Minutes of the April 25, 2013 Meeting of the Technical Advisory Committee on Monetary Policy

The thirty second meeting of the Technical Advisory Committee (TAC) on Monetary Policy was held on April 25, 2013 in the run up to the annual Monetary Policy 2013-14 on May 3, 2013. The main points of discussion in the meeting are set out below.

Most Members were of the view that the global economy is weaker than before. Growth in the US is tepid - unemployment is falling with increasing number of people dropping out of the labour force; household incomes are stagnating as jobs growth is in the low pay segment; and the US fiscal cliff is restraining aggregate demand. Output continues to decline in Europe– the Purchasing Managers’ Index (PMI) for Germany suggests that it could slip into recession; in Spain and Italy, production has fallen; in France, growth remains weak. While Japan’s economy is growing, GDP growth in China has been at sub-8 per cent level for two quarters in a row. China could not ease monetary policy as inflation expectations are high. Consumer price is rising in Hong Kong too. Brazil has, on the other hand, increased its policy rate. Thus inflation concerns remain in many emerging market economies.

On the domestic front, most Members were of the view that the overall demand situation is very weak. Industrial growth is subdued - new orders are expanding only modestly and instances have been reported where even after placing orders, clients are advising manufacturers not to deliver goods. Downgrading of companies by rating agencies has gone up by 30 per cent. The services sector is also weak and productivity in services and manufacturing sectors has been adversely affected, leading to supply constraints. The supply response is low, notwithstanding sizable unutilized capacity in the economy. Profit margins have been squeezed due to minimum wages rising with consequent wage pressures in the organized sector.

Members were of the opinion that while both core and headline WPI inflation have fallen, CPI inflation remains elevated. Stickiness in CPI inflation will continue as it reflects mismanagement of the food sector (such as through procurement prices). A Member suggested that a possible reason for CPI inflation being higher than WPI inflation could be that unlike WPI, CPI is fully tax- included. Moreover, the gap in food inflation between CPI and WPI is reflective of the increase in margins at the retail levels. This is due to the fact that the lending rates in informal markets are high and hardly touched by policy actions. Members suggested that the Reserve Bank should give higher weightage to CPI rather than WPI as the headline inflation indicator, since the former is an indicator of consumption while the latter omits services. The Reserve Bank should shift to CPI in a year or two from now.

On the fiscal front, Members felt that the high fiscal deficit continues to be a major concern. Although the government has made a firm commitment to fiscal consolidation, it is an election year and it may not be easy for the government to raise administered prices closer to the election. Some Members, on the other hand, were of the opinion that the government may meet the target for the gross fiscal deficit to avoid a ratings downgrade. However, the quality of fiscal adjustment may be poor. The targeted reduction in the revenue deficit would not help in significantly improving the savings rate. Another Member was of the view that the government has been pursuing fiscal consolidation by compressing expenditure, and raising tax revenues by increasing the tax base/reducing tax evasion and not by raising tax rates, which is a step in the right direction.

On the balance of payments (BoP), Members were of the view that with high oil and gold imports, the current account deficit (CAD) to GDP ratio which touched historically high levels in 2012-13 may take some time to correct to a sustainable level of 2.5 to 3.0 per cent. The fiscal situation does not provide much further comfort as the targeted reduction in revenue deficit would not suffice in reducing the savings-investment gap which is a necessary concomitant for reducing the bloated CAD. Members regarded the high CAD as the prime concern. The recent fall in global commodity prices has alleviated CAD risks to some extent. There is also greater FII inflows. In the period ahead, sudden change in global liquidity conditions cannot be ruled out. Such a scenario may adversely affect the prospects of capital flows to India, and the financing of CAD may again turn out to be a major challenge.

On monetary policy measures, three of the seven external Members recommended a reduction in the policy repo rate by 25 basis points. These Members felt that while WPI inflation is declining, and inflation expectations have softened modestly; aggregate demand is weak, output growth is low and industry is underperforming. A Member was of the view that the current macroeconomic environment requires a combination of tight fiscal policy and easy monetary policy. While the government has given a clear commitment on fiscal consolidation, monetary policy must ease. Moreover, in the current domestic and global growth and liquidity situation, a reduction in nominal interest rates will lead to exchange rate adjustments, greater competitiveness and reduction in CAD that is vital for stability in capital flows. Two of these three Members were also in favour of a CRR cut by 25 basis points to facilitate transmission of the rate cut to lending rates. The third Member suggested a cut in the statutory liquidity ratio (SLR). This, in combination with open market operations (OMOs), would improve liquidity and availability of credit to productive sectors. The other four Members recommended that the policy repo rates be left unchanged. In their assessment, the global situation is weak, the fiscal situation does not provide much comfort and the CAD could remain on a high trajectory. Reducing the repo rate may not help revive growth, since low growth reflects impediments to investment projects through power/fuel/supply linkages. Given the range of factors underlying the slowdown in growth and investment, investment at this stage may not be sensitive to interest rate changes. Moreover, even though the repo rate has been reduced by 100 basis points in 2012-13, lending rates have not gone down commensurately to activate investment. These Members suggested that the Reserve Bank may wait for at least one quarter to gauge the evolving macroeconomic situation.

The meeting was chaired by Dr. D. Subbarao, Governor. Other internal Members present were: Dr. Urjit R. Patel (Vice-Chairman), Dr. K.C. Chakrabarty, Shri Anand Sinha and Shri Harun R. Khan, Deputy Governors; and external Members present were: Shri Y.H. Malegam, Prof. Indira Rajaraman, Dr. Shankar Acharya, Prof. Errol D’Souza, Prof. Ashima Goyal, Dr. Arvind Virmani and Dr. Chetan Ghate. Officials of the Reserve Bank Shri Deepak Mohanty, Dr. Michael D. Patra, Shri B.M. Misra, Dr. B.K. Bhoi and Shri Pardeep Maria were in attendance.

Since February 2011, the Reserve Bank has been placing the main points of discussions of the TAC on Monetary Policy meetings in the public domain with a lag of roughly four weeks after the meeting.

Alpana Killawala

Chief General Manager

Press Release : 2012-2013/1957