RBI, not MPC, is dictating the stance. And it's not doing it well.

The MPC's continued focus on withdrawal of accommodation has left many scratching their heads

The Monetary Policy Committee's (MPC) decision on February 8 to continue focusing on withdrawal of accommodation meant this policy state will complete one year as the rate-setting panel's 'non-stance' when it next meets, in early April.

While it is the MPC that votes on the resolution to continue focusing on withdrawal of accommodation, the hand of the Reserve Bank of India (RBI) is far from invisible.

On paper, the MPC decides the policy stance and the RBI aligns liquidity conditions to this stance. But sample the following from Governor Shaktikanta Das' address on February 8: "The overall monetary conditions, therefore, remain accommodative and hence, the MPC decided to remain focused on withdrawal of accommodation."

Does that mean the MPC is looking at liquidity conditions, which are managed by the RBI, and then voting on the stance? When asked in the post-policy press conference what would change first, liquidity conditions or the stance, Das said it was a chicken-and-egg question, which the chicken should be allowed to decide, before going on to say he could not give any forward guidance on the matter.

RBI versus MPC

With half the MPC members being RBI representatives, the central bank exercises sizeable control when it comes to decisions. But the real issue arises when the three RBI members vote as a bloc—something external member Jayanth Varma pointed out in an interview to Moneycontrol in December.

"When we see that monetary policy is often slow to change course, that is a function of group-think," Varma had said.

In December, Varma and fellow external member Ashima Goyal voted against the continued focus on withdrawal of accommodation. For Varma, the guidance's language made no sense and betrays a belief in "constructive ambiguity". And for Varma, ambiguity is "always destructive and not constructive".

The tussle over the stance is not the first time the RBI is said to have undermined the MPC, with the other instance being the reverse repo rate cuts announced early in the pandemic, outside of MPC meetings.

The move led to the Liquidity Adjustment Facility corridor becoming a policy instrument and the reverse repo rate the effective policy rate.

"I think RBI's liquidity policy, if I can call it that, became more important than the interest rate policy on the margin," Chetan Ghate, who was a member of the MPC until September 2020, told this reporter in August 2021.

Ghate's concerns have been echoed by Varma, who had said in the minutes of the August 2021 meeting of the MPC that "if the reverse repo rate does not fall within the remit of the MPC, then the announcement of this rate should be in the Governor's statement and not in the MPC's statement". This view, Varma went on to add, had not found favour "with the rest of the MPC".

Obfuscating around the stance

Varma and Goyal are not alone in feeling uncomfortable with the MPC's continued focus on withdrawal of accommodation.

According to Nomura's economists, "obfuscation around the policy stance continues".

"In our view, there has been no consistent messaging on the meaning of the stance, making it an unnecessary source of volatility," Nomura's Sonal Varma and Aurodeep Nandi said in a note on February 8.

For Suyash Choudhary, head of fixed income at IDFC Mutual Fund, the MPC continuing with withdrawal of accommodation was the "the fly in the ointment".

When the stance makes little sense, people look elsewhere, such as the central bank's views on real interest rates, for clues but there was no clarity there either.

"The Governor continues to justify that (withdrawal of accommodation) on the current real positive rates basis immediate forward forecasted inflation as well as the level of system liquidity, when contrasted with a point in time prior to the pandemic," Choudhary noted.

"In the post policy press conference, however, deputy governor Patra clarified that the desired real positive policy rates will be adjusted basis evolving growth-inflation dynamics and not necessarily benchmarked to a point in time in the past."

Economists now expect the MPC to shift to a neutral policy stance, either in April or June. According to former RBI governor Urjit Patel, a neutral stance meant equal probability of a rate hike, a rate cut, and status quo.

We will only know what neutral might mean in practice when we come to that bridge.