Members expressed concern on the lacklustre global economic environment. In the US, GDP growth in Q2 of 2016 was much below expectations and Q1 GDP was revised downwards. The Eurozone is facing a mounting crisis that combines the fear of the economic consequences of the Brexit vote to leave the EU and a weaker growth outlook. The Bank of Japan has kept its key monetary policy tools unchanged, expanded its purchases of exchange traded funds, and will mount a comprehensive review of its policy framework in reaction to heightened uncertainty on the economic outlook. Among emerging market economies, growth continued to be sluggish in China.
On the domestic front, industrial production remains subdued with volume based indicators at the plant level (index of industrial production) and value based indicators at the establishment level (gross value added) continuing to diverge. Overall private investment demand continues to be lacklustre for a variety of reasons, and public investment accounts for a small share of total gross fixed capital formation in the economy. On the positive side, although global conditions continue to be fragile, stabilising commodity prices may be contributing to the uptick in India’s exports. This, together with a good monsoon and the 7th Central Pay Commission (CPC) awards, can provide a boost to aggregate demand.
Members found headline consumer price index (CPI) inflation to be sticky with a tendency to increase. One member noted that while food inflation has increased over the past couple of months – largely driven by pulses and vegetables – it seems to be ring-fenced, and has not become generalised. Excluding pulses, CPI inflation appears to be moderate. Members took comfort in the fact that there has been a marginal reduction in CPI inflation excluding food and fuel, suggesting that demand pressures are not impinging on the overall resource constraints of the economy. The monsoon has also been normal so far, although the targeted pulses production – pulses being a major driver of food inflation – will also likely be driven by higher minimum support prices in this sector. Members felt that increased upside risks to the 5 per cent CPI inflation target in Q4 of 2016-17 remain, specifically, from rising consumption demand – both private (because of a consumption led recovery) and public (one rank one pension; 7th CPC) – and cost-push shocks in the form of a steady rise in crude prices.
On the external sector, the sustainability of the pick-up in exports in June needs to be ascertained given that global conditions are still fragile. Indian financial markets have weathered recent risk-off events – Brexit; the Chinese devaluation; re-balancing of the Chinese economy – well. The external sector outlook is, by and large, robust. The current account deficit (CAD) in Q4 of 2015-16 was the narrowest in nearly a decade. With a comfortable CAD and robust net foreign direct investment inflows, the downside risks from sudden stops to portfolio inflows would be mitigated. The rupee has also been stable, but it needs to be insulated from global shocks, with a bias towards depreciation.
For the third bi-monthly monetary policy statement, four of the five Members recommended status quo. These Members were of the view that (i) CPI and CPI-food inflation have seen a recent uptick and certain other price indicators continue to be sticky; (ii) elevated food inflation has second round effects on headline inflation if it is persistently above double digits; (iii) although industrial growth remains weak, the improvement in liquidity conditions should help banks pass through past policy rate cuts; (iv) implementation of the goods and services tax (GST) poses an upside risk to inflation; (v) inflation excluding food and fuel shows some signs of the anchoring of inflation expectations that needs to be further strengthened by keeping the policy rates unchanged; and (vi) the real policy rate continues to be below the natural rate and there is no space for accommodation unless there is substantially lower inflation relative to the target of 5 per cent for March 2017 on a durable basis.
One Member recommended a reduction in the policy repo rate by 50 basis points. According to this Member, (i) there is a high probability of inflation softening to 4-5 per cent by the year end; and (ii) appreciation in the real effective exchange rate and increased interest differential will slow recovery of large corporate. For small and medium firms, however, the Member recommended stepping up in reserve money growth in case it is low relative to the historical average.
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.