Calling RBI: Show Us Some Thought Leadership

The Reserve Bank of India is not unaccustomed to tough economic conditions or to tough economic questions. It's an organisation with deep institutional memory and understanding of all aspects of the economy and the banking sector.

It is then a little worrying to see lack of thought leadership—or at least the lack of communication of that thought leadership—from the central bank in recent times.

Let me offer a few examples.

Why, And What Next?

The central bank on Wednesday chose to cut interest rates by 35 basis points. Not 25, not 50, but 35. Why? RBI governor Shaktikanta Das said that there is nothing sacrosanct about moving in multiples of 25 basis points. He had made that point in a speech in April as well. At the time, Das said he was throwing out the idea as something for practitioners to consider.

What then were the final considerations to move away from the convention of rate moves in multiples of 25 basis points? Why is a 35 bps cut better than a 50 bps cut or two 25 bps cuts?

The 35 bps cut also does not appear to be consistent with the MPC's analysis. In its accompanying statement, the MPC said that addressing growth concerns by boosting aggregate demand assumes “highest priority” at this stage. That's the strongest backing of growth we have seen from the MPC or the RBI in some time.

Against that backdrop, why was a 50 bps cut not acceptable? Now the RBI could have argued that monetary policy can only do so much to reverse a slowdown with structural undertones. It could have also argued that it is waiting for fuller transmission of earlier rate cuts.

All Governor Das said was that given the economic circumstances, they believed that 25 was too little but 50 was too much. If there are other, more substantive reasons for the shift, such as a model that the RBI follows, then those reasons remain unexplained.

Consideration must also be given to the uncertainty this 35 basis point cut generates. As a fellow journalist asked – will money markets now need to wonder whether the next cut will be 15 basis points, to add up to a total of 50 basis points eventually? Or will it be 25 or 50 or some other variable? MPC member Ravindra Dholakia, at the last policy meeting, had suggested 40 basis points.

So what comes next? And how will markets price in these unpredictable moves? We don't have the answer.

That's not the only reason for the disappointment with the RBI today.

Forecasting Failure

The central bank has already had one major analytical miss by failing to capture the sharp fall in inflation in the current cycle. Inflation has turned out to be much lower than expected, which, in hindsight, has led analysts to believe that the two rate hikes in 2018 were unwarranted. Sure, most economists outside the RBI got the inflation projection wrong as well, but the central bank, presumably, has more tools at its disposal and better models.

Now it looks like the RBI is missing the change in the growth environment.

The central bank started the year, in April, with a 7.2 percent growth forecast. That forecast was cut to 7 percent in June and 6.9 percent in August. Even now, some believe the forecast will prove to be off the mark, with growth seen settling closer to 6.5 percent for the year.

Beyond forecasts, the RBI has offered little insight into what has led to a decline in growth from 8 percent to 5.8 percent over a four-quarter period. The initial analysis was that rural demand had been hit by weak food prices. But then weakness in demand started to filter through into urban areas. It was then argued that this may be due to the slowdown in credit flow from NBFCs.

Does that explain it? Are there structural undertones to the slowdown such as weak income growth or falling financial savings? Does India need to take steps to avoid a middle income trap, as Rathin Roy, member of the Prime Minister's Economic Advisory Council, has cautioned?

Risks On the Horizon

Equally, the RBI has left too much unsaid about the fiscal risks building up and the recent attempt to tap into foreign savings via the issue of a foreign currency sovereign bond.

The August MPC was the first policy review after the final budget for the year was presented. Much has been written about the aggressive tax targets built in to the fiscal deficit projection of 3.3 percent of GDP. The CAG has also raised concerns about under-reporting of the fiscal deficit using the off-balancesheet borrowings route. Yet, the word ‘fiscal' was missing from the MPC statement.

When quizzed about the proposal to issue a foreign currency sovereign bond, Das chose to say that the RBI is in discussions with the government on the matter. While, on this issue, need for extreme caution is justified, the RBI is yet to articulate its thinking on the matter. Whatever we know about RBI's disapproval of foreign currency sovereign borrowings is from years past. Does the central bank still hold that view? We don't know.

The simple point—the central bank with all its resources, intellect and institutional memory is best placed to provide thought leadership in the economy. But where is that thought leadership?

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.