Tuesday, July 27, 2010

The impressive Dr. Subbarao

The First Quarter Review of Monetary Policy 2010-2011, as its now called, is a landmark event. It marks a coming of age for the Governor, Dr. D. Subbarao in more ways that one. While signs of this have been apparent for some time now, with the Governor’s outspoken opposition to the establishment of a inter-regulatory dispute resolution authority by the MoF, this particular monetary policy statement is dramatic, to say the least.

At the heart of the reason why this judgment is possible is the manner in which the width of the LAF corridor has been reduced. It’s something I have been writing about for some time now like here, here, here and here. But normally, an RBI Governor would have found it suitable to just reduce the “corridor” without any specific mention of the reasons. But that would just be a lesser Governor than what Dr. Subbarao is transforming into. The following sentence left me astounded by its sheer simplicity and honesty.

“55. There is no unique way to determine the appropriate width of the policy interest rate corridor. But the guiding principles are: (i) it should be broad enough not to unduly incentivise market participants to place their surplus funds with the central bank; (ii) it should not be so broad that it gives scope for greater interest rate volatility to distort the policy signal. The challenge, therefore, is to strike the right balance.”

When one says that the corridor should not be so broad that it gives scope for greater interest rate volatility, sets up a Working Group to look into it, but reduces the width of the corridor pending the working group’s deliberations and conclusion, it can only mean that the corridor was actually perceived to be wider than desired. That it was a policy prescription which was not suitable anymore, if it ever was.

It takes a very self-assured RBI Governor to make that statement. And all indications are that unlike his predecessor, we now have one. 

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