Context

• The article highlights the significance of communication between Reserve Bank and Monetary Policy Committee (MPC) as a critical element of monetary policy which plays critical role in the credibility of the public institution and its working.

Evident communication gap

• In the current inflation targeting (IT) regime, the resolution adopted by the Monetary Policy Committee (MPC) and published on the RBI’s website on the day of the monetary policy meeting is an important channel of communication with the public.
• Yet there seems to be a gap between what the MPC says and what the RBI does.

Communication channel

• Under the IT regime, the most important role in communication belongs to the MPC.
• MPC constitution: MPC, consisting of three external members, three RBI representatives, and chaired by the governor.
• Authority: By law, this is the highest monetary policy-making body, tasked with deciding monetary policy changes at regular intervals.
• Channel: These changes are then communicated through formal statements, with the discussions underlying these decisions also being published, so that the public can understand why the MPC decided the way that they did.

Why is communication so critical?

• Criticality of communication: Though the spikes in commodity prices would inevitably cause inflation to surge from time to time. But with well anchored inflation, it becomes relatively easy for the central bank to ensure that inflation returns to the target level before too long.
• Legislation: The most important task of the MPC, enshrined in the RBI Act (Amended), 2016 that introduced IT, is to decide the repo rate, since this has long been the lynchpin of India’s monetary policy framework.
• Corridor rates: Since the early 2000s, monetary policy had aimed to keep overnight money market rates aligned with the lower bound established by the reverse repo rate and the upper bound by the repo rate.
• Convenience: Since the width of this corridor was fixed, once the repo rate was decided, the reverse repo rate was automatically determined, and market overnight rates adjusted accordingly.
• Pandemic years: During the Covid-19 pandemic, the RBI constantly adjusted the reverse repo rate even as the MPC kept the repo rate unchanged, meaning that the fixed width of the corridor was lost, and the MPC lost any role in determining interest rates.
• Interrogative credibility: Accordingly, the remit of the MPC and indeed the credibility of the entire IT edifice was called into question.
• New Policy Instruments: The RBI also introduced a number of new policy instruments, again outside the remit of the MPC as follows:
• Government Securities Acquisition Programme (G-SAP): The GSAP programme is basically an unconditional and a structured Open Market Operation (OMO), through which RBI pre-commited to buying a certain amount of dated government bonds in order to control their yields.
• Variable Rate Reverse Repo programme (VRRR): The central bank has been rebalancing the surplus liquidity in the system by shifting it out of the fixed-rate overnight reverse repo window to VRRR auctions of longer maturity.
• Standing deposit facility : RBI more recently replaced the reverse repo rate with the long-dormant standing deposit facility rate. Standing deposit facility is a remunerated facility that will not require the provision of collateral for liquidity absorption. The rationale for this decision was not explained in the MPC statement.

Significance of communication

• Public trust: The faith of public in RBI in keeping inflation under control helps them act accordingly.
• Effect on Firms: Firms will moderate their price increases, fearing that large price rises will make them uncompetitive.
• Effect on workers and investors: The workers will accept moderate wage increases, while investors will accept low interest rates on their bond purchases.
• Benefit: Hence, with everyone acting in this way, it will be easier for the central bank to ensure that inflation indeed remains low.

Course of functioning of MPC

• Formative years: From 2016 to 2018, the MPC functioning worked quite well.
• During policy announcements, the governor would participate in a press conference to answer questions from the media. But otherwise the focus was squarely on the MPC statement, from which the public used to glean important information about the monetary policy strategy.
• Recent years: However from 2019 onwards things started shifting during the day of monetary policy meeting as follows:
• RBI began to release a separate governor’s statement
• RBI started presenting an inflation outlook and even explaining the decision taken by the MPC.
• Rationale behind the move: The day of policy announcements overlapped with the MPC statement.
• Concerns behind the move: It was made difficult for the public to understand what the policy strategy really was.
• Demonstration: The recent MPC statement following the 8^th June 2022 Monetary Policy Review consisted of the following:
• MPC statement: The MPC highlighted inflation concerns, and voted in favour of raising the policy repo rate.
• Governor’s statement: On the same day, a governor’s statement issued by the RBI mentioned that the central bank will also remain focussed on orderly completion of the government’s borrowing programme.
• Divergent objectives: The issuance of two such different statements can lead to confusion, especially as lowering inflation and lowering government bond yields are contradictory policy objectives.
• Outside MPC ambit: Unlike developed country central banks like the Bank of England for example, all unconventional monetary policy announcements were kept outside the MPC statement thereby raising questions about the role of the committee in deciding monetary policy actions at a crucial time like the pandemic.
• Forex market intervention: RBI Forex interventions by definition, influence the domestic monetary base and inflation. Yet the MPC in its monetary policy statements does not discuss either the exchange rate dynamics or the forex interventions. Just as it does not discuss the RBI’s interventions in the bond market to lower the yields.
• Evident communication void: The above demonstration is an example of how, over the past few years, a communication gap seems to have opened up between what the MPC has been saying and what the RBI has been doing, thereby potentially eroding credibility of the IT framework.

Way forward

• The net result of all these actions is a potential loss of both clarity and credibility. There appears to be a growing rift between what the MPC says and what the RBI does. And with the proliferation of policy instruments, it is no longer clear to the public how the policy stance should be measured or what the monetary policy framework is.
• In its latest two statements, the MPC indicated that policy would now be focusing on bringing India’s inflation rate under control. If the RBI is going to be successful in this endeavour, the first step must be to close the communication gap, by reintroducing a simple and clear policy framework and restoring the central role of the MPC.