions also require that domestic inflation pressures are contained quickly. With some optimism on the lifting of the shadow of Covid pandemic on the domestic supply chains, focus is now needed on achieving price stability, with the headline inflation rate moving close to the target of 4 per cent. Each step would have to be taken keeping in view the evolving conditions.
24. Accordingly, I vote to increase the policy repo rate by 40 basis points to 4.4 per cent.
25. I also vote to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
26. Indian growth remains quite robust despite a global slowdown especially since the threat of a possible 4th Covid-19 wave seems to be receding. Contact industries are also seeing a revival due to pent-up demand. As more and more countries seek to diversify their imports, MSMEs are benefitting from export orders.
27. Inflation is a concern, now. It has overshot official and private predictions in March as a result of unprecedented shocks. The prolonged Ukraine war is keeping international crude oil prices high. It is also aggravating food prices.
28. The history of past shocks in India shows food and oil price inflation together can give rise to second round effects. This is what happened in the 2010s. But so far pass through to wages is absent and consumer demand is soft. Higher agricultural productivity, food grain stocks, appropriate policy response, lower energy intensity and waning of war related price pressures may allow this time to be different.
29. Inflation is high due to multiple supply shocks following each other. Even so, in an inflation targeting regime it is necessary to respond to inflation persistently above tolerance bands in order to anchor expectations.
30. It is also necessary to respond in order to prevent large deviations in real rates, which cause risks of overheating or of a slowdown. Post GFC real interest rates were highly negative leading to overheating and in the 2010s they swung to large positive numbers (peaking at 4.85 per cent 1), aggravating the slowdown. Policy should aim for equilibrium real rates and avoid large swings in real rates.
31. In view of a reasonable recovery and the sharp rise in inflation, which will also raise inflation projections, frontloading of rate hikes is required to prevent the real rate becoming too negative. Among risks from negative real interest rates include households buying gold thus aggravating the current account deficit and hurting financial intermediation.
32. In my last minutes I had warned that the pace of exit depends on incoming data and repo hikes could follow the normalization of the LAF corridor. Markets were already over-reacting to global risk and to adjustment in liquidity that started last year and have priced in excessive rate hikes. Since consumer demand continues to be soft, and inflation is likely to reduce it further, such excessive rate hikes may not be necessary to impose the quantum of output sacrifice required to moderate inflation. A surprise in timing with an unannounced meeting at the start of the rate hike cycle maybe better to mitigate further over-reaction.
33. Therefore, I vote to raise the repo rate by 40bps while remaining accommodative yet focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
34. A credible demonstration of commitment to inflation targeting, that brings down inflation expectations to the tolerance band, together with OMOs, should reduce the excessive yield spread. Spreads widened when short rates were cut and should now narrow when they rise, flattening the yield curve. Relatively good growth, and domestic liquidity in surplus, will support the stock market despite withdrawal of excess accommodation. There is healthy diversification with domestic investors taking a contrary view to foreign investors.
35. Government supply-side action can also reduce future rate rises, output sacrifice and borrowing costs. Both central and state taxes are buoyant and likely to exceed any rise in subsidy costs because of the Ukraine crisis, giving them space to cut taxes on fuels. Countercyclical fuel taxes are necessary to prevent a ratchet 1 Goyal, A. 2022. 'Flexible Inflation Targeting: Concepts and application in India' IGIDR. Working paper no. WP- 2022-003, available at: http://www.igidr.ac.in/pdf/publication/WP-2022-003. pdf effect raising inflation, if fuel prices rise much more than they fall because taxes rise when crude oil prices fall but do not fall when prices rise. Such a ratchet occurred in the era of administered prices and is not compatible with inflation targeting. World crude oil prices were lower in early 2021 than they were in mid-2014. But Indian prices were higher. Fertilizer subsidy would also be reduced if energy price rise is contained. States that did not cut taxes in November last year should begin, that will trigger a second round of cuts. These have some of the highest fuel prices in the country, at a time when international crude oil prices are persisting at high levels and being passed through to consumers. Statement by Prof. Jayanth R. Varma
36. MPC meetings outside the annual calendar are at the sole discretion of the Governor based on his opinion that an additional meeting is required. Therefore, I confine my statement to the consideration of the action to be taken at this additional meeting.
37. In my statement in April, I stated that the principal reason for not taking immediate action on the policy rate at that time was that the forward guidance given in the February meeting effectively precluded such action. I also stated that the withdrawal of the forward guidance and the absence of any stance in April meant that in future meetings, the MPC would consider itself completely free to take any action on the policy rates that may be warranted. This meeting is taking place almost a month after the April meeting, and the MPC is now at liberty to consider the rate increase that it could have done in April itself in the absence of the February forward guidance.
38. Since April, inflation risks have become more pronounced both in terms of magnitude and in terms of persistence. On the other hand, the growth shock appears to be less severe than I feared initially, as most nowcast estimates suggest that the economy is coping reasonably well with the geopolitical tensions and the Chinese lockdown. In this context, the need for monetary tightening has become much more acute. Moreover, there is a lot of catching up to do because the MPC (a) rightly prioritized economic recovery at the height of the pandemic in 2020 and early 2021, and (b) delayed the normalization by continuing the forward guidance for far too long after the pandemic abated. This means that it is now imperative to front-load the rate action to the extent possible.
39. It appears to me that more than 100 basis points of rate increases needs to be carried out very soon. My preference therefore is for a 50 basis points increase in the repo rate in this meeting. The majority of the MPC is in favour of 40 basis points for reasons which are not very clear to me. Whatever symbolic or psychological benefit there may be from keeping the hike below 50 basis points is outweighed by the simplicity and clarity of moving in round multiples of 25 basis points. Also reducing the hike by 10 basis points now would require an extra 10 basis point hike at some point (and perhaps sooner rather than later). Nevertheless, I have thought it fit not to dissent on this issue as the optimal rate hike is not something that can be calculated with mathematical precision, and 40 basis points is not materially different from 50 basis points. I am thankful to the majority for not making my decision more difficult by choosing a 37.5 basis point hike (exactly mid-way between 25 and 50). In view of all this, I vote in favour of increasing the policy repo rate to 4.40 per cent.
40. The second resolution is identical to that in April, and my arguments in favour of this decision at that time remain valid. Monetary policy remains extremely accommodative despite the 40 basis point hike in this meeting. In fact, if the real policy rate is measured by subtracting the latest inflation print from the nominal rate, then the real policy rate after this meeting is lower than it was after the April meeting because the published headline CPI inflation has risen by much more than 40 basis points between the two meetings. Of course, it is more reasonable to calculate the real policy rate by subtracting the forecast inflation rate 3-4 quarters ahead, but even if one does that, it is obvious that the real policy rate continues to be sharply negative, and therefore highly accommodative. The first part of the second resolution is therefore simply a statement of fact, and the operative portion of the resolution is the second part which talks about withdrawal of accommodation. I have already explained why an expeditious withdrawal of accommodation is warranted.
41. However, most of the analyst commentary on the April meeting seemed to interpret the phrase “remain accommodative” as a stance despite the conscious decision to drop the word “stance”. I hope that this time around, the MPC’s intent will be more clearly understood, but if that does not happen, the MPC must consider rephrasing this resolution. It would not be wise for the MPC to persist with language that is pedantically correct, but falls short in communicative efficacy. But such rephrasing is a matter for a future meeting, and this time around, I vote in favour of the decision to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Rajiv Ranjan
42. The global macroeconomic and financial environment has turned extremely adverse since February 2022 with the start of the war in Ukraine and is posing significant challenges to real-time macroeconomic assessment and management. Against this backdrop, it would be useful to briefly recap the fast-paced developments over the past 3-4 months. At the time of the monetary policy committee (MPC) meeting of February 10, 2022, before the outbreak of the war, inflation trajectory was projected to moderate significantly to the target of 4 per cent by Q3:2022-23, with an average inflation rate of 4.5 per cent for the financial year 2022-23, premised on stronger seasonal winter correction of vegetables prices, a likely bumper Rabi harvest and further normalization of supply chains in the backdrop of ebbing of COVID-19 infections. This provided room for monetary policy to remain accommodative, to prioritise growth and support the domestic recovery.
43. The situation, however, changed drastically since the start of the war in Europe on 24th February. Taking cognizance of the potential adverse global commodity price spillovers, the MPC resolution of April 8, 2022 raised the inflation projection for 2022-23 by 120 bps to 5.7 per cent. With the war posing sizeable upside risks to the inflation trajectory and downside risks to domestic growth, the MPC, on balance, continued with the accommodative stance, though price stability was prioritised over growth along with a focus on withdrawal of accommodation in a calibrated manner over a multi-year period. The liquidity adjustment facility (LAF) corridor was also normalised while introducing the standing deposit facility (SDF). The MPC highlighted five major risks in its April resolution to the baseline inflation and growth trajectory: (i) the ratcheting up of geopolitical tensions; (ii) generalised hardening of global commodity prices; (iii) the likelihood of prolonged supply chain disruptions; (iv) dislocations in trade and capital flows; and (v) divergent monetary policy responses and associated volatility. It was expected that these risks will play out over time, but recent developments suggest that the upside inflation risks have materialised earlier than anticipated as reflected in the March CPI print and projected higher April print, warranting an off-cycle meet of MPC.
44. The March 2022 CPI release pointed to a larger than anticipated, broad-based pass-through of global price shocks to the domestic economy. The hardening of food inflation, which in January was predominantly driven by cereals and vegetables, has since then spread to meat and fish, milk, edible oils, spices and prepared meals in addition to cereals and vegetables. Further intensification of core inflation pressures (CPI excluding food and fuel) to 6.4 per cent in March emanated from broad-based price pressures across sub-groups. Barring housing, pan-tobacco and intoxicants and education, inflation in all core sub-groups was above 6 per cent.
45. Let me give another perspective on the generalization of inflation in the latest print. Since the start of the COVID-19 pandemic, October 2020 registered the highest headline inflation reading at 7.6 per cent. In October 2020, the key drivers were vegetables, transportation, meat and fish, edible oils, personal care and pulses. These sub-groups (with a weight of around 28 per cent in the CPI basket) accounted for about 60 per cent of the inflation. In March 2022, the contribution of these items was only 41 per cent to the headline inflation of 7.0 per cent. This suggests a significant change in the drivers of inflation in the recent period.
46. The broadening of inflation pressures is also reflected in various CPI diffusion indices 2. There has been a sharp pick-up in these indices for price increases at or above a seasonally adjusted annualised rate (SAAR) of 6 per cent, especially in March, confirming that it is not just incidence of broadening of price increases in CPI but also that of price increases at a very high rate. This is true for headline as well as core categories. The trimmed mean measures of CPI inflation 3 suggest that their pace of increase accelerated in March.
47. All of these indicate that amidst geo-political turmoil and heightened uncertainty, the sharp escalation in cost-push pressures is translating into a generalised upsurge in inflation, which became evident after the March CPI print was released on April 12th. It may be recalled that the CPI print crossed the 6 per cent mark even earlier on two occasions in 2020 and 2021. In each of these episodes, the MPC rightly decided to look through them as transitory price shocks. Though the current price rise is also essentially supply-shock driven, it cannot be ignored given its broad-based nature, spillover effects and persistence, which has a risk of unhinging inflation expectations. Thus, at this stage of macroeconomic dynamics, it is necessary to reinstate the primacy of price stability and strengthen the credibility of monetary policy through demonstrable actions.
48. With economic recovery better entrenched than before, it is time to address the concerns on the inflation front, the dynamics of which has been fundamentally altered by the outbreak of the conflict in Europe. Though monetary policy may not have a direct influence on exogenous global commodity price shocks brought about by the war, it can play an important role in avoiding the generalisation of inflationary pressures. If monetary policy decides to see-through these shocks, and especially if they are not transitory, inflation expectations could become unanchored, leading to a persistent upward drift that may not revert to the pre-shock level even after the initial shock completely dissipates. Given the recent inflation dynamics, a repo rate hike of more than the conventional 25 basis points would be more effective in anchoring expectations. I, therefore, vote for an increase in the policy repo rate by 40 bps, which is appropriate at this juncture, being neither too small nor too excessive. It is expected that this pre-emptive action in an off-cycle meeting will have more pronounced effect. I also endorse the unchanged stance from the April policy which The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their prices (seasonally adjusted) have risen, remained stagnant or fallen over the previous month and aggregates them to show whether the month-on-month (m-o-m) overall increase has been expansionary or contractionary. The diffusion indices constructed are weighted averages. In trimmed mean measures, CPI items which are located in the tails of the inflation distribution for every month (indicating highly volatile inflation movements) are excluded. remains accommodative, consistent with our stance of maintaining adequate liquidity to sustain credit offtake and meet the productive requirements of the economy. In this regard, the increase in CRR by 50 bps is in consonance with our objective of withdrawing surplus liquidity gradually which would attenuate any unintended effects on the price front. Statement by Dr. Michael Debabrata Patra
49. Geopolitical spillovers have thrust upon us a surge in the momentum of inflation we can ill afford. As long as the geopolitical crisis and retaliatory actions persist, so will inflation. As long as inflation stays and broadens in its ambit, people will increasingly be convinced it is going out of reach and this could un-anchor their expectations about its future path. So monetary policy authorities are being forced to respond to an elevation in prices brought on by shortages and bottlenecks they can do nothing about since the problem confronting them is not overstimulated demand but insufficient supply. In the absence of supply augmenting measures and/or easing of supply bottlenecks, they will do what they can do – front-load their actions, compress demand and render the recovery stillborn. Globally, stagflation could be transitioning from a risk scenario to a baseline scenario. The stagflationary shock is global but everywhere it is being exacerbated by country-specific factors in a synchronised way. The still raw scars of the pandemic will become even more excruciating to bear and more lasting.
50. At the same time, financial markets are telling us that the configurations that exist today – hardening US yields; ever strengthening US dollar; equity sell-offs; emerging currency depreciations and capital outflows; rising debt distress – are reminiscent of 1993-1994 after which followed a cascade of emerging market crises. At least, all the symptoms of a generalised financial deleveraging are in place.
51. In this milieu, a measured approach and a cool head is warranted. Recent incoming data suggest that India’s macro-fundamentals, barring imported food and fuel inflation, are still intact and in sync with the recovery that has been tenaciously making its way through waves of the pandemic. Labour absorption in manufacturing and services is rising, capacity utilisation is improving and there are signs of new investment gradually coming in. Yet, the momentum of the recovery is still below full strength, warranting policy support. IPOs and the rotation of risk-on risk-off portfolio flows may give India a brief respite on a given day but on other days plunge our markets back into the turmoil that other EMEs are going through.
52. Against this turbulent backdrop and with headline inflation persisting above the upper tolerance band for the third month in a row with signs of second order effects, the approach of reversing the extraordinary accommodation – in terms of both the policy rate and liquidity - that was undertaken in response to the pandemic is, to my mind, the right approach. When it is done, we will have reached a stage of neutral accommodation – in contrast to extraordinary pandemic time accommodation – from where the next stage responses can be calibrated. Accordingly, I vote for an increase of 40 basis points in the policy rate – reversing the reduction in the policy rate effected on May 22, 2020 – and for the stance of remaining accommodative while focusing on withdrawal of accommodation, as articulated in the MPC’s resolution of May 4, 2022. Statement by Shri Shaktikanta Das
53. In my MPC statement of April 8, 2022, I had stated that the Reserve Bank will use all its policy levers to preserve macroeconomic and financial stability while enhancing the economy’s resilience. I had also emphasised that the situation is dynamic and fast changing and our actions will be tailored accordingly. Together with the measures announced that day, the idea behind these statements was to convey the readiness of the RBI to effectively deal with the surge in inflation due to the war in Europe. Events since then have led to a further deterioration in the geo-political situation even as domestic inflation became more broad-based warranting immediate remedial measures. The off-cycle meeting held on 2nd and 4th May 2022 may be seen in this background.
54. Developments after the April MPC have caused further concern. First, headline CPI inflation for March, released on 12th April 2022, increased beyond expectations to 7 per cent, as the impact of adverse global commodity price shocks was felt across the CPI basket. Second, global commodity and food prices as reflected in indices of the Food and Agricultural Organisation (FAO) and the World Bank have touched historical highs in March with implications for the domestic food price situation. These pressures are likely to persist. Third, almost all measures of core inflation have registered a sharp pick-up in March, well above 6 per cent. Fourth, the revision in administered electricity tariffs across many states and the increase in prices of essential medicines pose further risks to inflation over the short-term. Fifth, the war in Europe – with its attendant consequences for supply chains, shortages and prices – is now expected to last much longer than earlier anticipated. Under these circumstances, the inflation print for April – to be released on May 12th – is expected to be further elevated. Hence, it becomes necessary to act through an off- cycle policy meeting. Waiting for one month till the June MPC would mean losing that much time while war related inflationary pressures accentuated. Further, it may necessitate a much stronger action in the June MPC which is avoidable.
55. Meanwhile, the rebound in domestic economic activity is gradually getting generalised. Improving contact-intensive services amidst revival in urban demand is driving personal consumption. The outlook for agriculture remains positive in the wake of normal southwest monsoon forecast for 2022, which would support rural consumption. Investment activity is gaining momentum with higher capacity utilisation and capital goods production registering an uptick. Exports remain resilient while persisting high import growth is suggestive of a revival in domestic demand. Nevertheless, higher global commodity prices in the wake of a long drawn geopolitical conflict, protracted shortage of critical inputs and policy tightening by major central banks pose downside risks to domestic economic activity.
56. The worsening outlook of inflation warrants timely action to forestall second round effects which could lead to unanchoring of inflation expectations. Heightened uncertainty and volatile financial markets could also add to such unhinging of expectations. Accordingly, decisive and measured monetary policy response is necessary to avoid any unintended shocks to the economy.
57. Considering all these factors, it has now become necessary to increase the repo rate on top of the increase in liquidity absorption rate done in April, 2022 through the standing deposit facility (SDF). Accordingly, I vote for an increase in the policy repo rate by 40 bps which is a reversal of our May 22, 2020 measure. Going ahead, we should keep our focus on withdrawal of accommodation to ensure that inflation remains within the target, while supporting growth. I, therefore, vote for maintaining status quo on the stance as in April policy. Further, the Reserve Bank will continue with liquidity withdrawal in a phased manner over a multi-year period in sync with monetary policy and macroeconomic developments. Given the persistent liquidity overhang, a 50 bps increase in the cash reserve ratio (CRR) by the Reserve Bank signals our intent on withdrawing accommodation over a multi-year period.
58. As several storms hit together, our monetary policy response should be seen as an important step to steady the ship. The Indian as well as global evidence clearly shows that high inflation persistence hurts savings, investment, competitiveness and growth. It has also more pronounced adverse effects on the poorer segments of the population. Our monetary policy actions today aimed at lowering inflation and anchoring inflation expectations should thus help to strengthen the medium-term growth prospects of the economy and protect the purchasing power of the weaker sections of society. Given the highly uncertain situation, the incoming data and information would be constantly monitored to reassess the outlook and take necessary measures. Just as we had remained steadfastly vigilant and responded to fragilities in growth caused by the pandemic during the last two years, this time around also we will remain equally resolute and committed to bringing back inflation closer to the target through all possible instruments at our disposal. (Yogesh Dayal) Press Release: 2022-2023/230 Chief General Manager
6. Since the MPC’s meeting in May 2022, the global economy continues to grapple with multi-decadal high inflation and slowing growth, persisting geopolitical tensions and sanctions, elevated prices of crude oil and other commodities and lingering COVID-19 related supply chain bottlenecks. Global financial markets have been roiled by turbulence amidst growing stagflation concerns, leading to a tightening of global financial conditions and risks to the growth outlook and financial stability. Domestic Economy
7. According to the provisional estimates released by the National Statistical Office (NSO) on May 31, 2022, India’s real gross domestic product (GDP) growth in 2021-22 was 8.7 per cent. This works out to 1.5 per cent above the pre-pandemic level (2019-20). In Q4:2021-22, real GDP growth decelerated to 4.1 per cent from 5.4 per cent in Q3, dragged down mainly by weakness in private consumption on the back of the Omicron wave.
8. Available information for April-May 2022 indicates a broadening of the recovery in economic activity. Urban demand is recovering and rural demand is gradually improving. Merchandise exports posted robust double-digit growth for the fifteenth month in a row during May while non-oil non-gold imports continued to expand at a healthy pace, pointing to recovery of domestic demand.
9. Overall system liquidity remains in large surplus, with the average daily absorption under the LAF moderating to ₹5.5 lakh crore during May 4 - May 31 from ₹7.4 lakh crore during April 8 - May 3, 2022 in consonance with the policy of gradual withdrawal of accommodation. Money supply (M3) and bank credit from commercial banks rose (y-o-y) by 8.8 per cent and 12.1 per cent, respectively, as on May 20, 2022. India’s foreign exchange reserves were placed at US$ 601.4 billion as on May 27, 2022.
10. CPI headline inflation rose further from 7.0 per cent in March 2022 to 7.8 per cent in April 2022, reflecting broad-based increase in all its major constituents. Food inflation pressures accentuated, led by cereals, milk, fruits, vegetables, spices and prepared meals. Fuel inflation was driven up by a rise in LPG and kerosene prices. Core inflation (i.e., CPI excluding food and fuel) hardened across almost all components, dominated by the transport and communication sub-group. Outlook
11. The tense global geopolitical situation and the consequent elevated commodity prices impart considerable uncertainty to the domestic inflation outlook. The restrictions on wheat exports should improve the domestic supplies but the shortfall in the rabi production due to the heat wave could be an offsetting risk. The forecast of a normal south-west monsoon augurs well for the kharif agricultural production and the food price outlook. Edible oil prices remain under pressure on adverse global supply conditions, notwithstanding some recent correction due to the lifting of export ban by a major supplier. Consequent to the recent reduction in excise duties, domestic retail prices of petroleum products have moderated. International crude oil prices, however, remain elevated, with risks of further pass-through to domestic pump prices. There are also upside risks from revisions in the prices of electricity. Early results from manufacturing, services and infrastructure sector firms polled in the Reserve Bank’s surveys expect further input and output price pressures going forward. Taking into account these factors, and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, inflation is now projected at 6.7 per cent in 2022-23, with Q1 at 7.5 per cent; Q2 at 7.4 per cent; Q3 at 6.2 per cent; and Q4 at 5.8 per cent, with risks evenly balanced (Chart 1).
12. The recovery in domestic economic activity is gathering strength. Rural consumption should benefit from the likely normal south-west monsoon and the expected improvement in agricultural prospects. A rebound in contact-intensive services is likely to bolster urban consumption, going forward. Investment activity is expected to be supported by improving capacity utilisation, the government’s capex push, and strengthening bank credit. Growth of merchandise and services exports is set to sustain the recent buoyancy. Spillovers from prolonged geopolitical tensions, elevated commodity prices, continued supply bottlenecks and tightening global financial conditions nevertheless weigh on the outlook. Taking all these factors into consideration, the real GDP growth projection for 2022-23 is retained at 7.2 per cent, with Q1 at 16.2 per cent; Q2 at 6.2 per cent; Q3 at 4.1 per cent; and Q4 at 4.0 per cent, with risks broadly balanced (Chart 2).
13. Inflation risks flagged in the April and May resolutions of the MPC have materialised. The projections indicate that inflation is likely to remain above the upper tolerance level of 6 per cent through the first three quarters of 2022-23. Considerable uncertainty surrounds the inflation trajectory due to global growth risks and geopolitical tensions. The supply side measures taken by the government would help to alleviate some cost-push pressures. At the same time, however, the MPC notes that continuing shocks to food inflation could sustain pressures on headline inflation. Persisting inflationary pressures could set in motion second round effects on headline CPI. Hence, there is a need for calibrated monetary policy action to keep inflation expectations anchored and restrain the broadening of price pressures. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 4.90 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
14. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to increase the policy repo rate by 50 basis points to 4.90 per cent.
15. All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das unanimously voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
16. The minutes of the MPC’s meeting will be published on June 22, 2022.
17. The next meeting of the MPC is scheduled during August 2-4, 2022. Voting on the Resolution to increase the policy repo rate to 4.90 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
18. The inflationary pressures have increased significantly since the MPC meetings of April 2022 and May 2022. The headline CPI inflation rose to 7.0 per cent in March and 7.8 per cent in April, YOY basis. The inflation rate was also at or above the upper level of the tolerance band of inflation target in January and February. The CPI headline increased by 0.96% in March and 1.4% in April, MOM basis, reversing the moderate increase or declining pattern seen in the previous three months of December 2021- February 2022, reflecting the increased price pressures, particularly in March and April. The broadening of the inflationary pressure is also seen in the rising rates of the three major components of CPI- food, fuel and miscellaneous. In the case of food, the MOM increase in CPI in March and April were 1.3 and 1.4 per cent, respectively, reversing the declining pattern during December 2021- February 2022. The CPI-Fuel & Light group rose by 3.1 per cent in April (MOM), the highest pace since July 2011. While the inflation rate has been rising since October 2021, in the period since March 2022 its trajectory has been significantly steeper from the previous months.
19. As the supply side of the economy began to return to some normalcy after the successive waves of the COVID-19 Pandemic, the rising commodity prices in the international markets have remained a major cause of rising input costs in 2021. The sharp increase in the momentum of prices since March is mainly due to the global supply disruptions caused by the Russia-Ukraine war and its aftermath leading to spikes in international commodity prices. In the case of food inflation, the supply interruptions in the international markets on account of both production shortfalls and war induced supply restrictions of edible oils and wheat have exacerbated the emerging supply-demand imbalance. The impact on fertiliser and other input supplies add to the cost of supply across the agricultural sector. Energy prices in general have been affected by supply disruptions and continued demand.
20. While the domestic monetary and economic policies remained supportive of growth through the pandemic period, achieving sustained growth momentum has been a challenging goal both as a result of the repeated waves of the pandemic and its global impact. At the global level the uncertainty over the timing of the end of the pandemic continues as sudden increase in infections has been reported in a number of countries. The provisional estimates (PE) of estimates GDP released by the National Statistical Office place the GDP growth for 2021-22 at 8.7 per cent reflecting catch-up of private final consumption expenditure, gross fixed capital formation and overall GDP, all measured in constant prices, with the pre-pandemic year 2019-20. The YOY growth of GDP in Q4:FY2021-22 is 4.1 per cent, 6.7 per cent over the previous quarter. In terms of GVA, all the major segments of the economy, agriculture, industry, and services inclusive of construction in 2021-22 exceeded the 2019-20 levels. In the services sector, only segment that includes the contact intensive ‘trade, hotels and transport’ subsectors, the GVA is yet to reach the pre- pandemic level.
21. More recent data on the economy remains positive on the whole, with broad based indicators such as non-food bank credit, GST collections and toll collections showing significant growth YOY basis up to May 2022. In the case of petrol and diesel consumption, for which data are available up to April 2022, YOY growth rate is higher than in the previous month. PMI for manufacturing in May 2022 has remained marginally lower compared to April and in the case of services, PMI has improved in May. The RBI’s enterprise surveys reflect business expectations of higher output/ turnover over the quarters in FY2022-23 particularly in the second half of the year. Merchandise exports in US$ value for April and May 2022 more than doubled compared to the same period 2020-21 and also exceeded the values in the same period in 2019-20. Imports have also increased sharply reflecting growing domestic economic activity. However, there are clearly uncertainties regarding the growth prospects, particularly in view of the emerging adverse global demand conditions with the global output and trade volume growth now expected to be lower in 2022 than in 2021. Sharp tightening of monetary policy in several major advanced economies has also adverse implications for capital flows, financial markets and exchange rate for India. The RBI’s Consumer Confidence Survey conducted during May 2-May 11, 2022 in the major urban areas shows weaker optimism in the general economic conditions for one-year ahead, with overall household spending expected to increase due to higher ‘essential expenditure’, also for one-year ahead.
22. Taking into account the present trends and projections of major indicators, the real GDP growth YOY basis for FY2022-23 has been retained at 7.2 per cent as projected in April 2022 meeting. As noted above, there are clearly uncertainties, particularly relating to the global macroeconomic conditions. The RBI’s Survey of Professional Forecasters conducted during May 2022 has the median forecast of 7.2 per cent for real GDP growth in FY2022-23, YOY basis, declining from 7.5 per cent obtained in March 2022.
23. Continued growth momentum in Q4:FY2021-22, and the positive trends in the broader indicators of economic activities in the first one or two months of Q1:FY2022- 23 suggest that demand conditions are supportive of economic growth in the face of the cost push inflationary pressures that have developed.
24. The projected headline inflation rate for FY2022-23, YOY basis, has now been revised upwards to 6.7 per cent from 5.7 per cent projected in the April meeting. One of the factors that has led to the upward revision is the increase in average crude oil price for the year also affecting trade balance. The projected quarterly headline inflation rates in FY2022-23 are provided in the MPC resolution for June 2022. Besides the petroleum prices, headline inflation is also significantly affected by food inflation. For the major food commodities, a normal rainfall would moderate the prices, although the international supply conditions for food commodities would be a factor that would affect the course of food price inflation.
25. In sum, the inflationary pressures that have intensified since March 2022 are expected to remain a concern in FY2022-23 unless the international supply conditions improve quickly. Changing the course of inflation trajectory to reach targeted level is a priority at this stage for monetary policy although the growth momentum remains modest one. Monetary policy tightening has begun in a number of economies globally to rein in inflationary pressures. Fiscal measures to contain the impact of international price spikes to the domestic consumer and measures to improve supply expansion would moderate price pressures. The RBI moved to streamline the LAF corridor in April 2022, with SDF as the floor and restoring the width of the corridor at the pre-pandemic level. The MPC raised the policy Repo rate by 40 basis points in its meeting held in May and RBI also announced an increase in CRR by 50 basis points. In view of the elevated levels of inflation rates which may persist given the disruptions international supply chains are experiencing, there is a need to ensure that policy rates are consistent with the requirements of moderating inflation expectations and liquidity conditions are consistent with the requirements of economic growth in an environment less constrained by the COVID pandemic. While the impact of these measures is likely to have some adverse impact on aggregate demand in the short term, moderating inflation pressures now is crucial to ensure a stable macroeconomic environment.
26. Accordingly, I vote to increase the policy repo rate by 50 basis points to 4.90 per cent. I also vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
27. There is worry about US inflation generalizing to the rest of the world, but we must remember Indian inflation differs. We did have much higher inflation than the US but that was in the past. The danger is Indian inflation is more susceptible to crude oil and food inflation triggered by the Ukraine war. Inflation is becoming broad- based but that is because rising transport and communication costs affect almost every product. But cost pass through is one-time. True second round effects require wages to rise. And since in India the majority still lives in rural areas, rural wages must rise. In India’s high inflation episode over 2007-2011 real rural wage growth became sharply positive. A rise in raw material input prices raises food prices but input prices do not rise again because food prices have risen. But if a rise in rural wages raises food prices, the later raises wages further.
28. There are a number of links in the chain from wages to prices. Wages rise with expected inflation and the tightness of the labour market. In India they are especially sensitive to food inflation. But the continuation of the free food programme blunts the sensitivity of rural wages to food prices. Moreover, the rise in minimum support prices is moderate. Other special factors that were relevant in 2011 are not active now 1.
29. The second big difference today is that we are in an inflation targeting regime. To the extent price expectations are anchored they will not raise wages. In a country with volatile inflation and thin news sources a lot of attention is paid to central bank communication. The inflation target can get internalized faster. In every country household inflation expectations exceed actual inflation but the impact of hierarchy shows up in extreme sensitivity to government action. Both times petrol and diesel excise was cut there was a steep fall in household inflation expectations. Countercyclical taxes may not raise the fiscal deficit because of buoyancy of taxes under high nominal output growth.
30. Third, if the labour market is not tight there would not be much impact of wages on prices despite expected inflation. Rising employment does not put pressure on wages, if there are many willing to work without higher wages. We know unemployment is high in India, especially for youth. Many are looking to shift to more productive jobs. Wages are rising in sectors like information technology where there is a shortage of skills, but it is not yet a general phenomenon. Contrast this with the US where acute shortages are pushing up wages. During the pandemic many firms have economized on labour cost and the share of wages has gone down. Moreover, the aggregate supply curve is estimated to be flat so that prices do not rise much even if employment rises.
31. Fourth, firms set prices as a mark-up on wages and other costs. But if demand is slack, they tend to reduce mark-ups or make other adjustments rather than pass on rising input prices to consumers. Corporate surveys show that input price indices have risen more than output price indices and yet mark-ups have remained constant. It is wage share that has fallen. This is the classic low demand response. India did not have excess stimulus like in the US, and excess demand is not adding to inflation pressures here.
32. Fifth, credit growth is moderate and has just reached double digits. Excess durable liquidity cannot create inflation if broad money supply growth is low and asset prices are falling because of foreign outflows. A key figure to note is that broad money growth at 8.8% was much lower than nominal income growth. Financial conditions are not loose.
33. Finally, since inflation largely stayed within the target band in the Covid-19 period the real interest rate was around -2%, compared to -6% in the US. Deviation from equilibrium real rates and the persistent distortions they can create were not large.
34. Global growth is wavering with the continuing Ukraine war and problems in China. Inflation and widespread monetary tightening are further threats to it.
35. Indian growth, however, seems quite resilient to these shocks as yet. The digital boom and supply chain diversification led export demand may outlast softening of global growth. There is pent-up demand for services, despite Covid-19 resurfacing, but it may not sustain. Other consumption is still soft. Investment is yet to take off broadly. However, an important difference policy has to keep in mind is that today the country is coming out of a pandemic-induced slump. In 2011 it was coming out of a boom with clear signs of over-heating. So policy also has to pay attention to the recovery. 1 See Goyal, A. and A. K. Baikar, ‘Psychology or Cyclicality: Rural wage and inflation dynamics in India’, Economic and Political Weekly, pp. 116-125. Vol. L No. 23. June 6, 2015.
36. RBI inflation projection for CPI headline in 2022-23 is 6.7% (up from 5.7% in the April policy), but the Q4 figure is expected to soften to 5.8%. Firms’ price expectations from the IIM Ahmedabad survey also show some slight moderation with one year ahead expectations at less than 6%. RBI surveys show cost pressures are expected to ease in the second half of the year. There are some signs of softening in prices of global commodities apart from crude oil.
37. At the current stage of recovery, however, the one-year ahead real rate must not be more negative than -1%. A fifty or sixty basis point hike would achieve this, while looking through part of the spike in 2022 even as further supply-side movement and clarity on global developments are awaited. Such a real interest rate, while not dampening the recovery much, will prevent a possibly inflationary further rise in demand and unsustainable current account deficit. Markets benefit from recovery and so are better able to absorb rate hikes that are in step with the latter.
38. Given the above considerations I vote for a 50 bps rise in the repo rate. Further changes will depend on growth and inflation outcomes. Since future moves will either be a pause or a rise it is also useful to change the guidance to withdrawal of accommodation. I therefore vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. While the real repo rate is a useful guide to actions, and has theoretical clarity, it is difficult to estimate the neutral rate precisely. The stance therefore can be more clearly defined in terms of action on liquidity, which started in 2021.
39. Under the external benchmark system, as it works currently, banks may not need to raise deposit rates commensurately until excess liquidity is sufficiently absorbed so that they have to borrow at the repo. If excess liquidity persists, yet policy rates rise, the ECB multi-tier excess reserve system 2 is an option. Higher rates paid on a part of reserves held at the central bank could be conditional on banks passing on a share of this to depositors. Statement by Prof. Jayanth R. Varma
40. In my statement during the May meeting, I called for more than 100 basis points of rate increases to be carried out very soon. Taking into account the 40 basis points hike in May, my preference would have been for an increase of 60 basis points in this meeting. However, I have decided to go along with the majority view of 50 basis points for the same reason as in May: a difference of opinion of 10 basis points is not material enough to be elevated to a dissent. Hence, I vote in favour of raising the policy repo rate to 4.90%.
41. I stated in May that the MPC has a lot of catching up to do, and that remains true today. Between April and now, the MPC has raised the policy rate by 90 basis points, but during the same period the RBI’s projection of inflation for the year 2022- 23 has risen by 100 basis points from 5.7% to 6.7%. The real policy rate, therefore, remains more or less where it was in April. This reminds me of Lewis Carroll’s adage that we must run as fast as we can, just to stay in place, and to go anywhere we must run even faster. Clearly, more needs to be done in future meetings to bring the real policy rate to a modestly positive level consistent with the emerging inflation and growth dynamics. 2 See https://www.ecb.europa.eu/press/pr/date/2019/html/ecb.pr190912_2~a0b47cd62a.en.html
42. I am therefore happy that the second resolution is clearer than the May resolution that I had described then as pedantically correct but falling short in communicative efficacy. The resolution no longer talks about remaining accommodative, and confines itself to remaining focused on withdrawal of accommodation. I therefore vote in favour of this resolution.
43. It appears to me however that as the MPC navigates this process of withdrawal, there is merit in signalling the likely pace of this tightening in more quantitative terms. Many leading central banks currently provide forecasts of the future path of the policy rate several quarters ahead. The MPC has now accumulated several years of experience, and the RBI has evolved into a mature inflation targeting central bank. I believe that the time is therefore ripe for MPC members to start moving towards providing projections of the future path of the policy rate. This would help stabilize long term bond markets and also anchor inflation expectations. Statement by Dr. Rajiv Ranjan
44. The ongoing war in Europe and the consequent sanctions have taken a heavy toll on the global economy by aggravating supply chain disruptions and heightening uncertainty about the post-pandemic recovery. With inflation scaling multi-decadal peaks across several countries and remaining stubborn, risks of long-term inflation expectations getting unhinged have increased manifold leaving monetary authorities with little room to manoeuvre. Several Asian economies, who abstained from policy tightening last year despite mounting inflation pressures, have joined the bandwagon of their advanced economy counterparts in the battle against inflation. The pace and extent of tightening, however, are tailored to country-specific macroeconomic developments and requirements.
45. In the Indian context, domestic economic activity is progressing on the expected trajectory in 2022-23 so far as evident from the available high-frequency indicators (HFIs) during April-May 2022. Notably, 51 HFIs out of more than 70 that are monitored to track real economic activity (both from demand and supply side) have crossed their pre-pandemic (2019-20) levels. While 37 HFIs have exceeded their pre-pandemic levels by more than 10 per cent, 30 HFIs have surpassed it by over 20 per cent. Overall, growth drivers seem to be holding up despite higher inflation and tightening monetary conditions.
46. The surge in inflation by 84 basis points in April to 7.8 per cent was accompanied by broad-based momentum effects (month-on-month price increase) covering food, fuel and core categories. Six out of 12 food sub-groups and 8 out of 10 groups/sub-groups in core registered a pick-up in inflation. Overall, around 78 per cent of the CPI basket recorded a rise in inflation in April. CPI diffusion indices – for positive price increases and those for price increases at or above a seasonally adjusted annualised rate (SAAR) of 6 per cent – edged up sharply in April, indicating widening price pressures. Reflecting these, all core inflation measures – exclusion- based and trimmed mean measures – exceeded 6 per cent in April and were in the range of 6.4 per cent to 7.5 per cent. The weighted median (inflation relating to the 50th percentile by weight) also increased further by 40 bps to 6.5 per cent in April.
47. Given the severity and extent of generalisation of inflation as mentioned in the preceding paragraph, average CPI inflation during 2022-23 is now projected at 6.7 per cent, an increase of one percentage point (100 bps) from 5.7 per cent indicated in the April 2022 policy. About three-fourths of the revision in inflation projections is on account of food as adverse global price spillovers are expected to be more than transient. Even though aggregate demand conditions have remained subdued during the past few years, repeated supply shocks seem to be primarily leading to higher inflation gap persistence 3 causing inflation to remain at elevated levels above the target. Such large and persistent supply shocks have the potential to un-anchor inflation expectations.
48. With protracted geopolitical tensions and no early resolution of the conflict in sight, considerable uncertainty clouds the evolving inflation trajectory. While the supply side measures taken by the government would undeniably alleviate some cost-push pressures, it needs to be complemented by calibrated monetary policy actions to anchor inflation expectations and contain the broadening price pressures. Given inflation expectations in India are largely adaptive or backward looking, persistent supply disruptions and the resulting price pressures could get entrenched in higher inflation expectations. Since the short-term trade-off between inflation and output worsens under high inflation expectations (the upward shift of the Phillips curve), this would call for front-loaded policy action to rein in inflation expectations. It is worthwhile to note that central bank credibility plays an important role in minimising the sacrifice ratio – the loss of growth due to policy tightening. Thus, more than the direct impact, it is the second-round effects that central banks seek to address through the anchoring of long-run inflation expectations which, in turn, can deliver low and stable inflation over the medium-term.
49. In view of the above and given the MPC’s projection that inflation is likely to remain above the upper tolerance level of 6 per cent through the first three quarters of 2022-23 with persistent shocks to food inflation sustaining pressures on the headline, I vote for a 50 basis points increase in the policy repo rate. I also vote for withdrawal of accommodation to align inflation with the target going forward, while remaining growth supportive. On the MPC’s decision of rephrasing the stance by abjuring the words “to remain accommodative” and focusing on withdrawal of accommodation, it is consistent with the recent monetary policy actions to withdraw the extraordinary pandemic measures-infused liquidity. The measures taken so far have ensured that liquidity conditions evolve in alignment with the monetary policy stance and liquidity overhang does not pose additional risks to inflation.
50. While frontloading policy measures, one needs to be aware that the pace of policy transmission has quickened after the introduction of the external benchmark- based lending rates (EBLR) in October 2019. With more than 40 per cent of the total floating rate outstanding loans linked to external benchmarks, the degree of pass- through to actual lending rates has increased and this would strengthen monetary transmission in the current cycle. The inherent framework of the EBLR regime which enables quicker and larger transmission to lending rates coupled with banks’ propensity to pass-through policy rate changes to lending rates rather quickly, particularly during tightening cycles, may have to be factored to achieve the desired outcome during the current tightening phase. Of course, the trajectory of inflation going ahead will be an important determining factor.
51. More importantly, when the monetary-fiscal coordination is at its best, fighting inflation becomes a joint responsibility which is crucial for engineering a successful disinflation. In this context, with monetary policy prioritising price stability and fiscal policy emphasising on quality of expenditure through capex, the economy becomes the net beneficiary. Thus, it may be important for the government – both centre and states – to successfully complete their budgeted capex plans and work through their 3 Inflation gap persistence (Cogley et al., 2010) is measured by the time varying persistence in the deviation of inflation from its long-term trend. Recent estimates with Indian inflation data suggest that it increased from 0.10 to 0.30. Ref: Cogley, T., Primiceri, G. E., & Sargent, T. J. (2010). Inflation-gap persistence in the US. American Economic Journal: Macroeconomics, 2(1), 43-69. counter-cyclical policy levers to ensure a soft-landing for the economy amidst monetary tightening to rein in inflation. Statement by Dr. Michael Debabrata Patra
52. “Globalisation is finished” seems to be the theme of discussions in business and financial fora the world over. Geopolitics has become front and centre of all investment decisions. Near shoring, on shoring and reshoring echo through investor conferences, adding to the influential call for friend shoring or relocation of supply chains to friendly countries. The age of globalisation based on outsourcing is over. Decades of productivity gains from opening up are being reversed and this is showing up in inflation.
53. Terms that are being used to describe the global outlook are now being drawn from extreme weather conditions. Bond yields and consumer surveys are flashing red. Google searches for “recession” are soaring. In fact, the narrative is shifting from whether there will be a recession to what will be the shape of the recession as monetary policy goes on to the front foot.
54. With inflation at multi-decadal highs across advanced economies and emerging and developing economies, the inflation crisis is global. In response, the most widespread monetary policy tightening in decades is underway. It is the most coordinated tightening cycle in many years, and the actions are appearing synchronised because imported inflation pressures are being exacerbated by country-specific factors acting at the same time. Yet, for monetary policy, rather than materially compressing demand, managing expectations is the key.
55. The global inflation crisis is just the face of one of the most severe food and energy crises in recent history that now threatens the most vulnerable across the globe. Across the developing world, food shortages will likely last through this year and the early part of next year, exacerbating the pain of soaring food prices. Even in the world’s richest nations, higher food prices are causing food poverty for the first time in a generation.
56. At the receiving end are emerging market equities and bonds. In terms of widely used indices, emerging market bonds are suffering their worst losses in three decades, hit by rising global interest rates. Surges of volatility in the foreign exchange markets have become a function of supply chain pressures, soaring shipping costs and the position of the host country on the path of monetary policy normalisation.
57. India is being impacted by the global inflation crisis as recent outcomes have shown. Two thirds of the change in the CPI since the war is reflecting the materialising of geopolitical risk. Although the ongoing inflation surge is a supply phenomenon everywhere, mending supply always takes time. Admirable efforts have been made in this direction at the cost of strains on fiscal discipline, demonstrating that price stability is a shared responsibility – the government sets the inflation target and the central bank implements it.
58. To gain time for supply to respond, the blunt instrument of monetary policy has to be deployed – there is no other recourse at this juncture. What will monetary policy do? The fact that inflation remains elevated and is broadening indicates that there is some demand that is able to afford these high prices, perhaps due to revenge spending in a pandemic stressed response. In fact, core core inflation – the most sluggish part of the index – CPI excluding food, fuel, petrol, diesel, gold and silver (44 per cent versus 47 per cent of the CPI in the standard core) – and the weighted median are both showing generalisation and momentum. High frequency indicators for May point to expansion in demand. This warrants some monetary policy front load to modulate it so that even though it is not at full strength, it does not exceed the available supply. In the process, spending will slow down, so will demand and so will the economy. The objective should be to take the repo rate to a height that is at least above the four quarters ahead forecast of inflation, knowing that monetary policy works with lags. Concomitantly, it is important to condition public perceptions and expectations that growth will be closer to 6 per cent than to 7 per cent in 2023-24 as a result of monetary tightening.
59. If this inflation is allowed to go out of hand, it could (i) corrode the foundations of the recovery that is gradually gaining traction – empirical evidence shows that inflation above 6 per cent in India is unambiguously harmful for growth; (ii) deter investment decisions because businesses will worry about demand for their products getting postponed at these elevated levels of prices; (iii) cause depositors to worry about negative returns to their deposits and hence shift to time tested holders of value like gold which translates to capital flight in the case of India – the world’s second largest importer of the yellow metal produces only 1 per cent of consumption domestically; (v) cause exchange rate depreciation which will increase imported inflation, discourage capital inflows and trigger large capital outflows.
60. So, the die is cast. On one side are the nihilists – they lick their lips and obsess that the RBI, like a lamb to the slaughter, is about to fail in its monetary policy mandate. They fail to differentiate between a procedural issue and sensationalism.
61. The accountability mechanism enhances credibility in the monetary policy framework and that is of paramount importance. The wide public sensitivity to accountability works in the same direction as monetary policy in the pursuit of ensuring price stability. It shows that inflation expectations are anchored around the conviction that monetary policy will not tolerate persistent deviations from target because it is enjoined by legislation (not) to do so. On the other side are the facts, the immutables, which suggest that inflation may be peaking. In June, the excise duty cuts on petrol and diesel will have kicked in strongly and knocked off 20 bps from headline inflation. After that second order effects will take effect. Other measures will work like second order effects to soften core inflation at the margin. As monetary policy works through its lags, demand will inevitably get restrained and become compressed to the level of supply. Inflation will fall back to below 6 per cent by the fourth quarter of 2022-23. In 2023-24, it should moderate to 4 per cent. This is the most pragmatic result that can be hoped for under the prevailing extraordinary circumstances.
62. Headline inflation levels will remain high across the world for some time; hence, the thing to watch is the direction of inflation, not its level, which will remain elevated for some time in view of the overwhelming shocks. If headline inflation starts moving down in the second half of the year, the objective of taking the policy rate above the level of future inflation will be achieved sooner than later, providing space to pause and reconfigure.
63. If the early arrival of the monsoon and the removal of the ban on edible oil exports by Indonesia foretell of a more benign outlook on food prices than currently envisaged, India would have tamed the inflation crisis even earlier and decoupled from the rest of the world. Without a doubt, the impact of the war in the form of generalising price pressures will cause a very grudging decline in inflation and a possible breach of the accountability criteria. The battle would be lost but the war would have been won if India is able to bend down the future trajectory of inflation. This is attributable no less to the supply side measures undertaken by the Government; the tightening of the LAF corridor and introduction of the standing deposit facility in April 2022 as its floor at a rate 40 basis points higher than the fixed rate reverse repo; the 40 basis points raising of the policy rate in May along with the 50 basis points increase in the cash reserve ratio requirement; and the proposed increase in the policy repo rate in today’s meeting.
64. To reiterate, given the extraordinary circumstances driving up inflation the world over, our endeavour should be to bring down inflation into the tolerance band by the last quarter of 2022-23 or the first quarter of 2023-24 and progressively align it to the target during the course of 2023-24. This should minimise the loss of output. If real GDP growth averages between 6-7 percent of GDP in 2022-23 and 2023-24, the recovery that is increasingly solidifying gets a fair chance of reaching the sunlight.
65. If all that happens, the RBI will have fulfilled its mandate of prioritising price stability while being mindful of growth.
66. Accordingly, I vote to raise the policy repo rate by 50 basis points and to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Shri Shaktikanta Das
67. The war in Europe is lingering. The end of war and sanctions are nowhere in sight. The uncertainty continues. Global growth and trade are steadily decelerating, global commodity prices remain firm and financial markets worldwide are turning more volatile. Monetary policy normalisation has become the order of the day across most central banks. The war has globalised inflationary pressures across geographies, and there are increasing risks of long-term inflation expectations getting unanchored. While prices of a few commodities – such as metals and fertilisers – have seen some softening, most food and all energy prices remain elevated.
68. Against this background, the domestic CPI inflation for April 2022 surged to 7.8 per cent – the fourth consecutive month of inflation being above the upper tolerance level of 6.0 per cent. Adverse spillovers from high global commodity prices continue to impinge on domestic prices in April and thereafter. Domestic factors also played a role, with a strong heat wave and consequent loss of production resulting in significant pick-up in prices of several food items. According to our latest assessment, the average annual inflation in the current year (2022-23) is expected to be 6.7 per cent, with the first three quarters remaining above six per cent.
69. Growth impulses, on the other hand, are broadly evolving in line with expectations as borne out by the available high-frequency indicators during April-May 2022. The forecast of a normal southwest monsoon, the improvement in employment conditions as reflected in the rates of labour force participation (LFP) and employment, the early results from RBI surveys indicating steady rise in capacity utilisation and improving non-food credit growth augur well for the growth outlook. Together, these developments can be expected to support private consumption and investment. Net household financial savings (HFS) in 2021-22, although moderating from the preceding year, remained above pre-pandemic levels and along with healthy balance sheets of banks and corporates, can support private consumption and investment. Merchandise exports clocked double-digit growth for the fifteenth successive month in May 2022, despite heightened global uncertainty. In the wake of all these developments, the projection of growth for 2022-23 has been retained at 7.2 per cent, the same as in the April MPC resolution.
70. Thus, while high inflation continues to be the major concern, revival of economic activity remains steady and is gaining traction. The time is appropriate to go for a further increase in the policy rate to effectively deal with inflation and inflation expectations. Accordingly, I vote for a 50 bps increase in the repo rate which would be in line with the evolving inflation-growth dynamics and will help in mitigating the second round effects of adverse supply shocks. This action will reinforce our commitment to price stability – our primary mandate and a pre-requisite for sustainable growth over the medium term.
71. I also vote for a change in the stance to provide greater clarity on our policy intent by focussing wholly on withdrawal of accommodation. It is important in this context to note that the repo rate is still below the pre-pandemic level and the liquidity surplus is still higher than what it was prior to the pandemic. As our policy in recent months has been unambiguously focussed on withdrawal of accommodation, both in terms of liquidity and rates, the change in wording of stance should be seen as a continuation and fine-tuning of our recent approach. The withdrawal of accommodation, as I see it, would be non-disruptive to the process of recovery and would strengthen our ongoing efforts to combat inflation and anchor inflation expectations. (Yogesh Dayal) Press Release: 2022-2023/406 Chief General Manager
6. Since the MPC’s meeting in June 2022, the global economic and financial environment has deteriorated with the combined impact of monetary policy tightening across the world and the persisting war in Europe heightening risks of recession. Gripped by risk aversion, global financial markets have experienced surges of volatility and large sell-offs. The US dollar index soared to a two-decade high in July. Both advanced economies (AEs) and emerging market economies (EMEs) witnessed weakening of their currencies against the US dollar. EMEs are experiencing capital outflows and reserve losses which are exacerbating risks to their growth and financial stability. Domestic Economy
7. Domestic economic activity remains resilient. As on August 4, 2022, the south- west monsoon rainfall was 6 per cent above the long period average (LPA). Kharif sowing is picking up. High frequency indicators of activity in the industrial and services sectors are holding up. Urban demand is strengthening while rural demand is gradually catching up. Merchandise exports recorded a growth of 24.5 per cent during April-June 2022, with some moderation in July. Non-oil non-gold imports were robust, indicating strengthening domestic demand.
8. CPI inflation eased to 7.0 per cent (year-on-year, y-o-y) during May-June 2022 from 7.8 per cent in April, although it persists above the upper tolerance band. Food inflation has registered some moderation, especially with the softening of edible oil prices, and deepening deflation in pulses and eggs. Fuel inflation moved back to double digits in June primarily due to the rise in LPG and kerosene prices. While core inflation (i.e., CPI excluding food and fuel) moderated in May-June due to the full direct impact of the cut in excise duties on petrol and diesel pump prices, effected on May 22, 2022, it remains at elevated levels.
9. Overall system liquidity continues in surplus, with average daily absorption under the LAF at ₹3.8 lakh crore during June-July. Money supply (M3) and bank credit from commercial banks rose (y-o-y) by 7.9 per cent and 14.0 per cent, respectively, as on July 15, 2022. India’s foreign exchange reserves were placed at US$ 573.9 billion as on July 29, 2022. Outlook
10. Spillovers from geopolitical shocks are imparting considerable uncertainty to the inflation trajectory. More recently, food and metal prices have come off their peaks. International crude oil prices have eased in recent weeks but remain elevated and volatile on supply concerns even as the global demand outlook is weakening. The appreciation of the US dollar can feed into imported inflation pressures. Rising kharif sowing augurs well for the domestic food price outlook. The shortfall in paddy sowing, however, needs to be watched closely, although stocks of rice are well above the buffer norms. Firms polled in the Reserve Bank’s enterprise surveys expect input cost pressures to soften across sectors in H2. Cost pressures are, however, expected to get increasingly transmitted to output prices across manufacturing and services sectors. Taking into account these factors and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, the inflation projection is retained at 6.7 per cent in 2022-23, with Q2 at 7.1 per cent; Q3 at 6.4 per cent; and Q4 at 5.8 per cent, and risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 per cent (Chart 1).
11. On the outlook for growth, rural consumption is expected to benefit from the brightening agricultural prospects. The demand for contact-intensive services and the improvement in business and consumer sentiment should bolster discretionary spending and urban consumption. Investment activity is expected to get support from the government’s capex push, improving bank credit and rising capacity utilisation. Firms polled in the Reserve Bank’s industrial outlook survey expect sequential expansion in production volumes and new orders in Q2:2022-23, which is likely to sustain through Q4. On the other hand, elevated risks emanating from protracted geopolitical tensions, the upsurge in global financial market volatility and tightening global financial conditions continue to weigh heavily on the outlook. Taking all these factors into consideration, the real GDP growth projection for 2022-23 is retained at 7.2 per cent, with Q1 at 16.2 per cent; Q2 at 6.2 per cent; Q3 at 4.1 per cent; and Q4 at 4.0 per cent, and risks broadly balanced. Real GDP growth for Q1:2023-24 is projected at 6.7 per cent (Chart 2).
12. Headline inflation has recently flattened and the supply outlook is improving, helped by some easing of global supply constraints. The MPC, however, noted that inflation is projected to remain above the upper tolerance level of 6 per cent through the first three quarters of 2022-23, entailing the risk of destabilising inflation expectations and triggering second round effects. Given the elevated level of inflation and resilience in domestic economic activity, the MPC took the view that further calibrated monetary policy action is needed to contain inflationary pressures, pull back headline inflation within the tolerance band closer to the target, and keep inflation expectations anchored so as to ensure that growth is sustained. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.40 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
13. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to increase the policy repo rate by 50 basis points to 5.40 per cent.
14. All members - Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma - voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
15. The minutes of the MPC’s meeting will be published on August 19, 2022.
16. The next meeting of the MPC is scheduled during September 28-30, 2022. Voting on the Resolution to increase the policy repo rate to 5.40 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
17. The sharp increase in inflation rate in March 2022, following two successive months of CPI inflation rate of 6 per cent or above, changed the policy perspectives on inflation. The developments in March caused by the Russia-Ukraine war imparted much uncertainty to global supplies of fuel, food and trade in general. The rise in global energy prices had clear impact on the domestic prices. In May policy rate was increased by MPC, which was followed up in June. Although the risks of Covid 19 pandemic remained, there were signs of strengthening economic activities as both supply and demand conditions improved in many of the sectors. Bringing inflation rate closer to the target was important to sustain the economic growth momentum over the medium term.
18. The headline consumer inflation rate for Q1: FY 2022-23 is at 7.3 per cent, although lower than the level projected in the June MPC meeting. At 7.3 per cent, it is also higher than any of the previous four quarters of 2021-22. The moderation seen in the headline inflation rate in May and June, from 7.8 per cent in April to 7.0 per cent was mainly on account of the decline in food inflation and inflation in the category of items excluding food and fuel & light. But in each of the three major components of the headline, the year-on-year (YOY) inflation rate remained at or above 6 per cent in June, highlighting the continued broad-based inflationary pressures.
19. Reduction in the excise duty on petrol and diesel by the central government and some of state governments towards the end of May helped ease price pressures for the transport sector. Withdrawal of Indonesia’s ban on palm oil exports by the end of May 2022 helped ease price pressures on food inflation.
20. The commodity prices in the international markets, including metals and crude oil, softened from the highs that prevailed when the Russia-Ukraine war broke out. The softening of the international crude oil prices appears to be a consequence of expected slowing down of global growth as monetary policies across countries tightened to rein in inflationary pressures. Slowing down of Chinese economy has also been a factor in the emerging global weak demand conditions as Covid 19 continues to cast a shadow on economic activities there.
21. These have been the positive developments as far as inflation scenario is concerned. However, uncertainty on inflation pressures in the global environment remains significant. Prolonged Russia-Ukraine conflict and disruptions in supplies, especially for energy and food commodities are a major source of uncertainty for price trends. The direct impact of supply disruptions, even if targeted to some geographies, is quickly transmitted elsewhere to meet the overall demand supply imbalances. Weakening of many currencies against the US dollar also imparts inflationary pressures on the domestic economies of the other countries.
22. On the domestic front, inflationary pressures exerted by the rising input prices are continuing. The impact of recent changes to GST rates, somewhat uneven distribution of the southwest monsoon rainfall with deficiency in the eastern region of the country, could be source of upward pressure on prices. The Enterprise Surveys conducted by the RBI in May-June 2022 find that majority of the firms in all the major sectors of the economy, manufacturing, services and infrastructure, expect the cost pressures to continue through the current financial year. As a consequence, product prices are also expected to increase. The bimonthly survey of consumers conducted in the first fortnight of July also points to the widely shared perception of the prevailing high rate of inflation one-year ahead, although the percentage of respondents who expect the rate to decline has increased compared to the previous survey in May 2022. The RBI Survey of Inflation Expectations of Households also conducted in the first fortnight of July shows that the 3 months ahead and one year ahead median expected inflation rates have declined from the expectations held in May. However, by a qualitative measure, the percentage of respondents expecting a decline in inflation rate 3 months ahead or one year ahead is far below the percentages who expect the rate to increase or stay similar. These sample survey results show some signs of expectations of decline in future inflation rates but the optimism is guarded. The RBI Survey of Professional Forecasters conducted in the second fortnight of July 2022 projects a CPI inflation rate of 6 per cent or above in the remaining three quarters of FY 2022-23.
23. The present pattern of trends and assessments suggest a gradual decline in inflation rate during FY 2022-23 but still above the upper level of the tolerance band around the target of 4 per cent. Going forward, the food inflation scenario would be affected by the overall rainfall conditions in the remaining period of the present monsoon and the crop prospects, besides the global price conditions. The easing of global prices in the case of energy and other raw materials may soften the prices in the non-food sectors although there may still be pressures from the incomplete pass through of the higher input prices that prevailed. The upside risks to any declining inflation trajectory in the short term are significant. Taking into account these trends, for FY 2022-23, the headline CPI inflation rates have been projected at 7.1 per cent for Q2, 6.4 per cent for Q3 and 5.8 per cent in Q4. The projected inflation rate for FY 2022-23 is at 6.7 per cent, the same as in the June MPC meeting.
24. The global economic conditions have turned unfavourable for growth from the combined shocks of the breakout of the Russia-Ukraine war, continued shadow of Covid 19 across countries and the tightening of monetary policies to rein in inflation in many countries. The revised projections by the International Monetary Fund for 2022, released in July, place world GDP growth at 3.2 per cent, sharp drop from 4.4 per cent projected in January 2022 and 3.6 per cent in April 2022. The world trade volume of goods and services is now projected to grow by 4.1 per cent in 2022 over the previous year, a decline from 6 per cent projected in January and 5 per cent in April 2022. Deceleration in growth, particularly in the major economies of the world would have an adverse impact on their imports. The spill over effects on imports of other countries are also adverse. The monetary policy tightening in the advanced economies has also led to capital outflow from the emerging economies, including India. The elevated levels of crude oil prices and the rising prices of natural gas in the international markets has meant rising import costs raising trade deficit.
25. The worsening global economic conditions have come at a time for us when the domestic economy was beginning to sustain its growth momentum after regaining the output level in 2021-22 from the shocks of the Covid 19 pandemic. Performance of a number of sectors showed sustained growth in Q1: FY 2022-23, particularly in manufacturing. Although IIP for April-May 2022 was only 4.0 per cent above the same period in 2019, it was 12.9 per cent YOY basis. The PMI for manufacturing has remained in the expansion zone for April-June and rose further in July. In the case of services also, PMI rose from April to June but fell in July. Capacity utilisation in manufacturing rose above the long-term average in Q4: 2021-22 and the RBI Industrial Outlook Survey reflects expectations of steady improvement through Q4: 2022-23. Although there are concerns over demand conditions in the case of services and infrastructure sectors in H1, improvement in conditions is expected in H2: FY 2022-23.
26. On the demand side, the RBI Survey of Consumer Confidence conducted in the first fortnight of July reflects continued caution by the consumers on non-essential spending. One year ahead from now, only about 30 per cent of the respondents expect to increase non-essential spending. The import of capital goods during January-June 2022 in terms of value in US$ are above the 2019, although IIP for capital goods is still below 2019 level for the same period. Export performance in both goods and services in 2021-22 was well above the 2019 levels and in Q1: FY 2022-23, exports exceeded the value, YOY basis as well. However, going forward, export performance would be affected by the global demand conditions, with strengthening dollar providing some incentive to exporters despite the higher cost of imported inputs.
27. The recent data on indicators such as GST collections, E-way bills and non- food credit indicate sustained momentum of economic activities. Although demand conditions may be restrained, the growth momentum has been sustained. Based on the overall economic activity conditions, the YOY GDP growth rate of 7.2 per cent for FY 2022-23 projected in the June 2022 MPC meeting has been retained.
28. The CPI inflation rate is in excess of 6 per cent in Q4: FY 2021-22 and Q1: FY 2022-23 and projected to be well above the target of 4 per cent in Q1: FY 2023-24. Both the GDP growth rate and inflation rate for FY 2022-23 have been retained at the same levels as in the June MPC meeting. There are significant uncertainties to both growth and inflation rates emanating from external and domestic factors. Sustaining the growth momentum will also require reduction in inflation rate. The prevailing inflation pressures, therefore, remain a concern and continued monetary policy measures are needed to ensure that the inflation rate is aligned with the target rate.
29. Accordingly, I vote to increase the policy repo rate by 50 basis points to 5.4 per cent. I also vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
30. The last three months show Indian growth sustaining despite continuing global shocks and rate rises. Indeed, India has done better than expected and in comparison to many countries under the pandemic and Ukraine war shocks. Among reasons for this are growing economic diversity that helps to absorb shocks. Large domestic demand can moderate a global slowdown; if industry suffers from lockdown, agriculture does well. Services compensate for less contact-based delivery with digitization, distance work and exports. Even if global growth slows, diversification from China, India’s digital advantage and government efforts to promote exports would support Indian exports. A rise in the current very small Indian share in world exports remains feasible. Another example of the value of diverse participants comes from the financial markets. Household SIPs in stock markets have compensated for FPI outflow. Since the share of stocks in their financial assets is still low (4 per cent compared to 27 per cent for US households) there is room for this to rise further safely and give households higher returns in a better diversified portfolio. Other types of diversity in the financial sector are improving stability.
31. The repo rate rise, which is reversing the large pandemic-induced cut of 115 bps in a more calibrated fashion, has not as yet slowed the recovery. Real rates remain negative and there are lags in pass through. Even so, rising rates may have prevented over-heating. Coordinated fiscal and monetary policy action to reduce inflation while maintaining adequate demand has worked well.
32. Inflation has also moderated. FPI are returning because India has better prospects among emerging markets, and the crash in currency and stock markets that they were waiting for in order to re-enter is proving unlikely. Commodity inflation is finally softening, and is likely to continue with a global slowdown and supply-chain bottlenecks turning into gluts due to excess inventories with firms. In India there is some rise in industry wages, but corporate margins remain high. Large sales and softening of other input costs gives space to absorb moderate wage rise. Although the RBI enterprise survey shows corporates expect prices to rise, if demand falls it may moderate their ability to raise prices. Rural wage growth is flat at 4.8 per cent. Household inflation perceptions and expectations have fallen.
33. Inflation, however, is still above the tolerance band, and shows signs of being so for the first 3 quarters of 2022-23. This can be destabilizing for inflation expectations. That policy responds strongly to ensure its inflation commitments is important for the credibility of an inflation targeting regime. Some rise in GST tax rates, electricity tariffs, energy costs and rupee depreciation, although the rupee is showing signs of mean reversion towards real equilibrium values, are short-term risks for inflation.
34. Attempting a soft landing for the economy is important, however. For this, policy rates should not depart far from equilibrium. Such an outcome also balances between those who gain from a rise in rates and those who lose from it. In my last minutes I had suggested (-)1 per cent as the then lower limit for the one year ahead real repo rate. Shocks affect the steady-state natural interest rate 1. Policy has to tighten against negative supply shocks as well as against positive demand shocks that raise the equilibrium rate. My research showed Indian real rates were required to be negative in slumps but low positive in booms 2. The healthy recovery suggests we are no longer in a slump. Crude oil prices have fallen, but their persistence above $100, is a negative supply shock, raising the required one-year ahead real rate into positive territory. One year ahead inflation is expected to be around 5 per cent. Therefore, I vote for a 50 bps rise raising the repo rate to 5.4 per cent, and delivering the required low positive real rate.
35. Since the real rate is now near neutral, but uncertainty and global risks to both growth and inflation remain high, policy has to carefully monitor incoming data and respond to current developments. Indeed, if the US Fed does that, tapering its rate rise with signs of a slowdown, it will reduce global risks.
36. One of the first impacts of rising policy repo rates should be on credit demand as pass through raises loan rates. India is just coming out of a deleveraging cycle and recovery requires credit growth to rise. Despite rising repo rates in May and June 2022, yearly credit growth over the respective months in 2021 continues to be high partly due to the base effect. Preliminary sectoral credit data shows sharp rise in bank loans to the service sector but average of MSME, NBFC and personal bank loans over May and June was less than in April, and loans to large industry fell in June. There are pitfalls in monthly comparisons and the picture will be clearer as more data comes in. The rise in loan rates is still limited but has begun.
37. I also vote for ‘withdrawal of accommodation’ to continue since such a stance defined in terms of liquidity also indicates that durable liquidity will continue to be in surplus. This reassurance is important in a period of risk-off and possible outflows as the Fed continues its quantitative tightening. The LAF system has enough instruments to sterilize any effect on domestic liquidity.
38. India’s flexible inflation targeting framework is mandated to respond only to inflation and growth. The repo rate does not respond to the exchange rate. This is market determined with India’s capital flow and reserve management effectively reducing exchange rate volatility, which can be too high in emerging markets under global shocks. Research shows that inflation targeting works better in developing economies if additional instruments are available to address excess exchange rate and capital flow volatility 3. India has many such instruments that can be activated if necessary.
39. Moreover, the interest differential with the US has only a minor and possibly perverse effect on capital flows. Debt liabilities in India’s net international investment position include fixed income flows, as well as ECBs and institutional cross border borrowing. Of these $14bn left in 2020, and after that, even as the differential narrowed, have been steady at $100bn. A rise in Indian interest rates will not induce equity investment, which is the one that is currently volatile, to stay. In 2013 and in 2018 following the Fed rate rise aggravated the Indian slowdown. Today policy has more degrees of freedom to use. Similarly, multiple instruments are required and are available to keep the current account deficit at sustainable levels. A competitive equilibrium REER and demand-reducing positive real interest rates will also help. Galí J. and T. Monacelli. 2005. ‘Monetary Policy and Exchange Rate Volatility in a Small Open Economy’, Review of Economic Studies. 72(3): 707-734. Goyal, A. and S. Arora. 2016. ‘Estimating the Indian Natural Interest Rate: A semi-structural approach’, Economic Modelling. 58: 141–153. November. doi:10.1016/j.econmod.2016.05.023. Buffie, Edward F., M. Airaudo, and Felipe Zanna (2018), ‘Inflation Targeting and Exchange Rate Management in Less Developed Countries’, Journal of International Money and Finance, 81, 159-184. Statement by Prof. Jayanth R. Varma
40. Inflation is at unacceptably high levels, and the projected trajectory is also above target during the entire forecast horizon. Economic growth has on the other hand proved resilient in the face of an adverse global environment. In this situation, there is clearly a need for front loaded hikes in the policy rate. The choice to my mind is between 50, 60 and 75 basis points.
41. The logic of front loading argues in favour of a 75 basis point hike: it would establish the credibility of monetary policy beyond doubt, would help achieve a faster reduction in the inflation rate, and would hopefully reduce the terminal repo rate consistent with bringing inflation close to the target. Weighing against that is the fact that a 75 basis point rate hike is quite unusual (despite a few recent hikes of this magnitude globally in the recent period). In the context of market expectations of a 35-50 basis point hike, such a large hike risks being misinterpreted as a sign of panic, and could be unnecessarily disruptive. Also even with a 50 basis point hike this month, the cumulative tightening in the past few months of 140 basis points would make the real interest rate positive based on projected inflation 3-4 quarters ahead. On balance, therefore, I do not favour a 75 basis point hike at this juncture.
42. The choice between 50 and 60 basis points is less clear cut. The latter has the advantage of bringing the repo rate back to a round multiple of a quarter percent, but shares some of the disadvantage of a 75 basis point hike to a much lesser extent. As I have argued in past statements, 10 basis points is not material and I am happy to go along with the consensus of the rest of the MPC on this issue. Therefore, I vote in favour of increasing the policy repo rate by 50 basis points to 5.40 per cent.
43. I now turn to the second resolution to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. This statement confuses more than it clarifies. Because the rate hike in this meeting takes the policy rate above the pre-pandemic level, “withdrawal of accommodation” cannot refer to the withdrawal of the pandemic era accommodation. It can only mean withdrawal of the pre-pandemic accommodation that began with the rate cut from 6.50% to 6.25% in February 2019. A plain reading of this resolution would then be that the MPC is focused on taking the repo rate back to 6.50%.
44. In my view, such an indication of a terminal repo rate of 6.50% is totally unwarranted in the situation that we are in. The reality is that the Ukraine war and monetary tightening in the advanced economies have led to a very serious risk of recession in the world economy. In the face of this, commodity prices have collapsed from their April peaks. Crude oil remained elevated for longer, but it too is softening even as the MPC meeting is in progress. If this trend continues, we could see significant downward adjustments to the projected inflation trajectory. Moreover, though the Indian economy has been highly resilient to geopolitical and commodity price shocks so far, the weakening of exports in July indicates that India would not be immune to growth shocks emanating from the rest of the world. In short, it is easy to imagine that a few months from now, the economic data could point to a terminal repo rate that is well below 6.50%. To focus on one thing implies paying less attention to other things, and I do not think it would be wise to say that the MPC will remain “focused” on withdrawal of accommodation ignoring other considerations.
45. I have made several different suggestions to the MPC regarding alternatives to this resolution. First, in June, I suggested that individual MPC members could start moving towards providing projections of the future path of the policy rate. Since these would be projections of individual members and not of the MPC as a whole, these projections would not tie the hands of the MPC itself in any way. At the same time, they would provide guidance to the public about the thinking within the MPC. Second, at this meeting, I suggested that this resolution should simply be dropped. It is better not to give any guidance than to give confusing guidance. Unfortunately, none of these proposals found favour with the other members.
46. At the same time, I do not wish to record an outright dissent on this resolution because clearly further withdrawal of accommodation is warranted. The terminal repo rate may or may not be 6.50% but it is almost certainly well above 5.40%. So I am confining myself to expressing my reservations on this resolution. The resolution should in my view be interpreted only as stating that there is a high likelihood of further front-loaded tightening without restricting the freedom of the MPC to respond to the changing environment in a data driven manner. Statement by Dr. Rajiv Ranjan
47. The risks to the global economy which were initially perceived as stagflationary are now increasingly surfacing to be that of an outright recession for most economies. This has fuelled a debate of hard 4 versus soft landing for the global economy. Central banks are thus confronted with trade-offs which are governed by both the magnitude as well as the timing of their policy tightening. While the need to rein in inflationary pressures without numbing the growth impulses remains a priority, central banks are treading a very narrow path and they will need a well-curated policy design for a safe and soft landing.
48. Domestic inflation after reaching a peak of 7.8 per cent in April 2022 moderated to 7.0 per cent in May-June 2022. A sequential tapering of the month-on- month prices increases (momentum) along with large favourable base effects in May brought about this softening. Headline CPI price momentum eased to 0.94 per cent in May and further to 0.52 per cent in June from an elevated 1.43 per cent in April. Headline CPI on a seasonally adjusted annualised rate (SAAR) basis also slowed down from 12.8 per cent in April to 2.6 per cent in June. In terms of contributions, while the deceleration in headline price momentum in May was primarily on account of core (CPI excluding food and fuel), food also started to contribute to the slowdown in headline price pressures by June. The deceleration in price momentum was broad- based across items within the food group. On the other hand, the softening in core momentum was primarily influenced by the one-off petrol and diesel price declines (reflecting the full direct impact of excise duty cut). Despite some softening, various trimmed mean measures of CPI inflation 5 for June were elevated, in the range of 5.7 per cent to 6.4 per cent. In spite of some softening, diffusion indices 6 for core CPI items were also at elevated levels, implying that underlying price pressures remain broad based.
49. Inflation expectations of households in India, being adaptive and backward- looking and influenced mainly by price expectations of food and fuel items (which constitute almost 55 per cent of the CPI basket), moderated in the July 2022 round but remained at elevated levels. Unmooring of inflation expectations, in the context of the spike in inflation following the conflict in Europe, is the biggest risk which the BIS in its monthly bulletin (July 2022) titled ‘Hard or Soft Landing?’ has referred hard landing as a situation of bringing inflation back to target but at the cost of a recession. In trimmed mean measures, CPI items which are located in the tails of the inflation distribution for every month (indicating highly volatile inflation movements) are excluded. The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their prices (seasonally adjusted) have risen, remained stagnant or fallen over the previous month and aggregates them to show whether the month-on-month (m-o-m) increase overall has been expansionary or contractionary. The diffusion indices constructed are weighted averages. MPC addressed through the off-cycle meet and frontloaded rate actions so as to increase the efficacy of the actions.
50. Going forward, though the fall in international commodity prices and the progress of the monsoon provide room for optimism, there is considerable uncertainty, particularly from the spatial and temporal distribution of monsoon and its implication for kharif paddy production, the depreciation of the INR exchange rate and pending pass-through in services. Importantly, the global geo-political scenario – the source of much of the price shocks – continues to remain unsettled.
51. While WPI inflation rose sharply in line with international commodity price movements, the full pass-through of high inputs costs reflected in WPI to CPI inflation was tempered by weak pricing power due to the prevailing slack in the economy. As the slack wanes and pricing power of firms return, there is a risk that the pass- through of past increases in input costs could continue, partly offsetting the favourable impact of recent fall in global commodity prices. Crude price uncertainty persists, though the pass-through of elevated crude oil prices to retail inflation has been moderate and low in the recent period 7 due to the impact of fiscal interventions, such as reduction in excise duties. Moreover, the recent depreciation of the INR exchange rate could also temper the beneficial impact of fall in commodity prices. These could keep core CPI inflation at elevated levels throughout this year. Moreover, if high cost of living conditions persists, the household inflation expectations could edge up feeding into wages in a broad-based manner and pushing up services inflation, which has been muted so far. Thus, monetary policy needs to be watchful of the evolving input cost pass-through and wage dynamics and take pre-emptive action to contain any possibility of the emergence of a wage-price spiral.
52. As mentioned in my minutes of June policy, we need to factor in quicker and improved monetary transmission with the introduction of the external benchmark regime in this tightening cycle while arriving at a terminal rate. In response to the interest rate cycle turning upwards, banks have swiftly increased their external benchmark linked lending rates (EBLRs) (by 90 bps) and the 1-year median marginal cost of funds-based lending rate (MCLR) (by 40 bps) during April-July, 2022. The weighted average lending rate (WALR) on fresh rupee loans has also increased. Though pass-through is relatively lower in case of retail term deposit rates, banks have increased their bulk deposit rates significantly. As credit growth is gathering momentum, banks can be expected to further increase rates on retail deposits to fund their lending. Moreover, with upward revisions in interest rates on small savings schemes (SSSs) in accordance with the formula-based mechanism as and when it happens, pressure will increase on banks to hike interest rates on retail deposits.
53. On balance, the inflation projection for the financial year 2022-23 is retained at 6.7 per cent, with a gradual moderation in headline inflation over H2:2022-23. As per the baseline projections, inflation is likely to remain above 6 per cent till Q3:2022-23. This would require monetary policy to persevere with its exit from accommodation to ensure that frontloaded policy rate hikes dampen inflation expectations, anchor second round effects and firmly establish our commitment to price stability. The frontloading of policy actions is expected to strengthen monetary policy credibility and temper the need for aggressive rate hikes in future. Greater credibility makes disinflation less costly, helps hold down inflation once it is low (Blinder, 2000 8). The dividends of establishing this credibility are not just in the contemporaneous transmission into the real economy, but also in lowering the necessary terminal policy Based on time varying regression estimates of pass-through of crude oil price changes to CPI inflation. Blinder, A. S. (2000), ‘Central Bank Credibility: Why do We Care? How do We Build It?’, American Economic Review, 90(5), 1421-1431. rate to achieve the inflation target in the medium run. Deft macroeconomic management has insulated the Indian economy from several shocks in the recent past thereby ensuring that recovery remains on a firm footing. Against this background, I vote for a 50 bps hike in the repo rate so as to reinforce the MPC’s commitment to price stability around the target. I also vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Michael Debabrata Patra
54. The global outlook becomes increasingly uncertain and tilted by downside risks. With inflation remaining elevated worldwide and a pervasive sense of guilt about the consequences of the pandemic stimulus having been underestimated 9, central banks have launched into the most aggressive, front loaded and synchronous monetary policy tightening in decades. Consequently, the probability of a recession or hard landing has risen to levels that preceded actual recessions in the past.
55. Each country is on its own - match the Fed or face currency depreciation, imported inflation, wider current account imbalances, capital outflows and reserve losses. Meanwhile, the war in Ukraine appears to be broadening and it is unlikely to cease soon. Friend shoring has begun 10.
56. The elephant in the room is the unrelenting strength of the US dollar which has risen by over 8.3 per cent since March 31, 2022 just to set up a numeraire. In India, there is a turn in the wind and financial markets are sensing it. The most recent demonstration of this shift is the strong appreciation of the Indian rupee in the relief rally that followed the fully priced in monetary policy action of the Fed in its July 2022 meeting. During the financial year 2022-23 so far (up to August 3), the Indian rupee has fallen by 3.9 per cent, 4.4 percentage points less than the MSCI advanced economy currency index and by 1.3 percentage points less than the MSCI EME currency index (5.1 per cent) against the US dollar.
57. This wedge reflects the underlying strength of India’s fundamentals. For instance, inflation in India is lower than the weighted average of its major trading partners 11. High frequency indicators suggest that there is some moderation in momentum in the first quarter of 2022-23 relative to the previous quarter, but the momentum is still positive in sharp contrast to the rest of the world. India’s real GDP growth is tracking the RBI’s projections, in spite of the downside bias imparted by the highly unsettled global environment. Portfolio investment is making its way back to India – the month of July has recorded net inflows of US $ 458 million, led by equities 12. In a span of around one month since June 17, 2022, the BSE Sensex has risen by 13.6 per cent - these gains coincide with the corporate earnings season, with many companies delivering robust first quarter results. The yield on the 10-year G- sec benchmark has softened from its peak of 7.62 per cent on June 16, 2022 and is trading 30-40 basis points below. Surplus liquidity in the banking system has moderated as credit growth has surged. Interest rates in the money markets have aligned with the policy repo rate, reflecting the stance of calibrated withdrawal of accommodation. Other short-term rates have firmed up. Monetary transmission is stronger to lending rates currently, but deposit rates have commenced the catch-up. “I was wrong about inflation” says Paul Krugman in the New York Times, July 21, 2022 On July 20, 2022 India joined 17 countries under the 2022 Supply Chain Ministerial Forum and issued a joint statement emphasizing transparency, diversification, supply chain security, sustainability and responsible business conduct. In the 40-country REER, partner countries account for 91 per cent of India’s merchandise trade, 88.4 per cent of world GDP and 86.4 per cent of world trade. In June 2022, India’s inflation differential vis-à-vis these 40 countries was -0.6 per cent. Some debt channels have also drawn back portfolio investment interest such as the Fully Accessible Route (FAR) which attracted US$ 229.2 million and the Voluntary Retention Route (VRR) which got US$ 48.5 million. All in all, the Indian economy is running a positive growth differential vis-à-vis the rest of the world.
58. Monetary policy, unseen and unsung, has played a key role in this swivel. The front-loaded and pre-emptive actions so far are already working into inflation expectations of households. Their perception of current inflation as well as their expectations three months and one year ahead have declined appreciably in the latest round of the RBI’s survey. Furthermore, uncertainty around their perceptions and expectations (measured by their respective coefficients of variation) has reduced, indicative of anchoring. Consumer confidence about price pressures easing across product groups over the year ahead is rising. In a world of global food shortages and price pangs, steady procurement operations and comfortable buffer stocks are positives for the growth outlook and positives for the food inflation trajectory. Undoubtedly, a more even spatial distribution of the south west monsoon could fortify these cushions further.
59. Although inflation seems to have peaked, it is still unconscionably high. Risks to the trajectory of inflation in the form of currency depreciation, seasonal pressures and the monsoon’s uneven progress could upend the moderation in momentum recently recorded.
60. Monetary policy’s response to supply shocks has to be predicated on managing expectations and fortifying credibility. Empirically, it can be demonstrated that when a shock is transitory, inflation returns to equilibrium without the need for any monetary policy action if credibility is high. On the other hand, repeated supply shocks trigger second round effects through cost pushes, expectations, exchange rate and demand channels, warranting pre-emptive monetary policy action. Even with perfect credibility, monetary policy cannot look through the second-round effects of repeated supply shocks. The inflation target may be breached for a prolonged period. This could unsettle expectations and eventually get reflected in higher inflation. Higher credibility can reduce – not substitute for – the monetary policy response to second round effects of repeated supply shocks. By frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target.
61. Another dimension of monetary policy credibility is the timing of its response. With imperfect credibility, a delay in the monetary policy response to repeated unfavourable supply shocks leads to a further loss of credibility, unhinging of inflation expectations and eventually, higher inflation outcomes with a higher sacrifice of growth. Accordingly, it is essential to (a) assess the life of the shock and (b) react to any signs of second round effects to avoid the generalisation of inflation.
62. At the current juncture, shocks are large and recurring. Combined with the rebound in spending liberated from the pandemic, they carry the risk of un-anchoring inflation expectations. Frontloading of monetary policy actions can keep inflation expectations firmly anchored, re-align inflation with the target and reduce the medium-term growth sacrifice as it is timed into the recovery underway. Small steps over a prolonged period could allow inflation to get entrenched and inflation expectations unhinged.
63. I vote for increasing the policy rate by 50 basis points and for the stance of withdrawal of accommodation as articulated in the MPC’s resolution. Statement by Shri Shaktikanta Das
64. Since the last MPC meeting in June 2022, there has been considerable slowdown in the global economy, which is now expected to grow only by 3.2 per cent in 2022 according to the International Monetary Fund (IMF). At the same time, global inflation has hardened further and is projected to remain elevated and persist for longer at around 6.6 per cent for advanced economies (AEs) and 9.5 per cent for emerging market and developing economies (EMDEs) (IMF, July 2022). This has triggered a synchronised and aggressive monetary tightening by central banks across the world, leading to tighter global financial conditions after almost a decade of accommodative policies.
65. On the domestic front, though inflation has moderated and plateaued since its recent peak of April 2022, it remains unacceptably and uncomfortably high. The high level of inflation continues to be broad-based with 13 out of 23 CPI sub- groups/groups, comprising close to 60 per cent of the CPI basket, registering more than 6 per cent inflation in June 2022. Going forward, though there are early indications that inflation might have peaked in April, significant uncertainties remain on account of adverse global spillovers coming from simmering geopolitical tensions, volatile global commodity prices and financial markets. While the let-up in global food and industrial metals prices should lower imported inflation, the appreciation of the US dollar could offset some of the gains. Persistently elevated cost of living conditions can engender wage-price spirals, especially as firms regain pricing power.
66. Domestic growth, on the other hand, remains resilient and gives us the space to act. High-frequency indicators for Q1:2022-23 and thereafter are evolving on the expected trajectory. The southwest monsoon has picked up and is progressing well. This will boost the prospects of agriculture and help revitalisation of rural consumption. Contact-intensive services have rebounded and have been driving consumer demand and growth. Government expenditure, both of Centre and states, is expected to provide support to aggregate demand.
