Monetary Policy of Dissent

The Monetary Policy Committee (MPC) cut the key policy repo rate by 25 basis points to 6 percent, lowest since 2010, in the meeting held on 2nd August, 2017, largely in line with expectations of the market, economists and experts. However, two members of the MPC, Dr. Ravindra Dholakia, and Dr. Michael Patra dissented with the majority decision. While Dr. Dholakia advocated a 50 bps cut in the repo rate to 5.75 percent, for the second time now after maintaining his stance in the June meeting, Dr. Patra voted for a status quo.

The RBI follows inflation targeting, and vows to maintain the benchmark inflation rate, the Consumer Price Index (CPI) at 4 percent, and keep it in a +/- 2 percent corridor. This effectively means that the RBI targets CPI in the range of 2 percent to 6 percent. The June 2017 CPI figured at 1.5 percent, 50 basis points lower than RBI’s lower bound of the CPI target. This has occurred due to various phenomena in the domestic as well as international economy.

The international scenario is largely seen to be improving from the second quarter onwards of this calendar year. Major European economies like Germany, France and Spain have showed an uptick in inflation. The European Central Bank too has stated that it soon plans to taper its bond-buying program. The Federal Reserve has now increased its key policy rate, the Federal Funds Rate, twice in two years, moving away firmly from its previous zero rate policy stance. Global oil prices are moderate, and are expected to be so for the medium term, as OPEC has decided not to curtail global oil supply. China and Japan are growing slowly, but steadily, too. Global capital markets are showing signs of positivity barring this past week, reflecting the global investment sentiment

The domestic scenario is fundamentally improving. We first look at India vis-à-vis the global economy. The exchange rate of the INR vis-à-vis the USD is at a high of five years, close to Rs. 63 a dollar. India’s Current Account Deficit stood at 0.67 percent of GDP, lowest in the immediately preceding four years. The country saw a healthy net inflow of FDI and FPI investments. The rupee could strengthen further if foreign investment inflows sustain.

India has seen a good monsoon for the second year in a row now, as per the projections of the IMD and it is well spread across the nation’s geographical area. This has led to a quick sowing of kharif crops. Food prices are generally under control, with prices of pulses falling. Tomato and Onion are the only vegetables with inflated prices, this price rise is however transient, and will go back down to its normal levels as soon as supply glitches are solved.

The above paints a favourable picture for a 25 basis points rate cut. Let us now do a preliminary analysis and find the reasons as to why two members on the committee would dissent with the majority vote, and that too, in that contradicts the other.

Manufacturing currently is a dull spot in the Indian economy. However, it is the one sector braving the twin shocks in the form of demonetisation and the Goods and Services Tax (GST), disrupting economic activity to a considerable extent. This is reflected in the fall in IIP. The graph below reflects YoY change in the IIP, both general and manufacturing. Manufacturing has a 77.63 percent weightage in the IIP.


Major dips are clearly visible in the months of February and May 2017. This could be a major reason, adding to the above given favourable scenario, why Dr. Dholakia is batting for a 50 basis point cut. Now let us compare this to credit offtake from commercial banks. The graph given below depicts private sector credit offtake from commercial banks and the YoY growth rate of the same. We can clearly see an upward trend in the former. However, the latter has fallen, however not very steeply. Growth has flattened, or is growing after February 2017, and shows an upward trend moving towards July 2017. This trend is expected to continue.


This signifies that credit is not a problem. The rates might be probably low enough, in the point of view of Dr. Patra. The real reason behind the low growth in credit offtake is the banks’ hesitation to lend to the private sector due to fear of default. However, the recent amendment to the Banking Regulation Act and the Insolvency and Bankruptcy Code should allay these fears of banks and enable them to lend again. The next step is to now see if there is enough consumer demand to spur private investments.


The Private Final Consumption Expenditure (PFCE) picture is not very encouraging. There is a visible spike in the quarter ending December as there is a sharp increase in the sale of consumer durables due to Diwali. Other than that, PFCE has grown by 8% on an average in the four other quarters depicted in the chart.

It can be concluded, reading the three charts above together, that the marginal fall in credit growth can be attributed to a subdued PFCE and high chances of defaults by the private sector. A high interest rate cannot be attributed as a reason to cut interest rates.

Now, let us take a look at the inflation figures.


As mentioned earlier, the RBI has a mandate to target CPI and keep it in the corridor as shown above. It can be seen that for the better part of the last 12 months, it has effectively been able to do so. This has opened up space for further rate cuts, which may be argued by Dr. Dholakia, it can also be seen in another way. The future outlook for inflation as per RBI household surveys is high. Low inflation, especially in a country like India is not a phenomenon which is here to stay. As can be seen from the graph above inflation for the month of June 2017 is below the target. This is on the back of falling food prices, low oil prices and a strong rupee. It shall be crucial to see what course inflation takes for the coming months, and whether or not it continues its falling trend. This matters especially given that RBI dividend payout to the Union Government has halved this year.

Given the above arguments, one can see merit in the stands taken by both Dr. Patra and Dr. Dholakia, now for two consecutive meetings. However, RBI has been overtly cautious while cutting rates and will continue to be so.


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