Why Rajan's rate cut decision surprised top RBI officials

Reserve Bank of India (RBI) Governor Raghuram Rajan's decision to cut rates last week surprised even top officials, a rare sign of divisions that could become much more public as the bank overhauls its decision processes in a way that will clip his influence.  

According to policymakers with knowledge of RBI discussions, the move to cut rates by 25 basis points -- the second cut in two months outside its normal meeting cycle -- came despite concern in the bank's senior ranks that there is no clear picture on the state of the economy or on inflationary pressures.  

And since the bank will now be judged by its ability to hit a formal inflation target, officials were also worried that a cut just days after the government's budget placed too much faith in New Delhi's promises of fiscal responsibility.  

"Now that inflation is being squarely laid at the door of RBI, this caution is warranted," said one policymaker.  

The contrast between conservative top ranks and Rajan's own position -- more in line with the government's -- comes as the bank prepares to introduce a monetary policy committee, following a structure embraced by most global central banks, which will reduce the governor's power to act alone.  

Although supported by Rajan, who believes it will bring transparency, a committee will nonetheless put the onus on him to convince other members of his views, and divisions are likely to become public, as MPCs typically release minutes or voting patterns. 

In its current top-down decision-making structure, the RBI provides limited visibility on dissent, releasing only a short statement on the votes of external technical advisers after scheduled meetings. It does not disclose the decisions of the internal RBI officials on the advisory committee.  

"Once you have a MPC-related structure, all those members will also have a vote," said Rupa Rege Nitsure, group chief economists at L&T Financial Services.  

"What suggestions they have made, it will be immediately put in the public domain. So there will be a debate."  

The RBI did not have an immediate comment.  

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The RBI has seen the biggest overhaul in a generation in recent weeks, rules that have introduced an official inflation target, to be followed by an MPC under terms that now need to be hammered out with the government.  

This new structure will require a different approach from Rajan, a former International Monetary Fund chief economist, who is not infrequently at odds with his more cautious lieutenants.  

Officials said Rajan's first out-of-cycle cut in January was discussed with top ranks, but the March move was more guarded.  

Rajan started asking for data on Friday evening, a day before the budget was announced. He met a few senior officials on Monday evening about the prospect of cutting interest rates, though policymakers said that by then it was clear he had already made up his mind.  

"A couple of days, and the governor had decided. We had not been told that's what he would like to do," said another senior policymaker.  

"I was not expecting a rate cut so quickly, but this was the governor's sole decision," said a third official.  

Officials said they were asked to draft a statement, finally issued to markets on Wednesday, catching out investors who had not foreseen a cut before the RBI's policy review on April 7.  

This despite misgivings among the bank's senior staff over the timing, calling it a move to align with a government push for growth, rather than a move concerned with economic health.  

The rate cut came days after the government announced plans in the budget to loosen some of its fiscal deficit targets in order to spend more on ageing roads and rail.  

Other officials also advocated a more cautious approach to rate cuts, citing the uncertainty behind global oil prices and the upcoming monsoon season, which will determine crop output.  

Adding to this caution is uncertainty in the bank over the government's recent change in the methodology of calculating gross domestic product, which showed India grew faster than China in the December quarter. That left a critical gap for the bank and its ability to assess economic prospects.  

"The potential growth is one key factor to determine the extent of rate cuts going ahead," said a third senior policymaker. "But the new data does not have any historical data series, which is required to estimate the output gap."  

The government's statistics office has said it needs several months to publish the full historical data series.