One of the highlights of the 5 December monetary policy statement was the lone voice of MPC member, Ravindra H Dholakia, who pitched for 'neutral' policy stance from the present 'calibrated tightening'. This found mention in the penultimate paragraph of the policy statement. Logically, this sparked a debate among a section of economists. Should the central bank switch to 'neutral' or hold on to so-called 'calibrated tightening' stance?
Let's ask 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.
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?
This is not to say that the whole thing is meaningless. It's not that policy guidance and stance flops all the time. If one looks at the stated policy stance and actual actions by the central bank in the last four years, out of fourteen monetary policy actions, where it has stated 'accommodative' stance, the RBI has cut rates on six occasions and left rates untouched on eight occasions. Also, there have been occasions when MPC's inflation projections and rate actions did not correlate.
|RBI's monetary policy actions|
|Date||Monetary policy statement||Repo rate changes||RBI stance|
|15-01-2015||Other than policy day||cut 25 bps to 7.75%||accommodative|
|03-02-2015||Sixth Bi-monthly FY15||no change||accommodative|
|04-03-2015||Other than policy day||cut 25 bps to 7.50%||accommodative|
|07-04-2015||First Bi-monthly FY16||no change||accommodative|
|02-06-2015||Second Bi-monthly FY16||cut 25 bps to 7.25%||Easing|
|04-08-2015||Third Bi-monthly FY16||no change||accommodative|
|29-09-2015||Fourth Bi-monthly FY16||cut 50 bps to 6.75%||accommodative|
|01-12-2015||Fifth Bi-monthly FY16||no change||Easing|
|02-02-2016||Sixth Bi-monthly FY16||no change||accommodative|
|05-04-2016||First Bi-monthly FY17||cut 25 bps to 6.50%||accommodative|
|07-06-2016||Second Bi-monthly FY17||no change||accommodative|
|09-08-2016||Third Bi-monthly FY17||no change||accommodative|
|04-10-2016||Fourth Bi-monthly FY17||cut 25 bps to 6.25%||accommodative|
|07-12-2016||Fifth Bi-monthly FY17||no change||accommodative|
|08-02-2017||Sixth Bi-monthly FY17||no change||Neutral|
|06-04-2017||First Bi-monthly FY18||no change||Neutral|
|07-06-2017||Second Bi-monthly FY18||no change||Neutral|
|02-08-2017||Third Bi-monthly FY18||cut 25 bps to 6.00%||Neutral|
|04-10-2017||Fourth Bi-monthly FY18||no change||Neutral|
|06-12-2017||Fifth Bi-monthly FY18||no change||Neutral|
|07-02-2018||Sixth Bi-monthly FY18||no change||Neutral|
|05-04-2018||First Bi-monthly FY19||no change||Neutral|
|06-06-2018||Second Bi-monthly FY19||up 25 bps to 6.25%||Neutral|
|01-08-2018||Third Bi-monthly FY19||up 25 bps to 6.50%||Neutral|
|05-10-2018||Fourth Bi-monthly FY19||no change||Calibrated tightening|
|05-12-2018||Fifth Bi-monthly FY19||no change||Calibrated tightening|
After that, ten policies were announced where the stated stance has been 'neutral', during which there has been one rate cut and two rate hikes. Post that, the MPC started using policy stance as 'calibrated tightening'; two policies have passed no action so far. Looking at the growth-inflation dynamic in the present scenario, chances of tightening from this point is unlikely in the near future and the RBI will have to either say on hold or go for a rate hike. When CPI inflation is consistently below the 4 percent mark for the three consecutive months (since August) and the GDP growth is on a sharp downward trend, no central bank will dare to hike rates and let it exposed to all-round criticism.
One can't blame the central bank for it; in the last two months, the rupee has been on a roller coaster ride, sliding all the way to 75 against US dollar and back to 70 per dollar with inflation on a sharp downward trend and crude showing signs of easing. Here, RBI is no better than rating agencies which do no better than cops in typical Bollywood films"acting at the end of an event or post-event. Data dominates every part of the show and completely nullify the stated policy stance/ guidance if it wishes so. Under the present scenario, if inflation continues to stay low and growth falters, the RBI will have to, most likely, give 'calibrated tightening' a miss and either stay on hold or cut rates. Remember, Inflation is projected at 2.7-3.2 percent, well below the 4 percent medium target in H2 FY2018-19. If that happens, what was the point of the whole 'calibrated stance'. In other words, the markets were initially guided towards a rate hike but, in reality, were given different actions.
The joke on 'neutral' stance
Since everything is dependent on data, the only rate stance that makes any sense, and can never go wrong, is 'neutral'. That's because when in neutral stance, the policy action can swing both ways. No complaints. But then, why we need a stated 'neutral' stance at all? Can't the MPC and RBI simply stop giving guidance on policy stance to markets and act according to the incoming data without announcing it in advance? The MPC will have to be neutral anyway to become flexible enough to tweak its rate decisions as per the situation demands. In that sense, every central bank is 'neutral' and will have to be 'neutral'; it's implicit in their kind of work.
It's perhaps time the RBI does away with certain jargons, instead goes for rate decisions depending on data, which is what it does anyway even now.
(Data support by Kishor Kadam)