Should RBI cut rates further; MPC minutes show a clear divide
The minutes of the Monetary Policy Committee (MPC) published during the week give a clear idea about the discussions within the MPC before the rate cut decision was taken. The MPC minutes document detailed discussions among the 6 members of the MPC and the logic for arriving at the rate decision which is communicated through the policy announcement.
Some differences within
Clearly, some differences have come out between the key members of the MPC before the decision was taken. For example, Dr. Viral Acharya was very skeptical about cutting rates this time around considering that rates had been cut in February. Dr. Acharya had some reservations about 2 consecutive rate cuts in two policies. Dr. Acharya was also concerned about the absence of transmission to the final borrowers. However, the RBI governor had a more flexible view on growth. Das was of the view that another rate cut would only restore the status quo as of June 2018. Also considering the weak IIP growth and the much weaker manufacturing numbers, Das felt that the time to cut rates was ripe. In fact, the governor has also hinted at being flexible about a series of rate cuts in the coming months as to spur growth. Dr. Acharya had expressed worries about core inflation remaining elevated around the 5.5% mark, although the RBI had shifted focus to headline inflation.
Acharya model may not work
Dr. Viral Acharya had focused on a more calibrated approach to rates at a time when the core inflation was sticky. However, a status quo would not really have worked for three reasons. Firstly, the transmission is an issue but that will automatically happen as liquidity and cost of funds become favorable. We saw that in the post demonetization period. Secondly, Indian real interest rates at above 4% are among the highest in the EMs. That is making Indian industry almost non-competitive. The only way to rectify the situation is to cut rates aggressively. Thirdly, corporates have seen the cost of funds going up by nearly 100-125 basis points even for blue-chip borrowers. That is hardly sustainable!
Das model may work better
The RBI governor has talked about a combination of 3 things. There have to be rate cuts to cut the cost of funds. Then there has to be liquidity infusion to depress rates at the short term and enable transmission. That is being done through OMOs and the dollar swap auctions. Thirdly, Das has also talked about mixing monetary and fiscal measures to be really effective. That may actually be the crux. Debating over rates may not be really productive. The bottom line is that real rates have to come down substantially. Of course, the big missing link will be a fiscal stimulus. That could complete the circle!
