Photo: Mint
Photo: Mint

Opinion | Two monetary policy meetings and one important message

Both the Fed and the RBI have forgotten the lesson of risk management in policymaking

There is a lingering perception in some quarters that the Reserve Bank of India (RBI) had been unhelpful with its monetary policies throughout the tenure of this government. Especially in the first two years, the RBI under Raghuram Rajan maintained a tight monetary policy, squeezed bank credit, kept the rupee strong and undermined economic growth. Of course, with all the statistical revisions, much of the sting had been taken out of this criticism.

In 2007-08, the Indian economy is now estimated to have grown 7.7% (at constant 2011-12 prices) with overall credit growth and credit to industries having grown at 23.3% and 27.8%, respectively. In 2016-17, the economy is now estimated to have grown 8.2% (same basis as above) with credit growth of 8.4% and growth in credit to industry of just 0.1%. The question, therefore, is not whether the RBI was anti-growth, but if it has been anti-growth lately, or even anti-systemic stability.

It had consistently overestimated inflation in the country and maintained a “bias to tighten" far longer than necessary. In its recent forward-looking surveys released in early February, one notices that industrial outlook and the outlook on capacity utilization and order books were not particularly cheerful. We have also seen newspaper reports that profit-to-GDP (gross domestic product) ratio of Nifty 500 companies had come down from 5.5% in 2008 to 2.8% in 2018. Clearly, the economy lacks momentum and the dramatic slide in inflation only confirms the underlying weak animal spirits.

On top of that, commentators have been repeatedly warning of a financial meltdown in the country. On 11 February, Andy Mukherjee wrote in Bloomberg that it was time for India to mind the financing gap faced by non-banking finance intermediaries. He followed it up with another piece on 17 February where he pointed out that the value of unsold homes in India’s top eight metros was four times that of sold homes and warned that the risks of disorderly deleveraging in India could not be ignored any longer.

Bank credit to small industries declined 0.9% (year-on-year) and the growth to large industries was a paltry 5.1% in December 2018. In this regard, it is worrying to note the comment that Viral Acharya, RBI deputy governor, made. He said that liquidity conditions had eased for high-quality non-banking financial companies (NBFCs) and housing finance corporations (HFCs). He added that mutual funds and others who provide capital to these NBFCs and HFCs were sorting out quality themselves. Well, a fund that was rated only at a moderately low degree of risk, had 34% of its net assets in debt issued by its parent company.

In sum, a more aggressive rate cut in its April meeting by the central bank is unlikely to be a big mistake, considering the uncertainties that dog the global economy.

In the US, the minutes of the meeting of the Federal Reserve Open Market Committee (FOMC) held on 29-30 January were released last week. In the meeting, the FOMC had reiterated that it was pursuing a medium-term inflation target of 2% annual change in the personal consumption expenditure (PCE) price index and that it believed that a 4.4% unemployment rate was consistent with the maximum possible employment in the country. The current unemployment rate in the country is 3.9% and the annual percentage change in the PCE price index is 1.8%. The FOMC voted to leave the policy rate unchanged. Several FOMC participants said that an interest rate increase would be necessary only if inflation outcomes were higher than their baseline outlook. Rising debt and elevated asset prices did not merit any consideration.

There were numerous references to the tightening of financial conditions since the December meeting of the FOMC as though it was abnormal and undesirable. Financial conditions in the US had remained too loose and, hence, its modest tightening and appreciation of downside risks in asset markets among market participants were necessary to avoid financial and economic instability risks from building up quietly. Instead, the FOMC reiterated its commitment to expand the balance sheet of the Federal Reserve and not just rely on the Federal Funds rate if economic conditions warranted. The FOMC did not deem fit to contemplate the question of whether central bank balance sheet expansion was an effective monetary policy instrument if their redeployment was deemed necessary at short notice. Nor did the FOMC members contemplate the possibility that their about-turn in monetary policy stance would elevate asset prices to a degree that they would decouple again from moderating economic growth.

From reading the minutes of the two central banks—India and the US—it is clear that both have forgotten an important lesson in policymaking as it is in the practical world. That is the lesson of risk management. More than justifying their decisions, they (the dissenters in India’s MPC and the entire FOMC in the US) should have contemplated if the costs of their decisions being wrong were likely to be substantial. Then, they might have arrived at different policy decisions.

V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University).