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Home / Opinion / Views /  RBI operations: Allow in more sunlight, not less

RBI operations: Allow in more sunlight, not less

Photo: AFP

Our central bank may end up reducing its ability to fulfil its inflation mandate if it shrouds its failure letter to the Centre from public view. Transparency would serve its purpose better

Modern central banking has come to rely a great deal on fashioning and managing the expectations of firms, households and markets as a part of conducting monetary policy. This trend accelerated during the Great Moderation that followed Paul Volcker’s battle with inflation as US Fed chief in the early 1980s. As access to real-time information improved, two instruments became critical to managing expectations of private economic agents: short-term interest rates and communication. This reality was reinforced in the aftermath of the 2008 financial crisis when central banks joined hands with fiscal authorities to avoid market meltdowns and foster economic revivals. Communication emerged as key to the expectations management model since there was little space left to move short-term interest rates. Papers were written, colloquia organized and methodologies developed for crafting a framework that could sculpt private expectations, especially on inflation. A lot of liquidity has flown since then, but the September 2022 monetary policy of the Reserve Bank of India (RBI) has sprung a surprise by resorting to secrecy over its strategy for dealing with inflationary pressures.

Modern central banking has come to rely a great deal on fashioning and managing the expectations of firms, households and markets as a part of conducting monetary policy. This trend accelerated during the Great Moderation that followed Paul Volcker’s battle with inflation as US Fed chief in the early 1980s. As access to real-time information improved, two instruments became critical to managing expectations of private economic agents: short-term interest rates and communication. This reality was reinforced in the aftermath of the 2008 financial crisis when central banks joined hands with fiscal authorities to avoid market meltdowns and foster economic revivals. Communication emerged as key to the expectations management model since there was little space left to move short-term interest rates. Papers were written, colloquia organized and methodologies developed for crafting a framework that could sculpt private expectations, especially on inflation. A lot of liquidity has flown since then, but the September 2022 monetary policy of the Reserve Bank of India (RBI) has sprung a surprise by resorting to secrecy over its strategy for dealing with inflationary pressures.

Last week, RBI Governor Shaktikanta Das said that the central bank shall not make public its letter to the government which is triggered under India’s flexible inflation targeting framework when our retail inflation misses the target rate of 4%, within a band of plus/minus 2%, for three consecutive quarters. This letter is expected to explain RBI’s reasons for missing the goal and the remedial measures recommended. The Centre could disclose it, of course. Yet, the fact that such a significant document may stay hidden is not only curious, but highly odd at a time like this. The admixture of today’s volatile variables, especially since they involve both external and domestic factors, demands transparency of RBI. Indeed, it will serve the cause of macro stability well if it is seen as duly determined to defend its legal mandate of controlling inflation, supporting growth and furthering financial stability. If expectation management is a key part of RBI’s toolkit, then shrouding its analysis of reasons for rising prices—even if fingers were to point at a government role—will not assist that task.

Last week, RBI Governor Shaktikanta Das said that the central bank shall not make public its letter to the government which is triggered under India’s flexible inflation targeting framework when our retail inflation misses the target rate of 4%, within a band of plus/minus 2%, for three consecutive quarters. This letter is expected to explain RBI’s reasons for missing the goal and the remedial measures recommended. The Centre could disclose it, of course. Yet, the fact that such a significant document may stay hidden is not only curious, but highly odd at a time like this. The admixture of today’s volatile variables, especially since they involve both external and domestic factors, demands transparency of RBI. Indeed, it will serve the cause of macro stability well if it is seen as duly determined to defend its legal mandate of controlling inflation, supporting growth and furthering financial stability. If expectation management is a key part of RBI’s toolkit, then shrouding its analysis of reasons for rising prices—even if fingers were to point at a government role—will not assist that task.

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We need more transparency on the whole. RBI’s 50-basis-points repo rate increase was widely expected and had even been discounted by the market. The market’s chief concern is the state of liquidity. It went into a temporary deficit for a couple of days for technical reasons. But it was enough to spook the market because, if nascent growth impulses are to be marshalled, sufficient liquidity must be available to nourish a recovering appetite for bank credit. The traditional pipeline of bank funds—supply of bank deposits—usually lags credit demand growth and any lingering anxiety over a dry spell could harden expectations, with adverse consequences for credit pricing. Shrinking liquidity has already added a few basis points to rising interest rates. The situation was compounded by RBI’s defence of the rupee’s external value and its impact on liquidity, with wild guesses on the amounts involved being thrown about. This required RBI to allow some sunlight on its currency operations and offer clarity on its approach to liquidity, instead of making a mere case for its adequacy and issuing the boilerplate statement: “remain focused on withdrawal of accommodation".

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