Banking Central | MPC minutes show panel’s deepening worries on growth

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At the December meet, the MPC’s forward guidance remained largely the same as it was in the previous round. The panel reiterated its 'decision' to remain on an 'accommodative stance' as long as necessary to support growth at least during the current financial year and into the next financial year.

This is where one of the MPC members Jayanth Varma had a disagreement in the previous round. Varma then had a question-- How can the MPC “decide” to be on an accommodative stance when the inflation scenario remains unpredictable?

Varma then said the date based forward guidance is not a decision, but an expectation. In a world that is full of unpleasant surprises, the MPC must, of necessity, be data driven.

“I am firmly of the view that the MPC risks a damage to its credibility when it uses words that do not accurately reflect what it means. I therefore disagree with the choice of the word 'decided' when it comes to the date based forward guidance in the MPC resolution,” Varma said.

Going by the latest MPC minutes (of December policy meet) released last week, Varma has repeated his caution this time as well.

“At the outset, let me reiterate my disagreement with the use of the word “decided” in the forward guidance part of the resolution.”

But regardless of this caution, the MPC has retained the word “decided” while announcing its policy resolution.

Has Varma’s dissent (or disagreement) has been ignored?

Probably, yes.

And there seems to a good reason to that — a sharp contraction in growth due to COVID-19 doesn’t give much choice to the MPC but to remain on a growth supportive stance and convey that stance clearly to financial markets.

To be sure, there is no comfort here on the inflation front yet. Price pressures remain high and sticky. The MPC now projects Consumer Price Index (CPI)-linked inflation at 6.8 percent for the third quarter, 5.8 percent for the fourth quarter of FY21 and 5.2 percent to 4.6 percent in H1 of FY22, with risks broadly balanced. Remember, the central bank’s mandate is to keep the inflation at 4 percent midpoint of the target range. The band is 2 percent to 6 percent.

The MPC members have acknowledged the inflation risks.

“Elevated inflation has checked in and may be here to stay. With retailers striving to recover lost incomes,” said Michael Debabrata Patra, in the MPC minutes. Governor Shaktikanta Das too has noted that inflationary pressures have continued unabated, posing challenges for monetary policy.

The CPI inflation has remained above the MPC’s band for nearly three quarters now. The breach of inflation above the 2-6 percent band for three quarters typically warrants an explanation from the rate setting panel to the government on why it has failed to contain the price pressures.

That has not happened this time probably because of the pandemic situation. For two months, April and May, there was a ‘break’ in the CPI series and this could have helped the MPC to escape the clause for now.

Growth worries above inflation fears

But, as mentioned above, the inflation concerns do not really matter in the pandemic-induced worrying growth situation—or it appears so.

Growth remains the biggest worry as the comments suggest. “It will take at least a year to reach the earlier peak GDP level and more to recover lost growth. Jobs have been lost, some voluntary and some involuntary, especially in the lower middle class. The turnaround needs policy support until it is well established,” Ashima Goyal wrote in her comments.

MPC is undoubtedly left with no choice on its policy priority—to support growth and rightly so. For the next one year or so, until growth recovers hopefully aided by the Covid-vaccine, the stance will likely remain so. But, the strength of the measures MPC can deploy will depend on the inflation trajectory.

The bigger question, perhaps, is on the effectiveness the monetary policy will have to revive growth simply by reducing interest rates and pushing liquidity into financial markets. Consider this: since February, the RBI has infused Rs 12.7 lakh crore of liquidity into the financial system. Despite this and a  cumulative 250 bps rate cut from RBI since early 2019, bank credit growth has not picked up.

MPC member, Mridul K. Saggar, clearly admits that though monetary policy so far has provided a bungee cord to the growth, its tensile strength depends on how inflation evolves ahead.

“The nature of inflation still remains predominantly supply driven but with addition of some elements of cost-push inflation that can get a further fillip if three is a feedback from recent increased rural wage inflation.” Saggar said.

Problem is that the MPC has limited policy tools to support growth. Unless there is a corresponding push from the fiscal side to help growth—by putting more money in the hands of consumers and propelling investments in large projects thus creating employment—growth recovery will remain distant no matter what the MPC does on the monetary policy front.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)