RBI policy: Raghuram Rajan's silence on 2 critical issues raises more questions

By all standard measures, the RBI’s second bi-monthly policy review for FY17 was a non-event. The central bank kept the policy rate unchanged at 6.5% which was widely expected by the markets. While the RBI made the point that it still remains accommodative, it highlighted upside risks to inflation going forward emanating mainly from the upswing in commodity prices and stickiness in core inflation. [caption id=“attachment_2822506” align=“alignleft” width=“380”]  Raghuram Rajan. PTI[/caption] We, in fact, expect limited rate cuts (to the tune of 0-25bps) to be administered over FY17 because (1) inflation is likely to remain sticky at 4.5-5.5% even if the monsoons are normal, and (2) it would make sense for the RBI to signal to the Central Government (by not cutting rates) that its fiscal maths appear overly ambitious. On the liquidity front, the RBI reiterated the point it made in its last policy statement that it will work towards maintaining a neutral position (compared to a deficit position earlier). As regards growth, the RBI expects GDP growth to be recorded at 7.6% in FY17 compared with 7.4% in FY16. This mild acceleration in FY17, according to the RBI, will come from strengthening consumption demand which will be aided by the tail-wind of 7th Pay Commission award and normal monsoons. However, the RBI highlighted that it remains cognizant of the fact that the private investments in India have not picked up. While the text of the monetary policy statement was entirely in line with expectations, the absence of any formal commentary on two critical developments that materialised in the run-up to this monetary policy review was conspicuous by its absence. For one, in the second half of the Budget Session, the Parliament approved a bill that calls for the setting up a monetary policy committee to decide policy rates. While this appears to be a step in the right direction in terms of bringing the RBI’s policymaking process in line with global best practices, it is critical to note that the Indian version of the monetary policy committee gives the RBI a lesser say in monetary policy compared with international standards. In fact, the proposed panel framework envisages lesser independence of monetary policy making than envisaged by the Urijit Patel committee which was set up by Raghuram Rajan ‘to revise and strengthen the monetary policy framework’ immediately after he assumed office of the Governor of RBI in September 2013. The Central Government proposed committee comprises three members from the RBI – the RBI Governor, Deputy Governor and Executive Director – and three independent members who would be nominated by the Government. This is in sharp contrast to the recommendations made by Urjit Patel’s ‘Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework’ which states that, “The Governor of the RBI will be the Chairman of the MPC, the Deputy Governor in charge of monetary policy will be the Vice Chairman and the Executive Director in charge of monetary policy will be a member. Two other members will be external, to be decided by the Chairman and Vice Chairman.” The complete absence of the RBI’s view regarding this important change was conspicuous and a departure from past practices. For instance, when the RBI accepted the Urjit Patel Committee recommendations and moved to targeting CPI rather than WPI, the monetary policy statement in January 2014 explicitly mentioned this important change. Secondly, in a significant departure from past practice the government has made the current Cabinet Secretary the head of the interview panel which has been constituted to select a Deputy Governor of the RBI (as Deputy Governor HR Khan’s term expires in July 2016). This appointment is usually the prerogative of the RBI and hence the panel is typically headed by the RBI Governor. This deviation from past practices is clearly an encroachment on the RBI’s territory and at the very least, it would have been appropriate for the RBI to convey information regarding the same. So while the monetary policy review was entirely along expected lines, the RBI’s lack of commentary on two material developments that transpired over the last 30 days raises certain uncomfortable questions. Given that Rajan’s report card as the RBI governor has been spectacular on the ‘macroeconomic management’ front and even better on the ‘engendering competition’ front, we hope that New Delhi makes an objective decision regarding Rajan’s term renewal and we see this Governor delivering the fourth monetary policy review statement in October 2016 as well. Ritika Mankar Mukherjee is senior economist - vice president, and Sumit Shekhar is junior economist, Ambit Capital.