RBI decision

The Reserve Bank of India did not lower its interest rate on Wednesday and shifted its stance to neutral (from accommodating). In other words, the next rate action could be in either direction. It has brought forth a barrage of criticism. I will have more to say on it in my piece for MINT on Tuesday. Some quick reactions in the meantime.

There is some justification in being annoyed with the central bank changing its bias to ‘neutral’ from ‘accommodating’. But, even that annoyance has limits. Central bank policy surprise is part of the arsenal. Read this for a sample of what I see as a flawed criticism.

Inflation expectations among households had come down in the latest quarterly survey of households that RBI published on the same day as it announced its monetary policy decision. It could be temporary and driven by the decline in the price of vegetables and pulses. The central bank has decided to be opportunistic about cashing in on and reinforcing the current disinflationary trend and expectations. They need to be commended for it.

Yes, the government bond yield had risen sharply. It raises government’s funding costs. It tightens financial conditions. So, it has real consequences and not just financial consequences. But, I shall leave it for my column to discuss as to what it says about the bond market itself.

Lending rates have dropped already substantially. Another 25 bp. did not matter. Interest rates are not the panacea for growth. They are over touted. Under some assumptions about normal balance sheets, credit transmission and standard garden-variety business cycles, interest rate tweaks in either direction have an impact. Otherwise, not.

Balance sheet stress in corporations, lack of adequate capital with banks and then as RBI mentioned in its last line, the government’s failure to walk the talk on tweaking rates on small savings as promised are the hurdles for credit and capex cycles to take off.

In fact, RBI observation on the failure of interest rates on small savings to be lowered is very important. We do not hold the government’s feet to the fire as much as we should be. What is the sanctity of the announcements? When this quarterly adjustment/reset of rates on small savings were announced, it was hailed as an important and significant reform holding out the prospect for credit transmission.

If that has remained on paper, please let us direct our ire and annoyance at the right target.

Most people missed the delightful sarcasm in the monetary policy statement on the “debilitating drag from insulated rubber cables from November…”.

Finally, those who were so happy to blast off at the RBI because it was a convenient proxy target of criticism directed at the government on demonetisation should now have the grace and decency to acknowledge the central bank’s assertion of independence, regardless of their views on the economic merits and demerits of the decision.

Of course, I have, on balance, no problems with the decision itself.

It is possible that many who visit my blog have a different view on this. Comments are greatly welcome. I can and will learn.

(Postscript: Prolific blogger Amol Agrawal took exception to the RBI decision on excluding the journalist from ‘Economist’ from attending its post-policy conference. At one level, it is easy to fault the decision. The logic is sound. There is another part of me that wants to chuckle at the decision. I am being honest).


One thought on “RBI decision

  1. A friend sent this comment to me by email. He prefers to remain anonymous. He permitted me to post his email here:

    Hi Ananth,

    In December the RBI was worried about achieving its 5% CPI target for March 2017 – most of us were stunned!! At the December policy it kept policy accommodative while pointing to upside risks to inflation – it looked like a political decision so as to imply no big shocks coming from demonetisation. It was a big surprise that the monetary policy division, which employs the largest number of economist Ph.Ds in India ( according to Urjit Patel when he was Deputy Governor), could not even get the direction of CPI 4 months hence. Now 2 months ahead most expect a 100-150 bps downside to the 5% target which the RBI has haltingly acknowledged. So now in Feb the risks to inflation have become two sided but they decided to move to neutral. On being asked about this anomalous shift the answer was something like we got data in the last 2 months which lowered inflation for this year but could increase inflation for next year- not sure what that was.

    Clearly they have the 4% medium term goal in mind which is great for medium term macro stability. I am guessing they are worried at core being sticky around 5% which implies food and vegetable prices have to be around 3% to achieve a durable 4%. A bit perplexed at why they keep harping on core when the Urjit Patel report was categorical on why it targets headline and not core. This dilly dallying between core and headline to suit their stance is worrying. As you point out on inflation expectations survey came out the same night- they again use this only when they want to sound hawkish. The 1-yr ahead number was a high 11% in September when they cut and one could argue that they could have used the steep fall in inflation expectations to even justify a cut now. Bottom line after saying no large effect of demonetisation on growth ( they said only 0.15% growth downside in December) or inflation now they want to attribute a big chunk of the fall in perishable food inflation to demonetisation and see it as transient- fair enough.

    The whole stance issue is also a bit confusing. After cutting 75 bps the Rajan RBI moved to an accommodative stance in June 2015. They cut a further 100 bps after that. The FED continues to hike while keeping its stand accommodative. As you say neutral just means that the next move could be a hike or a cut. Given the 4% target and RBI’s trajectory of 4.5-5% for second half of FY 2017 any jump to over 5% will get the market to price in hikes.

    The 10-yr bond took out the pre demonetisation yield level yesterday- seems fair as most money seems to have come back ( they still won’t tell how much) and we could see healthy remonetisation constrained only by how quickly and how much RBI releases the new notes. So net-net not a lot of benefit to the banking system from demonetisation .


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