Banking Central | What’s in a stance?

Jayanth Varma

Interest rates are at the centre of any central bank policy review but as a fierce fight continues to tame inflation, the policy stance is getting more than its share of attention.

Last week, in an interview to Moneycontrol, the Reserve Bank of India’s monetary policy committee member Jayanth Varma said MPC's policy stance has lost touch with reality.

Its current stance, “withdrawal from accommodation” were mere words carried over policies because it was thought desirable to avoid making a change. Increasingly, the plain language of the stance is out of sync with the MPC’s actions and its possible future actions, Varma said.

To a question on his preferred stance, Varma said it was better not to have a stance and leave the business of projections to individual policy members.

But Varma is the lone voice in the six-member panel. The majority, including RBI deputy governor Michael Patra, do not agree. Patra said continuing with the stance of “withdrawal of accommodation” is appropriate, as it adequately conveys the future course of interest rates.

So, how important is the policy stance?

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Understanding the stance

First, let’s understand the common terms used to express the policy stance. An “accommodative stance” means the central bank is prepared to expand the money supply to boost economic growth.

During an accommodative policy period, the RBI is willing to cut interest rates. A hike is ruled out. The central bank typically adopts this stance when growth needs policy support and inflation is not the immediate concern. As covid ebbed, most central banks adopted an accommodative stance to support the economic revival.

The second most common stance is “neutral”,  which suggests that the central bank can either cut or increase the rate. This stance is typically adopted when the policy priority is equal on both the inflation and growth fronts.

In a neutral policy, the interest rate can move to either side, depending on the incoming data. The guidance indicates that the market can expect a rate action either way.

Also read No stance is best stance for monetary policy: Jayanth Varma

Then there is a “hawkish” stance, which indicates that the central bank’s priority is to keep inflation low. During such a phase, the central bank typically tilts to hiking the interest rate to curb money supply and thus, reduce demand.

A hawkish policy also indicates a tight monetary policy. A rate cut is nearly certain in such a period. When the central bank increases rates or “tightens” the monetary policy, banks, too, raise their rate of interest on loans to end borrowers, which, in turn, curbs demand in the financial system.

Then there is “calibrated tightening” — when the central bank is on course to gradually tighten interest rates and a cut is off the table. It also means the central bank may not go for a rate increase in every meeting but the overall policy stance is tilted towards a rate hike. This can happen outside the policy meetings as well if the situation warrants it.

Stance doesn't dictate rate action

Regardless of the stance, the MPC can choose to act in either direction or hold rates based on the incoming data. The stance doesn’t necessarily dictate the policy action. Varma seems to be saying the same. Despite “withdrawal from accommodation”, he wonders why the MPC left the key interest rate unchanged in the last two meetings.

If an MPC member is finding it tough to decipher the policy stance, how will members of the public understand what the central bank is doing? If the policy stance is so difficult to understand and non-transparent, why do we need a stance at all? Perhaps, there is a case for a broader debate.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)