Consultation with external Members of the Technical Advisory Committee (TAC) on Monetary Policy was held electronically during May 24-30, 2016 in the run up to the Second Bi-monthly Monetary Policy Review, 2016-17 on June 7, 2016. The main points made by Members are summarised below.

1. Members noted that the global economic recovery is struggling to gain momentum. While strong decelerating forces persist in inhibiting growth in key emerging market economies (EMEs), growth in some key advanced economies (AEs) has moderated, clouding global economic prospects in the near term. Deflation fears remain on account of subdued global trade, weak growth prospects in EMEs and still low commodity prices. Monetary policy stances are set to diverge further in AEs, which could unsettle financial markets. The recent rise in international crude oil prices poses inflation risks to oil importing countries.

2. On domestic economic growth, the sustained weakness of industrial production continues to be a source of concern, and a drag on overall activity. Low capacity utilization numbers suggest that some sectors of the economy are operating below potential. There are also clear and continuing signs of a demand shortfall facing industry, which also continues to battle low global demand. Corporate sector activity may be improving as reflected in the Reserve Bank’s recent release of corporate results, with double digit growth in earnings before interest, depreciation, tax and amortisation (EBIDTA). Since the wholesale price index has moved up, there is likely to be some deceleration in the growth of value added in the industrial sector, although not of the magnitude reflected in the index of industrial production (IIP). Real growth in the services sector may continue to be robust despite a higher deflator, because of the increase in some nominal indicators, such as financial sector activity. Agriculture growth may surprise positively if the monsoon is good. In sum, while the economy has revived somewhat, and is likely to see a cyclical recovery if a good monsoon sets in, the latest IIP numbers have added to pressure that more needs to be done to put the economy on a trajectory of higher growth.

3. Most of the Members expressed concern on the inflation outlook since food inflation rose by 100 basis points, headline inflation moved up by 60 basis points, and even excluding food, fuel, petrol and diesel, inflation edged up marginally and remained sticky in April. There are also upside risks to inflation associated with a rebound in crude prices. Further upside risks to inflation could arise from the implementation of the Seventh Central Pay Commission and one-rank-one-pension recommendations, as also from adverse supply shocks (poor monsoon with consequences for cereal inflation, in particular).

4. On the external sector, favourable terms of trade continue to be weighed down by feeble global demand, resulting in a low current account deficit. In the US, there is growing evidence of wage pressures. If the Fed Funds rate rises, there may be another bout of financial turmoil and there may be net capital outflows from EMEs, as in January-February of 2016.

5. For the second bi-monthly monetary policy, three of the five Members recommended no change in the policy rate. Before contemplating any easing of policy rate, these Members wanted to (i) see substantially lower inflation relative to the 2016-17 target of 5 per cent on a durable basis; (ii) assess the effect of the monsoon in the next couple of months; (iii) get further clarity on the Fed's take on the Federal Funds Rate. Two Members recommended a policy repo rate reduction by 25 basis points. According to them, (i) the shortfall of demand in the economy calls for some stimulus, since the natural rate falls in such conditions; the stimulus will be consistent with flexible inflation targeting and anchoring of inflation expectation; (ii) the effect of the predicted good monsoon would keep food prices under check; (iii) there is a window of opportunity before a possible Fed rate hike in mid-June. One of these two Members was of the view that, given the fragmentation and incompleteness of India's financial markets, the repo rate has proved to be a much less effective instrument of monetary policy than in well developed markets like in the US. Therefore, the Reserve Bank must ensure that there is ample liquidity and that reserve money expands by 12-14 per cent if the effects of previous repo rate changes are to be transmitted to the markets. The Reserve Bank should also be prepared to make forex available to importers, if debt outflows follow a possible Fed rate hike in June.

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 the main points of discussions of the 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 : 2015-2016/3026