In recent years, especially after 2008, communication is considered an important component of monetary policy. Theoretically, communication helps in making central banks transparent and contribute to their reputation and accountability. Also, communication plays an important role in managing the expectations of economic agents.
There is empirical evidence to show that better communication policy reduces market uncertainty. Therefore, central banks aim to communicate better with markets to achieve policy effectiveness and credibility, accountability, and reinforce public support for independence. In times of uncertainty, communication policy assumes added responsibility in view of abundant online information. The hallmark of good communication is clarity in analysis, forecast and prescription. In fact, Mario Draghi, president of the ECB, considers communication a monetary policy tool in itself.
In India, since 1991, there has been significant progress in bringing transparency in the formulation of monetary policy. This is in keeping with general public policy, including fiscal policy. In literature, it is increasingly recognised that better communication policy enhances the effectiveness of monetary policy in a market-determined liberalised economic environment. According to YV Reddy, former governor of the Reserve Bank of India, “the need to communicate, by itself, compels far more rigorous thinking and analysis” and “compulsions to communicate catalyse the processes to improve the quality of decision making and by providing a helpful feedback”.
The RBI is responsible not only for monetary policy but also for banking regulation and supervision, management of external sector and government debt. There are constant challenges in each of these sectors and the public, including economic analysts, seek guidance from the RBI. After all, the RBI has professionals with adequate skills and experience, working independently of industry as well as the Government.
Traditionally, the RBI’s channels of communication include monetary policy documents and related interaction with media, speeches by top management, statistical data, and well researched reports, some statutory, on different aspects of the economy.
The monetary policy documents and statements have been shrinking over the years. Illustratively, signals given in the last monetary policy of the RBI announced on December 6, 2017, are hazy. First, monetary policy acknowledges that growth of real gross value added accelerated from 5.6 per cent during Q1 to 6.1 per cent in Q2 after five consecutive quarters of deceleration. While industry registered higher growth, agriculture slackened and services decelerated mainly on account of slowdown in financial, insurance, real estate, professional services, public administration, defence and other services. Construction activity remained tepid and growth in private final consumption expenditure slowed to an eight-quarter low during Q2. Thus, the growth is uneven.
Further, the high frequency data, according to the RBI, suggests a mixed picture of industrial activity in Q3. In October, many significant components of industry such as fertilisers, coal mining, cement, and sale of commercial vehicles recorded contractions. In November, according to the RBI survey, auto sales rebounded while PMI for services contracted.
In this mixed situation, based on trends over the last two years, it can be safely concluded that growth in Q3 and Q4 cannot scale very high to achieve an annual average of 6.7 per cent in 2017-18. The RBI probably has an econometric model that predicts that output gap is closing and therefore, in quick quarterly succession growth can rise to 7.2 in Q3 and 7.9 in Q4. In view of transparency and better communication, the RBI can share such a model with economic analysts in the country.
This analysis of growth is important for policy repo rate (PRR). If the actual growth path is lower than the predicted growth path, then retaining PRR is difficult to justify. The RBI should have explained through more convincing communication the reasons for retaining PRR at 6 per cent. There is also a need to share what the real rate of interest is that the RBI targets. Inflation, measured by CPI as well as WPI, has been at a historic low in the last few months, yielding real rate of interest of more than 3.25 per cent. If the projected inflation is expected to be in the range of 4.3 to 4.7 per cent in next four months and PRR is being retained at a neutral stance of 6 per cent, then the real interest rate would average around 1.5 per cent.
Need for guidance
The economy is recovering from demonetisation and is in the midst of implementing a pathbreaking fiscal instrument, the GST. In such uncertain times, when guidance is most needed, the monetary policy document has been shrinking as also the time dedicated by the RBI management to interaction with the media. On other crucial issues such as a rising level of non-performing and stressed assets, the emerging trend in digitisation, and implication of GST on banking, the policy document as well as media interaction did not provide any clarity. The hastily prepared mint street memos are at best supplements, but no replacement for well-researched documents like the erstwhile theme-based detailed report on currency and finance.
In view of inflation targeting in India, monetary policy, instead of becoming more transparent, has become like a black box. In return, analysts and academicians suffer suffocation due to inadequacy of independent and rigorous economic analysis from the RBI. To supplement the results of the econometric model given the dynamic economic situation in India, the RBI could consider initiating work on Beige Book, similar to the US Fed or Agents report of the Bank of England. Similarly, RBI could consider theme-based research seminars, conferences and workshops on topics that need urgent attention on a semi-annual basis. As recently adopted by the IMF, the RBI could encourage academic participation in RBI-sponsored conferences, by providing the opportunity to publish research in RBI’s prestigious in-house Occasional Papers . RBI chairs, more than a dozen in number, can provide research support in such an endeavour.
The writer teaches economics and social sciences at IIM-Bangalore