December policy: RBI Governor went with majority view for status quo

By keeping the policy repo rate unchanged at 6.75 per cent in the fifth bi-monthly monetary policy statement, Reserve Bank of India Governor Raghuram Rajan heeded the advice of a central bank panel that the rising inflation itself should warrant no change in financial accommodation. Four of the five members of the technical advisory committee on monetary policy recommended status quo in the policy rate, which is the interest rate at which banks borrow short-term funds from the RBI to overcome liquidity mismatches.

Consultation with the five external members of the Technical Advisory Committee (TAC) on Monetary Policy was held electronically between November 20 and 24, 2015 in the run up to the bi-monthly monetary policy, which was announced on December 1.

The external members of TAC are —Shankar Acharya, Arvind Virmani, Errol D’Souza, Ashima Goyal, and Chetan Ghate.

The reasons for a pause given by the members were that headline CPI (consumer price index based inflation) as well as measures of core inflation had risen sharply.

While global commodity prices continue to impart some disinflationary momentum, there are some upside risks to inflation from ‘inflation-internals’ (negative monsoon shocks, binding supply side constraints, government consumption shocks such as the VII Central Pay Commission).

Firming inflation The members were of the view that firming up of inflation warrants monetary policy to be cautious as it keeps its immediate target of 6 per cent in its sight. They felt that the rising inflation itself should warrant no change in financial accommodation.

Members opined that the bar for any further accommodation should increase as the Reserve Bank shifts towards inflation in the medium term.

With headline inflation at 5 per cent, the real policy repo rate was at 1.75 per cent. This is in the middle of the Reserve Bank’s preferred 1.5-2.0 per cent real neutral rate range, suggesting that policy is currently neutral.

Members said there prevails a slim negative output gap that needs to be addressed by real sector policies rather than the monetary policy. Further, since the last policy was frontloaded, it should be allowed to work through the system.

They also cautioned that sharp variations in monetary policy stances of major central banks around the world in the coming month will lead to currency volatility. All these suggested a pause in any rate action by the Reserve Bank.

On guidance, one of the members recommended that the Reserve Bank should mention that the current accommodative stance will be data dependent (since data can surprise on both the upside and downside).

The fifth member recommended a rate cut by 25 basis points since CPI inflation was low. The Member assumed that Central Government will meet its fiscal and revenue deficit targets in 2016-17.

Notwithstanding the relative unreliability of survey-based inflation expectation measures (over market based ones), the members felt that spike in pulses inflation of 42 per cent is likely to unmoor inflationary expectations making the downward movement of inflationary expectations unlikely in the short term. Volatility in specific components (like food) may make the anchoring of inflationary expectations challenging.

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