67. Sustained high inflation, unless addressed effectively, could result in unanchoring of inflation expectations and their second order effects. This necessitates appropriate monetary policy response to prevent upward drift in inflation from the target rate. I am of the view that at this juncture a 50 bps increase in the repo rate is necessary and, therefore, vote accordingly. I also vote for remaining focused on withdrawal of accommodation.
68. Our monetary and liquidity actions have been aimed at ensuring continued macroeconomic and financial stability that could set the foundation for a high growth trajectory over the medium term. We will continue with ‘whatever it takes’ approach, given the new set of challenges and very high uncertainties that we are confronted with.
69. Our actions today are tailored towards first bringing the CPI inflation within the target band and then taking it close to the target of 4.0 per cent over the medium term, while supporting growth. The sequence of our policy measures is expected to strengthen monetary policy credibility and anchor inflation expectations. Our actions would continue to be calibrated, measured and nimble depending upon the unfolding dynamics of inflation and economic activity. (Yogesh Dayal) Press Release: 2022-2023/737 Chief General Manager
6. Global economic activity is weakening under the impact of the protracted conflict in Ukraine and aggressive monetary policy actions and stances across the world. As financial conditions tighten, global financial markets are experiencing surges of volatility, with sporadic sell-offs in equity and bond markets, and the US dollar strengthening to a 20-year high. Emerging market economies (EMEs) are facing intensified pressures from retrenchment of portfolio flows, currency depreciations, reserve losses and financial stability risks, besides the global inflation shock. As external demand deteriorates, their macroeconomic outlook is becoming increasingly adverse. Domestic Economy
7. Real gross domestic product (GDP) grew year-on-year (y-o-y) by 13.5 per cent in Q1:2022-23. While all constituents of domestic aggregate demand expanded y-o-y and exceeded their pre-pandemic levels, the drag from net exports provided an offset. On the supply side, gross value added (GVA) rose by 12.7 per cent in Q1:2022-23, with all constituents recording y-o-y growth and most notably, services.
8. Aggregate supply conditions are improving. With the south-west monsoon rainfall 7 per cent above the long period average (LPA) as on September 29 and its spatial distribution spreading to some deficit areas, kharif sowing has been catching up. Acreage was 1.7 per cent above the normal sown area as on September 23 and only 1.2 per cent below last year’s coverage. The production of kharif foodgrains as per first advance estimates (FAE) was 3.9 per cent below last year’s fourth advance estimates (only 0.4 per cent below last year’s FAE). Activity in industry and services sectors remains in expansion, especially the latter, as reflected in purchasing managers indices (PMIs) and other high frequency indicators. The index of industrial production growth, however, slowed to 2.4 per cent (y-o-y) in July.
9. On the demand side, urban consumption is being lifted by discretionary spending ahead of the festival season and rural demand is gradually improving. Investment demand is also gaining traction, as reflected in rising imports and domestic production of capital goods, steel consumption and cement production. Merchandise exports posted a modest expansion in August. Non-oil non-gold imports remained buoyant.
10. CPI inflation rose to 7.0 per cent (y-o-y) in August 2022 from 6.7 per cent in July as food inflation moved higher, driven by prices of cereals, vegetables, pulses, spices and milk. Fuel inflation moderated with reduction in kerosene (PDS) prices, though it remained in double digits. Core CPI (i.e., CPI excluding food and fuel) inflation remained sticky at heightened levels, with upside pressures across various constituent goods and services.
11. Overall system liquidity remained in surplus, with the average daily absorption under the liquidity adjustment facility (LAF) easing to ₹2.3 lakh crore during August- September (up to September 28, 2022) from ₹3.8 lakh crore in June-July. Money supply (M3) expanded y-o-y by 8.9 per cent, with aggregate deposits of commercial banks growing by 9.5 per cent and bank credit by 16.2 per cent as on September 9, 2022. India’s foreign exchange reserves were placed at US$ 537.5 billion as on September 23, 2022. Outlook
12. High and protracted uncertainty surrounding the course of geopolitical conditions weighs heavily on the inflation outlook. Commodity prices, however, have softened and recession risks in advanced economies (AEs) are rising. On the domestic front, the late recovery in sowing augurs well for kharif output. The prospects for the rabi crop are buffered by comfortable reservoir levels. The risk of crop damage from excessive/unseasonal rains, however, remains. These factors have implications for the food price outlook. Elevated imported inflation pressures remain an upside risk for the future trajectory of inflation, amplified by the continuing appreciation of the US dollar. The outlook for crude oil prices is highly uncertain and tethered to geopolitical developments, with attendant concerns relating to both supply and demand. The Reserve Bank’s enterprise surveys point to some easing of input cost and output price pressures across manufacturing, services and infrastructure firms; however, the pass-through of input costs to prices remains incomplete. Taking into account these factors and an average crude oil price (Indian basket) of US$ 100 per barrel, inflation is projected at 6.7 per cent in 2022-23, with Q2 at 7.1 per cent; Q3 at 6.5 per cent; and Q4 at 5.8 per cent, and risks are evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 per cent (Chart 1).
13. On growth, the improving outlook for agriculture and allied activities and rebound in services are boosting the prospects for aggregate supply. The Government’s continued thrust on capex, improvement in capacity utilisation in manufacturing and pick-up in non-food credit should sustain the expansion in industrial activity that stalled in July. The outlook for aggregate demand is positive, with rural demand catching up and urban demand expected to strengthen further with the typical upturn in the second half of the year. According to the RBI’s surveys, consumer outlook remains stable and firms in manufacturing, services and infrastructure sectors are optimistic about demand conditions and sales prospects. On the other hand, headwinds from geopolitical tensions, tightening global financial conditions and the slowing external demand pose downside risks to net exports and hence to India’s GDP outlook. Taking all these factors into consideration, real GDP growth for 2022-23 is projected at 7.0 per cent with Q2 at 6.3 per cent; Q3 at 4.6 per cent; and Q4 at 4.6 per cent, and risks broadly balanced. For Q1:2023-24, it is projected at 7.2 per cent (Chart 2).
14. In the MPC’s view, inflation is likely to be above the upper tolerance level of 6 per cent through the first three quarters of 2022-23, with core inflation remaining high. The outlook is fraught with considerable uncertainty, given the volatile geopolitical situation, global financial market volatility and supply disruptions. Meanwhile, domestic economic activity is holding up well and is expected to be buoyant in H2:2022-23, supported by festive season demand amidst consumer and business optimism. The MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, restrain the broadening of price pressures and pre-empt second round effects. The MPC feels that this action will support medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.90 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
15. Dr. Shashanka Bhide, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to increase the policy repo rate by 50 basis points. Dr. Ashima Goyal voted to increase the repo rate by 35 basis points.
16. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Prof. Jayanth R. Varma voted against this part of the resolution.
17. The minutes of the MPC’s meeting will be published on October 14, 2022.
18. The next meeting of the MPC is scheduled during December 5-7, 2022. Voting on the Resolution to increase the policy repo rate to 5.90 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal No Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The global macroeconomic conditions have become adverse for growth and stability, particularly for the EMEs. While there are clear signs of slowing growth momentum in the economies across the world, inflation continues at much higher rates than the target for many countries. The uncertainty due to the Russia-Ukraine war has continued impacting the energy supplies and prices. While the COVID-19 pandemic has weakened, sporadic surges in some major countries are raising concern. Global monetary policy tightening to contain inflation pressures has increased the potential for significant global growth deceleration and volatility in financial markets. Declining export opportunities while imports remaining relatively high have added to the adverse external environment for the energy importing EMEs.
20. The CPI inflation in India, year-on-year basis, after a run of 7 per cent or more between March and June 2022, dropped to 6.7 per cent in July only to rise to 7 per cent again in August. With the exception of a few product groups, the high rate of price rise was widespread. Food & Beverages and fuel & light sub-groups of the CPI registered YOY rates above 7 per cent throughout this period from March to August, with the exception of a rate of 6.7 per cent in the case of food & beverages in July. Only in the case of housing and pan, tobacco and intoxicants, among the major categories of CPI, with a combined weight of 12.45 per cent in the CPI, the inflation rate was below 4 per cent during the period, with the exception of housing price index which rose by 4.1 per cent in August. Among the other remaining sub-categories, clothing and footwear registered inflation rate of about 9 per cent and the other remaining consumption items constituting ‘miscellaneous’ sub-category registered inflation rate of above 7 per cent in March and April followed by lower rates of 5-7 per cent in the subsequent May-August period. However, there was a decline in the month over month momentum of the overall CPI in May 2022 and it remained steady during June-August.
21. The policy response across the world has been to tighten monetary policy. This policy stance is expected to continue to achieve inflation targets.
22. Persistence of the higher rate of price increase at commodity and sectoral levels in the domestic market is on account of both the direct or spill-over effects of higher international market prices and also the domestic factors. Any decline in prices at the consumer level appears to be restrained by elevated levels of input prices although RBI’s enterprise surveys indicate that the input price pressure is expected to ease in the second half of the current financial year. 22. Both Private Final Consumption Expenditure and Gross Fixed Capital Formation, two major components of aggregate demand, registered sharp increase in Q1:FY2022-23 YOY basis. In this sense, the overall growth momentum appears to have been sustained in Q1.
23. The RBI survey of households conducted in September 2022 on price expectations indicates expectations of continued high rate of inflation, with the average expected inflation rate being higher than in the survey conducted in July 2022. Inflation rate is also expected to be higher 3-months ahead and one-year ahead compared to the prevailing situation. The expectations of future price readings appear to be affected more by the present conditions than the likely impact of the decline in the commodity prices in the international markets.
24. The survey of enterprises (Industrial Outlook Survey) conducted by RBI in September 2022 reflects some relief on selling prices in H2:FY2022-23 as the proportion of respondents who expect selling prices to rise drops compared to Q2: FY 2022-23. Although financing costs are expected to increase, other input cost pressures are expected to decline. The Wholesale Price Index, reflecting the price conditions at the producer level, has registered double digit rate of increase YOY basis in July and August. While there is a variation in the price changes across the broad range of commodities, in a few major categories of commodities, the price rise is significant. In the case of vegetables, fruits, crude petroleum, petrol, diesel, LPG and electricity, the WPI increased at double digit rates in July and August. In the case of cereals, the increase was 9.8 per cent in July and 11.8 per cent in August. The impact of decline in international market prices on domestic prices is yet to pass through to the domestic consumer prices. 24. The future trajectory remains clouded with uncertainties arising from continuing geopolitical conflicts, possibility of further supply disruptions, volatile financial market conditions and domestic weather related factors.
25. The rainfall in the monsoon period of June-September has exceeded the Long Period Average by the last week of September although the rainfall has been deficient in parts of the eastern and north-eastern regions for much of the monsoon period. The monsoon rains in the aggregate have improved the rabi crop prospects. Food commodity prices in the consumption basket will be subject to the size of the kharif harvest in the short run.
26. In the context of continued high inflation rate, the monetary policy rate has increased between May and August 2022. While the impact of this increase is beginning to affect the lending and deposit rates of the banking sector, its main impact on inflation would be through expectations of a decline in future inflation rate and on the aggregate demand. There are of course other factors such as the slowing down of the global economy and its impact on exports and aggregate demand. At this juncture, the adverse impact on aggregate demand may be insulated by the seasonal factors such as the festival season demand and the kharif crop harvest.
27. The Q1: FY2022-23 estimates of national income by the NSO place constant prices GDP growth at 13.5 per cent over the same period in the previous year. This is lower than the RBI’s projection of 16.2 per cent provided in the August meeting of the MPC. Despite the lower than the projected growth, it reflects sustained improvement in growth over the pre-pandemic output level of 2019-20 that began in Q2:FY2021-
28. Given the lower estimates of GDP growth for Q1, there is uncertainty over sustaining the growth momentum needed to achieve growth of 7.2 per cent for the full year, projected in the August MPC meeting. There are also signs of weakness in demand conditions in the qualitative results of the RBI surveys of Enterprises (Industrial Outlook). The overall Consumer Confidence Index as per the Consumer Confidence Survey (urban households) shows optimism for one-year ahead expectations, albeit, prevailing conditions are seen to be pessimistic. The increase in consumption expenditure over the previous year and one-year ahead expectation is more widely shared with respect to ‘essential expenditure’ as compared to ‘non- essential expenditure’. The expectations of overall business outlook over the remaining quarters of FY 2022-23, based on the Enterprise Surveys for September 2022 reflects optimism but also divergence in sentiments in manufacturing, services and infrastructure sectors. In this context, the revised GDP growth projection for FY 2022-23 is now at 7.0 per cent compared to 7.2 per cent in August. The quarterly growth rates for the year are provided in the Resolution.
29. In sum, there are significant uncertainties over the trajectories of growth and inflation. On the growth front, the COVID-19 pandemic related supply side constraints do not appear to be significant. Improvement in private investment and consumption spending would require price stability. The CPI inflation rate has continued to be high – above/in excess of 6 per cent, from January 2022 onwards. While there are indications of decline in the momentum of price rise, sustaining this decline in momentum is crucial for achieving inflation and growth objectives. To align the inflation expectations with the policy target rate of inflation, further increase in policy rates is necessary at this juncture.
30. I vote to increase the policy repo rate by 50 basis points to 5.9 per cent. I also vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
31. To start with global factors, major advanced economy central banks over- stimulated after Covid-19 and are over-reacting to inflation now, creating excess volatility in cross border flows to emerging markets (EMs). Forward guidance, whether hawkish or dovish, is harmful in such uncertain times. Being data-based allows real sector changes to counter the effect of interest rates on markets.
32. There are two mitigating factors for India, however. First, after an initial extreme reaction, cross border flows discriminate on a country basis. As commodity prices soften with a global slowdown, some of the investors who had left India because of its vulnerability to commodity inflation will return. Second, India still retains policy space for smoothing global shocks. Domestic demand can counter falling export demand. It is important for policymakers to stay calm to moderate fear and over-reaction.
33. Turning to the domestic situation, global commodity price softening affects WPI more initially. CPI is rising because of a cereal and end monsoon food price spike. As a result household inflation expectations rose, while those of firms fluctuated around 5% according to the IIM Ahmedabad survey. Rising uncertainty shows in the increasing dispersion of household inflation expectations. But firms still see inflation at 5.5% by mid-2023.
34. While India has one of the highest year-on-year growth rates in the world there are some signs of slowing down. Quarter on quarter GDP contracted in Q1. The OECD points out that seasonally adjusted Indian quarter on quarter growth was the lowest after China and Poland. It is uncertain if domestic demand will sustain after the festival spike. RBI consumer surveys show 45% of households reported no increase in income levels compared to a year ago.
35. Although the large pandemic-time repo rate cut is reversed, we are not yet at the terminal rate. Demand reduction has to contribute, along with other measures, to lowering the current account deficit. A firm monetary policy reaction to inflation exceeding tolerance bands helps anchor expectations. The repo rate has to rise more. But should the rise be taken upfront or staggered over time? We examine the arguments for and against frontloading.
36. When behaviour is forward-looking front loading can pre-empt inflationary pressures. But if lagged effects of monetary policy are large, as in India, over- reaction can be very costly. Harmful effects become clear too late and are difficult to reverse. Gradual data-based action reduces the probability of over-reaction. Taking Indian repo rates too high imposed heavy costs in 2011, 2014 and 2018. A credit and investment slowdown was aggravated and sustained. It is necessary to go very carefully now that forward-looking real interest rates are positive.
37. The sacrifice of output from tightening is low if unemployment is low and there is excess demand. Setting rates to reduce excess demand to zero has little output cost and the need for future rate hikes are reduced. In India, however, unemployment is high. That there is no second round inflation from wage rise points to slack labour markets. Employment is just recovering from a series of global shocks and demand may be slowing.
38. High uncertainty also calls for slow steps. If demand slows anyway, less policy tightening will be required. That both inflation and growth were slightly lower than last quarter RBI projections may indicate the effect of tightening was underestimated. It is necessary to monitor the softening of commodity prices. If they slump real rates can shoot up too high as in 2014-15.
39. If inflation expectations are unanchored a large sacrifice may be called for to reverse them. But in EMs communication has more impact. Continuing supply-side action, global softening and transparent communication about these factors all help anchor inflation expectations. If the target is headline inflation with a large commodity component for which fiscal action has greater impact there is more responsibility on the government to act. The Indian government has demonstrated commitment to lowering costs of living and to improving infrastructure.
40. A BIS study 1 of past country experience including 6 EMs found frontloaded actions tend to be followed by soft landings but average 45% of the policy rate rise was frontloaded in soft landings and the mean nominal rate hike was 2%. Large hikes were required in India to reverse steep pandemic-time cuts. Since that is completed, going slow now will allow policy to be agile and data-based. Extremes are always dangerous; 100% front loading can easily overshoot. Moderation is better.
41. Households tend to have a stagflationary view, so they expect inflation to rise when growth falls 2. In addition, Indian households expect inflation to increase if the repo rate increases 3. Excessive rate rises will not make inflation targeting credible if they are unable to lower supply-side inflation and instead raise costs as demand and investment falls.
42. Most analysts are arguing for a 50 bps rise just to preserve a spread with US policy rates. This is a fear driven over-reaction. In the mid-2000s the spread was less than 150 bps and there were large capital inflows. In the past 2 years spreads of above 300 bps have not brought in debt flows. If the terminal Fed rate is 5%, will it require we raise ours to 8%? The carry trade is not a stable source of financing. India has earned enough independence to protect itself from policy errors of other nations.
43. In view of all these considerations, and to signal tapering of action, I vote for a 35 bps rise in the repo rate. Both RBI and SPF headline forecasts for Q1 FY2023-24 are around 5%, implying the real rate will be approximately 0.75% with the repo rate at 5.75%. This is almost one, and can exceed unity if the fall in inflation is larger. This could be dangerous if growth slows. The MPC has to focus on the 6 month to one year ahead real rate, as this is the horizon where monetary policy will have its greatest impact. Boissay, F., F. De Fiore and E. Kharroubi. 2022. “Hard or soft landing?” BIS Bulletin No. 59. July. Coibion, O., Y. Gorodnichenko, and M. Weber. 2022. “Monetary policy communications and their effects on household inflation expectations.” Journal of Political Economy, forthcoming. https://doi.org/10.1086/718982 Goyal, A. and P. Parab. 2021. “What Influences Aggregate Inflation Expectations of Households in India?” Journal of Asian Economics 72 (February) 101260. https://www.sciencedirect.com/science/article/abs/pii/S1049007820301408
44. Moreover, as banking liquidity is tightening, there will be more pass through. Over time LAF tools and forecasting of liquidity shocks should develop to the point where a neutral MPC stance implies weighted average money market rates are maintained in the middle of the LAF corridor. At present I vote to continue with the ‘withdrawal of accommodation stance’ since durable liquidity is still in surplus. This, together with adequate adjustment of short-term liquidity, is required to counter global quantitative tightening (QT) and possible outflows, as required. The very slow pace of QT compared to the large surplus created, along with selective CB interventions, may be sufficient, if we are lucky, to prevent financial instability despite the rapid coordinated global rise in policy rates. Statement by Prof. Jayanth R. Varma
45. I wrote in my August statement that further withdrawal of accommodation is warranted beyond the rate increase in that meeting. However, I also indicated that we may be beginning to approach the terminal repo rate. My view remains largely the same today, and based on this, I think the MPC should now raise the policy rate to 6 percent and then take a pause.
46. A pause is needed after this hike because monetary policy acts with lags. It may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters. If we raise the repo rate to around 6 percent at this meeting, that would be a cumulative increase of around two percentage points in the space of just four months. Even this understates the extent of monetary tightening, because, a few months ago, money market rates were close to the reverse repo rate (65 basis points below the repo rate). Taking this into account, the full magnitude of monetary tightening would be well over 250 basis points.
47. Much of the impact of this large monetary policy action is yet to be felt in the real economy. In fact, much of the policy rate action is yet to be transmitted to even the broader spectrum of interest rates. For example, less than a third of the increase in the repo rate during April-August has been transmitted to retail bank deposit rates. Bank deposit interest rates play a critical role in stimulating savings, dampening consumption demand, and thereby mitigating inflationary pressures. We should hopefully see more of this transmission in ensuing quarters. While there has been much higher transmission from policy rates to lending rates, the transmission from lending rates to the real economy would also take time.
48. All this means that it is too early to know whether the policy action so far is sufficient or not. It may well turn out that even more monetary tightening is required, but it does make sense to wait and watch to see whether a repo rate of around 6 percent is sufficient to glide inflation back to target. If we were to continue to tighten without a reality check, we would run the risk of overshooting the repo rate needed to achieve price stability. It is true that inflation is currently well above 6 percent. However, since monetary policy acts with lags, what is relevant is the inflation forecasts 3-4 quarters ahead. Both the RBI’s forecasts and the survey of professional forecasters show inflation falling to around 5 percent in the first quarter of the next financial year. Relative to this forecast, a policy rate of around 6 percent would not only be a positive real rate, but also likely above the neutral rate.
49. In my view, it is dangerous to push the policy rate well above the neutral rate in an environment where the growth outlook is very fragile. While the level of economic output has recovered to pre pandemic levels, it remains well below the pre pandemic trend line. Tightening global financial conditions and recessionary fears in advanced economies are acting as drags on the domestic economy as well. Weakening export growth means that economic growth has to be driven by domestic demand which is still not sufficiently robust. Much of the hope for economic growth rests on the possibility of a revival of private investment in response to rising capacity utilization. We should be careful to ensure that an unreasonably high real interest rate does not thwart this much needed upswing of the investment cycle. Compared to the previous meeting, the upside risks to inflation have abated with a moderation in crude oil prices and continued weakness in other commodity prices.
50. I have given careful consideration to the extensive analyst commentary suggesting that a terminal repo rate of 6.25 or 6.50 percent is appropriate. Much of this analysis is from the perspective of the balance of payments. It is true that in the past (notably in 1998 and in 2013), India has very successfully used interest rates to defend the currency. However, all these episodes were before the inception of an inflation targeting MPC in 2016. The statutory mandate restricts the MPC to consider only two factors while setting interest rates - inflation and growth. It was a conscious legislative choice to let monetary policy be dictated by domestic economic considerations, and leave the external sector to be managed using other instruments. This means that the MPC cannot be guided by the effect of global monetary tightening on the interest rate differential.
51. My votes on the MPC resolutions are informed by these considerations. For the first resolution on the quantum of the rate hike, I considered three alternative choices: 35, 50, and 60 basis points corresponding to repo rates of 5.75, 5.90 and 6.00 percent. I think that 5.75 per cent would be well below the terminal repo rate, would leave the task of monetary tightening unfinished, and make it necessary to hike rates again in the next meeting. My preference is clearly for a front loaded hike to the 6 percent level that I have argued for in the above paragraphs. The majority of the MPC has chosen 5.90 percent which is only slightly below my preferred rate of 6 percent. As I have explained in past statements, 10 basis points is not material and I am happy to go along with the majority of the MPC on this issue. Therefore, I vote in favour of increasing the policy repo rate by 50 basis points to 5.90 percent. However, I vote against the second resolution because in my view the MPC should now pause rather than focus on further tightening. Statement by Dr. Rajiv Ranjan
52. Central banks across the globe continue their fight against inflation this year with more than a dozen central banks hiking rates by 75 bps or even more in one go. While global financial markets are witnessing the immediate brunt with associated spillovers for emerging markets including India on account of risk-off sentiment and US dollar strength, ‘historic’ global growth slowdown is the medium-term risk that the world economy has to face.
53. India is in a much better position relative to many other parts of the world. Growth is resilient, and that is also encapsulated in upgrade in growth forecasts for Q2, Q3 and Q4 of 2022-23. Although exports are vulnerable to global growth slow down, it could be offset by some favourable spillovers from lower global commodity prices coupled with other factors alluded to in the following paragraphs.
54. For Q1:2022-23, National Statistical Office (NSO) estimate of real GDP growth at 13.5 per cent was lower than our projection of 16.2 per cent. Despite a strong pick up in private consumption and investment which supported aggregate demand in Q1, lower growth in government consumption and higher drag from net exports contained growth in real GDP. High growth in real imports - with lower-than-expected deflator inflation at 13.7 per cent despite sharp rise in import prices - outpaced real export growth significantly.
55. Again, growth in contact-intensive services as reflected by GVA growth in trade, hotels, transport, communication and services related to broadcasting also fell short of expectations. While this sector had exceeded its pre-pandemic level by 1.7 per cent in Q4:2021-22 in a quarter marred by Omicron, it slipped below its pre- pandemic level by 15.5 per cent in Q1:2022-23 which was a relatively normal quarter. Assuming this sector could have just reached its pre-pandemic level in Q1:2022-23 (i.e., at the Q1:2019-20 levels), real GVA growth would have been 16.1 per cent during the quarter. Notably, this sub-group accounted for about one-fifth of the GVA in the pre-pandemic period.
56. Accordingly, the projection for H2:2022-23 has been revised upwards. It is also expected that the economic activity is likely to sustain momentum with full- fledged celebration of festivals after two years on the back of buffers of excess household savings, which will aid private consumption. Even though household’s financial savings have normalised from a peak level of 12.0 per cent of GDP during 2020-21 to 8.3 per cent in 2021-22, it is estimated that households still had an excess saving of around 7 per cent of GDP at end-March 2022 - based on their net worth which is higher than the level at end-March 2020. 4 As consumption gathers traction and capacity utilisation surges beyond a threshold, this could fuel investment – the second engine of growth. The real GDP growth for 2023-24, based on our macroeconomic model, is projected at 6.5 per cent. 5 India assuming G-20 presidency in 2023 is likely to support economic activity with large infrastructure and tourism related investment.
57. Since the last bi-monthly, headline CPI inflation after moderating to 6.7 per cent in July edged up to 7.0 per cent in August. Even so, month-over-month change in headline CPI (or price momentum) was steady at around 0.5 per cent during June- August 2022 and two-way movement in inflation was brought about by base effects. Food and CPI core (CPI excluding food and fuel) drove price momentum in recent months, with core inflation remaining sticky around the upper tolerance threshold of 6 per cent. Food inflation registered a significant pick-up in August on accentuation of price pressures in cereals along with pulses, milk, vegetables and spices. Various exclusion-based measures of core were in range of 5.9 per cent to 6.2 per cent in August. In fact, all trimmed mean measures of core inflation edged up in August and were in the range of 6.2 per cent to 6.8 per cent, with weighted median registering a sharp 80 bps pick-up in August to 6.5 per cent. In some ways a pick-up of price pressures in core in August is also visible from core diffusion indices which firmed up in August. Inflation expectations also remain elevated.
58. There is, however, reason for confidence on inflation slowing down within the tolerance band next fiscal, given lagged impact of RBI rate hikes and easing of supply constraints. RBI’s quarterly model-based projection shows that inflation rate during 2023-24, on an average, will be 5.2 per cent.
59. In the current macroeconomic mix, while a rate hike in this meeting is imminent, the choice between a 35 to 50 bps is a close call. Given the growth- inflation dynamics, my vote is for an increase in repo rate by 50 bps and continue As per estimates based on Table 50 (a) and (b) of RBI Bulletin, September 2022. Monetary Policy Report, September 30, 2022. with the policy stance of withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. First, with current inflation level and the uncertainty around it, mooring of inflation expectations is important to restrain the broadening of price pressures and enhance credibility of the central bank, the benefits of which I had explained in my last minutes. Second, by showing continued commitment to inflation target, monetary policy seeks focused attention on its ‘inflation mandate’. As we are living in an information-rich world, we may get carried away by certain information-fraction and tend to form expectations, impacting prices, consumption and investment. The committed monetary policy actions fix the attention of various agents in the economy on the ‘inflation mandate’ even when the current inflation is elevated. This, in turn, will again help to anchor inflation expectations. 6 Third, the resilient growth about which I mentioned before provides us the space to act. Fourth, despite the recent empirical evidence supporting the perceived wisdom that real neutral rates declined both globally as well as in India 7, we need to keep in mind the level of inflation and surplus liquidity conditions prevailing at this juncture.
60. Reflecting the increases in the policy repo rate, the weighted average lending rate (WALR) on fresh rupee loans of SCBs has increased by 82 basis points during the period May to August 2022. The increase in share of external benchmark lending rate (EBLR) linked loans (46.9 per cent as at end-June 2022) coupled with shorter reset period for such loans have significantly improved the pace of transmission to WALR on outstanding loans. On the liability side, pass-through to term deposit rates is higher, if one considers both retail as well as bulk deposits. The extent of transmission is expected to improve further with the upward revision in interest rates on some small savings instruments.
61. In a scenario where growth momentum gains further traction and inflation pressures are projected to remain elevated over the remaining part of the year, before registering a moderation by Q1:2023-24, monetary policy has to persevere with its exit from accommodation to ensure that calibrated policy rate hikes dampen inflation expectations and firmly establish our commitment to price stability. This would help achieve the optimal mix of growth and inflation which will set the foundations for a high growth trajectory over the medium term. Statement by Dr. Michael Debabrata Patra
62. Central banks race in lockstep to raise policy rates by much more than their own historical experience. After all, current levels of inflation haven’t been seen in decades. Are they overshooting, or overdoing it?
63. They are balancing the prospects of a recession against the risks of inflation remaining elevated and persistent. Given their mandates and the credibility they work hard to earn (in the pandemic, they prioritised revival over price stability which cannot be faulted, but it is), they prefer now to err on the side of hawkishness in their determination to bring inflation to targets, fearing a 1970s redux.
64. This inflation shock defeats conventional forecasting models. The parameters that characterise recent developments are far outside the ranges predicted by the conventional models. No one really knows what is too far or what is far enough in this Simon, H. A. (1971). Designing organizations for an information-rich world. In M. Greenberger (Ed.), Computers, Communications, and the Public Interest. Johns Hopkins Press. Sims, C. A. (2010). Rational inattention and monetary economics. In Handbook of monetary economics (Vol. 3, pp. 155-181). S. Pattanaik, H.K. Behera and S. Sharma ‘Revisiting India’s Natural Rate of Interest’, RBI Bulletin, June 2022. environment. Central banks, therefore, adopt a risk minimisation strategy, ensuring they eradicate inflation, while allowing them to correct course and lower interest rates later if necessary.
65. Even so, currently available projections of inflation suggest that the real policy rates will remain negative up to close of 2022. Hence, more forceful tightening of monetary policy in 2023 may be required if terminal rates have to be achieved. This is being reflected in aggressive forward guidance, which has effectively restrained the relief rally that followed in the wake of pricing in of large rate actions in the recent past. Currency slides have become cliff events. Equities and bonds alike are selling off. Extreme risk aversion grips markets and investors.
66. Inflation management is suddenly complicated by the crystallisation of the impossible trinity. The conduct of domestically oriented monetary policy is becoming hostage to unidirectional exchange market volatility and mobile capital flows seeking safe haven. Recession risks may be darkening the horizon, but more immediately, global macroeconomic and financial stability is under threat. No country is immune. Systemic central banks should pay heed to the possibility that today’s spillovers can become tomorrow’s spillbacks.
67. For net commodity importers like India, with over a third of the CPI being imported, a negative terms of trade shock convolutes macroeconomic management. As current account deficits widen and capital flows turn fickle, reserve depletions become not just sources of forex liquidity to a risk wrung market but also instruments of stabilising expectations – the RBI stands for stability. Minimising volatility in the exchange rate becomes important from two points of view: (a) limiting risks to financial stability from foreign exchange exposures and pressures on margins of corporations; and (b) ensuring orderly functioning of financial markets so that volatility does not translate into financial stability risks. Accumulations during happier times have proved to be prudent.
68. Spillovers are global and overwhelming; however, the responsibility for securing stability is national. Each country is on its own.
69. In India, the moderation in inflation that had commenced in May 2022 has been interrupted by supply shocks which may extend into September. Although these shocks appear transitory at this juncture – barring energy prices which will be shaped by the evolving geopolitical situation – it is critical to remain watchful about second order effects if the shocks persist or recur. What is disquieting, however, is that inflation stripped of these transitory effects has become unyielding and tightly range bound around the upper tolerance band of the inflation target. The RBI’s forward- looking surveys suggest that selling prices in manufacturing and services may rise further as pass-through from input cost pressures remains incomplete. Exchange rate volatility is amplifying these core price pressures, especially in view of key import prices being invoiced in the US dollar. Inflation expectations are rising, with signs that they are becoming unanchored over a one year ahead horizon. Taken together with a closing output gap, rising capacity utilisation in manufacturing, surging demand for services and the pick-up in spending as the festival season nears, monetary policy must move to red alert.
70. At this critical juncture, monetary policy has to perform the role of nominal anchor for the economy as it charts a new growth trajectory. The focus should be on being time consistent in aligning inflation with the target. In this context, front-loading of monetary policy actions can keep inflation expectations firmly anchored and balance demand against supply so that core inflation pressures ease. It will also reduce the medium-term growth sacrifice associated with steering inflation back to target because it is being timed into the strengthening of the recovery of the domestic economy that is underway and likely to gather further momentum as the year progresses.
71. Accordingly, I vote for increasing the policy repo rate by 50 basis points and for maintaining the stance of withdrawal of accommodation. Statement by Shri Shaktikanta Das
72. The world is in the eye of a new storm originating from aggressive monetary policy tightening and even more aggressive forward guidance from advanced economy (AE) central banks. This has resulted in a tightening of global financial conditions, extreme volatility in financial markets, risk aversion among investors and sharp appreciation of the US dollar. Such market turmoil on top of globalisation of inflation and deglobalisation of trade has hugely negative consequences for emerging market economies (EMEs). Even in AEs, the narrative is increasingly shifting from stagflation to possible recession. These developments are taking place even as the world is still grappling with the shocks from COVID-19 and the conflict in Ukraine.
73. Amidst all these, the Indian economy presents a picture of resilience with macroeconomic and financial stability. The balance sheet of key stakeholders like corporates and banks remain strong. In an interconnected world, however, the Indian economy is obviously impacted by the unsettled global environment. There are pronounced consequences not only for our domestic inflation and growth dynamics, but also financial markets.
74. On the growth front, economic activity is steadily improving. There are, however, mixed signals. While high frequency indicators are showing continued momentum in activity, global factors are putting pressure on external demand. The growth projection of 7.0 per cent for 2022-23, therefore, carries risks which are broadly balanced. Whatever be the unfolding scenario, India is expected to be among the fastest growing major economies in the world.
75. Headline inflation, on the other hand, remains elevated and above the upper tolerance band of the target. As per current projections, headline CPI is expected to moderate to 5.8 per cent in Q4 of 2022-23 and further to 5.0 per cent in Q1 of 2023-
76. Overall, I remain optimistic about the future prospects of the Indian economy, its resilience and capacity to deal with the current and emerging challenges. We need to do whatever is necessary and under our control to restrain broadening of price pressures, anchor inflation expectations and contain second round effects. The need of the hour is calibrated monetary policy action, with a clear understanding that it is required for sustaining our medium-term growth prospects. Accordingly, I vote for raising the policy repo rate by 50 bps. As regards the stance, I vote for remaining focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. It is important to note that even though the policy rate has moved to pre-pandemic levels, the overall monetary conditions taking into account the liquidity position and the inflation remain accommodative. The net liquidity adjustment facility (LAF) continues to be in surplus for more than three years. Liquidity in the system may also be seen in totality taking into account all moving variables including excess CRR and SLR holdings of banks, and revenue and expenditure pattern of the government.
77. Going forward, monetary policy needs to remain watchful and nimble, based on incoming data and evolving conditions. We should remain vigilant on the inflation front while strengthening our macroeconomic fundamentals. The financial and external sectors also continue to be under the Reserve Bank’s close watch. In the final analysis, there is optimism and confidence around the India growth story and our current action is expected to add credence to that narrative. (Yogesh Dayal) Press Release: 2022-2023/1043 Chief General Manager
6. The global economic outlook is skewed to the downside. Global growth is set to lose momentum as monetary policy actions tighten financial conditions and as consumer confidence weakens with the rising cost of livelihood. Inflation remains elevated and persistent across countries as they grapple with food and energy price shocks and shortages. More recently, however, there are some signs of moderation in price pressures, which have raised expectations of an easing in the pace of monetary tightening. Alongside easing in sovereign bond yields, the US dollar has come off its highs. Capital flows to emerging market economies (EMEs) remain volatile and global spillovers pose risks to growth prospects. Domestic Economy
7. On the domestic front, real gross domestic product (GDP) increased by 6.3 per cent year-on-year (y-o-y) in Q2:2022-23 after an increase of 13.5 per cent in Q1. On the supply side, gross value added (GVA) rose by 5.6 per cent in Q2.
8. In Q3, economic activity is exhibiting resilience. In the agricultural sector, a pick-up in rabi sowing (6.4 per cent higher than a year ago on December 2) is supported by the good progress of the north-east monsoon and above average reservoir levels. Activity in the industry and services sectors is in expansion mode, as reflected in purchasing managers’ indices (PMIs) and other high frequency indicators.
9. Aggregate demand conditions have been supported by pent-up spending and discretionary expenditures during the festival season, although their evolution is somewhat uneven across sectors. Urban demand has remained buoyant, and rural demand is recovering. Investment activity is in modest expansion. Merchandise exports contracted in October after an expansion for 19 consecutive months. Growth in non-oil non-gold imports decelerated.
10. CPI inflation moderated to 6.8 per cent (y-o-y) in October 2022 from 7.4 per cent in September, with favourable base effects mitigating the impact of pick-up in price momentum in October. Food inflation softened, aided by easing inflation in vegetables and edible oils, despite sustained pressures from prices of cereals, milk and spices. Fuel inflation registered some easing in October, driven by softening of price inflation in LPG, kerosene (PDS) and firewood and chips. Core CPI (i.e., CPI excluding food and fuel) inflation persisted at elevated levels at 6 per cent, with price pressures across most of its constituent sub-groups.
11. The overall liquidity remains in surplus, with average daily absorption under the liquidity adjustment facility (LAF) at ₹1.4 lakh crore during October-November as compared with ₹2.2 lakh crore in August-September. On a y-o-y basis, money supply (M3) expanded by 8.9 per cent as on November 18, 2022 while bank credit rose by 17.2 per cent. India’s foreign exchange reserves were placed at US$ 561.2 billion as on December 2, 2022. Outlook
12. The inflation trajectory going ahead would be shaped by both global and domestic factors. In case of food, while vegetable prices are likely to see seasonal winter correction, prices of cereals and spices may stay elevated in the near-term on supply concerns. High feed costs could also keep inflation elevated in respect of milk. Adverse climate events – both domestic and global – are increasingly becoming a significant source of upside risk to food prices. Global demand is weakening. Unabating geopolitical tensions continue to impart uncertainty to the food and energy prices outlook. The correction in industrial input prices and supply chain pressures, if sustained, could help ease pressures on output prices; but the pending pass-through of input costs could keep core inflation firm. Imported inflation risks from the US dollar movements need to be watched closely. Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 100 per barrel, inflation is projected at 6.7 per cent in 2022- 23, with Q3 at 6.6 per cent and Q4 at 5.9 per cent, and risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 per cent and for Q2 at 5.4 per cent, on the assumption of a normal monsoon (Chart 1).
13. On growth, the agricultural outlook has brightened, with the prospects of a good rabi harvest. The sustained rebound in contact-intensive sectors is supporting urban consumption. Robust and broad-based credit growth and government’s thrust on capital spending and infrastructure should bolster investment activity. According to the RBI’s survey, consumer confidence is improving. The economy, however, faces accentuated headwinds from protracted geopolitical tensions, tightening global financial conditions and slowing external demand. Taking all these factors into consideration, the real GDP growth for 2022-23 is projected at 6.8 per cent with Q3 at 4.4 per cent and Q4 at 4.2 per cent, with risks evenly balanced. Real GDP growth is projected at 7.1 per cent for Q1:2023-24 and at 5.9 per cent for Q2 (Chart 2).
14. Inflation has ruled at or above the upper tolerance band since January 2022 and core inflation is persisting around 6 per cent. Headline inflation is expected to remain above or close to the upper threshold in Q3 and Q4:2022-23. It is likely to moderate in H1:2023-24 but will still remain well above the target. Meanwhile, economic activity has held up well and is expected to be resilient, supported by domestic demand. Net exports would remain subdued due to the drag from evolving external demand conditions. Further, the impact of monetary policy measures undertaken needs to be watched. On balance, the MPC is of the view that, further calibrated monetary policy action is warranted to keep inflation expectations anchored, break the core inflation persistence and contain second round effects, so as to strengthen medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 35 basis points to 6.25 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
15. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to increase the policy repo rate by 35 basis points. Prof. Jayanth R. Varma voted against the repo rate hike.
16. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted against this part of the resolution.
17. The minutes of the MPC’s meeting will be published on December 21, 2022.
18. The next meeting of the MPC is scheduled during February 6-8, 2023. Voting on the Resolution to increase the policy repo rate to 6.25 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The official estimate of year-on-year real GDP growth in Q2: FY 2022-23 at 6.3 per cent equals the September 2022 forecast by RBI. Although the YOY growth in Q2 is well below 13.5 per cent registered in Q1, it reflects a strong sequential momentum with QOQ growth at 3.6 per cent. Private Final Consumption Expenditure, Gross Fixed Capital Expenditure and exports of goods and services have shown sequential expansion over Q1. However, going forward, the growth scenario would be affected adversely by the slowing global growth even as growth-supportive policy measures provide new opportunities in the economy.
20. A review of wide range of indicators of the recent economic activity point to a mixed outlook for growth. The Index of industrial production (IIP) for September 2022, the latest month for which data are available, increased by 3.1 per cent YOY basis. However, the pattern has been uneven across sectors and also over time. In August the growth was negative after a modest growth of 2.2 per cent in July. IIP Consumer Non-durables declined in July, August and September, while it was negative in August and September for Consumer Durables. Gross Value Added from manufacturing and industry as a whole declined in Q2: FY 2022-23 and rose for Services. Value of merchandise exports declined in October by 12.1 per cent in US$ terms, after a sharp deceleration in Q2. Services exports have expanded YOY basis in October but declined relative to September.
21. On the positive note, IIP for Capital Goods and Infrastructure, and Construction registered acceleration on YOY basis in September. Purchasing Managers’ Index for manufacturing and services remained in expansion zone in October and November 2022. Although non-oil non-gold merchandise imports declined in October over September, they remained above the level in the same period in the previous year. GST collections registered YOY double digit growth in October and November. Non-food credit growth was high, averaging 17.6 per cent during September-November.
22. The qualitative indicators from the RBI’s surveys of urban households for September and November 2022 point to a gradual improvement in sentiments relating to overall economic conditions, employment and income. Increased consumer spending is supported by ‘non-essential’ items, with an expected improvement in sentiments for ‘discretionary’ spending only on one-year ahead basis.
23. While the economic activity levels moving into Q3: FY 2022-23 suggest resilience, outlook is, however, faced with the slowing global growth conditions. The global growth outlook has deteriorated since the last meeting of the MPC in late September. The IMF in its October 2022 World Economic Outlook projects a decline of world output growth YOY basis from 6.0 per cent in 2021 to 3.2 per cent in 2022 and 2.7 per cent in 2023, with downside risks to projections. The external demand conditions and capital flows to EMEs may weaken as a consequence. As the causes of the global growth slow down include the impact of COVID 19 related issues in China and the Ukraine war, besides the monetary policy tightening measures across countries, the outlook is also affected by the risk of high energy and food prices as their supply chains get disrupted.
24. Taking into account the trends in key exogenous global and domestic conditions, the revised real GDP growth rate, YOY basis, for FY 2022-23 is 6.8 per cent with Q3 and Q4 at 4.4 and 4.2 per cent, respectively. The revised growth rate for FY 2022-23 is lower by 20 basis points from the projections provided in the September MPC meeting. The GDP growth rate for FY 2023-24 is projected at 7.1 per cent for Q1 and 5.9 per cent for Q2.
25. The YOY CPI inflation moderated to 6.8 per cent in October from 7.4 per cent in September, with decline of 140 basis points in food inflation and 50 bps in fuel & light. The core inflation, based on CPI components excluding food and fuel remained at 6 per cent. The MOM momentum of prices, however, remained high. The headline CPI increased by 0.8 per cent in October over September, contributed by significant month- over-month increase in all the major components of CPI.
26. The general upward pressure on inflation may be attributed to incomplete transmission of previous input price hikes even as overall demand conditions show gradual improvement. The successive supply side shocks affecting the costs and prices beginning with the rising input and energy prices, food prices and strengthening US dollar may not have been fully offset by the rising selling prices in all sectors. The Wholesale Price Index (WPI) inflation, a measure of producer level prices, dropped to single digit (8.4 per cent) in October 2022 for the first time after a run of double-digit annual increase since April 2021. WPI YOY inflation for manufactured products category as a whole has been in single digits since June 2022 although for many energy items, the inflation rate remains in double digits. Declining profitability of firms seen in the corporate performance in Q2: FY 2022-23 in the manufacturing sector is one indication of the inability to recover all the cost increases fully.
27. The RBI Inflation Expectations Survey of Households in urban areas conducted in November indicates a drop in the median perceived headline inflation rate in November 2022 compared to September. The expectations of inflation rate three-month ahead and one-year ahead have also moderated in November compared to the expectations in September. However, the decline follows an upturn experienced in September and accordingly, the moderation of CPI inflation in October may have influenced the current household expectations. The Business Inflation Expectations Survey conducted by the Indian Institute of Management Ahmedabad 1 points to a reduction of one-year ahead inflation based on unit costs to less than 5 per cent in August and September 2022, although 45 per cent of the respondents continue to see the one-year ahead inflation rate at 6 per cent or above. The survey has also reflected a declining pattern of one-year ahead CPI inflation rate.
28. Taking into account the current trends in both domestic and international commodity prices and their major determinants, the CPI inflation rate for the full current financial year has been retained at 6.7 per cent, the same level as in the September meeting. The projections of CPI inflation rate for Q2 and Q3 are at 6.6 and 5.9 per cent, respectively. The projected YOY inflation rates for Q1 and Q2 of 2023-24 are also below 6 per cent. The median headline inflation rate projected by the RBI survey of Professional Forecasters conducted in November 2022 is at 6.6 per cent for Q3: FY 2022-23 and 6.1 per cent for Q4: FY 2022-23, with 6.7 per cent for the financial year as a whole.
29. With overall domestic growth showing signs of resilience, the adverse global macroeconomic conditions require that domestic inflation rate is at moderate levels, within the tolerance band of the inflation target on a sustained basis. The persistence of core inflation at the upper limit of the tolerance band of the inflation target is of particular concern. Slippage on both growth and inflation objectives together would be a poor outcome. Keeping in view the need to achieve moderation in the inflationary pressures in a sustained manner, continuing with the monetary policy tightening measures is necessary at this stage.
30. Accordingly, (1) I vote to increase the policy repo rate by 35 basis points and also (2) I vote to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
31. Multiple global risks continue but as a growth slowdown threatens many countries, inflation and rate actions of major central banks are also slowing. While continuing to talk tough, even the US Fed has recognized the importance of monetary lags and of responding to economic and social developments. There is a view that since US long- term inflation expectations remain at 3 per cent, the ex-ante real rate is already restrictive.
32. Markets have priced in a possible pivot, although communication shocks continue to create volatility. The dollar is weakening especially as other advanced economy central banks also raise rates. The worst of the adjustment seems past. India saw a return of 1 https://iima.ac.in/faculty-research/centers/Misra-Centre-for-Financial-Markets-and-Economy/BIES. inflows in July, a few months before the reversal in other emerging markets (EMs) in November—indicating confidence in India’s outperformance. FX reserves are rising again. Large rupee depreciation is unlikely to add to inflation pressures in the months ahead.
33. Global commodity prices have softened. The index for Indian supply chain pressures has been falling since May 2021. It is now below the long-period average. The impact is visible in the sharp fall in India’s WPI. That this is falling without a substantial pass through to CPI, suggests that firms have not raised prices to the extent of input cost pressures. This may be partly due to soft demand and cost-saving measures, and hopefully the beginnings of the realization that cost shocks are temporary if the inflation target is working to anchor expectations. The IIM Ahmedabad business inflation expectation survey shows moderation in cost pressures and in sales, while one year ahead inflation expectation remains below 5%, although profit margins are expected to rise with the fall in costs. The gap between PMI input and output prices has almost closed for manufacturing while it has fallen significantly from its May peak levels for services. Good sowing despite extended rains is lowering food prices.
34. In core inflation the contribution of transport and communication is reducing, as is another dominant component, clothing, after cotton prices peaked in August. Persistence is due to multiple supply shocks more than to second round effects. RBI inflation forecasts are based on the assumption of the Indian crude oil basket at $100 but India’s current basket is ruling much below this level. Although domestic pass-through is yet to happen, downside risks to inflation are high.
35. Indian exports and manufacturing output are slowing with global demand; that imports are also decelerating, even with only about 60% pass through in fresh loans, suggests domestic demand is also shrinking. Anecdotal evidence indicates small firms are finding it too expensive to invest. Their contribution is necessary to reverse the investment slowdown of the last decade, to prevent future bottlenecks and rise in costs and to build export and employment capacity. India has excess non-oil imports partly because this capacity was not built in the last decade.
36. Inflation targeting anchors inflation if policy rates rise one for one with expected inflation, so the expected real rate is positive and close to the equilibrium rate. Second, lagged transmission of higher policy rates lowers demand. The MPC has made sure of the first and the second is in process.
37. The average inflation projection for the next four quarters is 5.7% and in Q2FY24 it is 5.4%. So the real policy rate is positive and will rise through the year. Since there are many factors working to chill demand, policy has to be careful in adding to these. Multiple estimations show that through the demand channel of transmission, Indian interest rates affect output first and inflation less and only with long lags.
38. Moreover, interest rate spreads in the Indian system are high. While the yield spread of investment grade G-secs over hard currency sovereign yields averaged 200bps for emerging markets 2; the Indian 10 year G-sec spread over the US 10 year is about double this (rates were 7.21% compared to 3.5% on December 1). The 3 month commercial paper rate is above 7%. Higher spreads imply a larger demand reducing effect of a rise in the policy repo rate. Pass through to loan rates is also faster with the external benchmark for loan rates. 2 IMF. 2022. 'Global Financial Stability Report: Navigating the High-Inflation Environment.' International Monetary Fund. October. Available at: https://www.imf.org/en/publications/gfsrIMF GFSR. See Fig 3 in the executive summary.
39. At present, however, Indian imports are still too high. A sticky terms of trade shock lowers potential output, requiring demand to fall. In addition, inflation still exceeds the MPC tolerance band for the 10th consecutive month. So I vote to raise the repo rate by 35bps to 6.25%. I would have preferred a smaller rise of 25bps, but 6.25% works well as a focal rate.
40. Other instruments are available, apart from a demand contraction, to attain a more sustainable current account deficit (CAD). These include export promotion, building domestic capacity and reducing dependence on oil imports. India’s remittances and software exports remain robust and the transition to a green economy is progressing well. Rising share of financial savings will also reduce the CAD. There are also multiple financing options for the CAD.
41. Since India does not have full capital account convertibility, the uncovered interest parity (UIP) relation that says nominal domestic interest rates must equal US nominal rates plus expected rupee depreciation does not hold in its pure form. Standard advice based on the UIP is a way to force other countries to follow US policy. They must either raise domestic rates with Fed rates to prevent depreciation; or under inflation targeting let the currency depreciate then raise rates as inflation rises. But this is the way to aggravate foreign shocks.
42. India has the space to suit policy to domestic needs and has done better because it has used it. Capital flow management and intervention has successfully prevented excess depreciation. Reserves are rising again. The interest gap is larger for longer periods and in real terms 3. For short rates prudential measures such as reducing banks’ open position limits can be used if necessary, without following US rate hikes.
43. Coming to the stance, withdrawal of accommodation was alright as long as the large liquidity surpluses and excessive rate cuts of pandemic times persisted. But durable liquidity seems to have contracted so much that the LAF system has not been able to compensate for liquidity shocks during the last two months. The call money rate has exceeded the repo rate for much of the time. It is time to move to a neutral stance, where movement can be data-based in any required direction, as new information affects forward projections. Accordingly, I vote against the part of the resolution on remaining focused on the withdrawal of accommodation.
44. An EM faces large liquidity shocks, especially as major countries go in for quantitative tightening. The LAF system has made much progress and should be able to prevent excessive short-term liquidity tightening. If shocks are too large adequate surplus should be created in durable liquidity. An inflation targeting regime itself provides the inflation anchor; the anchor is not money or liquidity supply.
45. In response to market volatility after the Truss budget, the Bank of England has shown how clear communication can separate the market-making from the monetary policy function of liquidity. While market-making may be required in AEs with high leverage and under-regulation of the non-bank financial sector, in India it can be used to ensure financial conditions are able to support the creation of credit even as repo rates rise. Financial regulation and balance sheets have strengthened, lending is risk-based, corporates have de-leveraged. It is time for a reversal of the credit drought of the last decade. The ten year G-sec spread is more than double the spread between US Fed and Indian repo rates. US real Fed rate is highly negative while the Indian real repo rate will soon be positive. Statement by Prof. Jayanth R. Varma
46. Since the September meeting, the balance of risks has shifted decisively away from inflation to growth both globally and domestically. There are now clear signs that the global supply side shocks emanating from the pandemic and the Ukraine war are finally receding. The strongest signal is the sharp fall in crude prices in the second half of November. Global inflation seems to have peaked and is now probably heading lower. Added to this is the fact that it is only over the next few quarters that the real economy will experience the full brunt of the front-loaded tightening by central banks across the world. All in all, there is much reason to be optimistic about global inflationary pressures easing.
47. In this context, I would like to point out that the RBI’s inflation projections (as well as that of some professional forecasters surveyed by the RBI) are still based on the assumption of an average crude price (Indian basket) of $100. This is about 15-20% higher than the Brent crude futures curve at the time of this meeting. Perhaps, these forecasters believe that the Brent futures market is unreliable due to various behavioural biases. But an assumption so sharply at deviance from liquid market prices needs to be justified on the basis of economic and geopolitical fundamentals. In mid-November, the futures market appears to have reassessed the geopolitical pulls and pressures on OPEC in the light of observed political outcomes. If the forecasters disagree with this reassessment, they need to articulate and justify their alternative narrative. In the absence of such articulation, one could be pardoned for suggesting that the $100 Brent crude assumption reflects the well known behavioural biases of salience and conservatism.
48. On the domestic front also, there is strong evidence of easing of inflationary pressures. The pricing power of producers appears to have eroded dramatically as reflected in the sharp reduction in corporate profitability. Inflation has eased from the 7%+ levels witnessed in the middle of the year, and more importantly inflation expectations of both households and businesses have trended down.
49. On the other hand, growth concerns have become more troubling in recent months both globally and domestically. Financial markets are pricing in the likelihood of a recession in several advanced economies. During the pandemic, exports and government spending were the two growth engines that counteracted the headwinds confronting the Indian economy. Of these, the global slowdown has already led to the export growth engine grinding to a halt. Fiscal constraints limit the ability of government spending to hold up the economy on its own. Private investment is unlikely to be able to pick up the slack. Anecdotal evidence suggests that concerns about future growth prospects are deterring capital investment even by companies that have reached more than 80% capacity utilization. That leaves only private consumption which has remained buoyant, but it remains to be seen how much of this is due to pent up demand which could dissipate over the coming months. All of this means that economic growth is now extremely fragile and definitely not robust enough to withstand excessive monetary tightening.
50. I believe that the 35 basis point rate hike approved by the majority of the MPC is not warranted in this context of reduced inflationary pressures and heightened growth concerns. I therefore vote against this resolution.
51. Turning to the stance, my views are the same as in September when I argued for a pause. Because monetary policy acts with lags, it may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters. The MPC has raised the repo rate by 225 basis points in about eight months. Accounting for the fact that in 2021 money market rates were close to the reverse repo rate (65 basis points below the repo rate), the full magnitude of monetary tightening would be 290 basis points. Much of the impact of this large front-loaded monetary policy action is yet to be felt in the real economy. For these reasons, I believe that 6.25% itself very likely overshoots the repo rate needed to achieve price stability, and poses an unwarranted risk to economic growth. The majority of the MPC is saying that they intend to tighten even more by withdrawing accommodation. This stance would be even more damaging to the fragile growth outlook and I therefore vote against this resolution also. Statement by Dr. Rajiv Ranjan
52. In these uncertain and difficult times, monetary policy making is a daunting task. Achieving and maintaining credibility 4 – a valuable asset for any central bank – is still a bigger challenge. In the quest to rein in inflation while supporting growth, central banks are, therefore, confronted with an important decision of ‘how fast, how far and how long’ 5 the ongoing tightening phase should continue. While entailing difficult trade-offs, these choices and its combinations, as would be eventually decided upon by the central banks, remain vital and would set the tone for the world economy in the ensuing year. Some central banks have already started considering a pivot towards slower pace and lesser quantum of rate hikes or taking a pause on the tightening cycle.
53. India is no different. There are several forces at work. One has to consider not only evolving domestic growth and inflation dynamics, while also accounting for related factors like cumulative tightening and its impact, lags in transmission, unexpected global and domestic shocks, the terminal rate itself, among others. Moving slowly and doing too little could lead to macroeconomic instability with the unhinging of inflation expectations which, more importantly, may warrant stronger actions later that could be much more detrimental than the costs of overtightening. 6 On the contrary, doing too much could hurt growth. Conventionally, monetary policy credibility varies endogenously with the policy pursued and a non-gradualist approach leads to enhanced credibility, can bring faster disinflation that entails lower sacrifice ratio (Sargent, 1986; Ball, 1994). 7 These outcomes are, however, subject to several rigidities and irrationality that may result in larger growth sacrifice. Therefore, monetary policy needs to be watchful depending upon evolving macroeconomic signals in balancing between gradualism and acting too fast, too soon.
54. As I had indicated in my statement of September 2022, there was a close call between increasing the policy repo rate by 35 bps or 50 bps. After frontloaded rate hikes since May 2022, there is a strong case now to take the foot off the accelerator while keeping a sharp vigil on the inflation trajectory. Moreover, with inflation trajectory panning out broadly along anticipated lines and also, considering the ongoing pass-through of earlier monetary policy actions and the evolving growth-inflation dynamics, monetary policy response can be calibrated to a lesser order. Thus, an increase of 35 bps is felt appropriate at the current juncture, while also continuing with the stance of withdrawal of accommodation, and I vote for the same. Any change in stance at this stage could be interpreted as weakening of our resolve to fight the inflation menace and will impede 4 See my statement in “Minutes of the Monetary Policy committee meeting of August 2022” released on August 19, 2022. 5 “Front-loading” monetary tightening: pros and cons, BIS Bulletin, December 2022. 6 IMF, World Economic Outlook, September 2022. 7 Ball, L., 1994. What determines the sacrifice ratio? In: Mankiw, N. G. (Ed.), Monetary policy. The University of Chicago Press, pp. 155–193. Sargent, T. J., 1986. Stopping Moderate Inflations: The Methods of Poincare and Thatcher. In: Sargent, T. J. (Ed.), Rational expectations and inflation. Harper & Row, New York, pp. 110–157. monetary policy transmission. The objective is to ensure a sustained disinflation that brings inflation down within the tolerance band in the short-run and closer to the target over the medium term, while supporting growth. These decisions are premised on the following considerations.
55. Though there has been moderation in inflation by 60 bps in October, certain underlying trends need to be closely watched. First, price momentum in October was at the highest level since May 2022 and has also showed a sequential increase since August 2022. Second, core (CPI excluding food and fuel) inflation remains sticky at 6 per cent, with its momentum in October being the highest since April 2022, even on a seasonally adjusted basis. In fact, deflation in petrol and diesel has masked the full extent of inflationary pressures in core. Excluding petrol and diesel, transportation and communication inflation was at 7.7 per cent. Trimmed mean measures of inflation remained elevated. Third, there is evidence of continuing generalisation of price pressures, especially in core. Diffusion indices for CPI headline and core continued to show strong expansion in prices across the CPI basket. These factors suggest persistent price pressures, which along with geo-political tensions and adverse climate events adds to uncertainty, warranting a continuation of calibrated monetary policy action.
56. Growth, on the other hand, remains resilient with drag coming mainly from net exports. Faster reopening of China, signs of deceleration in inflation in US and easing global commodity prices are tailwinds which may limit the downside to the world demand in 2023. From our perspective, signs of peaking of US dollar appreciation with lower crude prices, despite news of early reopening in China, are strong positives. Though lower crude prices would not help inflation immediately 8 due to unchanged petrol and diesel pump prices as under-recoveries of Oil Marketing companies (OMCs) continue, but will help external sector balance with lower imports, which already is showing sign of tapering. Importantly, the trend in the momentum of the major components of GDP is assuring. For instance, the momentum of real GDP in Q2:2022-23 has been robust at 3.6 per cent as against pre-pandemic (2012-13 to 2019-20) average of 0.9 per cent; similarly, the two main drivers of GDP – private consumption and investment – recorded a momentum of 1.0 per cent and 3.4 per cent, respectively, in Q2, as against negative pre- pandemic average momentum for Q2 [(-)0.1 per cent and (-)1.4 per cent, respectively, during 2012-13 to 2019-20)]. On the supply side, a strong rebound in contact-intensive services (trade, hotels, transportation, communication and others) with a momentum of 16.0 per cent (as against pre-pandemic average momentum of (-)1.6 per cent during 2012-13 to 2019-20) underpinned the growth in real GVA in Q2.
57. The discussion on terminal rate in monetary policy is clouded by the uncertainty on the strength and direction of growth and inflation impulses. In this scenario, the important point to note is that the terminal rate is time varying and has to be discovered based on incoming data and evolving situation. With the rate hikes done so far, and considering the inflation outlook, it can be said with certainty that real rates have moved decisively towards positive territory, yet one cannot be sure of the same if one uses the realised current inflation argument, which is fast gaining ground under uncertain conditions. 9 Ensuring monetary conditions and stance are appropriately calibrated to current growth- inflation dynamics is crucial as bank deposit and lending rates in real terms are much lower than pre-pandemic levels.
58. Overall, monetary policy geared towards price stability while taking into account output dynamics is the best guarantee to ensure lasting prosperity. Besides, in all 8 Accordingly, and given the uncertainties, the assumption of crude oil at US$ 100 per barrel was retained. 9“Interest rates have risen sharply. But is monetary policy truly tight?” The Economist, November 12-18, 2022. probability, growth concerns globally and in India may assume primacy in 2023 as the global economy slows down on the back of tightening financial conditions even as global supply chains get restored and input cost pressures ease from current levels. Statement by Dr. Michael Debabrata Patra
59. Recent data arrivals point to a pick-up in seasonally adjusted momentum of real GDP growth into positive territory in the second quarter of 2022-23. Notably, this improvement has occurred on the strength of domestic drivers that overcame the contraction in net exports. Projections indicate that positive momentum will likely be sustained through the rest of the year. It remains to be seen if the strength of that momentum is able to offset strong, pandemic-induced unfavourable base effects. For 2023-24, a tempering of the pace of real GDP growth relative to this year’s rate needs to be factored in, given warnings of global slowdown and hence a rising drag from net exports for India; still muted domestic private investment in spite of capacity utilisation having crossed trend levels in a number of industries; and, tightening financial conditions.
60. On the other hand, inflation in India remains unconscionably elevated, persistent and generalised, despite a grudging let-up in October solely due to favourable base effects. The momentum of price increases was, in fact, the highest since May 2022. Core inflation remains unyielding and diffused, with a rising price momentum as it tests the upper tolerance band on its own, warranting resolute monetary policy resolve to quell it. Evolving global inflation movements juxtaposed with our projections would suggest that India’s headline inflation may ease slightly through the rest of the year. The effects of monetary policy actions taken so far, supported by improvements in supply responses, could break the 7 per cent plus drift in average headline inflation and at best contain it in the range of 5-6 per cent over the year ahead. Thus, inflation can be expected to remain above target over the next 12 months.
61. The longer inflation stays at current levels, the greater is the danger of expectations getting unhinged, frittering away the moderation reported in the most recent surveys of households, businesses and professional forecasters. The risk of inflation eroding purchasing power and weakening consumer spending, especially on discretionary items, is becoming significant. Inflation expectations may also be stalling private investment in capacity creation, as reflected in corporate performance during the second quarter of 2022-23.
62. Accordingly, further withdrawal of accommodation is warranted to re-balance aggregate demand against supply conditions and return inflation first into the tolerance band and then to alignment with the target. This is essential for sustaining the positive turn in the momentum of growth.
63. The size and pace of further increases in the policy rate should take into account this inflation objective. It is also necessary to incorporate the effects of cumulative rate increases undertaken so far, the transmission to longer-term rates achieved so far, the movements in real interest rates, and the ongoing impact on macroeconomic and financial conditions as they evolve. Accordingly, a modest reduction in the size of the policy rate increase in this meeting would provide the opportunity to weigh that assessment carefully.
64. Should the incoming information indicate that the recent small easing of inflation is transient rather than the onset of a durable downturn, the MPC should be prepared to respond appropriately in order to achieve the desired inflation objective. In essence, the MPC needs to see a decisive decline in inflation over a series of monthly readings before it shifts stance, which would otherwise be premature.
65. I vote for an increase in the policy rate by 35 basis points and a stance that remains focused on the withdrawal of accommodation. Statement by Shri Shaktikanta Das
66. Amidst headwinds from slowing global growth and trade, the Indian economy is exhibiting resilience and holding up well. Real GDP growth at 6.3 per cent in Q2:2022-23 was on the lines expected by us. Incoming information for Q3 indicates that economic activity remains strong. Living as we are in an interconnected world, we cannot remain entirely decoupled from adverse global spillovers. External demand is weakening and this is having its negative impact on our exports. Overall, India’s real GDP is expected to grow by 6.8 per cent in 2022-23 and India will remain amongst the fastest growing major economies, even as rising recession possibilities characterise the global economy.
67. Headline inflation is moderating, albeit slowly. While the worst of inflation is behind us, it remains above the upper tolerance level. It is expected to decline in H1:2023-24 but would still be well above the target. Uncertainties surrounding the inflation trajectory remain sizeable, given the geopolitical tensions, global financial market volatility, pending pass-through of input costs to domestic output prices and weather-related disruptions. Core inflation (CPI excluding food and fuel) is exhibiting persistence around 6 per cent for the past few months. Hence, there is no room for complacency and the battle against inflation is not over. This necessitates a constant vigil on prices.
68. Our successive rate actions since May 2022 are working through the system. Considering the elevated inflation levels, especially the stickiness in core inflation, further calibrated monetary policy action is warranted to contain build-up in underlying inflationary pressures, keep inflation expectations anchored, and bring inflation closer to the target rate of 4 per cent over the medium term. This would strengthen the medium- term growth prospects of the Indian economy.
69. I am, therefore, of the view that a premature pause in monetary policy action would be a costly policy error at this juncture. Given the uncertain outlook, it may engender a situation where we may find ourselves striving to do a catch-up through stronger policy actions in the subsequent meetings to ward-off accentuated inflationary pressures. I, therefore, vote for an increase of 35 basis points in the repo rate – a departure from 50 bps on three previous occasions – which itself conveys the signal of an improvement in the inflation outlook.
70. Considering the prevailing policy repo rate, liquidity conditions and the expected trajectory of inflation over the next several months, it is essential to persist with the stance of withdrawal of accommodation. Hence, I vote for the same.
71. To conclude, let me add that in a tightening cycle, especially in a world of high uncertainty, giving out explicit forward guidance on the future path of monetary policy would be counterproductive. This may result in the market and its participants overshooting the actual play out of real conditions. In such circumstances, it would be prudent to keep Arjuna’s eye on the evolving inflation dynamics and be ready to act as may be necessary. Monetary policy has to be nimble to address any emerging risk to the price stability, while keeping in mind the objective of growth. (Yogesh Dayal) Press Release: 2022-2023/1420 Chief General Manager
6. The outlook on global growth has improved in recent months, despite the persistence of geopolitical hostilities and the impact of monetary policy tightening by central banks across the world. Nonetheless, global growth is expected to decelerate during 2023. Inflation is exhibiting some softening from elevated levels, prompting central banks to moderate the size and pace of rate actions. However, central banks are reiterating their commitment to bring down inflation close to their targets. Bond yields remain volatile. The US dollar has come off its recent peak, and equity markets have moved higher since the last MPC meeting. Weak external demand in major advanced economies (AEs), the rising incidence of protectionist policies, volatile capital flows and debt distress could, however, weigh adversely on prospects for emerging market economies (EMEs). Domestic Economy
7. The first advance estimates (FAE) released by the National Statistical Office (NSO) on January 6, 2023, placed India’s real gross domestic product (GDP) growth at 7.0 per cent year-on-year (y-o-y) for 2022-23, driven by private consumption and investment. On the supply side, gross value added (GVA) was estimated at 6.7 per cent.
8. High frequency indicators suggest that economic activity has remained strong in Q3 and Q4:2022-23. Rabi acreage exceeded last year’s area by 3.3 per cent as on February 3, 2023. Industrial production expanded by 7.1 per cent in November, after contracting by 4.2 per cent in October. Capacity utilisation in manufacturing is now above its long period average. Port freight traffic, e-way bills and toll collections were buoyant in December. Purchasing managers’ indices (PMIs) for manufacturing as well as services remained in expansion in January, despite some moderation compared to the previous month.
9. Domestic demand has been sustained by strong discretionary spending. Urban demand exhibited resilience as reflected in healthy passenger vehicle sales and domestic air passenger traffic. Rural demand is improving. Investment activity is gradually gaining ground. Non-oil non-gold imports expanded in December. Merchandise exports, on the other hand, contracted in December on weak global demand.
10. CPI headline inflation moderated to 5.7 per cent (y-o-y) in December 2022 – after easing to 5.9 per cent in November – on the back of double digit deflation in vegetable prices. On the other hand, inflationary pressures accentuated across cereals, protein- based food items and spices. Fuel inflation edged up primarily from an uptick in kerosene prices. Core CPI (i.e., CPI excluding food and fuel) inflation rose to 6.1 per cent in December due to sustained price pressures in health, education and personal care and effects.
11. The overall liquidity remains in surplus, with average daily absorption under the LAF increasing to ₹1.6 lakh crore during December-January from an average of ₹1.4 lakh crore in October-November. On a y-o-y basis, money supply (M3) expanded by 9.8 per cent as on January 27, 2023, while non-food bank credit rose by 16.7 per cent. India’s foreign exchange reserves were placed at US$ 576.8 billion as on January 27, 2023. Outlook
12. The outlook for inflation is mixed. While prospects for the rabi crop have improved, especially for wheat and oilseeds, risks from adverse weather events remain. The global commodity price outlook, including crude oil, is subject to uncertainties on demand prospects as well as from risks of supply disruptions due to geopolitical tensions. Commodity prices are expected to face upward pressures with the easing of COVID- related mobility restrictions in some parts of the world. The ongoing pass-through of input costs to output prices, especially in services, could continue to exert pressures on core inflation. The Reserve Bank’s enterprise surveys point to some softening of input cost and output price pressures in manufacturing. Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 95 per barrel, inflation is projected at 6.5 per cent in 2022-23, with Q4 at 5.7 per cent. On the assumption of a normal monsoon, CPI inflation is projected at 5.3 per cent for 2023-24, with Q1 at 5.0 per cent, Q2 at 5.4 per cent, Q3 at 5.4 per cent and Q4 at 5.6 per cent, and risks evenly balanced (Chart 1).
13. The stronger prospects for agricultural and allied activities are likely to boost rural demand. The rebound in contact-intensive sectors and discretionary spending is expected to support urban consumption. Businesses and consumers surveyed by the Reserve Bank are optimistic about the outlook. Strong credit growth, resilient financial markets, and the government’s continued thrust on capital spending and infrastructure create a congenial environment for investment. On the other hand, external demand is likely to be dented by a slowdown in global activity, with adverse implications for exports. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.4 per cent with Q1 at 7.8 per cent, Q2 at 6.2 per cent, Q3 at 6.0 per cent and Q4 at 5.8 per cent, and risks broadly balanced (Chart 2).
14. The easing of inflation in the last two months was driven by strong deflation in vegetables, which may dissipate with the summer season uptick. Headline inflation excluding vegetables has been rising well above the upper tolerance band and may remain elevated, especially with high core inflation pressures. Inflation, therefore, remains a major risk to the outlook. Domestic economic activity is expected to remain resilient aided by the sustained focus on capital and infrastructure spending in the Union Budget 2023-24, even as continuing fiscal consolidation creates space for private investment. While the policy repo rate increases undertaken since May 2022 are working their way through the system, it is imperative to remain alert on inflation so as to ensure that it remains within the tolerance band and progressively aligns with the target. On balance, the MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and thereby strengthen medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 25 basis points to 6.50 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
15. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to increase the policy repo rate by 25 basis points. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted against the repo rate hike.
16. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted against this part of the resolution.
17. The minutes of the MPC’s meeting will be published on February 22, 2023.
18. The next meeting of the MPC is scheduled during April 3, 5 and 6, 2023. Voting on the Resolution to increase the policy repo rate to 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal No Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The present trajectories of inflation and growth, relative to the situation that prevailed in the December 2022 MPC meeting reflect continued moderation in the pace of CPI inflation seen in November into December and also holding on to the growth momentum projected for FY 2022-23. However, the moderation seen in inflation is mainly driven by a few food commodities and the CPI excluding food and fuel, remained at or above 6 per cent, year on year basis, during November-December 2022. On the growth front, the slowdown in the pace of global output growth has begun to impact external demand conditions. While the indicators such as non-food bank credit, GST collections and PMI for both manufacturing and services point to the continued momentum of domestic demand, the overall YOY growth in H2 of 2022-23 is expected to be lower compared to H1. The evolving trajectories of growth and inflation in the short term are, therefore, subject to significant uncertainty.
20. The First Advance Estimates of national income by the NSO for FY 2022-23 place the real GDP growth at 7 per cent over the previous year, slightly above the assessment provided during the December 2022 meeting of the MPC. The first official estimates of the economic activity by the NSO for the year 2022-23 as a whole point to the continued modest growth momentum over the pre-pandemic year, in the face of multiple challenges that emerged through the year. Private Consumption Expenditure, Gross Fixed Capital Formation and Exports of Goods and Services rose YOY basis, but at slower pace than in 2021-22. The growth performance in FY 2022-23 was contributed mainly by the sharp rise of 13.5 per cent in Q1 followed by an expected average of 5.1 per cent in the subsequent three quarters. Nevertheless, the year has seen steady quarter-on quarter growth momentum.
21. The IMF projections of World Output growth for 2022 and 2023 have been revised upward in the January 2023 World Economic Outlook Update compared to the assessment in October 2022. However, the output growth rate in 2023 is projected to decline to 2.9 per cent from 3.4 percent in 2022 and then rise to 3.1 per cent in 2024. Growth in the World trade volume is projected to decline sharply in 2023 with a pickup in the momentum in 2024. Commodity prices - both fuel and non-fuel - are projected to decline by the IMF in 2023 and 2024. The IMF update also notes that the risks to the projections are on the downside, with lower growth and higher inflation, but more moderate than its October 2022 assessment.
22. The impact of slowdown of growth globally on India’s external sector was evident in the slower pace of growth of exports and imports of goods and services in terms of constant rupee value. In terms of US dollar value, merchandise exports growth was negative in Q3: 2022-23. Merchandise imports growth, YOY basis, declined sharply in Q3 turning negative in December.
23. As the external demand conditions remain weak, domestic growth impulses are necessary for sustaining aggregate demand. The FAE point to GVA growth of 13.7 per cent YOY basis in 2022-23 in trade, transport, communication and broadcasting services driving growth in the services sector as a whole at 9.1 per cent. Industry, in contrast, is projected to grow by less than 3 per cent and manufacturing by less than 2 per cent in terms of GVA. For industry, even in terms of IIP, the growth performance in 2022-23 has been fluctuating. IIP for capital goods and infrastructure/ construction goods rose sharply in November 2022, on YOY basis, after a weak growth in October. Similar pattern was seen during August and September 2022. IIP Consumer durables and non-durables registered negative YOY growth rates during August 2022 to October 2022, to rise in November 2022. In this sense, a balanced growth performance will require significant acceleration in the manufacturing growth that will also require rising demand for manufactured goods. The Union Budget for 2023-24 with its stepped up capital expenditure will support capital formation in the key areas of infrastructure.
24. In terms of forward-looking data, the RBI survey of consumer confidence conducted in January 2023, reflects improvement in one-year ahead expectations buoyed by expectations of higher spending, improved general economic conditions, employment and income. However, the spending sentiments appear cautious, especially the ‘non-essential expenditure’. While there is an increase in the proportion of sample households who expect to spend more on ‘essential items’ over the previous round of the survey, the sample households are evenly divided on the expectations to increase or not increase the ‘non-essential spending’ one year ahead from now. The caution appears to be related to the expectation of higher inflation rate. The one-year ahead consumer expectations point to a higher inflation rate compared to the prevailing conditions.
25. The enterprise surveys on outlook conducted by RBI during mid-October to mid- December 2022 reflect improved overall business situation in the immediate term of Q4:2022-23 for manufacturing and infrastructure but stable for services after an overall significant improvement in Q3 for all three segments. The expectations for the first two quarters of 2023-24 are mixed, with the manufacturing sector enterprises showing diminished expectations, while expectations of services and infrastructure enterprises remain unchanged from Q4: 2022-23. The NCAER-NSE Business Confidence Index 1 based on the quarterly survey of enterprises conducted in December 2022 was higher YOY basis but fell sequentially as compared to Q1 and Q2: 2022-23.
26. The inflation pattern in November and December 2022 shows moderation in price pressures at the aggregate level but the moderation is resulting mainly from a sharp decline in prices of vegetables. The headline CPI inflation came below 6 per cent mark in November and December. The ‘Food and Beverages’ component of CPI registered YOY increase of under 6 per cent in these two months, with CPI for Fuel and Light increasing at double digit rate and CPI excluding food and fuel at or above 6 per cent. The current momentum of the decline in inflation rate remains vulnerable to price changes in one or two commodity groups. Across the main commodity groups within the food sector, a number of them show YOY inflation rate of above 6 per cent. Cereals & products, eggs, milk and products, spices and prepared meals & snacks, accounting for more than half https://www.ncaer.org/BES/NCAER_NSE_BES_Report_January_2023.pdf. the weight of the Food & Beverages group in the CPI, rose at rates above 6 per cent in December 2022. Cereals and products rose at double digit YOY rates during September- December 2022. The Business Inflation Expectations Survey (BIES) conducted by IIM Ahmedabad covering mainly manufacturing firms has reported a decline in the one-year ahead expectation of YOY consumer inflation to 4.91 per cent in December 2022 compared to 5.32 per cent in October 2022. The survey also reports an assessment of the one-year ahead ‘business inflation’ based on the unit cost, at 4.19 per cent in December 2022 down from 4.70 per cent in October 2022. In both the cases, the expected inflation rates have generally declined in the period June 2022 onwards.
27. The trends in various indicators of level of economic activity point to achieving the FAE of GDP growth of 7 per cent in 2022-23. The weakened global growth conditions on account of tight monetary policy conditions and the continuing Russia-Ukraine war would mean a lower growth of about 6.4 per cent in 2023-24, with a quarterly break up provided in the MPC Resolution. The Survey of Professional Forecasters conducted by the RBI in January 2023 projects, YOY basis, GDP growth rate of 6.9 per cent for FY 2022-23 and 6.0 per cent for FY 2023-24.
28. The inflation pressures have persisted even with the decline in the headline inflation rate below 6 per cent in November and December 2022. The decline in vegetable prices, main contributor to the moderation in Headline inflation rate, is a seasonal feature, although the correction this time has taken place earlier and is more than the usual fall. The pattern in the several other commodity prices, where the price rise has been sharp, is of concern from a price stability perspective. Moderation in the headline inflation can be expected on a sustained basis only when most of the major components of the index come within the 6 per cent mark. External factors such as international commodity prices are expected to provide relief on the price front; but the pass through of this benefit to the consumer basket will be affected by the exchange rate variations and domestic price setting of petroleum fuels. The headline inflation rate for FY 2022-23 and FY 2023-24 is now projected at 6.5 per cent and 5.3 per cent, respectively, with the quarterly break up provided in the MPC Resolution. In comparison, the Survey of Professional Forecasters conducted by the RBI in January 2023 projects a headline inflation rate of 6.5 per cent for FY 2022-23 and 5.1 per cent for FY 2023-24.
29. Persistence of core inflation at a high level is a crucial concern at this stage. It is important to reduce the demand side pressures on inflation and bring the inflation expectations of the various stake holders closer to the policy target to sustain the growth momentum.
30. In view of the above, I vote (1) to increase the policy repo rate by 25 basis points and also (2) to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Statement by Dr. Ashima Goyal
31. Central Banks around the world had to raise rates fast to reverse large pandemic time cuts once inflation rose. But high inflation has not persisted as long as in the seventies so long-run inflation expectations largely remain anchored. Normalization of supply chains, softening commodity prices and falling global demand are bringing inflation down in most countries. US Fed communication on ‘higher for longer’ independent of data may not be appropriate and has mellowed somewhat. The economy seems to have survived sharp tightening well, as better growth compensated for higher rates. Crashing markets would be a very costly way to get policy transmission. Pressure on emerging market (EM) currencies and inflation from dollar appreciation has reduced.
32. Although global growth prospects have improved, a slowdown continues in advanced economies. Indian exports are showing signs of strain. The Indian PMI new export orders index fell to 51.2 in January from 53.4 in December. PMI has also softened for both manufacturing and services although it remains well above 50. There are still only early signs of a revival in private investment, which has yet to come out of a decade long slowdown. The RBI consumer confidence survey shows while consumer confidence is recovering it is still below 2019 levels. The current account deficit is also decreasing towards sustainable levels.
33. Headline inflation came in below forecasts, although largely driven by a sharp transient fall in vegetable prices. But agriculture seems to have been resilient to prolonged rains, pointing to productivity improvements that augur well for the future also. Diversification away from cereals has made output less volatile. The cereal price shock after the Ukraine war, however, has been a major factor raising Indian inflation. Higher fodder prices are raising milk prices. But wheat prices may also soften with sales from government stocks and expectations of a good harvest.
34. The government has stayed on its announced fiscal consolidation path reducing the government contribution to demand, while expanding supply with its sustained push on infrastructure. It also continues with other supply-side measures to reduce inflation. These enable the excellent monetary-fiscal coordination that has contributed to India’s relative outperformance in a difficult period.
35. It may be time, however, for some more excise tax cuts as multiple supply shocks have imparted persistence to inflation. The large commodity component in India’s consumer price basket, and pockets of supply constraints, respond better to fiscal action. Our government has used such action very effectively in the pandemic period. Inflation still has many administered price components and all regulators need to internalize the inflation target in order for it to be achieved. If inflation remains within its tolerance band the MPC can keep real interest rates low so that growth remains high and contributes to reducing the government debt/GDP ratio.
36. The RBI inflation expectation survey shows household expectation to be highly influenced by events. A pass through of the persistent softening in international oil prices could help to counter adverse effects of global uncertainty and reduce inflation expectations. Oil marketing companies have had ample time to complete cost recovery.
37. Since there are still little signs of wage or demand led second round effects on inflation, however, core may soften over the year. There are signs of the latter in some core components (transport, textiles, and recreation and amusement services). Since firms have benefitted from reduction in international input costs and demand is also slackening they may hesitate to raise prices. The WPI includes firm level prices and WPI inflation has fallen steeply. As the aggressive MPC tightening is more fully passed through it will further reduce demand. The interest elasticity of output is high in India because of a large young population buying flats and equipping them on credit.
38. The real rate is already positive and is likely to become more so, if inflation falls. The RBI’s average inflation forecast for FY 24 of 5.3 per cent gives a real interest rate of almost unity with a repo rate of 6.25 per cent. It can rise above this if inflation comes in below expectations that are based on an oil price of $95, risking a procyclical stance as policy tightens despite pressures on growth. Policy would then have moved away from the nuanced countercyclical stance that has been very effective in smoothing recent external pluri-shocks. Market inflation expectations are below those of the RBI. The Bloomberg consensus forecast is 5 per cent.
39. A real repo rate of around unity suits the current stage of the cycle. It also balances the conflicting requirements of inflation and growth, savers and borrowers well. It ensures nominal rates rise with expected inflation as is required in inflation targeting but prevents large nominal volatility. Research shows it is better to limit volatility so that real interest and exchange rates, that impact the real sector, do not deviate much from their equilibrium values 2. Some volatility of nominal rates is good for financial stability, as long as volatility is limited.
40. The US Fed is expected to over-correct and cut after. But it is only short-term market players who benefit from excess volatility and overshooting of exchange and interest rates, which hurt the real sector as well as those who take market positions based on fundamentals.
41. When the Fed is tightening, interest rates tend to rise more for EMs that have sharp currency depreciation. Intervention in FX markets has lowered rupee volatility and helped maintain independence from the Fed stance. Reserves have also recovered. Fed action is due to large excess demand, tight labour markets and an unprecedented deviation from the inflation target. India does not have these conditions and has the space not to follow the Fed. It also started from higher nominal policy rates.
42. If a sharp rise in the real policy rate, substantially above unity, triggers a shift to a lower trend of private investment and growth, then the sacrifice ratio of disinflation can be very high, as it was in the 2010s 3. When such multiple paths exist, over-tightening today does not necessarily improve the future. Inflation can rise over time because supply bottlenecks worsen.
43. Excessive front-loading of rate hikes carries the risk of over-shooting that is best avoided for compelling reasons in the Indian context: First, raising real policy rates to reduce demand has a stronger effect on growth than it does on inflation 4. Second, since there are more lags in monetary transmission in India, over-shooting can have persistent deleterious effects here, including instability. Third, macroeconomic stability improves most rapidly if real interest rates are kept smoothly below growth rates and counter external shocks. The Indian economy is well-poised to achieve this combination and to reduce its chronic underemployment.
