Government and the RBI – Part 3

The first best world is that the government follows the letter of the Reserve Bank of India (RBI) Act, as amended. That is, it gives inputs in writing which are taken on record.

​The second best world is that there is a direct communication with the Governor formally, before very meeting and it is taken on record.

The third best world is that the RBI Act is amended – the sections pertaining to the Monetary Policy Committee (MPC) – and the Government formally has a non-voting voice in the MPC meetings.

This is third best because the MPC has just been formally launched and this might strike one as a panic and ad-hoc reaction. Basically, it is too soon to amend it. May be, after two years. That is why this is third best on my list.

The fourth best world is what is happening now : CEA+PEA+DEA Secy. meeting MPC non-RBI and not on record. They are government appointees. The appearance of free-will is important. That might be lost here. Indeed, even if they wish to cut rates on their own, it might not be seen that way but seen as succumbing to government pressure.

Look at the optics for the world of financial markets (fair or unfair is a different issue). This is how they would see it:

A new MPC has four meetings and it has not cut interest rates and has become even neutral to hawkish from being accommodative. The government therefore loses it and wants to interfere. It will have implications for the exchange rate, for funds flows, etc. The narrative about India might change for the worse, from the government point of view.

If the Government has to interact with RBI, it can be Finance Secy. and RBI Governor interacting formally. Perhaps, this was suggested and turned down.

In the final analysis, it boils down to 100 basis points of interest rates. Otherwise, I doubt if the Government would be so exercised about this. I really doubt if a rate cut of any magnitude would be so efficacious as to risk walking down a path a little bit without taking into account long-term consequences. Rate cuts in a balance sheet constrained environment are of little use. Even if the current real policy rate is 3.5%, is it too high for an economy that is supposedly growing at 7+%?

Further, given the experience in India with inflation, it is never easy to let down one’s guard on that. Sonal Varma has a nice piece in MINT today on why it is too soon to declare victory on inflation.

This would set a precedent for future governments to flout protocol and norms even more flagrantly. That is in the nature of the times we live in.

We have a stock market that is rich in valuation. It can go ballistic with 100-200 bp. of rate cuts while doing zilch to capital formation in the real economy. The costs are there for a rate cut of such magnitude.

It is not as though the RBI is missing a sure, riskless bet that would benefit the economy and therefore, the government has to step in.

So, I think that the government might have been better off retreating or doing it much more formally so that the personalities involved matter little.


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