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RBI’s MPC is now decidedly more dovish, the consensus on ‘lower for longer’ rates is proof

Markets expects further interest rate cuts as the monetary policy committee of RBI sees inflationary pressure to ease.

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Mumbai: The six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI), which sets interest rate, has turned uniformly and structurally dovish with the induction of three new external members, minutes of the meeting of the monetary policy review held earlier this month show.

Economists Ashima Goyal, Jayanth Varma, and Shashanka Bhide have replaced Pami Dua, Ravindra Dholakia and Chetan Ghate as the latter’s four-year terms came to an end.

While Goyal is a professor at the Indira Gandhi Institute of Development Research, Varma is with the Indian Institute of Management (IIM), Ahmedabad, and Bhide is a senior advisor at the National Council of Applied Economic Research in Delhi.

The minutes of the October MPC meeting, which the RBI released Friday, showed all the new external members are in favour of supporting growth by cutting interest rates as they expect inflation to fall. 

“I think the assessment of new members at this juncture supports ‘lower for longer’ interest rates,” said Suyash Choudhary, head, Fixed Income, IDFC AMC.

“With the induction of the new members and given the underlying macro backdrop today, the leaning of the MPC is now decidedly more dovish now than what it was earlier,” Choudhary told The Print. “That is because of two reasons: one is that the new external members collectively seem more dovish and arguing for ‘lower for longer’ interest rates and within the RBI members, Dr Patra has shifted his views based on incoming data.” 

In the MPC meeting held in August, Michael Debabrata Patra, the deputy governor of RBI in-charge of the monetary policy department, had sounded hawkish due to inflation concerns.

Chaudhary said it is for the first time that the MPC has unequivocally argued for keeping interest rate lower for a long period.

“This is how I think they could arrive at a consensus of putting a time guidance for the accommodative policy in the final statement,” he said. “This is for the first time they have put out a time guidance because the composition (of MPC) unequivocally argues for lower interest rate for a longer period in light of both the massive growth destruction that has happened and slower path to recovery that lies ahead.”

In the previous committee, Ghate of the Indian Statistical Institute and Dholakia, an IIM-A professor, were seen as opposite sides of the spectrum — with the former viewed as a hawk while the latter a dove. 

But shouldn’t such a committee ideally have members from the entire range of the spectrum?

“Not necessarily because remember the underlying macro environment has changed substantially,” Choudhary said. “So, one should not compare the MPC leanings of one and a half years back and today. Today what is happening is that it is the worst recession the world has seen in many decades. The underlying backdrop has changed.”

Also read: RBI’s truce with bond market at risk as Modi govt ramps up borrowing

Minutes of the meeting

The MPC, while voting unanimously to maintain status quo on interest rates, also decided to maintain the accommodative stance “at least during the current financial year and into the next financial year”.  

Varma disagreed with this formulation.

“I have agonised a great deal about dissenting (in part) with a resolution on a narrow technicality when I am in agreement with the spirit of the resolution: am I making a mountain out of a molehill and creating unnecessary confusion?,” Varma said, according to the minutes of the meeting. 

He said MPC should have said ‘expects’, rather than ‘decide’ to maintain the accommodative stance until the next financial year. Varma may not have agreed with the formulation but he is of the view that excessively high long-term rates are inflicting damage to the economy and hence a sharp reduction in the rates is important.  

Bhide was of the view that the outlook for growth and inflation for the next 3-4 quarters suggests the need for a policy environment enabling recovery of output and that present assessment reflects moderating inflationary pressures in the remaining quarters of the year.

Goyal saw demand a greater constraint than supply. “Since the output gap is already so large, reducing demand and increasing the gap further cannot be the way to reduce inflation… Inflation is at present above the target band although it is expected to come down,” she said.

The uniform dovish stance of all the members of MPC has prompted the market participants to expect further lowering of interest rates after inflationary pressure abates.

BofA Securities sees a 75-bps reduction in the repo rate by March 2021 (100 bps = 1 percentage points).

“We expect the RBI MPC to cut rates as inflation peaks off to its 2-6% mandate. Our base case has a 50bp cut in December and 25bp cut in February as inflation falls to 5% levels in November and 2.8% in February,” BofA Securities said in a note to its clients. The reasons for such a steep rate cut was argued as growth has projected at -9.5% for the current financial year by RBI, inflation falling in the target zone by March and to support the ‘busy’ industrial season which starts in October. 

“Two members explicitly admitted that there was more room for rate cuts,” ICICI Securities said in a note. 

“Dr. Patra noted that it was essential for monetary policy to ‘opportunistically exploit the headroom’ when inflation is projected to recede in H2FY21. Governor Das also added that space for future rate cuts exists if inflation evolves along the projected trajectory,” the note said.

After cutting the repo rate by 115 bps between March and May, the central bank decided to maintain status quo in two next two policies — in August and October — as consumer price index-based inflation stayed high. 

The average inflation topped 6 per cent for three consecutive quarters — January-March, April-June and July-September. RBI’s mandate is to keep inflation between 2 per cent and 6 per cent, average inflation outside this band is seen as a failure. 

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