For the first time ever, India has seen a repo rate reduction by 35 basis points. So far, the Reserve Bank of India (RBI) and the Monetary Policy Committee (MPC) have only cut rates in multiples of 25 basis points. So why did the MPC not follow the conventional wisdom?
Before the media could ask about it, RBI Governor Shaktikanta Das, in his opening statement after the rate cut, said “the MPC considered it necessary to calibrate the size of the policy rate cut to the dynamics of the situation. Accordingly, the MPC was of the view that the standard 25 basis points might prove to be inadequate in view of the evolving global and domestic macroeconomic developments. On the other hand, reducing the policy repo rate by, say, 50 basis points might be excessive, especially after taking into account the actions already undertaken. Reducing the policy repo rate by 35 basis points was, therefore, viewed as a balanced level of cut under the circumstances.”
When asked about it at the press conference, the governor explained that this wasn’t some spur-of-the-moment decision. “Let me say it is not on the basis of gut feeling, it is driven by data and a lot of discussion takes place and at this point in time it was considered that 35 basis points was adequate” he said.
The signs were already there. In a speech on the sidelines of the International Monetary Fund-World Bank Spring Meetings in April this year, Governor Das called for the need to “think out of the box” and “challenge conventional wisdom.”
“Let me try and somewhat shock you with one such thought experiment,” said Das and he went on to elaborate why the unit of 25 basis points was not sacrosanct and just convention. He went on to say, “monetary policy will 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 illustrated this with an example in the same speech in Washington. “For instance, if easing of monetary policy is required but the central bank prefers to be cautious in its accommodation, a 10 basis points reduction in the policy rate would perhaps communicate the intent of authorities more clearly than two separate moves – one on the policy rate, wasting 15 basis points of valuable rate action to rounding off, and the other on the stance, which in a sense, binds future policy action to a pre-committed direction. Likewise, in a situation in which the central bank prefers to be accommodative but not overly so, it could announce a cut in the policy rate by 35 basis points if it has judged that the standard 25 basis points is too little, but its multiple, i.e., 50 basis points is too much. This approach can also be useful when the central bank is on a tightening mode and potentially help avoid policy turnaround from forward guidance via stance too far into the future, which in a highly volatile global scenario, may not even be a year.”
In a room full of central bankers and economists, Governor Das said he was not searching for a theory but for traction among domain experts who face these dilemmas in their day-to-day lives.
Now we can’t be certain if his proposal found traction in Washington, but it certainly found traction within the Monetary Policy Committee. Four members of the MPC including the governor, RBI representatives BP Kannugo and Michael Patra, along with external member Ravindra Dholakia voted in favour of a 35 basis point repo rate cut. Two members of the MPC, Pami Dua and Chetan Ghate, voted for a 25 basis point cut. The governor and his proposal prevailed.The pattern of the voting indicates that the two academic economists from JNU and Indian Statistical Institute are still unconvinced of the change from convention. The market too is divided if the new method of conveying a rate signal adds to communication or confusion. Some believe that the innovation has a purpose and that 35 bps cut conveys more dovishness than 25 bps. There are others who wonder what will the next cut of 15bps be read as? Or if the governor were to give the next cut at 40 bps, taking the repo rate to 5 percent? There is still much discomfort with the innovation. But so severe is the growth slowdown that most marketmen shooed away our questions on the step by saying that they have better things to worry about.