However, is the RBI doing all that is needed to ensure the efficacy of monetary policy? There are two notable features of the 125-basis-point rate cuts by the RBI. First, there have been apparent inconsistencies between the rate cuts and monetary policy commentary on the likely trajectory of inflation and interest rates. Second, out of the 125 basis points, 50 points were cut through out-of-turn monetary policy statements. Changing interest rates is a complex matter for banks. All product designs have to be reviewed, broader economic considerations revisited, and board decisions have to be re-taken. These tasks get complicated when the central bank cuts rates but simultaneously in the statement warns about raising rates. To banks, the mixed signal implies that the central bank is hedging its bets, and may undo the rate cut in the near future. Banks may then think it is not worth their while to change rates for an interest rate cut that is likely to be reversed.
Out-of-turn statements are likely to have the same effect on monetary policy transmission. Like mixed monetary policy signals, out-of-turn cuts suggest heightened uncertainty. Banks may then prefer to wait and watch, rather than to act. These problems of the monetary policy process are recent additions to the older shortcomings of the monetary policy transmission, with the lack of a bond market and insufficient competition in the lending business. The international slogan of good monetary policy is "say what you will do, and then do what you just said". The RBI must live by its promise of inflation targeting - and back this up with a well-constructed communication strategy.