Don’t waste interest rates, use RBI policy statement as policy tool in itself

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Updated: April 17, 2019 2:17:32 PM

The report suggested the RBI to provide “second generation signals” in its policy statement inorder to reduce the disconnect with market expectations.

RBI Governor Shaktikanta Das has sparked a debate on moving away from the conventional method of changing monetary policy interest rate in multiples of 25 bps. Instead, the size of the rate change could be calibrated in small or larger magnitudes to indicate policy stance, he suggested. This thinking indicates the RBI intent to use communication as the policy in itself rather than the policy statement just being a vehicle for communication, SBI said in its Ecowrap report this week.

Shaktikanta Das said this against the background of several limitations imposed by the conventional and unconventional monetary policy tools in the aftermath of the global financial crisis. Monetary policy must touch the real economy, spur investments and maintain fiscal and monetary stability, he said during an annual Spring Meetings of the International Monetary Fund and the World Bank last week. However, some economies have turned to the heterodox evolution of ideas that are being practiced as modern monetary theory, he noted.

Explained: Communication as a policy

In case the central bank needs to ease monetary policy but prefers to be cautious in its accommodation, a 10 basis point reduction in the repo rate could communicate the intent of authorities more clearly than two separate moves — one on the policy rate, wasting 15 basis points 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, Shaktikanta Das said during the event.

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Challenges

Although the intent of the RBI Governor looks positive, there remains concerns on the efficiency of an indicative rate cut of 10 or 15 basis points given the weak monetary transmission in the economy where even 25 or 50 basis points cut do not work, said SBI report. Moreover, rate changes of odd magnitude could be difficult to connect with markets unless properly decoded, the report added.

The report suggested the RBI to provide “second generation signals” in its policy statement inorder to reduce the disconnect with market expectations. This includes phrases indicating that policy accommodation “can be maintained for a considerable period” or “can be removed at a pace that is likely to be measured”.

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