The customary sign-off at the year-end compels a review of its defining developments. What such markers distinguish Indian monetary policy?
The customary sign-off at the year-end compels a review of its defining developments. What such markers distinguish Indian monetary policy? In 2016, there were several. Some of these are structural and institutional, which makes for interesting times ahead for their evolution and influences. There were others of minor and not-so-minor significance.
Outstanding developments occurred in institutional structures and processes of monetary policy. First, the RBI Act was amended to make price stability the primary monetary policy objective. Over August 5, 2016-March 31, 2021, the inflation target has been set at 4% with upper and lower tolerance levels of 2%. To foster transparency and accountability in monetary policy, there were two more accompanying reforms. A big shift was the transfer of decision-taking, or interest rate setting, from the RBI Governor to a committee made up of three external members plus the governor as chairman, a deputy governor and one officer of RBI; now, RBI governor has a casting vote, but not a veto, whereas the government appoints the external members as recommended by a search-cum-selection committee. The central bank is also now accountable for failure to meet the inflation target: the changes bind RBI to set out a report to the government stating reasons for this, the remedial actions it proposes to take and estimated time-period in which it will achieve the inflation target.
In the year’s last quarter, the broader, more open MPC (monetary policy committee) platform was constructed and made operational. Since October 2016, the MPC twice decided upon monetary policy, each time by consensus. Two important developments coincided with this, as well as a new governor, Urjit Patel: one concerns the precise inflation target. In October, the medium-term target inflation mandate was described as “4% within a band of ±2%”. This was a significant departure from the previous target of “4% in early 2018”, according to the projected disinflation path (e.g. the June 2, 2015, monetary policy statement). Some interpreted this as a shift from ‘point’ to a ‘range’ target, a dilution of the existing framework; others argued that this merely adhered to the legislated mandate. The second development is with regards to the real interest rate target, lowered to 1.25% from the existing 1.5-2.0%—not in the formal statement but at the post-policy media conference—and justified on grounds that neutral real rates had globally moderated. Both from the standpoint of timing and India’s strikingly reverse fundamental determinants, the rationale did not convince most. The absence of fuller explanations through off-statement communication has kept alive doubts and uncertainties about interpretational nuances of the monetary policy framework, potential output, etc. These surely carry over into the next year.
What about the MPC’s discussion minutes? Elsewhere in the world, these are closely scrutinised because differences in the tone of the meetings compared to the tone of the statement offers valuable information to which markets occasionally even respond. India’s first MPC minutes, the second yet to arrive, were eagerly awaited and found sketchy and brief; the terse deliberations provided no further insight than the actual monetary policy statement on the aforesaid departures and issues; the adjustment of the real interest rate target for instance, did not figure in the minutes. Advancements in these new structures and processes will attract a lot of curiosity and enthusiasm in forthcoming times. In future, the intensity and depths of MPC’s arguments and debates, more than anything else, will testify to the improved, superior quality of decisions.
Transmission of monetary policy was in focus this year as banks had not meaningfully responded to the central bank’s easing cues in the past. Here, an important change occurred in April when RBI moved its liquidity management policy from 1% (of total deposits) to a neutral stance, a reduction of about R800-900 billion through government bond purchases. Hard-pinched banks benefited from handsome treasury profits due to this, as did bond traders; the easing in rupee liquidity immensely supported RBI too in stabilising foreign currency outflows on account of maturing FCNR deposits (about $26 billion) in the year’s last quarter. For quicker transmission, RBI also introduced marginal cost pricing of loans, or the MCLR. How the latter improves percolation of interest rate changes at the borrower level is another matter for observation. One suspects that monetary policy transmission will continue to be in focus in 2017, too.
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Besides structural and institutional changes, the exceptional development of the year was demonetisation of 500- and 1,000-rupee notes. Its influences upon monetary policy outcomes will fully unfold in 2017. For now, the MPC has judged the demonetisation impact upon growth as transitory in its last review of the year on December 7; on this count, it projects gross value added, or GVA, to reduce 15 basis points in FY17, with a rebound after two quarters.
Finally, the year, at its end, has probably drawn the red line for monetary policy manoeuvres ahead. A firmed-up recovery has resulted in a convincing upturn in the US monetary policy and sent capital flocking into dollar assets; the Opec’s supply cut has restored oil prices; while prices of metals and other commodities continue to sustain their rally. It is always a tough ride for monetary policy in EMEs like India when currencies are under pressure and capital is flowing out; it is a lot worse when the domestic business cycle is turning down, divergent from the global one. If the demonetisation growth shock drags on longer than is currently anticipated, a buffer to reverse the adverse dynamics may be difficult in monetary policy.