Minutes of the March 26, 2014 Meeting of the Technical Advisory Committee on Monetary Policy

The thirty sixth meeting of the Technical Advisory Committee (TAC) on monetary policy was held on March 26, 2014 in the run up to the First Bi-monthly Monetary Policy Review of 2014-15 on April 1, 2014.The main points of discussion in the meeting are set out below.

1. Most of the Members were of the view that global growth is likely to be better than anticipated, led by advanced economies, especially the US, while growth impulses are still relatively weak in the emerging market economies. In the US, of the two targets indicated by the Federal Reserve – inflation at 2 per cent and unemployment at 6.5 per cent – the unemployment target may be hit earlier, leading to wage pressures, and hence inflation. As a result, the Fed may raise interest rates earlier than is being anticipated. Some Members were of the view that global recovery may be weaker than expected.

2. On the domestic front, Members’ outlook was that real GDP growth will be muted. The manufacturing sector is stagnant. Since exports and imports are declining, the manufacturing outlook is also weak. Members sensed that investment may pick up as stalled projects take off after the election results. This could raise the output-capital ratio as well as potential output and savings. If revival in growth is driven by a pick-up in investment, without matching revival in savings, there could be larger imbalances. The composition of growth, therefore, becomes important.

3. Members expressed concern on inflation in India being persistently higher than in other countries. On the inflation outlook, most of the Members noted that moderation in vegetable prices drove the recent softening of headline inflation and this is unlikely to be sustained. There are clear upside risks, such as suppressed pricing in electricity, LPG and diesel; impact of hailstorms on potato prices, if not on onion; increase in NREGA employment guarantee by 50 days; and decline in female labour force participation. Inflation excluding food and fuel is sticky since inflation in housing, education and medical care is still elevated. As the economy picks up, there will be an increase in these components and inflation may surge again after October/November 2014. Members cautioned that the Reserve Bank needs to be watchful of the decline in CPI to ascertain if the decline is likely to be on a sustained basis. One Member was of the view that consumer price inflation may soften to 7 per cent or even less, with the rate of growth in wages also likely to decline. According to this Member, inflation persistence factors could be food inflation and the fiscal deficit. High food inflation influencing nominal wage growth but not vice versa, implies that autonomous factors drive food prices. The shift in land utilisation by as much as 10 per cent of total cultivable area away from traditional agriculture and in favour of vegetables should help soften the inflation momentum, but for short-run blips, like hailstorms/unseasonal rains.

4. On the external sector, some Members noted that current account deficit risks, given sluggish financial savings, cannot be ignored. In the near-term, external sector risks might have eased because of the increase in forex reserves over the last six months. In the medium-term, however, the risk of capital outflows remains and may materialise if the US Fed raises interest rates earlier than is currently anticipated. Other Members expected a surge in foreign currency inflows going forward, which would put upside pressure on the rupee. They cautioned against a policy of allowing the real exchange rate to appreciate. While exchange rate appreciation may help in lowering inflation, it is not good for the economy in general as some categories of exports are highly sensitive to real appreciation, and there is a current account deficit. One Member was of the view than an exchange rate below ` 60 per US$ could hurt manufacturing growth because of severe import competition. Some Members were of the view that the Reserve Bank must actively intervene in the foreign exchange market to prevent excessive exchange rate appreciation. On the other hand, some other Members questioned the need for intervention when capital inflows are large. They were of the opinion that when inflows are good, firms should be allowed to adjust their balance sheets rather than the Reserve Bank intervening in the market. Reserves should only be used to manage volatility and not the level of the exchange rate.

5. On policy action, all Members unanimously recommended that status quo be maintained in the policy. Members listed upside risks to headline inflation in the near term which provide the rationale for a pause: high order of political and economic uncertainty engendered by the forthcoming national elections; the policy stance not being tight enough as the real policy rate is still negative; anchoring inflation expectations; sticky core CPI; and the large fiscal deficit. To manage the risks associated with capital outflows, most of the Members recommended that the Reserve Bank should focus on building up foreign exchange reserves. One Member recommended that the SLR be lowered to 22 per cent of net demand and time liabilities (NDTL) to improve transmission of monetary policy signals.

6. Members emphasised that the nuancing of forward guidance is important. Forward guidance should aim at maintaining interest rate stability, while recognising the challenges of dealing with capital outflows and supply shocks in the process of negotiating the disinflation path set out for January 2016. One Member was of the view that while forward guidance is important for anchoring inflation expectations, guidance should indicate that policy will turn growth supportive if inflation adjusted for base effects declines. Another Member recommended that the Reserve Bank should give forward guidance of a decline in the policy repo rate.

7. The meeting was chaired by Dr. Raghuram G. Rajan, Governor. Internal Members: Dr. Urjit R. Patel (Vice-Chairman), Dr. K.C. Chakrabarty and Shri Harun R. Khan, Deputy Governors; and external Members: Prof. Indira Rajaraman, Dr. Arvind Virmani, Prof. Ashima Goyal, Prof. Errol D’Souza and Dr. Chetan Ghate were present in the meeting. Shri Y.H. Malegam and Dr. Shankar Acharya could not attend the meeting. Dr. Acharya submitted his written views. Officials of the Reserve Bank Shri Deepak Mohanty, Dr. Michael D. Patra, Shri B. M. Misra and Dr. B.K. Bhoi were in attendance.

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

Alpana Killawala

Principal Chief General Manager