Yesterday RBI said:
– reduce the marginal standing facility (MSF) rate by 75 basis points from 10.25 per cent to 9.5 per cent with immediate effect;
– reduce the minimum daily maintenance of the cash reserve ratio (CRR) from 99 per cent of the requirement to 95 per cent effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4.0 per cent; and
– increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 per cent to 7.5 per cent with immediate effect.
You did not understand that? Neither did I.
I have been trying to read much analysis since yesterday and found that heart of successful monetary policy is a coherent monetary policy framework. There should be clarity on objectives, instruments and operating procedure. RBI has failed as a central bank because it lacks clarity on all three. As a consequence, India has experienced sustained macroeconomic instability:
Other than the 1999-2006 period, where we roughly achieved the goal of y-o-y CPI inflation from 4 to 5 per cent, there has been failure all through.
One factor which is holding back high growth in India today is the immense uncertainty about the future. What will happen to inflation and interest rates? Nobody knows, and this hurts confidence. There is a short-sighted view which suggests we should tolerate high inflation. But low inflation is a growth fundamental.
India now has the silliest monetary policy framework in the world where the central bank engages in monetary policy through changes in 8 numbers:
(1) The repo rate
(2) The MSF / Bank rate
(4) Reverse repo rate
(5) LAF window cap
(6) MSF window cap
(7) Minimum CRR to be maintained
In addition, they also mess with capital controls. A variety of objectives are in the fray including WPI, CPI, GDP growth, the exchange rate, exchange rate volatility, and then some. So RBI is supposed to chase 6 objectives using 9 instruments.
Raghuram Rajan did an excellent Day 1 speech (on the day he was appointed as Governor). All of us were optimistic about what might arise in his work on monetary policy. What is required is clarifying objectives, instruments and the operating procedure.
What we needed to say
Today’s speech needed to say:
• RBI now has an unruly menagerie of objectives and instruments.
• This situation has generated heightened uncertainty which is hurting the economy.
• We got into this tangled mess because of the fear of QE withdrawal and the currency fight of recent months.
• We recognise that this is a mess.
• Now that this fear has subsided, we will clean things up.
• We do not care about the exchange rate. The prime objective of monetary policy is low and stable CPI inflation.
• We recognise that a central bank with discretion but not rules is impotent. MIT and Yale teach Kydland and Prescott.
• We will replace this mess by a framework.
Compare and contrast the press conference by Bernanke —FedLink — which is a masterpiece of clarity, against what we got from RBI today — RBILink
The statement should have aimed to clarify objectives, instruments, and operating procedures. It has just intensified the muddle. And since the muddle — the lack of confidence in the macro framework — is India’s primary problem, it just made India’s problems worse.
I have taken thoughts from Ajay Shah