RBI Governor Shaktikanta Das is caught between a rock and a hard place. When he took over last December, expectations of a rate cut were high and bowing to market demands, he reduced policy rates by 25 bps in February. Two months later, those expectations continued to be perched on top, with added hopes of entering a rate easing cycle. Das once again complied, delivering another 25 bps cut, but banks punctured all hopes of lower rates on the ground by passing on a mere 10-20 bps to customers instead of 50. This seems to have got him thinking as to why central bank policy changes should be in multiples of 25 bps?
“… If the unit of 25 bps is not sacrosanct and just a convention, monetary policy can be well served by calibrating the size of the policy rate to the dynamics of the situation and the size of the change itself can convey the stance of policy,” Das said in his speech at the IMF recently. A 10 bps cut, he noted, would signal the intent and would be better than two separate moves — one on the policy rate, wasting 15 bps of valuable rate action to rounding off, and the other on the monetary policy stance. In a situation where the central bank prefers to be accommodative but not overly so, it could announce a cut in the policy rate by 35 bps if it has judged that the standard 25 bps is too little, but its multiple — 50ps — is too much, he explained.
According to SBI Research’s Sowmya Kanti Ghosh, Das’ comments signify RBI’s intent to use communication as a policy in itself, rather than the policy statement being the vehicle for communication, and reduce disconnect with the markets. “Like the US Fed, which modified the language of its policy statement during the financial crisis to communicate better, RBI too could use the rate change in non multiples of 25 bps,” he noted.
But, it’s not that simple. The problem of rate cuts of smaller magnitudes could lead to policy transmission issues and clarity in communicating with markets unless properly decoded. “Should there be a table of rate changes mapped to policy stance?” Ghosh wondered. Citing precedents, he observed that until October 2010, China has been experimenting with rate changes (27 bps was its number of choice besides unconventional ones like 18 bps, 54 bps, 144 bps etc). So did the European Central Bank.
The advantage of the 25 bps construct is in its simplicity in connecting with the market, but is it sacrosanct? When banks didn’t budge with a 50 bps cut, how will a 10 or 15 bps cut serve the purpose? Ghosh — perhaps agreeing with Das — believes that sometimes communication, instead of being a vehicle for policy, can be the policy itself.