Moneycontrol
Nov 02, 2016 02:47 PM IST IST | Source: Moneycontrol.com

Dovish MPC feels spare capacities, monsoon to keep inflation low

The six-member panel, which brainstormed over two days, unanimously agreed that inflation was unlikely to gallop past the tolerance threshold of 6 percent in the next few months.


Moneycontrol Bureau


The six-member monetary policy committee (MPC), headed by new RBI governor Urjit Patel, unanimously voted for a 25 basis point cut in RBI’s key lending rate—the repo rate—to 6.25 percent, arguing that large underutilised capacities and good summer rains will likely keep inflation low in the near future.

The six-member panel, which brainstormed over two days, unanimously agreed that inflation was unlikely to gallop past the tolerance threshold of 6 percent in the next few months.


But the minutes of the meeting, which were released on Tuesday, were unclear by when the MPC expects the retail inflation rate to come down to 4 percent.


The RBI and the government have set a retail inflation target of 4 percent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.


On October 4, the RBI cut the repo rate by 25 basis points to 6.25 percent, as the newly set-up panel felt that inflation levels were low enough to reduce loan rates.


“The persistence of core inflation remains a concern,” Chetan Ghate, professor at Indian Statistical Institute, said in the MPC meeting.

'Core' (non-food, non-fuel) inflation, untamed, can be a cause for worry.


“With persistent slack in the economy evidenced by unutilised capacity over the past few years, corporate pricing power remains weak,” Ghate said.


Pami Dua, Director, Delhi School of Economics, echoed similar views.


“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,” Dua said.


Ravindra H. Dholakia, Professor at Indian Institute of Management Ahmedabad, was of the view that there was substantial under-utilisation of capacity in the system.


This, in turn, means there was no “major risk to inflation if the output gap closes fast”, Dholakia said.


Michael Patra, RBI executive director,  said that “several parts of the economy are languishing,” but as agricultural activity, steel production, public investment in roads, railways and inland waterways and some services are “mending and coming together for a potential revival”.


R Gandhi, RBI deputy governor, said that while the pace of growth 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,” Gandhi said.


RBI governor Urjit Patel said that lead indicators pointed to a subdued outlook, though gradually improving, is buffeted by “continuing low capacity utilisation in industry”.


Under the new monetary policy framework, a six-member panel chaired by the RBI governor will decide on interest rates. The decision of the committee -- three each nominated by the government and the central bank – will be binding. The governor cannot override the panel’s decision by using a veto, but can cast a vote in case of a tie.


The October 4 policy was the first to be overseen by the MPC.

The RBI and the government have set a retail inflation target of 4 percent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 percent. Inflation levels above 6 percent will mean the economy has hit a danger zone.

High inflation means prices are rapidly rising eroding people’s buying power as it makes the rupee go less far. Conversely, very low inflation levels can be symptomatic of an economy-wide slide because of weak demand and muted investment activity.

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