RBI cuts repo by another 25 bps: Central bank’s rate cut spree and the logic of keeping ‘neutral’ stance don’t add up

The second consecutive rate cut announced by the Monetary Policy Committee (MPC) wasn’t unexpected. At a time when growth is slowing down and retail inflation remains low, this was the logical policy response from the panel. Will the 25 bps rate cut benefit the consumers in a tangible manner? Will the EMI burden ease for home and auto loan borrowers post this quarter bps cut? Unlikely. Banks might not be too keen to cut rates in a big way when demand is still low and fearing that profit margins will be impacted in the event of significant lending rate cuts. Growth concerns have clearly taken the central stage. Throughout the policy, there are clear warnings about the growth slowdown. The statement said, “The MPC notes that the output gap remains negative and the domestic economy is facing headwinds, especially on the global front. The need is to strengthen domestic growth impulses by spurring private investment which has remained sluggish,” This assessment hits the bull’s eye and sends a clear message to the fiscal authorities. But what is surprising is the logic behind retaining the ‘neutral policy stance’ even while announcing the second consecutive rate cut. A glance at the policy document clearly tells us that policy is now tilted, at least in the near term, towards a growth supportive stance. In the current context, going by the indications and the language of the monetary policy, the RBI is in a clear accommodative stance. This is despite lowering its CPI inflation forecast downwards to 2.4 percent in Q4 of 2018-19, 2.9-3.0 percent in H1 of 2019-20 and 3.5-3.8 percent in H2 of 2019-20 and slashing FY20 GDP growth forecast to 7.2 percent from 7.4 percent. The MPC has outlined a benign inflation stance and a struggling growth scenario, indicating a further rate cut. There was an expectation that MPC will change the stance to ‘accommodative’ from neutral in Thursday’s policy. The continuance of neutral stance is a tad perplexing. Why was the policy stance kept unchanged at neutral even when everything else in the policy document points towards an accommodative stance? [caption id=“attachment_4038879” align=“alignleft” width=“380”] Representative Image. Reuters[/caption] That brings us to a basic question—what really is this central bank guidance and what is its relevance? Central banks typically give policy guidance to financial markets so that all types of investors can make informed decisions. It also comes handy for economists and analysts to think ahead and work on their predictions to give clients a sense of where the interest rate regime is heading. However, there have been occasions when central bankers fumble, dodge questions and even show the serious face if asked to explain in simple, convincing terms to the public whenever the guidance go wrong on inflation projections and policy stance. What is the relevance of the stance itself given that MPC can do any policy action at any point no matter what is the stated stance is? Theoretically, the Indian central bank (and most of its counterparts too) gives three main types of forward guidance/policy stance to markets—accommodative (in other words, the central bank is telling the market to expect a rate cut anytime), tight (to indicate an impending rate hikes) and neutral (which doesn’t have any particular meaning. This means anything can happen anytime). Sometimes the RBI goes a step further and mentions words like ‘easing’ (meaning, double sure—the rate cut is here and now) and ‘calibrated tightening’ (not sure what it means—aren’t all policy actions ‘calibrated’ in some way?). Apart from these terms, markets have found their own favourites words like hawkish, dovish and loose. But many a time this forward guidance turns out to be useless for markets. The real events may unfold differently from what the RBI says in its policy stance. The reason for this is not hard to find; one needs to only look at the central bank policy statements, nine out of ten times, central bank uses the key disclosure ‘future actions will be dependent on incoming data’. That’s fine. All central banks do that. But then there is another question - if everything is dependent on incoming data and all policy decisions can change depending on incoming numbers, what’s the point of giving a stance at all? Clearly, Central bank’s rate cut spree and the logic of keeping ‘neutral’ stance don’t’ add up.