Tamal Bandyopadhyay: Monetary policy on a shorter leash

As opposed to the past, monetary policy is now taking a much shorter view of interest rates.

Last week, this column attempted to take a close look at the stance of the RBI's monetary policy, and found inconsistencies in what the RBI was signalling by way of its stance and the subsequent action, usually an increase in rates. Another way of explaining this apparent contradiction is the fact that the RBI's time horizon appears to have changed dramatically as well.

In the low interest rate regime, the stance of the monetary policy used to relate to the entire year. With the rates firming, the stance has started illustrating the RBI's immediate approach towards the interest rate trajectory. Also, while the monetary policy stance is the outlook for the time ahead, it is now open-ended and does not specify any timeframe. So, the RBI can take any action at any time "" in June, the RBI didn't even wait for the usual policy announcement dates, but just went ahead and hiked rates after some central banks across the world hiked their rates.

Indeed, the stance of the mid-term review of annual policy 2006-07, announced last month, is for the "period ahead". Ditto about the stance outlined in the first quarter review of annual policy 2006-07 in July.

The key elements in the stance of both the first quarter review and mid-year review of the 2006-07 monetary policy, however, remain the same: To ensure a monetary and interest rate environment that enables continuation of the growth momentum and price stability and anchor inflation expectations. While the October policy talks about "reinforcing" price stability, the July review stance was "emphasising" price stability. Both the policy statements speak about supporting export and investment demand and maintaining the emphasis on macroeconomic and financial stability.

Between 2001-02 and 2005-06, former Governor Bimal Jalan and then YV Reddy who took over in late 2003, always announced the stance for the entire year (or the rest of the year, in the mid-year review). Then, the RBI changed this stance to just that at a particular "juncture" (the April policy, for instance), and in July it brought it another imponderable by talking of the 'period ahead', which could be anything from a week to a month, or more.

In October 2005, when the RBI presented its mid-year review of the annual policy for 2005-06, the stance referred to a specific timeframe "" six months. The policy document had said that the overall stance of the monetary policy "for the remaining part of the year" would be provision of appropriate liquidity to meet genuine credit needs and support export and investment demand, and so on. It had, however, used the caveat that it would use all policy instruments at its disposal as and when the situation warranted. Since October last year, the RBI has hiked the reverse repo rate four times, quarter percentage points each time, to 6 per cent.

In April this year, the RBI wanted to "ensure a monetary and interest rate environment that enables continuation of the growth momentum consistent with price stability". It was also ready "to act in a timely and prompt manner on any signs of evolving circumstances impinging on inflation expectations". Even though it had left the rates unchanged, it made it clear that it would respond "swiftly" to the evolving global developments. No wonder that it did not wait till July when the next review was due and chose to hike the rates in June after some of the central banks across the globe hiked their policy rates.

The stance for the third quarterly review for 2005-06 in January 2006 also related to the "current juncture". The policy stance promised to provide "appropriate liquidity" to meet genuine credit needs of the economy with due emphasis on quality. This was the last time that Reddy spoke about providing "appropriate liquidity" to meet the credit needs. The subsequent three policy statements "" in April, July and October "" kept mum about the provision of liquidity. In fact, in the October policy, the RBI clearly spelt out that provision of liquidity through its repo window was not automatic and it could always use its discretion while infusing liquidity in the system.

So, while the frequency of the monetary policy review has been increased (from half yearly to quarterly) and more and more pages have been added to the policy statement (a booklet on macroeconomic and monetary developments now precedes the review), the RBI is taking an increasingly shorter call on the interest rate trajectory. This is because domestic factors alone no longer influence the central bank's decision. External developments are playing a major role in shaping up India's monetary policy stance.