The task of communication for a central bank is never simple, but there is clearly no easy road ahead for the Reserve Bank of India's Governor Shaktikanta Das and Co., no matter what the monetary policy decision announced on April 6 is.
By all indications, we are near the end of the repo rate hike cycle, but it is still unclear when it will end. As evidenced from the February Monetary Policy Committee meeting, at least two external members—Jayanth Varma and Ashima Goyal—already believe the RBI can pause now and let the 250-basis-point hike in the repo rate transmit through the system.
But they were in the minority in February, as the other four members continued to remain concerned about consumer price index-based inflation, and especially core CPI, and voted for a 25-basis-point increase.
The subsequent inflation prints, even if you account for data anomalies linked to free food distribution, only indicate retail inflation remains above the 6% upper band of the inflation target.
In such a scenario, if the rate-setting panel chooses to announce a status quo on repo rates, then Das and the MPC members will have the unenviable task of explaining why they are comfortable doing so, even as retail inflation and core CPI remain above their comfort band.
And it will take even more verbal dexterity to explain if this pause must be interpreted as the end of the rate cycle or as a pause to ascertain the direction ahead.
The challenge here is that no matter what Das and the MPC say, markets will interpret a ‘pause' as the end of the rate cycle, or worse, as a signal for dovish policy going ahead. But this will mean that if there is a fresh supply shock to inflation, then it will force the RBI and MPC to backtrack and reset market expectations.
A lot of the credibility of the RBI's actions in unwinding special Covid-19 measures, including on the policy front, has been built on how non-disruptive the reversal of these steps has been. The RBI was ahead of most central banks in the developed nations in sucking out excess liquidity, followed by starting the rate hike cycle early, which prevented large increases such as 75 bps hikes. They have also tempered the initial 50-basis-point increases to 35 basis points and 25 basis points in the last installment. Importantly, they have guided market expectations in that direction too.
A central bank that has taken such a calibrated approach wouldn't want to be caught on the wrong foot, where it announces a pause and then has to reverse course and hike rates if there is a fresh inflation spike.
A conversation with any central banker on the risk of an untimely pause will lead to them invoking the example of former Federal Reserve Chairman Paul Volcker, who made a policy error initially and then had to sharply correct course. This led to policy rates being hiked to 20% and sparked three recessions in a row in the U.S.
Even if academics and economists can talk about changing course in the future if necessary, a central banker knows that this is easier said than done. And once the credibility of their actions is lost, it takes much more action to get the same effect, and that would lead to a painful phase for the economy.
We only need to take one look at the linguistic acrobatics that the RBI and MPC have done with their stance to understand that this regime is unwilling to send out a signal that can be misinterpreted. That is why the stance, which was ‘accommodative,' was reworded to ‘withdrawal of accommodation' when the MPC started hiking rates. The RBI could have easily moved to a neutral stance, but instead chose to create a new stance called 'withdrawal of accommodation' to avoid any risk of misinterpretation of policy rates being near neutral.
The RBI and the MPC will remain concerned that markets may misinterpret a ‘pause' or shift to ‘neutral' stance as an indication that policy tightening is done. Or worse, this could start markets positioning for a policy rate reduction in the not-too-distant future, when other central banks may also change course.
There are no easy choices, but the RBI would not want to be pigeonholed into a corner when there remain domestic and global developments that can quickly emerge as a risk to any projections or calculations. For example, take the example of the Russian invasion of Ukraine in 2022 or the Organisation of Petroleum Exporting Countries' sudden decision to cut crude oil production in the last few days.
Imagine now that the RBI's Monetary Policy Committee sticks to broad market expectations of a 25-basis-point hike in the repo rate. Then the questions raised, as was the case in February too, would be why the MPC did not say the word ‘pause' or change the policy stance to ‘neutral' to clearly signal the end of this rate hike cycle.
If the MPC decides to hike by 25 basis points and simultaneously announces a change in stance to ‘neutral,' then it leaves no space for discussion that it is done with policy tightening. That is the best-case scenario for markets; however, it leaves the RBI and MPC facing questions on whether they think all the major risks to inflation—global and domestic—have been factored in. Also, most inflation projections for 2023–24, including those of the RBI, show inflation averaging above the 5% mark. This is well above the 4% mid-point in the target band, and any small supply risk can quickly push the inflation expectations and data higher.
Additionally, if there is a split vote within the MPC on the quantum of the hike or a shift in policy stance, then the proverbial cat will be set free among the pigeons. A split vote that necessitates the RBI governor using the casting vote or a vote that signals a split between central bank officials may quickly nullify the actual impact of the policy change.
At a time when there is a shift in policy, markets would be looking for consensus, if not unanimity, and a split vote would only raise more questions than answer them for markets and policy watchers.
This brings us back to the original question: If the RBI and MPC stay put on rates or change their stance to neutral, or both, how will the markets read into it?
Will it be seen as a prolonged pause or the first signal for easing? After building credibility on policy and the MPC over the last few years, can the RBI risk miscommunication when it nears the end of the rate cycle?
Based purely on past actions, expect the RBI and the MPC to err on the side of caution. They would prefer to underpromise and overdeliver rather than risk being on the wrong side of history.
T. Bijoy Idicheriah is a senior financial journalist who has been writing on the world of banking and central banking for 17 years.
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