MPC minutes: The unsettled state of monetary policy–times of india

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Reserve Bank of India’s Monetary Policy Committee (MPC) had an off-cycle meeting between May 20th and 22nd. Off-cycle because the meeting was advanced by about a fortnight as RBI felt the economic situation made it necessary. The policy rate, or repo rate, was reduced by 0.40 percentage points, taking the cumulative reduction in the policy rate between February 2019 and May 2020 to 2.5 percentage points.

To meet legal requirements, RBI placed the minutes of the meeting in public domain last week. A scrutiny of the minutes brings out an interesting divergence of views between one of the independent nominees on MPC, Chetan Ghate, and possibly the remaining five members.

To start with the point that everyone agreed on, the economy is in a bad shape. In all probability, the available national accounts data do not capture the scale of the deterioration in the recent past. Two MPC members, Ghate and RBI’s Michael Patra, said that India’s potential output has fallen.

Potential output is the estimate of what the economy can produce when it operates at the maximum sustainable employment.

Patra feels that it will take years to repair the damage to potential output.

All the six members on MPC voted to reduce the repo rate, but Ghate felt it should be only 0.25 percentage points.

What makes Ghate’s views thought provoking are his assessment of what the de facto policy rate is today and the stage of the economic cycle when rate cuts are most useful.

On the policy rate, Ghate feels the reverse repo rate ( the interest rate banks receive for parking funds with RBI) is now the effective policy rate. Reverse repo rates can be changed by RBI unilaterally without going through the MPC. This is exactly what RBI did in April when it lowered the rate to discourage banks from parking funds with it.  In other words, banks were being nudged to lend.

Today, the reverse repo rate is 3.35%.

Ghate’s view has two implications. In practical terms, it makes MPC irrelevant as the reverse repo rate can be changed by the RBI governor unilaterally. Second, it raises interesting questions on what is the real policy rate as the repo is 4% and reverse repo is 3.35%. If reverse repo is the de facto policy rate, the real policy rate in the current situation may not be too high as one of the MPC’s members, Ravindra Dholakia, feels.

Another interesting view from Ghate is on when to lower interest rates. He feels rates work most effectively when the economy is on the upside. Therefore, his position is that MPC should keep its powder dry.

It’s interesting to juxtapose Ghate’s views with those of RBI governor Shaktikanta Das. Das believes monetary policy is a rapid deployment instrument of public policy and a delay in monetary policy action could become a source of risk. Perhaps that explains RBI’s decision to reduce reverse repo rate in April.

Ghate’s views in the minutes indicate that we are, in practical terms, back to an era where changes in the policy rate are the monopoly of the RBI governor. He also appears unconvinced that some of the recent monetary policy actions will make a difference to economic performance.

At the moment, we are none the wiser on the efficacy of recent monetary policy actions. But the legal need to publish the minutes of MPC’s meetings foreground both meaningful changes in the conduct of monetary policy and also its unsettled state.

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