June 2017 Monetary Policy: what it points to…..

The June monetary policy announcement of the RBI makes interesting reading for reasons galore. One, it announced that members of the Monetary Policy Committee had refused an invitation from the Ministry of Finance for a private meeting. This is good to happen, for the monetary policy committee is supposed to be independent in its policy formulation, of course, taking into account the views of all the stakeholders including that of the government. That said, it also becomes essential to know as to what it is that the government wanted to discuss with MPC members before they decided upon its policy pronouncements. One answer could be: the government is perhaps interested in sharing their understanding of the macroeconomic data to obviously get them round to their point of view. If that is so, it is all the more disturbing, for it raises a fundamental question: Why not government place their interpretation of economic data in public domain?

Incidentally, this episode of MPC members declining ministry’s invitation for a dialog has also brought another important creeping malady of the nation into light: weakening communication policy of the government about its economic policies. Although it is essential for every player in the economy to know about the economic policies of the public institutions and the government at large so as to take informed decisions that help them in maximizing stakeholders’ value, there appears to be a general fall in the quality of economic research being carried out by the national institutions and the communication about its policy implications. Even the Economic Survey presented of late by the Ministry of Finance has lost its sheen in the sense that it has turned out to be more of a theoretical exposition rather than the government’s understanding of the data and its implications for the future of the nation. Even the RBI’s publications appear to have lost their analytical rigor. As our economy is passing through transition, the need for such governmental communication about economic policies to ensure confidence among the market players in the policy regime hardly needs to be stressed.

The other highlight of this announcement is that for the first time there was a dissent in the MPC meeting. That the MPC has not changed the policy rate is not a big surprise, but what is more surprising is: the underlying interpretation of the economic fundamentals that even leads to controversy and dissent. The Committee that moved from an ‘accommodative’ to a ‘neutral’ stance in February while holding the policy rate unchanged on the grounds that it needs “to assess how the transitory effects of demonetization on inflation and the output gap play out” had in April observed that “underlying inflation pressures persist”, and it also foresaw an increase in aggregate demand pressure while, of course, the effects of demonetization are “distinctly on the wane and should fade away by the quarter 4 of 2016-17” and hence retained the policy rate unchanged. And now in its June 7th statement, MPC stating that “transitory effects of demonetization have lingered on in price formations …entangled with excess supply conditions…; the current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks… for monetary policy to be effective”, retained policy rate unchanged.

It is against this inconsistency in the macroeconomic view of the RBI that the dissent of Ravindra Dholakia—who rather eloquently and logically arguing that:  

• given the change in the outlook and assessment of the inflation and output over time, any theoretical rule-based policy for flexible inflation targeting would not only justify but also necessitate at least 50 basis point cut in the policy rate; 
• with the monsoon forecasts creating optimism for the second consecutive good year for agricultural production, the momentum in agricultural inflation during the next 12 months is substantially less probable with obvious favorable impact on the headline CPI inflation; 
• the impact of 7th CPC recommendations on the headline CPI inflation of about 150 basis points estimated by the RBI is highly overstated because it assumes simultaneous and instantaneous implementation of the recommended HRA by the 7th CPC in the Centre and in all states almost immediately, though implementation by centre and all states in one go is more unlikely;  
• similarly, the concern about the recent farm loan waivers announced by a couple of states leading to fiscal profligacy is quite unlikely, for the states are bound by their own Fiscal Responsibility Legislations (FRLs) and even if all the states implement loan waver, its impact on inflation would only occur with a considerable time-lag, and hence it need not be a concern for the MPC, asserted that there is a justification for a 50 bp cut in policy rate—

assumes significance. Prof Dholakia even warned that “becoming cautious and not acting amounts to ignoring all costs associated with not supporting growth ... [and] is against the principle of prudence.”

Looking at all these developments, one is tempted to wonder: if there is a need for MPC to muster gumption for making economic decisions under uncertainty.

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