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T.C.A. Srinivasa-Raghavan

Signalling is an old and popular game. Cardsharps do it. Women receptive to male overtures do it. Auctioneers do it. Male peacocks do it. Others birds do it. The bees do it. Everyone does it. For several decades now, even central banks have started doing it.

As in the case of the other things, signalling is intended to convey your future intentions. However, there are two important caveats about signalling.

One is that what you want to say should not have already been announced by someone else; the other is that you should not have been told what to signal by someone else. If either happens, the key pre-condition for useful signalling is not fulfilled.

This pre-condition is that there should be an asymmetry of information between the signaller and the intended recipient/s. After all, if what you are signalling is already known, or everyone knows that you have been told to signal what you are signalling, why are you signalling?

The Reserve Bank of India (RBI), which announced its third quarter monetary stance yesterday, needs to ask itself this question.

The Finance Minister and the Prime Minister had both already said that there would be no change in the price of money (interest rates). So what was there left for the RBI signal?

Just one thing: that there is already too much money sloshing around and, since more is on its way, we had better do something about it. Raising the SLR by one per cent and the other things that the RBI announced in respect of export refinance and the special refinance facility for banks, etc., is supposed to be that signal.

But the question does need to be asked: if you see can see the tsunami coming, do you run up a red flag on the lighthouse or do you run like mad?

Since the flood of money is coming our way, why is the RBI only signalling and not doing anything about it? Why is it not running like mad?

The answer, one must assume, lies in the perception that economic recovery has not yet taken hold properly. Well, in that case, surely, the answer was to reduce interest rates?

Oh, no, goes the answer, that would increase liquidity. So why not raise rates then? Oh, no, goes the answer, that would choke off the incipient recovery.

So what do we get? A ‘signal’ that is of no real significance or consequence.

My view is that the time may have come to review this entire business of signalling. It has become orthodoxy and, for that reason alone, it needs a review.

This is not to say that signalling has become redundant. But one of the things that could be reviewed is the entire notion that signalling has to be consistent and that, if it is not, it will confuse the markets.

This leads to the question: why should the markets not be confused by the central bank once in a while? Considering everyone is confused right now, why leave the poor markets out? What is so holy about not confusing them?

My prescription, unheeded as usual, was that the RBI should have cut the rates, even if by only a little and raised the CRR and the SLR, quite sharply, if necessary. But this was seen as sending conflicting signals. To which my question is, so what?

Industry would have been happy at the lower rates (even if not for long) and the RBI would have been happy by impounding more (even if not in reality because the flood of dollars).

Much of the above will sound like gibberish to the orthodox. But I would urge them to think about the importance of being consistent in signalling when information is not asymmetric.

More Stories on : CRR & Bank Rates | Credit Policy | T.C.A. Srinivasa-Raghavan

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