44. In view of these arguments, I vote for a pause. It is better to give time for possible softening of both inflation and growth and effects of past monetary tightening to play out. I am also in favour of a shift to a neutral stance which is consistent with response in any direction as required depending on the impact of global and domestic factors on Goyal, A. and A. Kumar, 2021. ‘Asymmetry, Terms of Trade and the Aggregate Supply Curve in an Open Economy Model’, The Journal of Economic Asymmetries, Volume 24, November, e00206. https://doi.org/10.1016/j.jeca.2021.e00206. Goyal, A. and G. Goel, 2019. ‘Correlated Shocks, Hysteresis, and the Sacrifice Ratio: Evidence from India’, Emerging Markets Finance and Trade. Vol. 57, Issue 10. Pgs. 2929-2945. Published online: 11 Oct. https://www.tandfonline.com/doi/full/10.1080/1540496X.2019.1668770. Goyal, A. and S. Tripathi, 2015. ‘Separating Shocks from Cyclicality in Indian Aggregate Supply’, Journal of Asian Economics, 38: 93-103. 2015. https://www.sciencedirect.com/science/article/abs/pii/S1049007815000329. expected inflation. Policy, and market adjustments, would be based on incoming data and its effect on the future outlook. Statement by Prof. Jayanth R. Varma
45. Much of what I wrote in my December statement remains valid now as well. Rather than repeat those arguments all over again, I will be very brief. In the second half of 2021-22, monetary policy was complacent about inflation, and we are paying the price for that in terms of unacceptably high inflation in 2022-23. In the second half of 2022-23, monetary policy has, in my view, become complacent about growth, and I fervently hope that we do not pay the price for this in terms of unacceptably low growth in 2023-24.
46. I believe that the 25 basis point rate hike approved by the majority of the MPC is not warranted in the current context of diminished inflationary expectations and heightened growth concerns. I therefore vote against this resolution.
47. Turning to the stance, I believe that a repo rate of 6.50% very likely overshoots the policy rate needed to achieve price stability, and further tightening is not desirable. I therefore vote against this resolution also. Statement by Dr. Rajiv Ranjan
48. Besides growing divergence in the pace of policy normalisation across the world, recent monetary policy actions by systemic central banks suggest a dichotomy between the policy actions and the stance. Moreover, while nearly all have hiked rates with a pivot towards smaller quantum of rate hikes, clear forward guidance is missing given the difficulty in forecasting inflation presciently in the backdrop of prevailing uncertainties. Taking cues from tapered rate hikes and dovish tones in the stance, global financial markets have priced in a pause and subsequent rate cuts by major advanced economies in the later part of the year. The persistence of inflation, however, can lead to large repricing of risk with consequent market turmoil. Moreover, financial conditions have eased around much of the globe despite sharp monetary policy tightening, which poses a challenge for central banks. 5 Therefore, it will be premature to lower the guard on inflation as the credibility of central banks in fighting inflation has large ramifications for stabilisation of inflation and firm anchoring of inflation expectations.
49. In the Indian context, even though inflation remained below the upper tolerance threshold of 6 per cent for two consecutive months in November-December 2022, a deep dive into CPI inflation indicates little evidence of a decisive and durable disinflation process. The softening of headline inflation can largely be attributed to the sharp and early seasonal correction in prices of vegetables. Excluding vegetables, both food and headline inflation edged up during November-December 2022. Eight out of 12 food sub- groups, comprising 66 per cent of CPI food basket, registered an increase in inflation in December. 6 Core (CPI excluding food and fuel) inflation edged up above 6.0 per cent while other exclusion-based core inflation measures were in the range of 6.0-6.8 per cent. Trimmed mean measures of inflation and diffusion indices for CPI suggest heightened underlying and generalised inflation pressures across the CPI basket. https://www.imf.org/en/Blogs/Articles/2023/02/02/looser-financial-conditions-pose-conundrum-for-central-banks. Moreover, five food sub-groups comprising 54 per cent of CPI food basket registered an inflation rate of more than 6 per cent.
50. Our inflation projection is premised on crude prices at US$ 95 per barrel. I believe it is necessary to remain conservative on crude prices and avoid best-case scenarios given the volatile nature of crude prices, progressive opening up of China and continuing war in Europe. Moreover, with retail petrol and diesel prices unchanged, the sensitivity of inflation to crude oil price movements is low in the short term but remain relevant for the external sector.
51. Going forward, inflation is projected to moderate to 5.3 per cent in 2023-24. However, its quarterly path indicates considerable variation due to the large influence of base effects – especially in Q1:2023-24. There does exist considerable uncertainty to this baseline trajectory. A likely bumper rabi harvest could bring about a softening of food inflation; however, there could be risks emanating from adverse weather events. The trajectory of global commodity prices remains uncertain, even as output price pass- through of pending cost pressures continues, especially in services. This, along with housing component in CPI, needs to be monitored closely, given the stickiness of core inflation at around 6 per cent.
52. On the other hand, I am reasonably convinced about the inherent strength of the Indian economy as reflected in (i) high frequency indicators; (ii) resilient domestic demand; (iii) budgetary focus on capital expenditure; (iv) sound health of corporates and banking sector; (v) improving external sector indicators; and (vi) depth of the financial markets. Moreover, February 2023 has been a defining moment for fiscal monetary coordination, which has been the hallmark during the pandemic. Fiscal expansion through higher expenditures can stimulate or retard growth depending upon the phase of the business cycle and the quality of expenditure. 7 The government has continued on the path of fiscal consolidation in the Union Budget 2023-24 by reprioritising expenditure from revenue to capital, which will be growth augmenting through higher multiplier effect of investment over the medium term. Thus, the Union Budget served the macroeconomic objective as well as the inflation targeting mandate of the Reserve Bank. Prudent fiscal and monetary policies at this juncture are likely to give us the optimal macro-economic outlook – a soft landing for the economy through gradual disinflation amidst resilient growth outcomes. The growth projection of 6.4 per cent for 2023-24 reflects these underlying strengths. The quarterly momentum in the projection of real GDP is now close to that of the pre-COVID decade.
53. In the above context, it will be hasty to ease the vigil against inflation. As noted by Milton Friedman, there is a distinction: “... between a steady inflation, one that proceeds at a more or less constant rate, and an intermittent inflation, one that proceeds by fits and starts...”. 8 This crucial difference between “steady inflation” and “intermittent inflation” is paramount while formulating the policy choice. The overly large focus on the recent fall in inflation led by “intermittent inflation” may tempt for an untimely pause in monetary policy action, a costly policy error. The continuously high core inflation points to the persistence in “steady inflation”, which warrants caution. Thus, it will be premature to pause when there are no definitive signs of slowdown in inflation, particularly core inflation. Nevertheless, as the policy rate adjusted for inflation has now turned positive, albeit barely so, there is a case for paring down the pace of rate hike to the usual 25 bps. Report on Currency and Finance, RBI 2021-22. Revenue expenditures have negative multiplier during upturns. Friedman, Milton (1963), Inflation: Causes and Consequences, Bombay: Asia Publishing House, reprinted in, Dollars and Deficits, Englewood Cliffs, N.J.: Prentice-Hall, 1968.
54. These factors call for continuity in policy stance and response, to ensure a decisive and durable moderation in inflation towards the target, while keeping in mind the objective of growth. In view of the above, I vote for a lower rate hike of 25 bps without changing the stance. Going ahead, assessment of the impact of the cumulative rate hikes will become important especially in view of higher policy transmission in a primarily bank- based economy. Statement by Dr. Michael Debabrata Patra
55. Over the year gone by, monetary policy actions have been undertaken and accommodation has been withdrawn to restore price stability. The impact of these actions is beginning to be reflected in the channels of transmission. This provides little comfort though, as barring the pronounced winter easing of vegetables prices, almost every other component of the consumer price index is showing a hardening of price pressures. Statistical and exclusion-based measures of underlying inflation are actually showing an uptick. It is eminently likely that as the cooler weather gives way to summer, vegetable prices will turn up again as they usually do. Households sense this, as revealed in largely unchanged inflation expectations and muted discretionary spends, especially in rural areas. Businesses are accordingly encountering a moderation in sales and revenues. With input cost pressures still being passed through into expenditures, capital spending remains restrained.
56. Hence, the stance of monetary policy will need to remain disinflationary till inflation is returned to target. The Indian economy has demonstrated strength in the face of formidable global adversities and there is positive momentum underlying the steady emergence from the drag of the pandemic and the war. While the full effects of monetary policy actions on economic activity are yet to be seen, increasingly it is becoming evident that inflation is weakening domestic consumption and investment as well as confidence. Combined with the drag on exports due to the retarding effects of slowing global activity, and the expected consolidation of fiscal spending, the prospects for growth in 2023-24 hinge around price stability, anchored inflation expectations and improving supply responses across agriculture, industry and services.
57. Although it seems to have peaked, inflation remains high and, in my view, it is the biggest threat to the macroeconomic outlook. Restoration of price stability – as statutorily mandated – will provide a solid foundation for a growth trajectory that actualises India’s potential. Taking into account the height of inflation, current and projected, monetary and financial conditions still reflect some slack, although they are moving into tighter territory with the follow through of recent monetary policy actions. The issue is one of timing.
58. The fight against inflation is complicated by the global outlook. There is some consensus growing around a milder slowdown than earlier feared, although geographical disparities complicate the prognosis. Be that as it may, the outlook for global inflation is turning more uncertain than before. While central banks expect only a stubborn easing, financial markets are betting on a more dramatic downturn as commodity price pressures ease and supply chains improve. Nonetheless, future shocks associated with the war and the pandemic are possible.
59. Turning to the implications for policy, the MPC has to remain committed to its primary mandate. The recent experience has amply demonstrated that low and stable inflation is the credible nominal anchor for a reinvigoration of growth. Moving the policy rate into restrictive territory at a resolute pace has provided the headroom to continue to moderate the order of rate increases. This enables us to assess the impact of our actions carefully while taking into account the risks around the outlook. It also demonstrates the credibility of our actions through carefully calibrated rate changes without any backtracks. In the final analysis, the size and timing of rate changes is the best embodiment of the stance. While keeping in mind the objective of growth, the foot must remain on the brake as we chart our future trajectory. On a pragmatic basis, it is important to at least contain inflation within the tolerance band in 2023-24 as the first milestone to be passed in aligning inflation with the target. Accordingly, I vote for increasing the policy rate by 25 basis points while continuing to withdraw accommodation. Statement by Shri Shaktikanta Das
60. The global economic outlook has improved since the December (2022) meeting of the MPC. Inflation in major countries has eased in recent prints but remains significantly above their respective targets. Monetary policy is thus expected to remain in a tightening mode, but there is uncertainty about its trajectory. This is leading to bouts of volatility in global financial markets whose spillovers are posing challenges to emerging market economies.
61. In a world of extreme uncertainty, India is witnessing a conducive environment of macroeconomic stability: the economy remains resilient; inflation has moderated in the past two months to below 6 per cent; fiscal consolidation is gaining traction; current account deficit is showing signs of moderation; forex reserves have improved; and the banking sector remains healthy.
62. The sustained buoyancy in domestic demand, especially private consumption and investment, is driving growth. While weak external demand is a drag on our merchandise exports, growth of remittances and exports of services is robust. Going ahead, the persisting recovery in contact-intensive services and good prospects of rabi production are likely to support urban and rural consumption. The enhanced thrust on capital spending and infrastructure in the Union Budget 2023-24 should bolster manufacturing and investment activity.
63. CPI inflation has moderated primarily due to lower vegetable prices. Core inflation (i.e., CPI excluding food and fuel), however, is elevated and sticky at around 6 per cent. CPI inflation excluding vegetables has moved higher. Going forward, the baseline projections indicate that headline inflation is likely to moderate to 5.3 per cent in 2023-24. These projections also indicate that the disinflation towards the target rate is likely to be protracted given the stickiness of core inflation at elevated levels. Durability of a disinflation process cannot solely rely on food inflation, given its uncertainty and susceptibility to weather events. Overall, there is considerable uncertainty at this stage on the evolving inflation trajectory due to ongoing geopolitical tensions, global financial market volatility, rising non-oil commodity prices, volatile crude oil prices and also weather-related events.
64. We must, therefore, remain unwavering in our commitment to bring down inflation to ensure a decisive and durable moderation in inflation towards the target of 4 per cent over the medium term, while being mindful of growth. Hence, further calibrated monetary policy action is necessary in the current MPC meeting to keep inflation expectations anchored and break the persistence of core inflation while containing second round effects. I also believe that we should taper the pace of rate hike in view of two considerations: (i) we need to give time for our past policy actions to work through the system; and (ii) it would be premature to pause, lest we are caught off-guard and need to do a catching up later. I, therefore, vote for an increase of 25 basis points in the policy repo rate to 6.50 per cent. This order of rate increase provides space to calibrate future monetary policy actions and stance based on evolving macroeconomic conditions.
65. Our actions have nudged the policy rate adjusted for inflation to positive territory after a while. Liquidity remains in surplus mode, even as the surplus is moderating. The overall monetary and liquidity conditions, therefore, remain accommodative. In such a scenario, it is necessary to persevere with the stance of withdrawal of accommodation to ensure a decisive process of disinflation. Accordingly, I vote for continuing with the stance of withdrawal of accommodation.
66. There has been some discussion in the public space about the need to give forward guidance on monetary policy actions. As I have stated on several occasions, it would be inadvisable to provide specific guidance when we are in a tightening cycle and when we are experiencing such extreme uncertainty. The only forward guidance that we can provide is that we will remain vigilant, monitor every incoming information and data, and shall act appropriately to maintain price stability in the interest of strengthening medium-term growth. (Yogesh Dayal) Press Release: 2022-2023/1769 Chief General Manager
6. Global economic activity remains resilient amidst the persistence of inflation at elevated levels, turmoil in the banking system in some advanced economies (AEs), tight financial conditions and lingering geopolitical hostilities. Recent financial stability concerns have triggered risk aversion, flights to safety and heightened financial market volatility. Sovereign bond yields fell steeply in March on safe haven demand, reversing the sharp increase in February over aggressive monetary stances and communication. Equity markets have declined since the last MPC meeting and the US dollar has pared its gains. Weakening external demand, spillovers from the banking crisis in some AEs, volatile capital flows and debt distress in certain vulnerable economies weigh on growth prospects. Domestic Economy
7. The second advance estimates (SAE) released by the National Statistical Office (NSO) on February 28, 2023 placed India’s real gross domestic product (GDP) growth at 7.0 per cent in 2022-23. Private consumption and public investment were the major drivers of growth.
8. Economic activity remained resilient in Q4. Rabi foodgrains production is expected to increase by 6.2 per cent in 2022-23. The index of industrial production (IIP) expanded by 5.2 per cent in January while the output of eight core industries rose even faster by 8.9 per cent in January and 6.0 per cent in February, indicative of the strength of industrial activity. In the services sector, domestic air passenger traffic, port freight traffic, e-way bills and toll collections posted healthy growth in Q4, while railway freight traffic registered a modest growth. Purchasing managers’ indices (PMIs) pointed towards sustained expansion in both manufacturing and services in March.
9. Amongst urban demand indicators, passenger vehicle sales recorded strong growth in February while consumer durables contracted in January. Among rural demand indicators, tractor and two-wheeler sales were robust in February. As regards investment activity, growth in steel consumption and cement output accelerated in February. Merchandise exports and non-oil non-gold imports contracted in February while the strong growth in services exports continued.
10. CPI headline inflation rose from 5.7 per cent in December 2022 to 6.4 per cent in February 2023 on the back of higher inflation in cereals, milk and fruits and slower deflation in vegetables prices. Fuel inflation remained elevated, though some softening was witnessed in February due to a fall in kerosene (PDS) prices and favourable base effects. Core inflation (i.e., CPI excluding food and fuel) remained elevated and was above 6 per cent in January-February. The moderation observed in inflation in clothing and footwear, and transportation and communication was largely offset by a pick-up in inflation in personal care and effects and housing.
11. The average daily absorption under the LAF moderated to ₹1.4 lakh crore during February-March from an average of ₹1.6 lakh crore in December-January. During 2022-23, money supply (M3) expanded by 9.0 per cent and non-food bank credit rose by 15.4 per cent. India’s foreign exchange reserves were placed at US$ 578.4 billion as on March 31, 2023. Outlook
12. The inflation trajectory for 2023-24 would be shaped by both domestic and global factors. The expectation of a record rabi foodgrains production bodes well for the food prices outlook. The impact of recent unseasonal rains and hailstorms, however, needs to be watched. Milk prices could remain firm due to high input costs and seasonal factors. Crude oil prices outlook is subject to high uncertainty. Global financial market volatility has surged, with potential upsides for imported inflation risks. Easing cost conditions are leading to some moderation in the pace of output price increases in manufacturing and services, as indicated by the Reserve Bank’s enterprise surveys. The lagged pass- through of input costs could, however, keep core inflation elevated. Taking into account these factors and assuming an annual average crude oil price (Indian basket) of US$ 85 per barrel and a normal monsoon, CPI inflation is projected at 5.2 per cent for 2023-24, with Q1 at 5.1 per cent, Q2 at 5.4 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent, and risks evenly balanced (Chart 1).
13. A good rabi crop should strengthen rural demand, while the sustained buoyancy in contact-intensive services should support urban demand. The government’s thrust on capital expenditure, above trend capacity utilisation in manufacturing, double digit credit growth and the moderation in commodity prices are expected to bolster manufacturing and investment activity. According to the RBI’s surveys, businesses and consumers are optimistic about the future outlook. The external demand drag could accentuate, given slowing global trade and output. Protracted geopolitical tensions, tight global financial conditions and global financial market volatility pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 per cent with Q1:2023-24 at 7.8 per cent; Q2 at 6.2 per cent; Q3 at 6.1 per cent; and Q4 at 5.9 per cent, with risks evenly balanced (Chart 2).
14. With CPI headline inflation ruling persistently above the tolerance band, the MPC decided to remain resolutely focused on aligning inflation with the target. It is essential to rein in the generalisation of price pressures and anchor inflation expectations. An environment of low and stable prices is necessary for the resilience in domestic economic activity to be sustained. While the policy rate has been increased by a cumulative 250 basis points since May 2022, which is still working through the system, there can be no room for letting down the guard on price stability. Taking these factors into account, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting, with readiness to act, should the situation so warrant. The MPC will continue to keep a strong vigil on the evolving inflation and growth outlook and will not hesitate to take further action as may be required in its future meetings. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.
15. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 per cent.
16. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
17. The minutes of the MPC’s meeting will be published on April 20, 2023.
18. The next meeting of the MPC is scheduled during June 6-8, 2023. Voting on the Resolution to keep the policy repo rate at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The Second Advance Estimates (SAE) of the National Income for FY 2022-23 released by the National Statistical Office have retained the overall YOY growth of GDP at constant prices at 7 per cent as provided in the First Advance Estimates (FAE) published on January 6, 2023. However, the Provisional Estimates have been replaced by the First Revised Estimates (FRE) for 2021-22 as the base and the estimated GDP for 2022-23 is now actually higher by 1.3 per cent in the SAE than in FAE. Private Final Consumption expenditure, Gross Fixed Investment expenditure and exports of goods and services growth rates in FY 2022-23 have exceeded the growth rate of overall GDP. Slower growth of Government Final Consumption expenditure and higher imports have offset the higher pace of growth of other demand components.
20. While the overall GDP growth reflects the resilience of the economy, a large part of this strength is contributed by the sharp increase in the first quarter of the year, a reflection of the rebound from the sharp COVID-19 impact of Q1 FY 2020-21. The YOY growth rate of GDP in Q1: 2022-23 is now placed at 13.2 per cent and the growth in the subsequent two quarters at 6.3 and 4.4 per cent. At the sectoral level, the growth drivers are the contact intensive Trade, Hotels, Transport, Communication and Services related to Broadcasting; Electricity, Water Supply and Other utilities; and Construction, which have registered higher YOY growth rates of Gross Value Added compared to the overall GVA growth rate of 6.6 per cent for FY 2022-23. Growth rate of the GVA of Manufacturing in FY 2022-23 is less than 1 per cent. The growth performance, therefore, points to both uneven growth across production sectors and subdued growth in the more recent quarters of FY 2022-23.
21. The weak global economic environment is marked by decelerating demand and uncertainty in the financial markets and energy markets. Some of the weakening demand conditions are due to the monetary policy tightening in the major advanced economies and the slower pace of growth in China. The financial market uncertainty is both due to the slowing global growth, monetary policy actions to bring down high inflation rates and the continued year-long Ukraine war impacting a range of markets including energy. These conditions are expected to prevail at least until the inflation rates moderate significantly. Both IMF and the World Bank have projected World Output YOY growth rates of less than 3 per cent in 2023 and marginally above 3 per cent in 2024. The drag on India’s exports - particularly goods exports - due to these adverse global demand conditions is, therefore, expected to prevail in FY 2023-24.
22. Several factors are in play in determining the domestic output growth conditions in the short-term. The dynamics of high frequency indicators points to continuation of the present growth momentum. For example, the PMI for manufacturing and Services in March have continued to reflect an expansionary phase, although both are below their recent peaks. The GST collections and Railway freight traffic indicator show moderation in YOY growth in Q3: FY 2022-23 and the recent months of January-February 2023. Non-food credit growth, however, continued expansion at double digit rates. The sales growth data for the corporate sector, indicates price rise is an important driver of revenue growth in Q3: FY 2022-23.
23. The business outlook sentiments show a mixed picture. RBI’s survey of enterprises conducted during January-March 2023 points to a moderation of its Business Expectations index for the manufacturing sector firms in Q1: FY 2023-24, although the Business Assessment Index for the prevailing conditions moved up in Q4: FY 2022-23. Both the indices indicate an expansion of economic activities. Expectations of the overall business situation indicate rising optimism through Q1: FY 2023-24 to Q3: 2023-24 in the case of enterprises in the services and infrastructure sectors. Improvement in profit margins is expected by markedly smaller proportion of manufacturing enterprises in Q1: FY 2023-24 compared to Q4: FY 2022-23 than the enterprises in services and infrastructure. Increase in selling prices appears to be necessary to drive improvement in profit margin. The survey of Consumer Confidence for March 2023 points to expectations of improved conditions for employment over the expectations held in the previous round of the survey, with a marginal decline in sentiments on general economic conditions and household income. In all the three indicators of perceptions of the economy, one-year ahead situation is seen to be substantially superior to the present.
24. The estimates of GDP growth (YOY), for FY: 2023-24 provided by a number of agencies in the period from January 2023 onwards, have been around 6 per cent. The RBI’s Survey of Professional Forecasters conducted in March 2023 provides a median forecast of 6.0 per cent for 2023-24. Taking into account the growth trends and factors influencing growth along with an assumption of a normal monsoon for 2023 the GDP growth for FY 2023-24 is projected at 6.5 per cent with quarterly break up of Q1 at 7.8 per cent, Q2 at 6.2 per cent, Q3 at 6.1 per cent and Q4 at 5.9 per cent. The key concern on the growth front in the immediate future is the drag caused by the weak external demand conditions. The impact of any adverse weather conditions on Indian agriculture provides additional downside risk to the growth trajectory.
25. The headline Consumer price index rose by 6.5 and 6.4 per cent in January and February 2023, respectively, breaching the upper limit of the tolerance band of the policy target of 4% inflation, after two months of below 6 per cent inflation rate in November and December 2022. The key drivers of this high level of overall inflation rate in the recent two months were food items, particularly, cereals, milk and products, spices and ‘prepared meals, snacks and sweets’. However, the inflation rate of the category comprising of items excluding food and fuel, and light has also remained at or above 6 per cent in the first two months of the present calendar year. Among the components of the core inflation which exclude food and fuel items, price rise was well above 6 per cent in the case of Clothing & Footwear, Household Goods & Services, Health and Personal care & effects. Fuel & light has also been at close to double digit inflation rate in the first 11 months of FY 2022-23. A positive feature of the overall inflation trend is a decline in the month-to-month momentum, decelerating in February 2023. This development needs to be watched as the seasonal patterns may begin to reverse this pattern.
26. The combined impact of decelerating international commodity prices, significant monetary policy rate increases since May 2022 leading to higher bank deposit and lending rates is yet to translate into inflation rates below the upper tolerance band of the target in a sustained manner. There are significant downside risks to output growth momentum and gains from price led revenues for the firms may be limited. While policy rate increases were effected over a period of May 2022 to February 2023, the cumulative impact of these policy actions is yet to be realised. The recent Inflation Expectations Survey of Households by the RBI, points to expectations of reduction in inflation rate 3- months ahead and one-year ahead. The survey of firms by the Indian Institute of Management Ahmedabad points to reduction in the one-year ahead expected business inflation based on a cost-based Business Inflation Index in February 2023 compared to January 2023. The survey also finds a marginal increase in the one-year ahead expectations of CPI inflation in February 2023 as compared to the expectations in December 2022, with expectations of YOY inflation rates in both the rounds below 5 per cent 1.
27. The forecast for FY 2023-24 points to a reduction in inflation rate below the upper tolerance band of 6 per cent with Q1 at 5.1 per cent, Q2 and Q3 at 5.4 per cent, Q4 at 5.2 per cent and an annual average rate of 5.2 per cent. The decline in projected inflation rates is also supported by the base effect of high inflation rate in FY 2022-23.
28. While these projections point to a path towards achieving the inflation target in the medium term, there are clearly upside risks associated with these projections. The weather uncertainty affecting key agricultural prices globally and in the domestic markets, higher fuel and energy prices due to the supply disruptions resulting from geo-political conflicts and policies may lead to spikes in inflation rate and reversal of these shocks also may not be quick. In this context, it is important to assess the extent of the impact of monetary policy actions on inflation rate, besides the other developments.
29. Taking into account the projected patterns of growth and inflation for FY 2023-24, the risks attached to these projections and a need to watch the cumulative impact of the monetary policy actions so far, I believe that a pause in the policy rates is appropriate in this meeting, without any commitments on the subsequent actions except that aligning the inflation rate with the target will remain a policy priority.
30. Accordingly I vote: (a) to keep the policy repo rate unchanged at 6.50 per cent, and (b) to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
31. The global slowdown is turning out to be less severe than expected but there are signs of a slowing in both growth and inflation suggesting central banks (CBs) tightening is adequate and lagged effects will bring about the required further fall in inflation. But as financial stress materialized in some advanced economies (AEs), as was to be expected with sharp tightening following sustained excess liquidity, the major CBs had to continue to tighten to demonstrate absence of financial dominance. Fortunately, India had financial deleveraging prior to the pandemic, much stronger and more broad-based regulation and supervision, as well as ongoing focus on corporate governance, so its financial sector has actually outperformed under pluri-shocks 2. Continued regulatory vigilance is essential, but it is not necessary to demonstrate independence from financial dominance https://www.iima.ac.in/sites/default/files/2023-04/February%202023%20results.pdf. Goyal, A. 2023. 'Lessons from Outperformance in the Indian Financial Sector.' IGIDR Working paper no. WP-2023-002. Available at: http://www.igidr.ac.in/pdf/publication/WP-2023-002.pdf. here. Instead, India’s better policies and buffers make it possible to demonstrate independence from AE CBs and their weaknesses. Inflation here is also different. It is relatively close to target—excess demand due to over-stimulus or second round effects due to a tight labour market are not driving it.
32. Although growth is resilient, there are signs of slowdown in some high frequency data. Softening non-oil non-gold imports point to weakness in domestic demand; slowing exports are affecting manufacturing; rising loan rates are reducing demand for low income housing.
33. A 2012 RBI working paper 3 found monetary policy impacts output with a lag of 2-3 quarters and inflation with a lag of 3-4 quarters with the impact persisting for 8-10 quarters. The interest rate channel accounted for about half of the total impact of monetary shocks on output growth and about one-third of the total impact on inflation. Its effect on output was 2-3 times greater than that on inflation. Exchange rate changes had an insignificant impact on output growth, but a non-negligible impact on inflation. Many time series estimations before and since then had a similar pattern of results. A recent IGIDR M.Phil. on monetary transmission, using current data, also analysed GDP components and found monetary policy had the largest impact on investment through falling equity prices 4.
34. By October 2022 the repo rate had risen to a material level (5.9%) with liquidity also tightening and spreads rising for many short-term market instruments. And we see some growth softening two quarters later. The lagged effects of the rate rise are just beginning, and may continue to play out over the next few months. Those on inflation will follow.
35. But the estimations above do not include the expectations channel of monetary policy transmission. To the extent policy rates rise with inflation and clear communication on the inflation target anchors inflation expectations, and there is evidence for this 5, the interest rate channel does not have to carry the entire burden of adjustment. Inflation will fall faster and the growth sacrifice required to reach the inflation target is lower. This is more so if supply-side action is also reducing inflation. Such policy is part of the BCCR approach—balanced, countercyclical policy with good coordination across fiscal and monetary policy and continuing reform, which has helped make India a bright spot in a gloomy global macroeconomic scene.
36. Inflation is expected to come down over the year. There is the base effect but momentum is also slowing in some consumer goods. The RBI’s enterprise surveys shows firms expect inputs costs and selling prices to moderate. The exchange rate is stable or strengthening. The weightage issue that raised cereal prices sharply in the past 2 months is expected to have a reverse effect as market prices fall.
37. Since the inflation forecast for FY24 is 5.2% with Q4 at 5.2%, a repo rate at 6.5% implies the real policy rate is greater than one. It has already tightened enough to progressively bring inflation towards the target of 4%, with other complementary policies Khundrakpam, J. K. and R. Jain. 2012. ‘Monetary Policy Transmission in India: A Peep inside the Black Box’, RBI working paper series no. 11. Available at https://www.rbi.org.in/scripts/PublicationsView.aspx?id=14326. Mogor, B. 2023. ‘Relative Effectiveness of Monetary Policy Transmission Channels: Evidence from India’, IGIDR M.Phil. dissertation, 31st March. Goyal, A. and Parab, P. 2023. 'Working of Expectations Channel of Monetary Policy in India.' Journal of International Commerce, Economics and Policy, 14(1): 1-38. and barring major new shocks. A further rise in real interest rates is best avoided at present since high real rates can trigger a non-linear switch to a low growth path 6.
38. There is no logic for overshooting policy rates and then cutting in a country such as India where the largest impact of the interest rate is on growth, the relation between expected rupee depreciation and interest rates is weak, many tools are available to reduce excess volatility of the exchange rate and have been successfully used, the current account deficit has reduced and its financing is no longer an issue. Moreover, the exchange rate is not directly included in the mandate of the MPC.
39. In view of these arguments, I vote for a pause. But because of erratic weather and continuing global uncertainties, and until it is clear that inflation is well on the path to reaching the target, it is necessary to emphasize that this may not be the end of the rate hikes. So I also vote for withdrawal of accommodation as the stance. But this stance is now with respect to the repo rate, so it is consistent with the injection of durable liquidity if shocks are so large that LAF instruments prove inadequate. Major CBs have allowed their balance sheets to expand as required for other reasons, while at the same time raising repo rates for monetary policy purposes. Statement by Prof. Jayanth R. Varma
40. Two inflationary risks have come to the fore since the February meeting. The first risk emanates from the announcement of an output cut by OPEC+ during the weekend just before the MPC meeting. Crude oil promptly reversed the entire price decline of the preceding weeks and settled slightly above the levels prevailing at the February meeting. The output cut by itself is not worrying as it could simply represent an attempt by OPEC+ to match supply to sluggish demand in a slowing global economy. It would become a matter of concern only if it signals a structural change in the geopolitical alignment of the major oil producing countries. So far, the crude oil market has been relaxed about this development with the futures curve continuing to slope downward. Nevertheless, the MPC needs to keep a careful watch on this evolving situation. If crude were to creep towards the triple digit mark, there might be a need for a monetary response.
41. The second risk relates to the monsoon. It is only around mid April that scientists are able to provide monsoon forecasts with some degree of confidence, and the forecast accuracy improves towards the end of May. In this meeting, therefore, the MPC has no choice but to operate under the default assumption of a normal monsoon. However, in recent weeks, there has been increasing concern about some unfavourable oceanographic patterns that could impact the monsoon this year. A deficient monsoon would likely create inflationary pressures that would need to be counteracted with monetary policy measures. We will however have to wait till May or even early June to have reasonable clarity on this matter.
42. On the growth front, early warning signs of a possible slowdown are visible to a greater extent than in February. In the current situation of high inflation, monetary policy does not have the luxury of responding to these growth headwinds. In fact, it is almost axiomatic that monetary action can cool inflation only by suppressing demand. However, policy makers must be vigilant against overshooting the terminal policy rate, and thereby slowing the economy to a greater extent than what is needed to glide inflation to the target. Goyal, A. and A. Kumar. 2018. ‘Active Monetary Policy and the Slowdown: Evidence from DSGE based Indian Aggregate Demand and Supply’. The Journal of Economic Asymmetries. 17: 21-40. June. DOI: https://doi.org/10.1016/j.jeca.2018.01.001.
43. The balance of risks has, in my view, shifted slightly towards inflation since the February meeting, but the best estimate currently is that the 315 basis points of effective tightening of the overnight interest rate (from a reverse repo rate of 3.35% to a repo rate of 6.50%) would be quite sufficient to bring inflation under control. Therefore, I vote in favour of keeping the policy rate unchanged in this meeting.
44. Turning to the stance, I must confess that I fail to comprehend its meaning. My colleagues in the MPC assure me that the language is crystal clear to market participants and others. It may well be that I am the only person who finds it hard to understand. But I am unable to reconcile the language of the stance with the simple fact that no further “withdrawal of accommodation” remains to be done since the repo rate has already been raised to the 6.50% level prevailing at the beginning of the previous easing cycle in February 2019. It is of course possible to undertake further tightening, but that would not constitute a “withdrawal of accommodation” by any stretch of the imagination.
45. One interpretation that has been offered is that the real interest rate measured using the most recent published inflation rate needs to rise further. This is doubtless true, but monetary policy should not be conducted by looking at the rear view mirror. The real interest rate must be measured against the projected inflation rate 3-4 quarters ahead, and, as things stand right now, there is very little ground to argue for a further rise in the correctly measured real interest rate. Moreover, even if a flawed definition of the real interest rate is accepted, the projected rise in this real rate would not require any action by the MPC; it would happen as a mechanical result of a falling inflation rate and an unchanged policy rate. And the projected fall in the inflation rate would be a consequence of what the MPC has already done, and not what it will do in coming months.
46. I cannot put my name to a stance that I do not even understand. At the same time, it is clear that the war against inflation has not yet been won, and it would be premature to declare an end to this tightening cycle. There is need for heightened vigilance in the face of the fresh risks that I highlighted earlier in my statement. For these reasons, I refrain from dissenting on this part of the resolution, and confine myself to expressing reservations on it. Statement by Dr. Rajiv Ranjan
47. Let me begin from where I ended my last minutes of February 2023: “Going ahead, assessment of the impact of the cumulative rate hikes will become important especially in view of higher policy transmission in a primarily bank-based economy”. Consistent with that assessment and in the wake of new information that has since become available, I vote for a pause in today’s meeting.
48. First, the crosscurrents of uncertainty continue to sweep across the globe. The challenges faced in recent times have raised important questions about the conduct of monetary policy under heightened uncertainty. The gradient of unpredictability in the economy runs deeper from quantifiable risks in the near term to unknowable Knightian uncertainty (Knight, 1921) 7 over longer time horizons. Faced with these uncertainties, the ‘science’ of monetary policy – which is premised on a forward-looking and a rule-based approach (Clarida, Gali, and Gertler, 1999) 8 – must be blended with the ‘art’ of monetary policy, which is data-centric and based on prudent judgement of policymakers. A virtuous https://archive.org/details/riskuncertaintyp00knigrich https://www.aeaweb.org/articles?id=10.1257/jel.37.4.1661 guide to policymaking in such times is to tread cautiously (Orphanides, 2003). 9 As the then President of the ECB, Mario Draghi, put it, “in a dark room you move with tiny steps.” 10 I believe we are currently poised appropriately at this juncture to pause in the backdrop front-loaded rate actions even as monetary policy remains finely calibrated to the domestic and global situation.
49. Second, there are some clear positive signals visible on the domestic front. Inflationary expectations are gradually easing, domestic growth momentum remains robust, and India, so far, is insulated from the global banking crisis.
50. Third, it is important to keep in mind that there was considerable noise in the high inflation readings of January-February 2023 attributed to the statistical effect with respect to treatment of cereals. 11
51. Fourth, though inflation at present remains above the comfort zone, there are reasons for optimism going forward. The heat wave of February and the unseasonal rains of March are expected to have only some localised impacts, raising the prospects of an overall good rabi harvest. High frequency food price indicators for the month of March are already indicating a decline in wheat prices. Furthermore, international food prices have registered a decline of around 19 per cent in February 2023 from its peak in March 2022, which could help lower costs for critical import dependent food items through appropriate trade policies. Global metals and industrial input prices have also seen significant correction from their March 2022 peak levels which could likely result in softening of core inflation pressures over the year, though in a protracted manner. The key factors that could adversely affect the inflation trajectory over 2023-24 are climate related, structural demand-supply imbalance in important food items such as milk and volatile crude oil prices. At present, there is considerable uncertainty on how these events will play out over the year; hence, a wait and watch approach may be a better strategy.
52. Fifth, though core CPI inflation (excluding food and fuel) continued to remain sticky and elevated, there are signs of a modest softening in February, which was also observed across various other exclusion as well as trimmed mean measures of underlying inflation. The month-over-month (MoM) seasonally adjusted annualised rate (SAAR) of core CPI has also slowed down from around 6 per cent in December 2022 to around 5 per cent in February 2023. Moreover, headline CPI diffusion indices for February, though indicating an expansion of prices, also showed that for the first time since July 2022, a significant majority the CPI basket registered price increases of less than 6 per cent (SAAR). Diffusion indices for a core CPI which also excludes petrol, diesel, gold and silver have also indicated price expansion at rates lower than 6 per cent (SAAR) since November 2022. Softer household inflation expectations revealed by RBI’s latest survey provides comfort that second order effects on inflation will also remain subdued. Orphanides, A. (2003). Monetary policy evaluation with noisy information. Journal of Monetary economics, 50(3), 605-631. https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190307~de1fdbd0b0.en. html Since January 2023, states where prices of rice and wheat under public distribution system (PDS) was reduced to zero, there was redistribution of CPI weights of these zero priced PDS items to other items in the cereals group. The higher weightage to such market priced items, amidst rising market prices, pushed up sharply the published inflation rate in cereals (Das, P. and A. T. George (2023), Consumer Price Index: The Aggregation Method Matters, Reserve Bank of India Bulletin, March).
53. Sixth, new incoming information suggests that the growth outlook for 2023-24 has improved with investment revival likely to become more entrenched along with a lesser drag from external demand. The government’s sustained focus on infrastructure spending will also crowd in private investment and support growth. 12
54. Seventh, during the last one year of monetary policy normalisation, the operating target of monetary policy is up by around 320 basis points, the effects of which are yet to be fully transmitted to domestic macroeconomic aggregates. In the backdrop of increasing depth and liquidity in financial markets, the long and variables lags of monetary policy may have shortened in recent years, supported by complementary tools of better communication, forward guidance and balance sheet policies. The shift to external benchmark lending rate (EBLR) is an additional factor that has hastened the speed of transmission. Under these conditions, monetary policy tightening needs to be calibrated judiciously.
55. Eighth, real policy rates whether ex ante, or ex post, whether based on headline or core inflation, are now positive and expected to increase further given our projected inflation path. 13
56. Notwithstanding this, let me state that this is a ‘wait and watch’ pause. It is neither a ‘premature’ pause nor a ‘permanent’ one. Not ‘premature’ because we have already increased policy rate by 250 bps in about a year with frontloaded rate action of about 190 bps during the first 5 months. Not ‘permanent’ as any durable decline in inflation towards the target of 4 per cent is still distant. 14 Therefore, I vote to continue with our stance of withdrawal of accommodation. The inherent strength and resilience of the Indian economy with inflation expected to moderate going forward inspires confidence of our actions. Statement by Dr. Michael Debabrata Patra
57. The momentum of economic activity in India is broadening, and slack is being pulled in. The underlying price build-up indicates that demand pressures remain strong, especially for contact-intensive services. Hence, inflation remains elevated and generalised; and, as I stated at the time of the MPC’s February 2023 meeting, it is the biggest risk to the outlook for the Indian economy.
58. The lessons of experience and empirical evidence show incontrovertibly that inflation ruling above 6 per cent – as it has done through 2022-23 – is inimically harmful for growth. This is already showing up in the deceleration of private consumption spending and the moderation in sales growth in the corporate sector which, in turn, is hamstringing new investment. In my view, the baseline projection for real GDP growth at 6.5 per cent for 2023-24 will benefit from an upside from budgeted capital expenditure; this advantage should not, however, be frittered away by inflation. By current reckoning, the future path of inflation is vulnerable to several supply shocks. The MPC must accordingly remain on high alert and ready to act pre-emptively if risks intensify to both sides of its commitment: price stability and growth. Public investment multiplier on private investment and real GDP is found well over unity at 1.2 and 1.7, respectively, over a three- year period [Monetary Policy Report (MPR), April 2023]. Please refer my February 2023 minutes, … small positive real rates had given adequate reasoning for paring down rate hikes though not enough to pause. Inflation forecast is at 5.2 per cent even by end-quarter of 2023-24. Moreover, average for 2024-25 is at 4.5 per cent as per MPR April 2023.
59. Monetary policy must persevere with the withdrawal of accommodation. The stance of policy has to remain disinflationary and unwavering in its resolve to align inflation with the target of 4 per cent. It is prudent to anticipate future shocks to the inflation trajectory while evaluating the cumulative tightening of monetary policy so far. Bank credit growth is already reflecting the pass-through of past monetary policy actions, although it remains robust relative to the pace of underlying activity in the economy, and financial conditions more generally are supportive of growth.
60. While I vote for a pause in this meeting, an ongoing assessment of the macroeconomic outlook should inform a preparedness to re-calibrate monetary policy towards a more restrictive stance with consistent actions, should risks to the inflation trajectory materialise and impede its alignment with the target. The process of getting inflation back to target could turn out to be gradual and uneven, but the mission of monetary policy is to shepherd this process through potential bumps while containing second round effects and anchoring inflation expectations. Statement by Shri Shaktikanta Das
61. Since the last meeting of the MPC in February 2023, the global economic environment has changed dramatically. While issues of geopolitics and high inflation continue to impact the outlook, the emergence of banking sector turmoil on both sides of the Atlantic and the sudden announcement of oil production cut by the OPEC+ countries have rendered the global outlook even more uncertain. Global inflation is easing but at a tardy pace. Central banks face a runway which is becoming narrower and bumpy for soft- landing.
62. Against this background, inflation in India during January-February 2023 exceeded the upper tolerance limit of 6 per cent after a transitory respite during November- December 2022. Going forward, inflation projection for 2023-24 is indicating a moderation to an average of 5.2 per cent. Both domestic as well as global factors are expected to bring about this disinflation. There is better optimism on rabi harvest despite the recent unseasonal rains. This could significantly reduce price pressures on rabi food crops, particularly wheat. Further, prices of edible oils have moderated. The softening of global commodity prices from their peak levels a year ago is translating into lower input cost pressures for manufactured goods and services. These could result in some softening of core inflation going forward. The overall situation, nonetheless, remains dynamic and fast evolving. Clarity on monsoon would be available in the coming months. Milk prices may remain firm in the lean summer season on tight demand-supply balance and high fodder costs. The rising uncertainty in international crude oil prices also warrants close monitoring.
63. In parallel, domestic growth impulses remained buoyant in Q4:2022-23. Looking ahead, the thrust on infrastructure spending by the government would support investment activity. The drag from net external demand is moderating. Overall, broadening of economic activity and the strength of the external sector have allowed us room to remain steadfastly focused on inflation.
64. We have consecutively raised the policy repo rate by 250 basis points since May 2022 when we started the current rate hike cycle. Together with the introduction of the Standing Deposit Facility (SDF) at a rate 40 basis points above the fixed rate reverse repo rate, the effective rate hike has been 290 basis points. In tandem, our market operations have reined in surplus liquidity in an orderly manner. These actions have collectively transmitted into the weighted average call money rate (WACR), the operating target of monetary policy, along with other short-term rates.
65. The cumulative impact of our monetary policy actions over the last one year is still unfolding and needs to be monitored closely. Inflation for 2023-24 is projected to soften, but the disinflation towards the target is likely to be slow and protracted. The projected inflation in Q4:2023-24 at 5.2 per cent would still be well above the target. Therefore, at this juncture, we have to persevere with our focus on bringing about a durable moderation in inflation and at the same time give ourselves some time to monitor the impact of our past actions. I am, therefore, of the view that we do a tactical pause in this meeting of the MPC. Accordingly, I vote for a pause in rate action and for remaining focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. This is a tactical pause and not a pivot or a change in policy direction. We will continue to monitor all incoming information and undertake forward-looking assessment of the evolving economic outlook and stand ready to act, should the situation so warrant. Our fight against inflation is far from over and we have to continue with our efforts to bring down inflation closer to the target over the medium term. (Yogesh Dayal) Press Release: 2023-2024/88 Chief General Manager
6. In the second quarter of 2023, the global economy is sustaining the momentum gained in the preceding quarter in spite of still elevated though moderating inflation, tighter financial conditions, banking sector stress, and lingering geopolitical conflicts. Sovereign bond yields are trading sideways on expectations of the imminent peaking of the tightening cycle of monetary policy while the US dollar has appreciated. Equity markets have remained range bound since the last MPC meeting. For several emerging market economies (EMEs), weak external demand, elevated debt levels and geoeconomic disintegration amidst tighter external financial conditions pose risks to growth prospects, although capital flows are cautiously returning to them on renewed risk appetite. Domestic Economy
7. According to the provisional estimates released by the National Statistical Office (NSO) on May 31, 2023, India’s real gross domestic product (GDP) growth accelerated from 4.5 per cent (year-on-year, y-o-y) in Q3:2022-23 to 6.1 per cent in Q4, supported by fixed investment and higher net exports. Real GDP growth for 2022-23 was placed at 7.2 per cent, higher than the second advance estimate of 7.0 per cent.
8. Domestic economic activity remains resilient in Q1:2023-24 as reflected in high frequency indicators. Purchasing managers’ indices (PMI) for manufacturing and services indicated sustained expansion, with the manufacturing PMI at a 31-month high in May and services PMI at a 13-year high in April-May. In the services sector, domestic air passenger traffic, e-way bills, toll collections and diesel consumption exhibited buoyancy in April-May, while railway freight and port traffic registered modest growth.
9. On the demand side, urban spending remains robust as reflected in indicators such as passenger vehicle sales and domestic air passenger traffic which recorded double digit growth in April. Rural demand is gradually improving though unevenly – motorcycle sales expanded in April, while tractor sales contracted partly owing to unseasonal rains. Investment activity is picking up as reflected in the healthy expansion in steel consumption and cement output in April. Merchandise exports and non-oil non- gold imports remained in contraction mode in April while services exports sustained a robust expansion.
10. CPI inflation fell sharply to 4.7 per cent in April 2023 from 6.4 per cent in February on the back of large favourable base effects, with softening observed across all the three major groups. Food group inflation eased, with moderation in cereals, eggs, milk, fruits, meat and fish, spices and prepared meals inflation and deepening of deflation in edible oils. In the fuel group, inflation in LPG and firewood and chips prices fell and kerosene prices slipped into deflation. Core inflation (i.e., CPI inflation excluding food and fuel) dipped, driven down by clothing and footwear, household goods and services, health, transport and communication, personal care and effects and recreation and amusement sub-groups.
11. The average daily absorption under the LAF increased to ₹1.7 lakh crore during April-May from ₹1.4 lakh crore in February-March. Money supply (M3) expanded by 10.1 per cent y-o-y and non-food bank credit by 15.6 per cent as on May 19, 2023. India’s foreign exchange reserves were placed at US$ 595.1 billion as on June 2, 2023. Outlook
12. Going forward, the headline inflation trajectory is likely to be shaped by food price dynamics. Wheat prices could see some correction on robust mandi arrivals and procurement. Milk prices, on the other hand, are likely to remain under pressure due to supply shortfalls and high fodder costs. The forecast of a normal south-west monsoon by the India Meteorological Department (IMD) augurs well for kharif crops; however, the spatial and temporal distribution of the monsoon would need to be closely monitored to assess the prospects for agricultural production. Crude oil prices have eased but the outlook remains uncertain. According to the early results from the Reserve Bank’s surveys, manufacturing, services and infrastructure firms polled expect input costs and output prices to harden. A clearer picture will emerge when the final survey results are available. Taking into account these factors and assuming a normal monsoon, CPI inflation is projected at 5.1 per cent for 2023-24, with Q1 at 4.6 per cent, Q2 at 5.2 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent. The risks are evenly balanced (Chart 1).
13. The higher rabi crop production in 2022-23, the expected normal monsoon, and the sustained buoyancy in services should support private consumption and overall economic activity in the current year. The government’s thrust on capital expenditure, moderation in commodity prices and robust credit growth are expected to nurture investment activity. Weak external demand, geoeconomic fragmentation, and protracted geopolitical tensions, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 per cent with Q1 at 8.0 per cent, Q2 at 6.5 per cent, Q3 at 6.0 per cent, and Q4 at 5.7 per cent, with risks evenly balanced (Chart 2).
14. The MPC took note of the moderation in CPI headline inflation in March-April into the tolerance band, in line with projections, reflecting the combined impact of monetary tightening and supply augmenting measures. Headline inflation is projected to decline in 2023-24 from its level in 2022-23 but would still be above the target, warranting continuous vigil. The progress of the south west monsoon is critical in this regard. Domestic economic activity is holding up well. Consumer confidence is improving and businesses remain optimistic about the future. The cumulative rate hike of 250 basis points undertaken by the MPC is transmitting through the economy and its fuller impact should keep inflationary pressures contained in the coming months. Monetary policy would need to be carefully calibrated for alignment of inflation with the target. Against this backdrop, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent. The MPC resolved to continue keeping a close vigil on the evolving inflation and growth outlook. It will take further monetary actions promptly and appropriately as required to keep inflation expectations firmly anchored and to bring down inflation to the target. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.
15. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 per cent.
16. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
17. The minutes of the MPC’s meeting will be published on June 22, 2023.
18. The next meeting of the MPC is scheduled during August 8-10, 2023. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. Since the April meeting of the MPC, the GDP growth numbers for FY 2022-23 have been updated and we also have the headline inflation numbers for April 2023. The official provisional estimates (PE) for GDP at constant prices place the GDP growth higher at 7.2 per cent for FY 2022-23 from 7 per cent in the Second Advance Estimates. The headline YOY inflation rate in April dropped to 4.7 per cent, well below the rate in March, 5.7 per cent. A significant part of the improvement in GDP in FY 2022-23 was due to the growth in Q4 FY 2022-23 at 6.1 per cent in comparison to the expectations of growth of 5.1 per cent implied by the overall growth rate of 7 per cent in SAE. The better than anticipated growth in Q4 combined with the lower inflation reading for March-April reflect different sets of factors influencing growth and inflation.
20. The global macroeconomic conditions have continued to be adverse, reflecting slow growth momentum and moderating but elevated inflation pressures across economies. In addition, global trading opportunities have been limited by policies restricting supply chains. The recent events have also pointed to the vulnerability of the banking and financial sectors to monetary and fiscal policy stances. The energy markets experienced uncertainty in the face of global economic slowdown and the protracted Ukraine war. The monetary policy measures aimed at curbing inflationary pressures in the major advanced and emerging market economies appear to be successful in moderating inflation rate, although the rates remain well above the policy targets.
21. This provides an overall context for an assessment of the likely course of growth and inflation in the short to medium term. One important feature of GDP growth in 2022- 23 and also 2021-22 was the dominance of Q1 compared to the other quarters. As the pandemic induced sharp decline in GDP in Q1 of 2020-21 is offset by the subsequent growth, growth in Q1:2023-24 is likely to be closer to the growth across quarters. A second feature of growth performance in 2022-23 is the uneven performance across sectors. Manufacturing growth reflected in the growth of Gross Value Added (GVA) is placed at 1.3 per cent compared to the growth in construction (10.0 per cent) or the services sector (9.5 per cent). While the input cost pressures in 2022-23 appear to have had greater impact in the case of manufacturing than in the other sectors, slower growth of consumption spending and investment would also have affected demand for manufacturing more than the others. Finally, the deceleration in export demand would affect manufacturing output. Going forward, reduction in cost pressures and overall inflation, and revival of exports would be important in accelerating manufacturing growth. The indicators compiled by RBI for listed manufacturing companies in Q4: 2022-23 indicate significant improvement in profit margins with increased GVA growth and sustained improvement in capacity utilisation during the year are positive for the revival of manufacturing growth in 2023-24. However, there are segments within manufacturing sector where weak export environment would be a concern.
22. The services sector was the growth driver for the economy in 2022-23. Revival of demand in the service sectors badly hit during the pandemic has sustained the growth of the overall sector. GVA growth in the sub-sector Trade, Hotels, Transportation and Broadcasting in 2022-23 is still only 4.1 per cent over its pre-pandemic level in 2019-20 with considerable upside potential of the sub-sector for growth. The export of services is expected to be adversely affected by the global economic slowdown in 2023-24.
23. In the case of agriculture and allied sectors, GVA growth in 2022-23 turned out to be higher than 2021-22 although there were adverse weather effects during the year. The normal monsoon forecast by the Indian Meteorological Department, despite the emergence of the El Nino phenomenon, would be supportive of agricultural growth.
24. On the demand side of the economy, RBI’s recent sample surveys of households and enterprises indicate improving consumer sentiments and business outlook for 2023- 24. The improvement is, however, in comparison to a period of weak sentiments through 2022-23. Early results of the enterprise surveys indicate greater optimism on the part of services and infrastructure firms on demand conditions than in the case of manufacturing. The Consumer Confidence Survey of urban households conducted in May reflects steady improvement in confidence for the current period and strengthening optimism on ‘one- year ahead’ situation. Expenditure expectations remain broadly stable with indications of increasing non-essential expenditure by the households. While cost pressures are expected to moderate in Q1, the expectation of rising costs – inputs, financing and staff – is still widely shared especially in Q2. Higher selling prices are seen to improve profit margin. In the sectors where demand is buoyant, transmission of higher costs to selling prices would be greater. Overall, perceptions on cost pressures and selling prices vary across sectors. 24. Macroeconomic and financial stability is now well entrenched and needs to be nurtured and preserved with well calibrated and timely actions.
25. The high frequency indicators for the recent period of April-May provide a mixed picture. The urban and demand conditions show improvement, PMIs for manufacturing and services reflect rising output. However, there are also mixed signs of transport activity. Railway freight and port traffic, and motor spirit sale show YOY growth rates of less than five per cent but E-way bills and toll collections continue to register double digit growth. External trade has weakened in April. Non-food credit, a broader measure of economic activity, has increased by about 16 per cent during April-May 2023.
26. The overall growth momentum for 2023-24 is expected to be more moderate than in 2022-23. The projections provided in the April meeting of the MPC hold over the improved official estimates for 2022-23. The GDP growth for 2023-24 is retained at 6.5 per cent YOY basis. The quarterly YOY growth projections are Q1: 8.0 per cent, Q2: 6.5 per cent, Q3: 6.0 per cent and Q4: 5.7 per cent, respectively. The significant downside risks to growth are the unfavourable rainfall conditions during the monsoon season, steeper than expected decline in global demand conditions and supply chain disruptions due to spillovers from the geo-political conflicts. As compared to the April forecast, the quarterly growth rates in Q1 and Q2 are revised upward and Q3 and Q4 downward in the present set of projections. RBI’s Survey of Professional Forecasters provides a median forecast of 6.0 per cent for 2023-24, the same as in the previous round.
27. The headline inflation rate, YOY, dropped further to below 5 per cent mark in April, following the decline to below 6 per cent in March. The rate of price rise fell in all three main categories of consumption basket: food, fuel and the ‘core’. The decline was steeper in fuel and food than the ‘core’. This broad-based decline in the inflation rate was also seen in March. A number of factors have contributed to the significant decline in inflation rate in March and April: deceleration in the commodity prices in the international markets; decline in the inflation rates in the major economies, although they remain well above the targets; favourable base effects; and the impact of monetary and policy measures on inflation directly and through their impact on inflation expectations. RBI’s recent Inflation Expectations Survey of Urban Households finds that along with the perceived current inflation rates, the median expected inflation rate on a 3-months ahead and one-year ahead horizons is declining as compared to their levels in the previous round.
28. Taking into account the current trends and assessment of factors influencing price trends, RBI’s projected average headline inflation rate for FY 2023-24 is 5.1 per cent, with quarterly projections of 4.6 per cent in Q1, 5.2 per cent in Q2, 5.4 per cent in Q3 and 5.2 per cent in Q4. The projected inflation rate for FY 2023-24 is well below the rate of 6.7 per cent experienced in the previous year and close to the median forecast of 5.0 per cent for FY 2023-24 in the RBI’s Survey of Professional Forecasters.
29. However, a few concerns remain on the question of sustainability of the trends seen in March and April headline inflation rate. Several sub-categories of consumption basket still register price rise of well-above 6 per cent. Price rise, YOY basis, in the case of cereals and products is in double digits, and in milk and products above 8 per cent in March and April. Clothing and footwear and Household goods and services also are at or above 6 per cent rate of price rise in March and April. Among the broad groupings of items in the consumption basket excluding (1) Food and beverages, (2) Pan, tobacco and intoxicants and (3) Fuel and light, items with YOY price rise of 6 per cent or more account for 45 per cent of the weight of this broad group. The month over month change is higher in April as compared to March for several commodity groups although significant ‘base effects’ have lowered the YOY headline inflation rate. These issues require consideration in assessing the sustainability of moderating trend in headline inflation rate to the target of 4 per cent.
30. The decline in the overall headline inflation in the recent two months combined with the strong growth performance in Q4: FY 2022-23 suggest a trajectory of lower YOY inflation of 5 per cent and GDP growth of above 6 per cent in FY 2023-24. The projected inflation rate is below the upper tolerance limit of 6 per cent but well above the target of 4 per cent. There are also upside risks to inflation both on account of the evolution of sectoral price trends and developments at the global level. The impact of increase in policy rate between May 2022 and April 2023 by 250 basis points and other economic policy measures have been crucial in anchoring price expectations. As transmission of the policy changes through the economy to reach the inflation target is subject to unpredictable developments, it is necessary to ensure that the policy framework is focused on achieving the inflation target while supporting growth.
31. Accordingly, I vote: (a) to keep the policy repo rate unchanged at 6.50 per cent, and (b) to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
32. Global uncertainty continues although its economic impact has been less severe than expected. Major advanced economy (AE) central banks have slowed their tightening. Inflation is softening although it continues to be above target. They have shifted to a more data-based approach and are more willing to wait for the lagged effects of past tightening. Inflation has not been high for as long as it was in the seventies so there is less reason to fear persistence without higher for longer policy rates. Labour markets remain tight, but this may partly reflect labour hoarding by employers following the post Covid-19 labour shortages so that tightness may be overestimated. AE fiscal tightening has less global spillovers compared to monetary tightening so more AE fiscal consolidation may reduce pressures on monetary policy.
33. Indian growth outperformed market expectations but did fall from 9.1% in FY22 to 7.2% in FY23. Some turnaround in manufacturing and continued growth in fixed investment in Q4FY23 augurs well for the future, however. Construction also remains robust, but consumption and exports have areas of softness, pent up demand for services may moderate, and unemployment remains high.
34. Inflation has moderated into the tolerance band but is not yet firmly on the path to target, particularly in view of monsoon related uncertainties. Even so, it is clear that core inflation is neither persistent nor broad-based. Core inflation fell from 6.2% in January to 5.1% in April this year. Softening is to be expected in the absence of true second round effects from excess demand or from tight labour markets. Inflation was higher for so long because of multiple supply shocks.
35. Going ahead firms’ input output price gap is almost closed, profit margins rose sharply in Q4FY23, input costs have fallen, wage pressures are not there, and since demand is slack they are unlikely to raise prices. WPI inflation, that has a larger weight of manufacturing prices, is negative. The IIM Ahmedabad business expectation survey shows a moderation in firms’ one year ahead price and cost inflation as well as sales expectations. Preliminary results from the RBI enterprise surveys, however, show firms expecting price and cost inflation to rise, despite actual costs and inflation softening. This may be due to fears about the monsoon and bears watching over the next few months.
36. The quick succession of repo rate raises has brought the real rate to near equilibrium levels, which has prevented over-heating as well as over-tightening of demand and helped to anchor inflation expectations. The slowdown and pause was also well-timed.
37. It is necessary to build on the learning of the past few years where allowing sufficient nominal variation in repo and exchange rates to keep real rates near equilibrium has helped smooth shocks and sustain Indian growth resilience. The experience has shown that independence from AE monetary cycles is feasible and foreign inflows are not tightly linked to the interest rate differential with AE rates. Flexibility in inflation targeting, intervention in FX markets to reduce excess volatility, economic diversity, supply-side action and good monetary-fiscal coordination under supply shocks have all contributed to better outcomes.
38. As expected inflation falls, however, it is important that real repo rate does not rise too high. This is what happened in 2015 as international oil prices fell, damaging the economic cycle. Research suggests that the inflation targeting regime has contributed to reducing inflation expectations. Commitment to such a regime only involves aligning the nominal repo rate with expected inflation. Such action, together with the greater impact of official communication in emerging markets, is adequate to bring inflation to target as the effect of shocks dies down. It does not require the nominal repo to be kept higher for longer.
39. But in this meeting, it is appropriate for the MPC to pause. I also vote for the present stance to continue since at present it is not possible to give a signal about future action. The latter will be conditional on the data coming in. The pause is only for the current meeting. Moreover, transient events have created a liquidity surplus, so that withdrawal of liquidity itself is also required. Statement by Prof. Jayanth R. Varma
40. The outlook on inflation and growth has changed only marginally between the April meeting and this meeting. The two inflationary risks that I spoke about in April (crude prices and the monsoon) have become a little less worrisome. On the crude oil front, it is now clear that OPEC+ is struggling to reduce supply adequately to counter sluggish demand, and the risk of a substantial spike in crude price in the near term is not very high. As regards the monsoon, the official forecast of a normal monsoon provides some comfort, but it is tempered by the fact that the forecast includes an almost even chance of monsoon being below normal or worse. Fortunately, the forecast likelihood of a deficient monsoon is only marginally higher than the climatological probability, and the chance of a drought appears to be rather remote. This augurs well because the Indian economy is quite resilient to a monsoon which is somewhat below normal if its spatial and temporal distribution is satisfactory. Another indication of a slight reduction in inflationary risks is the slight decline in the RBI projections of inflation for 2023-24 between the April and June meetings. Similarly, the outlook for growth remains more or less the same as in April with several high frequency indicators suggesting that growth is not as robust as we would like.
41. Considering the balance of risks, I vote for keeping the repo rate unchanged in this meeting. I am of the view that the current level of the repo rate is high enough to keep inflation below the upper tolerance band on a sustained basis and also glide it towards the middle of the band. However, there are significant risks to both inflation and growth, and the process of bringing inflation under control is still very much work in progress. It would be premature to declare victory at this point of time based on the inflation prints of just a couple of months. In this context, I am not at all comfortable with the self- congratulatory tone of the statement in the MPC Monetary Policy Statement that “The MPC took note of the moderation in CPI headline inflation in March-April into the tolerance band, in line with projections, reflecting the combined impact of monetary tightening and supply augmenting measures.”
42. Turning to the stance, I find that with every successive meeting, this stance is becoming more and more disconnected from reality. Based on the forecast inflation for 5.1% for 2023-24, the real repo rate is now almost 1½%. (The real short term rate could well be above that level since in recent weeks, many money market rates have often drifted towards the MSF rate of 6.75%). In other words, monetary policy is now dangerously close to levels at which it can inflict significant damage to the economy. Despite this, the majority of the MPC wishes to remain focused on withdrawal of accommodation whatever that phrase might mean. I have therefore seriously considered dissenting on this part of the resolution, but after careful thought I have decided to confine myself to expressing reservations on it. The main reason for not dissenting is that, after two successive meetings at which the repo rate has been left unchanged, this stance now appears more vestigial than a serious statement of intent. Statement by Dr. Rajiv Ranjan
43. The reasons outlined for a pause in rate action in my previous statement of April 2023 broadly hold for this meeting as well. Moreover, as the latest prints of growth and inflation indicate a Goldilocks scenario, with growth higher and inflation marginally lower than anticipated, this is telling us that our cumulative actions taken so far are working in the right direction. It needs to be acknowledged, however, that knowing when to stop is hard. The effects of tight policy will continue to percolate through the system months after the pause. If policy makers continue tightening until inflation falls as much as they want, they are likely to go farther than they need to (Romer and Romer, 2023) 1. Notwithstanding this, it is important that we do not drop our guard against inflation, especially when we are still away from our primary goal of aligning inflation to the 4.0 per cent target.
44. On the domestic growth front, the optimism spelt out in my earlier minutes has materialised, with the acceleration in real GDP growth for Q4:2022-23 to 6.1 per cent from 4.5 per cent in the preceding quarter. The quarter-on-quarter (qoq) seasonally adjusted momentum in Q4 at 2.9 per cent, well above the pre-pandemic average of 1.7 per cent (2012-13 to 2019-20), bodes well for growth going forward. Furthermore, there are clear signs of economic activity holding up well in Q1:2023-24 2 as indicated by various high frequency indicators and this optimism is expected to follow through in the remaining quarters of 2023-24. This stems from three factors: (i) revival in rural consumption; (ii) private corporate investment gaining steam; and (iii) moderating drag from net external demand. Let me elaborate. Rural demand is supported by the robust rabi foodgrains production and expected normal monsoon. 3 Given the low share of agriculture in aggregate GVA (around 15 per cent in 2022-23) and its contribution to GDP growth, even if monsoon turns out be lower than normal, its impact on growth may not be significant. On the other hand, deficient monsoon could have a more tangible impact on inflation due to the higher share of food items in the CPI consumption basket.
45. There is an increasing revival in corporate investment due to slackening of input cost pressures and rising capacity utilisation. Credit growth to industry has improved driven by large industries, particularly, roads, steel, cement, construction, petroleum and chemicals. On the supply side, manufacturing sector performance, which turned positive in Q4:2022-23, is likely to improve further with softening commodity prices, normalisation of supply chains and production linked incentive (PLI) scheme gaining traction. Manufacturing companies in several key sectors have expanded their fixed assets. Services sector constituted about 63 per cent share in aggregate gross value added (GVA) and contributed around 83 per cent to growth in GVA during 2022-23 and is expected to remain the mainstay of growth in 2023-24. Higher contraction in merchandise imports coupled with buoyant services exports are improving net external demand.
46. Headline CPI inflation fell sharply by 1.7 percentage points between February and April 2023, supported by favourable base effects and soft price momentum. The softening in core inflation was seen across various exclusion based as well as trimmed 1 Romer C.D. and David H. Romer (2023), “Does Monetary Policy Matter? The Narrative Approach after 35 Years”, American Economic Review, Vol. 113, Issue 6, June. 2 Real GDP in Q1:2023-24 will also benefit from base effect which is yet to normalise. 3 Around 55 per cent of rabi production is accounted for in Q1:2023-24. mean measures. CPI diffusion indices indicate that a majority of the CPI items saw price increases less than a seasonally adjusted annualised rate (SAAR) of 6 per cent during March-April 2023, a significant reversal from February. All these suggest some waning of price pressures in CPI in recent months, as the impact of monetary policy actions, supply side measures and easing of global commodity prices played through. Inflation, however, is likely to remain well above the target rate of 4 per cent throughout the year.
47. We have been prudent in our approach using the flexibility imbedded in the framework to operate within the tolerance band in balancing macroeconomic priorities depending upon the need of the hour. With greater clarity on macro fronts, prudence requires that we now focus on aligning inflation to the target of 4 per cent. Time is opportune to emphasise the distinction between the inflation target and tolerance of deviations from the target. The tolerance band can be conceptually broken down into an uncertainty range 4 owing to imperfect knowledge of the (present and future) state of the economy; the indifference range over which monetary policy is not expected to react; and finally, the operational range that allows for intentional deviations to exercise short-run trade-offs between inflation and growth (Chung et al, 2020). 5 Sustained deviations of inflation from the target may lead to a steady drift of inflation expectations. The risk of ceding part of the operational range to the indifference range makes it imperative to emphasise the primacy of the 4 per cent inflation target. This is crucial to support the ongoing process of anchoring inflation expectations around the target. Moreover, real policy rate continues to be positive which will further anchor inflation expectations.
48. The rate pause in April seems to have had a sobering impact on domestic financial conditions. For instance, the average spread of the 10-year G-sec yield over the 1-year G-sec, 91-day Treasury bills, and the policy repo rate moderated to 20 bps, 29 bps and 58 bps, respectively, during April 6-June 7, 2023. In the credit market, the weighted average lending rate (WALR) on fresh rupee loans and the weighted average domestic term deposit rate (WADTDR) on fresh deposits of scheduled commercial banks fell by 23 bps and 12 bps, respectively, in April 2023. Such an easing of financial conditions occurred, even as the MPC had unequivocally argued that the pause was specific to the April policy and not a policy pivot. Accordingly, continuity in the stance with a clear-cut objective of aligning inflation to the 4 per cent target is important. Any premature change in stance may be hasty and could undo the hard work done so far. It may also tamper with the transmission process that is currently underway. Recent actions of some advanced economies reverting back to rate hikes after a pause need to be kept in mind. Thus, I vote for a pause in rate action and continuity of stance. Monetary policy actions would need to be calibrated carefully by assessing the impact of past actions, meticulously scrutinising the incoming data, and responding appropriately to the evolving macroeconomic conditions. Statement by Dr. Michael Debabrata Patra
49. Macroeconomic outcomes have broadly evolved along projected paths, vindicating the April 2023 monetary policy decision and stance. This provides elbow room to re- assess the evolving outlook with information gleaned from current rounds of forward- looking surveys and updated forecasts of goal variables, while keeping in mind the cumulative actions already taken and the lags of monetary policy’s effects on the economy. 4 This comprises forecast errors, Knightian uncertainty, among others. 5 https://www.federalreserve.gov/econres/feds/files/2020075pap.pdf
50. Overall, the outlook for real GDP growth in India is brighter than in April. Global risks appear contained for now, but idiosyncratic monsoon-related risks have risen and need to be seen off over the ensuing months. Financial conditions have eased considerably, and domestic financial markets are reflecting a stable growth outlook along with re-anchoring of inflation expectations.
51. The near-term outlook for inflation is also relatively benign vis-a-vis the 2022-23 experience. Beyond the first quarter, however, pressure points emanating from specific supply-demand mismatches could impart upward pressure to the momentum of prices and offset favourable base effects, especially in the second half of 2023-24. Hence, monetary policy needs to remain in ‘brace’ mode, ensuring that the effects of these shocks dissipate without leaving scars on the economy.
52. Accordingly, my vote for maintaining status quo on the policy rate should be seen as taking middle stump guard to prepare for a bouncier pitch. Holding the rate unchanged should not be interpreted as the interest rate cycle having peaked, but as a period of careful evaluation of a decision on the extent of additional policy tightening, if needed. This is a part of continuous learning about the underlying structure of the economy with new information until the next meeting of the MPC, and not a prolonged pause. Headline inflation is edging down towards the target, but it is still well above it and the balance of risks suggests that it will go up in coming months before it comes down. Therefore, continuing with the stance of withdrawal of accommodation is appropriate as it adequately conveys the future course of interest rates in the economy. Statement by Shri Shaktikanta Das
53. The global economy has sustained the growth momentum and the overall uncertainty is somewhat receding. Nevertheless, headwinds to global growth outlook persist. The geopolitical conflict continues unabated. Headline inflation across countries is on a downward trajectory, but is still high and above their respective targets. Central banks remain on high alert and watchful of the evolving conditions.
54. India’s macroeconomic fundamentals are strengthening and growth prospects are steadily improving and becoming broad-based. Inflation has eased and the external sector outlook has improved. Balance sheets of banks and corporates look resilient and healthy, thereby engendering twin balance sheet advantage for growth. Demand conditions remain supportive of growth on the back of improving rural demand and investment activity. Urban demand remains strong. Consumer and business outlook surveys display continued optimism. Overall, the Indian economy presents a story of resilience and sustainability, with an expected real GDP growth of 6.5 per cent in 2023-
55. The inflation trajectory has seen significant softening during March-April 2023, as anticipated, with the near-term outlook turning out to be more favourable than envisaged earlier. Inflation is now projected to average 5.1 per cent in 2023-24 compared to 6.7 per cent in 2022-23, but this would still be above the target. The disinflation towards the target rate of 4 per cent is likely to be gradual and protracted. Compared to April, uncertainties on the inflation outlook for H2:2023-24 have not abated. The spatial and temporal distribution of the south-west monsoon in the backdrop of a likely El Nino weather pattern needs to be watched carefully, especially for its impact on food prices. International prices for key food items like rice and sugar are at elevated levels. Adverse climate events have the potential to quickly change the direction of the inflation trajectory. Geo-political tensions, uncertainty on crude price trajectory and volatile financial markets pose further upside risks to prices. These considerations warrant close monitoring of the evolving price dynamics.
56. The pause in April MPC was based on the need to assess the cumulative impact of 250 bps rate hike over the past one year. Our surveys indicate that anchoring of expectations is underway and our monetary policy actions are yielding the desired results. Given the baseline inflation projections for 2023-24, positive real policy rates will aid the ongoing disinflation process. The full impact of past actions is still unfolding. In this situation, a pause in the rate hike cycle and closely assessing the evolving situation looks the most appropriate option for this meeting of the MPC. Accordingly, I vote for keeping the policy rate unchanged in this meeting of the MPC.
57. Our job is only half done, having brought inflation within the target band. Our fight against inflation is not yet over. We need to undertake forward-looking assessment of the evolving inflation-growth outlook and stand ready to act, if situation so warrants. Beyond this and given the prevailing uncertainties, it is difficult to give any definitive forward guidance about our future course of action in a rate tightening cycle.
58. I also vote to continue with the stance of withdrawal of accommodation, given that liquidity in the banking system is still in surplus and we have a way to go to align headline inflation with 4.0 per cent target on a durable basis and ensure that the overall financial conditions are in sync with the monetary policy stance. We will continue to remain agile and flexible in managing liquidity through two-way operations. We do recognise that durable price and financial stability are mutually reinforcing and necessitate greater policy focus at the current juncture. Our future actions will be shaped accordingly. (Yogesh Dayal) Press Release: 2023-2024/449 Chief General Manager
6. The standing deposit facility (SDF) rate remains unchanged at 6.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent. • The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below. Assessment Global Economy
7. The global economy is slowing and growth trajectories are diverging across regions amidst moderating but above target inflation, tight financial conditions, simmering geopolitical conflicts, and geoeconomic fragmentation. Sovereign bond yields have hardened. The US dollar fell to a 15-month low in mid-July on expectations of an early end to the monetary tightening cycle, although it recouped some of the losses subsequently. Equity markets have gained on expectations of a soft landing for the global economy. For several emerging market economies, weak external demand, elevated debt levels and tight external funding conditions pose risks to their growth prospects. Domestic Economy
8. Domestic economic activity is maintaining resilience. The cumulative south-west monsoon rainfall was the same as the long period average up to August 9, 2023 although the temporal and spatial distribution has been uneven. The total area sown under kharif crops was 0.4 per cent higher than a year ago as on August 4, 2023. The index of industrial production (IIP) expanded by 5.2 per cent in May while core industries output rose by 8.2 per cent in June. Amongst high frequency indicators, e-way bills and toll collections expanded robustly in June-July, while rail freight and port traffic recovered in July after remaining muted in June. The composite purchasing managers’ index (PMI) rose to a 13-year high in July.
9. Urban demand remains robust, with domestic air passenger traffic and household credit exhibiting sustained double digit growth. The growth in passenger vehicle sales has, however, moderated. In the case of rural demand, tractor sales improved in June while two-wheeler sales moderated. Cement production and steel consumption recorded robust growth. Import and production of capital goods continued in expansion mode. Merchandise exports and non-oil non-gold imports remained in contraction territory in June. Services exports posted subdued growth amidst slowing external demand.
10. Headline CPI inflation picked up from 4.3 per cent in May to 4.8 per cent in June, driven largely by food group dynamics on the back of higher prices of vegetables, eggs, meat, fish, cereals, pulses and spices. Fuel inflation softened during May-June, primarily reflecting the fall in kerosene prices. Core inflation (i.e., CPI excluding food and fuel) was steady in June.
11. The daily absorption of liquidity under the LAF averaged ₹1.8 lakh crore during June-July as compared with ₹1.7 lakh crore in April-May. Money supply (M3) expanded by 10.6 per cent y-o-y as on July 28, 2023 as against 10.1 per cent on May 19, 2023. Bank credit grew by 14.7 per cent y-o-y as on July 28, 2023 as compared with 15.4 per cent on May 19, 2023. India’s foreign exchange reserves stood at US$ 601.5 billion as on August 4, 2023. Outlook
12. Going forward, the spike in vegetable prices, led by tomatoes, would exert sizeable upside pressures on the near-term headline inflation trajectory. This jump is, however, likely to correct with fresh market arrivals. There has been significant improvement in the progress of the monsoon and kharif sowing in July; however, the impact of the uneven rainfall distribution warrants careful monitoring. Crude oil prices have firmed up amidst production cuts. Manufacturing, services and infrastructure firms polled in the Reserve Bank’s enterprise surveys expect input costs to ease but output prices to harden. Taking into account these factors and assuming a normal monsoon, CPI inflation is projected at 5.4 per cent for 2023-24, with Q2 at 6.2 per cent, Q3 at 5.7 per cent and Q4 at 5.2 per cent, with risks evenly balanced. CPI inflation for Q1:2024-25 is projected at 5.2 per cent (Chart 1).
13. Looking ahead, the recovery in kharif sowing and rural incomes, the buoyancy in services and consumer optimism should support household consumption. Healthy balance sheets of banks and corporates, supply chain normalisation, business optimism and robust government capital expenditure are favourable for a renewal of the capex cycle which is showing signs of getting broad-based. Headwinds from weak global demand, volatility in global financial markets, geopolitical tensions and geoeconomic fragmentation, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 per cent with Q1 at 8.0 per cent; Q2 at 6.5 per cent; Q3 at 6.0 per cent; and Q4 at 5.7 per cent, with risks broadly balanced. Real GDP growth for Q1:2024-25 is projected at 6.6 per cent (Chart 2).
14. The headline inflation is likely to witness a spike in the near months on account of supply disruptions due to adverse weather conditions. It is important to be vigilant about these shocks with a readiness to act appropriately so as to ensure that their effects on the general level of prices do not persist. There are risks from the impact of the skewed south-west monsoon so far, a possible El Niño event and upward pressures on global food prices due to geopolitical hostilities. Domestic economic activity is holding up well, supported by domestic demand in spite of the drag from weak external demand. With the cumulative rate hike of 250 basis points undertaken by the MPC working its way into the economy, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent, but with preparedness to undertake policy responses, should the situation so warrant. The MPC will maintain a close vigil on the evolving inflation scenario and remain resolute in its commitment to aligning inflation to the target and anchoring inflation expectations. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.
15. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 per cent.
16. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
17. The minutes of the MPC’s meeting will be published on August 24, 2023.
18. The next meeting of the MPC is scheduled during October 4-6, 2023. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. Growth indicators for the first four months of FY 2023-24 point to the resilience of the economy in the face of adverse external economic conditions and the uneven spread of monsoon over the months and spatially across the regions. The headline inflation rate dropped significantly in Q1: FY2023-24 but the headline inflation rate for FY 2023-24 as a whole as projected in the June 2023 MPC meeting was above 5 per cent, highlighting the distance to the policy target of 4 per cent. The policy rate was kept unchanged in the last MPC meeting in view of the need to assess the course of the inflation rate and the economic activity in the context of the increase in the policy rates effected since May 2022.
20. As far as the overall domestic economic activity is concerned, the outlook for the near term appears to be one of lower GDP growth compared to the 7.2 per cent growth rate achieved in FY 2022-23. The outlook for the global economic growth has become more optimistic with the IMF increasing its projection of the world GDP growth in its July update of the World Economic Outlook to 3.0 per cent in 2023 from the earlier projection of 2.8 per cent. However, there are risks of adverse shocks such as the further deterioration of geopolitical conflicts and the adverse climatic conditions affecting agriculture. The same is the case with respect to inflation outlook. Vulnerability to spikes in international commodity and energy prices caused by disruptions in supply chains pose a significant challenge to maintaining domestic price stability.
21. The high frequency indicators of the economic activity reflect growth resilience and the need for a cautious outlook. Merchandise exports and imports including non-oil non-gold imports have registered negative YOY growth rates in the recent months. Services exports are rising but the growth has decelerated. Services imports declined in June. Construction related indicators such as cement production and finished steel production point to sustained growth. Indicators such as E-way bills, GST collection and toll collection suggest sustained expansion in domestic economic activity. But air cargo, rail freight and port traffic show weak trends. The PMI for manufacturing and services for July 2023 re-iterate the resilience of the economy in the face of weak external demand conditions and uncertainties faced over the quality of the monsoon rains this year. However, expectations of the future output are on a cautious note.
22. The indicators related to household consumption expenditure reflect its moderate momentum. The Consumer Confidence Survey of urban households by RBI conducted in July 2023 indicates cautious optimism for the year ahead: the households are optimistic of improved economic conditions one-year ahead and the level of optimism remains stable at the level seen in the survey conducted in May 2023. The increased consumption spending is still driven by the ‘essential expenditure’ and the ‘non-essential or discretionary expenditure’ is expected to gain strength in the year ahead, though the optimism declined marginally in the latest round of the survey. The trends in IIP for consumer goods also appear to reflect this pattern: IIP for consumer non-durables has shown significant growth in April-May 2023 and the YOY growth rate of IIP for consumer durables remains negative. Indicators of consumption growth such as passenger vehicle sales, 2-wheeler sales and air travel are higher in April-May 2023 YOY basis, with the performance slowing in June for the auto sector. Maintaining the growth momentum of the agricultural sector seen in the last 2-3 years would be crucial in sustaining rural consumption demand.
23. The impact of the government’s capital expenditure support both at the Central and state levels for infrastructure and support for building production capacity in the industry is reflected in the indicators related to industrial activity. The IIP for infrastructure/ construction is the only sub-sector of industry to register double digit YOY growth during April-May 2023. The IIP for capital goods has also registered growth of 6.5 per cent in the same period but it is a sharp decline from the growth in Q4: FY2022-23. RBI’s survey of enterprises carried out in April-June 2023 reflected increased levels of investment plans for FY 2023-24. The investment intentions reflected in the funds raised for investment purpose in Q1 FY 2023-24 by the private corporates, based on an analysis by RBI, are strikingly high. The net FDI inflows in April- May 2023 at USD 5.5 billion are about half the level seen in the same period in 2022. Maintaining high investment demand would be important for sustaining growth momentum in FY 2023-34. 23. In manufacturing, raw material cost is the largest share of cost and it has fallen.
24. Considering the developments in the economy and the external global environment, the YOY GDP growth for 2023-24 has been retained at 6.5 per cent, the same as in the June meeting of the MPC. The quarterly growth projections are Q1 at 8.0 per cent, Q2 at 6.5 per cent, Q3 at 6.0 per cent and Q4 at 5.7 per cent. The median forecast of YOY GDP growth for FY 2023-24 from the RBI Survey of Professional Forecasters is 6.1 per cent.
25. At 4.6 per cent, the CPI based YOY headline inflation rate in Q1: FY2023-24, is below the 6 per cent mark after a run of above 5 per cent for the previous eight quarters. On the positive side, in Q1, the core inflation rate excluding food and fuel, has also come close to 5 per cent. Both food and fuel & light components of headline inflation were below 5 per cent in Q1.
26. The downward momentum of the inflation is complemented by the expectations of moderating inflation. The recent RBI bi-monthly sample survey of urban households indicates that the 3-months and one-year median expected inflation rates are lower than in the previous two consecutive rounds. The ‘Business Inflation Expectations Survey’ of firms conducted by the IIM Ahmedabad in June 2023 indicates a decline in the one-year- ahead expected CPI headline inflation rate of below 5 per cent.
27. Based on an assessment of the various factors affecting price trends, and an assumption of a normal monsoon, CPI headline inflation is projected at 5.4 per cent for 2023-24, with Q2 at 6.2 per cent, Q3 at 5.7 per cent and Q4 at 5.2 per cent. The projected inflation rate in Q2 and Q3 is now higher than the projections of the June MPC meeting, primarily on account of risks to food inflation. The Survey of Professional Forecasters conducted in July 2023 provides median forecast of headline inflation rate of 5.2 per cent in 2023-24.
28. While there is a moderating trend in the headline inflation rate, there are clearly upside risks on account of the weather uncertainty affecting agricultural prices. The international commodity prices have remained low in 2023 relative to the peaks of 2022; however, the volatility has increased for some of the agricultural commodities and there is hardening in the case of energy in the recent period. While the spikes in prices of a few commodities may not lead to persistent overall price pressures, broadening of price pressures would be a concern. The impact of policy rate actions initiated in May 2022 leading to an increase in the repo rate by 250 basis points by February 2023 is yet to be fully realised. There are also risks to growth projections, particularly as they relate to export demand. Therefore, there is a need at this juncture to retain the current policy rate and the policy stance to sustain the moderating forces on inflation.
29. Accordingly, I vote: i. to keep the policy repo rate unchanged at 6.50 per cent and ii. to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
30. Since global inflation is moderating without a major impact on growth a soft landing becomes more feasible. But financial fragilities in some countries, erratic weather and geopolitics continue to remain threats.
31. Indian growth also continues to be healthy especially since the rise in fixed investment can raise potential output. There are indications investment is becoming broad-based as state governments and small firms also invest more. It needs to strengthen further, however, for which policy certainty and smoothing of shocks is required. Export dependent industries such as textiles are not doing well.
32. Despite a late start, the monsoon more than made up in July. Precipitation is uneven, however, and extreme weather has caused unprecedented spikes in key vegetable prices. Even as headline inflation rose in June, core inflation stayed soft and professional forecasters expect it to fall below 5%. The pandemic related rise in firm costs has more than reversed. For example, container shipping rates in July were about half their 10 year average rates.
33. Since the Indian middle income consumer is price sensitive, profits have risen for FMCG firms that have passed on the fall in costs. Nominal sales growth of manufacturing companies softened in Q1 according to the early corporate results while real growth rose, pointing to factors limiting price rise. The RBI end June enterprise survey also shows the moderation in input cost is expected to continue in the 2nd half of the year. This should impact pricing. Prices are expected to rise, but by how much?
