Before MPC meet, PM advisor says RBI should cut rates

The Indian central bank’s tendency to overestimate inflation has prevented it from cutting interest rates further and cost the economy, according to one of Prime Minister Narendra Modi’s advisors.

“Their view of the economy doesn’t seem to be correct,” and by keeping rates high, they “have imposed a high output sacrifice,” said Ashima Goyal ( pictured), a member of Prime Minister’s Economic Advisory Council. “They believe inflation will rise, but you know their predictions of inflation have always been overestimated.”

The six-member monetary policy committee’s (MPC’s) two-day meeting to decide on policy rates will start on Tuesday.

While the central bank’s CPI forecasts are wrong, its notion that keeping rates higher will anchor inflation expectations has also worked against them and proved to be a drag on growth, Goyal said in an interview last week.

The RBI has room to reduce ratesby100basispointsasCPI will remain within its target rangeof4percentplus/minus 2 per cent and as India doesn’t need real rates of more than one percent, she said.

The repo rate, at which the central bank lends money to banks, isat6percentnowand economists don’t expect any changes in that, considering inflation is on the rise, accordingtoaBusinessStandardpoll of 10 economists and bond marketparticipants. Theretail inflationinOctoberwasat3.58 per cent, and according to many economists polled, the reading could be around 4.5 per cent for the rest of this financial year. The central bank strives to keep inflation at a central point of 4 per cent for the medium term The RBI did not respond to an email or phone call seeking comment.

“They have been working through the aggregate demand channel to reduce inflation but aggregate demand channel is weak in India,” said Goyal, who earlier served as a member of the RBI’s technical advisory committee on monetary policy. Decreasing aggregate demand, “decreases output, and has the first effect on output and little effect on inflation.”

The $2.3 trillion economy is likely to grow 6.5 percent this fiscal year as consumption and investment remain sluggish, she said. That would be the slowest pace of growth since 2014. Data last week showed gross domestic product grew 6.3 percent in the July-September quarter, rebounding from 5.7 percent in the previous quarter.

“The recovery is there but it’s not large,” she said. “There are demand constraints. So, therefore, whateverspacethere is – fiscal, monetary – should be used.” Inflation will remain undercontrolduetoa“secular downtrend in commodities,” better supply management of pulses by the government, improvements in agricultural marketingandtheexpectation that oil prices will remain lower, shesaid.“TheRBIhasoverdeliveredonitsinflation mandate,” said Abhishek Gupta, Mumbai-based India analyst with Bloomberg Economics. “Structural reforms are lifting potential GDP growth, but a tight monetary policy stance by the RBI is restraining consumption and investment demand.”The central bank in April 2014 forecast 8 per cent CPI by January 2015, but the actualreadingwas5.2percent. Similarly, in April 2015, it predicted CPI at 5.8 per cent by March 2016, while it cooled to 4.83 per cent and in early 2016 when it called for 5 per cent CPI by March 2017, it was 3.89 per cent.