India’s infant monetary policy committee (MPC) has already made history: In just three bi-monthly reviews beginning October, it has acted upon three different inflation assessments. At this pace, perhaps one shouldn’t be surprised if the panel decides to shift to a tightening bias at the next meeting in April!
The MPC’s decision to keep the repo rate unchanged at 6.25% on 8 February was unanimous. However, the minutes of the meeting reveal all the members didn’t bless the unexpected shift in stance to neutral from accommodative, though it was the majority view. To be sure, four of the six members mentioned the need to shift the stance; only one of the three external members agreed with them.
India’s MPC’s framework has a leg up compared with other such panels. This is because the meeting minutes contain comments by each of the six members. However, the MPC is still a work in progress as it attempts to find the right balance between the policy action, justification for that action and guidance, while being clear, consistent and credible within and across reviews. The latest minutes offer some useful insights but also raise some uncomfortable questions. Communication remains a key problem area behind the disconnect between market expectations and the Reserve Bank of India’s (RBI’s) shifting thought process.
The MPC has offered three different inflation assessments in as many reviews: dovish (October, when it eased and continued with the accommodative stance); uncertain/concerned (December, repo rate on hold but accommodative stance maintained; and unambiguously hawkish (February, on hold but shifted stance to neutral from accommodative).
The October rate cut was a close call as markets were struggling to decipher the new policy response function—there was a new governor, a new MPC, and, as some had flagged, a softer interpretation of the inflation target. The on-hold rate decisions in December and February were both unexpected by a wide margin. Not a single living entity anywhere in the world expected a shift in the policy stance in February.
Why have markets and the MPC been on persistently different wavelengths? It is certainly possible that those of us sitting in the trenches are clueless and have been misreading the MPC over its last three meetings. But there is more, and the committee itself is responsible for the miscommunication.
Governor Urjit Patel owes an explanation for the conspicuously missing focus on the 4% inflation target in his comments in the October minutes. This finds clear mention in the minutes for December and February. Perhaps the exclusion was because of the glaring inconsistency of the decision to cut rates despite the RBI raising the inflation forecast for FY18.
It was that repo-rate cut and the dovish tone of the statement that accompanied it that prompted financial markets to expect more easing after reassessing the monetary response function of the new institutional regime. It now turns out that that was a case of either an egregious miscommunication, or the MPC subsequently decided to become a born-again hawk. It is unclear if the latter has anything to do with questions about the RBI’s credibility with respect to demonetization.
The latest MPC minutes are also perplexing in some ways though the renewed commitment to the 4% target is welcome. First, the two members who did not favour changing the stance strangely chose not to (or were not allowed—we don’t know) share their reason(s). It is odd that the MPC concluded there was no useful information in explaining these differences.
Second, the lone external member (Ravindra Dholakia) who favoured the shift in stance is perhaps the most dovish MPC member. He was exceptionally upbeat about inflation, including the core component, according to the October minutes: “I do not see major risk to inflation if the output gap closes fast.”
Third, there is a misguided celebratory tone about the Centre’s budget and fiscal dynamics. While the budget showed a welcome restraint and had more positives than negatives, it is perhaps only in India that the government can miss the fiscal deficit target twice in three years but still be complimented for fiscal discipline!
Fourth, a related point, there is little concern about the deteriorating consolidated (Centre + states) fiscal picture. This is likely to remain under pressure because of worsening state finances. What matters for monetary policy is the consolidated fiscal position, not just the Centre’s fiscal dynamics. Only one member (Dholakia) mentioned the issue of state finances but the outlook was conspicuously absent.
Fifth, deputy governor Viral Acharya’s (first MPC meeting) insightful comments clarified the rate decision was a tough one for him and heavily influenced by external factors. This was because of the difficulty in resolving the trade-off between output gap and the persistent nature of core inflation. However, the services-led persistence in core inflation despite the manufacturing-driven low capacity utilization isn’t new, and it certainly didn’t prevent the MPC from cutting rates in October. Additionally, external concerns (eg. the fallout from Trump’s policies) existed in December as well when the accommodative stance was reiterated.
Finally, there is a missing focus on the adverse implications for monetary policy from the elusive investment recovery contributing to lowering the potential output while fiscal policy boosts consumption. This will affect how quickly the output gap closes, which in turn will affect the ability to achieve the ambitious inflation target of 4%.
The MPC must improve its communication by better appreciating the fallout from its inconsistent action-guidance mix across reviews. As a humble beginning, the central bank should explain why it has stopped uploading, beginning October, the recording and transcripts of the post-policy call with researchers. It has still not offered any explanation for this retrograde step. The RBI should walk its talk on transparency and accountability.
Rajeev Malik is a senior economist at CLSA, Singapore. These are his personal views.