Key takeaways from the minutes of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) minutes leading up to the credit policy were published by the RBI on 22nd February 2017. The MPC minutes are critical because they give a deep insight into the thinking of the 6 MPC members and the evolution of the monetary stance of the RBI. While the RBI in its Feb 08th policy chose to maintain status quo on rates, the big news was that the RBI had shifted its monetary stance from “Accommodative” to “Neutral”. Here are the key takeaways from the minutes of the MPC meeting…

Key takeaways from the MPC minutes ahead of the Feb 08th credit policy…

  1. In the credit policy discussions leading to the actual policy, there was clear unanimity among the 6 members of the MPC on the need to maintain status quo on repo rates. This is interesting because, even on the previous two occasions in October and December, there was 100% consensus among the 6 MPC members.
  2. It may be recollected that the MPC had cut rates by 25 basis points in its October policy. This actually indicated front-ending of rate cuts due to low retail inflation and weak growth. Subsequently, in December the MPC chose to maintain status quo on rates considering that the Fed policy was coming up in mid-December.
  1. The Feb policy came in the aftermath of the demonetization drive and the consequent cash crunch in the economy. Additionally, there is the all-important Fed meet coming up in March and Janet Yellen has already indicated at a rate hike of at least 25 basis points. The Fed Futures market is also factoring in at least 2-3 rate cuts in the full calendar year.
  1. Chetan Ghate, MPC member, was of the opinion that the RBI must wait for the full impact of remonetization to manifest itself in the form of higher growth. According to Dr. Ghate, the current economic slowdown was a reaction to the demonetization exercise and hence it would not be advisable to cut rates based on low growth. He voted for a status quo on repo rates.
  1. Pami Dua, MPC member and academician, felt that the job of cutting rates was also done by the banks in the form of sharp cuts in MCLR. When demonetization led to a glut of deposits in the banking system, SBI took the lead by dropping MCLR by 90 basis points. Most other banks followed suit leading to more than 100% transmission of rate cuts since Jan 2015. This actually made rate cuts by the RBI redundant. Dr. Dua also voted in favour of keeping rates constant.
  1. MPC member Dr. Ravindra Dholakia was of the view that the monetary policy discussion needed to dwell at length on the burgeoning fiscal deficit of the state governments. While the FRBM covered the central fiscal deficit, the state fiscal deficits were largely ignored. Dr. Dholakia was of the view that rates must not be cut till the time there is a clear visibility on the future trajectory of state deficits. Dr. Dholakia also voted for status quo on repo rates.
  1. Michael Patra, MPC member, expressed views that were critical for a couple of reasons. Firstly, he pointed out that the current fall in the CPI inflation was largely driven by fire sales of vegetables and pulses which had artificially depressed the CPI. Hence CPI needs to be looked after adjusting for this seasonality. Dr. Patra was also a strong proponent of shifting the stance of monetary policy from “Accommodative” to “Neutral”, which eventually became the theme of the MPC discussion and the tone of the credit policy.
  1. Viral Acharya, an RBI insider and a hands-on monetary policy manager, actually admitted that the decision to hold rates was a very difficult and complex trade-off between inflation and growth. However, the final decision was influenced by the fact that the fall in food inflation was largely seasonal. Dr. Acharya also focused on the need to keep a focus on the yield spread between Indian benchmark 10-year bonds to avoid a capital outflow embarrassment. Dr. Acharya also voted for a status quo on rates.
  1. Finally, RBI governor Dr. Urjit Patel stressed on the need to shift the stance from “Accommodative” to “Neutral”. According to the RBI governor, there was almost an implicit assumption in the financial markets that repo rates would either remain flat or be lowered. He has cautioned that the idea of shifting the stance of monetary policy was to prepare the financial markets to be prepared for rate moves either ways, contingent on the situation.
  1. The most important take-away from the MPC minutes was that the RBI and the MPC are consciously trying to prepare the markets to be more flexible in their rate expectations. In a hypothetical situation if inflation shoots up and the US Fed gets aggressive on rate hikes, then the RBI may be constrained to move rates in the upward direction. The signal is that the markets need to be prepared for such an eventuality.

The minutes of the 3rd MPC meet assumed significance in the light of the fact that there is a clear shift in stance of monetary policy. While it may be too early to call the end of the rate cut cycle, the message is that monetary policy may be entering an ambiguous period. How monetary policy actually transpires will depend largely on the flow of domestic data and global headwinds!

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