Choices in mon­e­tary pol­icy


Ever since the Re­serve Bank of In­dia moved to an in­fla­tion-tar­get­ing frame­work and de­fined the goal of the mon­e­tary pol­icy as keep­ing in­fla­tion around 4 per cent, and within a vari­a­tion of 2 per­cent­age points in the up or down di­rec­tion, one thing should have been clear: the in­puts on how in­fla­tion is mov­ing and is likely to move have be­come the most crit­i­cal piece of data to con­tend with. The more ro­bust the in­fla­tion sur­veys, the more ef­fec­tive would be the poli­cies of the RBI and its Mon­e­tary Pol­icy Com­mit­tee (MPC) in tar­get­ing in­fla­tion.

What we see to­day is quite the con­trary. At the high­est level, there ap­pear to be con­trary data points float­ing around, each of­fer­ing an in­fla­tion tra­jec­tory that sits at odds with the other.

Dif­fer­ing es­ti­mates

The Eco­nomic Sur­vey re­leased un­con­ven­tion­ally on July 31 sees “now a new phase of rel­a­tively low, pos­si­bly very low, in­fla­tion”, and it begs the ques­tion: Is In­dia un­der­go­ing a struc­tural shift in the in­fla­tion­ary process to­ward low in­fla­tion? Fur­ther­more, given the tar­get in­fla­tion of 4 per cent, the Sur­vey makes a case for the pol­icy repo rate to be 5.25-5.75 per cent as against the present level of 6 per cent.

The Cen­tral Sta­tis­ti­cal Or­gan­i­sa­tion’s CPI (Gen­eral) data on the other hand re­veals that July re­tail in­fla­tion (2.36 per cent) has shown signs of mov­ing up­wards but lower than July 2016 pri­mar­ily due to neg­a­tive food in­fla­tion (mi­nus 0.29 per cent) con­trib­uted by veg­eta­bles (mi­nus 3.57 per cent) and pulses (mi­nus 24.75 per cent).

Mon­e­tary Pol­icy Com­mit­tee mem­ber Ravin­dra H Dho­lakia (who voted for a stiff 50-ba­sis points re­duc­tion in the pol­icy repo rate at the last meet­ing of the MPC on Au­gust 2) has ob­served that “my es­ti­mates based on our in­de­pen­dent ex­er­cise sug­gest” a lower in­fla­tion rate at the end of fis­cal 2017-18, at around 3.5 per cent, which is 50 ba­sis points lower than the RBI fore­cast. He has also men­tioned that the IIM-Ahmed­abad monthly Busi­ness In­fla­tion Ex­pec­ta­tions Sur­vey for May and June 2017 shows that busi­nesses in In­dia ex­pect their cost in­fla­tion (core in­fla­tion) a year ahead to be around 3 per cent.

Armed with this con­vic­tion, Dho­lakia has ar­gued for steeper cuts in the pol­icy repo rate and an ac­com­moda­tive pol­icy stance rather than the neu­tral stance that the MPC now has adopted. The meet­ing ended with a pol­icy repo rate cut of 25 ba­sis points. The in­tro­duc­tion of the IIM-A sur­vey is an in­ter­est­ing new ad­di­tion to data points. It can pro­vide a new per­spec­tive that the RBI can weigh in on. Af­ter all, the very idea of hav­ing a multi-mem­ber MPC, with mem­bers from out­side the RBI, is to en­able the vet­er­ans of cen­tral bank­ing bal­ance their RBI-cen­tric views with what ex­perts (and com­mon­ers) out­side feel, think and read. To that ex­tent, new sur­veys are good. But equally they raise ques­tions on the ro­bust­ness of the sur­veys and on how these sur­veys square with the RBI’s sur­veys, which one pre­sumes are wider, larger and more ro­bust. In this con­text, the IIM-A sur­vey should be made avail­able and pub­lished more widely to en­able stake­hold­ers com­pare its depth with the RBI sur­vey. Equally, the RBI needs to see if its sur­vey is deep enough and if some of its meth­ods and pro­cesses need re­vis­it­ing.

Ques­tion of agenda

The wor­ry­ing as­pect should be whether an agenda is be­ing built and a case is be­ing crafted to take the pol­icy, and in­deed the en­tire pol­icy frame­work, to­ward ag­gres­sive rate re­duc­tions by play­ing on ar­gu­ments that may not sus­tain on closer scru­tiny. The is­sue, there­fore, is not whether two sur­veys per se are con­trary to each other.

The Eco­nomic Sur­vey (Vol­ume II) says that in the last 14 quar­ters, in­fla­tion has been over­es­ti­mated by more than 100 ba­sis points in six quar­ters with an av­er­age er­ror of 180 ba­sis points (and that too for a very short-term fore­cast, just three months ahead). The “er­ror”, it is sus­pected, now puts the RBI un­der pres­sure and prob­a­bly seeks to sig­nal that a con­ser­va­tive ap­proach to the burn­ing ques­tion of in­fla­tion, which is es­sen­tially a tax on the poor­est and the weak­est of In­dia, is a thing of the past.

For­mer RBI Gov­er­nor Duvvuri Sub­barao put it well in his book, Who Moved My In­ter­est Rate?: “The govern­ment’s pet peeve was that the RBI was be­ing too cyn­i­cal in its fore­casts…al­most seam­lessly, the dis­cus­sion would move…to sub­jec­tive con­sid­er­a­tions, with one of the se­nior of­fi­cers sug­gest­ing that the RBI must project a higher growth rate and a lower in­fla­tion rate in or­der to share re­spon­si­bil­ity with the govern­ment for ‘shoring up sen­ti­ment’.”

Long-term im­pli­ca­tions

Not hav­ing a con­sen­sus is wel­come but hav­ing a hid­den agenda will lead to de­ci­sions that will not only weaken in­sti­tu­tions and the pol­icy frame­work but also have longer term im­pli­ca­tions for growth.

Apart from all these, a few is­sues need to be de­bated. First is the ques­tion on whether met­rics like the neu­tral rate, Tay­lor rule, po­ten­tial out­put, out­put gap, core in­fla­tion should re­ally be a guid­ing force for tak­ing a de­ci­sion on mon­e­tary pol­icy. These con­cepts make sense in class­room read­ings. But com­pi­la­tion of these is sub­ject to data avail­abil­ity and method­olog­i­cal ro­bust­ness. The de­gree of ca­pac­ity util­i­sa­tion again is an em­pir­i­cal sub­ject.

In this con­text, what is ex­pected of the MPC is not to show­case dif­fer­ent po­si­tions and num­bers but to de­bate these, lead­ing to a pos­si­ble con­sen­sus that can re­flect a new kind of ma­tu­rity with pro­fes­sional free­dom. To achieve this, agen­das must be set aside.

Pattnaik is a pro­fes­sor at SPJIMR, Rattanani is edi­tor. The views are per­sonal (via The Bil­lion Press)

Lead­ing to con­fu­sion

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