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RBI monetary policy panel sees muted GDP growth

26 April 2014

The Technical Advisory Committee of the Reserve Bank of India (RBI) expects a muted growth in India's Gross Domestic Product (GDP) with a stagnant manufacturing sector and declining trade, including exports and imports.

Since India's exports and imports are declining, the manufacturing outlook is also weak, according to the TAC.

Most of the panel members were of the view that growth impulses remained relatively weak in the emerging market economies even though global growth is likely to be better than anticipated, led by advanced economies, especially the US.

There is also a possibility that global recovery may be weaker than expected, according to some members.

They argue that if the US Federal Reserve hits the twin targets of inflation at 2 per cent and unemployment at 6.5 per cent earlier, leading to wage pressures, and consequent rise in inflation, it may raise interest rates earlier than is being anticipated.

This could choke off fund flows to emerging markets, they point out.

However, members of the panel expect domestic investment to pick up as stalled projects take off after the election results with a new government at the centre . 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, the TAC pointed out.

The main concern, however, remained the persistently high inflation rate in India compared to most other countries.

The problem with tackling inflation in India is that it was decided by moderation in vegetable prices, which members of the TAC felt, was 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 a sticky issue 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,'' they noted.

Members of the TAC have 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.

At least one member of the TAC argued that the fact that in India high food inflation tends to influence nominal wage growth and 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,'' it was pointed out.

On the external sector, some members felt that although external sector risks might have eased because of the increase in forex reserves over the last six months, current account deficit risks, given the sluggish financial savings, cannot be ignored.

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 desirable for the economy in general as some categories of exports are highly sensitive to real appreciation, and with a current account deficit an exchange rate below Rs60 per dollar could hurt manufacturing growth because of severe import competition.

On policy action, however, all members unanimously recommended that status quo be maintained in the policy, considering the upside risks to headline inflation in the near term.

The TAC meeting was attended by RBI governor Raghuram G Rajan and vice chairman and RBI deputy governor Urjit R Patel, RBI deputy governors KC Chakrabarty, Harun R Khan (all internal members) and external members, including academics Indira Rajaraman, Arvind Virmani, Ashima Goyal, Errol D'Souza and Chetan Ghate.

Two other members, YH Malegam and Shankar Acharya could not attend the meeting, though Acharya submitted his written views.

The TAC meeting was held on 26 March 2014 in the run up to the first bi-monthly monetary policy review of 2014-15 on 1 April 2014.

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