It’s lonely up there in Monetary Towers

At the best of times, formulating and implementing monetary policy is not the easiest aspect of macroeconomic policy. But when there are uncertainties and signs of possible problems in the immediate ensuing period, monetary policy becomes a herculean task.

Again, in today’s political economy climate, with strong articulation on monetary policy by powerful segments of society and the general media frenzy, the Reserve Bank of India has to be ever ready to face brickbats. This is to be expected as monetary policy has to hold up the rear when there are problems in other wings of macroeconomic policy. The central bank has to be prepared to be criticised for saying and doing the right thing. To recall former British prime minister Tony Blair’s words: “The art of leadership is saying no, not yes. It is very easy to say yes.”

Percipient policy I have, on many occasions, been accused of being an apologist for the Reserve Bank of India, but when I have been critical of the RBI my critics conveniently forget that! Nonetheless I am emboldened to say that when the definitive history of the recent period is written up, Governor Raghuram Rajan’s June 2, 2015 policy will go down in history as a percipient and well nuanced one.

Calculated leaks from the government have berated the policy for the curmudgeonly 0.25 percentage point reduction in the repo policy interest rate, and more so for highlighting the critical areas of weaknesses in the economy.

It is the duty of the RBI to nag the government — central banks are uniquely placed to do so. Most of the other institutions find it politic to agree with every word the government says.

Governor Rajan has been forthright in identifying three risks to inflation. First, the possibility of a below-normal monsoon; second, the possibility of crude oil prices firming up; and third, volatility in the global environment. This leads the RBI to marginally raise its Consumer Price Index (CPI) projection for January 2016 from the earlier projection of 5.8 per cent to 6.0 per cent.

Taking on the critics Market players have been strongly calling out for significant policy interest cuts, and the government has been equally vociferous. Given the overall situation one could understand if critics of the RBI were to claim that the reduction of the repo rate on June 2 was unwarranted.

But this is nobody’s case. The critics seem to argue that there should have been a swingeing reduction in the repo rate. Furthermore, the calculated leaks point to the top echelons being unhappy with the RBI for emphasising the negative aspects.

Central bankers are traditionally a reticent lot but Governor Rajan is an exception in that he is comfortable interacting with government, bankers, industry, the media and students. He takes the critics head on when he says: “If I cut interest rates it means I want to please the government. If I don’t cut interest rates it is because I want a fight with the government. Make up your mind.” Governor Rajan stresses that his job is not to be part of the cheer squads on the sidelines and that he has a task (inflation control) which he has to focus on, but it is not as if the RBI does not take into account other economic parameters.

What may infuriate the cheer squads is not only the increase of the inflation projection but the downward revision of GDP growth in 2015-16 from 7.8 per cent in April 2015 to 7.5 per cent.

Given the ground realities, the RBI has been right to hint that at this stage, it does not see any prospects of further cuts in policy interest rates in the ensuing few months. Further policy responses would be data-driven. This should disabuse people of the popular perception that policy interest rates would be reduced at every policy review.

Looking for balance While setting out policy interest rates the RBI has to have a fine balance between the cost of credit to borrowers and the return for depositors. The government needs to appreciate that any further reduction in deposit rates will result in a backlash by savers who would turn to risky non-bank assets as also physical assets.

Such disintermediation will not reduce the overall level of deposits but will affect the composition of deposits. With a shortening of the deposit rate maturity structure, there would be a major asset-liability maturity mismatch that would generate instability in the financial system.

Monetary policy should be allowed to deliver on what it is best suited to do, namely inflation control. While facing brickbats for obviously right policies, Governor Rajan could take solace in the famous statement by Montagu Norman, the longest serving governor of the Bank of England: “Dogs may bark but the caravan moves on.” It is not for nothing that former Prime Minister Manmohan Singh, who was governor of the RBI in the early 1980s, called the job the loneliest in the country.

The writer is a Mumbai-based economist

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