34. Research suggests that Indian firms change prices about once in three years, so the passing on of cost softening is not yet complete and should continue as long as current supply-shocks reverse. Moreover, for firms that print a maximum retail price on packages, the increase is found to be at around 4% 1. This may indicate the inflation target is becoming a focal point. The sectoral structure of inflation also supports softening core inflation. In IT services where share of wage cost is above 50% wage growth is reducing as export demand slows. Wage growth was the highest in this sector in 2022-
35. In the initial period when inflation targeting was introduced, causality was thought to be from headline to core inflation 2. Then food inflation could have persistent effects on inflation. But later research showed this result was special to a period of sustained high food inflation that began in 2007 and led to second round rise in wages. In normal conditions, it was the more persistent core that affected volatile food inflation 3. Spikes in food prices can therefore be looked through as long as they remain just that.
36. The household inflation expectation and consumer confidence surveys suggest households are doing exactly this looking through, since inflation perceptions have risen but one year ahead inflation expectations have fallen.
37. However, agricultural prices must become more resistant to possibly more frequent weather shocks. For this diversified and resilient vegetable supply chains are required. Well-functioning markets respond before price spikes become very large. Delhi should not be buying tomatoes only from Himachal Pradesh. States can experiment with allowing corporations more direct access to farmer organizations. Large food retail chains also buying from mandies aggravates price movement in India. Farmer cooperatives have more bargaining power and platforms like Open Network for Digital Commerce (ONDC) can aid them in establishing supply agreements anywhere in the country. Processing and storage facilities must improve. In addition to these longer-term actions, trade offers short term degrees of freedom in an open economy.
38. Pre-emptive supply-side action that prevents repeated or persistent food price shocks would abort second round increase in wages and other prices that could require further monetary tightening and growth sacrifice. ‘Price Stickiness in CPI and its Sensitivity to Demand Shocks in India’, Sujata Kundu, Himani Shekhar and Vimal Kishore, RBI occasional papers, 42(2): 101-147, 2021. ‘Food Inflation in India: The Role for Monetary Policy’, Anand, R., Ding, D., & Tulin, V., International Monetary Fund, Working Paper Series no. WP/14/178, 2014. ‘Inflation Convergence and Anchoring of Expectations in India’, Ashima Goyal and Prashant Parab, Economic and Political Weekly, November 28, 55(47): 37-46. 2020.
39. Slower global growth is likely to keep a lid on international oil prices. Indian oil majors turned profitable in the summer last year and are showing large profits. They are in a position to reduce domestic prices. Oil price cuts have a large impact on household inflation expectations.
40. Commitment to flexible inflation targeting that anchors inflation expectations requires aligning the nominal repo rate with medium term expected inflation. The latter is less affected by transient shocks and measurement issues. Headline inflation forecasts have risen in the short-term but remain slightly above 5% for the next year so that a repo rate of 6.5% still gives a positive real rate of around unity. This is the apt real rate given uncertainties in both growth and inflation.
41. Therefore, in this meeting it continues to be appropriate for the MPC to pause. I thus vote for keeping the repo rate unchanged in this meeting. I also vote for the present stance to continue since at present liquidity is in surplus and policy needs to signal continuing watchfulness towards bringing inflation to the target. The progress of the rest of the monsoon, possible supply-side action, further pass through of past rate hikes, the behaviour of food prices and the evolution of core inflation, have all to be carefully observed. Statement by Prof. Jayanth R. Varma
42. In June, I warned against declaring victory based on the inflation prints of just a couple of months, and expressed discomfort with the self-congratulatory tone of the MPC statement of that month about inflation having come inside the tolerance band. It is now clear that we would have a couple of months of inflation readings well above the tolerance band. I view these monthly gyrations with some degree of equanimity. Just as a couple of low readings do not call for celebration, it is equally true that a couple of very high readings do not call for panic. What is important is the projected trajectory of inflation over the next several quarters. On this basis, I continue to have the same cautious optimism that I had in the June meeting. I expect the continuing slowdown in China to keep a lid on commodity prices. Moreover, rains in July have attenuated the monsoon risks, though there are continuing worries about the spatio-temporal distribution.
43. Considering the balance of risks, I vote for keeping the repo rate unchanged in this meeting. I am of the view that the current level of the repo rate is high enough to bring inflation below the upper tolerance band on a sustained basis and also glide it towards the middle of the band.
44. Turning to the stance, my reservations remain the same as in the past. However, this would be the third successive meeting at which the repo rate has been left unchanged (assuming that the MPC decides to pause now). This disconnect between stance and action has completely hollowed out whatever meaning the stance might have originally had, and turned it into a harmless ritualism. So I am content with expressing reservations about the stance. Statement by Dr. Rajiv Ranjan
45. In the last minutes, I had mentioned how growth momentum had surprised positively whereas inflation was turning soft, implying a goldilocks kind of scenario. That assessment broadly holds true, albeit with a transitory spurt in inflation. I had highlighted that the spatial and temporal distribution of the monsoon would be critical for the evolving inflation dynamics. As per the latest available information, this risk has materialised with the uneven progress of the monsoon manifesting in the form of excess rains in the north- west regions and disrupting supply, and deficient rains in the eastern part delaying crop sowing. Vegetables prices rose sharply in June-July – much above the seasonal trend and the largest in recent memory.
46. High frequency food price data for July indicate a major price shock from vegetables, particularly, tomatoes and this time around it is turning out to be different than earlier episodes. Since mid-June to end-July 2023 tomato prices have surged by 362 per cent, with more than 80 per cent of the price escalation happening during end- June and first half of July. The magnitude and intensity of the price shock this time around was substantially higher when compared to earlier years. 4 Our historical experience, however, suggests that the inflationary shocks emanating from commodities like vegetables are in fact transitory in nature. In 2017, when tomato prices soared by 27 per cent in the month of June and further by 138 per cent in July, this was followed by a sharp correction over the subsequent two months. Likewise, in June 2016, the steep increase in tomato prices was fully corrected within the next three months as market supplies improved. Although the catch up in kharif sowing augurs well for agricultural production, price increases observed across other vegetables as well as other food sub- groups such as cereals, pulses and spices remain a point of concern, demanding our vigilant monitoring. The forecast of continuation of uneven monsoon in the next two months together with an El Nino event, amid volatile global food prices, makes the food price outlook uncertain.
47. On the growth front, available information for Q1:2023-24 shows that domestic economic activity has been holding well, on the back of healthy growth in agriculture, rebound in the manufacturing sector, and continued robust expansion in services activity. In the agriculture sector, GVA growth is expected to be above 5.0 per cent on the back of 9.5 per cent growth in rabi foodgrains production. 5 Turning to the manufacturing sector, the early listed corporate results of Q1:2023-24 6 suggest increase in nominal GVA with moderating input cost pressures and double-digit expansion in staff cost. When seen in conjunction with negative deflator-based inflation of around 2.7 per cent and robust unorganised manufacturing activity 7, real growth of manufacturing GVA could be over 7.0 per cent in Q1:2023-24. Services activity gained an accelerated momentum in Q4:2022- 23, which seems to have continued in Q1:2023-24. Among services activities, ‘trade, hotel, transportation, communication’ component was 10.2 per cent below the pre- pandemic levels in Q1:2022-23, suggesting that this sub-group will receive a strong positive base effect in Q1:2023-24. Furthermore, strong momentum of this sub-group from Q4:2022-23 has carried forward to Q1:2023-24 as suggested by available indicators such as e-way bills, toll collections, GST collections etc. Considering all these factors, real GDP growth is expected to be around 8.0 per cent in Q1:2023-24.
48. Looking ahead, the real GDP growth will be driven by strengthening rural consumption on the back of good prospects of kharif crops; the manufacturing sector supported by easing input costs and wide scope for services activity to catch up with pre- By end-July 2023, according to the Department of Consumer Affairs data, the tomato prices were at Rs. 125 per kg. Between end-September and end-November 2021, the peak of tomato prices was Rs. 64 per kg. Between mid-June to end-July 2017 tomato prices increased to touch Rs. 67 per kg. As mentioned in my last statement that around half of rabi production is likely to be accounted for in Q1:2023-24. Private non-financial entities Reflected by index of industrial production (IIP) manufacturing growth of 5.5 per cent in April-May pandemic trend, particularly in “trade, hotels, transportation, communication, etc.”. Thus, taking all these factors, real GDP growth has been projected at 6.5 per cent for 2023-24.
49. Monetary policy clearly can do little about the first-round effect of a supply side shock emanating from say vegetables. If monetary policy responds to such a surge in headline inflation, the policy would likely be excessively tight and induce high volatility in macroeconomic conditions. 8 On the other hand, if these shocks do not go away and become persistent then inflation expectations can become unanchored, leading to a drift in inflation away from its underlying trend. It may be noted that on the earlier two occasions, during mid-2020 and during mid-2021, the MPC’s prognosis of looking through transitory pressures on inflation has in fact proved accurate.
50. Against the balance of risks, I vote for a pause in the rate action. While the impact of our actions so far continues to play out in the economy, our job is not yet fully over. The costs of high inflation regime are simply too high to take any chances (BIS, 2023). 9 It is in this context that the primacy of 4 per cent inflation target (as distinct from tolerance of deviation from target) emphasised in my last minutes assumes importance. Accordingly, I vote for the continuance of the stance of withdrawal of accommodation. Statement by Dr. Michael Debabrata Patra
51. With the visceral effects of the pandemic fading, the Indian economy is expanding at a moderate pace on the shoulder of the business cycle, and the output gap has closed. Corporate profitability is surging despite moderating top line growth. In the financial sector, credit conditions remain strong even as the cost of funds tightens. The revenge spending related rotation of demand towards services is in full tide, but the peak is subsiding. From the second quarter of 2023-24, unfavourable base effects may create a ‘wet patch’ in the trajectory of GDP; hence, strengthening the momentum of domestic economic activity is key to realising the projected path of the economy over the rest of the year.
52. Recent spikes in food, metal and energy prices have destabilised the international inflation environment as new spates of geopolitical hostilities take their toll on food and energy security worldwide. In addition, India faces the onslaught of overlapping localised supply shocks, which are causing price-sensitive food items in the CPI to spike and push up headline inflation. The elephant in India is the monsoon, with August shortfalls rendering the outlook uncertain in the shadow of El Niño effects even as Indian Ocean dipole conditions are turning positive.
53. Against this backdrop, recent inflation developments and outlook warrant careful assessment and strategy. Through the current episode, inflation has declined from an average of 7.3 per cent in the first quarter of 2022-23 (peak at 7.8 per cent in April 2022) to 4.6 per cent in the first quarter of 2023-24 (4.8 per cent in June 2023), i.e., by 270 basis points. Monetary policy tightening by a cumulative increase of 250 basis points in the policy rate contributed 130 basis points of disinflation, while the waning of supply shocks contributed 140 basis points and other factors offset each other. At the current juncture, however, the gains in output stabilisation are being threatened by the incidence of sporadic supply shocks which elevate the general level of prices instead of dissipating Frederic S Mishkin (2007), ‘Headline versus Core Inflation in the Conduct of Monetary Policy’, Remarks at the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, 20 October 2007. Bank for International Settlements (2023), Annual Report, June. through relative price adjustments within the budget constraint. Our surveys suggest that households’ inflation perceptions have been impacted by these food price developments – which is also reflected in consumer perceptions regarding the price level and inflation – but they should stabilise over the year ahead as supply conditions improve. A risk to the inflation outlook stems from the liquidity overhang in the banking system. Withdrawal of excess liquidity should engage primacy in the attention of the RBI going forward as it presents a direct threat to the RBI/MPC resolve to align India’s inflation with the target, besides the potential risks to financial stability.
54. While unanticipated and short-lived supply demand mismatches lie outside the realm of monetary policy, the commitment to price stability requires the RBI to see off these price perturbations by guarding against spillovers – in India, food price flares can permeate through wages, rents, transport costs and, importantly, through expectations into core inflation. Ensuring the sustained easing of core inflation is crucial to the MPC’s objective of bringing inflation down to the target. This objective should not be undermined by supply shocks that show any signs of persisting and getting broader-based. Accordingly, I vote for maintaining status quo on the policy rate and for persevering with the withdrawal of monetary policy accommodation. Statement by Shri Shaktikanta Das
55. The global economic environment continues to be uncertain. Financial conditions remain tight and volatile. Inflation remains above target in major economies. Amidst all these, India stands out for its resilience and stability and is emerging as the new growth engine of the world.
56. The resilience of Indian economy continued in Q1:2023-24 as reflected in high frequency indicators. The economy is largely evolving on the expected lines. The total acreage under kharif crops has crossed last year’s levels. The manufacturing sector continued to expand, supported by moderating input cost pressures. Services activity remained strong in Q1:2023-24 and it is likely to follow through during the remaining period of 2023-24.
57. Rural consumption has shown signs of improvement in Q1:2023-24 while urban consumption has remained stable. Investment activity is supported by strong government capex. State governments’ capex has also seen a jump. 10 The higher government capex and the twin-balance sheet advantage of banks and corporates provide a congenial environment for private sector investments to gather pace. Private investments are already happening in a few critical sectors like iron and steel, automobiles, petroleum, metals and chemicals. These growth drivers are expected to support the real GDP growth projection of 6.5 per cent for 2023-24 and 6.6 per cent for Q1:2024-25.
58. Headline inflation had eased significantly from 6.2 per cent in Q4:2022-23 to 4.3 per cent in May 2023 reflecting the combined impact of monetary tightening and supply augmenting measures. Inflationary pressures are, however, emerging again with inflation rising to 4.8 per cent in June on the back of rising food prices. Headline CPI is expected to harden significantly in July-August, driven by the spike in tomato and other vegetable The data available from the Comptroller and Auditor General of India (CAG) for 20 states indicates that capital expenditure of the states increased sharply by 74.4 per cent during Q1:2023-24 aided by the Union Government's 'Scheme for Special Assistance to States for Capital Investment'. As on July 25, 2023, the central government has approved expenditure amounting to ₹84,884 crore accounting for 65.3 per cent of the ₹1.3 lakh crore budgeted for 2023-24. prices. While the vegetable price shocks are expected to correct quickly with the arrival of fresh crops, there are risks to the food and the overall inflation outlook from El Nino conditions, volatile global food prices and skewed monsoon distribution - all of which warrant close monitoring. In the non-food category, crude oil prices have firmed up reflecting tighter supply conditions. Against this backdrop, supply side measures need to be continued to prevent the spiraling of frequent food supply shocks into generalised economy-wide price impulses. The softening of core inflation (CPI excluding food and fuel) by around 100 bps, from 6.0 per cent in Q4:2022-23 to 5.1 per cent in Q1:2023-24 is a source of some comfort in the face of rising food prices, although it is still at an elevated level.
59. The Reserve Bank’s liquidity management has been nimble and two-sided as per requirement. We will manage the liquidity overhang proactively using the various instruments at our command while ensuring that the banking system has adequate liquidity to meet the productive requirements of the economy.
60. Headline inflation has softened from last year’s elevated level but it still rules above the target. Our task is still not over. Given the likely short-term nature of the vegetable price shocks, monetary policy can look through the first-round impact of fleeting shocks on headline inflation. At the same time, we need to be ready to pre-empt any second-round impact of food price shocks on the broader inflationary pressures and risks to anchoring of inflation expectations. The impact of the cumulative rate hike of 250 basis points on the economy is still playing out. Considering all these aspects, I vote to keep the policy repo rate unchanged at 6.50 per cent with preparedness to act, should the situation so warrant. Further, as transmission of the repo rate increase of 250 bps to lending and deposit rates is still incomplete, I vote to continue with the stance of withdrawal of accommodation.
61. In this dynamic environment, we remain steadfastly committed to our goal of aligning inflation to the target of 4.0 per cent. We continuously assess the impact of our past actions, the implications of incoming data for the evolving inflation and growth dynamics and stand in readiness to act whenever necessary. (Yogesh Dayal) Press Release: 2023-2024/802 Chief General Manager
6. Global growth is losing momentum. Inflation is easing gradually but remains well above target in major economies. Concerns about higher for longer rates are imparting volatility to global financial markets. Sovereign bond yields have hardened, the US dollar has appreciated, and equity markets have corrected. Emerging market economies (EMEs) are experiencing currency depreciation and volatile capital flows. Domestic Economy
7. Real gross domestic product (GDP) posted a growth of 7.8 per cent year-on-year (y-o-y) in Q1:2023-24 (April-June), underpinned by private consumption and investment demand.
8. South-west monsoon rainfall recovered during September and ended 6 per cent below the long period average. The acreage under kharif crops was 0.2 per cent higher than a year ago. The index of industrial production rose by 5.7 per cent in July; core industries output expanded by 12.1 per cent in August. Purchasing managers’ indices (PMIs) and other high frequency indicators of the services sector exhibited healthy expansion in August-September.
9. On the demand front, urban consumption is buoyant while rural demand is showing signs of revival. Investment activity is benefitting from public sector capex. Strong growth is seen in steel consumption, cement production as well as in imports and production of capital goods. Merchandise exports and non-oil non-gold imports remained in contraction in August, although the pace of decline eased. Services exports improved in August.
10. CPI headline inflation surged by 2.6 percentage points to 7.4 per cent in July due to spike in vegetable prices, before moderating somewhat in August to 6.8 per cent. Fuel inflation edged up to 4.3 per cent in August. Core inflation (i.e., CPI excluding food and fuel) softened to 4.9 per cent during July-August 2023.
11. As on September 22, 2023, money supply (M3) expanded by 10.8 per cent (y-o-y) and bank credit grew by 15.3 per cent. India’s foreign exchange reserves stood at US$ 586.9 billion as on September 29, 2023. Outlook
12. The near-term inflation outlook is expected to improve on the back of vegetable price correction and the recent reduction in LPG prices. The future trajectory will be conditioned by a number of factors like lower area sown under pulses, dip in reservoir levels, El Niño conditions and volatile global energy and food prices. According to the Reserve Bank’s enterprise surveys, manufacturing firms expect higher input cost pressures but marginally lower growth in selling prices in Q3 compared to the previous quarter. Services and infrastructure firms expect a moderation in growth of input costs and selling prices. Taking into account these factors, CPI inflation is projected at 5.4 per cent for 2023-24, with Q2 at 6.4 per cent, Q3 at 5.6 per cent and Q4 at 5.2 per cent, with risks evenly balanced. CPI inflation for Q1:2024-25 is projected at 5.2 per cent (Chart 1).
13. Domestic demand conditions are expected to benefit from the sustained buoyancy in services, revival in rural demand, consumer and business optimism, the government’s thrust on capex, and healthy balance sheets of banks and corporates. Headwinds from global factors like geopolitical tensions, volatile financial markets and energy prices, and climate shocks pose risks to the growth outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 per cent, with Q2 at 6.5 per cent, Q3 at 6.0 per cent, and Q4 at 5.7 per cent, with risks evenly balanced. Real GDP growth for Q1:2024-25 is projected at 6.6 per cent (Chart 2).
14. The MPC observed that the unprecedented food price shocks are impinging on the evolving trajectory of inflation and that recurring incidence of such overlapping shocks can impart generalisation and persistence. Accordingly, the MPC resolved to remain on high alert, given the prevailing environment of elevated global food and energy prices and global financial market volatility. While vegetable prices may undergo further correction and core inflation is easing, the MPC noted that headline inflation is ruling above the tolerance band and its alignment with the target is getting interrupted. Hence, monetary policy needs to remain actively disinflationary. Domestic economic activity is holding up well and is expected to be boosted by festive consumption demand, pick up in investment intentions and improving consumer and business outlook. As the cumulative policy repo rate hike of 250 basis points is still working its way through the economy, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting, but with preparedness to undertake appropriate and timely policy actions, should the situation so warrant. The MPC will remain resolute in its commitment to aligning inflation to the target and anchoring inflation expectations. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
15. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 per cent.
16. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
17. The minutes of the MPC’s meeting will be published on October 20, 2023.
18. The next meeting of the MPC is scheduled during December 6-8, 2023. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
19. The spell of subdued overall price pressures during Q1: FY 2023-24 with the headline CPI inflation at less than 5 per cent, was broken by the spike in the vegetable prices pushing the headline inflation to 7.4 per cent in July and 6.8 per cent in August, respectively. While the sharp increase seen during July-August appears transitory, pressures on the price conditions remain.
20. The uneven distribution of rainfall in the current monsoon period is a source of concern on food prices, with cereals, pulses and spices experiencing double digit price rise from June to August. While the kharif sown area is estimated to be at roughly the same level as in the previous year, area under some of the key crops such as pulses and some of the coarse grains is lower than in the previous year. Trade and supply management policies of the government would moderate the price effects of any supply- demand mismatches but favourable weather for the rabi season would be crucial for keeping food inflation moderate.
21. The non-food segment of the CPI basket registered moderate price rise during July-August. CPI excluding food and fuel (core CPI) registered a rise of 4.9 per cent, YOY basis, in both July and August, down from 5.2 per cent in June. While clothing and footwear, health, education, and personal care & effects registered a price rise of above 5 per cent in August, the vulnerability of the core to shocks in the petroleum fuel prices remains significant as a range of transport services prices would be sensitive to fuel prices.
22. The recent Enterprise surveys by the RBI point to continued input price pressures in Q3 and Q4 in FY 2023-24 and expectations of higher selling prices, particularly in the manufacturing and infrastructure sectors as compared to the services sector. The overall business situation is also expected by the sample firms to improve in Q3 and Q4 in the manufacturing sector. The Business Inflation Expectations Survey conducted in July by IIM Ahmedabad indicates a rise in the ‘one year ahead’ expected cost-based inflation rate.
23. The RBI’s Inflation Expectations Survey of urban households conducted in September 2023 indicates a decline in median inflation expectations for 3-months ahead and one year-ahead.
24. The RBI’s Survey of Professional Forecasters conducted in September 2023 points to a median forecast of 6.6 per cent headline inflation rate in Q2 followed by lower rates of 5.5 per cent and 5.1 per cent in Q3 and Q4, respectively. The core inflation 1 is projected at 4.9 per cent in Q2, followed by 4.7 per cent and 4.6 per cent in Q3 and Q4, respectively.
25. Weak global economic growth and external demand have kept the global price pressures down. The global fuel and energy prices volatility and firming up of some of the food commodity prices are a concern in the short-term, in view of the persistent geopolitical tensions and vulnerability to adverse climate shocks. Financial market volatility has also meant volatile capital flows. 25. If these projections hold, the alignment of inflation to the target could be underway. But we need to guard against risks from recurring weather related events and rise in global energy prices.
26. Considering these broad trends, CPI headline inflation rate for FY2023-24 is projected at 5.4 per cent, unchanged from the projections in the August MPC minutes. The projections for Q2, Q3 and Q4 are at 6.4, 5.6 and 5.2 per cent, respectively, broadly in line with the August projections.
27. On the growth front, YOY GDP growth in Q1: FY 2023-24 at 7.8 per cent follows sharply higher Q1 growth in the previous two years, reflecting the resilience of growth momentum. However, the growth pattern continues to be uneven across sectors, with the services, which include construction, registering growth rate of 10 per cent while that of industry being lower (4.6 per cent). The GVA from manufacturing, accounting for around 80 per cent of GVA from industry, rose by 4.7 per cent. Within the services, all the major segments registered higher YOY growth rates than the overall growth rate of aggregate GVA. However, one segment, ‘Trade, hotels, transport and communication’ is yet to reach its GVA level of Q1:2019-20. The official estimate of GDP growth for Q1 came slightly lower than RBI’s projection of 8 per cent.
28. The RBI’s recent enterprise surveys indicate expectations of improved demand conditions in Q2 and subsequent two quarters in FY 2023-24, with relatively higher optimism in the manufacturing sector as compared to services and infrastructure sectors.
29. The divergence in growth performance also reflects demand conditions. On the demand side, investment spending increased at a faster rate than consumption with the external demand being a drag for the overall demand growth. During April-July 2023 period, index of industrial production (IIP) data reflects strong YOY growth of ‘infrastructure/ construction sector’ (12.2 per cent) and ‘consumer non-durables’ (6.8 per cent) but weaker growth in ‘consumer durables’ (-2.7 per cent).
30. The RBI’s recent Consumer Confidence Survey of urban households shows cautious optimism. The broader measure of sentiments used in the survey comprising one-year ahead expectations of general economic conditions, employment scenario and household income, reflects improvement over the current period. However, assessment of the current situation is cautious as the increase in ‘non-essential expenditure’ is lower both in the current period and one-year ahead as compared to the previous round of the Defined as excluding food and beverages, pan, tobacco and intoxicants and fuel and light. survey. The high inflation in July-August seems to have moderated optimism in the present round of the survey.
31. The recent high frequency indicators of economic activity reflect continuation of the growth trends at an aggregate level. The PMIs for manufacturing and services remained at high levels in July and August although the index fell in the case of services while it rose for manufacturing indicating expectation of expansion in output in the short term. Non-food bank credit, GST collections and domestic and international air passenger traffic registered double digit YOY growth in August and September. The drag is in the external sector: merchandise exports and imports declined YoY basis, through the current financial year, although the extent of decline has moderated in August. Services imports declined YOY basis in July and August with exports growing at a modest 8.4 per cent in August. Slower YOY growth is seen in the case of new launches and sales of housing units in Q1: FY 2023-24 as compared to the previous quarter.
32. The median projection of GDP growth for FY 2023-24 from the RBI’s September 2023 round of Survey of Professional Forecasters is 6.2 per cent, rising marginally by 0.1 percentage point from the forecast in July.
33. Overall, the demand conditions are expected to sustain the growth momentum observed in the August meeting of the MPC, although the concerns emerging from the uncertain global market conditions pose downside risks. The GDP growth projection for FY 2023-24 has been retained at 6.5 per cent, with the quarterly projections for Q2, Q3 and Q4 also remaining the same as in the August meeting.
34. The growth momentum is projected to be sustained in the present financial year despite the erratic distribution of monsoon and the weak external conditions based on more stable domestic demand conditions. The points flagged in the August meeting regarding the global economic conditions and incomplete transmission of the policy rate actions undertaken are still relevant at this juncture. It is necessary to assess the strength of the growth trajectory and inflation outlook in the medium term keeping in view the fact that the projected headline inflation remains above 5 per cent in the final three quarters of the current financial year.
35. Therefore, I vote: i. to keep the policy repo rate unchanged at 6.50 per cent and ii. to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
36. The global picture continues to be mixed. The interpretation of the Fed’s communication as ‘higher for longer’ has led to US ten year yields crossing 4.5%, especially as the US fiscal deficit continues to rise. There is fear that firms will be in trouble as they re-finance low interest loans taken during the pandemic. But at the same time the Fed is also saying its actions will be data dependent. Markets should take comfort that rates will not continue to be high regardless of what happens. Chinese excess inventories and deflation are contributing to reducing manufacturing costs in most countries. Global growth is expected to fall in FY24 but a turnaround is possible in FY25.
37. Indian growth trends also continue to be mixed. Some export dependent industries have slowed. Pent-up demand is waning for services but remains robust. Many indicators point towards a revival in private investment post recovery, but some surveys suggest election uncertainty may delay projects. This is unlikely, however, in sectors that are close to full capacity utilization with robust domestic demand.
38. There are some indicators of strong domestic demand. PMIs continue to be high. Confidence has improved for consumers and firms. The current account deficit (CAD) is up from -1.2% of GDP in FY22 to -2% in FY23. This equals the excess of investment over savings. Household physical savings is measured as identical to household physical investment savings in India, so it is the net financial savings that affect the CAD. These are down to 5.1% of GDP in FY23 from around 7% of GDP pre-pandemic. A post pandemic surge in net financial savings did not last and they fell to 7.2% of GDP in FY22.
39. Gross household financial savings remain high, however. It was household financial liabilities that increased from 3.8% of GDP in 2021-22 to 5.8% of GDP in 2022- 23, by a similar 2.1% fall in net financial savings. The rise in financial liabilities implies a rise in household physical investment and shows the interest sensitivity of demand in India, with a youthful population borrowing to acquire assets. In FY23 households shifted towards such borrowing since real rates became positive only towards the end of the year. Pass through to bank deposit rates was more delayed but this is happening now and bank deposits are rising. We need to wait and see if the share of financial savings rises again after post-pandemic disturbances. As investment and income rises, savings also tend to rise. Already in Q4 FY23 net financial savings rose to 7% of GDP from 4% of GDP in Q3 FY23.
40. There are signs of a revival in investment now after more than a decade. Sharp financial tightening in 2011 and 2017 punctured such past revivals and led to persistent slowdowns. So it is important to ensure a sustained and sustainable revival this time. There is no excess lending or an infrastructure boom this time, but a healthy gradual rise.
41. Indian household debt is low by international standards, but a sudden rise can be a concern. It is best to restrain over-enthusiasm in good times and thus avoid a crash. Prudential tightening, such as raising LTV ratios or risk weights, would be preferable to raising policy rates more. There is already some reversal of remissions given in the pandemic times. After the firm-lending based NPAs most banks are trying to increase retail loans. These are secured or based on cash or salary flows. But it will help to make sure lending continues to be risk-based and internal assessments are robust.
42. Despite the large inflation spikes to vegetable and crude oil prices, there is favourable news on inflation. The monsoon is ending near normal, spikes have passed with no second-round effects as core inflation continues to soften. The government is undertaking many supply-side measures to reduce inflation.
43. The headline inflation forecast of 5.4 for FY 24 gives a comfortably positive real repo rate. Therefore I vote for a pause in the repo rate, and also vote for the stance on withdrawal of accommodation in order to signal the MPC’s determination to reach its 4% target. This stance rules out a rate cut. It allows a rise but that will not be required unless there are second round effects from the repeated supply shocks. So far there are no signs of such pass through. The guidance therefore is that future moves will be data- dependent.
44. Liquidity has been tight in the past 2 months so that the weighted average call rate (WACR) has often been above the repo rate. This first happened in end-September 2022 suggesting withdrawal of pandemic –time excess liquidity was adequate. After that the WACR has spent more time at the top than at the bottom of the LAF corridor. Endogenous short term liquidity adjustments at the edges keep the WACR within this band.
45. Since March 31, 2014 average annual growth of broad money was 10%, less than nominal income growth, although reserve money growth varied widely over the pandemic and demonetization periods. Over December 2009 to February 2014, prior to the adoption of inflation targeting, average annual broad money growth was 15.0%.
46. But fine-tuning of liquidity is not as yet adequate to keep the WACR at the MPC mandated repo rate. Moreover, shocks can be so large that short-term liquidity is unable to compensate. Then durable liquidity must be adjusted. OMO purchases or sales that affect durable liquidity may be required depending on liquidity conditions.
47. Research finds that quantity (of money) as well as rates matter in Indian conditions. Both too much and too little liquidity has adverse effects. Liquidity aligned to stance increases the impact of a change in the Repo Rate 2. But due to a large informal sector and many financial institutions with no recourse to liquidity windows, large liquidity deficits lead to liquidity hoarding and more leakages 3. We have seen as liquidity tightens banks with surplus become reluctant to lend to those with deficits or participate in longer tenor VRRR despite profit opportunities. They prefer using RBI’s overnight windows. Impediments to developing an active overnight inter-bank call money market have to be addressed.
48. Analysts are again concerned about falling interest differentials with the US. But markets seem to understand that Indian macros are relatively more stable today. In September despite a 46 bps rise in US 10 year yields, Indian 10 year G-secs rose only 5 bps. The IMF gave the average spread for emerging markets at 200 bps in 2022. India still exceeded that at 280 bps in September. Despite narrower differentials, ECBs and other debt inflows continue. Even so, they are a small and therefore a manageable share of Indian markets. In addition, index inclusion is around the corner. More than higher Indian rates it is lower country risk, a stable currency and higher expected growth that keeps FPI here. There is the lure of high US risk free rates, but since higher Indian rates cannot compensate for this, the latter are best aligned to the domestic cycle. Statement by Prof. Jayanth R. Varma
49. Since the August meeting, the risks to inflation have increased, but only slightly. First, the official end of season report on the Monsoon confirmed that the rainfall was only 94% of the Long Period Average. This small shortfall coupled with the spatio- temporal dispersion in the rainfall could cause some volatility in food prices. However, the effect is more likely to consist of a few short lived inflation spikes rather than a sustained rise in inflation. The second factor is the indication in recent months of a possible geopolitical realignment of the two largest OPEC+ producers. This has imparted considerable volatility to crude oil prices in recent weeks. A sharp fall in crude prices while the MPC meeting was in progress suggests that a slowing world economy does place a limit on the upswing in crude prices. Therefore, I think that the impact of OPEC+ geopolitics would be limited to slowing the pace of decline in inflation, and is unlikely to cause a reversal of this trajectory.
50. Turning to growth, the outlook has improved modestly because of increasing consumer confidence as indicated in the RBI surveys. This increased confidence must also be seen in the light of household financial savings data released by the RBI in September. The data shows that consumers have incurred financial liabilities and Goyal, Ashima and Deepak Kumar Agarwal. 2020. ‘Policy Transmission in Indian Money Markets: The role of liquidity’, The Journal of Economic Asymmetries, 21 June e00137 https://doi.org/10.1016/j.jeca.2019.e00137. 3 Goyal, Ashima and Abhishek Kumar. 2018. ‘Money and Business Cycle: Evidence from India’. The Journal of Economic Asymmetries. 18. November. https://doi.org/10.1016/j.jeca.2018.e00105 reduced net financial savings to support consumption. This willingness to consume at the cost of reducing savings is very important because it is household consumption that has been propping up the economy in the face of headwinds from fiscal consolidation, weak external demand and tepid capital investment. It is possible that this consumer confidence could become a self fulfilling prophecy as robust consumption demand stimulates growth, generates income and strengthens household balance sheets. Even if that does not happen, global experience suggests that a debt fuelled consumption boom can last several years before petering out. Either way, the medium term growth outlook looks somewhat stronger than it did during the last meeting, though several headwinds still remain.
51. The changes in the outlooks for both inflation and growth are quite modest, and the real repo rate is already quite high. I, therefore, support the decision to keep repo rate unchanged. In my view, the real interest rate based on projected inflation is high enough to glide inflation towards the target within a reasonable period.
52. As regards the stance, I continue to have the same reservations as in the past. Successive meetings that promise to withdraw accommodation while actually keeping rates unchanged do not enhance the credibility of the MPC. I would much prefer a stance in which words are consistent with the actions. Moreover, at this point of time, the guidance that the market really needs is not about how high the terminal repo rate would be, but about how long the rate would be maintained at a high level. It would therefore be useful for the MPC to communicate its intention to keep real interest rates high enough for as long as is necessary to drive projected inflation close to the 4% target on a sustainable basis. Statement by Dr. Rajiv Ranjan
53. At this juncture, three global trends, among many others, need to be closely watched – rising crude oil prices, rising US yields and rising US dollar. On the domestic front, the containment of food price pressures, particularly vegetable prices, which is reversing, is an important assumption behind retaining our inflation projection at 5.4 per cent during 2023-24. Core inflation (CPI excluding food and fuel) continued to register further softening to 4.9 per cent. In fact, almost all exclusion and trimmed mean measures of inflation have registered a decline in recent months, a marked change from 2022-23 wherein core inflation remained sticky at highly elevated levels. The sequential saar momentum for core inflation was at 4.5 per cent in August with 3-month moving average below 4 per cent as per data available till August. Threshold diffusion indices 4 of CPI also indicate a significant slowdown in the rate of price increases across CPI core in the financial year so far. Sustained deflation in WPI non-food manufactured product inflation is also a comforting factor for core inflation. Moreover, moderation of services inflation to close to 4 per cent continues to be a relief as they tend to be stickier as seen in advanced economies.
54. There was also further progress on anchoring of household inflation expectations with 3-month ahead and 1-year ahead inflation expectations having seen a cumulative decline of 170 bps and 110 bps respectively since September 2022. Important point to note is that the sharp jump in vegetable prices have not deterred anchoring of inflation expectations with relatively less impact of food inflation on persistence of core inflation. But this has to be watched carefully. Going forward, waning of transitory food price shocks, the ongoing transmission of past monetary policy actions, improvement in supply 4 Threshold diffusion indices capture the dispersion of price increases in CPI basket beyond the specified seasonally adjusted annualised rate (SAAR) thresholds of 4 per cent and 6 per cent. chains, strong supply side intervention by the Government, and likely lower rate of increase in selling prices by firms (as per the RBI enterprise surveys) is expected to moderate inflation to 5.2 per cent in Q4 2023-24 and further to 4.3 per cent in Q4 2024-
55. On the growth front, with GDP growth at 7.8 per cent for Q1:2023-24 and our nowcast of around 6.5 per cent for Q2, it seems to be tracking our projection of 6.5 per cent for the full financial year. The third quarter would also be buoyed by festival related demand. On the supply side, manufacturing activity is gaining traction with corporate results in Q2 expected to be aided by strong demand and easing input cost pressures. The negative deflator (around -2.5% for July-August) and base effects will also extend support to the real GVA growth in the manufacturing sector in Q2. PMI future activity index in September signalled elevated level of confidence for manufacturing. Survey results show that optimism on demand for manufacturing goods is high and consumer confidence outlook has also improved significantly. Services sector growth continues to remain robust.
56. Broad-basing of economic activity is also reflected in the data on household savings. Though net financial savings of households moderated to 5.1 per cent of GDP in 2022-23, mainly due to significant rise in financial liabilities of households both from bank and non-bank sources (5.8 per cent of GDP from 3.8 per cent in 2021-22), the gross financial savings increased in absolute terms by 13.9 per cent in 2022-23 over the previous year. Moreover, household borrowings reflect higher spending on real estate, vehicles, consumer goods, among others. This implies that the overall savings of households is expected to hold steady with compositional shift in favour of physical savings. 5 This would be growth supportive either through direct addition to gross capital formation or by assisting upturn in private capex. Higher investment and income would reinforce higher savings as we have seen in Q4:2022-23 when the net household financial savings normalised to its long-term average of 7.0 per cent from a low range of 4.0 to 4.6 per cent in the first three quarters of 2022-23.
57. The concerns regarding statistical discrepancy on the expenditure side estimates at 2.8 per cent of GDP for Q1:2023-24 (-3.4 per cent of GDP in Q1:2022-23) are unfounded. This discrepancy varies from negative to positive ranging from -4.8 per cent to 6.4 per cent in the new GDP series during Q1:2011-12 to Q1:2023-24 and it eventually evens out. In the pre-pandemic period (Q1:2011-12 to Q3:2019-20), on an average, the share of discrepancy in GDP was 0.9 per cent, while in the post pandemic period (Q4:2019-20 to Q1:2023-24), it has averaged -0.4 per cent. As per the global practice, the production approach of compiling national accounts statistics (NAS) is considered to be firmer and the NAS presents discrepancy with the expenditure approach of GDP compilation explicitly in its regular releases (Sources and Methods, NSO, 2012), adhering to the recommendations by the system of national accounts (SNA 2008). Nevertheless, there is a need to improve GDP estimates from the expenditure side so that evolving dynamics of demand side components are captured appropriately.
58. Given that inflation expectations are backward looking in emerging markets including India, occurrences of multiple large adverse supply shocks run the risk of a drift in inflation expectations from underlying trend, which could eventually stall the ongoing disinflation process. Such supply shocks are challenging and test the inflation fighting credibility of central banks. Though transitory relative price changes in the economy that may spur temporary bouts of inflation may be looked through, monetary policy also Physical savings data will be released by NSO in end-February 2024. needs to be watchful to see that large and frequent supply side shocks does not trigger generalised increase in prices. 6 Past such instances in India, as in 2020, do give credence to MPC’s judgement with regard to optimal response to supply shocks with an objective to anchoring inflation expectations, rather than inflation per se. Besides, the sustained fall in core inflation as mentioned earlier vouches for its transitory nature going ahead.
59. Overall, with growth and inflation broadly moving in anticipated direction, monetary policy needs to hold on while earnestly persevering with disinflationary approach and remaining watchful with readiness to act if the situation demands. This calls for continuation of withdrawal of accommodation stance for monetary policy so as to facilitate further transmission of the cumulative policy repo rate hike of 250 basis points on the economy. Thus, I vote for pause in repo rate and continue with the stated stance. Statement by Dr. Michael Debabrata Patra
60. Within the dual mandate given to the MPC by the RBI Act, price stability is accorded primacy. Only when price stability is secured on an enduring basis against all threats to it can attention turn to the objective of growth. Without price stability, growth cannot sustain – the benefits of expanding GDP and employment will be frittered away by the erosion of purchasing power, hurting those the most that eke out livelihoods just to meet the costs of food, shelter and bare essentials.
61. The fight against inflation in the wake of the war in Ukraine has been arduous and herculean; by comparison, the moderation of inflation from the high reaches to which it had surged in the first quarter of 2022-23 has been grudging and underwhelming. The anchoring of inflation expectations is incomplete and muddied by uncertainty, going by the increase in variability of median expectations of households and the underperformance of revenues of businesses relative to their profits. There is also growing evidence that inflation is undermining growth – people are not increasing discretionary spending in view of high inflation and this is slowing sales growth of corporations.
62. As the economy negotiates the rapids of the second and third quarters of 2023- 24, the trajectory of inflation is being buffeted by price shocks related to perishables. Surprisingly, they are producing inordinately high and painful spikes in the headline that are unacceptable from the point of view of the overall welfare of our societies. When headline inflation faces price pressures from perishables like vegetables, the standard operating procedure of monetary policy is to look through the transitory impact of their first round effects and await mean reversion. Increasingly, however, these so-called transitory shocks test our buffers and policy responses, given their unanticipated nature. Moreover, these so-called transitory shocks recur with high intensity and disturbing force. Price pressures accumulate in the inflation formation process, imparting hysteresis to inflation expectations and potentially to actual inflation outcomes. This would be unfortunate at a time when our surveys show that in September 2023, households’ inflation perceptions have fallen by 50 basis points (bps) since July 2023, with expectations of lower price and inflationary pressures across most product groups and categories of respondents.
63. Inflation prints for September and October will need to be monitored carefully to look out for the moderation that our projections anticipate. If we tame inflation durably, we will prepare the ground for a long innings of strong and stable growth. Our projections BIS Quarterly Review, September 2021. anticipate that growth will gather positive momentum from the second quarter onwards. Monetary policy can contribute by remaining sufficiently disinflationary without being overly restraining. Accordingly, I vote for maintaining status quo on the policy repo rate and persevering with the stance of withdrawal of accommodation in this meeting of the MPC. Statement by Shri Shaktikanta Das
64. Global economic activity is decelerating under the impact of tight financial conditions, though it is proving to be more resilient than expected earlier. Headline inflation is moderating, but it remains above target levels in major economies. Monetary policy settings could remain tighter for longer in major advanced economies. Growth remains uneven in many of these countries.
65. Against the backdrop of this challenging global environment, domestic economic activity in India has exhibited resilience, with growth projected at 6.5 per cent during 2023-24. India is poised to become the new growth engine of the world backed by its strong domestic macroeconomic fundamentals and buffers. The judicious policy mix pursued during the recent years to deal with multiple and unparalleled shocks has fostered economic stability. Balance sheets of banks and corporates are strong and healthy. Construction; travel and transportation; and financial, real estate and professional services continue to maintain strong performance. The upcoming festival season is expected to give further impetus to households spending. Private sector investment is gathering pace with easing input cost pressures. Consumer outlook surveys have turned more optimistic. Business sentiment among manufacturing, services, and infrastructure companies is also optimistic. Both manufacturing and services PMI readings indicate a healthy expansion in these sectors. The external sector has remained eminently manageable, despite global headwinds.
66. The heightened inflationary pressures during July-August 2023, following the spike in vegetables prices, has once again shown that headline inflation remains vulnerable to recurring and overlapping food price shocks. Adverse weather events – unseasonal rains, skewed monsoon rainfall and unprecedented heat waves – have been major sources of food inflation pressures in recent years. Moreover, the intensity of food price shocks triggered by such events has increased, with the month of July registering the highest month-over-month increase in food prices in the current CPI series (2012=100). Such recurring supply side shocks are making episodes of high inflation more than transient. The spike in vegetable prices has likely corrected substantially in September and inflation is expected to fall significantly below the upper tolerance level of 6 per cent. The moderation in inflation in September would also be aided by the sharp reduction in household LPG prices in end-August. The projections suggest that throughout much of Q3:2023-24, food inflation pressures may not see a sustained easing, but ample buffer stocks of food grains, softening edible oil prices, and government’s proactive supply side interventions are expected to keep check on unusual price spikes of key food items. Even as headline inflation experienced considerable volatility, a silver lining has been the declining core inflation, supported by declining cost- push pressures and ongoing transmission of past monetary policy actions.
67. Going forward, inflation outlook continues to be beset with uncertainties, especially from adverse weather events, the playout of El Niño conditions, uncertainties in global food and energy prices and volatility in global financial markets. Inflation expectations of households – both three months and a year ahead – have, however, moved together to single digit for the first time since the COVID-19 pandemic. In this situation monetary policy must remain actively disinflationary to ensure that ongoing disinflation process progresses smoothly.
68. Liquidity in the banking system is expected to remain adequate in the coming months to meet the productive requirements of the economy with expected pick-up in government spending, although festival-related currency withdrawals may provide some counterbalance. The Reserve Bank has maintained a flexible and adaptive approach to liquidity management. It will remain nimble footed and ensure that liquidity is actively managed by undertaking whatever operations are necessary from time to time, including open market operation sales (OMO-sales). Needless to state, the timing and quantum of such operations will depend on the evolving liquidity conditions.
69. To sum up, domestic economic growth is maintaining the momentum. Our fundamental goal is to align inflation with the 4.0 per cent target and anchor inflation expectations. Recurring incidences of large and overlapping supply side shocks bring with them the risks of generalisation of inflation impulses, possible loss of monetary policy credibility and de-anchoring of inflation expectations. Monetary policy has to remain extra alert and ready to act, if the situation warrants. The hard earned macroeconomic stability has to be preserved. Accordingly, I vote for keeping the policy repo rate unchanged in this meeting of the MPC and continuing the focus on withdrawal of accommodation. (Yogesh Dayal) Press Release: 2023-2024/1155 Chief General Manager
6. Global growth is slowing at a divergent pace across economies. Inflation continues to ebb though it remains above target with underlying inflationary pressures staying relatively stubborn. Market sentiments have improved since the last MPC meeting – sovereign bond yields have declined, the US dollar has depreciated, and global equity markets have strengthened. Emerging market economies (EMEs) continue to face volatile capital flows.
7. Domestic economic activity is exhibiting resilience. Real gross domestic product (GDP) grew year-on-year (y-o-y) by 7.6 per cent in Q2:2023-24, underpinned by robust investment and government consumption, which cushioned the drag from net external demand. On the supply side, gross value added (GVA) rose by 7.4 per cent in Q2, driven by buoyant manufacturing and construction activities.
8. Continued strengthening of manufacturing activity, buoyancy in construction, and gradual recovery in the rural sector are expected to brighten the prospects of household consumption. Healthy balance sheets of banks and corporates, supply chain normalisation, improving business optimism, and rise in public and private capex should bolster investment going forward. With improvement in exports, the drag from external demand is expected to moderate. Headwinds from the geopolitical turmoil, volatility in international financial markets and geoeconomic fragmentation pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 7.0 per cent with Q3 at 6.5 per cent; and Q4 at 6.0 per cent. Real GDP growth for Q1:2024-25 is projected at 6.7 per cent; Q2 at 6.5 per cent; and Q3 at 6.4 per cent (Chart 1). The risks are evenly balanced.
9. CPI headline inflation fell by about 2 percentage points since the last meeting of the MPC to 4.9 per cent in October 2023 on sharp correction in prices of certain vegetables, deflation in fuel and a broad-based moderation in core inflation (CPI inflation excluding food and fuel).
10. Uncertainties in food prices along with unfavourable base effects are likely to lead to a pick-up in headline inflation in November-December. Kharif harvest arrivals and progress in rabi sowing together with El Niño weather conditions need to be monitored. Adequate buffer stocks for cereals and a sharp moderation in international food prices, along with pro-active supply side interventions by the Government may keep these food price pressures under check. Crude oil prices may remain volatile. Early results from the firms polled in the Reserve Bank’s enterprise surveys indicate softer growth in input costs and selling prices for the manufacturing firms in Q4 relative to the previous quarter, while price pressures persist for services and infrastructure firms. Taking into account these factors, CPI inflation is projected at 5.4 per cent for 2023-24, with Q3 at 5.6 per cent; and Q4 at 5.2 per cent. Assuming a normal monsoon next year, CPI inflation for Q1:2024-25 is projected at 5.2 per cent; Q2 at 4.0 per cent; and Q3 at 4.7 per cent (Chart 2). The risks are evenly balanced.
11. The MPC observed that recurring food price shocks are impeding the ongoing disinflation process. Core disinflation has been steady, indicative of the impact of past monetary policy actions. Headline inflation, however, remains volatile, with possible implications for the anchoring of expectations. Domestic food inflation unpredictability, and volatility in crude oil prices and financial markets in an uncertain international environment pose risks to the inflation outlook. The path of disinflation needs to be sustained. The MPC will carefully monitor any signs of generalisation of food price pressures which can fritter away the gains in easing of core inflation. On the growth front, improved momentum in investment demand along with business and consumer optimism, would support domestic economic activity and ease supply constraints. As the cumulative policy repo rate hike is still working its way through the economy, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting, but with preparedness to undertake appropriate and timely policy actions, should the situation so warrant. Monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. The MPC will remain resolute in its commitment to aligning inflation to the target. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
12. All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 per cent.
13. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
14. The minutes of the MPC’s meeting will be published on December 22, 2023.
15. The next meeting of the MPC is scheduled during February 6-8, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. The official GDP growth estimate for Q2: 2023-24, YOY basis, turned out to be surprisingly strong at 7.6%, following the growth of 7.8 per cent in Q1. The projected GDP growth for Q2 in the October 2023 MPC meeting was 6.5 per cent, well below the NSO estimates. Manufacturing and construction sectors recorded double digit growth rates of GVA in Q2 offsetting the weak growth in agriculture & allied sectors and services. The QOQ momentum in Q2 in the manufacturing and construction sectors, two drivers of GVA growth, was above their decadal average (2011-12 to 2019-20) for the quarter, pointing to the significant growth momentum in these sectors.
17. Although greater optimism in terms of output demand conditions or business turnover for Q2 by the manufacturing firms relative to the service sector firms was reflected in the RBI’s sample surveys of firms conducted during July-September, the actual growth in GVA in manufacturing has exceeded the expectations. At the aggregate level, GDP growth was in sync with some of the indicators of broader economic activity, such as PMI, non-food credit, GST collections and toll collections. Financial performance of the corporate sector for Q2 indicates improved profit earnings and spending on fixed assets in line with the overall GVA growth and the rise in gross fixed capital formation. We may also note that sharp increase in GVA in manufacturing in Q2 is in contrast to the stable overall capacity utilisation rates for the sector indicating the likely significant improvements in revenue realisations and cost efficiency in the present context.
18. The growth momentum while strong, it points to a few concerns as we go forward. Uneven performance, both on the production and demand fronts is evident. On the production side, the agriculture & allied sector and services registered low and modest rates of growth in Q2. The IIP for consumer durables has shown weak growth. On the demand side, real Private Final Consumption Expenditure registered modest 3.1% YOY growth as compared to 11% growth in real Gross Fixed Capital Formation. The November 2023 round of RBI’s Consumer Confidence Survey shows improvement in total consumer expenditure over the previous round, both on current period and one-year ahead basis. In the recent few rounds of the survey, the year ahead outlook has been marked by consistently positive net response rates on non-essential spending. On the external demand, the recent projections for global output growth in 2024 by IMF (October 2023) are slightly lower than in 2023 but expect world trade volumes to improve significantly. Sustained growth in fixed capital formation may also require maintaining the pace of government capital outlay.
19. Taking into account both the positive drivers of growth and vulnerabilities, the GDP growth projections for the remaining two quarters of 2023-24 are at 6.5 for Q3 and 6.0 per cent for Q4, taking the projections for FY 2023-24 to 7.0 per cent over the previous year. The projected growth for H2: 2023-24 is 6.3 per cent compared to 5.9 per cent for the same period in our October 2023 assessment. The projected GDP growth rates for the first three quarters of 2024-25 are 6.7, 6.5 and 6.4 per cent.
20. The headline inflation dropped to 5 per cent or lower in September (5%) and October (4.9%). Among the three major constituents – food, fuel and core – only food inflation remained above 6% in September and October. CPI Food inflation has remained above 6% since July this year, although pace of the increase has declined. Within the food & beverages category of consumption, cereals, pulses and spices registered double digit percentage price rise YOY basis in October. CPI for Eggs, milk and fruits rose by more than 6 per cent in October. Impact of the unfavourable rainfall conditions during the monsoon season this year has meant likelihood of weak kharif harvest for some of the main crops with implications to food inflation.
21. The weak global demand conditions have kept the commodity and energy prices in the international markets in check. However, continued geopolitical conflicts cast a shadow on supply chains with potential to disrupt global energy and commodity markets and inflation trends. The increased pace of economic activity in the last two quarters, driven mainly by investment spending has not led to rise in core inflation. Supply side policy measures by the government, particularly in the case of food commodities have also helped in reducing the price impact of supply shocks.
22. Inflation expectations survey of urban households conducted by RBI points to the sustained decline in 3 month-ahead inflation expectation since September 2022 up to November 2023, barring a spike in January 2023. The one year-ahead expected inflation rate has moved up marginally in the November round of the survey after following a declining trajectory since September 2022.
23. While the core CPI inflation rate (excluding food and fuel components) fell below 5% in Q2: 2023-24 and dropped to 4.3% in October, price pressures in the non-farm sectors are vulnerable to shocks to input costs. Early results of RBI’s enterprise surveys conducted during the latter part of October and November point to some divergence in the expectations of cost pressures and selling prices between manufacturing and other firms. Larger proportion of sampled manufacturing firms indicate expectations of softening of selling prices in Q4 relative to this proportion in Q3 but larger proportion of firms in the services and infrastructure sectors expect the selling prices to rise in the same period. The inflation expectations survey of business sector conducted by the IIMA in October 2023 points to a slight increase in one year-ahead ‘unit cost based inflation’ from 4.39% in September 2023 to 4.44% in October 20231.
24. The most recent RBI’s Survey of Professional Forecasters projects headline inflation rate for Q3: 2023-24 till Q1: 2024-25 declining from 5.4 per cent to 5.2 per cent and dropping to 3.9 per cent in Q2: 2024-25. The core inflation (CPI excluding items of Food, Pan, Tobacco and Intoxicants and Fuel & Light) is projected to drop from 4.3 per cent in Q3: 2023-24 to 4.1 per cent in Q1: 2024-25 but increase to 4.4 per cent in Q2: 2024-25.
25. Considering a range of factors influencing the inflation pattern in the short-term, the headline inflation is projected at 5.6% and 5.2% in Q3 and Q4: 2023-24, respectively, and 5.2% in Q1: 2024-25 followed by 4% in Q2 and 4.7% in Q3.
26. Overall, the economy presently reflects the impact of strong drivers for growth despite the unfavourable conditions in some respects. As noted earlier, adverse Business Inflation Expectations Survey (BIES)-October 2023, Misra Centre for Financial Markets and Economy, Indian Institute of Management, Ahmedabad. monsoon rainfall conditions, especially distribution of rainfall over the monsoon period and across the regions, have meant slower growth of agricultural output and rural demand. The weak external demand conditions have affected the export sector. The uneven feature of growth points to vulnerabilities. While investment has fuelled growth in demand, private consumption demand has grown much more slowly. One reason for the slower growth in consumption relates to the ‘base effects’ in H1 given the on-going ‘catch up’ overcoming the pandemic shock. But the uneven sectoral growth patterns also point to other factors influencing output noted earlier with respect to agriculture and external demand.
27. Inflation has moderated in the context of the continued pressure the cumulative monetary policy actions as well as supply side measures by the government in crucial consumption sectors have exerted. The weak external demand conditions have also meant favourable input prices in the international markets. However, food inflation is a concern in the short term. There remain significant risks of the impact of the on-going geopolitical conflicts on particularly fuel prices and consequently on both fuel and core inflation rates.
28. Given that inflation remains well above the target over the short term, with the projected headline CPI rate of above 5% up to Q1: 2024-25, there is a need to continue the policy support for sustaining the trajectory to the target.
29. Therefore, I vote: i) to keep the policy repo rate unchanged at 6.50 per cent, and ii) to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
30. There are more signs that global interest rates may have peaked. Fears that rates may be higher for longer have also faded as the US Fed has recognized that rates are restrictive already and becoming more so as inflation falls. Pointing to the 1970s to justify higher rates is not valid since inflation has not been high for as long as it was then and expectations remain anchored. International oil prices have also softened despite cartel action. But geopolitics continues to remain a threat.
31. Moreover, recent experience has underlined the freedom Indian rate setters have from international rates. Debt and equity inflows returned as rate differentials narrowed.
32. Indian growth has exceeded expectations again. Manufacturing performance is strong. There are more indications of the expected turnaround in private investment. While cement and steel production have been robust for long, IIP and imports of capital goods, banks’ project finance, firms’ investment intentions and fixed assets have also risen. Rising cash and reserves makes firms less dependent on household savings for financing.
33. The recent state election results reduce uncertainty around national elections and policy so more investment plans should be fast-tracked. But areas of weakness remain in consumption, IT and merchandise exports. Employment offers have slowed in IITs.
34. The centre has demonstrated commitment to fiscal consolidation in terms of sticking to the announced path of deficit reduction, higher share of spending on investment and discipline on off-budget items. Buoyant revenues are able to absorb a large post-pandemic subsidy burden. As countercyclical macroeconomic policy smooth’s shocks and delivers a real interest rate less than the real growth rate, the denominator rises, reducing debt and deficit ratios2.
35. Headline inflation is expected to be within the tolerance band at 5.4% in FY24 and to fall to 4% in Q2 FY25 but rise to 4.7 in Q3. Core inflation shows a broad based moderation falling from 6.1 in 2022-23 to 4.8 in Q2 FY24. Professional forecaster’s figure for core inflation in Q3 is at 4.4%.
36. There is a view that stronger growth will raise core inflation. But even with real GDP growth at 7% it does not necessarily imply potential output is reached implying excess demand and pressures on core inflation if reforms are raising structural growth.
37. Some research defines potential output in terms of expected inflation, and this is a forward-looking way to estimate it given India’s large underemployed population and rising investment—output is below potential if core inflation is below acceptable upper limits3. Time series methods of estimating potential output are backward-looking, with too much weight on recent growth.
38. Why has core inflation come in lower than expectations even as growth recovered?
39. There were no second round effects raising wages from the earlier commodity price shocks since Indian labour markets are slack.
40. Currently, falling costs and healthy sales have raised profits, despite factors that are restraining demand in India. Some firms have reversed earlier price increases that passed on higher costs. Higher sales help spread costs. Many firms had restructured during the pandemic to reduce costs. There is evidence that the mark-up on costs is countercyclical4. Lower price and higher volumes is a strategy that delivers profits in India. Moreover, FMCG majors face competition in 2 and 3 tier markets from many new regional entrants.
41. Investment is expanding capacity so that utilization has not increased despite good output growth.
42. There is evidence that firm’s inflation expectations are well-anchored around 4%5.
43. The government continues to take supply-side action to moderate short term price spikes as well as improve capacities in the long-run.
44. Indian oil majors are profitable again despite recent volatility in oil prices and will be able to pass on benefits to consumers if international oil prices fall sustainably below USD 80 per barrel. Current trends are towards this. Goyal, A. 2023. 'Indian Fiscal Policy: A possible escape route.' IGIDR Working Paper no. WP-2023-010. Available at: http://www.igidr.ac.in/pdf/publication/WP-2023-010. pdf Goyal, A. and S. Arora. 2013. ‘Inferring India's Potential Growth and Policy Stance’. Journal of Quantitative Economics, 11(1 & 2): 60-83. January-July; Svensson, L. E.O. Woodford, M. 2003. ‘Indicator variables for optimal policy’, Journal of Monetary Economics, Volume 50, Issue 3, Pages 691-720. Goyal, A. 1994. ‘Industrial Pricing and Growth Fluctuations in the Indian Economy’, Indian Economic Review, Vol. 29(1). The IIM Ahmedabad survey has given firms’ price expectations at around 4% since December 2022.
45. All this continues to reduce costs for firms. In these circumstances, core inflation should continue to converge towards 4% and headline should converge to a stable core despite any further transient supply shocks. New data affects outcomes within a structure. It is necessary to pay attention to the structure and context.
46. If inflation sustainably approaches 4% by the middle of 2024 real rates can easily become too high if nothing is done. A repo of 6.5% in 2018 and tight liquidity with a headline inflation of around 4%, even though core inflation was around 6%, proved severely deflationary. Both headline and core inflation fell steeply over the next year.
47. In this meeting, however, I vote for keeping the repo rate and the stance unchanged, in order to watch the impact of an expected rise in food inflation over the next couple of months, since repeated supply shocks are a concern. Even so, as yet they have not been able to raise inflation expectations or reverse the decline in core inflation.
48. Despite the stance, I expect the weighted average call rate (WACR) to ease away from the upper end of the LAF corridor towards the repo rate as government cash balances are drawn down and measures are taken to reduce liquidity hoarding by banks. Under inflation targeting, liquidity is endogenous and is expected to adjust to keep short rates near the repo rate set by the MPC. The RBI had clarified 6 post inflation targeting that its ‘operating procedure aims at modulating liquidity conditions so as to achieve the operating target, i.e., to anchor the WACR around the policy rate’ and ‘MSF rate and the fixed overnight reverse repo rate define an informal corridor for limiting intra-day variations in the call rate.’ Understanding this should alleviate the markets concern that liquidity can suddenly dry up. While under the current stance WACR may stay largely in the upper half of the LAF corridor, it cannot persistently exceed it.
49. Pass-through continues as old deposits and loans are re-priced, but the stance, as well as credit growth continuing to exceed deposit growth, should persuade banks of the virtues of passing through more of the 250bps repo rate rise to increase their primary liquidity. Statement by Prof. Jayanth R. Varma
50. Current indications are that, after many difficult quarters, the economic environment is turning more benign in terms of both inflation and growth. The challenge for monetary policy is to facilitate this benign outcome where inflation trends down and growth remains robust.
51. This requires two things. First, a restrictive monetary policy must be maintained long enough to glide inflation to its target of 4%. Second, as inflation drops well below the upper tolerance band, it is necessary to prevent the real interest rate from becoming excessive. At present, projected inflation two to four quarters ahead averages below 4.75%. The prevailing money market interest rates of 6.75% (close to the MSF rate) therefore represent a real interest rate of more than 2%. Three years of high inflation do justify a strong anti-inflationary monetary policy, but in my view a real rate of 2% clearly exceeds the optimal rate. In coming months, as we become more confident about the downward trajectory of inflation (apart from transient food price spikes), there would be a RBI (2015) Monetary Policy Report, April, Box IV.1, pp 26, released after the February 2015 Agreement on Monetary Policy Framework between the Government of India and the RBI, available at https://rbi.org.in/documents/87730/78716285/2015HYED1215458ES216FE667. pdf compelling case for continually calibrating the nominal policy rate so as to keep the real interest rate slightly below 1.5% (on the basis of projected inflation 3-5 quarters ahead).
52. For these reasons, I vote for maintaining the repo rate at 6.50%, but express my reservations on the stance. I believe that a stance is not needed at all at this stage. If at all there is a stance, it should be neutral. Statement by Dr. Rajiv Ranjan
53. I began my October statement with three global trends to be closely watched – crude oil prices, US yields and US dollar, all of which were rising then. Oil prices have decreased, yields have softened, and the US dollar has weakened since the last policy. Thus, we draw comfort from the reversal of these trends in this December policy. In addition, global commodity prices have eased further. The impact of these dynamics is seen globally in terms of faster than expected decline in inflation of advanced countries and the conjecture that the apprehension of ‘higher for longer’ may not last long. Domestically, improvement in manufacturing profit with easing of input cost pressures and decline in core inflation is clearly observed. Thus, despite continuing overall global uncertainty, the macroeconomic environment in advance and emerging market economies has not been adversely impacted to the same extent as it was expected, not a long time ago. In fact, the global economy seems to have dodged a hard landing, though it continues to remain vulnerable to slow down risks.
54. Since the last policy, we are in a relatively firmer footing on our domestic macros in terms of inflation and growth. The moderation in CPI to 4.9 per cent in October 2023 was driven by the fall in food and core (CPI excluding food and fuel) inflation along with deflation in the fuel group. Since September, core disinflation also gathered pace, softening by about 60 basis point in a span of two months to 4.3 per cent in October or by about 2 percentage points from a peak value of 6.2 per cent in January.7 Even within core, services inflation at 3.6 per cent was at the lowest level since the start of the 2012=100 series. Core goods inflation, from a peak of 7.1 per cent in February 2023 has since then sequentially moderated to 5.0 per cent in October. Various exclusion based and statistical trimmed mean measures of core inflation also softened in the range of 60- 120 bps between August and October. Going forward, core inflation pressure could remain muted, as our monetary policy actions play out and softer growth in input costs and selling prices of the manufacturing sector keep price pressures contained. Concerns on elevated food inflation, however, is a major source of uncertainty for the inflation outlook.
55. On the growth front, the economy is running at full steam. Growth has been resilient and continuously surprising us on the upside over last two releases. The seasonally adjusted momentum in Q2 at 4.3 per cent was stronger than Q2 last year (3.2 per cent) and the pre-COVID average for Q2 (1.6 per cent). This momentum is likely to continue in Q3 and Q4 of 2023-24. It is important to note that for the first time in Q2:2023-24, the fault lines in India’s growth story since the pandemic – tepid private investment and rural demand – seem to be gaining traction. This augurs well for the long-term growth trend, particularly, investment plays a larger role in terms of supply augmentation and improving potential growth in the medium to long-term. India has successfully accumulated capital stock over the past decades and continues to invest in Core CPI saar, from 6 per cent in January 2023, has softened to 3.6 per cent in October 2023. Threshold core CPI diffusion indices for price increases of greater than 6 per cent (saar) and 4 per cent (saar) remained in contraction zone over much of 2023-24 so far. capital formation, led by Government capital expenditure, as reflected in the recent GDP data release. Gross Fixed Capital Formation (GFCF), a proxy for investments, increased by 11 per cent in Q2. We are also in an advantageous position in terms of contribution to potential output through labour and total factor productivity (TFP) channels. India is in the forefront of technology-aided digitalisation with increasing internet penetration and mobile phone usage.8 Greater formalisation and digitalisation of our economy is giving a boost to TFP growth. With respect to human capital, India has a perceptible advantage in terms of demographic dividend and the economy could benefit from it.9 Taken together, capital and TFP, along with favourable demographic dividends, could have led to a sustainable increase in the potential level of output of the economy. This change in structural features of the economy could explain to a large extent the observed dynamics of robust growth numbers along with falling core inflation.
56. The best way monetary policy can support this high growth trajectory is by maintaining its commitment to price stability. While monetary policy has succeeded in getting headline inflation into the tolerance band, it is still above the target 10 and continues to remain vulnerable to supply shocks. The below 5 per cent print in October 2023 may reverse as early as next month. In essence, while a durable growth path backed by consumption and investment is visible from here on, the same cannot be said about disinflation yet. Hence, monetary policy must continue treading a cautious path and remain prudent in its approach. We need to continue with the pause on the policy rate in this meeting while observing every incoming information impacting growth- inflation dynamics. Given that inflation remains above target, our stance of withdrawal of accommodation also has to continue to aid fuller transmission. Having taken a pause during the last few policies, there could be an argument for a change in stance to neutral. I feel this is not the right time. Apart from being premature, a change to neutral stance may have to bear the brunt of the collateral damage caused by wrong signalling, particularly with looming uncertainties on the horizon and when market expectations are running ahead of policy intent. We need to consolidate the gains achieved so far. Accordingly, I vote for a pause on rate and continue with the stance. Statement by Dr. Michael Debabrata Patra
57. Inflation remains highly vulnerable to food price spikes, as the spurt in momentum in daily data on key food items for the month of November and early December reveal. This repetitive incidence is causing the accumulation of price pressures in the system and could impart persistence, reflected in a left-tailed skew in the distribution of inflation. Households are already wary: although they expect inflation to remain unchanged three months ahead, they are more unsure about this prognosis than they were two months ago. Over the year ahead, however, they are more sure than in the past that inflation will likely rise. Consumers too reveal more pessimism about inflation a year ahead than when they were surveyed in September. Consequently, monetary policy has to remain on high alert with a restrictive stance.
58. In my view, food prices in India are the true underlying component of inflation. They also generate non-trivial external effects that affect other components of inflation as well as expectations. When these spillovers occur and are significant, monetary policy has to pre-emptively act to prevent generalization, irrespective of the fact that the initial https://pib.gov.in/PressReleaseIframePage.aspx?PRID=187655 United Nations Population Fund. Refer to my June 2023 statement for the theoretical difference between inflation target and tolerance band around target. shocks emanate from outside the realm of its influence. Hence the stance of withdrawing accommodation and a readiness to take appropriate action must continue until their impact is seen off without second order effects.
59. The recent GDP data release reinforces the view that the output gap in India has turned positive since the beginning of the year and remains so. This points to the likelihood of demand pull shaping the course of inflation outcomes in the period ahead, amplifying future supply shocks. Over the rest of the year, rising momentum of activity will drive growth offset by waning of favourable base effects. Rural demand is gradually improving while urban demand remains ebullient. Investment has emerged as the mainstay of aggregate demand. It remains to be seen if the recent upturn in exports of merchandise sustains. The strength of underlying domestic demand is also being reflected in the pick-up in non-oil non-gold imports after a prolonged contraction.
60. Against this backdrop, the monetary policy reaction function needs to assign a higher weight to inflation relative to growth in a forward-looking sense. Accordingly, I vote to maintain status quo on the policy rate and continue with the stance of withdrawal of accommodation. Statement by Shri Shaktikanta Das
61. The years 2020 to 2023 will perhaps go down in history as a period of ‘Great Volatility’. In this environment, the Indian economy presents a picture of resilience and momentum as reflected in the higher than anticipated GDP growth in Q2:2023-24, surprising everyone on the upside. Reflecting this, our growth projection for the current year has been revised upward to 7 per cent. We expect this growth momentum to continue next year also.
62. The softening of headline inflation to 4.9 per cent in October 2023 gives further credence to the fact that the heightened and generalised inflation pressures seen in the summer of 2022 is behind us. This disinflation is underpinned by steady moderation in CPI core inflation, caused by easing of price momentum across core goods and services. Core inflation in October was the lowest since early 2020 and would show that our monetary policy actions are working.
63. Moving forward, while food inflation has receded from the highs seen in July, it remains elevated. The overall inflation outlook is expected to be clouded by volatile and uncertain food prices and intermittent weather shocks. In the immediate months of November and December, a resurgence of vegetable price inflation is likely to push up food and headline inflation. We have to remain highly alert to any signs of generalisation of price impulses that may derail the ongoing process of disinflation.
64. GDP growth is expected to remain resilient. Financial conditions are stable. Inflation is moderating, but we are still quite a distance away from our goal of reaching 4 per cent CPI on a durable basis. The projected inflation (4.7 per cent) in Q3 of next year, i.e., one year from now, is perilously close to 5 per cent. In these circumstances, monetary policy has to be actively disinflationary. Any shift in policy stance now would be premature and risky. Further, with past rate hikes still working through the economy, it would be desirable to closely monitor their full play out. The conditions ahead could be fickle and call for prudent evaluation of the emerging situation. Considering all the above factors, a pause in rate action and remaining focused on withdrawal of accommodation is considered necessary in this meeting of the MPC. Accordingly, I vote for keeping the policy repo rate unchanged and continuing with the focus on withdrawal of accommodation. We have to remain vigilant and ready to act effectively in our journey towards 4 per cent inflation target. (Yogesh Dayal) Chief General Manager Press Release: 2023-2024/1531
6. Global growth is likely to remain steady in 2024 after a surprisingly resilient performance in a turbulent year gone by. Inflation is edging down from multi-decade highs, with intermittent upticks. Financial market sentiments have been fluctuating with changing views about an early pivot by central banks in advanced economies (AEs). The likelihood of lower interest rates has spurred rallies in equity markets, although uncertainty about the timing of interest rate reduction is reflected in bidirectional movements in the US dollar and sovereign bond yields. Emerging market economies (EMEs) are facing currency fluctuations amidst volatile capital flows.
7. Domestic economic activity is strengthening. As per the first advance estimates (FAE) released by the National Statistical Office (NSO), real gross domestic product (GDP) is expected to grow by 7.3 per cent, year-on-year (y-o-y) in 2023-24, underpinned by strong investment activity. On the supply side, gross value added (GVA) expanded by 6.9 per cent in 2023-24, with manufacturing and services sectors as the key drivers.
8. Looking ahead, recovery in rabi sowing, sustained profitability in manufacturing and underlying resilience of services should support economic activity in 2024-25. Among the key drivers on demand side, household consumption is expected to improve, while prospects of fixed investment remain bright owing to upturn in the private capex cycle, improved business sentiments, healthy balance sheets of banks and corporates; and government’s continued thrust on capital expenditure. Improving outlook for global trade and rising integration in global supply chain will support net external demand. Headwinds from geopolitical tensions, volatility in international financial markets and geoeconomic fragmentation, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.0 per cent with Q1 at 7.2 per cent; Q2 at 6.8 per cent; Q3 at 7.0 per cent; and Q4 at 6.9 per cent (Chart 1). The risks are evenly balanced.
9. From its October 2023 trough of 4.9 per cent, CPI inflation increased successively in the next two months to 5.7 per cent by December. Food inflation, primarily y-o-y vegetable price increases, drove the pick-up in headline inflation, even as deflation in fuel deepened. Core inflation (CPI inflation excluding food and fuel) softened to a four- year low of 3.8 per cent in December.
10. Going forward, the inflation trajectory would be shaped by the evolving food inflation outlook. Rabi sowing has surpassed last year’s level. The usual seasonal correction in vegetable prices is continuing, though unevenly. Yet considerable uncertainty prevails on the food price outlook from the possibility of adverse weather events. Effective supply side responses may keep food price pressures under check. The continuing pass- through of monetary policy actions and stance is keeping core inflation muted. Crude oil prices, however, remain volatile. Manufacturing firms covered in the Reserve Bank’s enterprise surveys expect some softening in the growth of input costs and selling prices in Q4:2023-24, while services and infrastructure firms expect higher input cost pressures and growth in selling prices. Taking into account these factors, CPI inflation is projected at 5.4 per cent for 2023-24 with Q4 at 5.0 per cent. Assuming a normal monsoon next year, CPI inflation for 2024-25 is projected at 4.5 per cent with Q1 at 5.0 per cent; Q2 at 4.0 per cent; Q3 at 4.6 per cent; and Q4 at 4.7 per cent (Chart 2). The risks are evenly balanced.
11. The MPC noted that domestic economic activity is holding up well and is expected to be backed by the momentum in investment demand, optimistic business sentiments and rising consumer confidence. On the inflation front, large and repetitive food price shocks are interrupting the pace of disinflation that is led by the moderation of core inflation. Geopolitical events and their impact on supply chains, and volatility in international financial markets and commodity prices are key sources of upside risks to inflation. The cumulative effect of policy repo rate increases is still working its way through the economy. The MPC will carefully monitor any signs of generalisation of food price pressures to non-food prices which can fritter away the gains in the easing of core inflation. As the path of disinflation needs to be sustained, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting. Monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. The MPC will remain resolute in its commitment to aligning inflation to the target. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
12. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Prof. Jayanth R. Varma voted to reduce the policy repo rate by 25 basis points.
13. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Prof. Jayanth R. Varma voted for a change in stance to neutral.
14. The minutes of the MPC’s meeting will be published on February 22, 2024.
15. The next meeting of the MPC is scheduled during April 3 to 5, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. The First Advance Estimates of GDP for FY 2023-24 released by the National Statistical Office placed year-on-year real GDP growth for FY 2023-24 at 7.3 per cent, exceeding the 7.2 per cent in the previous year. The implicit growth rate of GDP for the second half of 2023-24 at 7 per cent, is well above the projections in the December 2023 MPC meeting. There has been no slow down in growth in FY 2023-24 despite the adverse monsoon conditions affecting agriculture, weak external demand conditions, risks to the global supply chains due to the geopolitical conflicts and elevated policy interest rates during much of the financial year. Moderation in consumer level inflation rate, decline in commodity prices in the international markets impacting input costs for the domestic producers, and increased pace of government capex spending have offset the impact of adverse growth conditions. The recent broader high frequency indicators of economic activity such as non-food credit, PMIs for manufacturing and services, GST collections point to strong demand conditions.
17. While the growth experience has not been evenly shared across output sectors and across sources of demand, broader supportive economic and monetary policies have helped in sustaining the growth drivers. Going forward, revival of growth in consumption demand would be the key factor in sustaining the current growth momentum, which in turn would require improved employment and household income conditions.
18. In the short-term, the RBI’s sample surveys of urban households conducted during Jan 2-11, 2024 show that consumer confidence is improving on the back of consumer’s assessment of general economic situation and household employment, and high household income in comparison to the findings of the previous round of the survey. The consumer optimism is accompanied by caution as the survey indicates that the expectation of increase in overall spending - i.e., the percentage of respondents expecting increased spending - is yet to reach levels of pre-pandemic period. The gap is particularly substantial in the case of discretionary spending.
19. The enterprise surveys of RBI conducted during October-December 2023, point to rise in business optimism over a period from Q4: FY 2023-24 to Q2: FY 2024-25. However, the expectation of improved overall business conditions is across each of the three quarters in the case of services and infrastructure sectors, with manufacturing sector expected to improve significantly only in Q2: FY 2024-25.
20. The growth performance in FY 2023-24 provides a strong base for the prospects for the next financial year. The assessment by international agencies point to significant improvement in the global trade conditions in 2024 and the economic growth is expected to remain stable at the level of the previous year. The international commodity price pressures are expected to remain moderate. In the domestic economy, favourable rainfall during the monsoon would be crucial in achieving both benign inflation and growth scenarios. With a target for reduction in the fiscal deficit in place, the availability of funds to the private investment would be less constrained than otherwise. While each of these conditions would be subject to risks, sustained growth momentum that focuses on domestic sources of demand is also likely.
21. Taking into account the various factors, the real GDP growth for 2024-25 has now been projected at 7% with quarterly growth of 7.2%, 6.8%, 7% and 6.9% in Q1 to Q4, respectively. The forecast is based on a normal monsoon for the year, which would also support rural consumption demand. The RBI Survey of Professional Forecasters conducted in January 2024 provides a median forecast of real GDP growth of 6.5 per cent in 2024-25, revised upward from the forecast of 6.3% in November 2023 round of the survey.
22. The headline consumer price index, YOY basis, increased by 5.6% in November and 5.7% December 2023, following relatively lower rates in the previous two months. The higher inflation rate in November and December was due to food inflation at 8% and 8.7%, respectively. Fuel and light index declined during November and December, YOY basis, and the price index excluding food and fuel (core inflation) rose by 4.1% and 3.8%, respectively. Therefore, in the present conditions, deceleration in food inflation would be key to bringing down the headline inflation to the target on a sustained basis.
23. The elevated food price inflation in December was marked by double digit increase in the prices, on a YOY basis, of pulses, fruits, vegetables and spices; the cereals and products and sugar and confectionary price indices rose by more than 6%. Meat and fish, eggs, milk & products, oils & fats, non-alcoholic beverages, and prepared meals, snacks etc. registered price rise of below 6%. A number of food items, therefore, registered high levels of price rise in December. Going forward, in the short term, deceleration in food prices would require a favourable rabi harvest and an adequate supply response.
24. The Expectations Survey of urban households conducted by RBI during Jan 2-11 indicates decline in the current and one year ahead inflation but an increase in the 3- months ahead horizon, suggesting moderation in price pressures in the medium term.
25. RBI’s enterprise surveys conducted in October-December 2023 point to a mixed picture for price conditions across sectors. In the immediate short-term period of Q4, the survey reveals expectations of declining input cost pressures in manufacturing but rising pattern in services and infrastructure. Consistent with the cost perceptions, larger proportion of firms expect increased selling prices in Q4: 2023-24 and subsequent two quarters in services and infrastructure.
26. The Business Inflation Expectations Survey (BIES) conducted by the Indian Institute of Management, Ahmedabad, during December 2023, reports a significant increase in one-year ahead unit cost based expected inflation as compared to the findings of its survey in November 2023. The survey also reports an increase in the one-year ahead expected headline inflation rate to 4.96% in December 2023 from 4.73% in October 2023. Respondents to the survey were from companies mainly from the manufacturing sector.1
27. The RBI Survey of Professional Forecasters conducted in January 2024 provides estimated median forecast of headline inflation at 5.1% in Q4 2023-24 followed by 5.2%, 3.8%, and 4.9% in Q1 to Q3 2024-25, respectively. The projected CPI inflation rate for 2024-25 is 4.6%.
28. Taking into account the various factors, the CPI inflation rate for 2023-24 is projected at 5.4%, with Q4 at 5%. The CPI inflation rate for 2024-25 is projected at 4.5% with quarterly projections of 5%, 4%, 4.6% and 4.7% for Q1 to Q4, respectively.
29. The present growth and inflation scenarios are nearly the same as we saw them in December: surprisingly strong growth momentum despite the several adverse conditions with prominent uneven patterns across sectors and sources of demand. The uncertainty over global economic conditions due to geopolitical conflicts and weather conditions has also persisted. As far as GDP growth is concerned, the baseline projections for 2024-25, are now revised upward compared to the projections in December. The inflation forecast for the first three quarters of 2024-25 is marginally lower than in the December projections but above 4.5% in Q3 and Q4.
30. Given the implications of current elevated levels of food inflation to the overall inflation pressures, and the prevailing strong overall growth, there is a need to remain focussed on achieving the inflation target in a sustained way. As we had observed in the December 2023 meeting, the transmission of increases in policy rates effected up to February 2023 is still incomplete. Therefore, it is critically important at this juncture to continue with the present policy rates so that the moderation in inflation rate to the target is achieved in a sustained manner.
31. Therefore, I vote: i) to keep the policy repo rate unchanged at 6.50 per cent, and ii) to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
32. Geopolitical risks continue but neither have oil prices risen as much as feared nor has global growth slowed as much as expected. As inflation approaches their target, advanced economy (AE) central banks (CBs) have announced rate cuts in 2024 as they recognize a further rise in real interest rates as inflation falls would be an over-correction and nuanced actions are required for a soft landing. Some emerging market CBs have already cut rates.
33. Indian growth has also exceeded expectations, demonstrating resilience to global shocks. But many high frequency indicators softened in November and December. Even so, imports continue to grow in volume terms and there is no slowing in credit growth. That capacity utilization has not risen despite good growth suggests private investment is taking place. 1 The Business Inflation Expectations Survey (BIES), December 2023. https://www.iima.ac.in/faculty- research/centers/Misra-Centre-for-Financial-Markets-and-Economy/BIESIndian Institute of Management, Ahmedabad.
34. Inflation has also come in below predictions and core inflation continues to soften, again indicating that output remains below capacity. Reforms and structural changes are reducing costs. Profit margins have risen although corporates are preferring volume over price growth. Corporate results show real sales growth continued to outpace nominal growth in Q3. FMCG majors are cutting prices because of local competitors. Oil majors also have room to cut prices. Current perceptions and long-term household inflation expectations have softened. There seems to be overall acceptance that inflation is moving towards the target. This should anchor core inflation around 4%. Faster than expected fiscal consolidation and a continuing better composition of government expenditure, will also lower inflationary pressures.
35. Since growth is still robust and recent headline inflation has been near the upper tolerance band, we can wait a bit longer to ensure that inflation continues movement to the target despite any geopolitics related or other commodity price shocks. The experience of the past year suggests commodity price shocks may now be short-lived and may not raise inflation persistently. Then it would not be necessary to keep rates high just because supply shocks are expected in the future. But we can wait to test this for some more time. So, I vote for status quo on rates though headline inflation FY25 projections of 4.5% gives room to cut. The rise in headline inflation towards 5% expected later in the year is due to base effects and an expected rise in food prices, but the latter are highly uncertain. I also agree to the stance interpreted in terms of policy rates still being disinflationary and vote for status quo on the stance.
36. Further supply-side improvements that could reduce shocks are necessary. Better integrated markets in AEs prevent the kind of food price shocks we have to face. Modern supply chains should use our geographical diversity as well as imports to prevent sharp fluctuations in key vegetable prices.
37. The daily weighted average call rate (WACR) has often exceeded the repo rate in the past few months. Just as the tightening cycle started by withdrawing liquidity to ensure the repo rate would rise above the reverse repo, now after 6 months of tight banking liquidity, and as expected real rates rise, measures to ensure the WACR largely stays at the repo rate are required. These would also bring down short rates and are part of the natural development of the liquidity adjustment framework that supports inflation targeting.
38. Even if the WACR exceeding the repo was due to unprecedented and extended large government cash balances, the toolkit to counter these and the many other shocks to which liquidity in India is subject to, can be expanded and activated. Part of surplus Government cash balances are already considered for VRR auctions, cash management itself can be improved and government borrowing staggered. Moving to the just in time mode would save interest costs. Money market timings can be extended and market microstructure developed to enable banks to lend to each other.
39. Banks are the only conduit of liquidity to the rest of financial system and they tend to hoard liquidity if it is tight. Since nonbank financial intermediaries do not have access to a lender of last resort and penalties for credit default are now high they also tend to hold excess liquidity. As a result large swathes of the credit system do not get serviced.
40. Work on resilience2 suggests CBs should act to reduce risk premiums anywhere in the financial system. An effective example of this is in the Indian foreign exchange (FX) market where rupee volatility and FX forward premiums have declined. This is one reason we have seen large debt inflows coming in at the narrowest interest differentials in the last 2 months3 and again points to the freedoms Indian policy rates have from US rates.
41. Macroprudential tightening also pre-emptively reduces balance sheet (BS) stress as do better macro fundamentals and fiscal consolidation. But adequate liquidity is also important to prevent illiquidity raising costs, turning into insolvency and creating BS stress. A major reason the Silicon Valley Bank collapse was not followed by others was the broad liquidity support the Fed made available to stressed financial institutions even as it continued with quantitative tightening. Statement by Prof. Jayanth R. Varma
42. Inflation is projected to average 4.5% in 2024-25, and, therefore, the current policy rate of 6.5% translates into a real rate of 2%. I do not believe that such a high real rate is required at this stage to drive inflation down to the target of 4%. It is true that economic growth is holding up well, but there is no evidence at all that the economy is overheating.
