External member Chetan Ghate wrote that fiscal imbalances embodied in the large public sector borrowing requirement — roughly 8-9% of GDP — will lead to detrimental outcomes for the economy.
Given the current and evolving inflation and growth scenario, it can no longer be a business-as-usual approach and supporting growth must be a priority, Reserve Bank of India (RBI) governor Shaktikanta Das wrote in the minutes to the monetary policy committee’s (MPC) August meeting while voting for a 35 basis point (bps) cut in the repo rate. Other members of the committee pointed to risks arising out of fiscal slippage, sought reforms to complement the rate easing cycle and flagged a rising trend in food inflation.
Das observed that economic activity has shown signs of further weakening since the last MPC meeting in June 2019. Several high frequency indicators have either slowed down or contracted in recent months. Headline Consumer Price Index (CPI) inflation has evolved broadly along the projected lines; CPI inflation, excluding food and fuel, continued to soften, while food inflation has edged up. The softening in core inflation reflects subdued input cost pressures relating to both agriculture and industrial raw materials. Inflation expectations of households are gradually getting better anchored. “Overall, the inflation situation remains benign,” Das wrote, adding, “The impact of monetary policy easing since February 2019 and favourable base effects are expected to support GDP (gross domestic product) growth, especially in the second half of the year.” Credit growth has slowed down somewhat in the recent period; credit to micro, small and medium enterprises, in particular, remains anaemic, the governor said.
External member Chetan Ghate wrote that fiscal imbalances embodied in the large public sector borrowing requirement — roughly 8-9% of GDP — will lead to detrimental outcomes for the economy. While a fiscal glide path should be seen as a limit, once in place, it becomes a target. Convergence to the limit happens, and a form of “creative accounting” kicks in, Ghate observed. “For instance, if agents in the economy expect that the government will disregard the level of debt but the central bank follows the Taylor principle (i.e., insists that inflation is not allowed to rise), then the economy can go through a spiral of lower output, higher inflation, and higher debt.”
Ravindra Dholakia, another external member, differed with Ghate on the question of fiscal slippage and said it is not a matter of serious concern for the rest of the year, because the Union Budget has maintained the target given in the fiscal consolidation path. “The fiscal policy as indicated by the Union Budget 2019-20 on the contrary is on a tighter side rather than expansionary side,” he wrote. Dholakia also seemed to disagree with the governor’s post-policy statement that fixing growth impulses is a priority higher than lowering real interest rates. “It (boosting investment activity) requires carrying out several economic reform measures in the land and labour markets, tariffs of electricity and other resources, and taxation of income and goods and services, besides urgently correcting prevailing high real interest rates in India,” Dholakia noted.
The third external member, Pami Dua, wrote that while monetary policy can impact cyclical factors, it has its limitations with respect to significantly impacting structural factors. “Therefore, investment-focused fiscal policy and active continuation of structural reforms are imperative at this juncture to complement the already substantial easing that has been delivered since February 2019,” she said.
BP Kanungo, deputy governor in charge of monetary policy, said a worrisome aspect of the recent growth slowdown is the moderation in private consumption which constitutes the largest segment of aggregate demand. “Given the benign inflation outlook that is expected to continue for the rest of the year and up to Q1:2020-21, I am of the view that there is a need for monetary policy action to support economic activity and close the output gap,” he wrote.
RBI executive director Michael Patra said since the MPC met in June, the macroeconomic outlook appeared to have darkened. “The dynamics of inflation excluding food and fuel warrant concern, especially its broad-based and persisting softness because it seems to be mirroring the weakening of domestic demand,” Patra wrote before going on to warn that from here on, the space for monetary policy action has to be calibrated to the evolving situation. “A more broad-sided response involving all levers of policy acquires the highest
priority now,” he wrote in the minutes.