MPC Minutes: Why A 35 Basis Point Rate Cut Was Picked By India’s Monetary Policy Committee

India’s six-member Monetary Policy Committee voted to reduce policy rates for the fourth time this year as the panel believed that weakness in growth warranted further monetary easing.

“It can no longer be a business as usual approach,” said Reserve Bank of India Governor Shaktikanta Das, who led the charge for a larger-than-expected 35 basis point cut in the repo rate.

Following the August policy review, the repo rate was reduced from 5.75 percent to 5.40 percent. The MPC has cut rates by 110 basis points so far this year in response to slowing growth and moderate inflation. The monetary policy stance has been retained at ‘accommodative’, suggesting more rate cuts remain a possibility.

Why 35 Basis Points?

The surprise in the August policy was not so much the reduction in rates but the quantum of the cut. The 35 basis point cut left economists wondering as to the rationale behind the shift and why the committee felt that neither 25 basis points nor 50 basis points was appropriate.

Das explained this move by saying that given the evolving growth-inflation scenario, it can no longer be “business as usual”

The calibration of the size of the rate cut is expected to reinforce and quicken the impact of past rate cuts, change in the stance from neutral to accommodative and the injection of large surplus liquidity in the system, Das added.

The RBI Governor wasn’t alone in supporting an unusually-sized rate cut.

Committee member Ravindra Dholakia said that he would prefer a 40 basis point cut but added that he “doesn’t mind” going along with the majority opinion of cutting rates by 35 basis points. “As far as the general practice of taking 25 bps as a unit for cutting or raising the policy rate is concerned, there is no logic or scientific basis for it, particularly when we measure inflation rate, GDP growth rate, fiscal deficit percentage, etc. in single decimal,” Dholakia wrote in the minutes.

Apart from Das and Dholakia, RBI deputy governor BP Kanungo and executive director Michael Patra voted for a 35 basis point cut in rates. Chetan Ghate and Pami Dua opted to vote for a more conventional 25 basis point rate cut. Ghate felt the need for improved transmission of already announced rate cuts before more monetary policy space is used up.

Growth Concerns Cloud Outlook

The committee’s deliberations remained focused on the slowdown in growth. GDP growth slipped to 5.8 percent in the fourth quarter of FY19 and is seen falling further in the first quarter of FY20.

“Virtually every indicator of activity is turning down,” said Patra, who is in-charge of the monetary policy department at the central bank. He cited weakness in domestic output and imports of capital goods, deceleration in construction activity and weakness in private consumption to back his concerns on growth. Patra added that weaker global growth may only add to plethora of concerns for the domestic economy

The key issue, Patra said, is to judge the extent of the slowdown.

Patra, however, added that monetary policy easing has been front-loaded as the first line of defence and added that further rate cuts would need to be calibrated to the evolving situation. He repeated his calls for wider support to growth saying that “a more broad-sided response involving all levers of policy acquires the highest priority now.”

Das, too, cited weakening consumption growth as an added source of slowdown in the economy, together with the continued sluggishness in private investment. Against this backdrop, there is a need to boost domestic demand, Das said.

Dholakia argued that a cut in the policy repo rate is important “to correct high real interest rates in order to enhance investment sentiments and revive growth impulses.”

The reasons cited by Dholakia to justify his rate cut call included a view that high real rates are turning corporations in savers rather than investors. “RBI surveys have found that the corporates are now investing more in the financial assets than in the physical assets. Thus, they are turning savers rather than investors. This provides indirect evidence of the adverse impact of high real interest rates prevailing in the economy,” he wrote.

According to Dholakia, the current environment justified an aggressive rate cut but this must be done “cautiously keeping some space for future exigencies.”

Ghate, who continues to be among the more hawkish members in the committee, said that the MPC has already enacted both “insurance-cuts” and “data-dependent” cuts. As such, further space for monetary policy easing should be used “judiciously.”

Fiscal Risks

For the consecutive MPC meet, Ghate chose to flag off possible fiscal risks.

“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 cautioned. He also said that the large public sector borrowing requirement (roughly 8-9 percent of GDP) could lead to detrimental outcomes for the economy.

According to him, policy coordination between monetary and fiscal policy will be crucial in ensuring a durable growth-inflation mix.

Dholakia countered that view.

He believed that fiscal policy remains in line with the path of consolidation set for it.

“As I had argued in my statement in the previous MPC meeting, adhering to the fiscal deficit target during a downturn of the business cycle amounts to a tight fiscal policy,” Dholakia said, adding that in such a scenario monetary policy has to “do its bit” to provide a boost to the economy “however short-lived it may be.”