43. Perhaps, the majority of the MPC worry that the output gap has already closed, and that the projected growth rate of 7% for 2024-25 exceeds the growth potential of the Indian economy. I do not think that such growth pessimism is warranted. During the last few years, we have seen several policy measures including digitalization, tax reforms, and a step up in infrastructure investment that should boost the potential growth rate of the economy. Also, the compound average growth rate of real GDP from the pre- pandemic level is quite low: 4¼% per annum from 2019-20 to 2023-24 (First Advance Estimate). Growth pessimism would require one to assume that the pandemic induced a massive permanent scarring of the economy. To the contrary, all indications are that the economy has been quite resilient, and even sectors that were badly battered by the pandemic are bouncing back.
44. If the potential growth rate of the economy is close to 8%, then the economy is not at risk of overheating in 2024-25. A real interest rate of 1-1.5% would then be sufficient to glide inflation to the target of 4%. A real interest rate of 2% creates the very real risk of turning growth pessimism into a self fulfilling prophecy.
45. It must also be borne in mind that the process of fiscal consolidation is projected to continue in 2024-25. This opens up space for monetary easing without risking an inflationary spiral. In my view, the time has come for the MPC to send a clear signal that it takes its dual mandate of inflation and growth seriously, and that it would not maintain a real interest rate that is significantly more than what is needed to achieve its target.
46. I therefore vote to reduce the repo rate by 25 basis points, and to change the stance to neutral. 2 Brunnermeier, M. 2024. 'Microfinance and resilience.' 2024 Presidential address at American Finance Association. Available at: https://www.youtube.com/watch?v=z94l-G5gz4o&list=PL42MdOODnBSvD0p8ervyECxCSfKv2XCRy 3 Rigorous estimations in the papers below show that exchange rate volatility raises EM interest rate spreads. Goyal, A. and Banerjee, K. 2020. ‘Monetary spillovers and real exchange rate.’ International Journal of Emerging Markets, 17(2): 452-484, 2020. https://doi.org/10.1108/IJOEM-02-2020-0192. Goyal, A., Verma, A., and Sengupta, R. 2021. ‘External shocks, cross-border flows and macroeconomic risks in emerging market economies.’ Empirical Economics, 62, pp. 2111-2148. Available at: https://doi.org/10.1007/s00181- 021-02099-z Statement by Dr. Rajiv Ranjan
47. Let me start from the outlook I had given in my December 2023 minutes, “While a durable growth path backed by consumption and investment is visible from here on, the same cannot be said about disinflation yet. The below 5 per cent print in October 2023 may reverse as early as next month.” Since the last policy, the growth inflation dynamics have evolved largely along these lines. Growth is holding up better than expected, while the inflation prints in November and December crossed 5 per cent. Core inflation has shown marked and durable signs of disinflation that gives us comfort from monetary policy perspective, but upside risks remain from food inflation.
48. Two other comforting developments since the last policy needs attention. The first relates to the global economy that is performing better than expected earlier. Global growth prospects have improved and inflation in advanced economies is slowly inching down, though intermittently deviating from the declining trend. Global commodity prices remain benign and crude oil prices have not risen despite several new flash points in the ongoing conflicts. Second, the central government in its interim budget stayed the course on a fiscal consolidation path. A prudent fiscal policy can reinforce the credibility of the flexible inflation targeting framework and thus help in anchoring the long-term inflation expectations.4 With less budgeted market borrowings and bond inclusion driven flows expected in 2024, the fisc has vacated space for the private sector on the one hand, while on the other hand taken steps to crowd in private investment through its continued focus on capex and other long term sustainable growth initiatives in areas like solar energy, health, innovation and renewables.
49. Against this backdrop, I vote to maintain status quo on rate and stance for the following reasons.
50. First, it may be recalled that we had frontloaded our rate actions by raising the repo rate cumulatively by 250 bps during May 2022 to February 2023 unlike central banks in advanced economies and several emerging market economies where rate hikes were of much higher order. In April 2023, when we paused majority of market participants were still expecting the MPC to hike rates. In other words, we did not raise our interest rates to a very restrictive zone, unlike the 400-500 bps increase seen by western central banks.
51. Second, given the growth-inflation dynamics, and the uncertainty related to the inflation path going ahead, it would be better to continue with status quo to get more clarity on the current rabi crop and upcoming monsoon rains to further reaffirm our conviction of a durable downward trajectory of inflation towards 4 per cent.
52. Third, markets are currently running ahead of policy makers worldwide including India. Any change in policy direction is going to have a multiplier effect. This is particularly tricky considering that transmission has slowed down in the last two months. The weighted average lending rate on fresh loans from commercial bank has fallen by 18 bps during November-December 2023.5 Any change at this stage could be a misstep and an undoing of the gains made so far. 4 Sims, C. A. (2004). ‘Limits to inflation targeting. The inflation-targeting debate’ (pp. 283-310). University of Chicago Press. 5 The weighted average lending rate (WALR) on fresh rupee loans rose by 181 bps during the current tightening cycle (May 2022 – December 2023). However, during November and December, the WALR on fresh rupee loan declined by 18 bps.
53. Fourth, led by productivity improvement through digitalisation and formalisation of the economy, increased capital formation, favourable demography, and new drivers of growth such as services exports, India’s potential growth is most likely now higher.6 This allows us to move more cautiously on inflation front. Softer core inflation despite strong growth supports this argument.
54. Fifth, successfully managing the final descent of inflation is the most challenging part of the journey and the history of past 100 inflation episodes teaches us that inflation shock, in general, tends to be persistent. What matters for success in defeating inflation is consistency and credibility of policy that helps firmly anchor inflation expectations.7 Avoiding any pre-mature move will help us guard against the biggest challenge to credibility, i.e., having to backpedal later if faced with upside surprises to inflation.8
55. Finally, let me emphasise that today we are in a period of transition, which is a little delicate where neither forward guidance works nor pre-emptive policy actions. Expectations of a change make agents and market participants behave in a way as if the change has already happened, which makes managing the present even tougher. For example, very recently we saw that expectations of rate cuts by major advanced economies have made global markets very exuberant. This makes the job of central banks even more difficult, especially since the last leg of disinflation is still pending. Caution and conservatism are the key during transition times unlike black swan events of the recent past when decisive, aggressive and innovative approaches worked. Staying the full course with determination without getting carried away is the best bet to address these transition challenges. Our strong fundamentals will help us to come out even stronger. Statement by Dr. Michael Debabrata Patra
56. Recent advance estimates of the National Statistical Office (NSO) and subsequently available high frequency indicators point to the momentum of domestic economic activity being sustained. This is underpinned by a shift from consumption to investment. Although a fuller private capex cycle is yet to gather steam, high corporate profitability, the surging housing and real estate market and the strong commitment to fiscal consolidation – now and in the medium-term – should quicken its broader-based onset. Productive capacity of the economy is expanding, mostly financed domestically as evident in the modest current account deficit. Consequently, growth impulses are insulated from the volatility of international financial flows in a highly uncertain and unsettled global environment. On the other hand, private consumption, which accounts for 57 per cent of GDP, is languishing under the strain of still elevated food inflation. This is particularly telling in rural areas. Inflation has to be restrained to its target for growth to be inclusive and sustained.
57. Persisting food supply pressures are holding hostage the disinflation that has been led by the steady easing of core inflation. In the latest CPI print for December 2023, unfavourable base effects snuffed out a decline in the momentum of food inflation. As winter’s seasonal price softening fades, however, demand-supply imbalances in the food category may show up again; they should not be allowed to negate the gains of monetary policy’s restraint on core inflation. Sentiment indicators are conducive. Consumer confidence is steadily improving across rural and urban areas even as 6 I have elaborated on this point in my last minutes. 7 Ari Anil and Lev Ratnovski (2023). ‘History’s Inflation Lessons’. Finance and Development. December. 8 International Monetary Fund, World Economic Outlook update, January 2024. inflation expectations of households have dipped over a year ahead, and they are more certain of this outcome in their current perceptions. Business sentiment is also upbeat, particularly among services sector firms. In the manufacturing sector, nominal sales growth is inching up, led by volume expansion. Debt servicing burdens and staff costs are moderating while profitability continues to expand.
58. The optimism generated by these evolving macroeconomic conditions and the recent improvement in financial conditions in response to prudent and growth-stimulating budgetary announcements would come full circle if inflation eases and aligns with the target. The outlook for the Indian economy remains highly sensitive to inflation risks. High inflation erodes purchasing power, especially for those least protected against the higher costs of essentials like food. Restoring price stability is beneficial for all. Accordingly, monetary policy must remain restrictive and maintain downward pressure on inflation while minimising the output costs of disinflation. It is only when inflation subsides and stays close to the target lastingly that policy restraint can be eased. Hence, I vote for keeping the policy rate unchanged and for continuing with the stance of withdrawal of accommodation. Statement by Shri Shaktikanta Das
59. In the current challenging and unsettled global environment, India presents a picture of strength and resilience. Our proactive, multi-pronged and calibrated policies have worked well to maintain and strengthen macroeconomic and financial stability. Our approach can be a good template for the future. Considering that price and financial stability are the foundations for strong, sustainable and inclusive growth, our endeavour all along has been to take a holistic approach to keep the economy in balance.
60. Real GDP in 2023-24 is expected to grow at 7.3 per cent on top of a growth of 7.2 per cent recorded in 2022-23. Inflation is edging down and is expected to soften to 5.4 per cent in 2023-24 from 6.7 per cent in the previous year (average for the year). Consumer confidence is rising, business sentiments remain upbeat and inflation expectations are getting steadily anchored.
61. CPI inflation has fallen decisively from the heightened levels of last summer, led by steady and sustained disinflation in core, though there have been intermittent interruptions caused by adverse food price shocks. This was so recently when food inflation picked-up to 8.7 per cent in December from 6.3 per cent in October. Consequently, headline inflation rose from 4.9 per cent in October to 5.7 per cent in December, even as core inflation (CPI inflation excluding food and fuel) softened to a four-year low of 3.8 per cent. Deflation in fuel has also deepened.
62. Inflation is expected to soften further to an average of 4.5 per cent in 2024-25 with a fleeting trough of 4 per cent in Q2. Food price uncertainty remains a major source of volatility for headline inflation outlook. Growing geo-political tensions and supply chain disruptions due to new flash points also pose further risks to the inflation outlook.
63. GDP growth, going forward, is expected to remain resilient with the momentum of economic activity continuing in 2024-25. Rabi sowing is now better than last year’s, which along with persisting momentum in allied activities, would support rural consumption. Urban demand continues to be strong. Private capex cycle has turned up, supported by government’s infrastructure thrust and twin balance sheets advantage from healthy corporates and banks. In fact, a strong growth in fixed investment validates the turnaround in the investment cycle which I have been emphasising in my previous statements during the year. Net external demand is expected to get an uplift from improving global outlook. On the supply side, manufacturing activity remains upbeat, aided by improving profit margins. Services sector is in a bright spot on the back of strong domestic demand. Accordingly, we expect real GDP to grow by 7.0 per cent in 2024-25.
64. The current setting of monetary policy is moving in the right direction, with growth holding firm and inflation trending down to the target. At this juncture, monetary policy must remain vigilant and not assume that our job on the inflation front is over. We must remain committed to successfully navigating the ‘last mile’ of disinflation which can be sticky. As markets are front-running central banks in anticipation of policy pivots, any premature move may undermine the success achieved so far. Price and financial stability are essential to sustain a long haul of high growth. Policy imperative at the current juncture is to remain focused on achieving the 4 per cent inflation target on a durable basis, keeping in mind the objective of growth. Accordingly, I vote to keep the policy repo rate unchanged and continue with the focus on withdrawal of accommodation. (Shweta Sharma) Press Release: 2023-2024/1916 Deputy General Manager
6. The global economy exhibits resilience and is likely to maintain its steady growth in 2024. Inflation is treading down, supported by favourable base effects though stubborn services prices are keeping it elevated relative to targets. As the central banks navigate the last mile of disinflation, financial markets are responding to changing perceptions on the timing and pace of monetary policy trajectories. Equity markets are rallying, while sovereign bond yields and the US dollar are exhibiting bidirectional movements. Gold prices have surged on safe haven demand.
7. The domestic economy is experiencing strong momentum. As per the second advance estimates (SAE), real gross domestic product (GDP) expanded at 7.6 per cent in 2023-24 on the back of buoyant domestic demand. Real GDP increased by 8.4 per cent in Q3, with strong investment activity and a lower drag from net external demand. On the supply side, gross value added recorded a growth of 6.9 per cent in 2023-24, driven by manufacturing and construction activity.
8. Looking ahead, an expected normal south-west monsoon should support agricultural activity. Manufacturing is expected to maintain its momentum on the back of sustained profitability. Services activity is likely to grow above the pre-pandemic trend. Private consumption should gain steam with further pick-up in rural activity and steady urban demand. A rise in discretionary spending expected by urban households, as per the Reserve Bank’s consumer survey, and improving income levels augur well for the strengthening of private consumption. The prospects of fixed investment remain bright with business optimism, healthy corporate and bank balance sheets, robust government capital expenditure and signs of upturn in the private capex cycle. Headwinds from geopolitical tensions, volatility in international financial markets, geoeconomic fragmentation, rising Red Sea disruptions, and extreme weather events, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.0 per cent with Q1 at 7.1 per cent; Q2 at 6.9 per cent; Q3 at 7.0 per cent; and Q4 at 7.0 per cent (Chart 1). The risks are evenly balanced.
9. Headline inflation softened to 5.1 per cent during January-February 2024, from 5.7 per cent in December. After correcting in January, food inflation edged up to 7.8 per cent in February primarily driven by vegetables, eggs, meat and fish. Fuel prices remained in deflation for the sixth consecutive month in February. CPI core (CPI excluding food and fuel) disinflation took it down to 3.4 per cent in February – this was one of the lowest in the current CPI series, with both goods and services components registering a fall in inflation.
10. Going ahead, food price uncertainties would continue to weigh on the inflation outlook. An expected record rabi wheat production in 2023-24, however, will help contain cereal prices. Early indications of a normal monsoon also augur well for the kharif season. On the other hand, the increasing incidence of climate shocks remains a key upside risk to food prices. Low reservoir levels, especially in the southern states and outlook of above normal temperatures during April-June, also pose concern. Tight demand supply conditions in certain pulses and the prices of key vegetables need close monitoring. Fuel price deflation is likely to deepen in the near term following the recent cut in LPG prices. After witnessing sustained moderation, cost push pressures faced by firms are showing upward bias. The recent firming up of international crude oil prices warrants close monitoring. Geo-political tensions and volatility in financial markets also pose risks to the inflation outlook. Taking into account these factors and assuming a normal monsoon, CPI inflation for 2024-25 is projected at 4.5 per cent with Q1 at 4.9 per cent; Q2 at 3.8 per cent; Q3 at 4.6 per cent; and Q4 at 4.5 per cent (Chart 2). The risks are evenly balanced.
11. The MPC noted that domestic economic activity remains resilient, backed by strong investment demand and upbeat business and consumer sentiments. Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process, posing challenges for the final descent of inflation to the target. Unpredictable supply side shocks from adverse climate events and their impact on agricultural production as also geo-political tensions and spillovers to trade and commodity markets add uncertainties to the outlook. As the path of disinflation needs to be sustained till inflation reaches the 4 per cent target on a durable basis, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting. Monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. The MPC will remain resolute in its commitment to aligning inflation to the target. The MPC believes that durable price stability would set strong foundations for a period of high growth. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
12. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Prof. Jayanth R. Varma voted to reduce the policy repo rate by 25 basis points.
13. Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Prof. Jayanth R. Varma voted for a change in stance to neutral.
14. The minutes of the MPC’s meeting will be published on April 19, 2024.
15. The next meeting of the MPC is scheduled during June 5 to 7, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal Yes Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. High growth and moderating inflation rates have marked the prevailing macroeconomic conditions. The recent assessment by the National Statistical Organisation in its Second Advance Estimates places the year on year growth of GDP in Q3: 2023-24 at 8.4 per cent, the third consecutive quarter this year with a growth rate of above 8 per cent. The annual growth of GDP for 2023-24 is now estimated at 7.6 per cent, higher than the growth of 7 per cent in the previous year, and also above the First Advance Estimates for the current year. The annual headline inflation rate for February was 5.1 per cent the same level as in the previous month and well below 5.7 per cent in December 2023.
17. Agriculture and allied activities is the only one among the main production sectors with a marginal growth of less than 1 per cent in GVA. Industry is estimated to grow at 8.3 per cent and services at 7.9 per cent in 2023-24. Growth in industry has followed negative growth (-0.6) per cent in 2022-23 and services sector has registered a high growth of 7.9 per cent over 9.9 per cent in the previous year. Year on year growth rate of GVA in mining and manufacturing in the industry and construction and the composite financial, real estate, and personal services in the services exceeded 8 per cent in 2023-24. The Index of Industrial Production shows, however, that there are sub-sectors in manufacturing such as chemicals, textiles, readymade garments and leather in which output growth during April-2023- January 2024 has been subdued. Weakness in the external demand conditions has posed constraints on some of export-oriented industries.
18. The expenditure side is marked by high growth in investment demand relative to consumption. The former expanded by 10.2 per cent over the previous year and the latter by 3 per cent. The quarterly assessments point to improvement in consumption expenditure as private final consumption expenditure rose by 3.5 per cent in Q3 compared to 2.4 per cent growth in Q2: 2023-24.
19. On the inflation front, the pattern remains the same, which prevailed at the time of MPC meeting of February: expectations of moderation in inflation rates of fuels and the ‘core’ items of consumption leading to softening of the headline inflation in Q4: 2023-24. The actual inflation rates for January and February have reflected the projected trends as the headline rate dropped to 5.1 per cent and food inflation was above 7.5 per cent. Although the projections for 2024-25 in the February MPC meeting were at 4.5 per cent, the headline inflation trajectory reflected rates above 4.5 per cent for three out of four quarters in 2024-25.
20. The favourable outlook for the short-term is, therefore, conditioned by the continuation of the present growth and inflation trends. The economic conditions in 2023-24 were also impacted by the slow recovery of overall global economic growth and moderation in inflation rates combined with a decline in commodity prices, particularly crude oil and vegetable oils. The supportive economic policies have sustained domestic growth and investment inflows.
21. The indicators of current economic activity reflect strong momentum of growth in a number of sectors. Indicators such as high levels of capacity utilisation in the manufacturing sector, government capital expenditure, FDI inflows have remained positive for investment spending. Although expansion of private consumption expenditure has lagged behind GFCF and exports, even with reference to the levels in 2019-20, there has been a steady improvement in the consumer confidence of urban households, particularly on the general economic conditions, employment, and household income, as reflected in the sample household surveys carried out by the RBI. The RBI’s enterprise surveys conducted during January to March 2024 indicate that the demand conditions in H1: 2024-25 for manufacturing and infrastructure firms are expected to remain stable; in the case of services, conditions are expected to improve significantly. The broader measures of economic activity such as decline in unemployment rate and steady bank credit growth point to the favourable conditions. A key exogenous factor impacting the outlook in 2024-25 is the nature of the monsoon this year. The present expectations are one of a normal monsoon, which would help bolster the output performance of agriculture, rural demand and moderate inflation pressures.
22. Taking these factors into account the GDP growth for 2024-25 is projected at 7 per cent, the same level as in the February meeting of the MPC. The quarterly projections are 7.1 per cent in Q1, 6.9 per cent in Q2 and 7 per cent each in Q3 and Q4. RBI’s Survey of Professional Forecasters carried out in March 2024 provides a median real GDP growth forecast of 6.7 per cent for 2024-25, with an upward revision from its previous assessment of 6.5 per cent.
23. On the inflation front, as noted, food inflation trends would remain crucial to sustaining the movement of the headline inflation closer to the policy target of 4 per cent on a durable basis. Global conditions affecting commodity prices are the other exogenous elements impacting the fuel prices and prices of other inputs. These conditions- the food inflation and the global supply, and price conditions remain subject to significant risks given the uncertain weather events and geoeconomic conflicts affecting supply chains. However, short term spikes may not affect the projected headline inflation trajectory, given the moderating trend in the recent period in the forward looking expectations of inflation by the households (RBI’s Inflation Expectations Survey of Households and Business Inflation Expectations Survey by the Misra Centre for Financial Markets and Economy, Indian Institute of Management Ahmedabad). But prolonged disturbances in the supply conditions would be a concern.
24. Based on an assessment of the developing situation and the assumption of a normal monsoon, the headline inflation for Q4: 2023-24 is projected at 5 percent, Q1: 2024-25 at 4.9, Q2 at 3.8, Q3 at 4.6 and Q4 at 4.5 per cent. The average inflation rate for 2024-25 is projected at 4.5 per cent, the same as in the February MPC meeting. The RBI’s Survey of Professional Forecasters conducted in March 2024 also places the forecast for 2024-25 at 4.5 per cent.
25. The prevailing macroeconomic conditions point to a continuation of the strong growth momentum into 2024-25, particularly as a normal monsoon brings relief to the outlook for agricultural sector. A favourable monsoon is also crucial in bringing down the present high levels of food inflation rates, which would also support consumption demand in the rural economy. Sustaining the growth momentum will require moderate levels of consumer inflation. Tight monetary policy and government interventions in managing the supply side shocks on the food and energy front have been important in moderating inflation. While the projected inflation trends point to further moderation in inflation rate in 2024-25, they also indicate an upturn well above the target rate of 4 per cent in the second half of the year. Given the strong momentum of growth at this juncture, it is necessary to maintain monetary policy focus on aligning the inflation trends with the target.
26. Accordingly, I vote: i. to keep the policy repo rate unchanged at 6.50 per cent, and ii. to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
27. Global trade seems to be recovering but growth is mixed and geopolitical risks continue. Inflation has come down substantially but further progress is slow. The consensus of current research for advanced economies (AEs) seems to be that those who thought inflation was largely driven by supply-side bottlenecks were right after all, because it has come down sharply without prolonged macroeconomic tightening. It persisted longer than supply chain unravelling because of labour market tightness1. Longer term inflation expectations remained anchored and central bank tightening helped ensure that.
28. India did not have a tight labour market but recurrent food price shocks created inflation persistence. A rapid rise in repo rates, as well as government supply-side action, helped anchor inflation expectations. Real rates near equilibrium kept demand in balance with supply.
29. Partly as a result, commodity shocks were transient in 2023. This transience suggests it is not necessary to keep rates high because of expected future shocks. Moreover, even reaching 4% is no warranty inflation will stay at 4% if there are large shocks such as the pre and post pandemic ones.
30. In term of current and expected core inflation, real interest rates are now higher than the natural or neutral interest rate (NIR) compatible with keeping inflation at target and output at potential. This is less of a worry at present, since corporate profits are also high and despite some issues, growth is strong; private investment is rising in sectors where there is innovation or capacity is reached; exports and rural consumption are recovering. Most important, credit growth continues to be robust. The slight slackening in momentum, especially in categories with sharp growth, is desirable since credit spikes create risk. India’s relatively low credit/GDP ratio has to rise, but it is best if this happens gradually so that it is sustainable.
31. But there has to be a limit to squeezing core inflation to compensate for periodic headline shocks. Core sustaining below 4% implies real policy rates are in the contraction zone.
32. Real policy rates kept near the neutral rate of around unity after the pandemic, along with supply-side action to neutralize shocks, supported growth while anchoring inflation expectations. But real rates rise as inflation falls and if they sustain above 1 English, B., Forbes, K. & Ubide, A. 2024. 'Monetary Policy Responses to the Post-Pandemic Inflation.' CEPR Press. London, UK. Available at: https://cepr.org/publications/books-and-reports/monetary-policy-responses-post- pandemic-inflation neutral rates lagged effects of monetary policy will start reducing growth after some months2. Flexible inflation targeting (FIT) is forward-looking and aims to ensure expected real rates do not rise above the NIR. Since the NIR is time varying and difficult to estimate precisely, judgement is important.
33. It is possible to assess relevant factors affecting the Indian NIR in the policy time horizon3. Higher growth and demand for credit raise the NIR, but reforms raising potential output and enabling non-inflationary rise in low per capita incomes; higher capital inflows, lower current account deficit, reduction in fiscal deficits, use of prudential risk weights and provisioning that lower risk premiums4; wage growth below productivity growth all tend to lower the NIR. Since these factors work in opposite directions they may cancel each other.
34. Expected medium-run variables are more important for current policy in emerging markets that are far from a steady-state. So inflation itself gives useful insights for determining feasible or potential growth. Inflation approaching the target suggests the absence of over-heating so growth is below potential and the NIR has not risen. If despite robust growth core inflation is less than 4%, yet continues to fall, there cannot be excess demand. The IIM Ahmedabad survey finds firms’ average inflation expectations remained well-anchored at 4.3% in the past year. Firms may have internalized the inflation target apart from restructuring and reducing costs. Non-inflationary high growth is feasible as part of a transitional catch-up process that would create productive jobs for India’s underemployed youth,
35. Core sustaining near target inflation and average headline below 5 implies a credible approach to target, since research for the FIT period suggests long-run causality continues to be from core to headline inflation despite the pandemic shocks5. Publishing forecasts of core inflation can help the convergence of headline to target inflation. Competitive forecasts are an important discipline in a FIT regime. Core is less volatile than headline but correct forecasts require an understanding of how new data acts in the Indian structure.
36. While there are risks, there are also reasons to expect moderation in future supply shocks and their impacts—such as improved governance6 and steady rise in investment reducing bottlenecks and logistics costs; resilience rising with development and diversity; El Nino changing to La Nina; the impact of substitution away from oil, of LPG and petrol-diesel price cuts and falling weights of volatile price items such as food in consumption baskets.
37. Even if the NIR is raised to 1.5% because of abundant caution since steady growth allows a focus on reaching the inflation target the real policy rate is above it at 2 Fear of this has made the US Fed’s ‘higher for longer’ to change from policy rates to inflation. There is more willingness to allow inflation to remain marginally above target for longer in order to reduce output sacrifice. 3 IMF (April 2023) in Chapter 2 of the World Economic Outlook estimates the long-term Indian NIR will converge to AE levels that will go back to pre-pandemic lows. 4 See Goyal et.al. (2021), for a cross-country estimation of the, factors including exchange rates, that affect EM risk premiums. Goyal (2024) analyses open economy factors affecting Indian interest rates. For example, one year forward exchange rate premium that was 5.19% over 2014-19 fell to 1.95% in 2023. Goyal, A., Verma, A., and Sengupta, R. 2021. ‘‘External shocks, cross-border flows and macroeconomic risks in emerging market economies’ Empirical Economics, 62, pp. 2111-2148. Available at: https://doi.org/10.1007/s00181-021-02099-z; Goyal, A. 2024. 'India's exchange rate regime under inflation targeting. ' Indian Economic Journal, Special Issue in honour of Dr. Rangarajan, 72(5), October, forthcoming. Previous version available at: http://www.igidr.ac.in/pdf/publication/WP-2023-015.pdf. 5 While an IMF study in 2014 found causality from headline to core inflation, subsequent studies all find a reversal. The time taken for convergence depends on shocks, but the direction does not reverse. It can be faster despite shocks to the extant inflation expectations are more anchored, George, A.T., Bhatia, S., John, J., & Das, P. 2024. 'Headline and Core Inflation Dynamics: Have the Recent Shocks Changed the Core Inflation Properties for India? RBI Bulletin, February: 101-116 Available at: https://rbi.org.in/web/rbi/-/publications/rbi-bulletin/headline-and-core-inflation-dynamics-have-the- recent-shocks-changed-the-core-inflation-properties-22393 6 Goyal, A. 2012. ‘Propagation Mechanisms in Inflation: Governance as Key.’ Chapter 3 in S. M. Dev (ed.), India Development Report 2012, pp. 32-46, New Delhi: IGIDR and Oxford University Press. 2% even in terms of expected FY25 headline inflation (4.5%); and even higher in terms of expected core inflation. Despite a cut in repo rates policy will still be contractionary. In the current situation of many types of uncertainty, however, maintaining stability must have priority. Therefore, I continue to vote for a pause in the repo rate and for an unchanged stance. Giving indications of the future repo rate is not compatible with data-based guidance and can create unnecessary market turbulence as it has in the US. Policy continues to be forward-looking since it responds to how data affects published inflation and growth forecasts. Its reaction function should by now be well understood by markets, giving them adequate guidance.
38. The tightness in market liquidity has abated. Such tightness affects short rates more, which have little effect on aggregate demand and inflation. Under FIT, policy transmission occurs best through keeping the repo rate at an appropriate level, determined by domestic factors. Rates transmit through both banks and markets. For example, non-food credit of banks as a % of annual flow of resources available to the commercial sector has averaged 44.3% over 2007-23. Competition from other sources may mean less than full transmission of policy repo to loan rates, but points to growing diversity, maturity, fall in spreads and rising efficiency in the Indian financial sector. Market rates also rise with repo rates. Statement by Prof. Jayanth R. Varma
39. My views are largely the same as in the last meeting (February 2024) and so I will be brief. Despite an uptick in crude oil prices, the outlook for inflation continues to be benign, and I remain convinced that a real interest rate of 1-1.5% would be sufficient to glide inflation to the target of 4%. The current real policy rate of 2% (based on projected inflation for 2024-25) is therefore excessive.
40. This unwarrantedly high real rate imposes significant costs on the economy because of the short run Phillips curve. The fact that economic growth in 2024-25 is projected to slow by over half a percent relative to 2023-24 is a reminder that high interest rates entail a growth sacrifice. Monetary policy should try to reduce this sacrifice while ensuring that inflation (a) remains within the band and (b) glides towards the target.
41. I therefore vote to reduce the repo rate by 25 basis points, and to change the stance to neutral. Statement by Dr. Rajiv Ranjan
42. In my last statement of February 2024, I had explained clearly why no easing in stance or rate was desirable at that time. Now between last policy and this policy, what has changed.
43. Real GDP growth has turned out to be firmer with stronger momentum, better than all projections, as per the Second Advance Estimates (SAE) released after February policy. There seems to be minimal scarring of growth due to the pandemic or monetary tightening.
44. CPI headline inflation moderation remains on anticipated lines, though the diverging trajectory between food and core inflation continues. Food inflation remained a hostage to vegetable prices due to shallower winter season price correction, which could linger due to the likely above normal temperatures during the summer. Core inflation softened further since the last policy. This has been broad based across goods and services and almost universal, across all exclusion-based measures of core as well as statistical trimmed mean measures.7 Besides, it is driven by lower price momentum.8 While low core inflation would further the disinflation process, concerns remain on food inflation outlook. We need to remain watchful on upside risks to inflation outlook from adverse climatic factors, supply side shocks and geopolitical events.
45. Going ahead, while monetary policy seems to be on the right track, it is too early to ease guard against inflation. It is important that we gain more confidence on our macro numbers for 2024-25 and their nuances. We are just at the beginning of the financial year. The financial year 2022-23 is not far behind when all our assumptions and projections got altered within a month’s time because of unforeseen events. Few months into the year, we will have clarity on monsoon and its spatial distribution, impact of expected hot weather in the current quarter, rabi production and procurement and kharif sowing, all of which are critical to shape up the growth- inflation balance in 2024-25. Crude outlook is fast changing with the changing perceptions on demand supply in line with the geopolitics and developments in the middle east, which is on the edge. Besides, led by global developments, input prices are showing signs of an uptick, which needs to be watched. Return of inflation to the 4 per cent target is our objective and having come this far, it is not far from sight. We need to utilise the space provided by stronger growth to focus on inflation. Our own history, including that of many other emerging market economies (EMEs), shows that taking any risk on inflation front leads to huge price in terms of unhinging of inflation expectations that elongates the inflation episodes and makes the price stability task more daunting.
46. Globally, market expectation of an early and faster rate cut by advanced economies’ central banks are not aligning with the incoming data that is adding to some uncertainty on market perceptions of timing of policy easing cycle in major economies. In India, however, market expectations at present seem to be closely aligned to the MPC views and assessment. This is a win-win situation for India’s last mile of disinflation process when beliefs are consistent with the policy regime contributing towards anchoring of long-term expectations.9 Therefore, even if the current upside risks to price stability were to materialise, largely pertaining to the non- core components from uncertain food or international commodity prices, anchored inflation expectations may lower the pass through of such shocks10 with benefits that go beyond monetary policy.11
47. To conclude, in recent years the series of large and unfavourable supply shocks have induced monetary policy with difficult trade-offs12 – to stabilise both prices and output, which were moving in adverse directions. The MPC has utilised the ‘flexibility’ of the flexible inflation targeting framework and we have reached a situation in which this trade off seems to have blurred with inflation on a declining path and growth on a firmer footing. During this transition phase, the three Cs – Caution, Consistency and Credibility – have been the hallmark. While ‘caution’ entails 7 Various exclusion-based measures declined in a range of 10-40 basis points between December 2023 and February 2024. Trimmed mean measures also declined in a range of 20-50 basis points between December 2023 and February 2024, with weighted median moderating from 4.1 per cent in December to 3.6 per cent in February. 8 CPI core momentum (on a Seasonally Adjusted Annualised Rate -SAAR basis) moderated to 2.4 per cent in February 2024 from 3.1 per cent in January. 9 Eusepi, S., and B. Preston (2010): “Central Bank Communication and Macroeconomic Stabilization,”, American Economic Journal: Macroeconomics, 2, 235–271. 10 Gáti, L. (2023), "Monetary policy & anchored expectations – An endogenous gain learning model", Journal of Monetary Economics, Volume 140, Supplement, pp S37-S47. 11 Anchoring inflation expectations increases FDI, helps stabilise output and employment. Helder Ferreira de Mendonça and Bruno Pires Tiberto analyse data from 75 emerging market and developing economies (EMDEs) from 1990 to 2019; https://www.bis.org/publ/bppdf/bispap143_j. pdf 12When economy is driven by only demand shocks, price stability and output stabilisation would warrant monetary policy to move in the same direction and there is no trade-off – ‘divine coincidence’ (A term coined by Blanchard, Olivier; Galí, Jordi (2007). "Real Wage Rigidities and the New Keynesian Model", Journal of Money, Credit and Banking. 39 (1): (35–65) waiting for more data to confirm our conviction, ‘consistency’ eliminates backpedalling in policy decision and ‘credibility’ facilitates firm anchoring of inflation expectations. This approach has stood us in good stead despite challenges and we need to persevere with this for its merits. To recall, just before we embarked on the path of monetary tightening, it was our endeavour then not to give up the accommodative policy setting till growth takes root and becomes self-sustaining. The fall out is that today growth is on a sustainable path despite monetary tightening. On a similar footing, ensuring a durable downward trajectory of inflation towards the 4 per cent target backed by this approach is the best way to address the transition challenges. Instead of haste for policy action, patience is the need of the hour. Hence, I vote for status quo on rate and stance in this policy. Statement by Dr. Michael Debabrata Patra
48. Recent inflation prints and high frequency data on salient food prices indicate that food inflation risks remain elevated. A relatively shallow and short-lived winter trough is giving way to a build-up of price momentum as summer sets in, with forecasts of rising temperatures up to May 2024. Some global food prices are firming up in an environment of rising input costs and supply chain pressures. The headroom provided by the steady core disinflation and fuel price deflation does not assure a faster alignment of the headline with the target. Consequently, headline inflation can be expected to remain in the upper reaches of the tolerance band until favourable base effects come into play in the second quarter of 2024-25. Hence, conditions are not yet in place for any let-up in the restrictive stance of monetary policy. Downward pressure on inflation must be maintained until a better balance of risks becomes evident and the layers of uncertainty clouding the near-term clear away. In the interregnum, the commitment to enduringly aligning inflation with the target of 4 per cent needs to be emphasised. Stabilising inflation expectations is progressing, as reflected in forward-looking surveys; anchoring them is crucial for achieving the inflation target.
49. Domestic demand is expanding, and the output gap has closed. The investment outlook is improving; however, a stronger revival in private consumption and in corporate sales growth may await greater confidence that inflation is declining. The recent improvement in export performance, if sustained, will ease the drag on aggregate demand.
50. Supply responses are also improving, but they will be contingent on a normal monsoon; an upturn in the private investment cycle to boost manufacturing sales and ease capacity constraints; and on sustaining the trend growth of services. The external balance sheet is strong, with a modest current account deficit, ebullient capital flows and rising foreign exchange reserves. This should insulate domestic economic activity from global spillovers in response to regime shifts in monetary policy stances of systemic central banks that are either underway or imminent. Nevertheless, financial stability risks to macroeconomic outcomes in India have to be closely and continuously monitored, and pre-emptively headed off. Overall, price stability has to be restored in order to ensure that the rising growth trajectory that India is embarking upon is sustained.
51. Accordingly, I vote for status quo on the policy rate and for perseverance with the stance of withdrawal of accommodation. Statement by Shri Shaktikanta Das
52. The Indian economy is growing at a robust pace with an average annual growth of 8 per cent during the last three years. India continues to be the fastest growing major economy in the world, supported by an upturn in investment cycle and revival in manufacturing. Services sector continues to grow at a strong pace.
53. CPI headline inflation during January-February 2024 (5.1 per cent in each of the months) has moderated from the elevated level seen in December 2023 (5.7 per cent). The persistent and broad-based softening in CPI core inflation (CPI excluding food and fuel inflation) by 180 bps since June 2023 is driving the disinflation process, though volatile and elevated food inflation is disrupting its pace.
54. Looking ahead, the baseline projections show inflation moderating to 4.5 per cent in 2024-25 from 5.4 per cent in 2023-24 and 6.7 per cent in 2022-23. This success in the disinflation process should not distract us from the vulnerability of the inflation trajectory to the frequent incidences of supply side shocks, especially to food inflation due to adverse weather events and other factors. Overlapping food price shocks, apart from imparting volatility to headline inflation, may also result in spillovers to core inflation. Lingering geo-political tensions and their impact on commodity prices and supply chains are also adding to uncertainties in the inflation trajectory. These considerations call for monetary policy actions to tread the last mile of disinflation with extreme care.
55. The growth prospects of the Indian economy in 2024-25 look bright. Expectations of normal southwest monsoon in 2024 augur well for the agricultural sector and rural demand. Strengthening rural demand, along with rising consumer confidence and optimism on employment and income, are expected to boost private consumption. Prospects of the manufacturing and services sectors also remain bright. Upbeat business outlook of firms, healthy corporate and bank balance sheets, upturn in private capex cycle with capacity utilisation ruling above the long period average can be expected to give further boost to domestic investment activity. Improving global growth and international trade prospects may provide thrust to external demand.
56. Given these growth inflation dynamics, I believe that the extant monetary policy setting is well positioned. Market expectations are also closely aligned with that of the MPC. Monetary policy transmission is continuing and inflation expectations of households are also getting further anchored. At this stage, we should stay the course and remain vigilant. The gains in disinflation achieved over last two years have to be preserved and taken forward towards aligning the headline inflation to the 4 per cent target on a durable basis. The strong growth momentum, together with our GDP projections for 2024-25, give us the policy space to unwaveringly focus on price stability. Price stability is our mandated goal and it sets strong foundations for a period of high growth. Accordingly, I vote to keep the policy repo rate unchanged and continue with the focus on withdrawal of accommodation. (Yogesh Dayal) Press Release: 2024-2025/138 Chief General Manager
6. Global economic activity is rebalancing and is expected to grow at a stable pace in 2024. Inflation has been moderating unevenly, with services inflation staying elevated and slowing progress towards targets. Uncertainty on the pace and timing of policy pivots by central banks is keeping financial markets volatile. Equity markets have touched new highs in both advanced and emerging market economies. Non- energy commodity prices have firmed up, while the US dollar and bond yields are exhibiting two-way movement with spillovers to emerging market currencies. Gold prices have surged to record highs on safe haven demand.
7. According to the provisional estimates released by the National Statistical Office (NSO) on May 31, 2024, real gross domestic product (GDP) growth in Q4:2023- 24 stood at 7.8 per cent as against 8.6 per cent in Q3. Real GDP growth for 2023-24 was placed at 8.2 per cent. On the supply side, real gross value added (GVA) rose by 6.3 per cent in Q4:2023-24. Real GVA recorded a growth of 7.2 per cent in 2023-24.
8. Going forward, high frequency indicators of domestic activity are showing resilience in 2024-25. The south-west monsoon is expected to be above normal, which augurs well for agriculture and rural demand. Coupled with sustained momentum in manufacturing and services activity, this should enable a revival in private consumption. Investment activity is likely to remain on track, with high capacity utilisation, healthy balance sheets of banks and corporates, government’s continued thrust on infrastructure spending, and optimism in business sentiments. Improving world trade prospects could support external demand. Headwinds from geopolitical tensions, volatility in international commodity prices, and geoeconomic fragmentation, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.2 per cent with Q1 at 7.3 per cent; Q2 at 7.2 per cent; Q3 at 7.3 per cent; and Q4 at 7.2 per cent (Chart 1). The risks are evenly balanced.
9. Headline inflation has seen sequential moderation since February 2024, albeit in a narrow range from 5.1 per cent in February to 4.8 per cent in April 2024. Food inflation, however, remains elevated due to persistence of inflation pressures in vegetables, pulses, cereals, and spices. Deflation in fuel prices deepened during March-April, reflecting the cut in liquified petroleum gas (LPG) prices. Core (CPI excluding food and fuel) inflation eased further to 3.2 per cent in April, the lowest in the current CPI series, with core services inflation also falling to historic lows.
10. Looking ahead, overlapping shocks engendered by rising incidence of adverse climate events impart considerable uncertainty to the food inflation trajectory. Market arrivals of key rabi crops, particularly pulses and vegetables, need to be closely monitored in view of the recent sharp upturn in prices. Normal monsoon, however, could lead to softening of food inflation pressures over the course of the year. Pressure from input costs have started to edge up and early results from enterprises surveyed by the Reserve Bank expect selling prices to remain firm. Volatility in crude oil prices and financial markets along with firming up of non-energy commodity prices pose upside risks to inflation. Taking into account these factors, CPI inflation for 2024- 25 is projected at 4.5 per cent with Q1 at 4.9 per cent; Q2 at 3.8 per cent; Q3 at 4.6 per cent; and Q4 at 4.5 per cent (Chart 2). The risks are evenly balanced.
11. The MPC noted that the domestic growth-inflation balance has moved favourably since its last meeting in April 2024. Economic activity remains resilient supported by domestic demand. Investment demand is gaining more ground and private consumption is exhibiting signs of revival. Although headline inflation is gradually easing, driven by softening in its core component, the path of disinflation is interrupted by volatile and elevated food inflation due to adverse weather events. Inflation is expected to temporarily fall below the target during Q2:2024-25 due to favourable base effect, before reversing subsequently. For the final descent of inflation to the target and its anchoring, monetary policy has to be watchful of spillovers from food price pressures to core inflation and inflation expectations. The MPC will remain resolute in its commitment to aligning inflation to the 4 per cent target on a durable basis. Accordingly, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting. The MPC reiterates the need to continue with the disinflationary stance, until a durable alignment of the headline CPI inflation with the target is achieved. Enduring price stability sets strong foundations for a sustained period of high growth. Hence, the MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
12. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted to reduce the policy repo rate by 25 basis points.
13. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted for a change in stance to neutral.
14. The minutes of the MPC’s meeting will be published on June 21, 2024.
15. The next meeting of the MPC is scheduled during August 6 to 8, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal No Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. The macroeconomic environment was marked by a high growth rate of the economy and moderating inflation rate during 2023-24. The Provisional Estimates (PE) released by the National Statistics Office (NSO) on May 31, 2024, reinforce the previous growth assessment further. Real GDP growth for 2023-24 is now estimated at 8.2 per cent, following the growth rates of 7 per cent in 2022-23 and 9.7 per cent in 2021-22. While there have been significant fluctuations and differences between the macro estimates available at the time of April MPC meeting and the recent PE for sectoral growth rates and in the sources of aggregate demand on account of both external and domestic factors, the overall growth rate has remained strong, above the 7.6 per cent in the SAE. In the meantime, the headline inflation rate, year-on-year, is at 5.4 per cent for 2023-24 and 5 per cent in Q4: 2023-24.
17. As per the PE for 2023-24, YOY growth of real gross fixed capital formation, reflecting investment demand, accelerated to 9 per cent from 6.6 per cent in 2022-23. Private consumption expenditure growth, however, fell from 6.8 per cent in 2022-23 to 4.0 per cent in 2023-24. Export of goods and services was also marked by deceleration in 2023-24 due to the weak global demand conditions. Going forward, improvement in the growth of consumption demand, exports and sustained growth of investment would be key to maintaining the strong overall growth of the last three years.
18. In terms of real GVA, YOY growth of agriculture and allied activities dropped from 4.7 per cent in 2022-23 to 1.4 per cent in 2023-24. Industry GVA rose from (-)0.6 per cent in 2022-23 to 9.3 per cent in 2023-24, led by manufacturing. Although construction GVA increased by almost 10 per cent in 2023-24, growth of overall services sector GVA slowed to 7.9 per cent in 2023-24 from 9.9 per cent in the previous year. In all the three major production sectors, YOY growth rates are the same or higher in the PE as compared to the SAE for 2023-24.
19. Several indicators reflect continuation of growth momentum into 2024-25. At the global level, the world trade volume is expected to recover in 2024 with growth also expected to hold. In its April 2024 assessment, the IMF projected YOY growth in the world output at 3.2 per cent in 2024, the same as in 2023 and the growth of volume of world trade in goods and services at 3 per cent in 2024 as compared to 0.3 per cent in 2023. Trends in global PMIs suggest stronger growth prospects in the case of services as compared to manufacturing, with both in expansion zone from February to April 2024.
20. In the domestic economy, most of the actual data are available only for April and May for the current financial year. However, surveys of households and enterprises on their expectations and professional forecasts provide assessments for next few quarters or the full financial year 2024-25.
21. Indicators such as PMI for manufacturing and services have remained in the expansion zone during April-May. Non-food bank credit and GST collections expanded at double digit rates on a YOY basis, during April-May 2024.
22. RBI’s consumer confidence survey of urban households indicates cautious optimism. The survey conducted in May 2024, reflects expectation of an increase in both essential and non-essential expenditure one-year ahead. Changes in future sentiments on household income is modest, however, expectations regarding the general economic conditions and employment moderated on one-year ahead basis.
23. Pattern of manufacturing output points to improvement in the production of consumption goods in 2023-24. Consumer goods IIP rose by 3.8% in 2023-24 as compared to 0.7% in 2022-23. Growth in consumer goods IIP improved on a YOY basis in H2: 2023-24 to 4.0 per cent as compared to the growth in H1 at 3.7 per cent. Moreover, consumer non-durables led growth in H1 and consumer durables in H2. Uptick in consumer expenditure reflected by the IIP growth in 2023-24 may be sustained into 2024-25 if the underlying drivers of growth continue.
24. Investment demand indicators in the first two months of Q1, reflect a mixed picture. Steel consumption has increased at a strong growth of 9.6 per cent in April, while cement production remained muted at 0.6 per cent during the month. Imports of capital goods improved in April, YOY basis. The capital expenditure in the public sector is expected to provide support for investment demand as in the previous year.
25. The assessment of the growth prospects for 2024-25 are conditioned by the momentum that has been set by the performance in 2023-24 and several global and domestic factors. While positive aspects of the emerging macroeconomic conditions affecting economic growth in 2024-25 are significant, there are also the risks from adverse scenarios. The spillover effects of continuing international geopolitical conflicts, trade limiting policies across the world, extreme weather events affecting agricultural output pose these adverse conditions. 25. The available high frequency indicators for April-May exhibits optimism to sustain momentum. Second, private consumption which was trailing will now get impetus from rebound in rural demand on the back of expected above normal south-west monsoon and improving agriculture sector. Third, external demand is witnessing a turn around with improving outlook for global trade. In April, merchandise exports entered into positive territory and services exports posted robust double-digit growth. Moreover, KLEMS database available for 2021-22 shows that total factor productivity has improved significantly. Given further digitalisation and formalisation of the economy leading to higher productivity, along with favourable demography, rising labour force participation and accelerated capital formation seems to have led to higher potential growth as I have been highlighting in my last four statements. Perhaps lower pressures from core inflation and the lower current account deficit in a scenario of high growth could be a pointer to it. Of course, monetary policy along with lower input costs have been the main driver of core disinflation.
26. The Survey of Professional Forecasters conducted by the RBI in May 2024, provides a median forecast of real GDP growth of 6.8 per cent in 2024-25, revised upwards from 6.7 per cent in the previous round of the survey in March. Private Final Consumption Expenditure and Gross Fixed Capital Formation are the growth drivers in these projections.
27. In the April meeting of the MPC, the YOY real GDP growth for 2024-25 was projected at 7 per cent. Taking into account a normal monsoon and sustained momentum of investment, the GDP growth for 2024-25 has now been projected at 7.2 per cent. The quarterly growth rates for GDP are: 7.3 per cent in Q1, 7.2 per cent in Q2, 7.3 per cent in Q3 and 7.2 per cent in Q4.
28. The pace of decline in YOY headline CPI inflation rate in the recent period has been steady. It declined from 5.4 per cent in Q3: 2023-24 to 5 per cent in Q4. The rate declined from 5.1 per cent in January 2024 to 4.8 per cent in April. While the CPI inflation for fuel & light and the non-food and non-fuel categories remained well below 4 per cent, food inflation was above 7.5 per cent in Q4: 2023-24 and 7.9 per cent in April in the current year. A favourable monsoon assisting the recovery of agricultural growth and suitable supply management measures would be a key to moderating food inflation as the year progresses.
29. There are risks to anticipated decline in CPI inflation rate given the uncertainties of temporal and spatial distribution of the rainfall, weather conditions during the crop season and the spillover effects of international geopolitical conflicts.
30. Commodity price trends in the international markets present a mixed pattern. In the case of agricultural prices, in April and May, wheat prices have advanced, rice prices have remained firm and sugar and palm oil prices have shown decline. In the case of other commodities, energy prices have been volatile and metals have increased. Improving world manufacturing output, divergent weather conditions and uncertainties over the impact of the on-going geopolitical conflicts will continue to influence the world commodity prices in the short term.
31. The RBI’s inflation expectations survey of urban households conducted in the first fortnight of May 2024 reflects the current deceleration in the consumer prices but also points to moderate increase in expected inflation rate by 20 and 10 basis points over a short-term horizon of three months and one year, respectively. The early results from the ongoing enterprise surveys by the RBI for April-June point to rising input price pressures in 2023-24, particularly in services and infrastructure. Input price pressures are also followed by expectation of rise in selling prices by majority of the respondents in manufacturing, services and infrastructure sectors.
32. The Survey of Professional Forecasters conducted by the RBI, referred earlier, provides an assessment of headline inflation in 2024-25. The median YOY CPI inflation rate in 2024-25 estimated from the survey is 4.5 per cent, the same level as estimated in the previous round of the survey in March. The expected ‘inflation rate’ for CPI excluding food, fuel and pan, tobacco and intoxicants is below 4 per cent.
33. Taking into account these factors, the headline inflation rate has now been projected at 4.5 per cent in 2024-25, the same level as in the April MPC meeting. The quarterly projections are 4.9 per cent in Q1, declining to 3.8 per cent in Q2, rising to 4.6 per cent in Q3 and 4.5 per cent in Q4. The sharp decline in Q2: 2024-25 corresponds to the period when inflation rate was a high 6.4 per cent in 2023-24.
34. The headline inflation rate gradually moving to below 5 per cent mark in March and April, and projected at less than 4 per cent mark in Q2, marks an important macroeconomic condition that can support sustained growth. Clearly, the moderate inflation rate will have to be durable to be an effective condition for sustained growth. In this context, the policy would have to continue its focus on maintaining the inflation rate aligned to the target over the medium term. The rise in projected inflation rate above the 4.5 per cent mark in H2 of the financial year reflects the underlying price pressures, which if not addressed would not meet the policy goal. As a major part of these price pressures relate to food inflation, a watchful approach is appropriate to ensure that there are no spillovers of high food inflation to the prices of the other items in the consumption basket. As the aggregate output projections for 2024-25 reflect strong GDP growth, keeping the monetary policy focus on achieving the inflation target on a durable basis is appropriate at this juncture.
35. With these considerations, I vote i. to keep the policy repo rate unchanged at 6.50 per cent, and ii. to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Statement by Dr. Ashima Goyal
36. Indian growth has outperformed expectations once again, suggesting it has strong roots. Real policy rates near neutral, along with supply-side action, have been important in sustaining growth while bringing inflation towards target. As argued in earlier minutes, the neutral real policy rate (NIR) is around unity in Indian conditions of high unemployment and an ongoing transition to higher productivity employment1.
37. Headline inflation has been around 5% since January this year while core inflation has been below 4% since December 2023. Volatile commodity prices, El Nino and heat waves have not been able to reverse the approach to target. The headline inflation projection of 4.5% for 2024-25 gives an average real repo rate of 2% implying that the real repo rate will be above neutral for too long if the repo rate stays unchanged. Falling inflation has raised real repo above unity. This will reduce real growth rate with a lag. Expected growth is around 7% in 2024-25 below the 8% achieved in 2023-242. Status quoism is praised as being cautious. But if doing nothing distorts real variables it aggravates shocks instead of smoothing them and raises risk.
38. Again, as argued earlier, in Indian conditions of growth transition, inflation itself is the best measure of potential growth. If headline inflation is approaching the target and core inflation is below target, and incoming data supports this3, it implies growth is below potential and NIR above neutral; so real policy rates can safely fall. Potential output and NIR defined by inflation require the repo rate to fall with inflation. It cannot be correct to allow monetary policy to become more restrictive the nearer inflation gets to its target.
39. Inflation has come down in the past through supply side action and anchoring of inflation expectations with the NIR at neutral, without a large growth sacrifice. Why then would higher real policy rates be required now to fight inflation that is lower? The sacrifice ratio from NIR above neutral is very high when aggregate supply is elastic as it is in India.
40. Let us examine some common arguments made against cutting the repo rate.
41. First, the fear of recurrent supply shocks. The volatilities facing policy in April have moderated. Global uncertainties continue, but the world seems to have learnt to live with them. Output and trade growth is improving. Conflicts have been contained and international oil prices that are important for India are softening despite extension of OPEC oil cuts, pointing to a reduction in OPEC’s monopoly power. Although global commodity inflation is mixed, palm oil inflation, that affects many consumer goods costs in India, is softening.
42. The good monsoon predicted has already set in and will likely reduce food inflation. The elections are over. Results suggest political stability but also policy continuity rather than disruptive changes. India gets a credible opposition, which 1 KLEMS data shows total factor productivity (TFR) for manufacturing and services increased at a higher pace during 2015-16 to 2019-20 (5 years) as compared to that during 2010-11 to 2014-15 (5 years). This helps absorb higher costs without requiring prices to rise and reduces the NIR despite higher growth. 2 The 8% growth was not due to base effects, which had raised Q1 growth after the pandemic year. But in 2023-24 growth rates was even through all the quarters. 3 The projected rise in inflation after a dip below target in August is due to base effects, so the overall approach to the inflation target continues. strengthens democracy. Even so, a conservative government with a good implementation record will return and is likely to continue with fiscal consolidation through a better composition of expenditure and other short and long-term cost reducing supply-side reforms.
43. In addition to a lower probability of a large supply shock, the experience of the past year shows supply shocks no longer have persistent effects on inflation or on inflation expectations. We have waited for one year to watch the impact of these shocks, now it is time to move on. Household inflation expectations have become much less volatile in the post-pandemic period, falling slowly along with inflation itself. Some anchoring seems to have made them immune to transient shocks.
44. Moreover, a durable approach to the inflation target is consistent with a transient rise in inflation. It is necessary to avoid the mistake of 2015 when international crude oil prices fell substantially but the fear that they would rise again prevented an adequate cut in the policy rate. Real interest rates rose substantially and hurt growth.
45. The second set of arguments is since growth is robust there is no need for a cut. But growth is below potential and may slow further since consumption remains weak. Increasing income and employment is the only sustainable way to bolster consumption, as well as private investment. Transfers from a small percentage cannot give prosperity to a billion people. Reducing unemployment is important for political and financial stability. Without a rise in productive employment, aggressive redistribution becomes more likely and may provoke a flight of wealth taking India back to the stagnant seventies.
46. But will lower repo rates raise already high personal credit growth too much? Over the last two years overall credit growth has been around 15% per annum. This implies a mild rise in credit ratios since nominal GDP growth is about 12%. Indian private credit ratios have to rise safely and steadily towards levels in peer countries, avoiding the type of debt explosion that accompanied Chinese growth. Seasonally adjusted monthly momentum in credit growth is slowing somewhat since January 2024 especially as sectoral prudential regulation moderates building up of excessive leverages. This regulation is preventive and reduces the need for monetary rate action that has broad effects4.
47. Spreads are high in India. Average loan rates are in double digits. While risk- based pricing is required, a cut in repo rates will prevent retail interest rates rising to unbearable levels. There may be some stress in loans to self-employed. If leverage is rising, lower interest rates reduce costs and a possible indebtedness trap. Despite some initial reduction after a repo cut, rising loan demand and slower deposit growth will tend to raise both loan and deposit rates.
48. Third, is the belief, widespread in financial markets that India cannot cut before the US Fed. But the US has its own special problems that do not apply elsewhere. Many other central banks are cutting rates. The fall in India’s current account deficit, index inclusion and ratings upgrade add to the many reasons that make interest differentials with the US less important. India’s inflation differential with the US is also narrowing again. 4 Goyal, A and A. Verma. 2022. ‘Cross Border Flows, Financial Intermediation and Interactions of Policy Rules in a Small Open Economy’. Quarterly Review of Economics and Finance, 89 (June 2023): 369-393. 2022. https://www.sciencedirect.com/science/article/pii/S106297692200117X
49. Finally, let us turn to the mechanics of cutting and the communication around it. At present only small steps are required to align the repo with the fall in inflation so this should not be seen as the start of a rate cut cycle. Communication should make it clear that there is no softening path and forward-guidance remains data-determined. A neutral stance is appropriate since the rate can then move in either direction as required.
50. In line with the above reasoning, I vote for a 25 basis points cut to the repo rate and a change in the stance to neutral. Even with these changes, monetary policy would remain disinflationary towards bringing inflation credibly to the target. Statement by Prof. Jayanth R. Varma
51. In my statement for the last meeting (April 2024), I expressed concern about the growth sacrifice in 2024-25 induced by restrictive monetary policy. It now appears that the maintenance of restrictive policy for unwarrantedly long will lead to a growth sacrifice in 2025-26 as well. Professional forecasters surveyed by the RBI are projecting growth both in 2025-26 and in 2024-25 to be lower than in 2023-24 by more than 0.75%, and lower than the potential growth rate (of say 8%) by more than 1%. This is an unacceptably high growth sacrifice considering that headline inflation is projected to be only about 0.5% above target, and core inflation is extremely benign.
52. As I have stated in the last several meetings, the current real policy rate of around 2% (based on projected inflation) is well above the level needed to glide inflation to its target. I therefore vote to reduce the repo rate by 25 basis points, and to change the stance to neutral. Statement by Dr. Rajiv Ranjan
53. The arguments made in my last statement are still valid. In a transition phase, the role of the three Cs – Caution that entails conviction about durable alignment of inflation to the target with more incoming information; Consistency that rules out backpedalling; and Credibility that facilitates firm anchoring of expectations – is much more relevant. On the whole, we are broadly in a similar monetary policy setting as in the last two bi-monthly reviews. Growth continues to be robust and has surprised further on the upside. While core inflation has softened further, food inflation risks have remained elevated.
54. Our growth projection for 2024-25 has been revised upward for the following reasons. First, GDP recorded a strong momentum (quarter-on-quarter growth) of 7.8 per cent in Q4:2023-24 as against an average of 5.8 per cent during the corresponding quarters of the pre-COVID period (2012-13 to 2019-20). Even the momentum of gross value added (GVA) was strong at 5.7 per cent during Q4:2023-24 in comparison with the average momentum of 2.4 per cent during the same pre- COVID period. This strong momentum is likely to continue supporting growth in 2024-
55. On the inflation front, headline and core inflation have moderated on anticipated lines. There is, however, little comfort in the near-term with inflation projected to remain sticky at around 4.9 per cent in Q1:2024-25 primarily due to the impact of unprecedented heat wave conditions on summer crop of vegetables and fruits; lower agricultural and horticulture production estimates; revision in milk prices across major cooperatives; and signs of a turnaround in commodity prices along with logistics and transportation costs. Food, with a weight of 45.9 per cent in CPI, contributed to three- fourths of the headline inflation in April 2024 compared to about 40 per cent a year ago. Discounting the likely one-off drop in inflation to below target rate in Q2:2024-25 due to favourable base effects, the ongoing disinflation process, though gradual, is expected to continue over the second half of 2024-25, with headline inflation projected at 4.5 per cent by Q4:2025-26. Realisation of a normal monsoon, particularly in terms of its spatial and temporal distribution, and the recharge of reservoirs would be critical for the continued disinflation in food and headline CPI.
56. Against this backdrop, let me elaborate more on why we cannot afford any misjudgement on our policy action at this stage. First, while we can draw some comfort from headline inflation running within the tolerance band successively for eight months in a row, we cannot drop our guard as the headline inflation is still not aligned to the target. Repeated incidence of food price shocks is delaying the final descent of inflation to the target. It is, however, encouraging that elevated food inflation over the last six months have not spilled over into core inflation, reflecting the gains from credibility of our maturing flexible inflation targeting framework. Nevertheless, given the large share of food in the household consumption basket, we need to stay vigilant to resist any such spill over and ensure that such price pressures are clearly dissipated. Any consideration on policy change has to factor in this aspect to avoid backpedalling in future.5
57. Second, there could be an argument that a pause for eight successive policies is a long pause. Let me emphasise, the inertia of inaction should not drive us to action. Rather the driving force should be the macroeconomic setting of growth and inflation. Clearly, the favourable growth-inflation balance and the outlook is pointing towards status quo. That said, even though the repo rate has been kept unchanged since February 2023, several policy actions on liquidity, transmission and communication have played out to stabilise the economy further. The views and assessment of all major stakeholders seem to be closely aligned towards no action at this stage. In any case, we do not face the kind of pressures being faced by some advanced economies which have gone for very restrictive policy settings in the current rate hike cycle.
58. Third, it is also being argued that with the fisc consolidating, monetary policy should be more growth supportive by easing policy rates. The counter argument is two-fold: (a) we need to see what drives fiscal consolidation – if it is largely driven by higher revenues including dividend, which is the case now, the adverse impact on growth may be non-existent. On the contrary, fiscal consolidation may actually be growth enhancing if it leads to improved country ratings, easing the financial conditions for the private sector and improving the overall sentiment. (b) More importantly, the best contribution that monetary policy can make to long-term growth is 5 IMF, World Economic Outlook, April 2024. via price stability.6 In this context, I stand by what I said in my last minutes that we need to utilise the space provided by stronger growth to focus on inflation.
59. To sum up, our monetary policy actions should continue to be primarily guided by domestic macroeconomic conditions and the outlook. The growth-inflation mix at the current juncture allows us to move more cautiously on the inflation front. Hence, we should not waver from our focus on price stability which remains so important for our long term sustained growth outcome. Accordingly, I vote for status quo on rate and monetary policy stance in this policy. Statement by Dr. Michael Debabrata Patra
60. Economic activity in India is evolving broadly in line with the baseline projection. Prospects of a favourable monsoon should offset the slackening momentum that has become a typical feature of first quarter GDP outturns in the post-pandemic period. Domestic demand should continue to drive the economy, with private consumption receiving a fillip from the revival in rural spending. Corporate balance sheets are showing rising investments in fixed assets, which should find expression in a fuller capital spending upturn. With output in broad balance in relation to its potential, monetary policy can remain neutral to growth at this juncture and stay focused on aligning inflation to the target. That objective remains incomplete, which can undermine medium-term growth prospects.
61. The speed of the easing of inflation has been disappointing so far, even from a cross-country perspective. Food prices are persisting for too long as the principal impediment to a faster disinflation. The Indian economy remains hostage to intersecting food price shocks. Their repetitive occurrence calls for intensifying monetary policy vigil to ward off spillovers to other components of inflation and to expectations. This also warrants looking through the statistical soft patch in inflation’s trajectory that is anticipated during July-August 2024, while staying prepared to blunt the uptick that is expected from September. Food prices are holding back any consideration of possible changes in the monetary policy stance. Hence, I vote for keeping the policy rate and the stance of withdrawal of accommodation unchanged. Statement by Shri Shaktikanta Das
62. The global economy is resilient but is growing at a lower rate than its historical trend. Inflation is easing unevenly across major economies. With varying growth- inflation dynamics across countries, the importance of domestic factors in policy making has come to the fore. Accordingly, there are initial signs of divergence on monetary policy actions across countries.
63. The Indian economy is growing at a healthy rate, averaging 8.3 per cent in the last three years. During 2023-24, the economy posted an impressive growth of 8.2 per cent despite continued global headwinds and weather vagaries. This was largely driven by domestic demand, especially investment activity. On the supply side, manufacturing and services provided major support to gross value added (GVA).
64. Domestic growth outlook for 2024-25 remains upbeat as economic activity continues to maintain momentum. South-west monsoon is expected to be above normal, boosting agricultural activity and supporting rural consumption. Buoyant 6 This is widely researched and catalogued, see commentary in Bernanke, B., 2006. "The benefits of price stability," Speech 171, Board of Governors of the Federal Reserve System (U.S.). 7 According to the IMF, the projection for global growth in 2024 and 2025 is below the historical (2000–19) annual average of 3.8 percent (World Economic Outlook, IMF, April 2024). services activity should sustain urban consumption. Business confidence remains strong across manufacturing, services and infrastructure sectors. Healthy balance sheets of banks and corporates and government’s capex thrust are expected to support investment activity. Projections of improvement in global trade by agencies,8 when they materialise, will spur external demand. Considering these evolving dynamics, GDP growth projection for 2024-25 has been revised upward by 20 basis points to 7.2 per cent. When this happens, it will be the fourth consecutive year of 7.0 per cent or higher GDP growth.
65. Headline CPI inflation is moderating, but at a very slow pace. The last mile of disinflation is turning out to be gradual and protracted. Since the April 2024 MPC meeting, headline inflation moderated by around 30 basis points from 5.1 per cent in February 2024 to 4.8 per cent in April 2024. Inflation in CPI core (CPI excluding food and fuel) and its services sub-component were at historic lows in April 2024. Food inflation is the main factor behind the grudgingly slow pace of disinflation. Recurring and overlapping supply-side shocks continue to play an outsized role in food inflation.
66. Going forward, the baseline projections show inflation moderating to an average 4.5 per cent in 2024-25. In the immediate months, however, the impact of exceptionally warm summer months on output of certain perishables; a likely rabi production shortfall in some pulses and vegetables – particularly potatoes and onions; and the upward revisions in milk prices, warrant close monitoring. A normal monsoon may eventually lead to easing of price pressures in key food items. Large favourable base effects could lead to a temporary and one-off undershoot of inflation to below the target rate in Q2, before rising again in Q3 and Q4 of 2024-25.
67. The move towards an active disinflationary stance of monetary policy since the beginning of 2022-23 has helped to bring down inflation from its highly elevated levels, break the core inflation persistence and prevent inflation expectations from getting unanchored. The calibrated tightening by 250 basis points between May 2022 to February 2023 has achieved disinflation with minimal output sacrifice as growth remains strong.
68. The growth-inflation balance is moving favourably in line with our projections. Resilient growth creates space for monetary policy to focus unambiguously on inflation which remains well above the 4.0 per cent target. With persistently high food inflation, it would be in order to continue with the disinflationary policy stance that we have adopted. Any hasty action in a different direction will cause more harm than good. It is important that inflation is durably aligned to the target of 4.0 per cent. Price stability is the bedrock for high and sustainable growth. I, therefore, vote to keep the policy repo rate unchanged at 6.5 per cent and to continue with the stance of withdrawal of accommodation. (Puneet Pancholy) Press Release: 2024-2025/539 Chief General Manager The IMF has projected world trade volume growth to rebound from 0.3 per cent in 2023 to 3.0 percent in 2024. The World Bank projects world trade to grow by 2.3 per cent in 2024 as compared to 0.2 per cent in 2023. Similarly, OECD projects world trade to grow by 2.3 per cent during 2024 as compared to 1.0 per cent in 2023. The WTO in its April update, projected world merchandise trade volume growth for 2024 at 2.6 per cent following a contraction of 1.2 per cent in 2023. IMF and OECD trade data refer to goods and services; World Bank trade refers to goods and non-factor services while WTO trade data refers to goods (merchandise) only.
6. The global economic outlook remains resilient although with some moderation in pace. Inflation is retreating in major economies but services price inflation persists. International prices of food, energy and base metals have eased since the last policy meeting. With varying growth-inflation prospects, central banks are diverging in their policy paths. This is creating volatility in financial markets. Amidst recent global sell offs in equities, the dollar index has weakened, sovereign bond yields have eased sharply and gold prices have soared to record highs.
7. Domestic economic activity continues to sustain its momentum. After a weak and delayed start, the cumulative southwest monsoon rainfall has picked up with improving spatial spread. By August 7, 2024, it was 7 per cent above the long period average. This has supported kharif sowing, with total area sown as on August 2, being 2.9 per cent higher than a year ago. Industrial output registered an expansion of 5.9 per cent (y-o-y) in May 2024. Core industries rose by 4.0 per cent in June, against 6.4 per cent in May. Other high frequency indicators released during June- July 2024 indicate expansion of services sector activity, ongoing revival of private consumption, and signs of pickup in private investment activity. Merchandise exports, non-oil non-gold imports, services exports and imports expanded during April-June.
8. Going forward, the Indian Meteorological Department’s (IMD) projection of above normal southwest monsoon and healthy kharif sowing will support improving rural demand. The sustained momentum in manufacturing and services suggests steady urban demand. High frequency indicators of investment activity as evident in strong expansion in steel consumption, high capacity utilisation, healthy balance sheets of banks and corporates, and the Government’s continued thrust on infrastructure spending, point to a robust outlook. Improving world trade prospects could support external demand. Headwinds from geopolitical tensions, volatility in international commodity prices and geoeconomic fragmentation, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.2 per cent with Q1 at 7.1 per cent; Q2 at 7.2 per cent; Q3 at 7.3 per cent; and Q4 at 7.2 per cent. Real GDP growth for Q1:2025-26 is projected at 7.2 per cent (Chart 1). The risks are evenly balanced.
9. Headline inflation increased to 5.1 per cent in June 2024 after remaining steady at 4.8 per cent during April-May 2024. Worsening of food inflation pressures – driven primarily by a sharp increase in prices of vegetables, pulses and edible oils along with a pick-up in inflation across cereals, milk, fruits and prepared meals – pushed up headline inflation. The fuel group remained in deflation, reflecting the cumulative impact of the sharp cuts in LPG price in August 2023 and March 2024. Core (CPI excluding food and fuel) inflation at 3.1 per cent in May-June touched a new low in the current CPI series, with core services inflation also at its lowest in the series.
10. Headline inflation has moderated from its peak but unevenly. Looking ahead, food price momentum has remained elevated in July. In Q2:2024-25, though favourable base effects are large, the sharper uptick in price momentum relative to earlier expectations is likely to result in a shallower softening of CPI headline inflation. Inflation is expected to edge up in Q3 as favourable base effects taper off. The steady progress in monsoon, pick-up in kharif sowing, adequate buffer stocks of foodgrains and easing global food prices are positives for containing food price pressures. Adverse climate events remain an upside risk to food inflation. Crude oil prices continue to be volatile on demand concerns and geopolitical tensions. The revision in mobile tariff rates is likely to lead to an increase in core inflation. Manufacturing, services and infrastructure firms surveyed by the Reserve Bank expect a pickup in selling prices in the second half of this year. Households’ inflation expectations have also gone up and consumer confidence has weakened. Assuming a normal monsoon, CPI inflation for 2024-25 is projected at 4.5 per cent with Q2 at 4.4 per cent; Q3 at 4.7 per cent; and Q4 at 4.3 per cent. CPI inflation for Q1:2025-26 is projected at 4.4 per cent (Chart 2). The risks are evenly balanced.
11. The MPC expects domestic growth to hold up on the strength of investment demand, steady urban consumption and rising rural consumption. Risks from volatile and elevated food prices remain high, which may adversely impact inflation expectations and result in spillovers to core inflation. There are also indications of core inflation bottoming out. Accordingly, the MPC decided to remain watchful on how these forces play out, going forward. The MPC stays resolute in its commitment to aligning inflation to the 4 per cent target on a durable basis. In these circumstances, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting. The MPC reiterates the need to continue with the disinflationary stance, until a durable alignment of the headline CPI inflation with the target is achieved. Enduring price stability sets strong foundations for a sustained period of high growth. Hence the MPC also considers it appropriate to continue with the disinflationary stance of withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.
12. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted to reduce the policy repo rate by 25 basis points.
13. Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted for a change in stance to neutral.
14. The minutes of the MPC’s meeting will be published on August 22, 2024.
15. The next meeting of the MPC is scheduled during October 7 to 9, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Shashanka Bhide Yes Dr. Ashima Goyal No Prof. Jayanth R. Varma No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Shashanka Bhide
16. Subsequent to the June 2024 meeting of the MPC, there is cautious optimism around the growth estimate of GDP of around 7 per cent in 2024-25. In July 2024, the Economic Survey for 2023-24 by the Ministry of India, projected a GDP growth of 6.5- 7.0 per cent for 2024-25. The IMF, in its July update of the World Economic Outlook raised India’s GDP growth projection to 7 per cent from 6.8 per cent indicated in its April 2024 assessment. The latest round of RBI’s Survey of Professional Forecasters conducted in July 2024 presents a median forecast of 7 per cent, up from 6.8 per cent projected in May 2024. These estimates are lower than the growth estimate of 7.2 per cent provided in the MPC resolution of June meeting. The YOY real GDP growth in 2023-24 exceeded 8 per cent in the first three quarters, dropping to 7.8 per cent in Q4. In 2023-24, growth of personal consumption expenditure and exports of goods and services experienced slower growth relative to gross fixed capital formation. While a favourable south-west monsoon and lower inflation rate may support higher personal consumption growth, sustained momentum of GFCF and export growth would also be crucial for the high growth in 2024-25.
17. At the global level, IMF’s WEO July 2024 Update has retained the pace of economic growth at 3.2 per cent, projected previously in April. The volume of world trade in goods and services, has been projected to rise at a marginally faster pace in 2024 than previously projected, after near stagnation in 2023. These reflect a stable external demand environment for India, although uncertainty emanating from slower than expected pace of disinflation and the geopolitical conflicts have persisted.
18. In the domestic economy, growth stimulus, particularly on investment through central government expenditure on infrastructure development has been preserved. In the central government budget for 2024-25, the budget estimate for ‘effective capital expenditure’ increased by about 20 per cent in nominal value over the provisional actuals for 2023-24, marginally higher than the increase in 2023-24 (provisional actuals) over the actual spending in the previous year. In the case of private investment, that includes corporate and household sector investment, the favourable policy incentives, emerging new opportunities in the economy and improved longer term growth prospects would be the key drivers of accelerated spending. The high frequency indicators of some of the investment activity such as consumption of finished steel and import of capital goods for April-June 2024 reflect rising level of investment activity; but output of cement in April-June and IIP for capital goods in April-May point to contraction or modest improvement. FDI inflows during April-mid July show significant increase as compared to the same period in 2023-24. The latest RBI’s survey of enterprises reflects greater optimism of improved demand conditions in H2:2024-25 over H1.
19. A major push on consumption spending growth is expected to come from the improved agricultural prospects supported by a favourable monsoon this year and the moderating inflation rate. While the monsoon rainfall is expected to be at the normal level and exceeding the level in the previous year, nature of its distribution during the monsoon period and across regions would be of critical for raising agricultural sector’s growth substantially from its estimated GVA growth of 1.4 per cent in 2023-
20. The indicators of urban demand such as the number of domestic air passengers and passenger vehicle sales for April-June 2024 exceed the levels YOY basis, but the pace of growth has been lower. The pace of vehicle loans in April-June 2024 has declined, compared to the previous year but remains in double digits. The latest consumer confidence survey of urban households conducted by RBI reflects weaker sentiments. A major factor affecting both rural and urban consumption would be the moderate headline inflation rate.
21. Merchandise exports and imports registered positive growth in April-June compared to negative YOY growth in the previous year. The service exports and imports also rose in April-June this year YOY basis, although there was a decline in exports and imports in June over May.
22. The purchasing manager indices (PMIs) for manufacturing and services declined in June from a high in May but remain in expansion zone. The indicators of broader level of economic activity, GST collections, E-way bills and non-food bank credit growth at close to double digit rates YOY in April-June 2024 reflect a strong growth momentum.
23. The outlook for growth in the current year, therefore, has both the positive features that may help maintain the momentum of 2023-24 and downside risks associated with both domestic and external factors. Considering these factors, the GDP growth projection for 2024-25 has been retained at 7.2 per cent, unchanged from the June MPC meeting. The quarterly estimates for GDP in 2024-25 are 7.1, 7.2, 7.3 and 7.2 in Q1-Q4, respectively. A significant driver of growth in the current year is likely to be consumption growth.
24. The sale of 2-wheelers and tractors in May-June 2024 either exceeding or matching the levels seen in the same period in 2023 is a positive indication that rural demand would be strengthened by a favourable monsoon this year. 24. Since July 2023, food inflation has remained at significantly high level compared to the other two broad components of the headline inflation. From its peak of 10.6 per cent in July 2023, food inflation (CPI for food and beverages) has declined over a 12- month period, ranging from 7.6-8.4 per cent between January and June 2024. The headline inflation has declined from 5.1 per cent in July 2023 to 4.8 per cent in May and then risen to 5.1 per cent in June 2024. A progressive decline in food inflation would be necessary to achieve the 4 per cent headline inflation which can be sustained.
25. Favourable monsoon aiding agricultural growth this year would ease the supply side pressures to bring down the prevailing high food inflation. Appropriate supply management strategies would always be needed to minimise the sharp changes in the prices of perishable commodities. The evolution of price trends in the non-food categories also need to be monitored even as the food inflation declines. The latest RBI survey of urban households reflects an upturn in 3 months- ahead and 1 year- ahead headline inflation rate, a continuation of the pattern seen in the previous round of the survey. The survey of enterprises indicates expectation of increased growth in output prices in Q2:2024-25 in the case of enterprises in the service and infrastructure sectors as input cost pressures also rise. However, in the manufacturing sector, growth in selling prices is expected to ease in Q2. A ‘Business Inflation Expectations Survey’ of panel business leaders conducted in June 2024 registered a marginal uptick in the one-year ahead consumer price index, while survey also estimated a marginal decline in the cost- based one-year ahead inflation rate relative to the previous round of the survey.1 The divergence in the cost-based inflation and consumer price inflation expectations may reflect the pressures of food prices in the latter. The international food and energy prices outlook has reflected stable or downward movement but risks from geo-political conflicts disrupting supply chains are significant. Taking into account these factors, and assuming a favourable monsoon rainfall, the average headline inflation rate for 2024-25 is projected at 4.5 per cent, the same as in the MPC meeting of June. With the actual reading of 4.9 per cent inflation in Q1, projections for the remaining three quarters of 2024-25 are Q2 at 4.4 per cent, Q3 at 4.7 per cent and Q4 at 4.3 per cent. The projected headline inflation in Q1:2025-26 is at 4.4 per cent.
26. The overall macroeconomic outlook is one of fairly strong growth and moderating inflation trend. The setting for monetary policy is, however, marked by the risks to the projected patterns of both inflation and growth. In both the cases, risks faced are common: those associated with the monsoon and climate conditions, external demand and price conditions, and financial conditions. Under a favourable monsoon and climate scenario, food inflation is expected to moderate significantly and effective supply management policies provide an effective framework to address price spikes limited to a few commodities. However, persistent food inflation may require core inflation to soften sufficiently to maintain the headline close to the target. High food inflation would therefore hit growth adversely as it affects consumption and require restrictive monetary policy to soften core inflation, especially when faced with significant spillovers of persistent food price pressures to core components. The average sequential month-over-month momentum of headline inflation is likely to be high during July-September. Therefore, at this juncture it is necessary to maintain the priority on achieving inflation target objectives.
27. Accordingly, I vote i. to keep the policy repo rate unchanged at 6.50 per cent, and ii. to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Statement by Dr. Ashima Goyal
28. Global uncertainties continue. The Fed in indicating a cut in its September meeting, pointed out that since monetary policy acts with a lag they can’t afford to Misra Centre for Financial Markets and Economy, IIMA. https://www.iima.ac.in/faculty- research/centers/Misra-Centre-for-Financial-Markets-and-Economy/BIES. wait until they reach their inflation target before cutting. That lag may be responsible for the sharply adverse August jobs report that has stoked recession fears and created market volatility. That a series of small signals were ignored, may have led to a critical large one. Monetary policy needs to act well in time. Spillovers led the global manufacturing PMI into contraction zone in July at 49.7.
29. In India food inflation has risen, but the heat wave has had less than the expected effect, although household inflation expectations, which are sensitive to supply shocks, have risen marginally. Vegetable inflation is transient, less than last year and is already correcting with the good monsoon. Supply chains seem to be improving. That Delhi now gets tomatoes from Karnataka as well as Himachal Pradesh has reduced the price spike compared to last year. Core inflation is at 3.1% and even if it rises should get anchored at the target, especially as global commodity prices are softening. The conservative view tends to build in mean reversion, but the mean is likely to have changed. Average Indian inflation is lower and trending down.
30. Although RBI inflation projections are rising after falling due to base effects, they fall again. So the overall trend into next year is downwards. The Q1 FY26 projection is 4.4%. Many analysts expect 4% headline inflation by summer next year as the base effect and good monsoon sharply reduces food inflation, implying the expected real policy rate is 2.5%. Since Indian inflation is not well measured, and could be over or under-estimated, too much precision with regard to a target is unproductive.
31. An EM is subject to many shocks, so it is better if forward guidance on rates is data-based, communicating only the reaction function. Even so, lags in action imply it is necessary to be forward-looking and take decisions based on expected future variables.
32. A view sometimes expressed is that government actions affect growth, not those of central banks (CBs). But then why would the MPC have growth as an objective? Since growth in economies in transition especially, is non-steady state and non- linear, excess monetary tightening can trigger a switch to a lower growth path so that the growth sacrifice is large.
33. There are some negative signals for Indian growth also. Early results of listed private manufacturing companies show sales and profits softened in Q1 FY25. Consumer confidence fell and the business expectations index has been moderating since Q4 FY24. The RBI Q1 FY25 growth forecast has been reduced.
34. Overall Indian growth is resilient, but it is still below potential. The Q1 FY25 softening in government expenditure was an election phenomenon and will reverse, while the good monsoon is likely to reverse the heat wave related softening in consumer expenditure.
35. Many experts had expected India to revert to low pre-pandemic growth. But growth has been robust at an average of 8.3% for 3 years now—this is beyond base effects. Something is different, including macroeconomic policy, which effectively smoothed shocks. Rising diversity and scale have also increased shock absorbing capacity.
36. Since this is my last MPC meeting I would like to record here my appreciation of policy-making in this period that helped India overcome major external shocks and set it on a path of high growth with stability. It was a privilege to watch its working from close quarters.
37. But continued vigilance is the price of success. I will flag some of the principles (marked P) that in my view were responsible for outperformance and the risks in departing from these.
38. Real variables were kept near equilibrium. This is an indicator of countercyclical smoothing of shocks (P1). Large deviations of real rates can make growth volatile, as happened in the 2010s.
39. Another major factor that worked well for India in the last 3 years was good monetary-fiscal coordination (P2). The budget shows a conservative fiscal deficit target overachieved, infrastructure spending maintained and other ongoing supply- side improvements (P3) that will reduce inflation currently as well as over time. These are essential for non-inflationary growth in India. Of course, it is always possible to do more and further raise potential output. In particular, it is important to shift from interventions that distort resource allocation to those that improve productivity in agriculture.
40. With fiscal policy doing its part, monetary policy must also keep the repo rate as low as is consistent with reaching the inflation target. It is not that reforms must come before monetary action. In a dynamic economy both can act together. This type of coordination is compatible with CB independence and credible anchoring of inflation expectations (P4) since action is conditional on inflation outcomes.
41. Svensson had warned long ago that flexibility (P5) in inflation targeting (IT) is very important for its social acceptance.2 Interest rates affect many groups in opposing ways. A low positive repo is also called for since it balances (P6) these differing interests. It worked well in the last few years also reducing core inflation to historic lows. Deviations can lead to protests in a democracy and eventually dilute IT and undermine coordination. As the real repo rises, we are beginning to see such comments, for example in the current Economic Survey.
42. This is unfortunate since the inflation target can serve as a fair benchmark for contesting groups. Trend inflation in any sector should not rise above the target, although spikes can be looked through as expectations remain anchored. Those proposing a higher trend price rise should, in time, become aware that as aggregate inflation rises real gains tend to be lost.
43. There is a view that the neutral real policy rate (NIR) rises with growth. But this holds only for departures from steady-state growth and need not apply if higher transitional growth is absorbing hitherto excluded workers with low productivity and consumption.3 The other important country-relevant issue that a current estimation must include is falling risk premia (P7) due to fiscal, monetary and regulatory actions that are reducing levels and spreads in interest rates. For example, lower volatility in the FX market is reducing interest differentials required with the rest of the world.
44. A clear counter-factual to conservative estimations based on methods developed for advanced economies (AEs) is China, whose sustained high catch-up growth was supported by low real interest rates. Svensson, L.E.O (2000), 'Open-economy inflation targeting', Journal of International Economics, vol. 50, pp. 155-83. Goyal, A., 2009. `The natural interest rate in emerging markets', in: Dutta, B., Roy, T. and Somanathan, E. (Eds.), New and Enduring Themes in Development Economics. World Scientific Publishers.
45. With a few exceptions market analysts that are most articulate about policy rates are mainly interested in the nominal level and its changes in order to guide their clients’ market positions. They will accept any estimate of NIR policy-makers give them, since commitment to a NIR value helps them make predictions.
46. The real rate affects the real sector. It is the MPC, whose mandate covers all groups, that has to be concerned about ‘correct’ real rates in order to balance interests, respond to pressing priorities and seize opportunities. The first priority for India is to create more productive jobs in order to utilize the demographic dividend as well as to prevent possible political instability.
