MPC Is Heading Towards Irrelevance: Abilene Paradox And Groupthink At Work

If there is one institution that deserves no thank you note for India’s nascent economic recovery, as evidenced in the July-September uptick in gross domestic product (GDP) numbers to 6.3 per cent (previous quarter: 5.7 per cent), it is the Reserve Bank of India (RBI) and its appendage, the Monetary Policy Committee (MPC). The MPC was premised on the logic that six heads are better than one, but it has instead turned into an RBI echo chamber, with only one dissenter carrying the flag of good sense over the last one year as the economy struggled with structural growth weaknesses.

Last week, the MPC announced that it was holding rates, thanks to reviving growth, the lurking threat of inflation, and the possibility of the fiscal deficit slipping out of the promised zone due to revenue hiccups in the initial phase of implementation of the goods and services tax (GST). It was probably the first time in the last one year that its neutral stance was defensible, but it failed to do the right thing by first cutting rates by 25 basis points to aid the recovery, which is far from certain.

Thanks to the MPC’s inexplicable cussedness so far, we now have a situation where base rates are at least 50 basis points (100 basis points make one per cent) higher than they need to be today. India Inc is paying a heavy price for the MPC’s groupthink.

The problem with the MPC is it has been looking for data to support its cussedness and finally found some of it coming this month. In the fortnight to 10 November, the latest for which data are available, bank credit to the commercial sector rose 8.3 per cent compared to 7.2 per cent at this time last year. And deposit growth is slowing, with demand deposits growth moderating from 18.7 per cent last year to 15.6 per cent and time deposits from 10.5 per cent to 7 per cent. This is one reason why the State Bank of India has raised interest rates for bulk deposits.

The revival of credit demand and growth has nothing to do with what the MPC has done, and more with what the government has. With demonetisation and the hefty growth in bank deposits pushing rates down, savers have shifted a part of their savings to mutual fund investments in equity and debt, which is one reason why the new issues market has been booming.

The RBI notes with approval that “capital raised from the primary capital market has increased significantly after several years of sluggish activity”, which is an indirect acknowledgement that the central bank has been the roadblock to reviving investment activity, not government or markets. If it had lowered rates earlier this year, when inflation was down below two per cent and growth was down in the dumps, the stock market would have been able to offer even better valuations for capital raisers, thus reviving investment faster and on a more enduring basis.

Given tight liquidity conditions, at the very least the RBI and the MPC could have cut the cash reserve ratio (CRR) by 25 basis points, which is like giving a rate cut without actually giving one. If money is tight, and bad loans are constraining banks from cutting rates more, a CRR cut would have eased things. CRR is one of the biggest non-performing assets in banks’ books, since these balances earn no interest. Only the RBI makes profits from this “free” money.

The question to ask is simple: what have we gained by creating an MPC when it has failed to bring in fresh thinking on monetary policy? A strange kind of groupthink seems to have prevailed, where the dominant view in the RBI seems to have influenced the thinking of at least two of the outside members in the committee, Pami Dua and Chetan Ghate. Only Ravindra Dholakia offered the committee a fresh perspective on rate policy, by consistently opposing the remaining five members’ conservative views on rates.

When rates were decided by the RBI Governor alone, he could weigh both the political and economic costs of adopting a course and take responsibility for it. Now that the blame can be evenly distributed among six members, the RBI Governor and his two co-members from within the institution can indirectly deflect blame for any mistake by assigning it to the MPC. It is only when, and if, the MPC is vertically split on an issue that we will see some real innovative ideas coming from it. So far that has not happened.

One suspects that the MPC is a victim of what is called the Abilene paradox. The story goes that one hot afternoon, a family in Texas is playing dominoes when the father-in-law, possibly in a fit of boredom, suggests that they go to Abilene for dinner. Not knowing what the others are thinking, the wife asks why not, and her husband agrees provided the mother-in-law also does. The mother-in-law, believing that all want to go, decides that she won’t play spoilsport and says yes. So, the family ended up doing what no one wanted to do since each one thought the other was keen to go to Abilene, a hot, dusty drive away. No one wanted to be a deal-breaker. They all suffered in silence by not speaking their minds.

One would suspect that the MPC’s decisions reflect some such groupthink, where the new members are under pressure to show “independence” and are thus vulnerable to suggestions from the RBI group on where monetary policy must head, never mind that the evidence and data point in another direction.

If the MPC is to finally work, the “independent” members should speak up and start saying dissonant things, and not follow the lead provided by the RBI’s conservative thinking. Or else we are all headed to Abilene, for all the wrong reasons.

If the MPC does not show fresh thinking in the months ahead, the government should consider scrapping it. We don’t need an innovation like MPC when its members don’t innovate anything.