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Business News/ Opinion / Views/  The Rajan era of monetary policy
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The Rajan era of monetary policy

The RBI governor has been able to surprise markets more than his predecessor D. Subbarao did

Raghuram Rajan, governor, Reserve Bank of India. Photo: Indranil Bhoumik/MintPremium
Raghuram Rajan, governor, Reserve Bank of India. Photo: Indranil Bhoumik/Mint

One of the key insights of modern monetary economics is that a central bank’s effectiveness is as good as its ability to surprise markets. By that yardstick, Reserve Bank of India (RBI) governor Raghuram Rajan seems to have been more effective in the battle against inflation compared to his predecessor, Duvvuri Subbarao, a Mint analysis shows. The median change in the call money rate on the days when Rajan made a policy announcement has been five times higher than in the case of Subbarao, as the accompanying chart shows, indicating that markets have failed to price in the RBI’s moves during recent times.

The Mint analysis only considers monetary policy announcements since May 2011 when RBI introduced its new monetary framework under which the repo rate became the sole operational rate and the call money rate became the operating target of RBI’s monetary policy. The market impact of each policy move is measured as the change between the closing yields on the day of the policy and the previous day.

In the Subbarao era, the median change in the call money rate was 5 basis points on policy dates. One hundred basis points (bps) make one percentage point. In the Rajan era, the median impact has shot up to 25 bps. During the Subbarao era, the call money rates often moved downwards even on days when RBI had not cut policy rates. At times, this reflected uncertainty over RBI’s monetary stance, especially when there were cuts in the Cash Reserve Ratio (CRR) even while the repo rate was kept unchanged, sending mixed signals to the market. In contrast, the decisive anti-inflationary stance of Rajan seems to have taken markets by surprise over the past year.

The impact on long term yields, such as the 10-year government of India (GOI) bond has been slightly lower in the Rajan era than in the Subbarao era. But this could perhaps reflect the fact that markets repose more confidence in RBI’s ability to bring down rates over the long term in the Rajan era than they did during the Subbarao era.

This is the first part of a two-part data journalism series on monetary policy. The second part will examine the case for a rate cut.

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Published: 26 Nov 2014, 10:15 AM IST
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