47. Even if growth is high, it has to rise to its full potential. A falling trend and low core inflation indicates growth is below potential,4 implying real rates are above the NIR and there is scope to reduce the repo rate and raise growth. This simple guide cuts through complexities in the estimation of NIR. The MPC must make sure, if the approach to target is long and slow, the real policy rate does not deviate too far from the NIR during that period.
48. Credit eventually creates deposits through rising incomes and savings, but in the meanwhile banks should maintain adequate liquidity buffers. We are seeing market rates coming down as liquidity improves with government spending. The call money rate is also near the repo rate. This should be maintained. Adequate liquidity is required along with prudential policies that create good incentives for the financial sector (P8), especially since the sources of liquidity are limited for many parts of India’s financial sector leading to liquidity hoarding. Balance requires that over- strictness is avoided.
49. In view of the above arguments I vote for a 25 bps cut in the repo rate and a change in the stance to neutral. These are necessary to lower risks of departure from the principles outlined above, which have contributed to policy successes in the last 3 years. Statement by Prof. Jayanth R. Varma
50. For the last several meetings, I have been expressing concerns about the unacceptable growth sacrifice induced by a monetary policy that is excessively restrictive. The majority of the MPC however do not share this concern, perhaps because they think that the Indian economy is already growing at close to its potential growth rate. I think that such a view reflects (a) an unwarranted pessimism about the growth potential of the economy and (b) an overly sanguine expectation about growth in ensuing quarters. I disagree with both prongs of this assessment.
51. Multiple policy measures during the last few years including digitalization, tax reforms, and a step up in infrastructure investment have in my view boosted the potential growth rate of the Indian economy to at least 8 per cent. A confluence of demographic and economic factors present India with a rare opportunity to accelerate its growth over the next decade or more. It is one of the tasks of monetary policy to ensure that this opportunity is not squandered by excessively high real interest rates. In this context it is depressing that India’s projected growth rates for 2024-25 and 2025-26 (despite being among the highest growth rates of any large economy in the world), are significantly lower than the potential growth rate of the Indian economy, 4 There is a literature that uses realized inflation to estimate potential growth, for example, Svensson, L. E.O. Woodford, M. 2003. ‘Indicator variables for optimal policy’, Journal of Monetary Economics, Volume 50, Issue 3, Pages 691-720. and also well below what is needed at the current stage of our demographic transition to meet the aspirations of the new entrants into the workforce.
52. At the same time, the majority of the MPC is, in my view, too sanguine about growth in ensuing quarters. Data from various RBI surveys show multiple early warning signals that growth may be already slowing down. Expectations of robust growth depend heavily on an expectation that private capital investment will pick up soon. However, we have been hoping for this revival for many quarters now, and hope is not a strategy.
53. The RBI’s projections show inflation bouncing up and down from quarter to quarter, but the trend line is clearly downward, and the projected inflation for the first quarter of 2025-26 is 4.4 per cent. On a forward looking basis, the current repo rate of 6.5 per cent translates into a real rate of 2.1 per cent. This is well above what is needed to drive inflation to the target of 4 per cent. It is true that disinflation has been protracted, and therefore restrictive monetary policy has to be maintained for a few more quarters. But a real interest rate of 1.5 per cent is sufficiently restrictive in this environment. This means that a reduction of over 50 basis points in the repo rate is needed within a short span of time, but it makes sense to move cautiously in this direction. I therefore vote to reduce the repo rate by 25 basis points, and to change the stance to neutral. Statement by Dr. Rajiv Ranjan
54. Since the last monetary policy committee meeting, risks to the global economic outlook have increased, while the domestic economy continue to exhibit resilience. Domestically, risks to inflation are higher than risks to growth at the margin. Let me elaborate on each of these.
55. Even though Q1:2024-25 growth projections have been slightly revised downwards, I am now more confident of overall growth holding up in 2024-25 mainly on three counts. First, consumption, which was lagging during 2023-24 will recover in the current year led by rural consumption on the back of better progress of the monsoon, higher sowing and moderating inflation. Higher FMCG sales in the rural areas during the last two quarters bears testimony to this trend. Second, the Union Budget 2024-25 is growth positive with provisions for higher capital and revenue expenditure. Capital expenditure is budgeted to grow by 17.1 per cent (on top of 28.2 per cent in 2023-24), while revenue expenditure excluding interest payments and subsidies is budgeted to grow by 7.4 per cent (1.2 per cent last year) with an absolute increase of about ₹ 82,244 crore from the Interim Budget estimates. Fiscal consolidation via higher receipts and medium-term debt reduction path as envisaged in the budget will be growth positive in the long run.5 Third, investment activity is picking up as witnessed from improving capacity utilisation, pick up in investment intentions, and continued buoyancy in steel consumption and capital goods imports. Strong FDI flows at the start of the year are also positive from capex cycle viewpoint. Thus, the growth of the Indian economy is likely to be sustained by all growth drivers working in tandem. The large divergence between gross value added (GVA) and GDP growth is expected to narrow down substantially in the current fiscal as central government subsidies are budgeted to contract moderately compared to a large contraction seen in the previous year. 5 Higher RBI dividends have been utilised partly to reduce fiscal deficit and partly directed towards higher revenue expenditure.
56. On the other hand, inflation outlook remains uncertain. The upturn in headline inflation in June to 5.1 per cent has been on account of a substantial pick-up in price momentum to around 1.3 per cent (from 0.5 per cent in May) though it was considerably offset by a favourable base effect of around 1.1 per cent. The surge in headline CPI price momentum was driven by the food component even as core (CPI excluding food and fuel) inflation collapsed to a new low in the current CPI series. High frequency food price indicators point to continuing strong food price momentum in July, though large favourable base effects are likely to more than offset it leading to a softening in inflation. Further, core inflation has also likely bottomed out in June, primarily as the impact of the mobile-tariff revision is likely to get reflected in CPI core inflation numbers in July. As a result, there has been changes to the quarterly path of inflation projections with Q2 projections being revised upwards, even as full year CPI inflation projection has been retained at 4.5 per cent.
57. In the recent period, food inflation has remained persistently elevated, averaging 8 per cent since July 2023 and has contributed to around 75 per cent of the headline inflation during April-June 2024. Such persistent food inflation pressures cannot be ignored considering the high share of food in household consumption basket and risk of its spillovers to non-food core CPI components. In this scenario, monetary policy should continue to remain actively disinflationary to ensure that inflation and inflation expectations remains durably aligned to the target rate.
58. The old debate of ‘core versus headline’ that was well settled when in 2016 we had adopted the flexible inflation targeting framework with headline as our target in line with international best practices has resurfaced with persistent divergence between food inflation that has remained elevated and subdued core inflation.6 As long as food constitutes an important segment of the consumer basket and food inflation shows signs of persistence, one cannot ignore food in the CPI basket given the common perception of households to look at food prices while evaluating inflation. Moreover, the likely indirect spill overs from the interrelation of prices over time and across sectors for both households and firms remains important.7 Recent cross-country evidence indicates an increase in the size and significance of inflation persistence post pandemic, thus, slowing down the disinflation journey even after energy price shocks and supply disruptions have abated.8 All this complicates the central bankers’ task and demands caution in policy conduct. Any adjustment of the goalpost, apart from undermining central bank’s hard-earned credibility, may have to bear the wrath of the markets, thus wiping out all the good work done so far.
59. Developments on the global front further add to the uncertainty as the outlook is evolving at a fast pace amidst ongoing geopolitical tensions and various data releases leading to changing perceptions about global economic prospects adding to financial market volatility. Some countries have embarked on easing cycle as their growth has started exhibiting withering signs and headline inflation has started softening, despite core inflation ruling above the headline inflation. On the other hand, a few countries are waiting for supply shocks to abate and favourable economic conditions to emerge before pivoting towards a rate cut cycle, despite low core inflation. There is also a third set of countries that are hiking their benchmark rates due to their country-specific factors. Under these circumstances, it is important that we define our own policy path based on prevailing domestic growth-inflation 6 For details, please refer Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chairman: U.R. Patel, January 2014). 7 The Pass-Through from Inflation Perceptions to Inflation Expectations by Stefanie Huber, Daria Minina, Tobias Schmidt :: SSRN (August 2023); How euro area firms’ inflation expectations affect their business decisions (europa.eu) (July 2024) 8 https://doi.org/10.17016/2380-7172.3562 (July 2024) dynamics. We cannot let down our guards against inflation at this juncture, when supply shocks are proving to be so persistent.
60. Going ahead, however, some positive developments are envisaged. Headline CPI inflation is projected to continue on the disinflation path towards the target rate, though gradually, with inflation projections indicating a significant moderation by Q4 of the financial year. Steady progress in monsoon with a favourable La Nina; higher kharif sowing; a likely favourable rabi season on the back of good soil moisture conditions; and softening global food prices may lead to a more than anticipated decline in food inflation pressures over the course of the year. This could open up the window for monetary policy to change its course. At the current juncture, however, more clarity and definiteness are needed - on food inflation outlook; spillovers of food price pressures to core inflation; domestic demand; and global risks. Till then, I will prefer to stay the course and remain cautious and watchful for these uncertainties to play out. Resilient growth gives us the space to remain focussed on inflation and maintain status quo till some of these risks are mitigated and the trade-offs are minimised. Accordingly, I vote for status quo on both stance and rate in this policy. Statement by Dr. Michael Debabrata Patra
61. The wedge between headline and food inflation has been widening, and stalling the alignment of the former with the target. Taking into account double digit inflation in salient food categories such as cereals, pulses, spices and vegetables for several months, empirical evidence points to a rise in the time varying persistence of food inflation, i.e., it is taking longer to revert to its trend after a shock. There is also evidence of the time varying trend of food inflation increasing, negating the gains made through core disinflation.
62. Higher trend food inflation is spilling over into inflation expectations of households and consumer confidence. In the case of the former, even their current perceptions have now started rising along with outer-term expectations. The recent assessment of the neutral rate of interest suggests that the disinflationary stance of monetary policy is appropriate, especially in view of the persisting positive gap between actual inflation outcomes and the target. Potential output is now rising faster than its pre- pandemic pace; even so, a positive output gap has opened up – actual output is running ahead of potential output - warranting vigil on aggregate demand developments.
63. Monetary policy is an instrument for modulating aggregate demand. Food price shocks may originate outside the realm of monetary policy and initially manifest themselves in supply mismatches, but when their effects stay in the inflation formation process, they can propagate through second order effects and get generalised to which monetary policy cannot be insensitive. Persistently rising prices are always and everywhere a reflection of too much demand chasing too less supply even if it is a supply shortfall that starts the price spiral. It is the remit of monetary policy to adjust demand conditions to the state of supply because this accumulation of price pressures threatens the outlook for both inflation and growth. The monetary policy committee (MPC) of the RBI has committed to align inflation durably to the target. That is not yet achieved; any faltering from this commitment could undermine the prospects of the Indian economy. Hence, I vote for keeping the policy rate and the stance of withdrawal of accommodation unchanged in this resolution. Statement by Shri Shaktikanta Das
64. Global economic activity has remained stable since the last meeting of the MPC in June 2024. Incoming data, however, presents a mixed picture with signs of slowing growth momentum in certain major economies. Inflation is on a softening path, but persistence in services prices is imparting downward rigidity. With changing growth- inflation dynamics, several central banks have become less restrictive by way of rate cuts and forward guidance. At the same time, there are a few others who have hiked their interest rates. Market expectations are constantly varying on the pace and timing of policy pivots by central banks, resulting in financial market volatility.
65. In this mixed global backdrop, India is treading on a steady growth path driven primarily by domestic factors. High frequency indicators suggest that momentum of activity witnessed during Q4:2023-24 continued during Q1:2024-25, though with some slowdown in corporate profits, lower general government expenditure and core industries output. Kharif sowing is progressing well thanks to the south-west monsoon. Improving reservoir levels augur well for the rabi output. Manufacturing and services activity remain buoyant.
66. The pickup in agricultural activity is expected to further boost rural consumption. Urban consumption continues to be steady. Budget allocation for government capex remains robust. Private corporate investment is also gaining steam with capacity utilisation reaching its highest level in 11 years. Healthy balance sheets of banks and corporates provide a congenial environment for private sector investments to gather pace. Indications of capacity creation in a few industries and growing investment intentions are getting visible.9 Improving global trade volume is expected to provide support to external demand.
67. Since the last bi-monthly policy review, headline inflation has seen upward movement in June to 5.1 per cent, as food inflation pressures increased and offset the impact of subdued core (CPI excluding food and fuel) inflation and deflation in the fuel group.
68. Going forward, headline inflation in July and Q2 of the current financial year are expected to be lower, given their base effect advantage; but with food inflation pressures showing little signs of abatement in the near-term, and household inflation expectations picking up, monetary policy has to remain vigilant to potential spillovers of food price pressures to the core components. This is critical for the ‘last mile of disinflation’ and anchoring of inflation expectations. Food inflation may soften due to good monsoon, steady improvement in kharif sowing, rising reservoir levels and a likely favourable rabi season output. Uncertainty, however, comes from frequent recurrence of adverse weather events, resurgence of geo-political tensions and financial market volatility. Further, core inflation might just have bottomed out.
69. The calibrated increase in policy repo rate by 250 basis points since May 2022 and subsequent change of stance to withdrawal of accommodation has facilitated gradual disinflation over 2022-23. With a forecast of 4.5 per cent headline inflation for 2024-25, the present policy repo rate is broadly in balance and avoids costly sacrifice of domestic economic activity. 9 As per RBI Surveys, manufacturers’ investment intentions for 2024-25 improved, with most firms planning similar or higher investments compared to last year. Funds raised for capex purpose by the private corporates during Q1:2024-25 through different channels (banks/FIs, ECBs, IPOs) remained strong.
70. At this stage, when durable disinflation to the target is still a work in progress, the issue of equilibrium natural interest rate is premature. Policy making in the real world cannot be based on an abstract, theoretical and model specific construct which is unobservable and time varying. Hence, any justification for policy easing based on so called high real rates can be misleading.
71. Introduction of flexible inflation targeting (FIT) in 2016 was a major structural reform. Over the last 8 years, it has gained in credibility and facilitated positive outcomes for the economy, despite the huge global shocks. Its credibility needs to be preserved and sustained.
72. Inflation is gradually trending down, but the pace is slow and uneven. Durable alignment of inflation to the target of 4.0 per cent is still some distance away. Persistent food inflation is imparting stickiness to headline inflation. Inflation expectations need to be kept anchored. Spillovers of food inflation to core have to be avoided. At such a crucial juncture, steady growth impulses are allowing monetary policy to unambiguously focus on supporting a sustained descent of inflation to the target. The best contribution that monetary policy can make for sustainable growth is to maintain price stability. Taking all these factors into consideration, I vote for keeping the policy repo rate unchanged at 6.5 per cent and continuing with the stance of withdrawal of accommodation. (Puneet Pancholy) Press Release: 2024-2025/949 Chief General Manager
6. The global economy has remained resilient and is expected to maintain stable momentum over the rest of the year, amidst downside risks from intensifying geopolitical conflicts. In India, real gross domestic product (GDP) registered a growth of 6.7 per cent in Q1:2024-25, driven by private consumption and investment. Looking ahead, the agriculture sector is expected to perform well on the back of above normal rainfall and robust reservoir levels, while manufacturing and services activities remain steady. On the demand side, healthy kharif sowing, coupled with sustained momentum in consumer spending in the festival season, augur well for private consumption. Consumer and business confidence have improved. The investment outlook is supported by resilient non-food bank credit growth, elevated capacity utilisation, healthy balance sheets of banks and corporates, and the government’s continued thrust on infrastructure spending. External demand is expected to get support from improving global trade volumes. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.2 per cent with Q2 at 7.0 per cent; Q3 at 7.4 per cent; and Q4 at 7.4 per cent. Real GDP growth for Q1:2025-26 is projected at 7.3 per cent (Chart 1). The risks are evenly balanced.
7. Headline inflation declined sharply to 3.6 and 3.7 per cent in July and August respectively from 5.1 per cent in June. Going forward, the September inflation print may see a significant pick-up as base effects turn adverse and food prices register an upturn. Food inflation, however, is expected to ease by Q4:2024-25 on better kharif arrivals and rising prospects of a good rabi season. Sowing of key kharif crops are higher than last year and the long-period average. Sufficient buffer stocks for cereals are available for ensuring food security. Adequate reservoir levels, the likelihood of a good winter and favorable soil moisture conditions augur well for the ensuing rabi season, though adverse weather events remain a risk. Firms polled in the Reserve Bank enterprise surveys expect input cost pressures to ease; however, the very recent upturn in key commodity prices, especially metals and crude oil needs to be closely monitored. Taking all these factors into consideration, CPI inflation for 2024-25 is projected at 4.5 per cent with Q2 at 4.1 per cent; Q3 at 4.8 per cent; and Q4 at 4.2 per cent. CPI inflation for Q1:2025-26 is projected at 4.3 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
8. The MPC noted that the domestic growth outlook remains resilient supported by domestic drivers – private consumption and investment. This provides headroom for monetary policy to focus on the goal of attaining a durable alignment of inflation with the target. The MPC reiterates that enduring price stability strengthens the foundations of a sustained period of high growth. After a transient spike in the near term, headline inflation is expected to moderate as projected above. With better prospects for both kharif and rabi crops and ample buffer stocks of foodgrains, there is now greater confidence on the disinflation path later in the financial year. Keeping in view the prevailing and expected inflation-growth dynamics, which are well balanced, the MPC decided to change the monetary policy stance from withdrawal of accommodation to ‘neutral’ and remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth. The change in stance provides flexibility to the MPC while enabling it to monitor the progress on disinflation which is still incomplete. Risks stem from uncertainties relating to heightened global geo-political risks, financial market volatility, adverse weather events and the recent uptick in global food and metal prices. Hence, the MPC has to remain vigilant of the evolving inflation outlook. Accordingly, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting.
9. Shri Saugata Bhattacharya, Professor Ram Singh, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Dr. Nagesh Kumar voted to reduce the policy repo rate by 25 basis points.
10. Dr. Nagesh Kumar, Shri Saugata Bhattacharya, Professor Ram Singh, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted for a change in stance from withdrawal of accommodation to ‘neutral’ and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.
11. The minutes of the MPC’s meeting will be published on October 23, 2024.
12. The next meeting of the MPC is scheduled during December 4 to 6, 2024. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Nagesh Kumar No Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Nagesh Kumar
13. At the outset, I must say, that looking at the global economic situation, one feels proud of the management of the Indian economy that has made it the fastest- growing large economy globally, with a relatively low inflation rate, exchange rate stability, large foreign exchange reserves, among other robust macroeconomic fundamentals. The effective monetary management by the RBI combined with the prudent fiscal management by the Finance Ministry over the years deserve to be applauded.
14. Within the broad overall picture, zooming in to the current juncture, however, certain pointers require consideration by the MPC. I wish to situate the discussion on the policy rates and inflation targeting in the context of the overall development priorities of the country from the perspective of the real sector, particularly the manufacturing sector. After all, the policies are the ‘means’ for achieving the ‘ends’ that are our development aspirations.
15. The job creation imperative for India’s youthful population has pushed the Government to focus attention on the manufacturing sector which has the potential to create decent jobs not only directly but also indirectly, especially for semi-skilled and unskilled workers. Several reforms and policy measures such as PLI have been taken over the past decade as a part of the ‘Make-in-India’. India is not alone in pushing the manufacturing sector. The US, until recently the greatest champion of free markets, for instance, is pushing industrial policy aggressively with a trinity of the Inflation Reduction Act, the CHIPS and the Science Act, and the Infrastructure Investment and Jobs Act adopted in 2022 which have collectively put more than a trillion dollars on the table to be handed out to industry in incentives and tax breaks, besides heavy tariffs imposed on the imports from China to protect the domestic industry. The EU is following the same playbook.
16. The external context for pursuing industrial policy, however, has turned less benign compared to the 1990s and early part of the 2000s when China’s industrial policy was supported by rapidly expanding world trade and investments. World trade and investments have never quite recovered from the global financial crisis and their growth rates have come down dramatically from an annual average of over 16% to under 4% for world trade and from around 20% to just 2% for FDI between the pre- and post-GFC periods. The rise of protectionism in the West, trade wars, and the collapse of multilateral trade negotiations have turned globalization into ‘slowbalization.’ The situation is complicated further, especially for India, by large excess industrial capacities sitting next door in China, with access to the Western markets made more difficult, and the threat of predatory dumping in our markets is real.
17. The disruptions during the pandemic have sparked a trend of global companies derisking their supply chains by restructuring them on a China+1 basis. This trend of restructuring of supply chains by global companies could be an opportunity for India to attract investments to build our productive capacities if we can get our act together in terms of investment climate, efficient logistics, stable macroeconomic environment, cost of capital, and overall cost of doing business vis-a-vis peer countries. To some extent, India’s success in attracting Apple and its vendors like Foxconn to assemble iPhones in India is a part of this trend.
18. The emerging trends in the Indian economy suggest a slowdown of the economic growth from 8.2% in 2023-24 to 6.7% in 2024-25:Q1 and the projection for the full year 2024-25, according to the Survey of Professional Forecasters, has been revised down by 10 basis points to 6.9%. The core sectors such as cement, iron & steel, and chemicals showing negative growth over the past two quarters despite a rather heavy infrastructure push by the government through unprecedented capital expenditure since 2023-24 is a matter of concern. The cost of finance of private companies has gone up steadily since March 2022 when the RBI started to raise the policy rates. According to the Enterprise Surveys, the demand conditions in manufacturing and the job landscape moderated across major sectors. The Consumer Confidence Surveys suggest that the general economic conditions have worsened compared to a year ago. Overall business sentiment has moderated in 2024-25:Q2. PMI for manufacturing eased somewhat in September although stayed in the expansionary zone. All these trends point to the weaknesses in demand in the domestic economy in general, and industry in particular. Similarly, India’s merchandise exports have shrunk by 9.3% in August due to subdued demand abroad. The April- August growth of merchandize exports has been just a marginal 1.1% only.
19. Therefore, the Indian industry is clearly suffering from demand deficits in both domestic and external markets. Demand deficits may be the reason private investment has not picked up momentum despite the companies' healthy balance sheets and all the reforms and incentives extended by the government.
20. The inflationary trends, on the other hand, suggest that the monetary policy interventions of RBI have had greater success in managing inflation. The CPI headline has been around 4.5%, and was slightly lower at 3.6% in July-August 2024. The inflation excluding vegetables is even lower at 3.2% (July-August). Food inflation especially cereals and vegetables has been challenging but it is driven by cyclical supply side issues rather than demand which is addressed by monetary policy. Household inflationary expectations/ perceptions have declined by 10 basis points. A lower proportion of households expect prices and inflation to increase over 3 or 12 months ahead. Therefore, it is apparent that the policy tightening by the RBI has succeeded in anchoring inflationary expectations well.
21. Furthermore, several industrialized and emerging economies have started to cut interest rates to revive economic growth. In the US, the Fed has cut the policy rate by 50 basis points. The EU, Switzerland, Mexico, China, and South Africa have begun to normalize monetary policy by cutting rates. India risks currency appreciation if we do not follow the process of normalization. The rupee has been already appreciating in real terms and a further appreciation would hurt the competitiveness of Indian products.
22. Given that inflationary expectations have been successfully anchored, and industrial demand in both domestic as well as export markets is flagging, a rate cut could help to revive demand and help boost private investment. I believe that it is an opportune moment for RBI to start the process of normalizing the monetary policy. In view of these observations, I vote for a 25 basis point cut in the repo rate and the adoption of a neutral stance in the monetary policy. Statement by Shri Saugata Bhattacharya
23. Global growth, while resilient, remains uneven, slowing in many large economies, prompting central banks to start cutting policy rates. Prospects for future demand remain hazy, with each emerging data point seeming to present a confusing and occasionally dissonant outlook. The forthcoming IMF World Economic Outlook is awaited for forecast updates. Future G-7 central banks’ rate actions and guidance, other than affecting economic activity, are likely to induce financial markets volatility, with expected spillovers to emerging markets.
24. In India, signals on growth momentum present a mixed picture, with uncertainty regarding aggregate demand. RBI projects a 7.2% real GDP growth for FY25. Forecasts of many institutional and multilateral organisations seem to be progressively converging closer to this.
25. In the near term, however, some high frequency economic indicators (both hard data and surveys) suggest a loss of momentum, but still do not seem to show a material slowdown. The Manufacturing and Services Purchasing Managers Indices (PMIs) for September, and the IIM Ahmedabad August Business Expectations Survey show a moderation in current and expected activity metrics. Lower cement and steel growth are a concern, but might partially reflect the base effects of very high growth rates in the corresponding months in FY24. Domestic IT hiring is reported to have slowed. The much-discussed slowdown in Personal Vehicles (PV) retail sales, with reported large inventory stocks at dealers, is a concern. The last reported prints for rural wages remain subdued. Tepid export growth is worrisome, accentuated by reports of China “dumping” excess capacity. 25. Rural demand is trending upwards, as manifested by several vital indicators: sales of two-wheelers during July-August 2024, a 16.6 per cent decline in demand for the MGNREGA work during July-September, and a higher growth of FMCG in rural areas. The sale of consumer durables and air traffic manifests a sustained urban demand.
26. A contrarian viewpoint is equally compelling. RBI surveys show increasing consumer confidence, Two-wheeler sales are doing well, particularly in rural areas. Tailwinds from the largely good rains are likely to bolster rural demand. Steel consumption recorded double digit year on year growth during April – August 2024 1. The automobile dealerships’ industry body notes that expectations of higher PV sales in October have improved. Manufacturing Capacity Utilisation (CU), seasonally adjusted, had inched up in Q1 FY25, auguring well for private sector investment. A study on banks’ capex sanctions and disbursements in FY24 reinforces this2. Although dated, RBI collation of non-financial private listed corporate Q1 FY25 results show that Indian Steel Industry: August 2024, Joint Plant Committee, Ministry of Steel. K. Gupta et al, RBI Bulletin August 2024, pp. 149-162. high interest rates have not hurt corporate financials to any significant extent; interest costs as a share of sales were actually creeping lower (2.7% in Q1 FY25). Retail credit, conjectured (albeit untested) to be a driver of consumption demand, while slowing, still remains robust. Weighing these metrics, we assess that domestic growth outlook remains largely resilient, even as we recognise the need to closely monitor developments in near term economic indicators.
27. Inflation, on the other hand, appears to be more stable now. Persistent high food inflation might gradually trend down, given the relatively good distribution of above average rains and higher acreage sown. High reservoir levels and ground moisture augur well for rabi crops. Excluding vegetables, CPI inflation has remained below 4% for the past 8 months. All synthetic measures of core inflation have remained stable despite persistent and overlapping food price shocks. Diffusion indices of price dispersion for CPI Core also indicated a seasonally adjusted annualised rate (saar) price momentum of less than 4 to 6 per cent 3. Yet, the September CPI inflation is likely to be significantly higher than in the last couple of months. Although we expect this likely rise to be transitory over a couple of months, we need to closely monitor trends in commodities prices. The arduous battle against inflation is far from won, but we are more confident of eventual success in bringing CPI inflation durably closer to the target. One important reason for this confidence is that household inflation expectations remain well anchored and have trended lower in the latest survey round.
28. Yet, risks on commodities inflation seem to be building up. The FAO Food Price Index (FFPI) was up 2.1% yoy in September ‘24. Geopolitical risks have risen sharply. Most metals prices had hitherto remained moderate, largely due to the China slowdown, but now some metals prices, particularly aluminium, are trending up. The magnitude and contours of China’s ongoing stimulus and their impact on Chinese demand still remain unclear. A study which had estimated India’s potential output growth at 7% for January-March 2024 4 reinforces the heightened risks of premature easing.
29. Given this assessment, risks to the near-term growth – inflation trade-off at this point in time seem largely balanced, even as inflation is projected to be trending towards the target and is eventually likely to durably align with it. The effects of the current uncertainty on the evolving and fluid economic conditions need to be understood in greater detail in order to guide policy actions at this inflexion point. However, the extent of ambiguity emanating from economic signals warrants a need for policy to be able to respond readily to evolving economic conditions, based on incoming data. The first step is to change the policy stance to neutral, providing flexibility and optionality for future actions.
30. It needs to be emphasized, given the current heightened uncertainty, both global and domestic, that a very cautious and calibrated approach to easing is called for; the costs of a “policy error” are likely to be large. The multi-dimensional implications of a repo rate cut at this time and in the future needs careful evaluation. One of these might be a further and excessive easing of financial conditions; these conditions, to an extent, have already in the recent past resulted in a de facto easing of restrictive policy. In addition, structural system liquidity has shifted over time from deficit to surplus, helping to anchor overnight and short-term rates close to the repo RBI Monetary Policy Report, October 2024. H. K. Behera, “Updating Estimates of the Natural Rate of Interest for India with Post Pandemic Evidence”, RBI Bulletin, July 2024, pp. 77-88. rate. Updates inter alia on the ongoing festive season sales and the results of listed private sector corporates for the July-September quarter of FY25 might provide more clarity on evolving demand conditions.
31. Accordingly, based on my assessment of the appropriate response to this complex economic environment, I vote for a change of the monetary policy stance to neutral while keeping the repo rate unchanged at 6.5 per cent. Statement by Prof Ram Singh Domestic Growth
32. The macroeconomic data and indicators available so far suggest that domestic economic activity remains steady. The real GDP has grown by 6.7 per cent in Q1:2024-25, a tad less than the projected value for the quarter. The GVA, on the other hand, expanded by 6.8 per cent in Q1 of 2024-25, higher than 6.3 per cent in the previous quarter. The core of production, i.e., manufacturing and services, grew by 7.0 per cent and 7.7 per cent, respectively, and drove the growth of GVA primarily in Q1. The data also suggest that a revival in private consumption and improvement in private investment has driven the growth in the first quarter. The GFCF has stood at 7.5 per cent in Q1:2024-25. It is also noteworthy that the investment as a share of the GDP has reached 34.8 per cent – the highest since Q2:2012-13.
33. The agriculture and services sectors remain resilient. Better kharif sowing owing to the above-normal monsoon rainfall is expected to help sustain the growth path. The improved reservoir levels and soil moisture conditions also augur well for the ensuing rabi crop. The services sector has continued to grow at a steady pace. PMI services at 57.7 in September indicate robust expansion though the pace slackened to a 10-month low in September as demand slowed.
34. The eight core industries' output fell by 1.8 per cent in August on an adverse base. Excess rainfall also dampened production in some sectors, such as electricity, coal and cement, in August. This comes in the backdrop of a tapering trend in the PMI over the last few months. However, PMI remains in expansion territory with a comfortable margin, and India has continued to record the highest PMI reading among major economies for manufacturing and services since July 2022 and April 2023, respectively. Also, the industrial outlook survey of manufacturing firms suggests improved expectations for production, order books, employment, capacity utilisation, and overall business situation during Q4:2024-25 and Q1:2025-26. Moreover, improving domestic demand with lower commodities and other input costs is conducive to the sustainability of manufacturing activities. On the external front, recent merchandise exports have contracted, but services exports support overall growth.
35. Regarding demand, PFCE growth has shown a moderate but consistent upward trajectory. It accelerated to a seven-quarter high of 7.4 per cent in Q1:2024-
36. Investment also remains buoyant, as indicated by steel consumption, production, and imports of capital goods. The GFCE is moderately improving after a 0.2 percent contraction during Q1:2024-25. Government capex is also rebounding from the contraction observed in the first quarter due to general elections. Government expenditures of the centre and the states are expected to pick up further pace in Q3 and Q4. The government’s continued thrust on capex and healthy twin-balance sheets would help sustain business optimism.
37. An expansion in non-food bank credit for most manufacturing and infrastructure subsectors is sustaining private investment. An increase in the seasonally adjusted capacity utilisation—from 74.6 per cent in Q4:2023-24 to 75.8 per cent in Q1:2024- 25—also adds to the positive outlook, as does a rise in investment intentions. A downtrend in finished goods inventory (FGI)/sales and steady raw material inventory (RMI)/sales are also a source of comfort.
38. In the rest of the fiscal year, growth will also depend on whether government spending in the remaining two quarters remains in line with the budget estimates, the growth rate for the core industries, and the growth in the flow of financial resources to the commercial sector.
39. However, fundamental growth drivers and the mainstay of aggregate demand – consumption and investment demand – are gaining momentum. The core components of aggregate demand, viz., private consumption and gross fixed capital formation, have remained strong with over 7.0 per cent growth in Q1, suggesting resilience of the growth. Further, momentum in private consumption looks sustainable on the back of improved agricultural outlook and rural demand. Sustained buoyancy in services is also expected to support urban demand. The high-frequency indicators point toward a sustained momentum in domestic economic activity. Overall, the real GDP growth for 2024-25 is projected at 7.2 per cent, which seems very much achievable. Inflation
40. The headline CPI inflation rate was below 4.0 per cent for the second consecutive month in August 2024. This is very comforting, especially given the core inflation readings remaining in the range of 3.3-3.4 per cent during this period. The fuel component of CPI remains in a contractionary phase. The RBI projected CPI inflation for 2024-25 at 4.5 per cent, with balanced risks.
41. Food inflation is an important source of uncertainty, which has increased in August from the preceding month. Moreover, there is a significant divergence within the food sub-groups. Going forward, the moderation in headline inflation can be unsteady in the near term due to adverse base effects. Food inflation is expected to moderate later this financial year because of strong kharif and rabi sowing on top of adequate buffer stocks. Adverse weather events, however, remain un-insurable risks to food inflation.
42. Considering all these factors, there is a case for remaining vigilant about food inflation and, at the same time, supporting growth. Therefore, I vote for: • Keeping the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50 per cent. And for • Changing the monetary policy stance to ‘neutral’. Statement by Dr. Rajiv Ranjan
43. In my August 2024 statement, I had stated that we could see a window opening up for monetary policy to change its course backed by steady progress in monsoon, higher kharif sowing, favourable rabi prospects and softening global commodity prices. Today, we have more clarity and definiteness on some of these aspects, all of which may contribute positively to our disinflation path.
44. There is ample evidence now to say that monetary policy actions since May 2022 have worked well. First, inflation expectations have come down significantly since September 2022, when they had reached a peak. Since September 2022, current perception, 3-month and 1-year ahead household inflation expectations declined by 210 bps, 160 bps and 100 bps, respectively, while business inflation expectations 5 have seen a decline of 104 bps over these last two years. Second, core inflation has softened from a 6 per cent level during May to September 2022 to around 3.2 per cent during the current financial year. Third, the cumulative rate hikes have percolated through the system adequately, broadly in line with the transmission observed during the easing phase. Fourth, beyond the near-term hump, inflation projections during the latter part of the financial year give us comfort with food inflation likely to benefit from strong kharif sowing, adequate buffer stocks and likely good soil moisture conditions for rabi sowing.
45. Fifth, policy rate hikes since May 2022 along with the prudential measure of increasing the risk weights for certain unsecured loan segments undertaken in November 2023 helped lower credit growth in the targeted sectors. Thus, prudential measures – whether ahead of or during a monetary tightening – complements monetary policy by providing central banks with more policy headroom to fight inflation, while helping to reduce the likelihood of financial stress. 6 Recent trends also indicate that credit and deposit growth gap, which has been a concern for some time, is narrowing. In absolute terms, the accretion to bank deposits has been higher than loan growth during the current financial year so far.
46. While being focussed on its task of containing inflation, monetary policy has also ensured that growth remains on a steady path. Both the major drivers of growth, consumption and investment, having more than 90 per cent share in GDP in Q1: 2024- 25, continue to grow at a good pace. The confidence in the strength of domestic demand is led by the recovery in rural consumption emanating from buoyant agricultural activity which had been lagging during the previous two years. Festive season will provide further impetus to demand. It is also supported by the expected recovery in Government consumption (both central and state governments) as budgeted for 2024-25 – which is evidenced in the data available for Q2 so far. Government capex is rebounding after having contracted in Q1. It is expected to keep pace to match the budgeted amount. Private investment continues to gain traction, supported by rising capacity utilisation, strong corporate and bank balance sheets, and higher industrial credit. The improving outlook of capex is led by infrastructure, speciality chemical, EVs, pharma, solar PV module, automobile, steel and renewable As per the monthly Business Inflation Expectations Survey (BIES) of the Indian Institute of Management, Ahmedabad. Boissay, F., Borio, C., Leonte c., and Shim, I. (2023). “Prudential policy and financial dominance: exploring the link”, BIS Quarterly Review. energy. Global trade volumes remain strong which is good for our exports. Softer crude prices, if sustained, could be a tailwind for growth.
47. On the global front, it seems like we are in an interesting but challenging phase. First, uncertainties on the global front undoubtedly remain high, yet some resilience is getting built in. Notwithstanding the rise in geopolitical risks along with Chinese stimulus and its demand side impact, oil remains volatile within a range that is neither striking nor worrying like yesteryears. Second, countries seem to be determining their monetary policies based on indigenous factors, while remaining largely immune to the Fed policy pivots. Post the Fed rate cut in mid-September, the world is divided - while 10 countries have followed the Fed, another 11 countries have taken a pause, while one has hiked its policy rate. Such varying monetary policy responses reflect growing divergence in the inflation-growth dynamics across countries that coupled with continued uncertainties have prompted central banks across the globe to steer their policy path in a guarded manner managing the risk of policy errors. Third, those who have begun their policy pivot by rate cuts can be categorised into three types – those who face sharp slowdown in their economies (UK, EU, South Korea), those who had very restrictive policies (US, Canada, Norway and Iceland) and lastly, those who had started hiking very early in 2021 (like Brazil, Hungary, Columbia and Chile). Clearly, India does not fall in any of these categories.
48. To conclude, there are enough evidence to give confidence that we are on the right track. Our cautious and calibrated approach has paid off. Monetary policy is working well to contain inflation. Going ahead, there is now greater confidence on inflation aligning with the target unless disrupted significantly by weather events and worsening of geo-political risks. We also need to keep a close watch on global commodity prices, especially food and metal prices, which have shown some signs of hardening. Keeping in mind the balance in the growth-inflation outlook, the risk-reward for a change of stance to neutral is favourable now. This would allow flexibility to adapt and operate in accordance with the evolving situation. But change in stance in no way implies dropping the guard on inflation. Considering the uncertainties still prevailing on the global front, a cautious data dependent approach with regard to further course of monetary policy actions is called for. Between now and December, we will have greater clarity on some of the uncertainties – US elections, geopolitical risks and Chinese fiscal stimulus and its impact on global commodity prices. At this juncture, India’s resilient growth story helps us to continue our determined focus on inflation and keep the policy rate unchanged at 6.5 per cent. Hence, I vote for a status quo on rates and change of stance to neutral. Statement by Dr. Michael Debabrata Patra
49. Since the beginning of 2022-23, monetary policy has pursued a sustained restrictive stance to achieve the goals of maintaining price stability while keeping in mind the objective of growth. There is now growing evidence that as the effects of some of the global shocks that drove up inflation are fading, our commitment is bringing about a better balance between aggregate demand and aggregate supply domestically. Accordingly, the path of inflation is reconfiguring towards the target in the baseline forecast, by my metric of four quarters ahead inflation. This trajectory will likely encounter a hump in the near months as the projections indicate, but this is largely due to an adverse base and one-off shocks to prices of vegetables, edible oils and gram. The expectation is that effects of these shocks should dissipate by December as supply conditions improve. It is, therefore, possible for monetary policy to look through these spikes while monitoring their evolution closely until they are seen off. The overall inflation environment is improving. Households’ and businesses’ inflation expectations have eased and remain anchored. Consumer confidence on the price situation a year ahead is improving. Input cost pressures are expected to ease in the manufacturing sector and selling prices are expected to moderate in the services and infrastructure sectors during the third quarter of 2024-25. The decline in capacity utilisation in the manufacturing sector is highly correlated with a slackening of the output gap in the sector, which should also work toward easing core price pressures.
50. Economic activity remains resilient in spite of the disinflationary monetary policy stance, supported by domestic drivers. While some high frequency indicators have slowed in the second quarter of 2024-25, this appears attributable to idiosyncratic factors like unusually heavy rainfall in the retreat of the south west monsoon and pitrupaksha. They should stabilize in the second half of the year as consumption receives a boost in the festival season, the revival of rural demand gathers further strength, and investment is buoyed by budgeted government capital expenditure gaining steam. Enterprises expect demand conditions to pick up for manufacturing companies; services and infrastructure firms indicate an optimistic outlook on demand. Overall business expectations for the last quarter of 2024-25 and the first quarter of 2025-26 are optimistic.
51. Given this outlook, it is possible to envisage that the persistence of inflationary pressures experienced so far could dissipate with a less restrictive stance of monetary policy. This assessment gains credence with the success in squeezing out inflation persistence that has been achieved. It would be apposite in this meeting to undertake an appropriate recalibration of the monetary policy stance that reflects an openness to reducing the degree of policy restraint if inflation evolves along the trajectory set out in the baseline projection. At the same time, reducing restraint too quickly may negate the progress made on disinflation. Hence, a gradual wait-and-assess approach to removing policy restraint in terms of the policy rate remains appropriate as long as inflation is not lastingly close to its target. Accordingly, I vote for maintaining status quo on the policy rate but a shift in the stance to neutral in this meeting. Statement by Shri Shaktikanta Das
52. The global economy continues to grow at a steady pace, with trade remaining resilient. Despite its uneven progress, headline inflation is softening. Divergent growth- inflation trajectories across countries have led to varying monetary policy responses from central banks.
53. In India, high frequency indicators suggest that economic activity remained steady during Q2:2024-25. Agricultural activity has significantly picked up due to a good south-west monsoon. This will contribute to both supply and demand side factors behind GDP growth. Manufacturing companies are expected to benefit from lower input costs. Services activity retains its buoyancy.
54. The Reserve Bank surveys indicate an improvement in consumer and business sentiments. Government expenditure has improved in Q2:2024-25 and this trend is likely to continue during rest of the year in line with the budget estimates. Private corporate investment is gaining steam with seasonally adjusted capacity utilisation improving in Q1:2024-25, and healthy balance sheets of banks and corporates. The two major drivers of GDP – consumption and investment – are expected to sustain their momentum observed in Q1. Consequently, the real GDP is projected to grow at 7.2 per cent in 2024-25. Further, the Reserve Bank’s model based projection suggests that the economy will grow at 7.1 per cent during 2025-26. India’s growth story remains intact.
55. Headline CPI inflation moderated during July-August 2024, as anticipated, benefiting primarily from a favourable base effect in July. Food prices registered a decline in July-August, but high frequency food price indicators available for September indicate an upturn in food prices. Together with a large unfavourable base effect, this would in all probability lead to a substantial jump in headline inflation in September. The momentum in food prices continues even in the first week of October which, if sustained, is likely to keep even October headline inflation high. Beyond the short-term, however, the outlook for food inflation is becoming more favourable with improvement in kharif and rabi season prospects. Core inflation, in absence of a major cost-push shock, is likely to remain contained on continuing transmission of past monetary policy actions. These considerations have resulted in inflation projection of 4.5 per cent for 2024-25.
56. Overall, the Indian economy presents a picture of stability and strength. The balance between inflation and growth is well-poised. Despite the near-term uptick in inflation, the outlook for headline inflation towards the later part of the year and early next year points to further alignment with the 4 per cent target. Thus, the conditions are appropriate for a change in monetary policy stance to neutral from withdrawal of accommodation. This would provide greater flexibility and optionality to monetary policy to act in accordance with the evolving outlook. It also provides space to watch out for the uncertainties on the horizon – ranging from heightened geo-political tensions and volatile commodity prices to risks of adverse weather in food inflation. These are significant risks and their impact cannot be underestimated. We need to remain vigilant.
57. At this stage of the economic cycle, having come so far, we cannot risk another bout of inflation. The best approach now would be to remain flexible and wait for more evidence of inflation aligning durably with the target. Monetary policy can support sustainable growth only by maintaining price stability. Taking all these factors into consideration, I vote for changing the stance from withdrawal of accommodation to ‘neutral’ while keeping the policy repo rate unchanged at 6.50 per cent. (Puneet Pancholy) Press Release: 2024-2025/1359 Chief General Manager
6. The global economy remains stable with growth holding up amidst waning inflation, albeit at a slow pace. Geopolitical risks and policy uncertainty, especially with respect to trade policies, have imparted heightened volatility to global financial markets.
7. On the domestic front, real gross domestic product (GDP) registered a lower than expected growth of 5.4 per cent in Q2:2024-25 as private consumption and investment decelerated even while government spending recovered from a contraction in the previous quarter. On the supply side, the growth in gross value added (GVA) during Q2 was aided by resilient services and improving agriculture sector, but weakness in industrial activity – manufacturing, electricity and mining – tempered overall growth. Looking ahead, robust kharif foodgrain production and good rabi prospects, coupled with an expected pickup in industrial activity and sustained buoyancy in services augur well for private consumption. Investment activity is expected to pick up. Resilient world trade prospects should provide support to external demand and exports. Headwinds from geo-political uncertainties, volatility in international commodity prices, and geo-economic fragmentation continue to pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 6.6 per cent with Q3 at 6.8 per cent; and Q4 at 7.2 per cent. Real GDP growth for Q1:2025-26 is projected at 6.9 per cent; and Q2 at 7.3 per cent (Chart 1). The risks are evenly balanced.
8. Headline CPI inflation surged above the upper tolerance level to 6.2 per cent in October from 5.5 per cent in September and sub-4.0 per cent prints in July-August, propelled by a sharp pick-up in food inflation and an uptick in core (CPI excluding food and fuel) inflation. Going forward, food inflation is likely to soften in Q4 with seasonal easing of vegetables prices and kharif harvest arrivals; and good soil moisture conditions along with comfortable reservoir levels auguring well for rabi production. Adverse weather events and rise in international agricultural commodity prices, however, pose upside risks to food inflation. Even though energy prices have softened in the recent past, its sustenance needs to be monitored. Businesses expect pressures from input costs to remain elevated and growth in selling prices to accelerate from Q4. 1 Taking all these factors into consideration, CPI inflation for 2024-25 is projected at 4.8 per cent with Q3 at 5.7 per cent; and Q4 at 4.5 per cent. CPI inflation for Q1:2025-26 is projected at 4.6 per cent; and Q2 at 4.0 per cent (Chart 2). The risks are evenly balanced. Based on early results of October-December 2024 Round of Reserve Bank’s enterprise surveys. Rationale for Monetary Policy Decisions
9. The MPC noted that the near-term inflation and growth outcomes in India have turned somewhat adverse since the October policy. Going forward, however, economic activity is set to improve along with rising business and consumer sentiments, as reflected in the Reserve Bank’s surveys. The recent spike in inflation highlights the continuing risks of multiple and overlapping shocks to the inflation outlook and expectations. Heightened geo-political uncertainties and financial market volatility add further upside risks to inflation. High inflation reduces the purchasing power of both rural and urban consumers and may adversely impact private consumption. The MPC emphasises that strong foundations for high growth can be secured only with durable price stability. The MPC remains committed to restoring the balance between inflation and growth in the overall interest of the economy. Accordingly, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting. The MPC also decided to continue with the neutral stance of monetary policy as it provides flexibility to monitor the progress and outlook on disinflation and growth and to act appropriately. The MPC remains unambiguously focused on a durable alignment of inflation with the target, while supporting growth.
10. Shri Saugata Bhattacharya, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50 per cent. Dr. Nagesh Kumar and Professor Ram Singh voted to reduce the policy repo rate by 25 basis points.
11. Dr. Nagesh Kumar, Shri Saugata Bhattacharya, Professor Ram Singh, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted for continuing with the neutral stance of monetary policy and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.
12. The minutes of the MPC’s meeting will be published on December 20, 2024.
13. The next meeting of the MPC is scheduled during February 5 to 7, 2025. Voting on the Resolution to keep the policy repo rate unchanged at 6.50 per cent Member Vote Dr. Nagesh Kumar No Shri Saugata Bhattacharya Yes Prof. Ram Singh No Dr. Rajiv Ranjan Yes Dr. Michael Debabrata Patra Yes Shri Shaktikanta Das Yes Statement by Dr. Nagesh Kumar
14. Since the October 2024 MPC Meeting, economic conditions have worsened dramatically on both economic growth and inflation fronts. At the last meeting, I had expressed my concerns about the growth slowdown and the need to support it through a cut in policy rates. The decline in the Q2 2024-25 growth numbers from 8.2% achieved in 2023-24 and from 6.7% on Q1 2024-25 to just 5.4% is much sharper than expected. The slowdown has led to the downgrading of the GDP growth forecasts for 2024-25 by most analysts from around 7% earlier to around 6.5% now. The RBI has downgraded it to 6.6% from 7.2% earlier. The extent of the slowdown is serious enough to warrant policy attention.
15. The slowdown largely reflects the weakness of the industrial sector. The growth rate of agriculture value added has actually improved from 2.0% in Q1 2024-25 to 3.5% in Q2. The services growth has moderated slightly from 7.7% in Q1 to 7.1% in Q2, while the growth rate of industrial value added has decelerated sharply from 7.4% in Q1 to only 2.1% in Q2. All the subsectors of the industry, namely mining, manufacturing and electricity, have decelerated. What is most worrying is the deceleration of growth of manufacturing value added from 7.0% to 2.2%. The corporate performance indicators corroborate the deceleration of manufacturing growth. The sales growth of manufacturing companies has moderated from 6.2% in Q1 to 3.3% in Q2. In particular, negative growth rates in iron & steel and cement are worrying. The listed private non-financial corporate performance results also suggest that manufacturing GVA growth decelerated from 11.7% (y-o-y) in Q1 to 5.0% in Q2. They also indicate the softening of corporate profit margins and corporate tax collections coming down for listed private manufacturing companies. The early results of Enterprise surveys suggest that seasonally adjusted capacity utilization declined from 75.8% in Q1 to 74.7% in Q2. There is also a trend towards deleveraging with the moderation of the total cost of projects sanctioned by banks and financial institutions. As a result of the slowdown of industrial activity, the employment sentiment deteriorated in Q2.
16. The factors driving growth slowdown are the slowdown of both consumption and investment. While government consumption has come out of elections-related squeeze of -0.2% in Q1 to a 4.4% growth in Q2, the growth of private consumption expenditure has moderated from 7.4% in Q1 to 6.0% in Q2. The fixed investment growth has declined from 7.5% in Q1 to 5.4% in Q2. The export demand has also declined from 8.7% in Q1 to just 2.8% in Q2. Although merchandise exports registered an impressive growth of 17.2% in October 2024, one has to see if the buoyancy sustains given the tendency of export figures to fluctuate wildly from month-to-month and were squeezing by -2.0% in July, -9.7% in August, and stayed rather flat at 0.4% in September 2024.
17. On the other hand, inflation, which was seemingly restrained in September, has hit 6.2% in October, a 14-month high. So, we find ourselves in a slow growth, high inflation scenario. However, inflation is largely on account of food prices, which have a rather high weight in the CPI. In particular, it is tomatoes, onions, and potatoes (TOP) which are largely responsible for the high inflation observed recently. As per the data from the Department of Consumer Affairs (DCA), price momentum for vegetables (TOP) went up from 0.7% in September 2024 to 14.0% in October but was easing to -4.4% in November 2024. DCA’s edible oil prices had also shown a high price momentum of 8.6% in October 2024 from 1.8% in September but eased down to 3.7% in November. Excluding food, the CPI headline comes down to just 3.1% in October 2024. Keeping in mind the easing of vegetables and edible oil in November, food inflation should be easing further in the coming months. Core inflation persistence has declined over time, suggesting an improving anchoring of inflationary expectations.
18. The policy responses to address the challenges of high inflation and growth slowdown should look into their determinants. Monetary policy, being a demand management tool, has limitations in addressing inflation largely driven by a supply- side shock driving up vegetable prices. The high vegetable prices represent an essentially seasonal supply-demand mismatch that has started to correct itself in November 2024.
19. On the other hand, the slowdown of the manufacturing sector can be addressed by bringing down the cost of capital, which may stimulate investments as well as consumer demand. Hence, a rate cut could help, among other measures. Expanding the manufacturing sector could also help in containing inflationary pressures by enhancing the supply capacity.
20. Most of the central banks around the world, barring a few, have embarked on an easing cycle in recent months, with some, like the US Fed, adopting a rather aggressive posture towards cutting the policy rates. India risks currency appreciation if we do not follow the process of normalisation when most others have moved forward. The rupee has already been appreciating in real terms, and a further appreciation would hurt the competitiveness of Indian products.
21. Therefore, I believe that a rate cut would help in reviving economic growth without worsening the inflationary situation, which may soften with seasonal correction in prices. Hence, I will again vote for a 25-basis point cut in the repo rate while keeping a neutral stance. In addition, we should also explore the use of non-rate measures for enhancing liquidity, such as a 50-basis point cut in CRR, to help enhance liquidity. Statement by Shri Saugata Bhattacharya
22. Among the multiple economic and financial developments informing a difficult voting decision, extracting interpretable signals from the set of factors underlying the unexpectedly sharp Q2 FY25 real GDP growth slowdown was, square and centre, the primary one. Was this slowdown transitory or a harbinger of some deeper underlying trend? Leading indicators broadly suggest the former, while highlighting some specific weaknesses. RBI nowcasts show a revival in Q3 growth outlook consistent with its FY25 GDP 6.6% forecast. Both data and surveys also point to expectations of an improving growth – inflation balance in the second half of FY25. Yet, we also note that some indicators keep alive niggling doubts.
23. Second, what is the extent of the growth sacrifice induced by inflation-focused tight monetary policy conditions? This is a complex question, necessitating a decomposition of transient, idiosyncratic, cyclical, policy-related and structural components underlying this slowdown. This is further complicated by the ongoing transmission of the previous easing cycle. A study provides some quantitative insights on the transmission effects of repo rate actions. 2 This study estimates that the macroeconomic impact of the cumulative 250 basis points increase in the repo rate since May 2022 was comparatively much smaller on aggregate demand while having a more significant effect on reducing headline inflation and inflation expectations. In addition, the “Impulse Response Functions (250 bps Shock to Policy Rate)” show that the largest adverse impacts on aggregate demand had been in FY23 and FY24, before tapering off in H1 FY25.
24. Third, among the factors widely reported to have contributed to the growth slowdown, high interest costs are increasingly hypothesised as the proximate one. This is a serious issue and deserves a more granular dissection. A priori, we would have expected that smaller companies have been more adversely affected. Based on the 2Q FY25 results of listed non-Govt non-finance (NGNF) companies 3, we calculate interest costs to EBIDTA ratios for smaller (with sales of less than Rs 100 crs), mid-size (Rs 100-1,000 crs) and large (greater than Rs. 1,000 crs) companies. For smaller companies, interest costs to EBIDTA are indeed high, but have fallen from a high of 46% in Q3 FY24 to 38% in Q2 FY25. The ratio for mid-sized companies has moderated from 25% to 18% and has remained stable for large companies at 11-12%. However, the share of smaller and mid-sized companies in total interest expenses is only about 9-11%; hence, they are unlikely to have contributed significantly to the growth slowdown. In no way, however, does this detract from the need to reduce interest costs for small enterprises.
25. Fourth, in my October ’24 statement, I had noted: “Retail credit, conjectured (albeit untested) to be a driver of consumption demand, while slowing, still remains robust.” Macro-prudential regulations have resulted in slowing growth in some of these segments, probably reducing the consumption stimulus. I remain unconvinced, though, given potential risks to financial stability, that lower policy rates are an antidote to this particular causal factor. Unquestionably, however, the flow of credit to micro and small enterprises needs to increase. This will require a coordinated policy response, one of which might be through augmenting system liquidity.
26. Fifth, the growth – inflation balance, from being “well-poised” as noted in RBI Governor’s October ’24 statement, has, in my view, turned adverse on both growth (as elaborated above) and inflation. The October CPI inflation printed at 6.2% (above the tolerance ceiling), following a 5.5% readout for September. Although largely the result of high prices of a few vegetables, other food components are also becoming more expensive. Preliminary data suggest that food price inflation for November, while moderating, is expected to remain elevated.
27. Globally, prices of edible oils have risen sharply. The FAO Food Price Index had surged to its highest level in 18 months in October ’24, up 5.5% yoy. This was led largely by vegetable oils, but also dairy products and sugar. High edible oils prices are also manifest in India. Prices of other agri-related inputs like non-edible oils (which are inputs into personal care products, confectionary, etc.) have also increased. These might eventually feed into consumer goods prices. IMD has Patra, M. D. et al, “Monetary Policy Transmission in India: The Recent Experience”, RBI Monthly Bulletin, October 2024, pp. 189-201. Capitaline forecast 4 that “during the upcoming winter season (December 2024 to February 2025), above-normal minimum temperatures are likely over most parts of the country”; this, I am told, does not augur well for rabi crop yields. Core inflation has also started to creep up. Various surveys also suggest that prices of non-farm inputs have risen and are expected to remain elevated; so are services prices.
28. Sixth, the effects of heightened uncertainty, largely emanating from global sources, on domestic macro-economic and macro-financial metrics have increased. Spillovers have already impacted domestic financial conditions, which, going forward, might affect economic activity. It is worth emphasising that financial channels influence domestic monetary policy through the well-established trilemma of open economy macroeconomics. The present neutral stance provides the flexibility to respond quickly and appropriately to evolving economic conditions.
29. The prevailing economic conditions bring to mind a phrase a former RBI Governor had invoked in a different context: “Festina Lente”, Latin for “make haste slowly”. This is now apposite for guiding policy decisions. I had earlier noted the risk of making a “policy error” in my October ’24 statement; if anything, this risk has now increased.
30. Accordingly, based on my assessment of the appropriate response to the increasing complexity of the economic environment, I vote to keep the repo rate unchanged at 6.5 per cent, while continuing with the neutral monetary policy stance. Statement by Prof Ram Singh
31. In my view, the following questions warrant the attention of the MPC: Is there a strong case for a shift in the monetary policy (MP) in response to the recent developments on inflation and growth fronts, domestically and internationally? How are wages and prices likely to play out in the short term and impact inflation growth trade-offs? What is the nature of the relation between the short-term and the long- term inflation growth trade-offs for the Indian economy? What are the implications of the elevated uncertainty for the MP?
32. Though elevated, the inflation trajectory remains along the projected/expected lines. As we advance, food inflation is likely to soften in Q4:2024-25, and energy prices are also expected to be stable in the near future. Overall, CPI inflation for 2024-25, projected at 4.8 per cent, is within the tolerance band though above the 4.0 per cent target. The risks are evenly balanced.
33. Moreover, by now it is widely accepted that vegetable prices are essentially a supply-side phenomenon. Interest rates have little bearing on the volatility in fruits and vegetables prices. During the last ten years, changes in repo rates seem to have made little difference to vegetable price volatility. Specifically, the elevated interest rates during the last ten quarters had no significant effect on price volatility, especially of TOP (tomato, onion and potato) vegetables, the primary source of volatility in headline inflation.
34. Therefore, the question becomes: Does the food inflation transmit to the core inflation?
35. There is empirical evidence that the impact of food inflation on core inflation has significantly reduced in recent years suggesting that the wages and price-setting https://internal.imd.gov.in/press_release/20241202_pr_3452. pdf mechanisms warrant a serious reexamination. The effectiveness of the main channel of transmitting food inflation to core inflation, i.e., the food price-induced increases in wages, has reduced in recent years. The result is a duality - significant divergence between the food and core inflations. During the last nine quarters, while the food prices remained elevated, the CPI core has remained below the price inflation target of 4%. A significant part of this divergence is attributable to slacks (weak wage growth) and other frictions in the labour and food product markets.
36. Moreover, the CPI inflation figures used by the MPC are somewhat higher than what would follow if the share of food and beverages (45.86%) was in line with the total household consumption expenditure (MPCE) data. Even with current weights, core inflation is at 3.8%. From April to October 2024, the CPI excluding TOP, Gold, and Silver on an average stood at 3.80%, whereas the core inflation rate (%) excluding Gold and Silver was on an average at 2.84%. GDP Growth
37. The GDP growth rate has hit a seven-quarter low of 5.4% in Q2 amid a manufacturing slump and deceleration in private consumption and investment. The GVA, a critical indicator of economic activity, also came at 5.6 per cent in Q2. Accordingly, the RBI has lowered the GDP growth forecast to 6.6 per cent, down significantly from earlier projections of 7.2 per cent.
38. The MPC's mandate is to ensure price stability while supporting growth. The present situation of significantly slower growth without material changes in the prospects for inflation requires shifting the pivot of monetary policy to a counter- cyclical mode.
39. The empirical relation between the core inflation and GDP growth rate (actual and potential) is well established. A persistent decrease in the core inflation during the last 7-8 quarters, combined with the slowdown in growth rate, suggests that the difference between the actual and potential growth rate is increasing. These observations and the fact that the labour market is not tight mean that the economy can grow significantly faster without triggering inflation.
40. From another perspective, the difference between the core inflation (<4%) and the policy rate (at 6.5 %) has been more than 2.5% for over a year now; this makes for a restrictive monetary regime. Further, the existing policy rates are more than two percentage points higher even when compared to the estimated average CPI inflation for the next four quarters - CPI inflation for 2024-25 Q3 at 5.7 per cent and Q4 at 4.5 per cent. For 2025-26, Q1 is projected at 4.6 per cent, and Q2 at 4.0 per cent. Therefore, the forward-looking policy rate is greater than the neutral R-star.
41. When the correlation between food prices and core inflation is weak at best and the share of items contributing to inflation has come down, keeping interest rates elevated to keep overall inflation closer to the target imposes growth costs that are disproportionate to the gains on the prices front.
42. Several indicators point to a slowing economy. Nominal sales growth of listed private manufacturing companies has fallen to 3.3% in Q2: 2024-25. Operating profit margins have moderated for manufacturing and non-IT services while the staff cost has seen only a modest increase even after factoring in the additional jobs. The flow of financial resources to the commercial sector has slowed noticeably, and the total costs of bank/FIs-funded projects have come down. The leverage ratio of companies surveyed by the RBI has reduced from almost 35% in H1: 2022-23 to 29.5% in H1: 2024-25.
43. A rate cut will reduce the costs of doing business and increase the opportunity cost of holding on to cash for firms and companies. Hopefully, this will boost companies' investment plans and improve the scope of employment-linked incentive schemes helping induce a virtual cycle of wage growth and demand. By tightening the labour market, it will also improve efficacy of the MP.
44. A growth-supportive monetary policy is also consistent with the international scenario. In most of big developed markets, the central banks have already cut benchmark interest rates. China's central bank has also cut interest rates. Furthermore, the currencies of several Asian countries, including our competitors, including China, are depreciating against the USD. Expectation of low crude prices is expected to provide further elbowroom for rate cuts by the RBI.
45. While deciding on short-term inflation-growth trade-offs, MP must factor in the long-term implications of the decisions made today. How we address the short-term inflation-growth trade-offs has implications for the long-term growth path. High growth rate, by providing meaningful employment to the millions on the job, boosts demand while reducing supply-side constraints.
46. There will always be uncertainty about the path of inflation and the appropriate policy rates. Due to increases in the capital intensity of production processes due to advances in ICT and AI, the employment elasticity of output is likely to fall in the future. As such, we have a limited window of 10-15 years to capitalise on the demographic dividend. So, the imperative is high growth rate while minimising the likelihood of extreme scenarios on the inflation front.
47. In a world with heightened uncertainty, if the MP were to use insights from research in the areas of Rules-versus-Standards and Regulation under Uncertainty, it would be more plausible to aim for price stability within a range rather than aiming to bring CPI inflation to a point target of 4%. The costs of trying to shoot at the point target in every state of the uncertainty ridden future can be unjustifiably high.
48. Considering all these factors, I vote to: • Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.25 per cent. • Maintain the monetary policy stance to ‘neutral’. Statement by Dr. Rajiv Ranjan
49. In my August 2024 statement, I had stated that we could see a window opening up for monetary policy to change its course, which materialised in October 2024 as the risk-reward for a change in stance to neutral was favorable then. Subsequently, in my October 2024 statement, I had mentioned that the neutral stance would allow flexibility to adapt and operate in accordance with the evolving situation. Since then, however, incoming data seems to have disturbed the balance between inflation and growth, thereby pushing ahead the space to normalise policy rate that was opening up. Let me elaborate on this based on the global and domestic perspective.
50. Globally, the easing cycle is quite guarded notwithstanding the fact that the tightening was unprecedented in many dimensions. 5 The challenges to policy makers are aggravated predominantly because of the uncertainty that is prevailing on various fronts keeping the financial markets on razor’s edge. Even though many economies, who have had historical high policy rates or face severe sharp slowdown, have begun cutting policy rates, they remain cautious, maintaining a restrictive stance due to lingering uncertainty about inflation aligning sustainably with their targets. The last mile of disinflation is turning out to be trickier for many systemic and inflation targeting countries, slowing down the number and size of their rate cuts. With incoming data giving mixed signals, central banks are increasingly getting unintentionally checkmated by their own communication or rate action. Meanwhile, there are also countries like Australia, Norway and Malaysia, which had raised rates in a calibrated manner during their tightening cycle and are now holding back till their economic conditions become favorable to start the easing cycle.
51. On the domestic front, the inflation-growth balance turned adverse since the last policy in October. While inflation has surprised on the upside, growth has also surprised on the downside. As per our assessment, both are likely to reverse their course in the near future. At this juncture, confirmation of durable softening of inflation in the coming months is important. The critical factor would be the ongoing rabi season which will give us the clarity about the expected correction in food prices. Early indications point to a good start for crop sowing, adequate reservoir levels and good soil moisture conditions. We also need to be sure that the moderation in growth in Q2 was just one-off and the economy will recover on projected lines. Agriculture and government spending growth is expected to be much stronger and we expect around 7 per cent growth on average in the second half of 2024-25.
52. In this context, sequencing and timing of measures are very important for its effectiveness as witnessed during the pandemic time easing and post pandemic tightening. After the change in stance to neutral in the last meeting, addressing liquidity conditions to ensure adequate systemic liquidity seems more appropriate sequentially. Thus, a cash reserve ratio (CRR) cut of 50 bps by the Reserve Bank is appropriate at this juncture as it will provide durable liquidity to banks and keep the money market rate well aligned with the repo rate. It will also facilitate improvement in transmission, once the rate easing cycle sets in. This move is consistent with the neutral stance and will normalise the CRR to its pre-policy tightening and pre- pandemic level of 4 per cent of net demand and time liabilities (NDTL). The multiplier effect of the CRR cut would have an expansionary impact on deposit and credit over an extended period. A deft mix of policy tools, if timed and sequenced well, can best address the current challenging situation.
53. To conclude, amidst difficult policy trade-offs, our cautious and calibrated approach has kept us in good stead. Related literature shows that during periods of heightened uncertainty with mixed data signals, conservatism and cautious approach can be useful. 6 The need of the hour is to be watchful of the forthcoming data to ascertain the projected improvement in the balance between inflation and growth outlook. If food price pressures wane on projected lines, this would open up the policy space to normalise rates. Our neutral stance provides the flexibility to respond Forbes K (2024), “Monetary Policy in an era of transformation: Rate Cycles”, ECB Forum on Central Banking, July. Cacciatore, Matteo; Matveev, Dmitry; Sekkel, Rodrigo (2022): Uncertainty and Monetary policy experimentation: Empirical challenges and insights from academic literature, Bank of Canada Staff Discussion Paper, No. 2022-9. to the evolving situation. Accordingly, I vote for a status quo on rates and stance in this meeting. Statement by Dr. Michael Debabrata Patra
54. The estimates of national accounts in India for the second quarter of 2024-25 reveal the corrosive power of repeated inflation shocks on economic activity. On the supply side, the drag from manufacturing performance shows the toll that persisting price pressures are taking on the urban consumer’s spending capacity. In turn, this is depressing sales growth among non-financial corporations and slowing down capex plans – as evident in the deceleration in gross capital formation – since corporates’ outlook for demand remains tainted by inflation. There may be wider ramifications on investment activity if slower growth in nominal GDP prompts expenditures on capital outlays to be pruned to ensure the achievement of fiscal targets. The prospects for the second half of the year are brighter than the outturn for the first half. It is now that efforts must be made to bring down inflation and revive consumption and investment spending.
55. Food price pressures are typically treated as transitory; however, if these shocks are not followed by reversals in the form of price declines, the pressures remain in the consumer price index and influence its evolution. Consequently, the readings for November and December are also expected to remain elevated, delaying the convergence of outcomes with the target. Households’ inflation perceptions and a year ahead expectations have ticked up, and consumer pessimism on the inflation situation has increased. Professional forecasters have revised their inflation projections upwards and lowered growth projections. Clearly, the fears of complacency due to sub-target outcomes for July and August are coming to roost. What is worrying is that core inflation has edged up by 70 basis points from its July low. There are early signs of second order effects or spill overs of high primary food prices – following the surge in prices of edible oils, inflation in respect of processed food prices is starting to see an uptick. The pick-up in price rises of household services like those of domestic helps/cooks also reflects higher cost of living pressures due to elevated food prices beginning to transmit to these specific wages. In this environment, the hardening of input costs across goods and services and their flow into selling prices needs to be watched carefully. If allowed to run unchecked, it can further undermine the prospects of the real economy, especially industry and exports.
56. It is a durable reduction in inflationary pressures that can rekindle the impulses of growth in a sustained manner. The expected winter easing of food prices may provide the turning point. With the prospects for private consumption expected to improve over the rest of the year, the key is to get investment going, since exports are hostage to a difficult external environment. Private investment will want to see a robust revival of domestic demand to draw in the slack that it is now experiencing. The monetary policy stance is open to support growth, but it must await the ebbing of inflation on a durable basis or else the uneven progress made so far in disinflation will get dissipated. Accordingly, I vote to maintain status quo on the policy rate and persevere with a neutral stance in this meeting. Statement by Shri Shaktikanta Das
57. The Indian economy remains resilient, notwithstanding the lower GDP data for Q2 of 2024-25. The direction of inflation is downwards, although the path is interrupted by periodic humps due to food inflation. As a result, the inflation growth balance has got somewhat unsettled now.
58. The latest high frequency indicators suggest that economic activity is recovering in Q3. Rabi sowing has exceeded previous year’s level and high reservoir levels augur well for the overall rabi output. With the expected pick up in government capital expenditure and end of monsoon related disruptions, industrial activity is expected to normalise and recover from the lows of the previous quarter. Services activity remains buoyant. On the demand side, consumption and investment is expected to pick up in the second half of the financial year on the back of factors like improving agricultural outlook, higher government expenditure, steady services sector growth, etc. Improving global trade volume will provide support to external demand. Overall, the real GDP growth is projected to be higher in the second half of the year at 7.1 per cent and for full year at 6.6 per cent.
59. A sharp accentuation in food inflation pressures led to headline inflation moving above the upper tolerance level of 6 per cent in October from sub-4 per cent levels in July-August. While primarily emanating from the spike in vegetable prices, the sharp pick-up in edible oil prices due to levy of import duties and continuing stickiness in cereals inflation also added to the surge in food inflation in October. Core inflation, though muted, also registered a sequential uptick during September-October 2024. Though, yet again, supply side shocks in food have interrupted the ongoing disinflation towards the target rate, moderation in food inflation can be expected in Q4:2024-25 due to correction in vegetables prices, robust kharif harvest arrivals, a likely good rabi crop and adequate cereal buffer stocks. Core inflation is likely to remain broadly contained as the disinflationary effect of past monetary policy actions continues to play out. On balance, headline inflation is expected to ease to 4.5 per cent in Q4:2023-24 and further to 4.0 per cent by Q2:2025-26.
60. In my overall assessment, the gains achieved so far in the broad direction of disinflation need to be preserved, while closely monitoring the evolving outlook of both inflation and growth. The flexibility inherent in the neutral stance of monetary policy gives us the space to monitor the incoming data and assess the outlook for confirmation of our expectations on the fronts of inflation and growth.
61. The policy priority at this critical juncture has to be on restoring the inflation- growth balance. The fundamental requirement now is to bring down inflation and align it with the target. Lower inflation will enhance disposable income with households and increase their purchasing power. Such an approach would support consumption and investment demand. Without addressing this core issue, it would not be possible to foster sustainable growth. As I have pointed out on several occasions, the biggest support for higher growth would come from price stability. Prudence and practicality demand that we now continue with the neutral stance of monetary policy and keep the repo rate unchanged at 6.50 per cent. Accordingly, I vote for the same. Any other approach would be counterproductive and a case of inappropriate timing. (Puneet Pancholy) Press Release: 2024-2025/1748 Chief General Manager
6. The global economy is growing below the historical average even though high frequency indicators suggest resilience amidst continued expansion in world trade. The world economic landscape remains challenging with slower pace of disinflation, lingering geopolitical tensions and policy uncertainties. The strong dollar, inter alia, continues to strain emerging market currencies and enhance volatility in financial markets.
7. On the domestic front, as per the First Advance Estimates (FAE), real gross domestic product (GDP) is estimated to grow at 6.4 per cent (y-o-y) in 2024-25 supported by a recovery in private consumption. On the supply side, growth is supported by the services sector and a recovery in agriculture sector, while tepid industrial growth is a drag.
8. Looking ahead, healthy rabi prospects and an expected recovery in industrial activity should support economic growth in 2025-26. Among the key drivers on the demand side, household consumption is expected to remain robust aided by the tax relief in the Union Budget 2025-26. Fixed investment is expected to recover, supported by higher capacity utilisation levels, healthy balance sheets of financial institutions and corporates, and Government’s continued emphasis on capital expenditure. This is corroborated by positive business sentiments highlighted in the Reserve Bank’s enterprise surveys and PMIs. Resilient services exports will continue to support growth. However, headwinds from geo-political tensions, protectionist trade policies, volatility in international commodity prices and financial market uncertainties, continue to pose downside risks to the outlook. Taking all these factors into consideration, real GDP growth for 2025-26 is projected at 6.7 per cent with Q1 at 6.7 per cent; Q2 at 7.0 per cent; and Q3 and Q4 at 6.5 per cent each (Chart 1). The risks are evenly balanced.
9. Headline inflation softened sequentially in November-December 2024 from its recent peak of 6.2 per cent in October. The moderation in food inflation, as vegetable price inflation came off from its October high, drove the decline in headline inflation. Core inflation remained subdued across goods and services components and the fuel group continued to be in deflation.
10. Going ahead, food inflation pressures, absent any supply side shock, should see a significant softening due to good kharif production, winter-easing in vegetable prices and favourable rabi crop prospects. Core inflation is expected to rise but remain moderate. Continued uncertainty in global financial markets coupled with volatility in energy prices and adverse weather events presents upside risks to the inflation trajectory. Taking all these factors into consideration, CPI inflation for 2024-25 is projected at 4.8 per cent with Q4 at 4.4 per cent. Assuming a normal monsoon next year, CPI inflation for 2025-26 is projected at 4.2 per cent with Q1 at 4.5 per cent; Q2 at 4.0 per cent; Q3 at 3.8 per cent; and Q4 at 4.2 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
11. The MPC noted that inflation has declined. Supported by a favourable outlook on food and continuing transmission of past monetary policy actions, it is expected to further moderate in 2025-26, gradually aligning with the target. The MPC also noted that though growth is expected to recover from the low of Q2:2024-25, it is much below that of last year. These growth-inflation dynamics open up policy space for the MPC to support growth, while remaining focussed on aligning inflation with the target. Accordingly, the MPC unanimously voted to reduce the policy repo rate by 25 basis points to 6.25 per cent.
12. At the same time, excessive volatility in global financial markets and continued uncertainties about global trade policies coupled with adverse weather events pose risks to the growth and inflation outlook. This calls for the MPC to remain watchful. Accordingly, the MPC unanimously voted to continue with a neutral stance. This will provide MPC the flexibility to respond to the evolving macroeconomic environment.
13. The minutes of the MPC’s meeting will be published on February 21, 2025.
14. The next meeting of the MPC is scheduled during April 7 to 9, 2025. Voting on the Resolution to reduce the policy repo rate to 6.25 per cent Member Vote Shri Sanjay Malhotra Yes Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Dr. Rajiv Ranjan Yes Shri M. Rajeshwar Rao Yes Statement by Dr. Nagesh Kumar
15. I have been concerned with the economy's slowdown since the October 2024 Meeting of the MPC and have been making a case for a rate cut to support growth. Over the past few months, one has observed with concern the deepening of the growth slowdown, which has led to the downgrading of the growth outlook for 2024-25 by RBI from 7.2% in October 2024 policy to 6.6% in December 2024 to 6.4% now, as per the NSO’s first advanced estimate, i.e. 80 basis points downgrading in a matter of four months!
16. In particular, the slowdown reflects the weakness of the manufacturing sector, as the services sector continues to grow robustly, and agriculture growth performance has improved in the current year. The slowdown of the manufacturing sector is a matter of concern, given its role in the creation of decent jobs for our youthful population.
17. Several pointers corroborate the weakness of the manufacturing sector, including the performance of listed companies, which shows that the sales growth of manufacturing companies continued to remain weak despite improved profit margins, with the core sectors like iron & steel, cement, and petroleum products continued to report negative growth or are shrinking. The business assessment index for manufacturing enterprises in Q3:2024-25 remained close to their levels in the previous quarter.
18. The slowdown of the manufacturing sector is resulting from moderate urban consumption affecting demand for durable goods, and slow growth of private investment, as also corroborated by the Economic Survey presented on 31 January 2025 by the Government of India. The external environment has also turned less benign with the subdued performance of the global economy and international trade and investments. The average annual growth rate of world trade has come down from around 16-20% during 2003-2008/09 which supported the emergence of China as a global manufacturing hub, to just 3-4 %.1 This year it is expected to be around 3.4%, as per the projections of the UN, IMF and the World Bank. Then there is a trend of rising protectionism with major industrialized countries such as the US pursuing industrial policy very aggressively with more than a trillion dollars to be given to the industry in the form of tax breaks, incentives and subsidies under the Inflation Reduction Act, the Chips Act and the Infrastructure and Jobs Act. With Mr Trump as the President, this trend of protectionism is only expected to be accentuated further. It is also too early to expect that India will be spared while tariffs will be slapped on Mexico, Canada and China! There are widespread fears of the world economy going into a deep and prolonged slump with such protectionist trade policies.
19. There is also concern about a threat of dumping of excess capacities in China with their deep pockets and their access to the Western markets coming under a cloud. Some of our manufacturing sectors have begun to feel the pinch including steel (possibly explaining the negative growth) while labour-intensive consumer sectors, such as garments and leather goods have been facing an onslaught. As the latest Economic Survey shows, FDI inflows have been subdued, with foreign investors both FDI and FPIs repatriating, leaving little investments in net terms.
20. Therefore, the case for supporting growth cannot be overemphasised. In the Union Budget 2025-26 presented on 1 February 2025, the fiscal policy has done its 1 ISID (2025) India Industrial Development Report 2024-25, New Delhi: Academic Foundation for Institute for Studies in Industrial Development (ISID). bit by sustaining the public investment (capex) and through income tax concessions to the middle-income groups to enhance disposable incomes to augment consumption. It is now monetary policy's turn to support economic growth through a rate cut. A rate cut could help to spur demand for investment in housing and durable consumption goods and could support private investment by lowering the cost of capital.
21. Fortunately, the inflation outlook has moderated since the last MPC which provides the elbow room for a rate cut. The inflation for January 2025 is expected to be sub 5% vis-a-vis 6.2% in October 2024. The CPI headline has come down to 5.2% in December from 5.5% in November. But CPI excluding food and fuel continues to stay at 3.7%. The bulk of the inflation, therefore, is on account of food prices, especially vegetable prices, which result from seasonal demand-supply mismatches that correct themselves. As I have argued in the previous meetings, monetary policy has limitations in addressing the demand-supply mismatches in vegetables. Fortunately, the food prices have started to ease. Furthermore, the Union Budget has accelerated the path to fiscal consolidation by limiting the fiscal deficit to just 4.4% of GDP for 2025- 26.
22. Globally commodity prices are softening due to several factors. The crude oil prices are likely to head downwards due to the Chinese slowdown, the recently announced ceasefire in the Middle East with the prospects of the Ukraine conflict also brightening with the Trump 2.0 Presidency which is also likely to enhance the US output of oil and growing dependence on renewables.
23. Considering the seriousness of the growth slowdown and the elbow room provided by moderating the inflationary outlook, I strongly feel that the MPC should begin the process of normalisation of the monetary policy with a rate cut. We could be more ambitious and target a 50 basis point cut. It would send a signal to the markets and private investors within and outside the country that India is serious and would do whatever it takes to revive economic growth momentum.
24. However, given the global uncertainties, for the present policy I vote for a 25 basis point cut in the repo rate while keeping the neutral stance. Statement by Shri Saugata Bhattacharya
25. Directionally, two important macroeconomic indicators, viz. growth and inflation, have moved favourably since the meeting of Monetary Policy Committee (MPC) in December 2024.
26. First, domestic economic activity has improved post the GDP growth low of Q2 FY25. The NSO Advance Estimates of GDP FY25 imply H2 GDP growth at 6.7%. The RBI’s FY26 GDP forecast is 6.7% yoy; the Economic Survey projects 6.3 – 6.8%. Second, inflationary pressures appear to be gradually receding. The high 6.2% yoy CPI October ’24 inflation print, which was the proximate factor influencing my vote at the Dec ’24 MPC meeting, has since moderated to 5.2% in Dec ’24.
27. Despite the improvement in these two indicators there are two pertinent questions.
28. First, the issue of growth. Preliminary Q3 FY25 financial results of listed manufacturing companies show growth in net sales barely holding up, while operating and net profits growth remain under pressure. Although many high frequency indicators remain resilient, they are weaker than in previous years. While January ‘25 PMIs show continuing economic resilience, the responses in central bank and private surveys present a mixed picture, again particularly for manufacturing. In other words, there are sufficient signals suggesting the need to support both consumption and investment led growth.
29. It is important to keep in mind the possible spillovers of frictions in global trade and protectionist policies. A global growth slowdown led by disruptions in trade linkages and uncertainty about responses of global central banks might further complicate domestic policy choices. The most significant near-term risk of accelerating policy easing at this juncture is renewed volatility in external financial conditions.
30. Second, on inflation, there is a certain degree of optimism. The FAO Food Price Index had trended down in December ‘24, with, notably, edible oils prices off their highs. Major metals prices have also fallen or remain stable. The IEA assesses2 that non-OPEC+ oil output “additions should cover both potential supply disruptions and expected demand growth”. While unpredictable, the balance of probability is that high oil prices will not be a significant risk to the medium-term inflation forecast. The January ’25 print is widely expected by analysts to be sub-5% yoy. RBI forecasts CPI inflation for FY26 at 4.2%, with a (slightly wobbly) glide path down to 4.2% in Q4 FY26 (and average 4.0% in H2 FY26). The median forecast for CPI “core” (that excludes ‘Food & Beverages’, ‘Fuel & Light’ and ‘Pan, Tobacco & Intoxicants’) inflation in the Survey of Professional Forecasters (SPF), while gradually creeping up to 4.1% in Q3 FY26, is, for the most part, lower than the headline CPI target for most quarters. This is likely to be important reinforcement for a durable alignment of headline inflation with the target in the medium term.
31. However, the 3- and 12-month ahead RBI Household Inflation Expectations (in the January ‘25 survey round) have inched up. The IIM Ahmedabad Business Inflation Survey December ’24 round shows that a majority of respondents expect one-year ahead input costs to rise sharply. Manufacturing and Services January ’25 PMI surveys also show both input and output prices rising, albeit in varying magnitudes, yet mostly above their long-term averages.
32. All things considered, I am now cautiously optimistic about the downward trajectory of inflation. I believe that, at this point, the required policy response on the inflation – growth trade-off – even factoring in significant margins of error from emerging risks – seems skewed in favour of the latter.
33. Given the forecast inflation trajectory, the policy repo rate might soon, if not even as of now, become excessively restrictive, thereby increasing the risk of cumulatively damaging growth impulses. This assessment is based on the last study3 of the “real natural rate of interest” that I am aware of.
34. One sector which is vital for stimulating economic activity is MSMEs. Bank credit to the “Micro and Small Enterprises” segment of MSMEs had slowed to 12.1% yoy as of December ‘24 vs 20.3% in the corresponding month a year back; in the manufacturing segment, from 14.8% to 9.8%. For me, this – a slowing momentum in credit flows to a priority segment – is a matter of concern. As I had noted in my minutes of the December ’24 MPC meeting, the ratio of interest expenses to EBIDTA for smaller listed companies remains high; for most small enterprises, this is likely to be significantly higher. One instrument for inducing increased demand for credit from this sector is lowering the borrowing cost. Transmission of a policy repo rate cut to borrowing costs for MSMEs, given EBLR pricing, is likely to be relatively quick. In addition, RBI’s liquidity infusion measures are likely to gradually ease MCLR-based borrowing costs, thereby reducing Weighted Average Lending Rates (WALR). 2 IEA, Oil Market Report, January 2025 3 Behera, H. K., “Updating Estimates of the Natural Rate of Interest for India with Post-Pandemic Evidence”, RBI Monthly Bulletin, July 2024.
35. A possible repercussion of policy easing might be an increase in currency volatility and a depreciation of the USDINR pair. This might not be a major cause for concern. A recent study4 estimates that if INR depreciates by 5%, CPI “inflation could be higher by around 35 bps” while GDP growth “could edge up by 25 bps through short-term stimulation of exports”. This should probably be treated as indicative, given the significant changes which have happened in the world since this study.
36. Accordingly, based on my assessment of the downward inflation trajectory, I vote to cut the repo rate by 25 bps to 6.25 per cent. This, I believe, is the appropriate policy response at this point of the economic cycle. I also vote to continue with the neutral monetary policy stance. This stance will provide the flexibility to appropriately respond to any emerging shocks and the resultant uncertainty in the economic environment. Statement by Prof Ram Singh
37. Since the December meeting of the MPC, we have received additional data related to the economy's inflation trajectory and growth prospects. Besides, there have been significant developments on the foreign exchange rates front. These macro data and related indicators underscore the case for a comprehensive review of the existing monetary policy (MP). Inflation
38. Following a predicted downward trajectory, the headline inflation in December 2024 was 5.2%, with CPI inflation excluding food and fuel at 3.7%. Prices of most farm produce and non-food commodities have moderated, except gold. Looking ahead, food inflation is likely to soften in Q4:2024-25, and energy prices are also expected to be stable in the near future. Overall, CPI inflation for 2024-25, projected at 4.8 per cent, is within the tolerance band though above the 4.0 per cent target.
