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Business EconomyPosted at: Aug 27 2020 6:49PM


Monetary policy is a science, but this RBI is making it an art : Report

Kolkata, Aug 27 (UNI) Monetary policy is a science, but this RBI is making it an art, says
a research report from State Bank of India’s Economic Research Department, authored
by Dr Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.
In 1996, Alan Blinder one of the most profound exponents of monetary policy making
had famously commented “By making itself more predictable to the markets, the central
bank makes market reactions to monetary policy more predictable to itself”.
This was reiterated by Michael Woodford in his famous Jackson Hole address in 2001
“successful monetary policy is not so much a matter of effective control of overnight
interest rate as of affecting the evolution of market expectations”.
Incidentally, Professor Woodford is a speaker in 2020 Jackson Hole also, speaking on
effective lower bound.
Following the sagacious advice of Blinder and Woodford, this RBI seems to have
managed the art of managing expectations as auction outcomes are turning out to be in
line with market expectations.
G-sec yield has risen significantly in the recent month more so after the RBI August
monetary policy committee and the release of Policy Minutes.
The yield has increased across all tenures and the most in 5 year. It seems that the
entire purpose of monetary transmission was being defeated.
Against this background, the operation twist/OT was a much-needed relief for the
markets after yields had moved up by as much as 56 points in the aftermath of August 6.
Before the auction there was some concern among market participants that OT may
not work in this scenario as majority of the holders of these securities would be out of
the money.
By accepting offers at prices much higher than market, RBI has indicated its willingness
to support the market at a time when supply outstrips demand.
The OT coupled with the Governor’s address in the morning has soothed frayed market
sentiments. It is perhaps perfectly legitimate that the RBI has chosen to use OTs instead
of direct OMO purchases to avoid adding more liquidity to the banking system which is
already flush with liquidity after the LTROs and TLTROs done earlier this year.
RBI may have to continue to manage auction expectations more aggressively in coming
days through OT so as to pull down the yields even further.
RBI has been largely successful in managing the yield movements in the current year.
For example, when we look at the G-sec spread, it reached a peak of 350 basis points
in FY09.
The spread has reached 284 basis points in the current year. With a Rs 22 trillion
consolidated borrowing, yield should have been at much higher level now if RBI had
not acted with alacrity.
Finally, when fear runs high amid a hawkish MPC minutes and higher CPI prints,
market players across all markets may take short positions to stop out the long, as
like any asset class behaviour.
" We thus expect RBI to continue to make policy announcements in tune with changing
times like LTRO in the 3-5 year G-sec, exercising green shoe options and other
announcements as it may deem fit. "
" We must appreciate that for any central bank specifying an explicit policy rule, from
which the central bank would never deviate under any circumstances, is naïve. "
" In this context, it will thus not be a surprise and it will be better to keep the markets in
a wait and watch mode as monetary policy is all about managing expectations and as long
as this RBI is doing it successfully, market players should not have too many complaints. "
UNI BM
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Tags: #Monetary policy is a science# but this RBI is making it an art : Report
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