There are two extraordinary reasons to take a close look at the new monetary policy that Reserve Bank of India (RBI) governor D. Subbarao is scheduled to announce on Tuesday.
Illustration: Jayachandran / Mint
Such announcements are usually important because the central bank tries to change the level and structure of interest rates at which companies and consumers borrow. But there is an overwhelming consensus right now—and one that this newspaper agrees with—that Subbarao should not try to change interest rates for some time. He has already cut rates six times since October.
The industrial recovery is still tentative and wholesale price inflation is below zero, even as an erratic monsoon and rising food prices are hurting farmers and consumers. These are reasons enough to hold interest rates at their current levels. At most, the governor can once again scold banks for not bringing down interest rates by enough.
Subbarao’s bias could continue to be towards monetary easing. This is in contrast to the situation in countries such as the US, where policy interest rates close to zero ensure that the next move by the Federal Reserve can only be of tightening— despite recent intellectual debates about whether an economy can actually have negative interest rates.
So, it is very likely that the Tuesday policy announcement could lead to a big yawn as far as interest rate policy goes.
That’s where the two issues we mentioned at the beginning of this editorial come in. First, the central bank will have to give bond markets a clear idea of how it plans to fund a Rs4 trillion government borrowing programme that is needed to fund a fiscal deficit estimated at 6.8% of gross domestic product. It seems likely that the central bank will have to monetize part of this deficit—a move that will increase inflationary pressures after a lag. Subbarao should provide clear clues on what he will do to ensure that monetary policy is not overwhelmed by loose fiscal policy.
Second, the governor said in a recent interview that he would like to improve communication “both at the technical and non-technical level” over the next three years. Monetary policy statements are notoriously long and confusing. Part of the reason is that the Indian central bank tries to balance multiple targets—from inflation control to credit growth to financial stability—unlike some other central banks that focus on inflation alone and, hence, can send out a simpler message to the markets. But, then, there is also the fact that obfuscation is an old tradition at RBI. Tuesday will be an early test case of Subbarao’s intentions.
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