Focus shifts to growth @ Mint Road : The Global ANALYST
Focus on Growth at Mint Road*
M G Warrier
Last month (TGA, June 2019), Madhusudhanan S concluded his article on Monetary Policy Committee with this prophetic observation: “The MPC should not only look at inflation targeting as its only goal, but it should also use its Monetary Policy Framework to accommodate policy to ensure sustainable growth. As it is said, ‘Policy is meant for growth and not for impairment.’”
For sure, the above observation was recorded much before the MPC met between June 4 and 6, 2019 and RBI came out with a cut in base rate by 25 basis points simultaneously changing central bank’s policy stance from ‘neutral’ to ‘accommodative’. Just thought it appropriate to place on record that the time lag between analysts’ perceptions and policy action by the central bank is reducing.
In India, at least since 1990’s GOI and RBI have reconciled to the reality that fiscal and monetary policies are married with no option for a divorce. RBI has never asserted supremacy of monetary policy over the economic policy expectations of GOI. If there were visible frictions in their relationship, they emanated from the poor understanding on the part of certain individuals, of the roles of GOI represented by the finance ministry and the RBI, the institution responsible to implement certain mandated responsibilities.
The Monetary Policy Committee which has now been institutionalized by amending the RBI Act in reality is just a formalization of the role assigned to it by the Preamble of RBI Act, which has been played reasonably well by RBI, all along.
The clarity in the institutional mind of RBI as regards the objective of monetary policy and price stability comes out in uncertain terms in the then governor Dr C Rangarajan’s observations on the objectives of monetary policy and price stability in relation to the economy of India at the Second Conference of the Econometric Society’s Regional Chapter for India and South Asia in Delhi on December 28, 1996 (see Box).
Monetary Policy continuity
The policy perceptions of RBI has continuity, despite the relatively short term nature of appointments at top level. This is evident from the observations made by Dr Raghuram Rajan, who was governor during 2013-16, in a speech delivered at the Tata Institute of Fundamental Research (TIFR) on June 20,2016 (almost 20 years after Dr Rangarajan’s speech quoted above). He said:
“The received wisdom in monetary economics today is therefore that a central bank serves the country and the cause of growth best by keeping inflation low and stable around the target it is given by the government. This contrast with the earlier prevailing view in economics that by pumping up demand through dramatic interest rate cuts, the central bank could generate sustained growth, albeit with some inflation. That view proved hopelessly optimistic about the powers of the central bank.
Put differently, when people say, ‘Inflation is low, you can now turn to stimulating growth’, they really do not understand that these are two sides of the same coin. The RBI always sets the policy rate as low as it can, consistent with meeting its inflation objective. Indeed, the fact that inflation is fairly close to the upper bound of our target zone today suggests we have not been overly hawkish, and were wise to disregard advice in the past to cut more deeply. If a critic believes interest rates are excessively high, he either has to argue the government-set inflation target should be higher than it is today, or that the RBI is excessively pessimistic about the path of future inflation. He cannot have it both ways, want lower inflation as well as lower policy rares.
At the same time, the RBI does not focus on inflation to the exclusion of growth. If inflation rises sharply, for instance, because of a sharp rise in the price of oil,it would not be sensible for a central bank to bring inflation within its target band immediately by raising interest rates so high as to kill all economic activity. Instead, it makes sense to bring inflation back under control over the medium term, that is, the next two years or so, by raising rates steadily to the point where the bank thinks it would be enough to bring inflation back within the target range…..More generally, the extended glide path over which we are bringing inflation in check appropriately balances inflation and the need for reasonable growth.”
The emphasis, obviously is on the policy continuity at RBI with focus on price stability and growth, over decades, despite all constraints and pressures from various stakeholders.
The confidence with which RBI is moving forward simultaneously on policy front and in prompt initiation of regulatory and supervisory measures is building trust in those who are managing the institutional system in the financial sector. The central bank has, as expected, taken in its stride the pressures from policy makers in Delhi and those who are affected by its more stringent supervisory and regulatory stance to discipline players in the economy who are reluctant to fall in line. The message is, the RBI is willing to act decisively where warranted.
June 6 Policy Announcement
While announcing the Bimonthly Monetary Policy on June 6, 2019, RBI observed:
“The MPC notes that growth impulses have weakened significantly as reflected in a further widening of the output gap compared to the April 2019 policy. A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern. The headline inflation trajectory remains below the target mandated to the MPC even after taking into account the expected transmission of the past two policy rate cuts. Hence, there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity, while remaining consistent with its flexible inflation targeting mandate.’
Governor’s observation in the post-policy announcement interaction with the media that the ‘decision is driven by growth concerns and inflation concerns in that order’ says it all.
Transmission of interest rates
A change in base rate by itself doesn’t mean much for the economy in the Indian context, as the banking system’s dependence on RBI is not significant. So far, the message that a cut in base rate by, say, 25 basis points in base rate is an expression of expectation that banks will reduce lending and deposit rates by quarter percent or near-about has not gone down the line loud and clear. There are reasons for this. Banks are aware of this expectation. But there are market realities. Banks’ term deposit rates have some relationship with government’s own savings schemes like Provident Fund and National Savings Schemes. Savers expect a reasonably positive return on their savings, net of inflation. So, there are constraints in reducing deposit rates. Despite all these, there exists a case for reducing lending rates, by reducing the need for high margins. If margins have to come down, efficiency in fund management, recovery rate and overall discipline in the financial system should improve. Here, RBI will expect support from policy makers and judiciary.
Signals from Mint Road
RBI-watchers have started assessing the impact of the presence of new governor Shaktikanta Das at RBI. Six months is too short a period for such exercises. But intuitively, I feel the tidings are positive and with Nirmala Sitharaman as Finance Minister, the decade-old uncertainties in the relationship between North Block and Mint Road will become a memory we can push into archives. Why?
The change in RBI’s own monetary policy stance from ‘neutral’ to ‘accommodative’ can be considered as symbolic. The IAS grounding and cordial relationship with his erstwhile colleagues in the Finance Ministry are helping the new RBI governor in solving contentious issues amicably with GOI.
Review of February 12, 2018 circular
By any yardstick, RBI’s February 12,2018 circular on handling loan defaults was a landmark in regulatory guidance from the central bank. When the matter reached Apex Court, while the authority of the RBI was not contested, the circular was set aside on legal/technical grounds. RBI deserves praise for coming out with a revised version of the circular fast, rectifying some of the irritants in the original circular. The modifications in instructions include more time for banks for completing certain processes, bringing down the need for the assent of creditors to 75% for restructuring plan, provided all creditors agree to restructuring in principle and discretion to lenders with regard to design and implementation of resolution plans.
Transfer of RBI’s surplus to GOI
A Panel headed by former governor Bimal Jalan which examined the adequacy of reserve with RBI will be submitting its report shortly. Now, armed with the expert views, RBI will be able to take an informed decision on the issue. In case the Panel fails to come to a consensus on capital and reserves requirement of RBI, accretion of surpluses and their deployment including the modalities of arriving at transferable surplus, one expects the provisions of the RBI Act will be respected and GOI and RBI will amicably sort out the issue.
Excerpts* from the then RBI Governor Dr. C. Rangarajan’s observations on the objectives of monetary policy and price stability in relation to the economy of India at the Second Conference of the Econometric Society’s Regional Chapter for India and South Asia in Delhi on 28/12/96.
*Source: BIS Review 8/1997(BIS Website)
**Article published in The Global ANALYST, July 2019.