Governor Das’ out-of-the-box suggestion that Central banks need to be more flexible on the size of their interest rate ought to be taken seriously
Speaking at the 2019 Spring Meetings of the World Bank Group and the International Monetary Fund (IMF), Reserve Bank of India Governor Shaktikanta Das made an extremely significant point that can have far-reaching ramifications, one that would have revolutionary implications for the monetary policy worldwide. He asked Central bankers all over the world to reflect on the conduct of monetary policy and not restrict themselves to the existing norms of oversimplified stances on policy direction and standardised 25 basis point tranches of policy action.
Governor Das explained that the current approach, followed by Central banks worldwide, actually serves to deter policy through an example: “If the easing of monetary policy is required but the Central bank prefers to be cautious in its accommodation, a 10 bps reduction in the policy rate would, perhaps, communicate the intent of authorities more clearly than two separate moves — one on the policy rate, wasting 15 bps of valuable rate action to rounding off and the other on the stance, which, in a sense, binds future policy action to a pre-committed direction.”
This leads us to reflect as to why such a convention exists and why we have persisted with it for so long. A logical conjecture that comes to mind is that it is a remnant of the unipolar economic world of the last quarter of the last century when the United States overwhelmingly dominated global markets both in terms of volume of real as well as financial products. In those days, it made eminent sense for all economic activity to be aligned, both operationally and conceptually, to American practices. Hence, it made sense for Europe, Japan, non-Japan Asia, Australia and emerging markets to be in sync with the actions of the US Federal Reserve.
So do we need to use those conventions any longer? The answer is a clear no. The current approach is unwieldy and insufficient for the needs and growth of today’s economies. Take the example of India. Governor Das cannot be hamstrung by being forced simply by convention to make a delayed impact instead of one that he is required to make instantaneously. The market he operates in is large enough and diverse enough to adjust to policy in extremely quick time. In addition, India is clearly a supply side economy and a policy factoring in rational expectations is needed, not the old traditional post Keynesian policies of late 20th century America. In such an economy, the RBI Governor not only needs freedom of action but actually more empowerment.
Governor Das is clearly a Central banker for growth, unlike any in the recent past. Most Governors have been stance-driven liquidity managers in the last 20 years, whether India was in growth mode or not. This had resulted in the self-imposed restriction of inflation management as the almost sole function of the RBI and one at which it has not been a spectacular success. Witness what happened to the USDINR and the purchasing power of the rupee in this decade. For the longest time, RBI watchers have almost repetitively focussed solely on the reverse repo window and overnight liquidity management numbers. Combined with this activity was the occasional reactive positioning on USDINR spot that came to define the limits of RBI’s role, which was one of a passive Central bank, similar to the Reserve Bank of Australia, one utterly unsuited to the RBI’s role in an economy as diverse, dynamic and with the amount of potential as that of India’s.
In contrast to the past, Governor Das’ conduct of Open Market Operations, as exemplified by the dollar swap initiatives of March and April this year, are directed to meeting multiple growth and rate management objectives and have been an unqualified success. Not only have these issues been applauded by the market by being three time oversubscribed but they have also succeeded in providing the market with direction via a definite notional level for the three-year USDINR rate while infusing the much-needed liquidity into the system through a proper, tractable swap mechanism. This reminds us of the incredibly successful monetary policy conducted by Japan in the 1970s and 1980s while the US faltered. Hence, in terms of actual operational conduct of monetary policy, imitating US conventions with a voting Monetary Policy Committee is not optimal. Though we are all for a strong MPC, it should have a strictly closed door advisory role to the RBI Governor. If the buck stops with him, there is no way his actions should be fettered in any form. Governor Das is absolutely right. More power to him.
(The writer is a product strategy at Metropolitan Stock Exchange)
