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The central banks’ role is important, both during normal as well as crisis times. While mandates for the central banks broadly remain same during both the periods, weightage attached to competing objectives and the choice of policy instruments become crucial in the crisis periods, says the RBI governor.
While it is true that crises lead to reforms, experience shows that other extraneous and complex factors can lead to future financial crises.
For instance, despite learning lessons on inadequacies of regulation and supervision in many emerging economies during the East-Asian crisis of 1997, the occurrence of global financial crisis of 2008 originating from advanced countries could not be avoided.
While macroeconomic vulnerabilities derived from large current account deficits, fiscal imbalances, excessive leverage and inadequate regulation and supervision of financial institutions were some of the most common features of this crisis, it was of truly global nature with much more intensity and depth.
Another episode of stress witnessed across EMEs including India was during the taper talk period of mid-2013.
The Indian economy was vulnerable due to the then prevailing high inflation of around 10 per cent and large current account deficit at 4.7 per cent of GDP.
The Reserve Bank resorted to a host of policy measures including monetary tightening, restriction on gold import, special dollar swap window for public sector oil companies, special concessional swap window for banks for attracting Foreign Currency Non-Resident (Bank) deposits, increase in overseas borrowing limit of banks, and raising FII investment limit in government debt.
What do we learn?
Though there is no unique solution to these policy issues confronting the global economy, we could clearly draw three broad inferences:
First, the central banks’ role is important, both during normal as well as crisis times. While mandates for the central banks broadly remain same during both the periods, weightage attached to competing objectives and the choice of policy instruments become crucial in the crisis periods.
Second, communication by the central banks is very important that may be different in crisis times than in normal times. Not only it helps convey decisions in a more transparent way, it also signals the present and future policy stance of the central banks.
In fact, unconventional monetary policy measures undertaken by the central banks during the crisis period worked mainly through the confidence and signaling channels.
The US Federal Reserve’s statement on December 16, 2008 provided a clear forward guidance for the markets. On the other hand, only a mere hint of monetary policy normalisation by the US Fed (popularly known as taper tantrum) in May 2013 triggered portfolio outflows from some emerging market economies (EMEs). This led to high volatility in equity, debt and currency markets. In fact, such market volatilities in EMEs could have been avoided through clear advance communication.
In the Indian context, the Reserve Bank of India communicates its monetary policy decisions in terms of changes in the policy repo rate and stance based on an assessment of the current and evolving macroeconomic situation.
The stance of the monetary policy is communicated as neutral, accommodative or calibrated tightening in consonance with the mandate of achieving the medium-term inflation target of 4 per cent ± 2 per cent, while keeping in mind the objective of growth.
The RBI’s approach to communicate the policy stance is to explain it with rationale, information and analysis to enable market participants and stakeholders to have better clarity.
Third, the global financial crisis was also a testimony to the fact that coordination of policies both at the global and domestic level is important for macro-financial stability. It is only through better coordination between the central banks and between monetary and fiscal authorities in the domestic sphere that adverse consequences of spillovers and spillbacks could be contained.
The fact remains that as most policy makers have domestic mandates, international cooperation may be hard to engender if international outcomes militate against domestic policy preferences. Therefore, success of coordination depends on deft calibration of policies by major stakeholders.
Issues in the current context
Even after more than a decade of global financial crisis and six years after taper-tantrum, the global economy is still not on a stable growth path. Following an upward swing in 2017, there has been growing evidence that global growth and trade is weakening. Unsettled trade tensions and developments around Brexit are imparting further downside risks to the outlook.
While signs of weakening world industrial production and trade volume were discernible in early 2019, other business confidence indicators have also dampened in many OECD countries. Taking cognisance of these factors, projections of world growth for 2019 have been revised down by the IMF, World Bank and the OECD in their latest assessments.
While the global economy is still to recover to the pre-crisis growth path, India has continued to exhibit robust growth driven by consumption and investment demand in the last three years.
However, we have seen a loss of speed in the second half of 2018-19 as some drivers of growth, notably investment and exports, slowed down.
On the supply side, activity in agriculture and manufacturing moderated sharply. It is expected that the end of political uncertainty associated with an election season and continuation of economic reforms would lead to a reversal of the current weaknesses in some of the indicators in our economy.
To reinvigorate growth by improving investment climate, a healthy financial sector, inter alia, plays an important role. In this context, the RBI has accorded high policy attention to reform both banking and non-banking sectors.
We have been taking several steps to strengthen the regulatory and supervisory frameworks in order to increase the resilience of the banking system. New guidelines have been issued for resolution of stressed assets, which will sustain the improvements in credit culture.
In the non-banking sector, the RBI has recently come out with draft guidelines for a robust liquidity framework for the NBFCs. We are also giving a fresh look at their regulatory and supervisory framework.
It is our endeavour to have an optimal level of regulation and supervision so that the NBFC sector is financially resilient and robust. The RBI will continue to monitor the activity and performance of this sector with a focus on major entities and their inter-linkages with other sectors.
Interplay between inflation and growth objectives
At the end, let me highlight the role of the RBI in the context of the mandate under the Reserve Bank of India Act, 1934: “to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage”.
This mandate has been interpreted over time as to maintain price stability, financial stability and economic growth with the relative emphasis between these objectives governed by the prevailing macroeconomic conditions.
This role of the RBI has been restated as per the amendment in the RBI Act in May 2016 according to which “the primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth”.
Therefore it has been our endeavour in the RBI to ensure price stability under the flexible inflation targeting regime and simultaneously focus on growth when inflation is under control.
Photograph: PTI Photo.
Edited excerpt from a speech by RBI Governor Shaktikanta Das at the Lal Bahadur Shastri National Academy of Administration, Mussoorie, June 17.