Member tells MPC Oct strategy to flatten the yield curve a flop show

MUMBAI: In a remarkable instance of candidness, Prof Jayanth Verma admitted at the April rate-setting meeting of RBI’s Monetary Policy Committee that the time-based forward guidance given by the MPC in October failed to flatten the government bond yield curve in the country.

“From my perspective, the principal motivation for the forward guidance was to reduce long-term yields in the backdrop of an excessively steep yield curve. Unfortunately, that forward guidance has failed to flatten the yield curve, and I see little merit in persisting with it anymore,” Verma said, according to the minutes of the MPC’s April monetary policy meeting released on Thursday.

Government bond yields have continued to edge higher throughout 2021 amid concerns over a large supply of government bonds and inflation.

In October, MPC had stated that it would continue with its accommodative stance “at least through this financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy.”

The guidance of the rate-setting panel in this instance was both time-based and state-based, as it tied up the monetary policy stance till at least the next financial year and on the condition that growth was ‘durable’.

Verma used a popular quote to describe the situation: insanity is doing the same thing over and over again and expecting different results.

Verma said another reason why time-based forward guidance is difficult to rely on is due to the breakdown of the forecasting models caused by the pandemic.

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“It is apparent that some economic and statistical relationships have tended to break down in the current exceptional environment. Consequently, the model risk has now become an important issue,” Verma said.

Verma said the rate-setting panel should have the flexibility to act ‘rapidly and adequately’ to surprises in the data and that a time-based guidance would be inconsistent with this imperative.

Verma’s apprehensions about time-based guidance were echoed by RBI Governor Shaktikanta Das, who said, “given the uncertainties and the fact that we are at the start of a new financial year, it is too early to give explicit time-based forward guidance.”

The rate-setting panel dropped its time-based forward guidance in the Monetary Policy Committee (MPC) meeting earlier this month and instead chose to stick to a state-based guidance.

“The MPC also decided to continue with the accommodative stance as long as it is necessary to sustain growth on a durable basis, and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward,” the MPC resolution said.

Das said the MPC’s guidance of securing sustainable growth on a durable basis “itself testifies to our commitment to continue to mitigate the impact of Covid-19 on the economy” and keep inflation within target.



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