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What to infer from the minutes of the Monetary Policy Committee (MPC)

05 Jan 2023

The idea of the Monetary Policy Committee for taking decisions on interest rate setting was first mooted during the tenure of Dr. Raghuram Rajan. But, it was only after Dr. Urjit Patel took over as the governor of the RBI that the idea of MPC was actually implemented. The MPC meets every second month for a period of 2 days and the outcome of the discussions translates into the monetary policy announcement. The minutes of the MPC meeting are announced 2 weeks after the policy announcement. Since October 2016, the MPC has had 4 meetings. While the October MPC meet cut the repo rates by 25 basis points, the 3 subsequent MPC meets in December 2016, February 2017 and April 2017 preferred to maintain status quo on rates. Interestingly, on all the four occasions, there has been total consensus among the 6 MPC members on the rate decision.
Non-core inflation as a variable in the MPC rate decision
Dr. Chetan Ghate has rightly focused on the risks to inflation due to the non-core factor. Over the last few months, food inflation has maintained its downward trajectory but it is non-food inflation that has been inching up. The reasons are not far to seek. A key component of non-food inflation is crude oil and that has been on an upswing since December 2016. Ever since the OPEC agreed to production cuts to the tune of 1.8 million barrels per day (bpd), oil prices moved up from $44/bbl to $56/bbl. With India depending on imports of oil for over 75% of her daily requirement, this impact also had a downstream inflationary impact. Higher prices of commodities have also been responsible for higher non-food inflation.
Food inflation continues to be a risk going ahead
As two key members of the MPC, Dr. Viral Acharya and Dr. Pami Dua, have pointed out, the sharp fall in food inflation over the last few months was largely predicated on the negative inflation in pulses and vegetables. Negative inflation in pulses was more due to the base effect, while vegetables inflation was on account of distress sales. Their apprehension is that neither scenario was sustainable. There is also a worry that we could see the El Nino effect coming back this year. El Nino leads to heat wave conditions which reduces the monsoon percentage, distorts the distribution of rain and creates drought-like conditions, impacting the Kharif sowing and spiking food inflation.
Rate cuts to spur IIP growth may not be a workable solution
In the first MPC meeting in October 2016, one of the key justifications for the 25 basis points rate cut was that it was required to spur the growth in IIP and consequently in GDP. A lot has changed since then. The government announced its demonetization program in November and December. That led to a surge of bank deposits to the tune of Rs. 4 trillion. As a result of this surge in deposits, most banks were forced to cut their MCLR by as much as 90 to 100 basis points to ensure that they do not end up with a mismatch wherein they end up paying interest on deposits despite credit growth not picking up. Between January and April, there has not been any substantive improvement in credit despite a 100 basis points cut in lending rates. As Dr. Pami Dua points out, this surfeit of liquidity and lower lending rates only mean that further rate cuts to spur growth are not required. What is required is greater demand for credit coming from industry, which will ultimately predicate on a revival of the capital investment cycle. In fact, even Dr. Ravindra Dholakia, has pointed out at the surplus liquidity in the system as a justification for holding rates.
Global flows will be the key to the MPC rates decision
One thing is clear from the MPC minutes that the global scenario will continue to dictate the direction of rate trajectory in India. Dr. Viral Acharya has underlined the importance of watching the Fed moves. The Fed hiked rates in December 2016 and again in March 2017. The global markets are expecting two more rate hikes in this calendar year. The RBI needs to ensure that rate hikes by the Fed do not result in a sharp narrowing of the bond yields between India and the US. That could lead to a sharp outflow of FPI funds from Indian bonds, as we saw in mid-2013 and again in early 2016.
Finally, interest rates could now become a two-way affair
One of the most important takeaways of the MPC minutes was that analysts and markets need to reconcile to the reality that the era of regular rate cuts, which began in January 2015, may be over. In the February minutes, Dr. Michael Patra and the Dr. Urjit Patel had already highlighted a shift from an “Accommodative Stance” to a “Neutral Stance”, implying that rates could also be tweaked higher if there were inflation risks or if the rate differential with the US benchmark bonds starts narrowing beyond a point. That is something the markets may not really appreciate.
After 3 consistent MPC meets with absolute consensus, the April MPC was the first meet where some debate over rate trajectory actually came up. While Dr. Patra favoured a hawkish approach to rates, Dr. Ravindra Dholakia favoured a more benign rate policy considering that inflation fears were vastly overdone. The next MPC minutes may be a lot more interesting!

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