Who cares about monetary policy?

Asuri Vasudevan

The Reserve Bank of India (RBI) would announce monetary policy in less than two days. There are already speculations about the official rate of interest, essentially based on the information about softening of the inflation rate. Movements in both the Consumer Price Index for all items (CPI) and Whole Price Index (WPI) show declines much below the average inflation target of 4 per cent. In the circumstances, it is no wonder the Chief Economic Adviser to the Government of India in the Ministry of Finance (MoF) has strongly pitched for rate cut. Bank of America-Merrill Lynch strongly favors rate cuts. A number of other commentators have taken the same position. However, the amount of rate cut is not under any serious discussion at this point in time.

Do markets, money and asset markets, care for monetary policy announcements now? Don’t they have solutions, digital or otherwise, to counter the different scenarios of rate cut and constancy of the rate? If markets anticipate policies correctly, then the RBI will not have a cause to pat itself on the back. Those who closely studied the atmospherics before the policy announcements in the last 20 years or so would have noticed an element that is not openly spoken about. All Governors during this period, notwithstanding their protestations to the contrary, seem to experience an impulse, human as it is, to go down in ‘history’ as having followed a uniquely individual style of policy pursuit. They often tend to infuse a ‘surprise’ element where possible or to give a nuanced interpretation of the data to defend the policies they intend to pursue. It is only recently, perhaps 2 to 3 years, the MoF’s activism in matters that belong to the jurisdiction of the RBI, has tended to throw cold water on the central banker’s impulse, giving rise, in the process, to the debate on Central bank independence.

Does RBI have information sets that are vastly different from those of the markets and of fiscal policy analysts? If there is ‘private’ information with the RBI, how authentic is it? Could it be verified? If this is not a good enough defense of the impulse of creating ‘surprise’, should one believe that the RBI has a model that researchers and that gives results much different from those of the markets and researchers at the time of the meetings of the Monetary Policy Committee (MPC)? Pray, what could it be? If there exists such a model, one would believe that members of the MPC will be privy to it. Will the RBI release the background technical papers prepared for each of the MPC meetings?

These questions are not easy to answer. One thing, however, is certain. Low inflation with uncertainty about major output gains over the average growth rate in recent quarters will give relatively low nominal GDP. This could result in lower tax revenues unless one expects sharp growth in the tax base to compensate for the revenue shortfall. If tax revenues indeed fall, expenditure commitments on account of growing security challenges and new Pay Commission disbursements, to name just two, may not be met. Should the fiscal discipline then be so strictly observed that the deficit targets cannot be compromised?

If monetary policy does not provide relief in terms of rate cut for some reason, say the facetious argument that US rates are poised to move up thereby cutting down capital flows into India, fiscal discipline will have to be given up. This will be in accordance with the first principle of policy coordination—if one policy is tight, the other policy could afford to be relatively more accommodative. Fiscal authorities of course will have to do much more than indulge in excess expenditures. They could also pursue institutional policies to stimulate demand and match the expected gains in agricultural output on account of favorable monsoons. The Government’s institutional policies will have to address the terms of trade issue. Agriculture prices cannot afford to move down further and dampen farmers’ incomes. Prospects of private firms’ profits could improve once demand picks up. If fiscal stimulus edges up prices somewhat, the pressure on the external value of the rupee which has already impacted on exports to a noticeable extent, could soften. If Government’s institutional policies catalyze banks to lend with due diligence to agriculture and to high growth sectors with a touch of human face, the matching of supply-demand would be secured and growth dynamics safeguarded.

If on the other hand monetary policy eases somewhat, should fiscal stimulus be not allowed in the current circumstances, of uncertain improvement in the growth rate, likely dip in inflation owing to expected bumper crops, high expenditure requirements on account of infrastructure and security challenges and other commitments? What if both the policies are cautiously accommodative as a part of a coordination pact and together with institutional reform measures, would it be welfare-enhancing or economic chaos? Would RBI take the opportunity to come out with repo futures rate so that the markets would be much better prepared to address the future challenges?