Home >opinion >online-views >Deciphering RBI’s actions

On Tuesday, in its biannual monetary and credit policy, the Reserve Bank of India (RBI) is most likely to signal an easier monetary policy through a policy rate cut and/or a cut in the cash reserve ratio. If indeed it does so, it will not be for “monetary policy" reasons but for “credit policy" considerations.

Looked at from the credit policy prism, there may be reason for decreasing rates and easing liquidity since the rate of growth of credit is falling, deposit growth is down and defaults are highest in a decade. Lowering the cost of money, may in some marginal way help address this situation. As for the macroeconomic reasons, there is none; be it in terms of the pressure on the rupee, post-budget inflationary expectations, heightened fiscal imbalance, the vulnerability on the external account balance. All point to pause.

All this is better known to and appreciated by policymakers at RBI. Which leads one to believe that what may finally tilt the decision in favour of easing is of RBI’s own doing—its guidance in the previous policy.

If the fiscal policy has tied RBI’s hands, its own rather explicit guidance over the last few policies and monetary reviews may have tied its feet as well.

In RBI’s transition from a closed economy credit distributor to a open economy regulator—started by C. Rangarajan in 1992, strengthened by Bimal Jamal and structurally adapted by Y.V. Reddy—D. Subbarao has contributed by changing the style of monetary policy communication. There is no denying the fact that his personal style—participative, democratic and accommodative—has got reflected in the monetary policy management.

Last year, setting out his agenda of reaching out, Subbarao emphasized the need of listening to and learning from the “‘wisdom of the crowds’ in reaching a monetary policy judgement". In explaining the “known knowns" and indicating the “known unknowns", using the informally formal channels of communications, RBI has become open about its thoughts and intentions. The formal forward guidance, even if short of a commitment, has been getting bolder. The manner in which RBI’s guidance has been worded it really amounts to an assurance.

It needs to be understood and appreciated that the guidance given is read by market participants not another central bankers. So the risk that the markets and the public will not fully understand the conditionality attached to the announced future policy path is high. The guidance is being misinterpreted as a quasi-promise, which has the potential to cause disorderly adjustment of interest rate expectations.

This is seriously compromising the flexibility of RBI with respect to future policy decisions. In case the RBI policy deviates from its own guidance, for very valid reasons, as is the case at this point of time, it is bound to affect its own credibility. This is exactly the dilemma facing RBI.

As such, while transparency is of paramount importance, in an economy where financial and money markets are not mature, and in a world of uncertainty, providing markets with a likely future path of policy rates may entail a number of risks that may ultimately undermine the initial intention to further reduce financial market and aggregate output volatility. In other words, the monetary policy actions may not have just become more constrained but also less potent.

Jalan prescribed the ideal mix in a lecture in Sri Lanka in 1999: “the goals of transparency are best served by a balanced and symmetric evolution of information between the authorities and the market participants."

What this translates into is a clear agenda on transparency: less about guidance on actions and more about information on processes underlying the actions. For instance, it would be more useful to know the manner in which information about the economy is translated by RBI into policy actions. At what level of a particular variable, in conjunction with related variables, does RBI think of acting and using different instruments?

Similarly, what would help soothe the nerves of the markets and market participants is to know not just the objective of the central bank as a motherhood statement, but the relative values or weights it places on each goal when there are multiple objectives.

Otherwise, if one corporate guidance going awry can send the markets into a tailspin, imagine what the central bank’s wrong guidance can do. Not that RBI should be too bothered by that. The guiding factor should be macroeconomic situation as it is, not how it was seen to be.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com

Also Read |Haseeb A. Drabu’s earlier columns

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