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Let RBI rate decisions get some sunlight and fresh air

A new monetary policy panel would do well to make a new beginning on decision-taking transparency

The old monetary policy process pursued by the Reserve Bank of India (RBI) had many flaws, with one recurring complaint: it privileged the governor of the day with unilateral powers. The overwhelming policy desire was to make monetary policy rules-based, with limited latitude for individual discretion. There was some truth to the criticism. Governors had sole authority over determining the direction of interest rates or systemic liquidity after consulting colleagues and technocrats, studying and assimilating all relevant data.

Former governor D. Subbarao’s tenure between 2008 and 2013—when RBI increased interest rates 13 times—probably tipped the balance. What was originally a subterranean desire turned into a vocal movement, creating a groundswell of support in Delhi for a policy transition. A 2016 amendment to the RBI Act gave birth to a legal monetary policy framework based on a flexible inflation-targeting (FIT) regime, thereby inserting independent external members—along with senior RBI officials—into the process and legally empowering monetary policy with independence.

Evidence of that independence seems mixed. This is important because the government has started selecting the second batch of external monetary policy committee (MPC) members as the current group ends its tenure, which was divided into two phases: when Urjit Patel was governor (2016-2018) and thereafter under current governor Shaktikanta Das.

Patel’s appointment as RBI governor coincided with the appointment of the first ever MPC, and he presided over 14 MPC meetings. Its sequence of rate actions is interesting: a 25 basis points rate cut to 6.25% in October 2016 to mark the MPC’s first outing (soon after Patel took over from Raghuram Rajan), no action for the next four meetings, a second cut to 6% in August 2017, then stasis for another four meetings, then two successive rate hikes (in June and August 2018, taking the rate back to 6.5%), and then no change in the next two meetings till Patel resigned in December 2018. During this period, there were only three dissenters: Ravindra H. Dholakia who demanded deeper rate cuts five times, RBI’s deputy governor Michael Patra (executive director then) who once voted for status quo when rates were reduced and twice demanded increases, and Chetan Ghate who voted for an increase once when the MPC settled for no change.

But things changed remarkably after current governor Das took over. Patel’s last policy statement in December 2018, while leaving rates untouched, mentioned a virtual closing of India’s output gap. But, only two months later with Das chairing his first policy meeting, the MPC resolution had a surprising change of heart: “The MPC notes that the output gap has opened up modestly as actual output has inched lower than potential." This allowed the MPC to launch a prolonged rate-cutting exercise which, over the course of 10 meetings, brought the benchmark repo rate down by 250 basis points to 4%. The voting pattern was also interesting.

Former deputy governor Viral Acharya and external member Ghate initially rejected the first two rate cuts. Of the 10 policy meetings chaired by Das so far, Ghate has voted differently five times—twice to veto and thrice to suggest a lower rate cut than recommended by the MPC (Pami Dua agreed with him twice). Dholakia disagreed only once, demanding—as usual—a deeper rate cut than resolved by RBI. Patra, who insisted on rate hikes during Patel’s term, voted “aye" on all rate cuts. The oddity lies elsewhere.

At the Fund-Bank spring meeting of April 2019, Das revealed that central banks had no reason to change interest rate by only 25 basis points: “…the unit of 25 basis points is not sacrosanct and just a convention, monetary policy can be well served by calibrating the size of the policy rate to the dynamics of the situation…" And, thus, from the August 2019 meeting began RBI’s unconventional rate cuts: first by 35 basis points, then by 75 basis points in March 2020 and finally by 40 basis points in May, when strangely all MPC members agreed to the odd configuration, except for Ghate (who wanted only 25 basis points). How did the members converge on this unusual number? Did they consider alternatives, like 45 basis points or 50 basis points or even 35 basis points? If they did, why were these rejected? The minutes reveal nothing.

The minutes from MPC’s December 2018 meeting record Dholakia stating: “While the MPC resolution points largely to the upside risks to the RBI’s inflation forecasts, there are downside risks that cannot be overlooked." Does that pre-formatted resolution—which, by the way, is perfectly legal—influence members’ voting preferences?

The process raises some unavoidable questions of transparency, especially whether MPC communiques have become a proforma exercise. RBI’s FIT regime has been selective while drawing inspiration from other inflation targeting models across the world.

For example, members of the Bank of England’s (BoE) monetary policy committee are allowed to vent their views freely; Michael Saunders recently said on a public platform that BoE should loosen policy further. Another member, Silvana Tenreyro, told Reuters that BoE had not ruled out negative interest rates from its tool-kit.

The new MPC should also let in some sunlight and fresh air.

Rajrishi Singhal is a policy consultant, journalist and author. His Twitter handle is @rajrishisinghal

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