39. The core goods and services inflation rates in December 2024 have remained moderate at 3.6% and 3.5%, respectively. The CPI core, excluding petrol, diesel, gold and silver, is down at 3.3%. For FY 2025-26, the CPI inflation is expected to be 4.2%.
40. The CPI headline inflation figures will appear even more benign if the shares of food and beverages in the CPI inflation are reduced to their levels observed in the Household Consumption and Expenditure Surveys (HCES) data of the recent vintages. As such, the headline Indian inflation rate is actually lower than the global average. GDP Growth
41. The RBI has significantly lowered the GDP growth forecast for FY25 from 7.2 to 6.4 per cent. In Q3:2024-25, the manufacturing sector sales growth remains subdued, and net profit margins have further moderated. For the IT sector, staff costs have only slightly increased even as headcount has reduced for top IT companies. The CU has not improved, and the interest coverage rate of non-IT service sector companies remains low, though above unity. Looking ahead, RBI’s enterprise survey indicates a moderate improvement in demand parameters regarding turnover and employees. The CU at 74.2 per cent in Q2:2024-25 is above the long-run average.
42. It is in this context that the Economic Survey 2024-25 has projected the GDP growth to be 6.4% in FY25 and between 6.3% and 6.8% in FY26. As per the first 4 RBI Monetary Policy Report, October 2024, Section 1.4: Balance of Risks Advanced Estimates, the real and nominal GDP are expected to grow at 6.4% and 9.7%, respectively, in FY25. In FY26, the nominal GDP is projected to grow by 10.1%. These figures underscore the downward trajectory on the inflation front.
43. Subdued private consumption due to a low growth rate of real wages is a factor behind the slowdown. However, excessively contractionary monetary policy has aggravated the problem. High interest rates and regulatory tightening have brought down the credit growth rate. The growth rate for bank credit has declined from 15.6% (y-o-y) in December 2023 to 12.4% in December 2024. This puts downward pressure on demand growth for several segments of the economy.
44. The moderated demand is often cited as the reason behind the slow recovery in private capex in this sector. While demand expectations are important for investment decisions, the high interest rates have raised the risk premium assigned to capital investments. This seems to be a leading factor behind the noticeable slowdown in the flow of funds to the commercial sector. Total costs of bank/FIs-funded projects have seen no appreciable increase. The aggregate bank credit growth rate remains low at 12.4% in December 2024. The rate for industry is even lower (7.4%) under very tight financial conditions overall.
45. The Union Budget 2025 has given a push to demand. However, demand push will not result in higher private capex unless interest rates are reduced immediately. The difference between the core inflation, excluding gold and silver (<4%), and the policy rate (at 6.5 %) has been more than 2.5% for the past year. This means the capex-relevant real interest rate is significantly greater than the growth-neutral real interest rate, R-star. Very high effective real interest rates for capital goods are a drag on private capex and a leading factor why the investment rates remain below what is needed for a high growth rate.
46. With reference to CPI inflation also, the policy rates are more than two percentage points higher than the CPI inflation forecast for the next five quarters – Q4: 2024-25 at 4.4 per cent, Q1: 2025-26 at 4.5 per cent, Q2: 2025-26 at 4.0 per cent, Q3 at 3.8 per cent and Q4 at 4.2 per cent; and FY: 2025-26 is at 4.2%. Undoubtedly, the present MP is contractionary.
47. The combination of a persistently low core inflation rate during the last two years and the slowdown in FY25 suggests that the actual growth is significantly below the potential growth rate.
48. Given the demand boost from Budget 2025, a rate cut powered by a commensurate increase in liquidity will decrease the risk premium demanded by investors, thereby boosting private investment to support growth. By reducing the cost of capital, the rate cut can increase the commercial viability of the public-private partnership schemes for warehouses, cold storage, and infrastructure logistics. By reducing the wastage of fruits and vegetables (the significant causes of inflation), such investments can help induce a virtuous cycle of faster growth and lower inflation.
49. Low core inflation strengthens the case for a rate cut, especially when food price inflation is expected to moderate further. To the extent that inflation risk arises from food prices, it is expected to have a limited impact on core inflation. During the last five quarters, the CPI core, excluding petrol, diesel, gold and silver, has remained mostly below the price inflation target of 4%.
50. In contrast, during the last ten years, including the eight years under the flexible inflation targeting framework of 2016, repo rates have had no significant effect on food prices or their volatility. This lends credence to the claims that food inflation is a primarily supply-side phenomenon.
51. Additionally, the persistent duality in the CPI – that is, a significant and persistent divergence between the food and core inflation levels in recent years – calls for the MPC to see through the fluctuations in food prices while setting policy rates. Further, food prices should be viewed in the broader context of the income-boosting effect of growth and the reduced share of food in the consumption basket, as is evident from the two consecutive rounds of HCES in 2023 and 2024.
52. Admittedly, a rate cut carries risks, too. It will reduce the interest rate differentials between India and the advanced economies (AEs). This, in principle, can increase outflows, putting pressure on the exchange rate. This, in turn, can result in imported inflation. Going by the data, this seems to be a rather low-probability scenario. During the last five years, the benchmark rate differentials between India and AEs have decreased. For instance, vis-à-vis the US, the policy rate differentials have decreased from almost 4% in 2020 to about 1.5% in September 2024 till the US Fed started rate cuts – the real policy rate differentials have also changed significantly. The increased differentials did not adversely affect inflows of USD, very likely due to strong growth fundamentals.
53. In the short run, several factors, including global uncertainty, can change the direction and quantum of capital flows. Interestingly, the recent months have witnessed outflows even as interest differentials between India and most of the AEs increased in the aftermath of rate cuts by the US Fed and other central banks starting September 2024. In any case, as most major economies have already reduced their interest rates, even accounting for the impact of interest rate differences, there is room for us to reduce policy rates without adversely affecting the foreign exchange flows.
54. The risk of imported inflation also does not seem very high. On one hand, some adjustments in the INR-USD exchange rate cannot be ruled out. On the other hand, according to the World Bank’s Commodity Markets Outlook, oil prices and other commodities are expected to decrease risk in CY 2025 and 2026. The effect of tariff hikes on India is difficult to predict. Overall, the risk of imported inflation appears to be low.
55. Considering the trade-offs discussed above, I vote to: • Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.25 per cent. • Maintain the monetary policy stance as ‘neutral’. Statement by Dr. Rajiv Ranjan
56. In my statement of August 2024, when June inflation number of 5.1 per cent was available and we were expecting around 4 per cent inflation numbers in July and August 2024, I had said that positive developments on inflation and growth front could open the window for monetary policy to change its course. But at the same time, more clarity and definiteness were needed as we were anticipating some price shocks in September and October, which turned out to be much higher than projected, delaying the opening of the window. In December, when the October number was available at 6.2 per cent, above the tolerance band, it was not credible and optical to ease policy rates. Thus, we preferred to stay the course and remain cautious and watchful for these uncertainties to play out.
57. Under the circumstances, we sequenced our policy measures – shifting the monetary policy stance from ‘withdrawal of accommodation’ to ‘neutral’ in October 2024 thereby enhancing the flexibility to act and subsequently reducing the CRR in December 2024 to release durable liquidity.5 In fact, we also made a very subtle change in October 2024 in the wording of our stance given in the MPC resolution from “…a durable alignment of inflation to the target” to “…a durable alignment of inflation with the target” – implying more flexibility in our approach. Perhaps, this went unnoticed.
58. Globally also, as compared to the highly synchronous tightening phase in a world grappling with elevated inflation, there is now a hesitant, guarded, divergent and discontinuous rate cut cycle under progress. Uncertainty has been high due to elevated trade fragmentation concerns, persistent geopolitical tensions and slowing disinflation. Definitely, our decisions are guided by domestic growth-inflation trade- offs, while remaining attentive to global developments.
59. In line with the sequencing path that we followed, a policy rate cut in February 2025 is the most rational and appropriate next step as we now have greater confidence on the disinflation path. In line with this prognosis, we also prepared the market by infusing sufficient liquidity for better transmission. The baseline projections suggest headline inflation to average at 4.2 per cent during 2025-26. Oil and other global commodity prices are expected to remain rangebound. On the other hand, growth slow down concerns are more evident today.
60. It needs to be emphasised that India’s forte is its immense growth opportunities and strong macroeconomic fundamentals. There is a need to preserve the high growth momentum over the medium term, necessitating monetary policy to be sensitive to the evolving growth scenario and use various policy instruments including liquidity injection to reinvigorate growth. Capital flows to India are driven more by its distinctive growth story rather than interest rate differentials, a phenomenon observed for many EMEs.6 Reviving growth and building on resilience is an imperative, especially at a country specific level. Interest rate defence of exchange rate could turn out to be counter-productive especially during periods of global tide towards outflows driven by factors that do not differentiate across nations such as the risk-taking propensity of global investors or uncertainty driving reserve currency strength.7
61. The Union Budget 2025-26 has also prepared the ground for a counter cyclical push to growth, which can then be complemented by monetary policy. The commitment to pursue fiscal consolidation in the next five years coupled with proposals for strengthening agriculture and achieving self-sufficiency in pulses and rationalisation of duty structures will be supportive of price stability and help in anchoring of inflation expectations over the medium term. Moreover, the adherence to fiscal consolidation and debt path without compromising on the quality of expenditure will help in improving country ratings, attracting flows, easing financial conditions, and improving overall sentiment and outlook. Well-coordinated fiscal and monetary policy working in tandem could undoubtedly generate improved outcomes in terms of better growth-inflation balance.
62. To sum up, having duly sequenced our stance and liquidity measures during the last two policies and given the outlook on inflation, time has come to accord higher weight to growth in our policy setting. Coupled with Government measures to boost consumption in the Union Budget, monetary policy easing will support higher aggregate demand. Heightened global uncertainty, however, persists, necessitating the need to continue with neutral stance to retain flexibility to act appropriately as per 5 This was followed by a number of measures in January 2025 to release sufficient system liquidity. 6 Aizenman J, Park D, Qureshi I, Saadaoui J and Uddin G (2024), “The Performance of Emerging Markets During the Fed’s Easing and Tightening Cycles: A Resilience Analysis Across Economies, Asian Development Bank, August (https://www.adb.org/publications/emerging-markets-fed-easing-tightening-cycles) 7 Gelos G., Patelli P., & Shim I. (2024), “The US dollar and Capital Flows to EMEs, BIS Quarterly Review, September (https://www.bis.org/publ/qtrpdf/r_qt2409d.htm). the evolving situation. Accordingly, I vote for a reduction in the policy repo rate by 25 bps while maintaining the neutral stance. Statement by M. Rajeshwar Rao
63. There has been a shift in the domestic growth inflation balance since the December 2024 policy – while the inflation registered sequential softening, growth outcomes were weaker. Heightening uncertainties, emanating from the global financial markets and trade policies too cloud the outlook for domestic growth and inflation.
64. Real GDP growth in 2024-25 at 6.4 per cent (y-o-y) was below expectations, with weak capital formation proving a drag, even while private consumption registered a rebound. Growth projections for the first half of 2025-26, given in the December 2024 resolution have been scaled down by 20 bps and 30 bps, respectively, for Q1 and Q2. On the whole, real GDP growth is projected to edge up to 6.7 per cent in 2025-26. Household consumption growth will be supported by robust agricultural outlook, stable consumer confidence and tax relief in the Union Budget. Rising capacity utilisation, healthy corporate and bank balance sheets, and improving business sentiments, set up conducive conditions to support pickup in private investment. At the same time, protracted uncertainty in the external environment – particularly volatile financial markets and rising protectionist trade policies – could dampen growth impulses.
65. The inflation outlook is turning out to be more benign. Food inflation at present is the predominant driver of headline inflation, contributing to around 70 per cent of the overall inflation in December (food group has a weight of 45.86 per cent in the CPI basket). A correction in food inflation is necessary for a durable softening of headline inflation. Reassuringly, recent data is signalling a favourable rabi season. This, along with the kharif market arrivals and the ongoing winter season correction in vegetables prices, should lead to a significant easing of food inflation pressures in the coming months. Core inflation (inflation in CPI excluding food and fuel) pressures are also expected to remain muted. The headline inflation is projected to average 4.2 per cent during 2025-26 down from 4.8 per cent in 2024-25. At the same time, considerable upsides to the baseline inflation projections remain, particularly from adverse weather events impacting rabi crop yields and risks of rising imported inflation on account of volatility in financial markets.
66. Monetary policy amidst the challenges posed by COVID-19, Ukraine war and the recurring domestic food price shocks, has been able to effectively maintain the growth-inflation balance, in line with its primary objective of price stability while keeping in mind the objective of growth. At the current juncture, with a further alignment of headline inflation towards the 4 per cent target, there is greater space to address concerns regarding growth by way of reduction in the policy repo rate. This monetary policy measure in conjunction with the fiscal measures announced in the Budget should give a fillip to aggregate demand conditions. Furthermore, Government has reaffirmed its commitment to fiscal consolidation, which should help to anchor medium-term inflation expectations. The liquidity measures – CRR reduction in December 2024 as well as a slew of other measures taken in January 2025 to meet the durable liquidity requirements of the banking system, have created conditions conducive to help in transmission of the rate cut.
67. The current environment is replete with uncertainties which calls for watchfulness, coupled with alertness and nimbleness in response. Monetary policy at this juncture has to maintain the required flexibility to pro-actively address emerging risks to the growth-inflation balance. This necessitates a continuation of the neutral stance in the February policy.
68. Accordingly, I vote for a cut in the policy repo rate by 25 basis points to 6.25 per cent and to retain the neutral stance. Statement by Shri Sanjay Malhotra
69. In a world order dominated by continuing geopolitical tensions and elevated trade and policy uncertainties, monetary policy, as the guardian of macroeconomic and financial stability, is traversing through a challenging time. It has to balance a multitude of pressure points and continuously evolving policy trade-offs. Stronger policy frameworks and robust macro fundamentals remain the key to resilience and fostering overall macroeconomic stability. Domestically too, there is a need to preserve the high growth momentum, while maintaining price stability, necessitating monetary policy to use various policy instruments to maintain the inflation-growth balance.
70. Headline inflation, after moving above the upper tolerance band in October, has moderated in November and December. Going forward, food inflation pressures are likely to see significant easing on robust kharif harvest arrivals, winter season correction of vegetables prices and a promising rabi crop outlook. The food inflation outlook is turning decisively positive. Moreover, the budget proposals on agriculture and the commitment to fiscal consolidation, among others, are positive for price stability and would help to anchor inflation expectations over the medium term. These would provide greater impetus to disinflation of headline CPI and its eventual alignment with the target rate in FY 2025-26. CPI inflation for Q4 is projected at 4.2 per cent and that for the financial year 2025-26 at 4.2 per cent.
71. The real GDP growth for the current year is estimated at 6.4 per cent, a softer expansion after a robust 8.2 per cent growth last year. Even though, the GDP growth is expected to recover in the second half of 2024-25 and 2025-26 from 6.0 per cent recorded in the first half of 2024-25, the growth rate projected by various forecasts for 2025-26 vary from 6.3 to 6.8 per cent. This will be supported by healthy rabi prospects and an expected recovery in industrial activity. From the demand side, consumption and investment are also expected to improve.
72. Given the macroeconomic outlook when inflation is expected to align with the target, and recognising that monetary policy is forward-looking, I view a lower policy rate to be more appropriate at the current juncture. Accordingly, I vote for a reduction in the repo rate by 25 basis points. Monetary policy easing, coupled with good agricultural sector growth and various growth supportive measures in the Union Budget, would boost household consumption, investment in housing, capital expenditure, etc thereby strengthening the pick-up in aggregate demand.
73. At the same time, rising uncertainties on global financial markets and trade policy front, coupled with continuing risk of adverse weather events pose risks to the inflation and growth outlook. We need to be watchful of how these forces play out. Hence, I vote to continue with the neutral stance of monetary policy. This will provide the flexibility to respond to the evolving macroeconomic environment. By taking this logical course, monetary policy will be able to fulfil its mandate and play its part in the sustainable development of the Indian economy. (Puneet Pancholy) Press Release: 2024-2025/2219 Chief General Manager
6. After assessing the current and evolving macroeconomic situation, the MPC unanimously voted to reduce the policy repo rate by 25 basis points to 6.00 per cent with immediate effect. Consequently, the standing deposit facility (SDF) rate under the liquidity adjustment facility (LAF) shall stand adjusted to 5.75 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 6.25 per cent. This decision is in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. Growth and Inflation Outlook
7. The global economic outlook is fast changing. The recent trade tariff related measures have exacerbated uncertainties clouding the economic outlook across regions, posing new headwinds for global growth and inflation. Financial markets have responded through sharp fall in dollar index and equity sell-offs with significant softening in bond yields and crude oil prices.
8. The National Statistics Office (NSO) has estimated real Gross Domestic Product (GDP) growth at 6.5 per cent for 2024-25, on top of 9.2 per cent in 2023-24. Going forward, sustained demand from rural areas, an anticipated revival in urban consumption, expected recovery of fixed capital formation supported by increased government capital expenditure, higher capacity utilisation, and healthy balance sheets of corporates and banks are expected to support growth. Merchandise exports would be weighed down by the evolving global economic landscape which appears to be uncertain at the current juncture, while services exports are expected to sustain the resilience. On the supply side, while agricultural prospects appear bright, industrial activity continues to recover, and services sector is expected to be resilient. Headwinds from global trade disruptions continue to pose downward risks. Taking all these factors into consideration, real GDP growth for 2025-26 is now projected at 6.5 per cent, with Q1 at 6.5 per cent; Q2 at 6.7 per cent; Q3 at 6.6 per cent; and Q4 at 6.3 per cent (Chart 1). The risks are evenly balanced.
9. CPI headline inflation declined by a cumulative 1.6 percentage points during January- February 2025, from 5.2 per cent in December 2024 to a low of 3.6 per cent in February 2025. On the back of a strong seasonal correction in vegetable prices this year, food inflation dropped to a 21-month low of 3.8 per cent in February. Fuel group continued to remain in deflation. Core inflation, after remaining steady in December 2024-January 2025, inched up to 4.1 per cent in February 2025, driven primarily by a sharp pick-up in gold prices.
10. The outlook for food inflation has turned decisively positive. There has been a substantial and broad-based seasonal correction in vegetable prices. The uncertainties on rabi crops have abated considerably and the second advance estimates point to a record wheat production and higher production of key pulses over last year. Along with robust kharif arrivals, this is expected to set the stage for a durable softening in food inflation. Sharp decline in inflation expectations for three months and one year ahead period would help anchor inflation expectations going ahead. Furthermore, the fall in crude oil prices augurs well for the inflation outlook. Concerns on lingering global market uncertainties and recurrence of adverse weather-related supply disruptions pose upside risks to the inflation trajectory. Taking all these factors into consideration, and assuming a normal monsoon, CPI inflation for the financial year 2025-26 is projected at 4.0 per cent, with Q1 at 3.6 per cent; Q2 at 3.9 per cent; Q3 at 3.8 per cent; and Q4 at 4.4 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
11. The MPC noted that inflation is currently below the target, supported by a sharp fall in food inflation. Moreover, there is a decisive improvement in the inflation outlook. As per projections, there is now a greater confidence of a durable alignment of headline inflation with the target of 4 per cent over a 12-month horizon. On the other hand, impeded by a challenging global environment, growth is still on a recovery path after an underwhelming performance in the first half of 2024-25. While the risks are evenly balanced around the baseline projections of growth, uncertainties remain high in the wake of the recent spurt in global volatility. In such challenging global economic conditions, the benign inflation and moderate growth outlook demands that the MPC continues to support growth. Accordingly, the MPC unanimously voted to reduce the policy repo rate by 25 basis points to 6.00 per cent. Moreover, it also decided to change the stance from neutral to accommodative. However, it noted that the rapidly evolving situation requires continuous monitoring and assessment of the economic outlook.
12. The minutes of the MPC’s meeting will be published on April 23, 2025.
13. The next meeting of the MPC is scheduled from June 4 to 6, 2025. Voting on the Resolution to reduce the policy repo rate to 6.00 per cent Member Vote Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Dr. Rajiv Ranjan Yes Shri M. Rajeshwar Rao Yes Shri Sanjay Malhotra Yes Statement by Dr. Nagesh Kumar
14. The April MPC meeting is taking place against the backdrop of highly disruptive global events of the previous week. In a huge blow to the multilateral trading system, and its bedrock Most-Favoured Nations (MFN) treatment that the members of the WTO accord to each other, President Donald Trump of the United States announced high reciprocal tariffs on imports from most countries of the world on 2 April 2025, the so-called Liberation Day. China, among other countries, retaliated, provoking a further punitive dose of tariffs on it, leading to a full-scale trade war between the US and China, bringing the rate of tariffs applied to imports from China to a staggering 145%. Expectedly, these announcements led to a meltdown in the financial markets around the world.
15. Different countries are mulling actions to address the effects of these tariffs. For India, the Trump Tariffs represent a mixed blessing. The 26% tariff applied to Indian exports is somewhat lower than that imposed on the Asian peers, especially China and Vietnam. They may help to extend India’s export share in the US. They may also hasten the restructuring of supply chains away from China, some of which may find India to be a good base. However, India may face competitiveness pressures in other markets like the EU/UK, besides its domestic market, where Chinese companies would dump their products, pushed out of the US. With huge excess capacities and deep pockets, the dumping of cheap goods in different markets has become a real threat already. Several countries in Southeast Asia, like Thailand, have already seen thousands of factories closing down under the dumping of cheap stuff from China and have begun to take steps to contain the damage. India needs to take action to protect the domestic industry from the dumping of Chinese goods, especially in labour-intensive consumer goods like garments, imitation jewellery, non-leather footwear, toys, and furniture where it is already rampant. In addition, the ongoing FTA negotiations with the EU and UK need to be concluded quickly to preserve market access for Indian products in these markets.
16. Furthermore, there is a serious risk of the world economy getting into a prolonged recession because of the trade wars and protectionism, which would also affect India’s growth prospects adversely. The WTO has already warned about the negative outlook for world trade. The global GDP growth projections for the current year are likely to be revised downwards in the aftermath of the reciprocal tariff and the trade war.
17. The economic growth and inflation outlook in India since the February MPC Meeting presents a mixed picture. The sales growth in manufacturing and IT companies improved in 2024-25:Q3 and the improvement was likely to continue in Q4. Capacity utilisation in the manufacturing sector has also improved. Despite these healthy improvements, however, investment intentions of private corporations were estimated to have moderated in 2024- 25:Q4. Gross FDI inflows and ECBs for private capex were expected to moderate. The net FDI inflows continue to remain trivial due to hefty repatriations. The credit growth has also shown some signs of moderation in recent months, as the RBI surveys suggest. The growth outlook for 2025-26 has been downgraded by 20 basis points from earlier projections. The global uncertainty arising from the ongoing trade war is also likely to adversely affect FDI inflows and private capex.
18. In such times of such uncertainties, there is a greater need for stimulating private consumption and investments through fiscal and monetary policy to sustain the growth momentum. Fortunately, there is policy space for necessary actions. The Union Budget has augmented fiscal space by limiting the fiscal deficit to just 4.4% in 2025-26 while sustaining the momentum of public investment. The monetary policy space is provided by a downward movement in headline inflation. The CPI Headline was 3.6% in February 2025, down 70 basis points from January 2025, due to a sharp correction in vegetable prices that have seen a nearly 39% correction since November 2024. The inflationary expectations remain anchored. Furthermore, the declining crude oil and other commodity prices with the subdued global demand, and normal monsoon predictions for 2025-26 suggest that CPI headline will remain within the target range of 4%. This provides headroom for adopting a more accommodative monetary policy.
19. The RBI has already started normalising the monetary policy since February 2025 with a 25 basis point cut in the repo rate. The time has now come for changing the stance to an ‘accommodative’ from ‘neutral.’ Given the need to support growth through private consumption and investment, we should continue with further repo rate cut. One could be more ambitious and target a 50 basis point cut, which in my view may be more effective than two cuts of 25 basis points each. However, given the global uncertainty, we can go about it cautiously in a phased manner. We need to remain watchful regarding the evolving global scenario and its impact on India’s growth outlook.
20. Hence, I vote for a 25 basis point cut in the repo rate and go with the change in stance from neutral to accommodative. Statement by Shri Saugata Bhattacharya
21. Due to the elevated uncertainty regarding global trade, the continuing spillovers into financial markets volatility and the prospects, continuing well into the medium term, of adverse economic shocks on growth, economic forecasts at this point are only indicative in nature, conveying merely a sense of the direction of travel.
22. The dominant balance of probability is that inflation in India is likely to remain moderate over FY26. Factoring in a likely pre-emptive need to support growth given the evolving disruptions, I vote to cut the policy repo rate by 25 basis points to 6.0%.
23. High Frequency Indicators – both those presented in the RBI’s March Bulletin and the Monetary Policy Report – suggest that economic activity in Q4 FY25 had remained resilient. Even a predicted growth slowdown (RBI FY26 forecast of 6.5% and the Economic Survey 2024-25 6.3-6.8%, relative to the 9.2% in FY24) is respectable considering the pervasive uncertainty in the global economy. My sense, however, is that – if the trade tariff actions are not significantly diluted – global trade and hence growth will slow down materially, likely spilling over into India via external channels, further decelerating India’s growth.
24. India’s FY26 external balance might also become a matter of concern. Trends in India’s (goods and services) trade will need close monitoring, and the trade balance will depend inter alia on the responses of domestic households to their consumption – savings decisions if growth does indeed slow. Capital inflows and remittances might also be adversely affected.
25. As stated above, I remain more sanguine about moderate inflation. Skymet has just forecast a normal monsoon in 2025. Although prices of vegetable oils remain high, the March ’25 FAO Food Price Index has largely remained stable over the past 5 months. The CRB Commodity Index had eased sharply in early April, to October ’24 levels. Industrial metals prices were mostly lower or stable. Most importantly, crude oil prices have reduced on concerns about slowing growth and oil demand. The IEA March 2025 Report 1 states that “global oil supply may exceed demand by around 600 kb/d” in 2025. Softer crude prices (even after factoring in higher excise duties and LPG price hikes) will help to further moderate CPI inflation. In addition, concerns on “dumping” of foreign goods in India, if they were to materialise, while adverse for domestic output, will also help lower input and intermediate goods costs.
26. RBI forecasts an average 4% CPI inflation in FY26. Despite the possibility of adverse tariff related supply chain dislocations pushing up input costs in the short term, these are likely to be transitory; growth and demand slowdown in developed and other markets are likely to result in lower prices over the course of the year. In addition, domestic household inflation expectations remain well anchored.
27. This forecasted moderate inflation path opens up more space for “good news” policy easing. Moreover, the present resilience of economic activity does not as yet necessitate additional “bad news” actions associated with prospects of a significant growth slowdown. RBI’s liquidity infusion will also hasten transmission to the relevant interest rates.
28. I did have prior reservations on changing the policy stance to accommodative. I have associated a neutral stance with the flexibility for policy to respond appropriately to the changing balance of risks. The elevated uncertainty at present regarding the evolving https://www.iea.org/reports/oil-market-report-march-2025 economic outlook, which is likely to continue into the near future, warrants that policy decisions be taken considering incoming data on a “meeting-by-meeting” basis. However, it was clarified that the change in stance signals only that “a rate hike is off the table”; an accommodative stance remains consistent with a pause, should macro-financial conditions necessitate. Hence, I concur with the change of stance to accommodative while noting that, in my view, this does not provide guidance of a pre-determined policy easing path.
29. These decisions, I believe, are the appropriate policy responses at this point given the evolving balance in the domestic growth – inflation dynamics. Statement by Prof Ram Singh
30. My assessment of the situation and the appropriate monetary policy (MP) response align with the MPC statement for the April 2025 meeting. So, to avoid repeating the contents of the MPC statement and in the interest of brevity, I will keep my statement brief, mentioning only a few key considerations regarding policy rate and stance.
31. The global economic outlook has been changing fast for the last couple of months. Recent trade tariff-related measures have exacerbated uncertainties clouding the economic outlook across regions, posing new headwinds for global growth and inflation. Amidst this turbulence, the USD has weakened noticeably, equity markets are correcting, and crude oil prices have fallen to their lowest in recent times. This calls for the MPC to remain cautious while focusing on domestic priorities regarding inflation and growth. Inflation
32. On the inflation front, the decline in food inflation has been significant, driving down the CPI inflation. The headline inflation moderated during January-February 2025 following a sharp correction in food inflation. CPI headline inflation declined from 5.2 per cent in December 2024 to a low of 3.6 per cent in February 2025, with food inflation dropping to a 21-month low of 3.8 per cent. CPI excluding food and fuel inflation inched up to 4.1 per cent in February 2025, mainly on account of increases in gold prices.
33. Looking ahead, inflation levels and volatility are expected to remain within the RBI's comfort band. The outlook for food inflation has turned decisively positive. The uncertainties regarding rabi crops have abated considerably. Furthermore, the fall in crude oil prices and the forecast for stable commodity prices augur well for the inflation outlook. However, concerns about lingering global market uncertainties and the recurrence of adverse weather-related supply disruptions pose upside risks to the inflation trajectory.
34. Overall, we are looking at a durable softening of food inflation. Assuming a normal monsoon, CPI inflation for the financial year 2025-26 is projected at 4.0 per cent, with Q1 at 3.6 per cent, Q2 at 3.9 per cent, Q3 at 3.8 per cent, and Q4 at 4.4 per cent. The risks are evenly balanced. GDP Growth
35. Real GDP is estimated to grow 6.5 per cent in 2024-25. Gross value added (GVA) at basic prices (y-o-y) is expected to grow by 6.4 per cent. In 2024-25, agriculture and allied activities witnessed an improvement to register a growth of 4.6 per cent, and services grew by 7.5 per cent, even as industrial growth was low at 4.3 per cent. In 2025-26, prospects of the agriculture sector remain bright on the back of healthy reservoir levels and robust crop production. Manufacturing activity and business expectations show revival, with PMI manufacturing at 64.4. Services sector activity continues to be resilient.
36. On the demand side, rural demand is likely to remain healthy, riding on the good prospects of the agriculture sector's growth. Investment activity is expected to improve further due to improvements in capacity utilisation, demand revival, and healthy balance sheets of banks and corporations.
37. Taking all these factors into consideration, real GDP growth for 2025-26 is expected to be a tad lower than the earlier estimate - 6.5 per cent for FY 2025-26, with Q1 at 6.5 per cent, Q2 at 6.7 per cent, Q3 at 6.6 per cent, and Q4 at 6.3 per cent.
38. India’s foreign exchange reserves are substantial, providing a comfortable import cover of about 11 months. INR is also holding up well. The external sector remains resilient; however, uncertainties remain high in the wake of the recent spike in global uncertainties, which are likely to dampen merchandise exports while services exports are expected to remain resilient. Headwinds from global trade disruptions pose a downward risk to the growth rate.
39. Overall, the inflation outlook has improved decisively, and confidence in a durable alignment of headline inflation with the target of 4 per cent over a 12-month horizon has improved. On the other hand, growth is still on a recovery path after an underwhelming performance in the first half of 2024-25. Under these economic conditions, with growth below potential and a benign inflation outlook, the MPC should support growth by cutting the repo rate.
40. In addition, there is a strong case for changing the stance to accommodative as a signal of policy guidance for the near term. For an effective and fast transmission of interest rate cuts and consistent with a changed stance, the RBI's liquidity management tool need to be geared accordingly to operationalise these changes. In particular, monitoring the liquidity conditions to take timely measures to ensure adequate liquidity will be salient to the transmission of the rate cuts.
41. Considering the above-described case for a supportive MP while remaining cautious about the upside risks on the inflation front and unquantifiable global uncertainties, I vote to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.00 per cent.
42. Further, I support the change in the monetary policy stance from ‘neutral’ to ‘accommodative’. Statement by Dr. Rajiv Ranjan
43. Since the February Monetary Policy Committee (MPC) meeting, global uncertainty has increased further. Yet, amidst this heightened uncertainty, some clarity is emerging on the global front. All pervasive tariff is now a reality with adverse implications for global trade and growth. On the domestic front, inflation has entered a decisive softening phase with risks to growth outweighing those of inflation. Let me elaborate on these points.
44. The current global environment is highly challenging with a new restricted and fragmented global trade order taking shape amidst announcements of reciprocal and retaliatory tariffs. The broader implications of these tariffs and the individual policy responses of different countries could result in prolonged instability, upended and inefficient global supply chains, a slowdown in international trade and lower investment confidence, ultimately jeopardising the prospects of global economic recovery. Global growth, that was already below its historical average of 3.7 per cent, 2 is going to undergo downward revisions. Faced with this uncertainty and complete assessment of the impact of these tariffs taking time, monetary policy actions by central banks remain guarded with many countries taking a pause in their latest meeting in March/April 2025, while a few reduced rates with caution. 3 The IMF, in its January 2025 update of the World Economic Outlook (WEO), projected the global economy to grow by 3.3 per cent in 2025, as against the average growth of 3.7 per cent recorded during 2000-2019. US, UK, Japan, Australia, Czech Republic, Israel, Norway and Sweden among advanced economies (AEs) and Russia, China, South Africa, Chile, Colombia, Hungary, Indonesia, Malaysia, Peru, Poland and Romania among emerging market economies (EMEs) maintained the status quo on their monetary policy rates. On
45. With global rules of the game changing, India is bound to get affected through several channels. Even as India remains essentially domestic demand driven, the drag to growth may come from global front, through lower external sector contribution and high investment uncertainty. Accordingly, we have pared our GDP growth projections for 2025- 26 to 6.5 per cent now, which matches the growth seen in 2024-25. As indicated in the Monetary Policy Report, April 2025, real GDP growth for 2026-27 is projected only a tad higher at 6.7 per cent.
46. On inflation, there seems to be greater conviction of inflation remaining aligned with the 4 per cent target during the current financial year. Even during 2026-27, our model projects CPI headline inflation averaging 4.3 per cent. Sharp decline in inflation expectations of households for both three months and one year ahead and of businesses for one year ahead suggest anchoring of inflation expectations going ahead. While the impact of tariffs on our domestic inflation is uncertain, the fall in energy prices augurs well for the inflation outlook. All in all, considerable progress achieved on the disinflation front has offered latitude to monetary policy to be growth supportive. This state contingent policy preference is the true spirit of flexible inflation targeting.
47. On balance, while growth is still reasonable, it is lower than our aspirations and needs policy impetus amidst a challenging global environment. As emphasised in my last minutes, India’s forte is its higher growth potential supported by strong macroeconomic fundamentals, and accordingly, we need to continue to accord higher weight to growth in our policy setting amidst benign inflation outlook with reasonable degree of definiteness. Thus, given the evolving growth inflation dynamics – lower growth and lower inflation projections – I vote for another rate cut of 25 bps.
48. Also, keeping in mind the evolving growth-inflation outlook, the change of stance to accommodative is best at this juncture. The current uncertain global environment has enhanced monetary policy and interest rate uncertainty globally, creating frictions between markets and central banks on the one hand and across different segments of the market, on the other, 4 which is detrimental to monetary policy transmission. In this context, a change in stance to accommodative helps provide a clear signal for future rate action, thereby facilitating monetary transmission. 5 This stance indicates that the direction of policy rates going forward would be either a status quo or further easing, considering the benign outlook for inflation for most of the year on the one hand and the formidable headwinds facing domestic growth from heightened global uncertainties on the other. This will also be consistent with the large liquidity infusion that we have been doing in the recent past to aid policy transmission in this easing cycle. As the saying goes, never let a crisis go to waste; we should use the current tumultuous geo-economic episode as an opportunity to reform our domestic economy by undertaking productivity enhancing and Ease of Doing Business (EoDB) measures. Statement by Shri M. Rajeshwar Rao
49. Uncertainty is the key word dominating the discourse in financial world at this juncture. The escalating trade tensions led by recent reciprocal tariff impositions impart greater uncertainty to the global as well as domestic growth outlook. Its effects are still unfolding and there is uncertainty on its eventual outcomes. Global composite PMI has already begun signaling a slowdown in growth momentum. The global growth estimates for both 2025 and 2026, which have been revised down in the OECD March 2025 report, are the other hand, Euro area, Canada, Iceland, Switzerland, Mexico and Turkey cut their benchmark rates while Brazil hiked its policy rate. BIS quarterly Review, March 2024 and 2025. The stance of monetary policy, by providing a slightly medium-term outlook, helps facilitate transmission, empirically validated for both durable goods sector and firm investment (Sterk and Tenreyro, 2018; Choi et al, 2024) expected to undergo further downward revisions by the IMF and the World Bank in their upcoming releases.
50. The benign inflation outlook with headline CPI inflation for February 2025 falling sharply to 3.6 per cent - registered a decline for the fourth consecutive month. In terms of CPI food sub-groups, the deflationary pressures are broad based. Core CPI inflation edged up contributed partially by personal care and effects which include rise in price of gold. Food price momentum (m-o-m) based on high frequency data from the Department of Consumer Affairs (DCA) shows that food prices have fallen in April so far (April 1-7). Further correction in global crude and commodity prices due to slowing global demand provide further comfort on inflation outlook. The significant softening of headline inflation and greater confidence of a benign outlook, especially on food prices, signals a likely durable alignment of inflation with the target rate over 2025-26.
51. On the growth front, even though the Indian economy has recovered from a weak Q2:2024-25, the annual GDP growth for 2024-25 is lower at 6.5 per cent compared to a strong growth of 9.2 percent as per the Second Advance Estimates (SAE) released by NSO. Strong rural demand on brightened prospects for agriculture along with improving urban demand, and a resilient services sector bode well for the growth outlook, however, global headwinds pose downside risk to growth. Uncertainties remain high going ahead. Accordingly, growth projection for 2025-26 has been revised downward by 20 basis points to 6.5 per cent. Our model-based projection (MPR, April 2025) suggest that growth will recover to 6.7 per cent during 2026-27, which will still be below 7.0 per cent.
52. Growth in aggregate deposits (y-o-y) of all scheduled commercial banks (SCBs) and bank credit remain in double digits. The liquidity conditions have also improved in the recent months in response to a slew of measure taken by the RBI which we believe will ensure orderly market conditions and thereby, facilitate monetary transmission.
53. India’s external sector situation looks sustainable supported by a comfortable current account deficit (CAD) of 1.1 per cent of GDP in Q3:2024-25. Among capital flows, external commercial borrowing (ECB) and non-resident deposit flows remained robust during 2024- 25 so far. Though remittances from abroad face risks from lower global growth especially from the US, they remain robust. FPI inflows will depend largely on the evolving global situation, although the domestic macroeconomic conditions provide the crucial support. In the context of emerging situation, foreign exchange reserves US$ 665.4 billion at the week ended March 28, 2025, provides the much-needed buffer to tackle unforeseen global headwinds.
54. The current environment mired as it is with unprecedented global uncertainties, calls for constant watchfulness and monitoring, as well as promptness in policy actions to deal with any emerging risk to the growth-inflation balance. While the exact impact of US tariffs on India is not certain, with US being India’s largest export destination, it could weigh on trade, financial markets, and domestic economic activity through both direct and indirect channels.
55. Assessing the overall situation, we find that while inflation outlook remains benign, GDP growth could face a downward pressure. The recent waves of global uncertainty demand decisive policy support to growth. Continuing with the easing cycle in February policy, I vote in favour of a 25 bps rate cut. I also support a change in stance from neutral to accommodative. Statement by Shri Sanjay Malhotra
56. The global economic landscape remains in a state of flux amidst heightened trade and policy uncertainties, with attendant implications for economies across the world, posing complex challenges and trade-offs in policy making. The channels through which these global shocks could impact economies, particularly emerging market economies, include spillovers from global growth slowdown, elevated financial markets volatility and dented consumer and investor confidence. The Indian economy remains relatively less exposed and better placed to withstand such spillovers with its growth driven largely by domestic demand. Nevertheless, we are not immune to the aftershocks and ripple effects associated with global disturbances. There may also be some positive spin-off to the Indian economy from the likely softening of crude oil and commodity prices and relative tariff advantage.
57. The high frequency indicators for the latest period indicate that domestic demand continues to be resilient, with urban consumption improving with an uptick in discretionary spending and rural consumption remaining robust on the back of favourable agricultural prospects. Investment activity shall get a boost from a pick-up in government capex and a congenial environment for private corporate investment. Thus, I believe that robust domestic demand will cushion the impact of external headwinds as in the past. At this juncture, the growth projection for 2025-26 at 6.5 per cent, a downward revision of 20 basis points from the February 2025 policy, is appropriate. Although even at 6.5 per cent growth, India would continue to be the fastest growing major economy, this is lower than what we aspire for.
58. Turing to inflation, headline inflation reading at 3.6 per cent in February 2025 (averaging at 4.0 per cent during January-February 2025) aided further disinflation with food inflation turning out to be very benign. There is now greater clarity on the food inflation outlook as the uncertainties related to rabi crops production have abated. The second advance estimates suggest record wheat production and higher production of key pulses. Core inflation (excluding fuel and food), although inching up to 4.1 per cent in February 2025 from 3.6 per cent in January, continues to be around the 4 per cent mark, suggesting that underlying inflationary impulses in the economy are benign and well anchored. CPI inflation excluding food, fuel, gold and silver was still at a muted 3.2 per cent in February 2025. Fuel group continues to be in deflation. Moreover, the decline in crude oil prices should impart a softening bias to the inflation outlook. Coming to the imposition of tariffs, in my view, the implications for inflation are two sided. On the upside, uncertainties may lead to possible currency pressures resulting in imported inflation. On the downside, slowdown in global growth will further soften commodity and crude oil prices, which would ease the pressure on inflation. Overall, favourable factors for the inflation outlook outweigh those with possible adverse impact and should drive further disinflation in the headline CPI. It is expected that inflation will be well aligned to the target during the current financial year.
59. When consumer price inflation is decisively around its target rate of 4.0 per cent and growth is still moderate and recovering, monetary policy needs to nurture domestic demand impulses to further increase the growth momentum. This is specially so amidst an uncertain global environment, which has amplified downside risks to growth. Accordingly, I vote for a reduction in the repo rate by 25 basis points. This will bolster private consumption and support a revival in private corporate investment activity. Going forward too, considering the evolving growth-inflation trajectories, monetary policy needs to be accommodative. (Puneet Pancholy) Press Release: 2025-2026/164 Chief General Manager
6. After assessing the current and evolving macroeconomic situation, the MPC voted to reduce the policy repo rate by 50 basis points (bps) to 5.50 per cent with immediate effect. Consequently, the standing deposit facility (SDF) rate under the liquidity adjustment facility (LAF) shall stand adjusted to 5.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 5.75 per cent. This decision is in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. Growth and Inflation Outlook
7. The uncertainty around the global economic outlook has ebbed somewhat since the MPC met in April in the wake of temporary tariff reprieve and optimism around trade negotiations. However, it continues to remain elevated to weaken sentiments and lower global growth prospects. Accordingly, global growth and trade projections have been revised downwards by multilateral agencies. Market volatility has eased in the recent period with equity markets staging a recovery, dollar index and crude oil softening though gold prices remain high.
8. According to the provisional estimates released by the National Statistical Office (NSO) on May 30, 2025, real GDP growth in Q4:2024-25 stood at 7.4 per cent as against 6.4 per cent in Q3. On the supply side, real gross value added (GVA) rose by 6.8 per cent in Q4:2024-25. For 2024-25, real GDP growth was placed at 6.5 per cent, while real GVA recorded a growth of 6.4 per cent.
9. Going forward, economic activity continues to maintain the momentum in 2025- 26, supported by private consumption and traction in fixed capital formation. The sustained rural economic activity bodes well for rural demand, while continued expansion in services sector is expected to support the revival in urban demand. Investment activity is expected to improve in light of higher capacity utilization, improving balance sheets of financial and non-financial corporates, and government’s capital expenditure push. Trade policy uncertainty continues to weigh on merchandise exports prospects, while the conclusion of free trade agreement (FTA) with the United Kingdom and progress with other countries is supportive of trade activity. On the supply side, agriculture prospects remain bright on the back of an above normal south-west monsoon forecast and resilient allied activities. Services sector is expected to maintain its momentum. However, spillovers emanating from protracted geopolitical tensions, and global trade and weather-related uncertainties pose downside risks to growth. Taking all these factors into account, real GDP growth for 2025-26 is projected at 6.5 per cent, with Q1 at 6.5 per cent, Q2 at 6.7 per cent, Q3 at 6.6 per cent, and Q4 at 6.3 per cent (Chart 1). The risks are evenly balanced.
10. CPI headline inflation continued its declining trajectory in March and April, with headline CPI inflation moderating to a nearly six-year low of 3.2 per cent (year-on-year) in April 2025. This was led mainly by food inflation which recorded the sixth consecutive monthly decline. Fuel group witnessed a reversal of deflationary conditions and recorded positive inflation prints during March and April, partly reflecting the hike in LPG prices. Core inflation remained largely steady and contained during March-April, despite increase in gold prices exerting upward pressure.
11. The outlook for inflation points towards benign prices across major constituents. The record wheat production and higher production of key pulses in the Rabi crop season should ensure adequate supply of key food items. Going forward, the likely above normal monsoon along with its early onset augurs well for Kharif crop prospects. Reflecting this, inflation expectations are showing a moderating trend, more so for the rural households. Most projections point towards continued moderation in the prices of key commodities, including crude oil. Notwithstanding these favourable prognoses, we need to remain watchful of weather-related uncertainties and still evolving tariff related concerns with their attendant impact on global commodity prices. Taking all these factors into consideration, and assuming a normal monsoon, CPI inflation for the financial year 2025-26 is now projected at 3.7 per cent, with Q1 at 2.9 per cent; Q2 at 3.4 per cent; Q3 at 3.9 per cent; and Q4 at 4.4 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
12. Inflation has softened significantly over the last six months from above the tolerance band in October 2024 to well below the target with signs of a broad-based moderation. The near-term and medium-term outlook now gives us the confidence of not only a durable alignment of headline inflation with the target of 4 per cent, as exuded in the last meeting but also the belief that during the year, it is likely to undershoot the target at the margin. While food inflation outlook remains soft, core inflation is expected to remain benign with easing of international commodity prices in line with the anticipated global growth slowdown. The inflation outlook for the year is being revised downwards from the earlier forecast of 4.0 per cent to 3.7 per cent. Growth, on the other hand, remains lower than our aspirations amidst challenging global environment and heightened uncertainty.
13. Thus, it is imperative to continue to stimulate domestic private consumption and investment through policy levers to step up the growth momentum. This changed growth-inflation dynamics calls for not only continuing with the policy easing but also frontloading the rate cuts to support growth. Accordingly, the MPC voted to reduce the policy repo rate by 50 bps to 5.50 per cent. Dr. Nagesh Kumar, Prof. Ram Singh, Dr. Rajiv Ranjan, Dr. Poonam Gupta and Shri Sanjay Malhotra, voted to decrease the policy repo rate by 50 bps. Shri Saugata Bhattacharya voted for a 25 bps cut in repo rate.
14. After having reduced the policy repo rate by 100 bps in quick succession since February 2025, under the current circumstances, monetary policy is left with very limited space to support growth. Hence, the MPC also decided to change the stance from accommodative to neutral. From here onwards, the MPC will be carefully assessing the incoming data and the evolving outlook to chart out the future course of monetary policy in order to strike the right growth-inflation balance. The fast-changing global economic situation too necessitates continuous monitoring and assessment of the evolving macroeconomic outlook.
15. The minutes of the MPC’s meeting will be published on June 20, 2025.
16. The next meeting of the MPC is scheduled from August 4 to 6, 2025. Voting on the Resolution to reduce the policy repo rate Magnitude of policy repo Member Vote rate reduction (basis points) Dr. Nagesh Kumar Yes 50 Shri Saugata Bhattacharya Yes 25 Prof. Ram Singh Yes 50 Dr. Rajiv Ranjan Yes 50 Dr. Poonam Gupta Yes 50 Shri Sanjay Malhotra Yes 50 Statement by Dr. Nagesh Kumar
17. The June MPC is taking place against the backdrop of continued global uncertainties on tariffs, protectionism, and trade wars that are affecting the global trade and growth outlook. The global economic outlook has been described as ‘fluid and fragile.’ The IMF has downgraded the global economic growth from 3.3% to 2.8% in 2025, with the OECD also projecting almost a similar figure. The global manufacturing PMI has dipped below 50, while the composite PMI has managed to barely stay just above 50.
18. The WTO has projected world trade to contract by 1.5% in 2025 in view of the trade policy uncertainties. The April 2025 world trade projection for 2025 is ‘nearly 3 percentage points lower than it would have been without such policy shifts’ and marks a significant reversal from the WTO’s assessment of world trade at the beginning of the year. The uncertainties surrounding the future of reciprocal tariffs beyond 9 July, when the 90-day pause ends, continue to occupy policymakers’ attention, with India, among several countries, engaged in negotiations with the Trump Administration for a bilateral trade deal. Besides the shrinking global trade, countries like India are also likely to face the onslaught of dumping of cheap Chinese goods in both domestic and overseas markets, which are shunned by the advanced economies, as I had argued in my April MPC statement.
19. Domestically, the recovery of economic growth to 7.4% in Q4:2025 from 6.4% in Q3:2025 was a pleasant surprise. It helped to close the year 2024-25 with 6.5% growth overall. However, the recovery has not been broad-based. It was supported by the rural consumption and government capex. Private investment, especially in manufacturing, and urban consumption, have continued to remain subdued. It is not clear that the growth momentum will continue in the Q1 of the current year, given the fact that consumption and investment growth is moderating. The survey of corporate performance shows that companies are deleveraging their balance sheets with rising profits. Despite the capacity utilisation crossing beyond 75%, the investment intentions in manufacturing have moderated in 2025-26. The difficult external environment is likely to further complicate the economic growth outlook for 2025-26, especially for the manufacturing sector outlook, with implications for job creation. It calls for supporting growth through both fiscal and monetary policy.
20. Fortunately, the policy space has been augmented in both domains. The fiscal consolidation, partly helped by the hefty transfers by the RBI, provides some potential for a fiscal stimulus to support growth if needed, including by front-loading the substantial magnitude of public investment provided in the Budget 2025-26.
21. Monetary policy space has been created by the benign inflationary outlook. Retail inflation in April 2025 slowed down to 3.2% is at its lowest level since 2019 (69 months). Furthermore, given the softening of commodity prices, especially the crude oil to around $ 65 p.b. compared to around $75 p.b. earlier, predictions of a good or above average monsoon, and a soft dollar, all indicate that the inflationary outlook would continue to remain sub-4% in 2025-26. Inflationary expectations also remain well anchored as per the RBI surveys.
22. Since the February 2025 MPC, the RBI has started to support growth by cutting policy rates. The repo rate has been cut by 50 basis points in two instalments, besides massive liquidity expansion. The monetary policy stance has also been changed to accommodative in April 2025. However, the transmission of the monetary easing has been slow or moderate as reflected by the sticky deposit and lending rates (especially for the public sector banks), and credit growth has been moderate, due to inefficiencies in the system.
23. In the April MPC, I had argued that a 50 basis points cut at one go may be more effective than two cuts of 25 basis points each. In view of difficult external circumstances requiring support to economic growth, and a favourable inflationary outlook providing headroom for further rate cuts, I believe that the case for a 50 basis points cut in the repo rate has become stronger. A heavier-than-expected cut in policy rate (along with the possible fiscal policy support) would send a clear message that India is serious about supporting economic growth momentum and would spare no effort in terms of policy interventions. A double dose of rate cut is likely to bring down lending rates significantly, helping to spur the investment and consumption of durable goods.
24. Hence, I vote for a 50-basis point cut in the repo rate to 5.50%. I also suggest a shift in stance from accommodative to neutral. Statement by Shri Saugata Bhattacharya
25. Phrases related to “uncertain” and “volatility” occur in the MPC statement 6 times. This continuing elevated uncertainty remains, to my mind, the primary reason to exercise caution in pacing monetary policy easing. Hence, there is little to add to the essence of my statement in the minutes of the last April ’25 meeting.
26. Given the growth performance of the Indian economy in Q4 FY25 and the full FY25 as well as incoming high frequency indicators, I believe that the current growth impulses continue to exhibit economic resilience despite the prevailing uncertainty stemming from external developments. Moreover, the experience of the periodic FY24 GDP data revisions also support a calibrated policy easing path. On the demand side, I await a sense of the effects of the well-thought income tax rate cuts, as well as other price and income support measures.
27. While the near- and longer-term forecast of inflation offers more space of easing, I also recognize that the transmission of the policy rate cuts into bank lending (and some deposits) rates did accelerate post March ’25 and is expected to proceed apace. RBI’s liquidity infusion and other measures have played a key role in this process, partly via lower money market and short-term interest rates reducing the overall banks’ cost of funds. RBI data suggests that Rs 9.5 lakh crores of durable liquidity was injected into the banking system since January ’25. In this context, I believe that the RBI’s assurance of continuing large durable liquidity support is likely to have a more dominant effect on further transmission compared to a deep cut in the repo rate.
28. Recognising the prevailing uncertainties, I believe that a measured and cautious progress in policy easing is more appropriate at this time. Accordingly, I vote to cut the policy repo rate by 25 basis points to 5.75%. I concur with the view to change the stance from accommodative to neutral. Statement by Prof. Ram Singh
29. My assessment of the current growth-inflation dynamics and the prospects is very similar to what is described in the MPC statement for the June 2025 meeting. Inflation
30. The current headline inflation print for April 2025 was below the target of 4%. The CPI inflation has fallen to a nearly 6-year low of 3.2% year-over-year (yoy) in April 2025, primarily due to a sharper than usual seasonal fall in vegetable prices by 3% month-over-month (mom). Vegetable inflation fell to a 26-month low of -11.0% yoy in April. The CPI Core inflation has inched upward to 4.2%, mainly due to the elevated gold prices. Excluding gold, the CPI Core inflation is 3.4%. For FY 2025-26, RBI’s average headline inflation forecast is 3.7%, comfortably below the target. The market expects even lower headline inflation prints for FY26. GDP Growth
31. The GDP growth rate remains below the aspirational levels of 7-8% - The RBI’s and GoI’s forecast for the GDP growth rate for FY 2025-26 is 6.5%. Given the prospect of benign inflation, there is a strong case for the rate cut to provide a helping hand to growth.
32. Therefore, I will directly address the two relevant issues: What is the scope of the rate cut in this cycle? How much rate cut is plausible given the current uncertainty on the global economic front?
33. Given the headline inflation forecast of 3.7% for FY 26, at the current policy rate (6%), the real repo rate turns out to be 2.3%, significantly higher than a rate that would qualify as growth supportive policy rate. At any point in time, there is uncertainty about the exact value of the neutral interest rate, r*, which is the real interest rate consistent with stable inflation and a growth path – to be growth supportive, real rate should be lower than neutral rate. The neutral interest rate fluctuates due to several factors, even in the short term. Except in the aftermath of Covid-19, neutral interest rates have been declining over the last two and a half decades, for both advanced and emerging economies, including India.1 Following the COVID-19 pandemic, the neutral rates experienced an uptick across countries, driven by short-term factors such as increases in public debt and changes in output gaps.
34. Due to the COVID-19 effect, the average r* estimated for India had increased from 1.2% for Q3:2021-22 to 1.65% for Q4: 2023-24. Now that the COVID specific factors – elevated public debt and pent-up demand - are behind us, the neutral rate has likely headed toward pre-COVID levels. Even if we go by the post-pandemic average neutral interest rate (1.65%), there is scope for about a 75 bps cut in the current cycle without heating the economy.
35. However, assumptions about global growth and inflation are changing daily. Given the high degree of uncertainty regarding growth and food inflation at home, caution is warranted in the rate cut. Moreover, the MPC needs to ascertain the likelihood and timeline of the pass-through of the rate cut, following two rate cuts in recent times. All considered, a 50-basis-point rate cut in this cycle seems very reasonable and highly desirable. Moreover, the current situation warrants a front- loaded rate cut. Obstfeld, Maurice (2025), “Natural and Neutral Real Interest Rates: Past and Future”, NBER Working Paper No. 31949.
36. While rural demand is holding up, riding on the back of rising rural real wages, several indicators point to a situation where there is a demand deficit. There is moderation in actual as well as expected salary outgo for the corporate sector along with slowing of the labour intensive sectors like, hotel, tourism, transport and communication. Demand for mid-size housing and urban consumption remains subdued. Private investment also remains tepid, despite the massive capital expenditure undertaken by the Centre.2 The Capex to net surplus from operations ratio remains below the pre-COVID level. Since H1: 2022-23, there has been a decline in the debt-to-equity ratio for listed private companies, as absolute debt levels have not increased during this period. During Q4:2024-25, sales growth has moderated for manufacturing and non-IT service companies. The business assessment index has also moderated in Q1: 2025-26.
37. Despite two rate cuts in February and April 2025, and call money rates dipping below the repo rate and at times even below the SDF rate, credit growth has not picked up. The demand for loanable funds is lower than usual. It has been moderating over the last 7 quarters to reach 9.8%, the weakest in recent times. Sanctioned loan books are not being utilised. The realisation of 7-8% GDP growth will require a credit growth rate, which is significantly higher than the current rate.
38. The expectation of further rate cuts has likely delayed the materialisation of demand and investment decisions. In such an environment, given the market expectation of a 50-bps rate cut in this cycle, a staggered rate cut can further delay the materialisation of demand and investment decisions. By contrast, a front-loaded 50- bps cut in the policy rate is likely to help achieve the twin objectives of supporting demand and growth by reducing the cost of funds for borrowers. It would result in a significant reduction in the EMI/NMI ratio or the debt service period for EBR-linked loans, including home and MSME loans, generating a substantial income effect for middle-income groups and the MSME sector.
39. While several factors determine demand and credit growth, with healthy bank balance sheets, a 50-basis-point rate cut is likely to provide the required push to borrowers and lenders alike. Given the under-leveraged corporate balance sheets, a pickup in private demand will, in turn, motivate private capital expenditure.
40. Furthermore, the 50-basis-point rate cut should not cause any overheating in the economy, as there are no indications of demand-pull inflation. The core CPI excluding petrol, diesel, gold and silver remains low at 3.5% yoy in April 2025. This inflation series has hovered in the 3.2-3.5% range for the last eight months. Even at the subgroup level, the core CPI inflation remains muted for most subgroups. According to the World Bank forecast and the S&P commodities index, global commodity prices are expected to remain stable, except for gold.
41. Food inflation continues to ease, driven by decline in inflation for cereals and animal proteins, while the deflation in pulses continues. In April 2025, pulses prices declined by 5.2% yoy, marking a 6-year low. From a near-term perspective, there is no visible sign of any adverse impact on vegetable prices from the unusually early onset of monsoon. The past episodes of early monsoon onset were not necessarily associated with a rise in vegetable prices. Going forward, edible oil prices are expected to decline supported by the recent reduction in the import duty (from 20% to 10%), strengthening the benign inflation outlook.
42. This suggests a healthy supply of the previous crop and buoyant expectations for the next harvest, which is currently being sown. Budget 2025 has focused on the India's listed companies are holding onto cash or preferring to distribute it as dividend rather than invest. Dividend payouts are increasing despite relatively moderate growth in both revenue and net earnings. food processing industry. This, along with the substantial improvements in supply chain logistics, means we can look forward to a period of moderated food inflation with reduced price volatility in the future.
43. Certainly, the banks would face pressure on their net interest margins (NIM). However, some of the adverse effect on NIM can be neutralised by other monetary policy instruments available with the RBI. Another concern is that a relatively big rate cut would mean that the interest rate differential with the U.S. Fed would reduce to lowest levels in recent time. This, ceteris paribus, can put pressure on the rupee, especially vis-à-vis the USD. However, given the robust fundamentals of Indian economy including comfortable current account situation, any pressure on INR is likely to be confined to short run. Further, a pick in growth can more than offset the adverse effect of reduced interest rate differentials, if any.
44. Considering the above-described strong case for a growth supportive MP, I vote to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points to 5.50 per cent.
45. However, in view of unquantifiable global uncertainties, I support the change in the monetary policy stance from ‘accommodative’ to ‘neutral’. Statement by Dr. Rajiv Ranjan
46. Since the April policy, the incoming data point to more than anticipated softening of inflation. The Reserve Bank’s anti-inflationary policy stance in the last two years, supply side measures by the Government and a good agricultural season seem to have helped gain control over inflation. This has given flexibility and opportunity for monetary policy to support growth. Accordingly, the MPC voted for a rate cut of 50-bps in this policy. My vote for this frontloaded rate cut was premised on following arguments.
47. First, on the inflation front, the baseline outlook for 2025-26 remain largely comfortable. Inflation is likely to undershoot the target as reflected in the downward revision of 30 bps in our projections in this policy. The headline CPI inflation in H1:2025-26 is projected to remain close to 3 per cent, with some pick up in second half. Food price pressures is expected to remain benign. Trends in core (CPI excluding food and fuel) inflation shows that the underlying inflation pressures remain quite contained. This is corroborated by various exclusion as well as trimmed mean measures.
48. Second, on growth, although we have not changed our projection, but it is felt that it could be higher given the trend in recent years. Domestic investment though on a recovery mode continues to suffer as enhanced global uncertainties are restraining investment impulses. Deflation in China is a pressure point and a possible threat to our manufacturing, which could further dampen investment sentiments. Thus, there is a strong case to support aggregate demand through a frontloaded rate cut. A larger cut in the expansionary cycle may be necessary to have the same effect on output as in the contractionary cycle (Barnichon and Matthes, 2014).3
49. Third, as monetary policy works with a lag, under the current circumstances, a 50-bps cut is preferable to two 25 bps cut for faster and greater transmission. Similar to the frontloaded rate hikes during the tightening cycle, frontloading rate cut could help in hastening transmission by providing decisive signals and confidence to the stakeholders. This rate cut, coupled withs several liquidity measures already https://events.bse.eu/live/files/383-tsa14-barnichonpdf undertaken, along with a CRR cut from September onwards should help boost credit growth while protecting bank margins in a rate easing cycle.
50. Fourth, on the global front, the outlook in 2025 continues to be disconcerting, even as trade policy uncertainty has somewhat ebbed since April. Amidst such global uncertainties, it would be appropriate to provide some certainty on the domestic rate and liquidity front so that agents do not delay and postpone their decisions. Literature suggest that uncertainty plays a role in forming the "zone of inaction" whereby economic agents may see-through incremental changes while larger policy impetus may trigger threshold effects (Belke et al, 2020; Bordo et al, 2016).4
51. On the whole, from the perspective of inflation, growth, transmission, global and most importantly signaling and imparting certainty perspective, a 50 bps cut is apt at this juncture.
52. At the same time, it was felt that pairing the 50 bps rate cut with the same accommodative stance is not suitable, even though we shifted to this stance just two months back. Having front-loaded the policy rate cut by 50 bps, we would be left with less room for further downward adjustments in policy rates. There is a risk that a combination of 50 bps cut with an accommodative stance could mislead financial markets about the scale and scope of further monetary policy easing, repricing of which eventually could create unnecessary volatility. At the same time, it is to be noted that the shift in stance to neutral should not be confused to be a sign that the direction of monetary policy has changed. The neutral stance provides flexibility and is meant to signal that there is no strong bias for any rate action absent any meaningful change in the macroeconomic outlook. It needs to be highlighted that our policy setting under prevailing uncertainties is not cast in stone. We will be responding appropriately through our policy action in the event of any material change in the outlook. In the near term, we need to focus more on facilitating transmission of easier monetary policy, while keeping a close watch on the incoming data. Statement by Dr. Poonam Gupta
53. The Indian economy has exhibited remarkable resilience during the past decade, amidst an extremely uncertain and shifting global economic outlook, marked by worsening trade dynamics, financial volatility and geopolitical flareups. Despite being one of the fastest growing large economies, its rate of economic growth, however, can be further accelerated based on the favourable demographics, conducive shift in regulatory policies, significant infrastructure enhancement, and leveraging on the macroeconomic stability achieved during the past decade.
54. As per the provisional estimate of the National Statistical Office, the Indian economy recorded a growth of 6.5 per cent in 2024-25, in line with the average growth rate of the last decade. Growth in 2024-25 was mainly driven by a revival in private consumption while private corporate capex remained tentative and confined to only certain pockets. Growth is projected to be in a similar ballpark for the current year.
55. On the inflation front, the headline CPI inflation averaged 4.6 per cent during 2024-25, but is seen to be on a downward trend, moderating to 4.0 per cent during Q4 and further to a 69-month low of 3.2 per cent in April 2025. While food inflation has decelerated sharply, core inflation has been contained at around 4 per cent and would be lower if the impact of high and rising gold prices is excluded. Inflation expectations too are on a moderating trend. With the inflation projection for 2025-26 revised downward from 4.0 per cent to 3.7 per cent, headline inflation is expected to align with https://www.sciencedirect.com/science/article/abs/pii/S0167268120300962; https://www.nber.org/system/files/working_papers/w22021/w22021. pdf the target further durably, and in fact undershoot at the margin, giving space for monetary policy to support growth.
56. Aforementioned developments indicate that there is both a need as well as the room for monetary policy to provide support to the economy in order for it to attain and even surpass the past rates of growth.
57. The issue then arises, how much support can be provided, and at what pace. Overall, while a case can be made for two consecutive rate cuts of 25 bps each in this as well as the next policy cycle, there is also merit in front-loading these cuts. Therefore, I vote for a policy rate cut by 50 bps in this meeting. This should help in fostering policy certainty and faster transmission than a staggered rate cut, and in more effectively countering the challenges emanating from the global economy.
58. Going forward, I support a change in stance from accommodative to neutral. This means that any further actions should be contingent upon incoming data and the evolving global uncertainties. Statement by Shri Sanjay Malhotra
59. The global economic situation remains fragile and fluid. Apart from the near- term uncertainties, the medium-term outlook is also overcast amidst recurrent geopolitical flareups and reshaping of a new global trade order. At present, global growth is on a weak footing, while inflation is generally receding, though at a slow pace.
60. Domestically, the GDP growth print for Q4:2024-25 released by the NSO at 7.4 per cent indicates sequential improvement in the economic activity. Going forward, the expected above-normal monsoon will provide further impetus to rural demand. Decline in inflation and continued momentum in the services sector will help revive urban consumption. On the investment front, the post-COVID recovery so far has been largely led by public investments, while private sector investments have been weak despite high capacity utilisation and improved corporate balance sheets. Moreover, heightened global uncertainties may put on hold investment decisions by businesses, underscoring the need for growth supportive policies.
61. Inflation has trended down since the last MPC meeting, with the headline CPI inflation recording a nearly six-year low of 3.2 per cent in April 2025. The recent moderation has been primarily driven by the sustained moderation in food inflation, which currently stands at 2.1 per cent in April, well below the headline. Core (CPI excluding food and fuel) Inflation has remained largely stable and contained (4.2 per cent in April 2025), even though rising gold prices have exerted significant upward pressure. With prospects of an above-normal southwest monsoon, food inflation is expected to remain moderate during the year. Core inflation is also likely to remain largely contained, especially in an environment of moderating commodity prices.
62. With a projection of 3.7 per cent for 2025-26, the inflation outlook for the year is looking more benign than we had anticipated in the April policy. On the other hand, while growth remains steady, it is lower than our aspirations. The growth forecast remains the same as the outturn of last year which was 6.5 per cent. On the whole, I believe that, given the current macroeconomic conditions and the outlook, monetary policy needs to support growth, while remaining consistent with the objective of price stability. Given the sharp reduction in inflation of about 3 percentage points over the past few months (6.2 in October 2024 to 3.2 in April, 2025), and the projected reduction in annual average inflation by almost one percentage point from 4.6 to 3.7 per cent, I vote for a 50 bps rate cut. It is expected that the front-loaded rate action along with certainty on the liquidity front would send a clear signal to the economic agents, thereby supporting consumption and investment through lower cost of borrowing.
63. As regards the stance for monetary policy, it is important to keep in mind that the stance not only reflects the current macroeconomic conditions, but more importantly the outlook that goes into policy calculus. While the CPI headline inflation for April 2025 is 3.2 per cent, the projection for Q4 is 4.4 per cent. Growth is projected to be 6.5 per cent in this year. This growth-inflation outlook is contingent on the spatial and temporal distribution of the southwest monsoon and at the same time considerable uncertainties persist in the global commodity, financial, and currency markets. Given these uncertainties, and after having reduced the policy rates by 100 bps in quick succession since February, in the prevailing growth-inflation scenario and the outlook, monetary policy will be left with very limited space to support growth. Thus, it would be appropriate to change the stance from accommodative to neutral. A neutral stance would provide monetary policy the necessary flexibility viz., to cut, pause or hike policy rate, in response to the evolving domestic and global economic conditions. This package of measures will provide some certainty in the times of uncertainty and is expected to support growth. (Puneet Pancholy) Press Release: 2025-2026/570 Chief General Manager
6. After assessing the current and evolving macroeconomic situation, the MPC voted to maintain the policy repo rate at 5.50 per cent. Consequently, the standing deposit facility (SDF) rate under the liquidity adjustment facility (LAF) remains unchanged at 5.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 5.75 per cent. This decision is in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. Growth and Inflation Outlook
7. The global environment continues to be challenging. Although financial market volatility and geopolitical uncertainties have abated somewhat from their peaks in recent months, trade negotiation challenges continue to linger. Global growth, though revised upwards by the IMF, remains muted. The pace of disinflation is slowing down, with some advanced economies even witnessing an uptick in inflation.
8. Domestic growth remains resilient and is broadly evolving along the lines of our assessment. Private consumption, aided by rural demand, and fixed investment, supported by buoyant government capex, continue to boost economic activity. On the supply side, a steady south-west monsoon is supporting kharif sowing, replenishing reservoir levels and boosting agriculture activity. Moreover, services sector and construction activity remain robust. However, growth in industrial sector remained subdued and uneven across segments, pulled down by electricity and mining.
9. As for the growth outlook, the above normal southwest monsoon, lower inflation, rising capacity utilization and congenial financial conditions continue to support domestic economic activity. The supportive monetary, regulatory and fiscal policies including robust government capital expenditure should also boost demand. The services sector is expected to remain buoyant, with sustained growth in construction and trade in the coming months. Prospects of external demand, however, remain uncertain amidst ongoing tariff announcements and trade negotiations. The headwinds emanating from prolonged geopolitical tensions, persisting global uncertainties, and volatility in global financial markets pose risks to the growth outlook. Taking all these factors into account, projection for real GDP growth for 2025-26 has been retained at 6.5 per cent, with Q1 at 6.5 per cent, Q2 at 6.7 per cent, Q3 at 6.6 per cent, and Q4 at 6.3 per cent. Real GDP growth for Q1:2026-27 is projected at 6.6 per cent (Chart 1). The risks are evenly balanced.
10. CPI headline inflation declined for the eighth consecutive month to a 77-month low of 2.1 per cent (y-o-y) in June 2025. This was driven primarily by a sharp decline in food inflation led by improved agricultural activity and various supply side measures. Food inflation recorded its first negative print since February 2019 at (-) 0.2 per cent in June. High-frequency price indicators signal a continuation of the lower price momentum in food prices this year to July as well. Core inflation, which remained within a narrow range of 4.1-4.2 per cent during February-May, increased to 4.4 per cent in June, driven partly by a continued increase in gold prices.
11. The inflation outlook for 2025-26 has become more benign than expected in June. Large favourable base effects combined with steady progress of the southwest monsoon, healthy kharif sowing, adequate reservoir levels and comfortable buffer stocks of foodgrains have contributed to this moderation. CPI inflation, however, is likely to edge up above 4 per cent by Q4:2025-26 and beyond, as unfavourable base effects, and demand side factors from policy actions come into play. Barring any major negative shock to input prices, core inflation is likely to remain moderately above 4 per cent during the year. Weather-related shocks pose risks to inflation outlook. Considering all these factors, CPI inflation for 2025-26 is now projected at 3.1 per cent with Q2 at 2.1 per cent; Q3 at 3.1 per cent; and Q4 at 4.4 per cent. CPI inflation for Q1:2026-27 is projected at 4.9 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
12. The MPC noted that the inflation outlook in the near term has become more benign than anticipated earlier, and the average CPI inflation this year is expected to remain significantly below the target. This is driven mainly by lower food inflation that entered deflationary territory in June. However, CPI inflation is likely to edge up above the 4 per cent target from Q4:2025-26 onwards. Moreover, core inflation has been rising steadily from the recent low of 3.6 per cent recorded during December- January 2024-25 and averaged 4.3 per cent in Q1 this year. Core excluding precious metals has witnessed an uptick and averaged 3.4 per cent in Q1.
13. Growth has held up well with some pick-up expected in the coming festive season and is evolving in line with our assessment of 6.5 per cent for 2025-26.
14. Thus, while headline inflation is much lower than projected earlier, it is mainly due to volatile food prices, especially of vegetables. Core inflation, on the other hand, has remained steady around the 4 per cent mark, as anticipated. Inflation is projected to go up from the last quarter of this financial year. Growth is robust and as per earlier projections though below our aspirations. The uncertainties of tariffs are still evolving. Monetary policy transmission is continuing. The impact of the 100 bps rate cuts since February 2025 on the economy is still unfolding.
15. On balance, therefore, the current macroeconomic conditions, outlook and uncertainties call for continuation of the policy repo rate of 5.5 per cent and wait for further transmission of the front-loaded rate cuts to the credit markets and the broader economy. Accordingly, the MPC unanimously voted to keep the repo rate unchanged. The MPC further resolved to maintain a close vigil on the incoming data and the evolving domestic growth-inflation dynamics to chart out the appropriate monetary policy path. Accordingly, all members decided to continue with the neutral stance.
16. The minutes of the MPC’s meeting will be published on August 20, 2025.
17. The next meeting of the MPC is scheduled from September 29 to October 1, 2025. Voting on the Resolution to keep the policy repo rate unchanged at 5.5 per cent Member Vote Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Dr. Rajiv Ranjan Yes Dr. Poonam Gupta Yes Shri Sanjay Malhotra Yes Statement by Dr. Nagesh Kumar
18. The MPC held its August meeting against the backdrop of continued challenges to the sustainability of economic growth, especially in the manufacturing sector, posed by the trade policy uncertainties and subdued private investment, while inflationary pressures have eased further.
19. The inflationary outlook has continued to remain benign. The CPI headline has softened further in June 2025 to 2.1 per cent, the lowest level since January 2019, driven by declining food prices, which went into negative territory at -0.2% on a y-o-y basis. The inflationary expectations remain well anchored as the RBI household surveys confirm the continued easing of inflationary expectations. Hence, the projections for headline CPI for 2025 have been revised downwards by 60 basis points from 3.7% at the time of June Policy to 3.1% now.
20. The economic growth outlook remains challenging. Despite healthy growth of profits and profit margins, and capacity utilisation rates trending upwards and staying above the 75% level (including the seasonally adjusted capacity utilisation), considered a critical threshold, especially for manufacturing, the sales growth moderated, and private investment is not showing signs of picking up. The credit offtake has also not happened in the expected manner, despite lower interest rates. The urban demand continues to remain subdued, although rural demand is showing healthy growth, led by rising rural wages, robust agricultural growth with the prospects of a good monsoon.
21. The private investment sentiment is adversely affected by the trade policy uncertainties. While the signing of the UK-India FTA is an important positive development, the US announcement of 25% tariffs on India is causing a lot of anxiety about the economic outlook. The preliminary calculations suggest that these tariffs may hurt the growth rate in the current year by 20 to 30 basis points but given the fact that the US is a major market for India’s exports of labour-intensive goods such as textiles and garments, leather goods, gems and jewellery, shrimp among other food products, the threat of job losses is more serious. One can only hope that the penal tariffs for Russian oil purchase will be withdrawn and the ongoing bilateral trade negotiations will succeed in eventually bringing down the US tariffs on Indian exports to more manageable levels and broadly in line, if not better, with the Asian peers, such as ASEAN countries and Bangladesh and the disruption will be short-lived. However, the uncertainty is affecting the investment climate. Going forward, diversification of markets for goods will be important. In that context, the negotiations of the India-EU FTA need to be expedited and the FTAs or the comprehensive economic partnership agreements with Japan and the Republic of Korea need to be reviewed to make them more effective, especially for the export of labour-intensive goods. Tapping the domestic market fully for the finished consumer goods by reducing the dependence on imports would also be helpful. Enhancing the domestic value addition in consumer goods exports through building the globally known Indian brands and supply chains, including through overseas direct investments (ODI) and acquisitions of foreign retail chains, would also be important.
22. Keeping in mind the compulsions to support economic growth, the repo rate has been lowered three times since the February 2025 MPC meeting bringing a total of 100 basis points reduction. Transmission of the repo rate cuts to the lending and deposit rates happens with a lag. However, the transmission was accelerated by the hefty 50 basis point cut in June 2025 policy. By now, overall, the lending rates have gone down by 71 basis points, and the deposit rates by 87 basis points for fresh loans and deposits. Given the lag in transmission, further softening of lending rates may happen in the coming months, especially given that liquidity continues to remain in surplus.
23. While the case for stimulating private investments and urban demand remains, and the benign inflation outlook provides policy space, we may wish to wait and watch as the transmission of the existing actions takes place and how the trade policy uncertainties play out before considering policy actions at the October meeting of the MPC. Hence, I vote for keeping the repo rate unchanged at this juncture. I also feel that we could continue with the neutral stance to keep our options open in this challenging and complex economic environment. Statement by Shri Saugata Bhattacharya
24. The MPC has been pro-active in easing monetary policy since February 2025, in conjunction with multiple RBI measures to reinforce transmission and ease lending conditions. The policy repo rate has been cut by 100 basis points in the space of 5 months. Average system liquidity has been in Rs 3.0 lakh crores surplus since the June 2025 MPC meeting, and the pre-emptive guidance of a 100 basis points cut in the CRR starting September is expected to keep liquidity in surplus. Financial conditions, as reflected in RBI data, remain easy.
25. At this point, we need to step back, assess the impacts of the rate decisions and other policy actions. As trite as this sounds, it is worth re-emphasising that monetary policy has to address multiple, often conflicting, objectives and optimise the consequent trade-offs.
26. The most important of these trade-offs, to my mind, is the balance between loan and deposit rates. The intervening period from June 2025 has seen a fairly large transmission of the policy easing into credit interest rates, particularly for fresh loans. To reiterate, one of the principal objectives of monetary policy easing is to lower borrowing costs to support investment intent and decisions. This can presumably facilitate increased demand for credit. To an extent, this has happened. Bank credit flows to the micro and small enterprises (as of 27th June) have largely held up. More broadly, overall flows of funds to the commercial sector, via both domestic and offshore channels, have also been robust.
27. During this same period, though, interest rates on fresh deposits have fallen more sharply than on fresh loans. Prima facie, this likely would have primarily been driven by cuts in wholesale deposits rates, due to the large liquidity surplus. Even factoring in the underlying deposit mix, this fall in deposit rates is of some concern regarding the accretion of domestic household savings, given my conjecture about restricted foreign savings (capital) flows into India, at least in the near future.
28. Building on the credit narrative, domestic economic activity, based on high frequency indicators, remain largely resilient, despite moderation in some proxies of aggregate demand. RBI Survey responses indicate continuing consumer confidence. Inflation forecasts over the next couple of quarters in FY26 are moderate, but are projected to rise thereafter. In addition, the sources of the moderation in recent inflation prints originate from a concentrated subset of the index, which is a latent risk. This is the second trade-off.
29. As to the broader macroeconomic environment, uncertainty about global trade and economic activity remains elevated, even though the emerging scope and scale of US tariffs are becoming somewhat clearer. Despite this, uncertainty about global supply chain dislocations remains heightened. The outlook on India-US trade, in particular, has become fraught, based on the publicly available information on India- specific US tariffs plus unknown additional penal tariffs. Geo-strategic considerations have thus added another layer of uncertainty. The outcome and timelines of a bilateral trade deal with the US are unclear. If these tariffs persist, there is likely to be an adverse impact on India growth in FY26, and probably beyond. All these have clouded the outlook on India’s external balance, both current and capital accounts. The balance between the domestic economic dynamics and the offshore uncertainty is the third trade-off.
30. Given this level of extant and evolving uncertainty, it is difficult to provide even a modicum of forward guidance. Policy decisions will continue to be based on incoming data and be taken on a meeting-by-meeting basis. While the current trade dynamics play out, data on economic data on activity in India in the recent past, notably Q1 FY26 GDP and Balance of Payments, are also awaited.
31. Hence, given the fluidity of the macro-financial environment, coupled with the ambiguities in the information set presently available, I believe that a pause in monetary policy decisions, both on the repo rate and the stance is appropriate. Hence, I vote for status quo in this MPC meeting. Statement by Prof. Ram Singh
32. I will make a brief statement about the August 2025 meeting, as my assessment of the current growth-inflation dynamics and the prospects is very similar to what is described in the MPC statement. I will avoid duplicating the data presented in the MPC statement. Inflation
33. The CPI headline inflation has continued on its downward trajectory during the last two quarters, almost touching the floor of the tolerance band in June. The unexpected drop in CPI inflation has been driven primarily by a sharp decline in food inflation that registered its first negative print in June 2025 at (-) 0.2 per cent, the lowest since February 2019. Decline in food inflation is broad-based. The high- frequency indicators signal a continuation of the lower price momentum in food prices in the coming months as well. Fuel inflation has also moderated over the last couple of months to touch 2.6 per cent in June. The Core inflation, in contrast, has increased to 4.4 per cent in June from 4.1-4.2 per cent during February-May of this calendar year. An increase in gold and precious metal prices is a significant factor behind the uptick in Core inflation.
34. The inflation outlook in terms of average CPI inflation, for the fiscal year (FY) 2025-26, has become very benign, mainly on account of unexpectedly low food inflation. The RBI has lowered its CPI inflation forecast to 3.1%. However, the average core inflation is likely to remain above the target range during coming quarters. GDP Growth
35. Overall, the GDP growth is holding up so far amidst mixed signals coming through some high-frequency indicators. The rural consumption, including tractor and two-wheeler sales, remained resilient in Q1: 2025-26, whereas indicators of urban consumption, including FMCGs, passenger vehicle sales and also air passenger growth, remained tepid.
36. Going forward, several factors are expected to provide comfort: an increase in the flow of funds to the private sector through bond markets and non-banking channels, a super-healthy corporate balance sheet, high levels of PMIs for the manufacturing and services sectors, and rising capacity utilisation. The above-normal monsoon, low inflation, supportive monetary, regulatory, and fiscal policies, along with the onset of the festival season, are expected to support growth by boosting demand. The sustained growth rates in construction, trade and a broad range of services sectors are expected to remain buoyant in the coming months, supporting the growth.
37. There are also some stress signs associated with achieving a 6.5% growth rate. Private capex growth remains below expectations, though the recent signals in this regard are encouraging. Overall, fixed investment is primarily supported by government capex. Growth in the industrial sector remained subdued and uneven across segments. The Index of Industrial Production (IIP) has also shown moderation. The net FDI is also trending at low levels.
38. Moreover, prospects on the exports front are highly uncertain amidst ever- changing tariff announcements and protracted trade negotiations. The headwinds emanating from a fluid geopolitical scenario, heightened global uncertainties, and volatility in international financial markets pose serious risks to the domestic growth outlook. US tariffs have already put Indian exporters at a disadvantage. Signs of distress in growth and employment for MSMEs are visible in sectors reliant upon the US market, such as diamond and jewellery, textile and apparel, and fisheries.
39. Under normal circumstances, there would be a case for a growth-supportive interest rate cut given benign inflation prospects. However, the unusually high degree of uncertainty on both inflation and growth fronts calls for greater caution. The CPI inflation is projected to cross 4 per cent in Q4:2025-26 and remain above the point target in subsequent quarters due to unfavourable base effects. Moreover, the impact of the demand boost from the monetary and fiscal policy in action is yet to play out. There is a risk of imported inflation due to uncertainty about the prices of some commodities and the unquantifiable implications of volatility in global financial markets.
40. On the other hand, improved domestic food supply chain logistics, healthy kharif sowing, and above-normal water reservoirs bode well for food inflation in the coming quarters. The expected revision in the inflation series based on the revised CPI index (with a lower weightage for food) adds to the downside of inflation risks. In the future, the base effect (high prices of precious metals) can also moderate the core inflation.
41. All these factors have increased the variance of the inflation forecast. The assumptions about global growth and inflation are changing by the day. Global growth is holding up so far. Exports have been front-loaded, with exporters absorbing a larger share of the tariff costs. This means that the full impact of tariff tussles is yet to play out fully on the US economy and the rest of the world. In the second half of the fiscal year, global growth and inflation can turn out to be very different from the projected levels.
42. The tariff tussle between the two largest economies will simultaneously unleash inflationary and deflationary pressures on the Indian economy. The overall effect is hard to quantify. Given the high degree of uncertainty regarding growth and the volatile nature of food inflation, caution is warranted in the rate cut. The interest rate decisions of the US Fed and other central banks in the coming months will also have a bearing on the feasibility of a further rate cut by the RBI and its quantum.
43. To respond to an unpredictable set of events, it is crucial to maintain policy options, in terms of the number of policy tools that can be used as well as their force. Only the incoming data can help in assessing the inflation with the precision required under the current global economic order. Moreover, the MPC needs to watch the pass-through of the 100 bps rate cut to ascertain its effects on inflation and growth. We need to monitor the sectoral impacts of direct and indirect effects of tariffs on Indian exports.
44. In view of the above-discussed multi-dimensional and high-order uncertainty, I vote to pause the policy repo rate under the liquidity adjustment facility (LAF) at 5.50 per cent.
45. For the same reason, I support keeping the monetary policy stance as ‘neutral’. Statement by Dr. Rajiv Ranjan
46. The August MPC meeting was my 21st meeting as MPC member. This was one of the most difficult meetings in terms of deciding on the future course of monetary policy. Even though I had said in my June 2025 meeting minutes, “…having front-loaded the policy rate cut by 50 bps, we would be left with less room for further downward adjustments in policy rates”, I felt that the arguments were equally strong and delicately poised on both sides in this August meeting – to cut the policy repo rate by 25 bps or not to cut. Let me first summarise the arguments in favour of cutting the policy rate by 25 bps.
