Dear Governor Rajan,

At the very outset, let me congratulate you for continuing the attempts to fix India’s—dare I say, still misunderstood—inflation challenge. Admittedly, the political establishment also has the same goal of ensuring low inflation, but its actions on the ground, to that effect, appear less encouraging.

I am focussed here on the combination of RBI’s actions, justification of those actions and the guidance in recent monetary policy statements. These appear to have become somewhat eclectic to people sitting in the trenches of financial markets. This is despite a more transparent inflation-targeting monetary framework having been adopted.

Frankly, I don’t know of any central bank which admits to any inconsistency or contradiction in its guidance or actions. This of course is to be expected—no central bank would consciously offer such a concoction. But the feedback loop of market expectations relative to central banks’ guidance is an important input in improving the details of policy statements.

My comments are over and above the strange expectation carried by many equity investors that somehow there was aggressive monetary easing in the pipeline. I know from personal experience that countering that view by suggesting that only one—or maximum two, if we are lucky—rate-cuts were left would be generally dismissed.

For the record, RBI has cut the policy repo rate by a total of 75 bps, to 7.25%. It is probably a coincidence, but the cumulative magnitude is the same as the total increase in the repo rate soon after you joined RBI. The rate-cuts were in mid-January, early March and early June, with the first two being out-of-policy-cycle, unexpected actions, while the latest cut was widely expected though it was probably a closer call than most believed.

In the last six months, there have been only marginal (up and down) revisions to the January 2016 CPI inflation forecast of 6%. However, three rate-cuts have been announced over this period. These can be justified on the basis of still-weak growth—no one believes the GDP data—and the better-than-expected inflation numbers aided by a collapse in international crude oil prices, which frankly are not in India’s control. What is interesting is that neither factor has improved the January 2016 inflation assessment, suggesting their one-off impact.

The policy statement accompanying the June rate-cut revised up slightly the inflation forecast for January 2016 to 6%, expressed concern over the monsoon outcome and indicated upside risks to the central forecast. Perhaps, RBI waited for a scheduled policy to act this time despite continuing weak activity data as a third consecutive out-of-policy rate-cut last month would have been bizarre.

For an inflation-targeting central bank to revise up inflation forecast and signal upside risk to inflation but still cut interest rates is strange, to say the least. A central bank can always explain its actions; that doesn’t make them consistent! Also, the frequent and marginal up and down revisions to the January 2016 inflation forecast only increase forecast volatility and uncertainty.

There is also a built-in asymmetric bias in your policy. For all practical purposes, you have signalled a pause because of the risk to inflation, partly because of the monsoon. However, it is almost a foregone conclusion that you are unlikely to raise interest rates if inflation rises because of the monsoon deficiency. You will probably justify not raising rates because of the temporary nature of the supply-side monsoon shock, the still weak aggregate demand and being on track for the 4% inflation target. So, why turn-off easing because of a temporary monsoon risk?

Equally importantly, let us assume that the monsoon impact is not as bad as feared or the government rises to the occasion and manages food inflation remarkably well, as a result of which actual inflation is better than your forecast. Will there be one more rate-cut? Perhaps. But there is also the strong possibility that you could subjectively shift your optics and focus on the understandable need to disinflate further towards the 4% target, thereby favouring status quo on rates.

Interestingly, whatever happened to the assurance about the government’s commitment to work with RBI to deliver low inflation in the new monetary framework? This commitment was one of the reasons for RBI’s surprise rate-cut in March. It seems that in less than four months, RBI has doubts. If that weren’t the case, the policy statement would have been structured differently, perhaps still signalling an easing bias while reassuring that the adverse monsoon impact—if it materialises—will be temporary.

Finally, I am surprised nobody has asked the real question. The issue with the GDP data isn’t just about the one-off factors that pushed up headline GDP growth even as GVA growth weakened in 1Q15. The real question for RBI is the glaring reality that India’s GDP data don’t even pass the common-sense smell test. Economies growing at 7-7.5% have a certain spring in their step, which is conspicuous by its absence in India. How different would RBI’s policy response function be if it better appreciates that economic growth is actually significantly lower?

The author is senior economist, CLSA, Singapore. Views are personal

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