Consultation with external Members of the Technical Advisory Committee (TAC) on Monetary Policy was held electronically during January 19-22, 2016 in the run up to the Sixth Bi-monthly Monetary Policy Review, 2015-16 on February 2, 2016. The main points made by Members are set out below.

1. Members expressed concern on global developments. Overall growth in the US in 2016 will slow towards trend, with underlying US domestic economy looking solid. Macroeconomic conditions in Europe are not good – unemployment is elevated, growth is close to 1.5 per cent, and structural reforms in labour and product markets are not happening. Quantitative easing in Europe will not have the same effects as in the US since US equity ownership is more widespread. The essential challenge in Europe is that diverse economies are forced to live with a single exchange rate and single monetary policy. Among emerging market economies (EMEs), the pace of growth in China was the lowest last year since 1990. China has to deal with large debt and excess capacity in several industries such as steel.

2. On domestic growth, Members were of the view that the economy has stabilised, and appears to be on a path of a modest recovery. While the November IIP collapse suggests a slowing down of economic activity (partly also due to festival induced fewer working days), a smoothed average over October-November suggests a slow but gradual revival in economic activity. However, the pace of recovery is constrained by problems in both the banking and infrastructure sectors. This has led to weak private investment. Consumption, somewhat tepid, however, is contributing to demand, although contribution from durables and non-durables is mixed. There are risks in the revival of growth. First, weak data from the corporate sector are getting worse with bad debt concentrated among large corporates (especially in steel and power). Second, stressed corporate balance sheets are pushing capex down, suggesting that private investment is likely to be flat in the short term. Third, even though public investment in 2015-16 increased to compensate private investment, the absorptive capacity of the economy may be limited. On the fiscal front, there has been a significant improvement in fiscal balances, alongside a shift from revenue to capital expenditures, with a general improvement in the aggregate fiscal position of the states.

3. While most Members felt that the 6 per cent inflation target for January 2016 will be comfortably met, a Member expressed concern on the recent increase in all measures of inflation. Headline CPI prints have gone up from 5 per cent in October to 5.6 per cent in December; food categories have recorded sequential gains with pulses inflation above 40 per cent for three months in succession; inflation in items excluding food and fuel is gathering pace, a gauge that indicates caution in further loosening of monetary policy stance; and the extent of deflation in WPI has slowed. The disinflationary pass-through from lower crude oil prices will be mitigated by the recent nominal depreciation of the rupee, coupled with future increases in excise duties. While the government has managed food inflation well, there were several risks to the evolution of headline and core inflation in the medium term. First, following the implementation of the Seventh Central Pay Commission (7th CPC) recommendations whether the economy will see a wage-price spiral and how this will ultimately affect the labour market in the services sector. It is yet to be seen if the 7th CPC recommendations will be staggered and in which manner. Second, while the fall in commodity prices conveys a weak global economy, and therefore global slack, services inflation continues to be high - inflation from non-tradables, which relates to domestic slack rather than global slack, therefore remains a concern. Third, inflationary expectations continue to show inertia and are elevated - this may be related to the problem of expectation formation being adaptive.

4. On the external sector, Members did not see severe balance of payments risks, although capital outflows were a concern. Recent exchange rate volatility was related to the language coming from the US Federal Reserve on the speed of lift-off from the zero interest rate policy (ZIRP). Faltering growth from China and other EMEs will continue to lead to outflows of capital from EMEs including India, leading to possible downward pressure on the rupee. A strengthening US dollar will make the cost of servicing debt denominated in dollars harder to bear for emerging markets. All measures of volatility – the Chicago Board Options Exchange Volatility Index, the Nikkei Stock Average Volatility Index, and the Merrill Lynch index of anticipated price swings in Treasury Bonds – are on an uptick this year. In India it is manifesting through rupee volatility and surges in gold imports. Members had different views on managing exchange rates – one Member opined that the rupee should be allowed to depreciate, so as to correct the 36-currency REER appreciation over the last year or so; another Member was of the view that the caps on debt flows and shift to longer-run debt will be protective during market stress; yet another Member felt that pushing masala bonds even with a premium to be paid to borrow overseas in the domestic currency requires to be stepped up.

5. For the sixth bi-monthly monetary policy, four of the five Members recommended status quo since, (i) all measures of inflation have increased; (ii) the impact of implementing the pay commission recommendations on the evolution of headline and core inflation in the medium term needs to be watched; (iii) while the fall in commodity prices convey a weak global economy, high services inflation remains a concern; (iv) inflationary expectations continue to show inertia and are elevated; (v) while industry continues to underperform, which along with the fall in external demand justifies taking some measures to stimulate domestic demand, it may be worthwhile to assess supply-side measures and fiscal consolidation efforts outlined in the budget before making a move to cut policy rates; and (vi) the real policy rate is slightly below the neutral rate suggesting that policy is currently accommodative, rather than neutral. One of these Members was of the view that given the continuing weakness in the domestic economic recovery and the growing signs of further weakness in the international economy, consideration may be given to an out-of-cycle policy rate reduction, synchronized with the Union Budget. Such synchronization could have salutary “confidence effects” on the flagging domestic private investment. The fifth Member recommended a policy repo rate reduction by 50 basis points.

6. All the five external Members – Dr. Shankar Acharya, Dr. Arvind Virmani, Prof. Errol D’Souza, Prof. Ashima Goyal, and Prof. Chetan Ghate – sent their feedback through e-mail.

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

Alpana Killawala
Principal Adviser

Press Release : 2015-2016/1984