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Minutes show growth concerns tilted decision to cut
In the Jun ’19 monetary policy review, the MPC unanimously cut repo rate by 25bps and changed the stance to ‘accommodative’. The RBI released minutes of the meeting today. Below, we present the key takeaways from the minutes:
* Easing inflation expectations, weak growth encourage MPC members to cut: Like in every policy review, MPC members discussed households’ inflation expectations in detail. Since the last review, household’s 3-month ahead inflation expectations have eased by 20bps, making it the fourth consecutive decline. Also, the recently-released growth numbers show that India’s economy grew just 5.8% in Q4FY19, pulling down full year growth to 6.8%. Weak growth and falling inflation expectations made a solid case for rate cut.
* Low inflation trajectory and falling core inflation prompted change in stance: Further, sub-3% headline inflation, recent sharp decline in core inflation, and soft inflation trajectory in FY20 effectively meant policy rate could move only in one direction in the near future – down. Hence, the committee unanimously voted for change in stance to ‘accommodative’.
* Dr. Dholakia thinks there is space to cut rates by 75-80bps…: The most dovish MPC member, Dr. Dholakia argued that oil prices are likely to remain soft, core inflation is expected to ease and food prices may not pick up to the extent predicted. Hence, he assessed that there was space to cut rates by further 75-80 bps.
* … while Dr. Acharya reluctantly voted for 25bps cut in June: On the other hand, Dr. Acharya argued that monsoon uncertainty, oil prices and fiscal undercurrents posed upside risks to inflation. Moreover, he felt that the committee should keep some headroom if inflation rises faster-than-expected and also to revive growth with monetary accommodation. However, he reluctantly voted for a cut due to weak growth and negative output gap.
* Members discuss fiscal deficit and its impact in detail: Ahead of the budget, fiscal deficit and its inflationary implications received lot of attention in this review. While some members expressed concerns about possible fiscal slippage, Dr. Dholakia argued that fiscal slippage arising from lower nominal GDP growth or revenue shortfall is not ‘genuine slippage’ and such cases should be evaluated through ‘full-employment budget deficit’ or ‘structural budget deficit’ angle. We agree with this assessment. If overspending leads to fiscal slippage, it adds to aggregate demand and could be inflationary. However, lower revenue collection or lower nominal GDP growth indicate already weak economy and fiscal slippage caused by these factors may not be inflationary. Hence, sources of fiscal slippage should be reviewed carefully to ensure that fiscal policy does not end up being pro-cyclical.
* Off-budget borrowing by PSUs also discussed at length: The practice of sticking to fiscal deficit target by pushing certain expenditures ‘off budget’ was discussed at length. Dr. Acharya noted that Public Sector Borrowing Requirement (PSBR) (which includes extra-budgetary resources and central and state governments’ off-balance sheet borrowings) had reached 8-9% of GDP. Increasing recourse to off-budget financing distorts interest rates, crowds out private investment and increases economy’s reliance on external funding. Hence, Dr. Acharya argued that instead of focusing on only consolidated fiscal deficit number, we should also consider PSBR to assess push to aggregate demand and subsequently inflationary pressures.
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