It Was Necessary For The RBI To Show It Hasn’t Lost Its Head And It Has Done Exactly That

The Monetary Policy Committee (MPC) of the Reserve Bank Of India (RBI) has defied consensus and slightly extreme expectations of a 50 basis points (bps) rate cut. The latter would have been quite negative, in my view, negating the purpose of drawing more money into the banking system.

The MPC members have avoided a knee-jerk reaction. They did not wish to fuel panic. That is a good thing. Most of the expectations coming from many analysts are not based on data. One doesn’t wish to blame them because there is no hard data yet. So, most downside expectations are possible. But, they have to pass three more stages: plausible, probable and then reality. So, there is time.

So, the RBI did the right thing by waiting for data rather than go by hearsay and expectations that are as much influenced by noise and anecdotal evidence as they contribute to such noise.

The MPC has evidently taken into consideration the recent volatility in financial markets, the strength of the U.S. dollar, the impending monetary policy decisions from the United States (next week), European Central Bank (tomorrow) and the decision by the Organization of the Petroleum Exporting Countries (OPEC) to cut production.

The communication mentions, at least in three places, the stickiness of core inflation: headline inflation less food and fuel. They are concerned about its persistence and rightly so.

There are cynics and sceptics who question whether monetary policy has any influence on the evolution of actual inflation and inflation expectations. But, in a world that is dominated by financial and international capital flows, monetary policy matters. For the inhabitants of that world, monetary policy credibility matters. That, in turn, affects portfolio flows and the currency.

The RBI monetary policy decision has done no disservice to the credibility of the newly formed Committee and has thus underpinned the Indian rupee.

After their somewhat thinly-supported rate cut in their very first meeting and their relative silence since the 'withdrawal of Specified Bank Notes' (as the Bank puts it), questions were beginning to be asked of their credibility and even competence and rightly so.

I think this decision goes a long way in addressing those questions and allaying those concerns. Some would call their rate cut in October and this 'no-change' decision as a case of compensating errors. May be. That is a point of view that Yours Truly does not share.

When the government appears to be conducting policy by the seat of the pants and changing goal posts, it was necessary for the RBI to show that it has not lost its head. It has an inflation mandate and it is sticking to it. Good for them.

The Reserve Bank of India has also withdrawn the temporary Cash Reserve Ratio (CRR) of 100 per cent that they had imposed on incremental bank deposits. This is a good decision.

Overall, it has been a good day in office for the RBI Governor and the MPC.

This post was first published on the Gold Standard blog and has been republished here with permission.