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Same Data But Different Interpretations: That’s RBI For You!

They say great mind thinks alike. So when you have a few great minds pouring over same set of data, they are most likely to concur. But that’s not what you get when you go through the minutes of RBI last policy meet. They look at same set of numbers but one bats for rate cut while the other feels that it is not yet time! Why so? Read along for an interesting insight into minds of doves and hawks.

We have five intelligent minds beside the Governor in this decision making board. We will pour into the points of each of one of them. We have not analyzed Governor comments because his conclusion was long foregone. He was brought in with a purpose.

If we have to look for an one liner to summarize the thoughts of each of one of them, it will perhaps read like below starting with the Hawks first!

  1. Dr. Chetan Ghate: Inflation has softened but not to my satisfaction. Hence NO to rate cut
  2. Dr. Viral Acharya: Inflation has softened but still remains high. Hence NO to rate cut
  3. Dr. Pami Dua: Inflation has softened and I believe there will be moderation in future. Hence YES to rate cut
  4. Dr. Ravindra Dholakia: Inflation has softened and I believe it will remain within RBI target in future. Hence YES to rate cut
  5. Dr. Michael Patra: Inflation has softened and I believe that any future rise will be on low base. Hence YES to rate cut

Somewhere you may start to believe that they had already made up their mind while coming for the meeting. The rest i.e. numbers and statistics are referred to defend their position.

The below chart codifies the responses of each of the members. We could observe seven key evaluation factors. The responses to each of these factors have been categorized as Favorable (GREEN), Favorable but with Concern (Yellow) and Not Favorable (RED).

What generally the central bank looks at for policy rate?

  1. RBI, like many other central banks, does inflation targeting. 4% is a comfortable position
  2. Growth and inflation are correlated. Higher growth generally leads to higher inflation. Hence if RBI sense that inflation is going up, it increase policy rate to curb demand and hence reduce inflation. But this works well for demand led inflation but not that well for supply constraint led inflation
  3. If inflation is on lower side and growth is also moderated/ dampened, then lowering rate is good. It will spurt growth (improve consumption, growth in economy) and inflation will still remain within comfort
  4. Not all of the factors can be controlled in a globally connected economy. For ex. food prices/ inflation depends more on agricultural yield/ seasonality etc. while oil prices/ non food inflation may depend on crude oil price movement in international market.
  5. RBI looks at current rate and future expectation while deciding on policy rate

In the current context of India, the GoI brought in the new Governor primarily to take a more Dovish approach. The logic is that reduction in rate can lead to:

  1. Better market sentiment and hence, consequently rise in SENSEX etc.
  2. Spurt consumption and hence, growth due to greater demand
  3. Improve employment. Phillips curve implies that unemployment and prices rise/ inflation are inversely related. Hence government would like to focus more on employment generation even if it comes at a slightly less comfortable on inflation. Remember that the GoI has been dillydallying on the job data for quite some time.

With election nearby, structural reforms and long term outlook is not the immediate focus for the government. A reduction in rate induces a positive sentiment across the populace and can swing more people towards government, even though the impact may be for a short term.

A few of the board members have actually alluded to long term uncertainties and potential negative impact of lack of fiscal prudence (at time of election) while batting for keeping the rate unchanged and watch for another quarter before deciding. There is a bigger strategy working out there. By next quarter, the election results would be out and the new government would be in place.

Source:

RBI Minutes of meeting (21st Feb 2019): Minutes of the Monetary Policy Committee Meeting February 5-7, 2019

Featured image from https://freerangestock.com/

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