47. We have reduced the projection of inflation substantially by 60 basis points to 3.1 per cent in the current policy as the inflation outlook for the remainder of 2025-26 has turned benign, supported by favourable base effects, a well-progressing southwest monsoon, healthy kharif sowing, and comfortable foodgrain stocks. With projections for 2025-26 marked down significantly, inflation well below the 4 per cent target in the near term and greater traction of cyclical policy support for economic activity as the festive season approaches, there is a good case to be made that the room has opened up again for policy to ease further in support of growth, especially in an uncertain global environment.
48. On the other hand, the arguments to maintain the status quo with respect to the policy rate and stance seemed to be stronger on account of the following. First, the recent monetary easing cycle has already delivered a front-loaded 100 bps rate cut since February 2025. Its effects are still working through the system, and transmission to credit markets is ongoing. Thus, it is prudent at the current juncture to adopt a wait-and-watch approach to see the extent of transmission before delivering further policy stimulus. The impact of the CRR cut done earlier will also start kicking in from September 2025.
49. Second, the growth outlook for the Indian economy for 2025-26 has been evolving on the lines projected in the previous policy, despite unfavourable global demand conditions. The monsoon season has been progressing well with higher kharif sowing. Performance of the non-financial corporate sector is holding well. Key high-frequency volume-based activity indicators show that economic activity is holding firm. As such, growth is tracking our earlier projections, robust but still below aspirations.
50. Third, the decline in headline inflation has been largely due to sharp correction in its volatile component i.e., the food prices. Core inflation remains around 4 per cent, with potential upside risks from demand revival. Adverse weather shocks could upend the current sanguine food price scenario. The baseline inflation projections indicate that headline inflation is likely to overshoot the 4 per cent target by Q4:2025- 26 and further increase to 4.9 per cent by Q1:2026-27. Given these risks, there is a strong case for monetary policy to wait for a more definitive signal about a sustained moderation in inflation before venturing into further policy easing.
51. Fourth, globally, countries are moving cautiously with either pausing or cutting rates intermittently. We have had a rather accelerated easing in the last three consecutive policies.
52. Overall, growth remains resilient, supported by public capex, resilient rural demand, and steady services activity, although industry shows some unevenness. Inflation is significantly lower than projected earlier, but the decline is concentrated in a few volatile components and the outlook suggests a rise in inflation to above the target going forward. In next few months, we can have clarity on how tariffs and their impact on the macroeconomy evolve. The prudent course of action is to allow time for the recent policy easing to transmit fully into the economy and to assess its effects on real economic activity. An additional rate cut at the current juncture could also reduce our policy space should global or domestic risks materialise. After weighing these considerations, I conclude that the balance of risks calls for no action in this meeting, and accordingly I vote for the policy repo rate to be kept unchanged at 5.50 per cent.
53. I also feel that the neutral stance of policy should be maintained, as it allows enough flexibility to react to the unfolding growth-inflation dynamics. Policy will have to be data-dependent, forward-looking and nimble-footed, aiming to secure price stability while supporting growth. Such an approach leaves the space to act, should downside risks to growth arises and inflation remains on the projected trajectory. Statement by Dr. Poonam Gupta
54. In this meeting, I vote for the status quo, i.e., to keep the policy repo rate unchanged at 5.5 percent. My vote is predicated on the following three factors.
55. First, the evolving growth-inflation dynamics have weighed on my vote. Despite receding from their peak of May and June, financial market volatility and geopolitical uncertainties have remained elevated; and some trade uncertainties have aggravated for India. Notwithstanding these challenges, the Indian economy remains resilient overall. A favourable monsoon, low inflation, government infrastructure spending and congenial financial conditions facilitated by frontloaded policy easing remains supportive of domestic economic activity.
56. Since the last policy, the inflation outcome has turned out to be surprisingly benign with CPI headline inflation declining to 2.1 per cent (y-o-y) in June. One could argue that the benign inflation outlook gives the headroom to continue with policy easing in support of accelerating the growth momentum. However, this moderation is not general, but is primarily driven by a deflation in food (-0.2 per cent y-o-y), particularly by a sharp decline in the prices of vegetables and pulses. Besides, CPI inflation is likely to firm up above 4 per cent from Q4:2025-26 as the unfavourable base effects would come into play and move closer to 5 per cent in Q1:2026-27 even with moderate price momentum. Additionally, core inflation is likely to remain above 4 per cent in the near to medium term, barring any major negative shock to input prices.
57. Second, this policy action needs to be seen in its totality and in the context of the past actions. There has been a cumulative rate cut of 100 bps since February 2025, which includes a frontloaded rate cut of 50 bps in the June policy. Simultaneously, the RBI has deployed other tools during this period, including easier liquidity conditions; regulatory easing; and transparent, and frequent communication and forward guidance. The effect of all these actions has been permeating through the economy. Transmission of the cumulative rate cut has been impressively rapid, but it is still unfolding, and is likely to pick up in the coming months, facilitated by the CRR cuts coming into effect from September 2025.
58. Third, while awaiting the transmission to be completed, the cost or availability of funds (bank credit and other sources of funds) is not deemed to be a material constraint to growth at the current juncture. Rather, heightened global uncertainties and structural factors seem to be more constraining for new investment and consumption decisions.
59. Taking into account the growth-inflation outlook, past actions, the state of the domestic economy, and the global dynamics, I do not see the scope or rationale for a further policy rate cut at this point. I also propose a neutral stance so that the future actions could be data dependent, i.e., conditioned by the relative dynamics of growth and inflation, while also internalizing the impact of policy actions from other relevant countries. Statement by Shri Sanjay Malhotra
60. The global economy continues to traverse a period of heightened uncertainty on account of trade and tariff negotiations and lingering geopolitical tensions. Global growth outlook, however, has improved at the margin for 2025 driven by front loading of exports in anticipation of tariffs, easing of financial conditions and fiscal expansion in advanced economies (AEs). The pace of disinflation, however, has slowed down and inflation continues to remain above the target in most AEs.
61. Domestic growth has evolved largely in line with the assessment set out in our June policy. Growth projected at 6.5 per cent is resilient, considering the current uncertain environment which shows no signs of abatement. However, this is certainly lower than what we can achieve. High-frequency indicators point toward buoyant rural economic activity and consumption, whereas urban spending continues to remain sluggish. During the remaining part of the financial year, growth is likely to receive support from both favourable supply-side factors as well as a supportive policy environment. Monsoon has progressed well, sowing has been satisfactory, and reservoir levels are comfortable, all of which augur well for farm output and rural demand. Urban demand is likely to pick up during the festive season, especially in a period of benign inflation. Services sector activity is also likely to remain strong, as evident from forward-looking assessments from surveys. Uncertainty in external demand, driven by tariff and geopolitical uncertainty, remains the major drag on growth as it also hinders private investment intentions, which is yet to show visible signs of improvement.
62. Inflation continued its downward trajectory, with the headline CPI inflation in June at 2.1 per cent - a 77-month low. The decline in inflation was primarily driven by the food component, which registered a year-on-year contraction of -0.2 per cent in June. The extent of moderation in food inflation turned out to be larger than that expected during the June MPC meeting, as supply-side conditions turned out to be much more favourable. Core (CPI excluding food and fuel) inflation recorded a modest rise to reach 4.4 per cent in June, driven by higher gold prices. Headline inflation, driven by the food component, is likely to record substantially lower numbers in the near term. The baseline forecast for CPI inflation during 2025-26 is being revised downwards to 3.1 per cent.
63. Overall, our economy presents a picture of strength, stability, and opportunity. India’s strong fundamentals, growth inducing policies, and forward-looking economic strategy clearly place it in a strong position. While growth has remained steady, inflation outcomes have been far more benign on account of higher food price moderation. Although we are likely to see inflation undershooting the target in the near term, with a likelihood of monthly numbers even crossing the lower tolerance band of 2 per cent, headline inflation is projected to inch up from Q3 onwards. The uncertainties of tariffs are still evolving. Monetary policy transmission of the cumulative 100 basis points cut in the policy rate since February 2025, though hastened due to various measures, is still continuing. The CRR cut, that is likely to kick in from next month, will also facilitate further monetary transmission and stimulate economic activity.
64. Considering all these, especially the current state of uncertainty on the external front, monetary policy needs to remain watchful. Therefore, I vote to keep the policy repo rate unchanged at 5.50 per cent. I also support retaining the neutral stance as it would provide monetary policy the necessary flexibility to respond to the evolving domestic and global economic conditions. (Puneet Pancholy) Press Release: 2025-2026/940 Chief General Manager
6. After a detailed assessment of the evolving macroeconomic and financial developments and the outlook, the MPC voted unanimously to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 5.50 per cent; consequently, the standing deposit facility (SDF) rate remains at 5.25 per cent while the marginal standing facility (MSF) rate and the Bank Rate remains at 5.75 per cent. The MPC also decided to continue with the neutral stance. Growth and Inflation Outlook
7. The global economy has been more resilient than anticipated in 2025, with robust growth in the US and China. The outlook, however, remains clouded amidst elevated policy uncertainty. Inflation has remained above their respective targets in some advanced economies, posing fresh challenges for central banks as they navigate the shifting growth-inflation dynamics. Financial markets have been volatile. The US dollar strengthened after the upward revision of US growth numbers for the second quarter, and treasury yields hardened recently tracking changes in policy rate expectations. Equities have remained buoyant across several advanced and emerging market economies.
8. In India, real gross domestic product (GDP), driven by strong private consumption and fixed investment, recorded a robust growth of 7.8 per cent in Q1:2025-26. On the supply side, growth in gross value added (GVA) at 7.6 per cent was led by a revival in manufacturing and steady expansion in services. Available high frequency indicators suggest that economic activity continues to remain resilient. Rural demand remains strong, riding on a good monsoon and robust agriculture activity, while urban demand is showing a gradual revival. Revenue expenditure of the Union and State Governments registered robust growth during the fiscal year so far (April-July). Investment activity, as suggested by healthy growth in construction indicators i.e., cement production and steel consumption in July-August, is holding up well even though production and import of capital goods witnessed some moderation. Recovery in manufacturing sector continues while services activity is sustaining its momentum.
9. Looking ahead, an above normal monsoon, good progress of kharif sowing and adequate reservoir levels have further brightened prospects of agriculture and rural demand. Buoyancy in services sector coupled with steady employment conditions are supportive of demand, which is expected to get a further boost from the rationalisation of goods and services tax (GST) rates. Rising capacity utilisation, conducive financial conditions, and improving domestic demand should continue to facilitate fixed investment. However, ongoing tariff and trade policy uncertainties will impact external demand for goods and services. Prolonged geopolitical tensions and volatility in international financial markets caused by risk-off sentiments of investors also pose downside risks to the growth outlook. The implementation of several growth-inducing structural reforms, including streamlining of GST are expected to offset some of the adverse effects of the external headwinds. Taking all these factors into account, real GDP growth for 2025-26 is now projected at 6.8 per cent, with Q2 at 7.0 per cent, Q3 at 6.4 per cent, and Q4 at 6.2 per cent. Real GDP growth for Q1:2026-27 is projected at 6.4 per cent (Chart 1). The risks are evenly balanced.
10. Headline CPI inflation declined to its eight-year low of 1.6 per cent (y-o-y) in July 2025 before rising to 2.1 per cent in August – its first increase after nine months. Benign inflation conditions during 2025-26 so far have been primarily driven by a sharp decline in food inflation from its peak of October 2024. Inflation within the fuel group moved in a narrow range of 2.4-2.7 per cent during June-August. Core inflation remained largely contained at 4.2 per cent in August. Excluding precious metals, core inflation was at 3.0 per cent in August.
11. In terms of the inflation outlook for H2: 2025-26, healthy progress of the south-west monsoon, higher kharif sowing, adequate reservoir levels and comfortable buffer stock of foodgrains should keep food prices benign. The recently implemented GST rate rationalisation would lead to a reduction in prices of several items in the CPI basket. Overall, the inflation outcome is likely to be softer than what was projected in the August MPC resolution, primarily on account of the GST rate cuts and benign food prices. Despite the anticipation of moderate momentum during H2, large unfavourable base effects are likely to exert upward pressure on headline CPI inflation, especially in Q4. Considering all these factors, CPI inflation for 2025-26 is now projected at 2.6 per cent with Q2 at 1.8 per cent; Q3 at 1.8 per cent; and Q4 at 4.0 per cent. CPI inflation for Q1:2026-27 is projected at 4.5 per cent (Chart 2). The risks are evenly balanced. Rationale for Monetary Policy Decisions
12. The MPC observed that the overall inflation outlook has turned even more benign in the last few months, due to the reasons discussed above. The average headline inflation for 2025-26 is now revised lower from 3.7 per cent and 3.1 per cent projected in June and August policy, respectively, to 2.6 per cent. Headline inflation for Q4:2025- 26 and Q1:2026-27 too have been revised downwards and are broadly aligned with the target, despite unfavourable base effects. Core inflation for this year and Q1:2026- 27 is also expected to remain contained.
13. Growth outlook remains resilient supported by domestic drivers, despite weak external demand. It is likely to get further support from a favourable monsoon, lower inflation, monetary easing and the salubrious impact of recent GST reforms. However, growth continues to be below our aspirations. Even though the growth projection for the financial year 2025-26 is being revised upwards, the forward-looking projections for Q3 and beyond are expected to be slightly lower than projected earlier, primarily due to tariff-related developments, despite being partially offset by the impetus provided by the rationalisation of GST rates.
14. To summarize, there has been a significant moderation in inflation. Moreover, the prevailing global uncertainties and tariff related developments are likely to decelerate growth in H2:2025-26 and beyond. The current macroeconomic conditions and the outlook has opened up policy space for further supporting growth. However, the MPC noted that the impact of the front-loaded monetary policy actions and the recent fiscal measures is still playing out. The trade related uncertainties are also unfolding. The MPC, therefore, considered it prudent to wait for the impact of policy actions to play out and greater clarity to emerge before charting the next course of action. Accordingly, the MPC unanimously voted to keep the policy repo rate unchanged at 5.5 per cent. The MPC also decided to retain the stance at neutral. However, two members - Dr. Nagesh Kumar and Prof. Ram Singh, were of the view that the stance be changed from neutral to accommodative.
15. The minutes of the MPC’s meeting will be published on October 15, 2025.
16. The next meeting of the MPC is scheduled during December 3 to 5, 2025. Voting on the Resolution to keep the policy repo rate unchanged at 5.5 per cent Member Vote Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Shri Indranil Bhattacharyya Yes Dr. Poonam Gupta Yes Shri Sanjay Malhotra Yes Statement by Dr. Nagesh Kumar
17. The external context for economic development has changed dramatically since the August MPC. While the growth rate of 7.8% in the first quarter of the current fiscal year was impressive, exceeding expectations, leading to an upward revision of projections for the year, to 6.8% from 6.5%, it does not factor in the shock that India has faced after the first quarter. Hence, the economic growth trajectory and projection suffer from possible discontinuities. The acceleration in first-quarter growth has been underpinned by consumption, especially rural consumption, and front-loading of government capex. Private investment has continued to remain sluggish, despite healthy growth of profits and profit margins, and capacity utilisation rates staying above the 75% level, perhaps due to the trade policy uncertainties. Hence, there is no room for complacency as the future looks uncertain because of external shocks.
18. In particular, the Trump Administration has delivered a comprehensive assault on India with successive announcements over the past few weeks. Before we could absorb the 25+25% reciprocal and penal tariffs on goods that became effective from the end of August, a hefty $100,000 fee was imposed on H1B visas. There are also other measures, including the proposed HIRE Act on outsourcing, the 100% tax on patented pharmaceuticals, among others which may affect India’s economic prospects.
19. The trade policy measures adopted by the US, India’s biggest trade partner and biggest market for exports of goods and services, pose challenges for the economy. While the effect on the economic growth rate may be limited to between 40-60 bps, a larger effect is expected on MSMEs and jobs. This is because the US is a much more important market for our labour-intensive goods than for all imports. The US accounts for nearly 20% of India’s merchandise exports, but our exposure to the US market is far greater at 33% for labour-intensive goods such as textiles and garments, leather goods, gems & jewellery, processed food products like shrimp. These are also the sectors that are dominated by MSMEs and account for a disproportionately larger share (around 40%) of jobs in the manufacturing sector. Therefore, high penal tariffs imposed by the US on India have the prospect of affecting MSMEs and the jobs in a significant manner.
20. In that context, diversification of export markets is the need of the hour, besides exploiting the domestic demand better. The Government has undertaken GST reforms that should help in charging the domestic consumption engine. Diversification of export markets beyond the US is also critical. In that context, the recent signing of the UK- India FTA and the India-EFTA Economic and Trade Agreement that became effective on October 1, 2025, are important developments. The negotiations of the India-EU FTA have been expedited, and new ones have been planned with the Eurasian Economic Community. We should also tap the potential of existing FTAs with Japan, the Republic of Korea, Australia and the UAE more effectively, for the export of labour- intensive goods, helping to reduce our dependence on the US market. We should also move up the value chain in these sectors by building and acquiring globally known brands, retail chains, and technological upgradation.
21. On the monetary policy front, a pre-emptive action would be important to contain the damage and to support private investments through liquidity provision, credit guarantees/ moratorium for MSMEs, including through a cut in the repo rate. Fortunately, the inflationary expectations remain well-anchored, and the average headline inflation has trended down, with projections for 2025-26 have now been revised downwards to 2.6% from 3.7% in the June MPC meeting. The GST reforms are also likely to push it down further. Therefore, the benign inflation outlook opens up policy space for monetary action. However, we may wish to wait and watch as the transmission of the existing actions is still unfolding and to see how the trade policy uncertainties play out before considering a rate cut at the December Meeting of the MPC. Nevertheless, we may like to signal the readiness of monetary policy to support the industry, investments and growth by changing the stance from ‘neutral’ to ‘accommodative.’
22. Hence, I vote for keeping the repo rate unchanged at this juncture but feel that the stance could be changed to accommodative. Statement by Shri Saugata Bhattacharya
23. Despite the continuing moderation in inflation opening up space for further monetary policy easing, the arguments for a pause in my August 2025 statement remain materially the same.
24. Although domestic economic activity remains resilient, trade and tariff uncertainties remain a risk to growth and investment. The following line from the MPC resolution aptly summarises my position: “The impact of the frontloaded monetary policy actions and the recent fiscal measures is still playing out. Trade related uncertainties are still unfolding. The MPC therefore considered it prudent to wait for the impact of policy actions to play out and greater clarity to emerge before charting the next course of action.”
25. A moderation in the inflation rate is not a compelling reason, at this point, to cut the policy rate. The Monetary Policy Report forecasts an average FY27 inflation of 4.5 per cent, with Q1 and Q2 FY27 also at 4.5% and Q3 at 5.1%. This is assuming a normal monsoon and no exogenous shocks. In addition, real GDP growth in FY27 is projected at a robust 6.6 per cent, following a forecast 6.8 per cent in FY26. The Report notes that “domestic economic activity remains resilient and is expected to maintain momentum”. 25. For FY 26, robust services exports and remittance receipts is expected to keep the CAD in the comfort zone. 8 The S&P Global expects two 25-basis-point rate cuts by the Fed in calendar year 2025, in addition to the 25 pbs cut in September.
26. Domestic financial conditions remain easy, largely balanced. On bank credit, I should also point to the recent study on banks’ sanctions and disbursement pipeline in FY26. While loan sanctions in FY25 have moderated, total projected disbursements in FY26 remain robust, with the remaining tranches in H2 expected to boost credit growth 1.
27. The cumulative effects of the multiple, mutually reinforcing, policy stimulus measures – fiscal, monetary, financial and banking, trade, investment, regulations, etc. – which have been progressively rolled out, need to be monitored.
28. It is also worth re-emphasising that monetary policy has to address multiple, often conflicting, objectives and optimise the consequent trade-offs. Given the economic conditions described above, at this juncture, I do not see the need for a policy easing.
29. Hence, taking into account the fluidity of the macro-financial environment, I vote for a pause in monetary policy decision on the repo rate and for the same reason I believe that stance quo on the stance is appropriate at this point. Statement by Prof. Ram Singh
30. Since the last MPC meeting, the case for another rate cut in this cycle has become stronger. However, in view of the fiscal measures and the earlier monetary easing still working and the uncertainty on the external front looming large, I vote for a pause in the policy repo rate. At the same time, I am in favour of a change in stance from “neutral” to “accommodative”. Below, I elaborate on my decisions.
31. CPI headline inflation has continued to surprise on the downside, as it declined to 2.1 per cent (y-o-y) in August 2025 after registering its eight-year low of 1.6 per cent in July. The sharp decline in food inflation from its October 2024 peak has been consistent and broad-based. The available indicators and projections signal a continuation of the lower price momentum in food prices in the coming months. Accordingly, the CPI inflation for FY 2025-26 has been revised downward to 2.6 per cent, with Q3 at 1.8 per cent and Q4 at 4.0 per cent.
32. Core inflation (excluding food and fuel) has also mainly remained contained in the range of 4.1-4.4 per cent in the financial year so far. The print for Core inflation in August was 4.2 per cent - excluding precious metals, it was 3.0 per cent.
33. The inflation trajectory looks benign at least for the next two quarters. Improved domestic food supply chain logistics, a good kharif harvest, and above-normal water reservoirs bode well for low food inflation in the coming quarters. Crude prices are also expected to remain stable, with a downward bias. The CPI inflation may exceed the 4.0 per cent target in the next fiscal year, as the unfavourable base effect and the expected boost in demand take hold. Core inflation is also expected to be elevated but contained, as the base effect turns favourable following unusual increases in gold and silver prices over the last few months.
34. The GDP surprised on the upside, registering 7.8 per cent growth in Q1:2025-26 – GVA also grew by 7.6 per cent. For Q2, GDP growth also seems to be holding up amid mixed signals from some high-frequency indicators.
35. The GDP growth projection for FY26 is now revised upwards to 6.8 per cent, factoring in the unexpectedly high Q1 number along with the demand boost from monetary easing and GST rationalisation. Still, compared to the MPC’s February 2025 growth forecast, the latest H2: 2025-26 growth projections have been revised 1 “Private Corporate Investment: Growth in 2024-25 and Outlook for 2025-26”, RBI Monthly Bulletin, August 2025. downwards indicating some slack in momentum. In February, the forecast for Q3 and Q4 of FY 26 was 6.5 per cent each, whereas the latest growth forecasts are lower at 6.4 per cent for Q3 and 6.2 per cent for Q4. Real GDP growth for Q1:2026-27 is projected at 6.4 per cent.
36. The prevailing inflation rate is too low - it is neither conducive for businesses nor for public finances. Besides, the downward revisions to the growth forecast of H2:2025-26, coming on the heels of a more benign inflationary outlook, make a case for an additional growth-supportive interest rate cut. The case is further supported by the adverse effects of US tariffs and the headwinds from a fluid geopolitical landscape and heightened global uncertainties.
37. The next question to ponder over is what could be the downsides of a further rate cut. It may make more challenging for the banks to mobilise deposits to support credit growth. 2 But what matters more is the total savings and the flow of funds to the real sector, and not just credit through the banking channel. An increasing share of savings is being channeled to the private sector through bond and equity markets. 3
38. The moderation in aggregate savings rates is a concern from a macroeconomic perspective. 4 But interest rates do not seem to be the main driving force of the aggregate saving rate. 5 Research suggests that aggregate saving rates are driven by several factors, including demographic and other structural changes in the economy, differences in the rates of return on different forms of capital, and labour market dynamics, including the distribution of wages and income across economic strata. At the household level, interest rates do matter. But their effects are more pronounced on portfolio choices than on total savings. 6 Thus, the likely adverse impact on bank deposits and moderation in household savings should not be the reason for not going for a further rate cut.
39. On the external front, the tariffs and financial market-related uncertainties have persisted over the last two quarters. It seems the forex market has already priced in the worst in this regard. Though the exchange rate remains a concern, any pressure on the INR is likely to be confined to the short term, given the robust fundamentals of the Indian economy, including adequate forex reserves, a comfortable current account position 7, and the centre’s commitment to maintaining the fiscal glide path. The inclusion of Indian bonds in global indices and improved prospects for gross and net FDI are also a source of comfort.
40. Another concern is our interest rate differential with the U.S. and other major economies. The rate cuts by the US Fed, the BoE and the ECB in recent months have added some comfort on this count. Markets expects few more rates cuts by the US Fed in 2025, which would be further comforting for interest rate differential. 8 2 The rate cut can adversely affect banks’ NIMs and RoAs, ceteris paribus. However, the adverse effects will at least partly be mitigated by the 100 bps CRR cut and other regulatory easing measures for the banking sector. 3 According to the RBI data, the total flow of resources from non-bank sources to the commercial sector increased by ₹2.66 lakh crore in 2025-26 so far, more than offsetting the decline in non-food bank credit. 4 India’s gross domestic savings rate fell from 34.6% of GDP in 2011-12 to 30.7% in FY 24, with a slight uptick in FY25. 5 During 2014-24, (excluding the two Covid years) while the policy rates have varied significantly in the range of 7.75%-5.50%, the aggregate saving rates have fluctuated in the range of 29.6% to 32.2% 6 The RBI’s analysis of household savings a shift away from bank term deposits. The share of term deposits declined from 50.54% in FY20 to 45.77% in FY25, due to households moving to alternative, higher-yielding investments like mutual funds and equities. 7 India’s CAD moderated to 0.2 per cent of GDP in Q1:2025-26 as compared with 0.9 per cent of GDP in Q1:2024-
41. In sum, there is ample scope for an additional rate cut. The question is: Is there a need for one during this policy cycle?
42. When the impact of the demand boost from the 100 bps cuts in repo rates this year is yet to play out fully, a further rate cut today runs the risk of an overdose. The intended effects of the monetary easing and the fiscal measures are still working through the system. 9
43. The risk aversion among investors seems to have eased, driven by a demand boost from the fiscal side (income tax reliefs and GST rationalisation), conducive financial conditions, broad-based transmission of rate cuts 10, robust system-level financial parameters, and easing of micro and macroprudential regulations on banks. Recent signals on Private capex growth are encouraging. Several indicators corroborate this inference, such as an increased capacity utilisation 11, significant pickups in the flow of funds to the corporate sector through non-bank channels, among others.
44. Going forward, buoyancy in a broad range of service sectors and a resilient agriculture sector are supportive of growth momentum. The demand is expected to get a further boost from the GST rationalisation and the festival season. Domestic demand should continue to support fixed investment, amid continued monetary transmission driven by adequate liquidity in the system and the remaining three tranches of CRR cuts.
45. Under such conditions, the available scope for rates can be leveraged to sustain the growth momentum for a longer period by extending the easing cycle. A change in stance to accommodative increases the odds of a rate cut in this easing cycle. Backed by conducive liquidity conditions and further improvement in transmission, it will add to the income and demand effects induced by the 100 bps rate cuts so far. Furthermore, an expectation of a rate cut will likely put downward pressure on bond yields, thereby enhancing the appeal of the bond market for borrowers seeking to raise funds through market instruments. Yet, the accommodative stance gives the RBI flexibility to delay or hold back on further cuts in the event of unexpected developments in food prices or on the external front.
46. In view of the above, I vote to take a pause in the policy repo rate under the liquidity adjustment facility (LAF) at 5.50 per cent.
47. But I am in favour of changing the monetary policy stance from ‘neutral’ to “accommodative”. Statement by Shri Indranil Bhattacharyya
48. In a world characterised by geo-political strife, geo-economic fragmentation and strategic realignment brought about by all-pervasive uncertainty on trade and tariffs, 9 According to RBI, in response to the cumulative policy repo rate cut of 100 bps in the current easing cycle (as of September 29), the WACR, the 3-month T-bill rate, the 3-month CP issued by NBFCs, and the 3-month CD rate declined by 92 bps, 105 bps, 118 bps, and 147 bps, respectively. 10 During February-August 2025, in response to the 100-basis points (bps) cut in the policy repo rate, the WALR of SCBs moderated by 58 bps for fresh rupee loans; 71 bps is on account of interest rate effect. The moderation for outstanding rupee loans is to the extent of 55 bps. On the deposit side, the WADTDR on fresh deposits declined by 106 bps, while that on outstanding deposits softened by 22 bps over the same period. Transmission has been broad-based across sectors. The system-level financial parameters related to capital adequacy, liquidity, asset quality and profitability of the SCBs continue to remain healthy. The system-level parameters of NBFCs too are sound, with improved GNPA ratios. 11 Manufacturing PMI surged to a 17.5-year high of 59.3 in August 2025, along with strong business optimism. Services PMI reached a 15-year high of 62.9 in August. the Indian economy has demonstrated strength and resilience. Based on buoyant services sector activity and rebounding of the manufacturing sector, GDP growth registered an impressive 7.8 per cent in Q1:2025-26, significantly higher than the consensus estimate. 12 High-frequency indicators available so far suggest resilience in economic activity in Q2:2025-26; therefore, growth is likely to remain buoyant in Q2.
49. Looking ahead, growth in H2:2025-26 and beyond is likely to be determined by the interplay of domestic tailwinds and external headwinds. Domestic demand is expected to get a boost from growth supportive measures and policies such as GST rationalisation, income tax relief, past monetary policy actions and several regulatory measures announced by the Reserve Bank today. Benign inflation outlook and lower GST rates are also supportive of a revival in urban consumption demand. The spatial and temporal distribution of monsoon has generally been positive for agricultural activity and rural demand. Along with congenial financial conditions, several growth- supportive policies undertaken by the Government and the Reserve Bank should also be a catalyst for a turnaround in private investment sentiments. However, tariff and trade-related uncertainties would inhibit external demand, although it may get partially offset through higher consumption spending. Considering all these factors and the higher realised numbers for Q1, GDP growth for 2025-26 has now been revised upwards from the August policy by 30 basis points.
50. In a span of 10 months, headline inflation moderated from 6.2 per cent in October 2024 to 1.6 per cent in July 2025 before increasing to 2.1 per cent in August. This sharp disinflation was solely brought about by the precipitous decline in food inflation. This unexpectedly swift moderation and its continuation over an extended period suggests that the food inflation trajectory is likely to be more benign than what was anticipated earlier. Moreover, rationalisation of GST is likely to ease prices albeit in varying degree depending on the extent of pass-through to the final consumer. Cumulatively, these factors led to a downward revision in headline inflation forecast for 2025-26 to 2.6 per cent, a cumulative revision of 110 basis points from the projection of 3.7 per cent in June 2025. In terms of the quarterly forecast trajectory, inflation is expected to remain well below the target till Q3:2025-26 but progressively edge up thereafter. Therefore, the current ultra-low levels should be seen as a transitory phenomenon, and monetary policy has to be cognisant of potential demand pressures over the medium term generated by the cumulative impact of past monetary and fiscal measures. At the same time, one needs to be wary of potential supply shocks from weather related uncertainties as well as volatility in international commodity prices.
51. Drawing from the above discussion, it can be inferred that the sharp moderation in inflation has undoubtedly opened up policy space for further rate easing. However, I vote to pause at the present juncture based on several considerations. These are (i) given the heightened uncertainty, a rate cut at this point may not have the intended impact; (ii) allow for all past monetary and fiscal measures as well as the ensuing ones (CRR reductions) to work its way through the financial system; and (iii) given no market expectation of a rate cut 13, any rate reduction would surprise the market, which is detrimental in terms of policy credibility over the medium term.
52. Given the prevailing uncertainties, I also agree to continue with the neutral stance as it allows central banks to avoid committing to specific policy settings. 14 A neutral stance provides the necessary flexibility to be nimble and agile in conducting two-way 12 Bloomberg poll of economists suggested a median growth forecast of 6.6 per cent in Q1 2025-26. 13 As evident from the flat OIS rates. 14 Agustín Carstens (2025). “Lessons learned and challenges ahead for central banks in the Americas” speech delivered by General Manager, Bank for International Settlements, at the BIS Chapultepec Conference, Mexico City, February 6. market operations consistent with evolving requirements. Any shift to an accommodative stance at this stage could be viewed as explicit forward guidance on the future interest rate path, suggesting that it can only go down. Such precise guidance needs to be avoided since a neutral stance is not inconsistent with a rate cut. In this milieu, messaging has to be done with effective communication as errors can be costly. In this context, it is worthwhile to remember the sagacious advice of a former Fed Chairman “Monetary policy may be 98% talk and only 2% action but cost of sending the wrong message can be high”. 15 Statement by Dr. Poonam Gupta
53. The Indian economy is proving to be resilient overall, well on its way to attain a healthy growth rate in the ballpark of 6.5 to 7.0 per cent, both this year and the next. Lower and steadier inflation has been another welcome enabler. Besides its inherent resilience on the back of robust domestic demand, a proactive policy response is adding strength to the economy to withstand the challenges posed by a complex and fast evolving global policy environment. If it were not for the adverse global conditions, perhaps it would have already triggered a turnaround in the private investment cycle and further accelerated economic growth.
54. In this context, the following developments that have occurred since the last meeting of the MPC in August, weigh on this round of policy.
55. With the implementation of the rationalized GST rates since September 22, 2025, the inflation outlook appears to be more benign. This along with the lesser food price build up has led the RBI to lower its current year inflation projection since the last policy by 50 bps to 2.6 per cent.
56. Simultaneously, the growth outlook has evolved too. Due to stronger than anticipated growth rate of 7.8 per cent for Q1:2025-26, and various indicators pointing to a robust expansion in Q2:2025-26, growth forecast for 2025-26 has been revised upwards to 6.8 per cent. This subsumes the expected adverse effects of the US tariffs, partly compensated by the likely growth inducing effects of GST rationalization.
57. As far as the economic outturns at quarterly and half yearly basis are concerned, growth is projected to be much higher in the first half relative to the second half of the fiscal year. Inflation, on the other hand, is projected to be more benign at 1.8 per cent during Q2 and Q3 of this year and is expected to inch up to 4.0 per cent in Q4 and 4.5 per cent in Q1 next year, as the unfavorable base effect kicks in.
58. The described growth-inflation mix, particularly slower growth in H2 and a benign inflation rate, has potentially opened some space for lowering the policy rates further; yet it is difficult for me to vote for a rate cut at this juncture.
59. This is for the following reasons.
60. First, while the recent measures announced by the government have significantly bolstered consumer sentiment, these measures are still working their way through. It would be prudent for the impact of these measures to be sufficiently realized before taking another supportive measure right away. Second, even the policy rate cuts announced by the RBI during this calendar year are currently being transmitted through the system. Announcing a rate cut at this time may only be marginally effective. Third, the global uncertainties are evolving at a very fast pace. Depleting policy ammunition 15 Benjamin.S. Bernanke (2015), Inaugurating a new blog, The Brookings Institution, Economic Studies. at this point does not seem warranted until there is more clarity on how the global policy environment will unfold henceforth.
61. Hence, I vote for the status quo, i.e., to keep the policy repo rate unchanged at 5.5 per cent.
62. While voting for a pause in the policy rate, I propose to retain the stance at neutral based on the following considerations.
63. Despite some space that has possibly opened up given the forward-looking growth- inflation dynamics, I feel changing the stance to accommodative is not required as the neutral stance does not prevent us from reducing the repo rate when warranted.
64. Moreover, given the heightened global uncertainty, it may not be possible to confidently commit to a new stance. Hence, I consider it prudent to retain the stance at neutral. Statement by Shri Sanjay Malhotra
65. The global economy has been resilient in the first half of 2025. Frontloading of consumption, inventory restocking, and delayed tariff implementation have supported growth. The outlook, however, remains subdued, with downside risks due to current policy uncertainties and simmering geo-political tensions. Inflation is overshooting target in some countries while fiscal concerns remain elevated in advanced economies. There is also downside risk from repricing of financial markets as equity markets remain buoyant amidst bearish sentiments on bonds (hardening yields).
66. Domestic economic growth too was resilient in Q1:2025-26. High frequency indicators suggest that it is likely to remain strong in Q2. Thereafter, however, it is expected to soften due to the impact of tariffs although the GST rationalisation would partially cushion the impact. Several indicators suggest that agricultural prospects are bright in the current year; consequently, rural demand is likely to be buoyant. Strong services sector growth and steady employment conditions would support growth. External demand, however, is likely to remain lukewarm in the wake of prevailing tariff and trade-related uncertainties. On the whole, growth outcome for 2025-26 is now expected to be higher at 6.8 per cent than 6.5 per cent envisaged in the August policy, even as the outlook from H2 onwards is softer.
67. Headline CPI inflation moderated to an eight-year low of 1.6 per cent in July before inching up to 2.1 per cent in August. The decline in inflation was primarily driven by the food component due to improved supply conditions and measures undertaken by the government to manage the supply chain. Core (CPI excluding food and fuel) inflation remained contained at 4.2 per cent in August despite pressures from higher prices of gold and silver. In view of GST rationalisation and benign food prices, the projection of headline inflation for 2025-26 has now been lowered to 2.6 per cent from 3.1 per cent projected in the August policy and 3.7 per cent in June. The outlook for inflation in Q1:2026-27 is also benign and has been revised downwards.
68. To summarise, even though growth is strong by current reckoning, its outlook is softer and is expected to be below our aspirations. The benign outlook for headline and core inflation as a result of the downward revision of projections opens up policy space to further support growth. However, several growth-inducing policies unveiled by the Government and the Reserve Bank should help growth, going ahead. The cumulative impact of fiscal and monetary measures is yet to be realised fully. Tariff- related uncertainties are still evolving. There is elevated uncertainty on the external front. In view of these factors, even though there is policy space to further cut the policy rate, I feel this is not the opportune time for the same as it will not have the desirable impact. Therefore, I vote to keep the policy repo rate unchanged at 5.50 per cent. The intent of policy, nevertheless, is to continue to facilitate growth-enabling conditions. Some of the regulatory measures announced today will also be supportive of this objective.
69. Moreover, I prefer to retain the neutral stance as any change to an accommodative stance at this stage, as suggested by some members, would tantamount to giving a definitive forward guidance about the future trajectory of the policy rate. The policy uncertainty, rapidly evolving developments and the foggy outlook suggest that we exercise caution and take a view for each policy as per the then prevailing macroeconomic conditions and outlook. (Brij Raj) Press Release: 2025-2026/1317 Chief General Manager
6. After a detailed assessment of the evolving macroeconomic and financial developments and the outlook, the MPC voted unanimously to reduce the policy repo rate under the liquidity adjustment facility (LAF) to 5.25 per cent. Consequently, the standing deposit facility (SDF) rate shall stand adjusted to 5.00 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 5.50 per cent. The MPC also decided to continue with the neutral stance. Growth and Inflation Outlook
7. The global economy is holding up better than expected, though the earlier frontloading of trade is showing signs of normalising. Uncertainty has eased somewhat following the end of the US government shutdown and progress on trade agreements, yet it remains elevated. Global inflation dynamics remain uneven, with inflation trending above target in most major advanced economies. The US dollar strengthened primarily on safe haven demand while treasury yields remained range bound. Equity markets remain volatile, driven by shifting views on the monetary policy outlook and concerns surrounding stretched valuations in tech stocks.
8. In India, real gross domestic product (GDP) registered a six-quarter high growth of 8.2 per cent in Q2:2025-26, underpinned by resilient domestic demand amidst global trade and policy uncertainties. On the supply side, real gross value added (GVA) expanded by 8.1 per cent, aided by buoyant industrial and services sectors. Economic activity during the first half of the financial year benefited from income tax and goods and services tax (GST) rationalisation, softer crude oil prices, front-loading of government capital expenditure, and facilitative monetary and financial conditions supported by benign inflation.
9. High-frequency indicators suggest that domestic economic activity is holding up in Q3, although there are some emerging signs of weakness in a few leading indicators. GST rationalisation and festival-related spending supported domestic demand during October-November. Rural demand continues to be robust while urban demand is recovering steadily. Investment activity remains healthy with private investment gaining steam on the back of expansion in non-food bank credit and high capacity utilisation. Merchandise exports declined sharply in October amid subdued external demand, accompanied by softer services exports. On the supply side, agricultural growth is supported by healthy kharif crop production, higher reservoir levels and better rabi crop sowing. Manufacturing activity continues to improve, and the services sector is maintaining a steady pace.
10. Looking ahead, domestic factors such as healthy agricultural prospects, continued impact of GST rationalisation, benign inflation, healthy balance sheets of corporates and financial institutions and congenial monetary and financial conditions should continue to support economic activity. Continuing reform initiatives would further facilitate growth. On the external front, services exports are likely to remain strong, while merchandise exports face some headwinds. External uncertainties continue to pose downside risks to the outlook, while speedy conclusion of ongoing trade and investment negotiations present upside potential. Taking all these factors into consideration, real GDP growth for 2025-26 is projected at 7.3 per cent, with Q3 at 7.0 per cent; and Q4 at 6.5 per cent. Real GDP growth for Q1:2026-27 is projected at 6.7 per cent and Q2 at 6.8 per cent (Chart 1). The risks are evenly balanced.
11. Headline CPI inflation declined to an all time low in October 2025. The faster than anticipated decline in inflation was led by correction in food prices, contrary to the usual trend witnessed during the months of September-October. Core inflation (CPI headline excluding food and fuel) remained largely contained in September-October, despite continued price pressures exerted by precious metals. Excluding gold, core inflation moderated to 2.6 per cent in October. Overall, the decline in inflation has become more generalised.
12. Turning to the inflation outlook, food supply prospects remain bright on the back of higher kharif production, healthy rabi sowing, adequate reservoir levels and conducive soil moisture. Barring some metals, international commodity prices are likely to moderate going forward. Overall, inflation is likely to be softer than what was projected in October, mainly on account of the fall in food prices. Considering all these factors, CPI inflation for 2025-26 is now projected at 2.0 per cent with Q3 at 0.6 per cent; and Q4 at 2.9 per cent. CPI inflation for Q1:2026-27 and Q2 are projected at 3.9 per cent and 4.0 per cent, respectively (Chart 2). In fact, the underlying inflation pressures are even lower as the impact of increase in price of precious metals is about 50 basis points (bps). The risks are evenly balanced. Rationale for Monetary Policy Decisions
13. The MPC noted that headline inflation has eased significantly and is likely to be softer than the earlier projections, primarily on account of the exceptionally benign food prices. Reflecting these favourable conditions, the projections for average headline inflation in 2025-26 and Q1:2026-27 have been further revised downwards. Core inflation, which had been rising steadily since Q1:2024-25, eased at the margin in Q2:2025-26 and is expected to remain anchored in the period ahead. Both headline and core inflation are expected to be around the 4 per cent target during the first half of 2026-27. The underlying inflation pressures are even lower as the impact of increase in price of precious metals is about 50 bps. Growth, while remaining resilient, is expected to soften somewhat.
14. Thus, the growth-inflation balance, especially the benign inflation outlook on both headline and core, continues to provide the policy space to support the growth momentum. Accordingly, the MPC unanimously voted to reduce the policy repo rate by 25 bps to 5.25 per cent. The MPC also decided to continue with the neutral stance. However, Prof. Ram Singh was of the view that the stance be changed from neutral to accommodative.
15. The minutes of the MPC’s meeting will be published on December 19, 2025.
16. The next meeting of the MPC is scheduled during February 4 to 6, 2026. Voting on the Resolution to reduce the policy repo rate to 5.25 per cent Member Vote Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Shri Indranil Bhattacharyya Yes Dr. Poonam Gupta Yes Shri Sanjay Malhotra Yes Statement by Dr. Nagesh Kumar
17. The December 2025 MPC Meeting is taking place against the backdrop of mixed trends in the Indian economy. The GDP growth in FY2026:Q2 at a robust 8.2% exceeded expectations, particularly in the context of a challenging and uncertain external environment. What was more remarkable about the quarterly growth was its acceleration over the past four consecutive quarters, from 6.4% to 7.4%, 7.8%, and finally to 8.2%. After lagging for many quarters, the Q2 growth was led by manufacturing, which grew at over 9%, underpinned by the robust consumption, especially rural consumption, and investment growth. Higher manufacturing growth augurs well for jobs-creation. With FY26:H1 having delivered a solid 8%, the full-year projections have been upgraded from 7.0% to around 7.3%. On the other hand, inflation not only continued to remain benign but the headline CPI declined further to 0.3% in October 2025, largely driven by declining food prices. It is in contrast to FY25:Q2, when the growth was slowing, but inflation was at relatively high-levels.
18. The celebrations of this ‘goldilocks moment’ (high growth, low inflation), however, were tempered by trends for October 2025 published only a few days later, suggesting that the economic activity had peaked in Q2. The industrial activity, as measured by Index of Industrial Production began losing momentum in October 2025 to 14 months low, with mining and quarrying contracting and manufacturing reporting only 1.8% growth. The high-frequency indicators, such as PMI for manufacturing, dropped from 59.2 to 56.6. The merchandise exports declined by around 12% in October 2025. The export orders were at their weakest, bringing the New Orders PMI to 13 months low. The rupee came under pressure and breached the psychological barrier of INR90 to a dollar. RBI’s Industrial Outlook Surveys also suggest moderation in business assessment and expectations.
19. There is some evidence that the geopolitical and trade related uncertainties have started to hurt the business sentiment. The Trump tariffs are particularly affecting the labour-intensive industries such as textiles and garments, leather goods, gems & jewellery, processed food products like shrimp that have a higher exposure to the US market. These are also the sectors that are dominated by MSMEs and account for a disproportionately larger share (around 40%) of jobs in the manufacturing sector. Hence, the high tariffs imposed by the US on India have the prospect of affecting MSMEs and the jobs in a significant manner, as I had observed at the October 2025 MPC.
20. Therefore, there is a case for supporting growth through demand stimulus to preserve the growth momentum in H2 of 2025-26. From the fiscal side, the GST 2.0 reforms, the Rs 25,060 crores Export Promotion Mission to support diversification of markets, a Rs 20,000 credit guarantee scheme, and notification of the new labour codes, among other measures, have been announced to support economic growth. Coordinated fiscal and monetary policy actions have been very effective in reviving growth in the past. Hence, the monetary policy could step in to support the growth momentum, given that the transmission of the 100-basis point cut in the repo rate effected over the past year in a phased manner, is nearly complete. The headline inflation at 0.3% in October 2025, with projections for the full year 2025-26 at 2%, provides space for monetary policy action. Inflationary expectations remain well anchored. The current inflation rate is actually too low, breaching the lower bound in the flexible inflation targeting regime, especially if precious metals like gold are excluded. Besides, too low an inflation rate is not healthy for a developing country like India, suggesting a demand deficit.
21. Against that backdrop, I would like to vote for a 25-bps cut in the repo rate to support the growth momentum, while keeping a status quo on the stance. Statement by Shri Saugata Bhattacharya
22. The October 2025 MPC resolution had noted that the then “current macroeconomic conditions and the outlook opened up policy space for further supporting growth”, based primarily on low inflation. Subsequent data on inflation – even lower than forecast – has further expanded this space, irrespective of the strong Q2 FY26 GDP growth print, whose interpretations have been widely debated.
23. Inflation has continued to undershoot forecasts. While the low prints have largely emanated from a small set of components, the broader basket of “underlying” inflation too is likely to undershoot the inflation target for many months. In addition, there is little to signal a risk of potential overheating of capacity even if growth momentum were to sustain. Household inflation expectations remain well anchored and have responded to the recent sharp drop in inflation.
24. However, growth forecasts, both in the resolution and the Survey of Professional Forecasters (SPF), suggest a gradual deceleration. The contraction in the October merchandise export data is concerning, and the trade balance will need to be closely monitored. The uncertainty inter alia relating to the trade environment, is also now showing up in a gradual slowdown in certain metrics like the Manufacturing (Purchasing Managers Index) PMI, the sales levels readings of the IIM Ahmedabad (Business Inflation Expectations Survey) BIES, etc. In addition, as a working hypothesis, lower seller pricing power suggested by the expected moderate “underlying” inflation in the near future might not be conducive to investment decisions, even if FY26 growth remains close to 7.3% forecast in the resolution. The expected time for inflation to converge to its target might be longer than growth to its estimated potential. Hence, there might be a need for a relative overweight on inflation at this point.
25. Another factor for consideration is transmission. In the October 2025 MPC minutes, I had noted that the "impact of the frontloaded monetary policy actions and the recent fiscal measures is still playing out", which had prompted me to vote for a pause. One component of these effects was transmission into the Weighted Average Lending Rate (WALR) for both fresh and outstanding Rupee loans, which had then been ongoing. Latest data suggests that transmission has been satisfactory and broad based across sectors. Given the RBI commitment to liquidity infusions, further transmission is also likely.
26. Bank credit offtake and the broader flow of resources to the commercial sector have been rising over the past few months, specially to both small and medium enterprises. This might be reflective of a moderate revival in private investment and a pickup in economic activity. A further cut in interest rates in the EBLR segments of banks’ loan portfolios (in association with committed further liquidity infusions) is likely to boost credit demand, particularly in the MSME segment. This can complement the credit supportive measures (including the macro- and micro-prudential relaxations) which RBI has progressively announced and notified in the financial sector.
27. All things considered, based on the assessed costs and benefits of a rate action at this point, the current macroeconomic environment, including inflation and growth forecasts factoring in various exogenous drivers of uncertainty, suggests that the appropriate risk management action is to err in favour of a policy easing. I, as individual member of the MPC, am risk averse to criticism of having “fallen behind the curve”, particularly the mistake of attributing as “transient” those drivers of inflation which might ultimately emerge as structural components. While overall financial conditions remain easy, there is an implicit worry that, at the present level, the real policy rate might be slightly more restrictive than warranted by the forecast macro-economic conditions in the near term. Notwithstanding my concerns regarding the adverse effect of lower interest rates on household savings behaviour, and hence bank deposits, a priority now is to overweight growth in the balance of multiple objectives.
28. To repeat, however, I believe that the cumulative policy rate cuts and liquidity infusions will now have moved the orientation of monetary policy from mildly restrictive to balanced. Pending incoming data, I believe the policy interest rate is now consistent with macroeconomic stability.
29. Based on the totality of this assessment, I vote to cut the policy repo rate to 5.25%, with the caveat that the next actions will be data dependent. Hence, especially taking into account the continuing uncertainty on the external balance, it is prudent to continue with the neutral stance. Statement by Prof. Ram Singh
30. Since the MPC's October meeting, incoming data on growth-inflation dynamics have provided additional policy space to support the growth momentum. Inflation has registered unprecedentedly low levels with average headline inflation at 1.7 per cent for Q2:2025-26, dipping further to 0.3 per cent in October 2025. Excluding gold, core inflation has also moderated to 2.6 per cent. The CPI inflation forecast for the full financial year 2025-26 is 2.0%. During the first half of 2026-27, both headline and core inflation are expected to remain benign relative to the 4 per cent target. With this kind of inflation trajectory, the question is not whether, but how much, of a repo rate cut is possible without heating the economy.
31. Monetary policy easing is warranted on both the inflation and growth fronts, independently. At the current policy rate, the real repo rate of 3.8 per cent for Q2:2025- 26 was very high. From a forward-looking perspective, the real policy rate over the next three quarters will remain well above what can be considered a growth-supportive rate (4.9% in Q3 FY26, 2.6% in Q4 FY26, and 1.6% in Q1 FY27). If we filter out the effect of elevated precious metals prices, the real rates are even higher.
32. So, the inflation data itself makes a strong case for an additional rate cut and underscores its urgency A counter-cyclical price-stabilising monetary policy must aim to bring prices toward the target as soon as possible.
33. A delay in the rate cut would hurt real GDP growth by keeping real interest rates unnecessarily above growth-supportive levels. The delay will extend the low-inflation phase, which has important implications both micro and macro including a less-than- expected nominal GDP growth (estimated at 8.3% for the full FY26, down from the budgeted projection of 10.1%).
34. Besides, the prevailing low inflation will squeeze profit margins and increase the real value of debt and interest rates for the private sector. Disinflationary expectations running across several quarters can dampen and defer private-sector investment even in the short run. As MSMEs' businesses operate in highly competitive markets and have limited ability to raise prices through the market power channel but the wages tend to be downward sticky, low inflation is detrimental to their interests as well.
35. Will the rate cut heat up the economy? Numbers speak for themselves. Whichever way we slice the inflation data, the headline CPI inflation has been on a downward trajectory, even though a substantial part of the transmission expected from 100 bps repo rate cuts so far has already materialised. The decline is broad-based. Core inflation, a crucial indicator of underlying price trends, has remained stable and range-bound. Excluding gold, core inflation moderated to 2.6 per cent in October 2025 and is expected to be below 4% for the next 3-4 quarters. According to the World Bank Commodity Price Forecasts for October 2025, prices are projected to moderate in 2026 from 2025 levels, except for some precious metals. International oil prices are looking south. Even after factoring in the base effect turning adverse for food prices, a rate cut is unlikely to alter the projected trajectory significantly.
36. The supply side also does not suggest any upward pressure building up. The GDP growth rate for recent quarters - Q2 FY 2025-26 at 8.2%, Q1 FY 2025-26 at 7.8% and Q4 FY 2024-25 at 7.4% - may appear to be above the trend. At the same time, the projected growth trajectory for the coming four quarters indicates a moderation in growth from the level achieved in the preceding three quarters. Besides, several indicators suggest a slack in the economy. 1 Even otherwise, we should not infer from the recent real GDP growth prints that the output gap is positive – that is, the economy's actual real GDP rate is higher than its maximum sustainable output growth rate. Several structural changes underway appear to have increased the potential real growth rate.
37. For one, the incremental capital–output ratio (ICOR) has come down. So, the same level of additional capital investment produces higher output today than before. 2 Productivity gains due to fast adoption of technological advances in conjunction with rapid expansion of physical and digital infrastructure (improved digitalisation, better infrastructure (roads, railways and power, among others) over the last decade have been more pronounced substantial, especially in construction and the services sector. From now on, however, structural reforms in the factor markets (labour and land) and regulatory easing aimed at improving the efficiency of the capital market are bound to raise productivity in the manufacturing sector, putting it on a higher growth-rate path. GST 2.0 reforms will also provide a much-needed boost to manufacturing's growth potential. Thus, it may well be the case that the output gap is negative - economy is still running below its potential – an inference corroborated by the trajectory of the core inflation excluding gold.
38. As the demand for industrial products, the 2025 Household Consumption Expenditure Survey (HCES) data paint a clear and encouraging picture for demand prospects for the manufacturing sector. During the last decade, rural spending on 1 The capacity utilisation has reached 74.8% giving a fillip to private capex. But CU needs to improve further for the private capex to pick up in full force. In recent months, there has been a moderation in the PMI Manufacturing (to 56.6 in November 2025 a 9-month low) in growth in index of industrial production (down to 0.4 per cent in October 2025). Electricity demand has remained in contractionary zone while steel consumption and cement production have recorded only modest growth rates. 2 HDFC estimates suggest that between FY10 and FY19, India’s ICOR has come down from 4.6 to 4.0. Various other sources also, including reports from CRISIL, the SBI, and economic think tanks like ICRIER, provide evidence that India's incremental capital-output ratio (ICOR) has come down in recent years, indicating improved capital efficiency. durable goods has surged by 217%. Demand for durable goods in urban areas has grown even more. This kind of surge in demand for durable goods is likely to be a force multiplier for industrial growth, as Indian households shift to higher-value durable goods.
39. Due to these productivity gains and the healthy prospects for domestic demand, the economy can now sustain higher real GDP growth than in the past. To me, a growth rate above 7.5% appears realistic without building up price pressure. A rate cut will further boost the demand and help sustain a high growth rate.
40. In view of the above, there is a very persuasive case for a 25-basis-point cut in the repo rate. Filtering out the effect of precious metals in headline CPI and CPI core (approximately 50 basis point), or the base effect turning favourable for these metals, gives us additional room for a rate cut. However, the decision on the quantum of the rate cut should also factor in the challenges on the external front.
41. Exports will continue to face headwinds from uncertainty related to US tariffs and competition from Chinese exports. On the one hand, the latter put strain on the prospects for Indian exports. On the other hand, China’s strategy of exporting its vast excess domestic capacity acts as a global inflation stabiliser, exerting downward pressure on global goods prices. Together, these effects also strengthen the case for demand-supportive rate cuts without compromising the predictability of the inflation trajectory.
42. However, a rate cut can add to the pressure on the INR. The Real Effective Exchange Rate (REER) for INR has fallen substantially due to FPI outflows triggered by global financial market uncertainty and less appealing price-earnings ratios for India. However, the economy’s fundamentals – BOP, Forex, fiscal deficit, debt-to-GDP ratio, corporate and bank balance sheets, inflation, and growth dynamics – are all robust. Therefore, I expect exchange pressures and FPI flows to be self-limiting. As such, the depreciation is unlikely to cause imported inflation due to low oil and commodity prices - international pricing benchmark Brent crude (BZ=F) has fallen to a lowest level in recent times and World Bank’s CPF has projected most prices to moderate in 2026.
43. Overall, given the uncertainty on the external front, it seems prudent to go for only a 25-basis-point cut at this point. Additionally, in view of the dormancy in the price momentum underlying headline CPI and CPI core, and the case for supporting growth momentum, the rate cut should be accompanied by a change in stance to “accommodative”. Statement by Shri Indranil Bhattacharyya
44. The global economy remained robust in 2025 as evident from upward revision in growth projections 3 but lingering uncertainties and persisting fragilities continue to cloud its outlook. In this milieu, growth in India surprised on the upside at 8.0 per cent in H1:2025-26, powered by both fiscal activism and monetary stimulus – rate cuts and liquidity injections – in an environment of benign inflation. While domestic tailwinds (GST cut, easy financial conditions) continue to support growth, external headwinds from the trade and tariff-related uncertainties are acting as a dampener. Illustratively, while merchandise exports contracted by around 12 per cent in October 2025, exports to the US declined by 8.6 per cent. In terms of outlook, although high frequency indicators suggest that the economy is holding its course in Q3, few leading indicators 3 In October, the IMF raised its 2025 global growth forecast by 20 bps to 3.2 per cent, due to lower than anticipated negative impact of tariff. point towards a deceleration in momentum in the period ahead. Accordingly, growth is projected to moderate from H1:2025-26 to about 6.8 per cent each in H2 and H1:2026-27.
45. In contrast to growth, inflation surprised on the downside by plummeting to 0.3 per cent (lowest level in the current CPI series) in October 2025. Moderation of headline inflation by about 180 bps during September-October was faster than anticipated and was primarily driven by the deflation in food prices. Although core inflation remained rangebound at around 4 per cent, it was powered by the disproportionate impact of rising prices of precious metals (gold and silver). Core excluding precious metals recorded a muted momentum with seasonally adjusted annualised rates averaging 2.0 per cent during Q2:2025-26 and turning negative in October, partly reflecting the rationalisation of GST rates. CPI diffusion index, which tracks the extent of generalisation of price pressures, declined to its lowest level in October since the COVID-19 pandemic. 4 The benign inflation scenario is likely to prolong, as reflected in the trimming of the CPI inflation forecast by 60 bps each for 2025-26 and Q1 2026-27 to 2.0 per cent and 3.9 per cent, respectively. The forecast of 4.0 per cent in Q2:2026-27 indicates eventual alignment of headline inflation with the target. During this period, core inflation (excluding precious metals) is likely to remain well-below the target.
46. Given the above context, I vote for a 25-bps rate cut based on the following considerations. First, flexible inflation targeting derives credibility from predictable policy responses based on the current state of the economy, while retaining the flexibility to use discretion during exceptional circumstances. 5 In the Indian context, the credibility of monetary policy is reinforced by a firm commitment to the 4 per cent inflation target. In the current context, when muted inflation outlook, both in terms of the trajectory of headline and core (excluding precious metals), suggests absence of demand pressures, the MPC ought to support growth, particularly when it is projected to decelerate going ahead. This is also consistent with the MPC communication in October of acting on policy space provided by lower than projected inflation prints. Second, calibrated policy easing, as being done since February 2025, supports output stabilisation as failure of policy to adjust to evolving conditions can increase macroeconomic volatility. 6 This, however, has not resulted in compromising price stability, as inflation expectations have also moderated in line with the decline in inflation. Finally, given the neutral stance of policy, lower realised inflation and a downward revision in the inflation forecast warrants downward adjustments in the nominal policy rate. I also support retaining the neutral stance as it preserves the flexibility to respond judiciously to the evolving situation by remaining data dependent while avoiding the pitfalls of precommitment in an uncertain environment. Statement by Dr. Poonam Gupta
47. The last two months since the October policy have been momentous, with the following three developments holding particular relevance. First, the global economy has held up well despite prevailing uncertainties. No new shocks have emerged on 4 The cumulative weight of items that recorded an annual inflation of below four per cent has increased to about 80 per cent in October indicating that inflation moderation has been comprehensive across items. 5 For a detailed discussion on the role of rule versus discretion within Inflation Targeting framework, see Bernanke, B. S., & Mishkin, F. S. (1997). Inflation targeting: A new framework for monetary policy. Journal of Economic Perspectives, 11(2), 97–116. 6 Role of output stabilisation under inflation targeting is discussed in Svensson, L. E. O. (2010). Inflation targeting. In B. M. Friedman & M. Woodford (Eds.), Handbook of Monetary Economics (Vol. 3B, pp. 1237–1302). Elsevier. the global front during this period. One could perhaps safely conclude that the global uncertainties have peaked.
48. Second, the recent economic momentum has not just sustained but has even improved, as borne out in the data for Q2:2025-26 (real GDP growth rate accelerating to 8.2 per cent). The high frequency indicators for Q3 thus far seem to be holding up. Indications are that the growth outcomes during the second half of the year may moderate from the elevated levels of H1 but would continue to remain strong.
49. Third, inflation dynamics have been more benign than were earlier projected. Inflation has been below the 4 per cent target for the last nine months averaging 2.3 per cent and is likely to remain well contained for at least nine more months. The average inflation for 2025-26 is projected to be 2.0 per cent, down by 60 bps from the October policy.
50. The most crucial recent development from the perspective of monetary policy has been the faster than anticipated moderation in CPI headline inflation. Under the current Flexible Inflation Targeting Framework, the mandate is price stability (an inflation target of 4 per cent within a band of 2 to 6 per cent) keeping in mind the objective of growth. Therefore, even if the MPC members traditionally consider a whole host of factors in their decisions, but when the prevailing inflation and its forecast is as low as it is currently - it alone ought to get a larger weight in the monetary policy deliberations.
51. Therefore, I vote for a rate cut of 25 bps.
52. One may ask whether the current rate cut, resulting in a cumulative rate cut of 125 bps, could lead to overheating in the economy. However, not just headline and core inflation, but most other nominal indicators of the economy are prevailing at levels that indicate that the economy at this point is not showing any signs of overheating. Instead, one could interpret the data as indicating that there is slack in the economy.
53. As for the stance, I propose to retain it at neutral. In other words, let any future course of policy action be totally data dependent. Statement by Shri Sanjay Malhotra
54. Global growth has remained resilient during the year but persisting risks from geopolitical and trade tensions, policy uncertainty, and economic fragmentation continue to temper its outlook. Receding inflation pressures, although above targets in some advanced economies, open up the scope for more accommodative policies in the ensuing months. Financial market sentiments remain circumspect, conditioned by lingering uncertainties on divergent policy paths of major central banks, and regional disparities in macroeconomic outcomes.
55. Domestically, H1 witnessed strong growth, driven by several positive domestic factors viz., direct and indirect tax rationalisation, monetary easing, conducive financial conditions and benign inflation. Although domestic economic activity remains resilient in Q3, weakness in some leading high-frequency indicators is suggestive of a deceleration in the growth momentum in H2 vis-à-vis H1. Overall, real GDP growth is poised to exceed 7 per cent, much above our expectation of 6.5 per cent at the beginning of the year, as healthy domestic prospects outweigh the concerns on the external front. Going forward in H1 next year, domestic growth is projected to remain strong, though moderate to 6.7-6.8 per cent.
56. At the same time, headline inflation in H1:2025-26 turned out to be much softer than anticipated due to the generalised moderation in price pressures, particularly the sharp decline in food prices. Moreover, core inflation (CPI headline excluding food and fuel) remained rangebound notwithstanding the continued increase in prices of precious metals. In fact, core inflation excluding precious metals, has been low for a long time. Since the beginning of 2024, it has been in the range of 2.5 to 3.4 per cent. Going ahead, good agricultural production, low food prices and exceptionally benign international commodity price outlook suggest that headline inflation for the full year (2025-26) is likely to be around 2 per cent, half of what was projected at the beginning of the year. Headline inflation is projected to be close to the 4 per cent target in H1:2026-27. Excluding precious metals, inflation is likely to be much lower, as has been the trend since the beginning of 2024.
57. Thus, demand pressures, as evident from low core inflation (excluding precious metals), are minimal and projected to remain low in the next three quarters. Considering the benign inflation outlook – headline as well as core - real interest rates need to be lower. Therefore, I vote for a 25-bps rate cut. This will also stimulate demand and be growth-supportive. Moreover, I am in favour of retaining the neutral stance which gives the requisite flexibility to remain data-dependent and act according to the evolving macroeconomic conditions and outlook. (Brij Raj) Press Release: 2025-2026/1739 Chief General Manager
6. After a detailed assessment of the evolving macroeconomic and financial developments and the outlook, the MPC voted unanimously to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 5.25 per cent. Consequently, the standing deposit facility (SDF) rate remains at 5.00 per cent and the marginal standing facility (MSF) rate and the Bank Rate remains at 5.50 per cent. The MPC also decided to continue with the neutral stance. Growth and Inflation Outlook
7. The global economy showed remarkable resilience in 2025, aided and supported by trade front-loading, a milder-than-anticipated impact of tariffs, broad fiscal stimulus and accommodative monetary policy. Inflation is on a path of gradual decline, although it remains above target in several advanced economies. US yields are trading with an upward bias amidst receding expectations of imminent rate cuts underpinned by firm economic data. Equities, supported by sustained investment in tech stocks, have advanced, even as fiscal strains, geopolitical uncertainty and monetary policy divergence continue to impart volatility to financial markets.
8. On the domestic front, real gross domestic product (GDP), as per the First Advance Estimates (FAE), is estimated to grow at 7.4 per cent (y-o-y) in 2025-26. Private consumption and fixed investment contributed significantly to overall growth. Net external demand, however, continued to be a drag, with imports outpacing exports. On the supply side, real GVA growth of 7.3 per cent is driven by buoyant services sector, resilient agricultural sector and revival in manufacturing activity.
9. Looking ahead, sustained buoyancy in services sector, GST rationalisation, healthy rabi prospects, monetary easing and benign inflation environment should support private consumption. Investment activity, supported by high capacity utilisation, conducive financial conditions, healthy balance sheets of financial institutions and corporates, robust credit growth and Government’s continued thrust on capital expenditure, is expected to maintain its momentum. Moreover, robust domestic demand is likely to attract fresh investments by the private sector. While services exports are expected to remain strong, merchandise exports will get a boost from the prospective trade deal with the US. The landmark comprehensive trade pact with the European Union coupled with trade deals with New Zealand and Oman should help diversify exports and strengthen the external sector. On the other hand, headwinds from geopolitical tensions, uncertain global trade environment, volatility in global financial markets and international commodity prices continue to pose downside risks to the outlook. Taking all these factors into consideration, real GDP growth projections for Q1:2026-27 and Q2 are revised upwards to 6.9 per cent and 7.0 per cent, respectively (Chart 1). 1 The risks are evenly balanced.
10. Headline CPI inflation remained low at 0.7 per cent in November and 1.3 per cent in December, 2025. While food group continued to be in deflation, inflation within the fuel group remained moderate in November and December. Core inflation (CPI excluding food and fuel) too remained benign, despite the pick-up in prices of precious metals. Excluding gold, core inflation remained stable at 2.6 per cent in December. Projections for full year 2026-27 will be set out in the Monetary Policy Resolution to be announced in April 2026 after incorporating the new GDP and CPI series (base 2024=100) to be released on February 27 and February 12, 2026, respectively.
11. Near-term outlook suggests that food supply prospects remain bright on the back of healthy kharif production, adequate buffer stocks of foodgrains and favourable rabi sowing. Core inflation, barring potential volatility induced by prices of precious metals, is expected to be range-bound. Geopolitical uncertainty coupled with volatility in energy prices and adverse weather events are other possible upside risks to inflation. In terms of headline inflation trajectory, unfavourable base effects stemming from large decline in prices observed in Q4:2024-25 would lead to an uptick in y-o-y inflation in Q4:2025-26, despite the anticipated momentum being muted. Considering all these factors, CPI inflation for 2025-26 is now projected at 2.1 per cent with Q4 at 3.2 per cent. CPI inflation for Q1:2026-27 and Q2 are projected at 4.0 per cent and 4.2 per cent, respectively (Chart 2). Excluding precious metals, the underlying inflation pressures remain muted. The risks are evenly balanced. Rationale for Monetary Policy Decisions
12. The MPC noted that since the last policy meeting, external headwinds have intensified though the successful completion of trade deals augurs well for the economic outlook. Overall, the near-term domestic inflation and growth outlook remain positive.
13. Headline inflation during November-December remained below the tolerance band of the inflation target. The outlook for CPI inflation in Q1:2026-27 and Q2 continues to be benign and near the inflation target. The slight upward revision in the inflation outlook is primarily due to increase in prices of precious metals, which contribute about 60-70 basis points. The underlying inflation continue to be low.
14. On the growth front, economic activity remains resilient. The First Advance Estimates suggest continuing growth momentum, driven by domestic factors amidst a challenging external environment. The growth outlook remains favourable.
15. Based on a comprehensive review of the domestic macroeconomic conditions and the outlook, the MPC is of the view that the current policy rate is appropriate. Accordingly, the MPC voted to continue with the existing policy rate. The MPC also agreed to retain the neutral stance. However, Prof. Ram Singh retained his view that the stance be changed from neutral to accommodative. Going forward, the MPC will be guided by the evolving macroeconomic conditions and the outlook based on data from the new series in charting the future course of monetary policy.
16. The minutes of the MPC’s meeting will be published on February 20, 2026.
17. The next meeting of the MPC is scheduled for April 6 - 8, 2026. Voting on the Resolution to keep policy repo rate unchanged at 5.25 per cent Member Vote Dr. Nagesh Kumar Yes Shri Saugata Bhattacharya Yes Prof. Ram Singh Yes Shri Indranil Bhattacharyya Yes Dr. Poonam Gupta Yes Shri Sanjay Malhotra Yes Statement by Dr. Nagesh Kumar
18. The economic outlook for the Indian economy has brightened considerably since the December 2025 MPC Meeting. The conclusion of the long-pending EU-India FTA negotiations on 27 January, followed quickly by the announcement of the US- India trade deal have helped to lift the sentiment, which had been depressed by the imposition of 50% tariffs on India’s exports by the US since August 2025. The first advance estimates for 2025-26 suggest continued growth momentum. This momentum has been further boosted by the Union Budget 2026-27 proposals, including for fostering the manufacturing sector, tourism, services, including the new Data Centres policy, while sustaining the big thrust to the infrastructure capex. Together, these developments have lifted India’s economic outlook significantly.
19. The economic outlook has also been looking up even before these recent events, with improved manufacturing performance and accelerated growth of IIP manufacturing in Q3: 2025-26, a strong infrastructure pipeline, and continued robust rural consumption, which is now complemented by a turnaround of urban demand. These improvements happened against the backdrop of the fact that high US tariffs did hit India’s exports of non-exempted goods, especially the labour-intensive goods. However, we were able to diversify our exports to alternative markets. Hence, the loss of export earnings was minimised. Having expressed my concerns at previous MPC meetings about the implications of potential loss of export opportunities in the US due to high tariffs, particularly in labour-intensive goods such as textiles and garments, leather goods, gems & jewellery and shrimp, among other food products, I am very impressed by the ability of our exporters to diversify to other markets with the government support measures. The diversification of export markets should not stop now that we have the market access in the US back, with the trade deal.
20. The most important implication of the new trade deals is that India is back at the table as the most promising destination for China+1 supply chain restructuring, given its large and fast growing domestic market, abundant skills, a robust and stable economic framework, fast improving infrastructure and logistics, with zero duty access to virtually entire European market (considering the EFTA, UK and EU deals), Australia, UAE, Japan, Korea, among other markets, and access to the US market at 18% tariff level, which is comparable to its peers, if not better. This brightens the outlook for FDI inflows and for manufacturing.
21. The inflation outlook continues to remain benign, with headline CPI remaining low at 1.3% in December 2025, and the inflation outlook not showing any concerns of overheating. With the opening up of Venezuelan oil supplies for India, brightening of the prospects of the Iran deal, the oil prices are likely to remain in check. The upshot of these trends, namely brightening economic growth outlook amid a continued benign inflationary trend, provides an opportunity for India to stay in the ‘goldilocks’ zone for longer.
22. This leads to a possible changed narrative for monetary policy discussion. The monetary policy actions in the recent past were addressed to curb the inflationary pressures or to help support economic recovery. Now, with the continued benign inflationary outlook opening up some policy space and with growth rates looking up, the monetary policy may turn its focus to support the acceleration of economic growth rates from around 7% to around 8%, complementing the fiscal policy, in tune with the Viksit Bharat vision.
23. However, at this juncture, maintaining the status quo is a prudent action, as we await the new data series on both CPI and growth rates, and the transmission of the December policy rate cut is still happening. Hence, I vote for the status quo on both the repo rate and the stance. Statement by Shri Saugata Bhattacharya
24. The RBI Governor’s statement post the February 2026 policy review provides a comprehensive and detailed coverage and analysis of the present domestic and global macroeconomic environment and outlook. This does not bear repetition here. The following just briefly emphasises some specific trends.
25. Overall, high frequency indicators signal resilience in economic activity. Bank credit growth to non-retail sectors has gradually increased, which, together with a stable manufacturing capacity utilisation and signs of fiscal stimulus-led consumption demand boost, might be a harbinger of a gradual revival in private sector capex.
26. At the same time, the resolution projects CPI inflation to rise to the target in H1 FY27. In my assessment, not just higher inflation, the risks of further inflationary pressures are accumulating. Despite this, the good news is that household inflation expectations remained anchored.
27. The new GDP, CPI inflation and IIP series, derived from economic structures of the new base years, are pending. These incorporate revised methodologies, classifications and data sources, which are designed to better capture economic activity and price formation. These data series will provide a clearer lens on the growth – inflation balance.
28. Assessing the macro-financial environment, while awaiting the new economic data series, I think the policy rate is appropriate. Hence, I vote to keep the repo rate at 5.25%. Moreover, taking into account the continuing uncertainty on various geo- economic dimensions, it is prudent to continue with the neutral stance. Statement by Prof. Ram Singh
29. The real GDP (FAE) is estimated to grow by 7.4 per cent in 2025-26, with private consumption and fixed investment contributing significantly to the growth. On the supply side, buoyant services sector, the resilient agricultural sector, and the revival in manufacturing activity are expected to deliver real GVA growth of 7.3 per cent. Looking ahead, real GDP growth is projected to be 6.9 per cent and 7.0 per cent for Q1:FY27 and Q2: FY27, respectively.
30. Despite the 7 per cent plus growth rate, there are no signs of overheating in the economy. CPI inflation for 2025-26 is expected to be 2.1 per cent, with Q4 at 3.2 per cent. CPI inflation for Q1and Q2 of FY27 is projected to be a tad higher at 4.0 per cent and 4.2 per cent, respectively. Filtering out the effect of increases in prices of precious metals (60-70 bps), the underlying inflation pressures are expected to remain muted.
31. Going ahead, robust domestic demand in conjunction with improved capacity utilisation is likely to attract fresh private-sector investment. Conducive financial conditions, healthy balance sheets of banks, NBFCs, and corporates, a pick-up in credit growth, and the central government capex provide resilience to the growth outlook. However, geopolitical tensions, uncertainty around the global trade environment, and volatility in global financial markets continue to pose downside risks to the growth outlook.
32. Overall, the growth momentum is steady, and the transmission of the 125 bps repo rate cut is still underway. So, the current policy rate seems appropriate at this time. Accordingly, I vote to keep the repo rate at 5.25 per cent.
33. An important question is: At this point, will a growth-supportive monetary policy risk fuel inflation? The extent and timing of further repo rate cuts will largely be determined by the incoming data. However, a few trends on inflation and growth fronts are noticeable for a forward-looking monetary policy.
34. On the price front, a review of the headline CPI and CPI-Core inflation data suggests that in the recent years the two have diverged quite significantly. In recent quarters, it is the headline CPI that seems to be swinging around CPI-Core inflation; the latter has been moderate and range-bound The expected rise in the headline CPI to 4.0% in Q1 and 4.2% in Q2 of FY26-27 is not entirely driven by domestic demand- pull factors; precious metals prices have also played a significant role. Further, the CPI core (excluding gold) has been well below 4 per cent over the last 8-9 quarters, even though the economy is expected to register average growth of above 7.4% over the last 5 quarters.
35. It seems the economy is entering a structural phase where a 7 per cent-plus growth rate and moderate inflation can coexist. If anything, the output gap might still be negative. As I have argued in the past, a growth rate above 7.5% appears realistic without building up price pressure. The potential growth rate seems to have inched up aided by productivity and efficiency gains from infrastructure and the technological advances in the last few years. Going forward, impact of AI is expected to be supportive on growth as well as inflation front.
36. These data points and developments suggest room for further rate cuts at an appropriate time. The forecast also suggests that the CPI core (excluding gold) will remain benign in the near term, with GDP growth around 7%. The World Bank’s CPF has projected commodity prices, except for some precious metals, to be moderate in 2026. If we use the CPI core (excluding gold and silver) as a reference point, there is a case for a growth-supportive stance, given that the economy’s fundamentals – BOP, Forex, fiscal deficit, debt-to-GDP ratio, corporate and bank balance sheets, inflation, and growth dynamics – are robust.
37. The Centre’s Fiscal Deficit for FY25-26 is on track to meet the below 4.5% of GDP target as promised in 2021-22, with a clear roadmap towards reducing debt levels to 50 per cent (+/- 1%) by 2030-31 as given in FY26-27 Budget. The CAD is expected to remain at a highly sustainable 1.1% of GDP for FY26, supported by buoyant service exports and robust private remittances. The recent announcement of trade deals with the EU and the US is expected to improve the trade and capital accounts, thereby supporting the INR.
38. In view of the reduced volatility underlying headline CPI and the dormancy of the CPI core (excluding gold and silver), it cannot be the end of the current easing cycle. Moreover, the convergence of internal price stability, robust economic fundamentals, and developments on the trade and investment fronts has created a rare window for monetary policy, in which remaining "neutral" is not appropriate at a moment that demands a proactive signal to the economy.
39. The exact quantum and timing of the further rate cut will depend on the incoming data, but a growth-supporting stance is very much consistent with a stable inflation outlook. Moreover, given the stable inflation and fiscal outlooks, a change in stance to “accommodative” will facilitate transmission of the rate cuts so far by putting downward pressure on market rates, yields for sovereign and corporate bonds and the rate spread between the two.
40. Therefore, I vote for a status quo in policy rate and am in favour of the stance being “accommodative”. Statement by Shri Indranil Bhattacharyya
41. Notwithstanding an escalation of geo-political strife amidst intensifying tariff wars between transatlantic allies, global growth projections for 2026 has been revised upwards. At the same time, economic activity in India remained robust with various high frequency indicators bearing testimony to the continued resilience of the economy in Q3:2025-26. Accordingly, real GDP growth for 2025-26, driven by consumption and investment, is estimated to be robust at 7.4%, despite external headwinds. Even as domestic demand continues to be buoyant, the recently concluded trade deals with major trading partners have considerably improved the external outlook for the ensuing year. Besides boosting merchandise exports and strengthening the current account, these deals would support India’s labour-intensive sectors while drawing higher investments. As the fine print of various trade deals is yet to be comprehended fully, our preliminary assessment suggests an improvement in growth by about 20 basis points each in Q1 and Q2 of 2026-27 – to 6.9 per cent and 7.0 per cent, respectively.
42. Since the last MPC meeting, developments on the inflation front have been largely on expected lines barring the significant increase in prices of precious metals, viz., gold and silver. CPI headline inflation has inched up from its historical low levels although it remains below the lower tolerance threshold. While assessing headline inflation, its underlying trends as well as its likely trajectory going forward, the key elements of its major constituents would have to be delineated. While food has generally recorded deflation in six of the last seven prints, core inflation rose to 4.6 per cent in December, driven by prices in precious metals. Excluding such items, core inflation remained considerably low at 2.3 per cent indicating muted demand pressures. Going forward, food inflation is expected to pick-up and turn positive in the coming months while non-food inflation (excluding precious metals) will continue to remain benign. Supply side developments remain favourable as international commodity prices, barring metals, remain largely contained while higher rabi sowing for most crops augurs well for agricultural production. The baseline forecasts for inflation indicate that headline inflation is likely to remain around the target of 4 per cent during H1:2026-27, ruling out the risks of both undershooting the lower tolerance threshold as well as significant upward deviation from the target. The marginal upward revision in inflation forecasts essentially reflect the impact of higher prices of precious metals, and do not alter my assessment made in the December MPC meeting that the benign inflation scenario is likely to persist for long. The impending release of the new CPI series is expected to provide greater clarity on inflation developments as the weighting diagram of the new index will reflect a more updated consumption basket.
43. With headline inflation remaining well below the target throughout 2025-26 and projected at around the target in H1:2026-27, the current policy rate and the stance offers scope for remaining growth-supportive without stoking inflation. The flexible inflation targeting (FIT) framework supports maintaining the current stance as long as inflation expectations remain well-anchored. The efficacy of monetary policy transmission also depends critically on the persistence and consistency of the policy signal. 2 The modest upward revision in projected inflation, till it remains within the tolerance band of the FIT framework and do not unhinge inflation expectations, does not warrant a change in the policy rate. Given that inflation, excluding precious metals, is expected to remain benign for the foreseeable future, I vote for retaining the current policy rate at its present level. I also support retaining the neutral stance as it provides the flexibility to respond appropriately to the evolving situation. Statement by Dr. Poonam Gupta
44. The global environment remains uncertain, with economies, financial markets, and commodity markets facing varied levels of volatility and risks. Yet, from the Indian perspective, the announcement of a trade deal with the US and the signing of a major free trade agreement (FTA) with the EU have resulted in a more favorable external sector outlook.
45. In addition to receding external uncertainty, domestic growth-inflation mix continues to remain favorable for India. GDP growth is turning out to be quite robust, with the First Advance Estimates for 2025-26 at 7.4 per cent. GDP growth is supported by both private consumption and fixed investment, with their respective growth rates estimated at 7.0 per cent and 7.8 per cent in 2025-26, and momentum likely to continue in 2026-27.
46. Underpinned by the continued buoyancy of high frequency indicators, and model-based projections, preliminary estimates of growth for 2026-27 by various agencies have been revised upwards. RBI has also slightly raised the real GDP growth Caballero, J. and B. Gadanecz. (2024). "Did Interest Rate Guidance in Emerging Markets Work?" Journal of International Money and Finance, Vol. 149. projections for Q1 and Q2 of 2026-27, guided by the positive near-term outlook and the trade deals.
47. Low inflation continues to be a boon. Barring precious metals, inflation in most components of the CPI basket has remained low, with full year projection for 2025-26 at 2.1 per cent. Importantly, core inflation excluding precious metals (often known as core-core) remains at 2.3 per cent (as per the latest print for December 2025) and is projected to remain benign in the next two quarters (Q1 and Q2 of 2026-27).
48. Professional forecasts and RBI’s own analyses indicate that inflation is likely to remain benign across sectors, going into 2026-27. As of now, risk to inflation from external sources (e.g. oil prices, commodity prices, or pass through of the exchange rate depreciation) is perceived to be limited as well. With capacity utilization rates steady at 74 per cent, there does not seem to be a risk of buoyant economic activity resulting in higher inflation.
49. Having already lowered the policy rate by a cumulative 125 bps in four of the last six meetings; with transmission of the last rate cut announced in December 2025 still unfolding; and as the data from the new series is awaited for both GDP and inflation, another rate cut does not seem warranted at this point in time.
50. Hence, I vote for the status quo, i.e., to keep the policy repo rate unchanged at 5.25 per cent. I also propose to retain the stance at neutral, i.e., the future course of policy action ought to be data dependent. Statement by Shri Sanjay Malhotra
51. Despite escalating geopolitical tensions and increasing trade frictions posing huge challenges, global growth, supported by a surge in technology-related investments, conducive fiscal and monetary policies, and accommodative financial conditions, is expected to be marginally higher in 2026. Inflation outcomes may remain divergent across countries; accordingly, central banks are likely to tread dissimilar policy paths while approaching the end of their easing cycles. In the backdrop of large fiscal stimulus and geopolitical uncertainty, global investor sentiments are nervous and financial markets remain volatile.
52. In India, economic activity, driven primarily by domestic factors, remained resilient with real GDP growth in 2025-26 projected to be higher by 90 bps from 6.5 per cent in 2024-25. The outlook for the ensuing year is also expected to be strong. Domestic drivers of growth continue to be robust. Several growth-supportive measures announced in the Union Budget should further boost growth. Moreover, the recent trade agreements /deals with our major trading partners – particularly, the European Union and the United States – have also considerably brightened the external sector outlook. Accordingly, we have increased our projection of real GDP growth by 20 bps each in Q1 and Q2 of 2026-27. These trade deals will not only strengthen exports and the current account but also bring in higher investments.
53. Inflation in November and December 2025 continued to remain low and below the lower tolerance threshold. In terms of the overall trajectory, inflation, as projected earlier too, is expected to remain benign. Headline inflation is projected at 2.1 per cent for 2025-26. The revised outlook for inflation, with headline CPI inflation in Q1:2026- 27 and Q2 at 4.0 per cent and 4.2 per cent, respectively, is also near the inflation target. From the perspective of monetary policy, it is germane to mention that, while we target headline inflation, the composition of inflation too is important as monetary policy has varying impact on different constituents of inflation. Excluding precious metals, inflation outlook is even lower. Precious metals contribute about 60-70 basis points to inflation. The underlying inflation continues to be low.
54. Overall, India’s macroeconomic fundamentals over the medium-term, including the external sector, remain healthy and robust. In terms of the inflation-growth dynamics, we are in a similar or slightly better position than at the last policy. Growth prospects are looking up while inflation outlook remains broadly unchanged. Moreover, several recent developments on the external front have provided room for greater optimism. Given the present state of the economy and its outlook – buoyant growth and benign inflation – I feel the current policy rate is appropriate. Accordingly, I vote for continuation of the policy repo rate at 5.25 percent and retain the neutral stance. (Brij Raj) Press Release: 2025-2026/2144 Chief General Manager