October repo rate cut
It’s no secret that Raghuram Rajan, the former RBI (Reserve Bank of India) Governor, was not given another term due to his differences with the political establishment on the direction of monetary policy. While the Indian government believed that a reduction in the repo rate was vital for the economic growth of India, Rajan continued to believe that guiding inflation to its target was more important and that the prevailing circumstances at the time did not command a rate cut.
So the natural question to ask is this: Did the October 4 rate cut appease the market and the political establishment, or did it simply affirm and fulfill what was seen as a required policy action?
To please or not to please?
One of the reasons that the RBI put in place the MPC (Monetary Policy Committee) was to take away from the RBI Governor the power of single-handedly taking or changing policy decisions. The committee-based approach was expected to account for a broader perspective. And theoretically, the approach does look better. But another aspect is that external influence can guide the decision toward a certain result by majority vote. So the independence of the six-member committee becomes crucial in ensuring that decisions are taken objectively.
The fall in inflation in August, in addition to other advance inflation indicators available to the committee, led to the repo rate cut. However, it seems that at least part of the decision was to appease the market and the government. If there was convincing evidence of a decline in food inflation—especially since the monsoon season is already over, and there is a good estimate of the crop harvest—a 50-basis-point cut would have shown greater confidence by the committee. On the other hand, no rate action would have meant caution.
In this sense, the committee took the middle path—a 25-basis-point cut, which shouldn’t fuel inflation much. At the same time, this middle path could help douse the fire coming from the industry.
This perspective doesn’t imply that the committee isn’t independent. October was just the committee’s first meeting, and the impact of the transition to the new approach remains to be seen. Still, it seems that the current environment had left no options to the committee but to cut the rate. The release of meeting minutes on October 18 will likely provide further clarity.