The signals for monetary policy easing had set in from late 2011, after a pause was given to continuous hikes in policy rate by more than 300 bps. The rates had touched a level of 8 per cent.

From early 2012, there were signals for aggressive easing, first by steep cuts in CRR by 125 bps and a hefty and totally unexpected cut in policy rate by 50 bps in mid-April.

Naturally, the expectations were built up for another round of aggressive easing, in the face of a definite slowdown in investment and economic activity and some easing of inflation, particularly in core non-food manufacturing items.

Markets, therefore, got a jolt and were perplexed when the mid-quarter review did not further ease policy rates. Any amount of explanation, post the announcement by the RBI, does not seem to have cleared the air.

The current easing phase of policy has turned out to be awkward, or ‘uneasy’, for a variety of reasons. First, the initial expectations about growth and inflation were belied. The growth outcome became poorer and the inflation became dearer.

Second, expectations on positive and firm efforts towards fiscal consolidation and other supply side measures were not forthcoming, because of fragile political conditions.

Third, the added risks arising out of worsening global developments and their spillover into capital flows, current account and domestic currency did not subside, but on the contrary got worse. All these are understandable. But the discomfiture over the current easing phase stems from somewhere else.

Communication issues

First, there was a huge gap between consistency in action and consistency in communication. Looking at the actions taken by the RBI, it remained consistent in its dharma of containing inflation, if necessary sacrificing some growth in the face of global economic and domestic currency developments. These actions are indeed laudable and depict courage and conviction, given the hostile attitude of both government and business.

But jarring communication both from the government and even within the RBI in the run-up to the mid-June policy announcement, contributed to the unease. This spilled over into domestic financial markets, rendering them volatile. This was perhaps unintended, but in all fairness avoidable.

While one of the Deputy Governors who is in charge of monetary policy indicated that there was room for reducing policy rates, another Deputy Governor, though not in charge of monetary policy (but a member of the Monetary Policy Advisory Committee), indicated that interest rate is not a significant factor in explaining slowdown in investment and economic activity.

Even as the market was miffed by such contrary signals, the Finance Minister, through his interactions with the media, almost confirmed that the RBI will take actions (to ease policy further), and even directed public sector banks to follow up with immediate cuts in lending rates.

What he forgot was that after his official nomination for the President’s post, his voice as Finance Minister had lost its weight. After the announcement of the policy, he was apologetic that the Governor need not consult him for mid-quarter policy reviews, further conveying the impression that if it had been a quarterly or annual review, the RBI would have been obliged to follow the Government’s direction!

Two things emerge out of this. It is well known that, legally speaking, the RBI is not that autonomous with respect to monetary or banking policy.

But the government should at least desist from making pronouncements proclaiming its supremacy, and effectively undermining the central bank’s credibility in both domestic and international circles.

It is an established internal communications policy of the RBI that the Governor or the Deputy Governor in charge of monetary policy will be the spokespersons on the subject. In the interest of market stability, it would be desirable to adhere to this discipline.

Policy Channels

The second source of uneasiness about the current policy cycle arises from the credibility of instruments and their transmission to the economy. The underlying principle behind the use of the interest rate instrument is that it gets transmitted from short-term to long-term interest rates and impacts the economy through investment demand, and thereby overall demand.

The pronouncements from the RBI have generated some cynicism about the whole process. While production decisions by firms may not be that dependent on interest rate cycle, investment demand with long gestation periods and heavy leveraging with debt is bound to be affected. That’s why India Inc and bankers who would have liked to see larger credit flow at cheaper interest rates, were most disappointed by the recent policy.

Farmers are immune to rate cycles because of subsidy and possibilities of eventual write-offs. The services sector is knowledge-based and less dependent upon credit; in any case, it has been performing well on a consistent basis and did not clamour for high interest rates. The services sector also stands to gain from currency depreciation. The earlier the RBI clears the air about this, the better.

It seems that some bankers also have given in to this idea. It was indicated that a policy rate change is only symbolic, and with a further cut in CRR, banks would consider easing of lending rates. In fact, following the heavy CRR cut, no bank cut lending rates.

It was probably because the earlier cuts in CRR only substituted the injection through the LAF window. After the hefty cut in repo rate by 50 bps, most banks have not responded and even the limited response from banks, mostly nationalised ones, was lukewarm.

Yet another dimension to this process is the very opaque relationship between the base rate, the benchmark prime lending rate (BPLR) and the actual lending rate. Most banks still announce BPLR, and these rates are at their peak, averaging at around 16 per cent, whereas the base rate is around 10 per cent.

The actual lending rates are anyone’s guess. It is understandable that banks have a serious structural problem — their inability to reduce deposit rates and the apparent compulsion to reduce lending rates, thereby facing serious compressions on their margins, which get exacerbated by increasing non-performing loans.

The RBI should, however, ensure greater transparency and provide disaggregated information dissemination about the lending rates of banks.

(The author is Director, EPW Research Foundation. The views are personal >blfeedback@thehindu.co.in )

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