By Ranjan Chakravarty
The recently released minutes of the latest RBI Monetary Policy Committee speak volumes. The multiplicity of views of members on the state of the economy was a bit disconcerting. Had the growth imperative not been there the reluctance to cut on behalf of some of the members would have been acceptable. But with the slowdown bringing unnecessary drag to the economy, cuts, and in fact deep cuts are necessary, and now. It is clear that if anyone has read the economy right it is Governor Das.
Clearly, the slowdown in the economy has impacted the demand side. There is yet time for monetary stimuli to pay huge dividends, provided they come as positive shocks. As I have argued elsewhere, the current 25 basis point cut is not nearly enough. The Governor should be empowered, unilaterally if necessary, to drive 50 to 75 bp cuts while still there is a shock and uniqueness effect. If the status quo at the Fed changes, and there are strong indications of it, cuts there may be forthcoming. We can be sure there would be matched by the European Central Bank and the Reserve Bank of Australia, leading the world into a rate cutting mode. In that case, the uniqueness and growth impetus delivered by any RBI rate cut would be lost.
This is not the first time this year that Governor Das has exhibited his deep and accurate understanding of the potentialities and limitations of Monetary Policy. Speaking on operational matters at the International Monetary Fund (IMF)-World Bank Spring Meetings in Washington earlier this year, he made an extremely significant point, far reaching in its ramifications, and one that would have revolutionary implications for monetary policy worldwide. He asked Central Bankers all over the world to reflect on the conduct of monetary policy and not restrict themselves to the existing norms of oversimplified stances on policy direction and standardized 25 basis point tranches of policy action.
Governor Das explained that the current approach, followed by Central Banks worldwide, actually serves to deter policy, through an example: “If the easing of monetary policy is required but the central bank prefers to be cautious in its accommodation, a 10 bps reduction in the policy rate would perhaps communicate the intent of authorities more clearly than two separate moves – one on the policy rate, wasting 15 bps of valuable rate action to rounding off, and the other on the stance, which, in a sense, binds future policy action to a pre-committed direction.”
This leads us to reflect on why such a convention exists, and why we have persisted with it for so long. A logical conjecture that comes to mind is that it is a remnant of the unipolar economic world of the last quarter of the last century when the United States overwhelmingly dominated global markets both in terms of the volume of real as well as financial products. In those days it made eminent sense for all economic activity to be aligned, both operationally and conceptually to U.S. practices. Hence it made perfect sense for Europe, Japan, non-Japan Asia, Australia and the Emerging Markets to be in sync with the actions of the US Federal Reserve. So do we need to use those conventions at all any longer? The answer is clearly no. The current approach is unwieldy and insufficient for the needs of the growth economies of today. Take India, for instance. The Governor cannot be hamstrung by being forced simply by convention to make a delayed impact instead of one that he is required to make instantaneously.
The market he operates in is large enough and diverse enough to adjust to policy in extremely quick time. In addition, India is clearly a supply side economy and rational expectations type policy is needed, not the old traditional post Keynesian policies of late 20th century America. In such an economy the RBI Governor not only needs freedom of action but actually more empowerment.
Governor Das is clearly a central banker for growth, unlike any in the recent past. Most governors have been stance driven liquidity managers in the last twenty years, whether India was in growth mode or not. This had resulted in the self- imposed restriction of inflation management as almost the sole function of the RBI, and one at which it has not been a spectacular success . Witness what happened to the USDINR and the purchasing power of the Rupee in this decade.
For the longest time RBI watchers have almost repetitively focused solely on the repo-reverse repo window and overnight liquidity management numbers. Combined with this activity was the occasional reactive positioning on USDINR spot that came to define the limits of RBI’s role, which was one of a passive Central bank, similar to the Reserve Bank of Australia, one utterly unsuited to the RBI’s role in an economy as diverse, dynamic and with the amount of potential of India’s.
In contrast to the past, Governor Das’ conduct of Open Market Operations, as exemplified by the dollar swap initiatives of March and April this year are directed to meeting multiple growth and rate management objectives, and have been an unqualified success. Not only have these issues been applauded by the market by being three times oversubscribed but they have also succeeded in providing the market with direction via a definite notional level for the three year USDINR rate while infusing much needed liquidity into the system through a proper, tractable swap mechanism. This reminds us of the incredibly successful monetary policy conducted by Japan in the 1970s and 1980s, while the U.S. faltered.
Hence, in terms of the actual operational conduct of monetary policy we reiterate that imitating US conventions with a voting Monetary Policy Committee is not optimal. Though we are all for a strong MPC, we feel it should have a strictly closed door advisory role to the RBI Governor. If the buck stops with him, there is no way his actions should be fettered in any form. Governor Das is repeatedly proving right and we are fortunate he is at the monetary policy helm.
The author is Product strategy, Metropolitan Stock Exchange (MSE). The views expressed are the author’s own.