MUMBAI: The first year of the Monetary Policy Committee (MPC) was nothing but tumultuous, according to Michael Debabrata Patra, executive director, Reserve Bank of India. India now has such an explicit numerical inflation target and the primary objective of monetary policy is defined, for the first time.
But at its first meeting a year ago, RBI was amid leadership change – governor Urjit Patel had just assumed office, and the deputy governor responsible for monetary policy had not yet been appointed. The accommodative monetary policy cycle that began in January, 2015 was maturing. Macroeconomic and liquidity conditions were about to undergo tectonic shifts. The MPC prognosticated inflation developments and voted for a 25 bps rate cut taking the cumulative rate reduction to 175 bps and maintained an accommodative stance.
Speaking at RBI’s Jaipur office last month (the text of the speech was made public on Monday), Patra noted that within a month after MPC taking shape, demonetisation, altered monetary conditions drastically. “A wall of liquidity moved through financial markets, threatening to take down everything in its path – interest rates, yields, exchange rates, asset prices,” Patra recalled.
Standing alone between the ocean of liquidity and financial chaos, RBI mounted an extraordinary liquidity absorption strategy. It combined unconventional instruments with regular operations when the liquidity tsunami was so overwhelming that it could have completely depleted the RBI’s stock of government securities that are used as collateral in reverse repo auctions.
The MPC weighed ponderously in December 2016, February and April 2017 meetings and decided – unanimously again – to look through the ‘transitory but unclear effects’ (of demonetisation). It kept the policy rate unchanged, but noted that inflation excluding food and fuel was setting a floor to headline inflation by exhibiting downward inflexibility.
The MPC also worried that global financial market spillovers could impact macroeconomic conditions in emerging markets. Accordingly, it changed the policy stance from accommodative to neutral in its February meeting.The June and August meetings were different, being literally on the horns of the growth-inflation dilemma. And, for the first time, the MPC voted to keep the policy rate unchanged not by unanimity but by a five-member majority, as the scars left by falling growth and inflation set up conflicting pulls.
Growth projections for FY17 and FY18 were revised downwards by a cumulative 70 basis points for each year. “Monetary policy is the art or science of the feasible. When asked how the quantitative easing would work, former US Fed chairman Ben Bernanke replied: The problem with QE is it works in practice but it doesn’t work in theory.
It’s true of monetary policy, which is always complex and severely testing. An MPC decision is typically undertaken in an explosion of diverse views, each differing from the other in intensity and fervour. Looking ahead, MPC’s taks is cut out and to quote RBI Governor Dr Urjit Patel: We should aim at achieving the inflation target without losing sight of supporting economic growth,” Patra concluded.