How should one judge the RBI’s credit policy statement, due tomorrow? In the current context, it would be worthwhile evaluating it from three points of view, on a checklist adding up to 10 points. The first aspect is: does the RBI get back to its core job of managing monetary policy? At present, it is suffering the embarrassment of a dysfunctional interest rate signalling mechanism. The RBI lends overnight funds at 7.75% and borrows at 6%, and this band is supposed to set the market’s short-term rate. But it also has a borrowing cap of Rs 3,000 crore per day, which is such a small figure that the money market ends up with a call rate that displays complete disregard for the RBI’s intent. So, if the RBI reduces the gap between the two rates to
1 percentage point, and removes quantitative limits on both borrowing and lending, award it three points. The second checkpoint is: does the RBI abandon its defence of the dollar exchange rate of Rs 40? The last time round, it tried in vain to prevent a rupee appreciation and then let go in mid-March. Exporters were blindsided by this sudden move, and they did not even have recourse to the safety of a good hedge in a local currency derivatives market. So, this time round, if the RBI starts making its intentions loud and clear to all, allows a currency futures and options market to emerge (with no restrictions on access), and finally embarks on a phased programme of increasing currency flexibility, award the central bank another three points.
The last and most important aspect concerns inflation. The centrepiece of monetary policy statements in all developed economies is the “inflation report”, since price stability is the main task entrusted to a central bank. The approach taken to inflation displays its analytical understanding, and even accounts for its credibility with investors and analysts at large. What the inflation outlook is, what the target rate is, over what time horizon the target is to be achieved, and precisely how this is to be done—all these are critical issues that the central bank is expected to outline. So, if the RBI issues an intelligible inflation report—in plain language—as part of its credit policy statement, award it another four points. That makes up 10. Keep this checklist handy tomorrow as Governor YV Reddy starts his speech.