In its mid-year review of monetary policy, the Reserve Bank of India delivered not one, but three pleasant surprises.
First and the most commonly perceived, is the higher-than-expected cut in the benchmark repo rate — while the markets were expecting a 25-bps easing, the central bank delivered a 50-bps cut. Cumulatively, the RBI has now reduced policy rate by 125 bps over the last nine months.
Second, the accompanying policy tone can be construed to be accommodative, with near-term focus on working in unison with the government to ensure that impediments towards monetary policy transmission are removed. This is a welcome departure from the previous hawkish pronouncements. More importantly, it also acknowledges the critical role of policy enablers in improving monetary transmission.
Third and more subtle, is the underlying shift of monetary policy approach from normative to positive. Let me elaborate. Positive economics is objective, fact based and, hence, passes the test of scrutiny. Normative economics, on the other hand, is more subjective, the validity of which can seldom be tested.
Since the time RBI started easing monetary policy, the approach has been extremely cautious. Emphasis on upside risks to inflation in the form of un-sustainability of softness in commodity prices, deficient monsoon related volatility in food inflation, lack of prompt monetary policy transmission, etc., had been more than warranted. These asymmetric risks did not quite pan out due to ongoing global and domestic changes. Weakness in commodity prices has proved to be more than transitory in a subdued global growth environment. While monsoon outturn in 2015 turned out to be nearly as bad as the preceding year, proactive administrative and policy response has ensured that overall food inflation remains contained. Monetary policy transmission as always commenced with a lag, and has now started to gather traction with improvement in money market liquidity conditions. This is likely to improve further after the big monetary leap in
RBI’s September 2015 policy and the proposed change in computation of banks’ base rate.
While WPI lost policy attention with institutionalisation of the CPI anchor, its information value remains useful. Record deflation at the wholesale level and its interplay with an economy that is operating below potential (or in other words, being characterised by weak pricing power) has further managed to allay concerns over any sequential pickup in core CPI inflation.
It’s comforting to know that the September 2015 policy review unambiguously acknowledges the durability of softness in commodity prices and the need for a pickup in domestic investment cycle that could respond more strongly with improved visibility on the extent of monetary stimulus, even if transmission follows with a lag.
The other important aspect of normative to positive approach in monetary policymaking stems from the shift in real rate benchmark to the 1-year Treasury Bill rate from repo rate earlier (T-Bill rate is better attuned with money market rates than the policy repo rate). While the range of 1.5-2.0% real rate still holds as a desirable magnitude of real rate for the economy, the shift in the September 2015 policy review lowers the range implicitly by about 25 bps vis-à-vis the previous benchmark as 1-year T-Bills on an average trades 25-30 bps above the repo rate. This in a subtle way unlocks space for at least 25 bps monetary easing without any change in the desired magnitude of real rate.
These three pleasant surprises underscore a holistic approach towards monetary policymaking, something which is in sync with domestic idiosyncratic conditions while taking into account ongoing shifts in the global economy.
By Shubhada Rao
The writer is senior president & chief economist, YES Bank
