‘Below-target inflation, need for internal boost to demand led to a 25 bps rate cut’

The need to give an internal boost to demand in the backdrop of weakening economic activity and below-target inflation prompted all six members of the monetary policy committee (MPC) to unanimously vote for a 25 basis points cut in policy repo rate, and a change in the monetary policy stance from ‘neutral’ to ‘accommodative’.

The repo rate (the interest rate at which the Reserve Bank of India provides liquidity to banks to overcome short-term liquidity mismatches) was cut from 6 per cent to 5.75 per cent on June 6.

Growth front

As per the minutes of the committee’s meeting held between June 3 and June 6, Chetan Ghate, Professor, Indian Statistical Institute, observed that on the growth front, compared to the last review, several indicators are flagging red.

“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”, he said.

Output gap is the difference between the actual output of an economy and its potential output.

Pami Dua, Director, Delhi School of Economics, said the gloomy global scenario 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.

Ravindra H Dholakia, former professor, Indian Institute of Management- Ahmedabad, felt that 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 the next three-four quarters.

“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,” Dholakia elaborated.

Michael Debabrata Patra, Executive Director, RBI, underscored that the evolving macroeconomic configuration imparts urgency for strong policy support to the flagging economy, in pursuance of the goals set for the MPC.

Inflation

In fact, with inflation projected to remain below target, a higher weight needs to be assigned to growth relative to previous meetings.

Patra suggested: “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.”

Referring to counterfactual exercises suggesting that a fiscal slippage of 50 basis points (a conservative assessment based on the public sector borrowing requirement estimates) or an oil price increase of 10 per cent leave no space to cut the policy rate below 6 per cent, Viral V Acharya, Deputy Governor, said: “In spite of my dilemma, I vote – albeit with some hesitation – to frontload the policy rate cut from 6 per cent to 5.75 per cent.”

“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 materialise,” he explained.

Shaktikanta Das, Governor, said overall, there is clear evidence of economic activity losing traction, with the GDP growth in the fourth quarter of 2018-19 slowing down to 5.8 per cent

The Governor observed that growth impulses have clearly weakened, while the headline inflation trajectory is projected to remain below 4 per cent throughout 2019-20, even after considering the expected transmission of the past two policy rate cuts.

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