Rate or stance?

Reserve Bank of India (RBI) Governor Shaktikanta Das stoked a debate last week when he urged central banks across the world to think “out of the box” while speaking on the sidelines of the International Monetary Fund (IMF)-World Bank Spring Meetings in Washington. Mr Das said the practice of changing policy rates by 25 basis points or in multiples thereof is “not sacrosanct and just a convention”. Another aspect that policy watchers keenly follow is the so-called policy “stance” of the RBI. Often enough, the stance signals a bigger shift in the RBI’s outlook and approach towards monetary policymaking than action on the repo rate. But here, too, Mr Das was of the view that monetary policy could be well served simply by calibrating the size of the policy rate to the dynamics of the situation. In other words, a central bank could simply focus on the quantum of the policy rate change to convey the stance of the policy, instead of using the twin modes of rate change and declaration of stance.

Elaborating on his point, Mr Das said if easing of monetary policy was required but the central bank wanted to be cautious in its accommodation, a 10 bps (basis points) reduction in the policy rate would perhaps communicate the intent of the authorities more clearly than two separate moves. He further explained that in a situation in which the central bank prefers to be accommodative but not overly so, it could announce a cut in the policy rate by 35 basis points if it had judged that the standard 25 basis points was too little, but its multiple, i.e. 50 basis points, was too much. There is no doubt that Mr Das was making a pertinent point. And, on the face of it, a case could be made for dropping the issuance of “stance” and choosing a less structured approach to repo rate tweaks. Yet, in the RBI’s monetary policy review in February, the bigger news wasn’t the 25 basis cut in the repo rate; it was the shift in the RBI’s policy stance from “calibrated tightening” to “neutral”. Indeed, the shift in stance was enough for most to correctly predict that the RBI would go for another cut in the April review. It can be argued that the declaration of stance does work quite effectively as a signalling mechanism. 

It can also be argued that in a country such as India where monetary policy transmission is a constant cause of concern, no one can expect mere repo rate cuts to effect changes in the economy. The biggest monetary policy concern for the time being in India is the tight liquidity in the banking system. The liquidity problem had its genesis in the phenomenon of bank deposits growing at a slower rate than bank credit. According to the April policy statement, systemic liquidity moved into deficit during February 7 to March 31, and, for the full year, the RBI injected a total liquidity of Rs 2.98 trillion in the market in 2018-19. The RBI keeps doing open market operations and has added three-year buy-sell swap for the rupee through an auction process to address the liquidity issue. This process of liquidity management has helped somewhat, but the central bank needs to do more to address the situation.