Communicating with financial markets is an occupational hazard for central bankers. Indeed, it has been a few years since financial markets in India were roiled because of the Reserve Bank of India’s (RBI) inaction on interest rates or comments at a scheduled policy meeting, as happened earlier this month. However, there was more to investors’ palpitations than just the absence of the widely anticipated increase in the repo rate. It is worth exploring that and some related issues.

First, what was the need for “calibrated" in front of “tightening" for the revised change in the monetary stance? I’m not being facetious or splitting hairs. It suggests that the monetary policy committee (MPC) makes a distinction between “tightening" and “calibrated tightening" when there is none. Any central bank watcher in the world will confirm that a tightening monetary stance does not mean that the policy rate will be increased at every policy meeting, which is the assurance the MPC wanted to convey.

When the repo rate was cut at the first MPC meeting in October 2016, the stance signalled was “accommodative", not, say, “calibrated easing". I doubt anyone interpreted what was announced to conclude a rate cut would occur at each meeting. A simpler communication approach, always desirable to avoid redundancy of words and to lessen the risk of miscommunication, would have been to use just “tightening". The press briefing could have been used, as was done, to emphasize that the adjustment will be calibrated or gradual—interest rates won’t be raised at every meeting.

Second, my compliments to the RBI staff responsible for the biannual monetary policy report (MPR). They swiftly incorporated my humble request to include the combined (Centre and states) fiscal deficit in the baseline assumptions.

However, the assumed figure is questionable. The RBI and the MPC members are probably alone in thinking that the combined fiscal deficit in 2018-19 will be within the slightly improved budget estimate of 5.9% of gross domestic product (GDP) compared with the 6% assumed in the April MPR. Far more likely is its overshoot even if the Centre juggles to stick to its fiscal deficit target of 3.3% of GDP in 2018-19. Recall that the Centre’s target already captures slippage of 0.3 percentage points, and follows the overshooting of the original budget forecast in 2017-18.

What matters is the trajectory of inflation, irrespective of what is impacting it -

It is unclear why the MPC is oblivious to two other problems with the assumption of the combined fiscal deficit. One, it meaningfully understates the true shortfall. This is because it counts asset sales as revenue, instead of a financing item, as is done by the International Monetary Fund (there is no reason why India should not follow this approach). Also, there is a risk of overshooting the target, but the MPR and the MPC are too shy to take a stand on that. For the record, the IMF forecasts India’s general government deficit at 6.6% of GDP. There is, of course, a non-trivial risk that the actual outcome will be worse than that.

Two, the RBI’s (and government’s) assumption mischaracterizes the fiscal impact on the economy. The use of the more accurate fiscal deficit metric would surely impact macro assessment and, potentially, even the fiscal-monetary mix, especially in light of the chronic fiscal dominance over monetary policy.

Third, who calls the shots on the rupee? The RBI has always stated that it does not target any level, but the Union ministry of finance (MoF) self-servingly attempts to talk up the rupee by publically stating a range for USD/INR. The MoF is also not shy of publically ‘instructing’ the RBI to intervene in the foreign exchange market. It appears there isn’t much coordination or understanding between Mumbai and New Delhi.

Four, and related to the previous point, why is it said that the RBI only intervenes in the currency markets to manage volatility? Most people in the financial trenches will confirm that it often intervenes for other reasons. In any case, currency volatility comes in different forms, such as nominal, real, bilateral and multilateral. Which one is the RBI targeting and why?

Finally, why is the MPC interpreting its flexible inflation targeting (IT) mandate in a manner that appears fanatical when compared with practitioners in emerging economies? Unlike inflation targeters in developed economies, emerging economies cannot ignore their exchange rates. Their central banks are frequently active in the currency markets to manage volatility, ensure financial stability or avoid misalignment of the exchange rate.

The post-policy spooking of investors wasn’t because they did not understand the MPC’s mandate. It was because they expected India’s MPC to be more like other flexible inflation targeters, including those in the Asian region, who have not totally ignored the exchange rate. Ultimately, what matters in IT is the trajectory of inflation, irrespective of what is impacting it. India’s MPC habitually lists risks to the inflation outlook. One risk that is conspicuous by its absence is outsized currency depreciation.

Using interest rates to check excessive currency depreciation to achieve the inflation target isn’t inconsistent with flexible IT, as is confirmed by other practitioners. The MPC must explain its puzzling approach of ignoring the rupee by pretending that it is freely floating, only to have the RBI and the government intervene to prevent the depreciation warranted by its hands-off approach. The MPC cannot have its cake and eat it too.

Rajeev Malik, is a strategist at River Valley Asset Management, Singapore. These are his personal views.

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