New dynamics at work in credit policy

The fifth meeting of the Monetary Policy Committee (MPC) held on June 6 and 7 for the first time broke with unanimity and also went against widespread industry aspirations of a policy repo rate cut; five members voted to hold the rate while one wanted a rate cut. Now, the minutes of that meeting are out and the document is a reflection of the emerging dynamics as the relatively new institution of the MPC takes root.

A committee works best when contrary views are brought to the table. So at one level it is heartening to note that a unanimous approach has been replaced by an exchange (if not a clash) of contrary views.

At the same time, the concern is of members now doing their own jig, coming as they do from different backgrounds, so that divergent views (which can be a good thing) rest on foundations that are uneven (which can turn diversity into discord).

Consider MPC member Ravindra Dholakia’s strong and aggressive argument in favour of “a minimum of 50 basis point rate cut” to bring down the policy repo rate to 5.75 per cent from the current 6.25 per cent. He went on to add, “…the policy rate cut could be even higher.” Dholakia placed on record that his readings on “a clear declining trend” in inflation, were contrary to that of the RBI, as actual inflation had turned out to be lower than the latter’s projections.

Dholakia offers probably the strongest language coming from a committee that has taken over a role which only a year ago was supposed to be the prerogative of the Governor of the RBI. Language that was usually more cautious, under`stated and often tentative is now being replaced with more forthright points being placed on record, and the implications of this for the RBI and its approach and culture remain to be seen.

On the other hand, Michael Patra, a career central banker, and two other members (Pami Dua and Chetan Ghate) opted for what may be called a tentative “no” to a rate cut, saying they would “wait and watch” as the data pans out, a stance that contrasts with the resounding “yes” for a rate cut offered by Dholakia.

If this were a match, it can be said that the “no” side won 5:1 – a thumping victory. But with the minutes being released, the reading changes; apart from the one, the three other “wait and watch” are being seen as temporary “nos” so the result might well be interpreted as tending towards a 2:4 outcome that indicates that a rate cut is on the way soon enough. Indeed, many analysts now indicate that a rate cut is in the offing.

This raises the question on how the minutes are likely to influence market perspectives, particularly since there isn’t any clear forward guidance provided as a holistic view of the Committee as a whole. Further, there remains a larger risk of a policy decision arising out of a melange of views that prosecute individually held or ideologically driven opinion. Take the example of the “output gap”, which is the actual output minus potential output, and is an important measure to help a central bank assess short-run inflationary pressures. A negative gap calls for an expansionary monetary policy, which in this case means a policy repo rate cut. Members have commented on the emerging output gap.

Dholakia has observed a “persistent if not widening output gap in the near to medium term”, a perception that can be questioned when one takes agricultural and non-agricultural output gap. And as Patra noted, “…an output gap calculated on data for 2016-17 that profile a slowdown will, by definition, be negative and wider than otherwise. For an economy that is projected to grow at 7.3 per cent in 2017-18, however, it must be the case that the output gap would narrow and close.”

These are very divergent views, and they might indicate a reiteration of held positions, rather than a discussion in which the two convince each other.

Deputy Governor Viral Acharya (“We have a problem”) and the Governor, Urjit Patel (“The quiescent investment cycle remains a key macroeconomic concern”), stand out for their clear and sharp positions as they touch on one of the most critical aspects of the monetary policy – the lack of transmission of any possible rate cut at a time when the balance-sheet of banks remains stressed.

Even if a rate cut is offered, a likely scenario is that banks will not reduce the lending rate, or make very minor changes and will take up the “wait and watch” approach, as they often have in the past. But they will be tempted to cut the deposit rate further. This brings some unintended and undesirable results for a policy that is meant to boost the dormant investment cycle.

In general, it can be said that while Dholakia is a man in a hurry for a policy repo rate reduction, mirroring what possibly is a view that is usually said to be held by the government wanting a booster for the economy. The pressure was earlier from New Delhi, which is showing signs of getting restless, and even sought a meeting with MPC before the policy announcement. The MPC, however, refused the meeting. But a similar pressure now comes from within the MPC. Here is a good clash of ideas building up, bringing a new kind of dynamic to the RBI.

Pattnaik is a professor and Rattanani is an editor at SPJIMR, Mumbai. Through The Billion Press

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