Monetary policy committee must focus on financial stability now
Many in the market are hoping that the MPC’s resolution statement contains an assessment of the current turmoil in credit markets brought about by the liquidity crunch at IL&FS
Monetary policy watchers are hoping that at its meeting this week, the MPC (monetary policy committee) goes beyond its expected guidance on growth and inflation to comment on financial stability. Now two years old, the MPC was set up with the mandate of determining a policy rate appropriate for achieving the mandated inflation target of 4%. But this time, it is not enough for the MPC to merely give its view on inflation and growth and state the upside or downside risks to them.
Many in the market are hoping that the committee’s resolution statement, expected on Friday, contains an assessment of the current turmoil in credit markets brought about by the liquidity crunch at infrastructure behemoth Infrastructure Leasing and Financial Services Ltd (IL&FS). The government clearly feels that the mess at IL&FS poses systemic risks, which is why it has acted to contain them.
Surely, it affects the stance of monetary policy too, at least as far as the provision of liquidity is concerned? What, if any, is the connection between the withdrawal of liquidity in the international markets and the liquidity crunch in the Indian market? Is it not the Reserve Bank of India’s (RBI’s) remit to assess maturity mismatches between assets and liabilities in systemically important institutions? If so, was it sleeping while infrastructure assets were being funded by commercial paper— a sure recipe for disaster? What is RBI’s view on the too-big-to-fail debate? And, most importantly in today’s context, what does RBI think about the failure of the rating agencies, and what steps should be taken to rectify their defects?
To be sure, there is a view that what began as a decentralization of the policy rate-setting process must not make every role of RBI committee-based. But these concerns are unfounded. Recall that three members of the committee are from RBI which includes the governor. The resolution statement itself is a mesh of views of all members. By giving guidance beyond their view on where interest rates should be, the MPC will widen its scope, but not step on RBI’s toes.
In fact, RBI, especially governor Urjit Patel, should take the chance to express the central bank’s views on financial stability and all the questions listed above, which impinge on financial stability, through the committee’s statement. It would not only tell us RBI’s views but also provide additional comfort that the regulators are indeed watchful.
As to whether the MPC would vote for a rate hike, it is a forgone conclusion that there would be an increase in the policy rates. The credit market has galloped way ahead of the interest rate curve and the MPC by voting for a rate hike would only be playing catch-up.
It is time for RBI and the MPC to put out a little more in words than the customary paragraphs on growth and inflation.