The curious trend in the monetary policy committee (MPC) decisions ever since the panel approach was pursued is that while there has been unanimity in the decisions, there have been only two outliers – one who has pitched for tightening of rates and the other loosening of the repo rate. This time while everyone agreed to no change in the repo rate, the lone contrarian in the group wanted the stance to be changed from ‘calibrated tightening’ to ‘neutral’. In fact, this member has been critical of the inflation forecasts that are being put out as the actual inflation rates appear to be always lower than the forecast. What can one make of this concept of ‘stance’?
Before the MPC documents brought in the concept of ‘stance’, the terms which were made legendary by the Indian media (which has been acknowledged in global press) are the concepts of governors being ‘hawkish’ or ‘dovish’ where the former meant being negative in outlook of generally everything concerning interest rates and hence pitching for hikes and the opposite for being dovish. Now with the policy document putting in a stance these bird analogies are passé.
Let us look at what all is in the policy statement. There is a call on the interest rates and then a stance which is affirmed. We have had stances being ‘neutral’ and ‘accommodative’ which was interpreted to mean that the RBI on balance felt neutral about conditions going forward or were going to be more aggressive and accommodative. Being accommodative meant also that the central bank would be more liberal. But if one puts the question as to what exactly are we meaning in terms of possible action, it gets confusing.
The RBI can become accommodative after lowering interest rates by only supplying more liquidity. But this also does not sound okay because today when liquidity is tight, the RBI has been forceful in open market operation (OMO) to ensure that there is more liquidity. Hence with a tough ‘calibrated strengthening’ stance, accommodation through liquidity has been the maximum. Therefore, liquidity cannot be associated with stance.
The other prognosis that one can link the stance with is future inflation as inflationary expectations are important when it comes to monetary policy. Here too, it gets confusing because every statement gives the RBI the view on GDP growth and inflation. Therefore, there is a forecast which today is in a wide range for the coming two quarters or half of the running year and a view also on the first or two quarters of the next financial year.
If this is already said, then the stance cannot be linked to the same. For example, the RBI, this time, has lowered the inflation forecast for the second half of the year to 2.7-3.2 percent. If this were done, then logically there is no case for ‘calibrated tightening’ as the committee feels inflation will only be coming down. When inflation was higher, there was no rate hike, and hence if expectations are that inflation will come down, then there can be no case for tightening. Therefore, this too sounds out of place.
The challenge to understand the conduct of the MPC decisions is that while we have targeted inflation at 4 percent with a band of 2 percent on either side, inflation has always been within 2-6 percent, and rarely comes close to either 2 or 6 percent and it has been between 3-5 percent. Even the bi-monthly forecasts made have been in this range, yet there have been different actions taken by the RBI from ‘no change’ to ‘cut’ or ‘increase’ in repo rates. If one adds the stance concept to the rate action, it makes the picture fuzzier.
Now when we talk of any stance, it does not seem to be aligned with expected inflation for sure as those numbers are there for us to see and bear little resemblance with the emotion. At the same time, it also does not indicate that the MPC may be looking at tightening or loosening the interest rate regime as often the stance is not aligned to the action on rates or future action on rates. And as has been stated in the beginning, there are no links with provision of liquidity as it is the duty of the central bank to provide funds to the banking system as and when required through the repo and OMO window. And this has been done proactively and not linked to the stance.
If this be the case, there can be a discussion point on whether the inclusion of a ‘stance’ is important in the broader scheme of things in the policy and as a corollary, is it relevant. One can always say that it can be ignored, but the point is that the position on stance is a talking point for the market and yields move based on the stance taken. The new concept of ‘calibrated tightening’ last time spooked the market as it was assumed that it meant increasing interest rates in future.
Remember, all of us were talking of 25-50 bps hike till March and now with same stance, we are talking of a possible cut in February! Maybe if the stance changed to neutral this time, it would have been more in sync with the forecast and action on rates.
While it is true that the concept of a stance is taken by other central banks, they do not normally give forecast for inflation every two months and only indicate whether the economy is closer to the 2 percent target or not. When we are providing the inflation forecast for the coming quarters that should be indicative of how rates can move in future and the MPC can leave it at that. Alternatively, the forecasts can be eschewed and a stance taken which will indicate the same. Keeping both which only send different signals that can bring in some speculative interpretation and hence volatility in the market.
(The writer is chief economist, CARE Ratings)
Updated Date: Dec 07, 2018 14:51 PM