Rate set­ting by com­mit­tee

The Pak Banker - - OPINION - Niranjan Ra­jad­hyak­sha

In June 2008, then Re­serve Bank of In­dia (RBI) gover­nor Y.V. Reddy is­sued a state­ment from the side­lines of a con­fer­ence in Pune. What he said then pro­vides some in­ter­est­ing in­sights into the process of mon­e­tary pol­i­cy­mak­ing in In­dia, at a time when such dreary mat­ters have im­prob­a­bly hit the head­lines.

The latest in­fla­tion data had been a shocker. Prices were ris­ing at the fastest pace in 13 years. Reddy said he had de­tailed dis­cus­sions with his col­leagues in the cen­tral bank, had spo­ken with then prime min­is­ter Man­mo­han Singh and fi­nance min­is­ter P. Chi­dambaram, and had con­sulted with mem­bers of the tech­ni­cal ad­vi­sory com­mit­tee on mon­e­tary pol­icy (ital­ics added). It was an ad­vance warn­ing that the cen­tral bank was about to act to quell the in­fla­tion­ary fire. A day later, Reddy hiked in­ter­est rates by a steep 50 ba­sis points, be­sides us­ing other poli­cies to tighten liq­uid­ity. One ba­sis point is one-hun­dredth of a per­cent­age point. This for­got­ten episode is im­por­tant at a time when there is a heated de­bate about the com­ing shift in the way mon­e­tary pol­icy will be con­ducted in In­dia. There is a wide con­sen­sus that mon­e­tary pol­icy should be de­cided by an em­pow­ered mon­e­tary pol­icy com­mit­tee rather than the cen­tral bank gover­nor alone. The on­go­ing de­bates are about how this com­mit­tee is to be ap­pointed: by the gov­ern­ment or the RBI?

The rea­son I have men­tioned what Reddy did in the mid­dle of 2008 is to high­light the fact that the RBI gover­nor does not take uni­lat­eral de­ci­sions as some would like us to be­lieve. A ma­jor pol­icy shift in June 2008 was pre­ceded by dis­cus­sions with the gov­ern­ment as well as the tech­ni­cal ad­vi­sory com­mit­tee, which is a mon­e­tary pol­icy com­mit­tee with­out any statu­tory power. Of course, there have been sev­eral times when the gover­nor has taken in­ter­est rate de­ci­sions at odds with what a ma­jor­ity of mem­bers of the tech­ni­cal ad­vi­sory com­mit­tee be­lieved should be done. An em­pow­ered mon­e­tary pol­icy com­mit­tee where the gover­nor is at best a first among equals is the prac­tice in an in­creas­ing num­ber of cen­tral banks across the world. The fi­nal de­ci­sion whether to in­crease, de­crease or not change in­ter­est rates is of­ten a sub­jec­tive call, rather than a me­chan­i­cal one de­rived from a rule such as Milton Fried­man's fa­mous fixed money sup­ply growth rule or the mod­ern Tay­lor Rule. The move to pol­icy by com­mit­tee will be a welcome change since a group de­ci­sion re­duces the risk of the an­a­lyt­i­cal bi­ases of one per­son skew­ing mon­e­tary pol­icy.

But that still leave us with a tricky ques­tion: how dif­fer­ent would In­dian mon­e­tary pol­icy have been if it had been de­cided by a com­mit­tee in re­cent years?

The RBI has been pub­lish­ing the min­utes of the meet­ings of the tech­ni­cal ad­vi­sory com­mit­tee since Jan­uary 2011. A com­par­i­son be­tween its rec­om­men­da­tions (or rather, what the ma­jor­ity of mem­bers said) and what the RBI even­tu­ally did in its sub­se­quent pol­icy pro­vides in­ter­est­ing in­sights into the na­ture of the com­ing tran­si­tion. There are two par­tic­u­lar pe­ri­ods I want to fo­cus on: the first when in­fla­tion be­gan to ac­cel­er­ate af­ter the rapid eco­nomic re­cov­ery fol­low­ing the global fi­nan­cial cri­sis, and the sec­ond in the months pre­ced­ing the run on the rupee in July 2013. Let us con­sider the in­fla­tion cri­sis first. It is now widely ac­cepted that the RBI was be­hind the curve. Whole­sale price in­fla­tion peaked in March 2010 while the pol­icy in­ter­est rate peaked only 19 months later in Oc­to­ber 2011. The RBI even­tu­ally raised in­ter­est rates by a to­tal of 200 ba­sis points to bring in­fla­tion un­der con­trol. The tech­ni­cal ad­vi­sory com­mit­tee had sug­gested only three rate hikes of 25 ba­sis points each in that year. The cen­tral bank was be­hind the curve. But the quasi­mon­e­tary pol­icy com­mit­tee seems to have been even more so.

Now, let us move to the months be­fore the rupee cri­sis. The RBI cut in­ter­est rates by 125 ba­sis points from March 2012 to March 2013, even as the cur­rent ac­count deficit was widen­ing to dan­ger­ous lev­els. The tech­ni­cal ad­vi­sory com­mit­tee did not sug­gest rate hikes to pro­tect the cur­rency in those months ei­ther. The cen­tral bank be­gan another cy­cle of mon­e­tary tight­en­ing af­ter the rupee came un­der at­tack in July 2013. The min­utes of the tech­ni­cal ad­vi­sory com­mit­tee meet­ings over the past cou­ple of years show the mem­bers were gen­er­ally less hawk­ish than the RBI. But they have also failed to an­tic­i­pate the mon­e­tary eas­ing that be­gan this Jan­uary.

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