The Hindu Business Line : No bark, no bite, only CAC

For a long time the mainstream view among economists had been that monetary policy can and should be counter-cyclical but not counter-intuitive. The former implies rate tightening during upswings (or overheating) of the business cycle, and monetary easing during downswings. This is to ensure that inflation and unemployment remain low and stable, and economic growth is close to its maximum.

But in the 1970s some economists began to challenge the wisdom of counter-cyclical policies, and even advocated that policy can be effective only if it is completely unanticipated, that is, counter-intuitive. This theory says that otherwise the markets completely discount policy action, and hence there can be no real impact of such anticipated policies.

One of the proponents of this view, Robert Lucas, even got a Nobel Prize and possibly influenced many a central banker in his time. However in today's post-Greenspan world, largely devoid of cryptic policy talk, most central bankers have abandoned "surprise" as an element of policy strategy. In fact, some old-timers despair that in many parts of the world, financial markets are leading policymakers, rather than the other way round. (The same can be said sometimes of rating agencies too!)

Surprise element

In this world, the RBI Governor, Dr Y. V. Reddy, stands out as someone who continues to use an element of surprise effectively in his conduct of monetary policy. We can conclusively call it a trait of the Governor, since we have seen the RBI successfully thwart second guessers for more than two years now. And one has to accept that this strategy has worked.

The latest evidence was RBI's action on the last day of the previous financial year, when the markets least expected it. Even RBI's abstaining from intervening in the currency markets was somewhat unexpected. Due to a series of aggressive and cleverly timed moves in the past six months, we now find that credit growth and money supply growth have indeed moderated. Thus Tuesday's Policy, when no rates or ratios were touched and indeed some risk weights were actually reduced, fits the classic pattern described above.

Strategic inaction

It would be incorrect to ask "where is thy sting" to the Governor, since yesterday's inaction was rather strategic. Even though there seems to be complete lack of any hawkish stance, the worry on inflation is clear and present. Next year's estimate of 5 per cent is higher than the desirable band of 4.5 to 5. Inflation is definitely on RBI's mind, and allowing the rupee to appreciate to almost 41 is in support of that concern, even though at this level the rupee is overvalued by 11 per cent.

How much of inflation moderation can be attributed to currency, rather than previous rates hikes is debatable. But the danger to exports, especially employment in small and medium enterprises is real. The most prominent aspect is the several steps taken towards capital account convertibility. Especially welcome is the move to allow wider participation in currency forward markets, to even those who only have an economic exposure and no direct imports or exports.

This will benefit many domestic producers who face global competition through shadow prices. Even individuals have greater access to foreign assets. It would have been great if some steps had also been taken for individual foreigners to access our stock markets.

The monetary stance mentions "financial inclusion" explicitly, perhaps for the first time, which explains the reduction in risk weights to smaller housing and gold loans.

The outlook on growth is strong and the slight moderation in estimates of credit and money supply growth rates means that overheating concerns are on the "back burner". But given the Governor's guile, it wouldn't be prudent to misread his pause as too dovish!

(The author is economist with the Aditya Birla Group.)

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No tinkering

RBI restrains to surprise

Hands-off, deliberately

Opening door wider for MFs

Growth wins over inflation

Lull before the storm

Living with `impossible trinity'

An attempt at fine-tuning

No bark, no bite, only CAC

Emphasis on managing currency overvaluation

Leaving room for future action

A benign policy

Inflation control