Time for a Reserve Bank of India ‘dot plot’
On 22 September 2016, India’s monetary policy framework took a significant step forward, with the formation of the monetary policy committee (MPC). The Narendra Modi government appointed three scholars—Chetan Ghate, Pami Dua and Ravindra Dholakia—to the committee, a welcome decision. The academics joined three internal members of the Reserve Bank of India (RBI)—Urjit Patel, R. Gandhi and Michael Patra—in determining interest rates for the world’s fastest growing economy.
Why was the MPC created? Why was it hailed as a “revolutionary step in the fight against inflation” by former RBI governor Raghuram Rajan? He cited three reasons: “First, a committee can represent different viewpoints. Second, spreading responsibility for the decision can reduce pressure that falls on an individual. Third, a committee will ensure broad monetary policy continuity when any single member changes.” His assessment consists of three elements: pluralism, independence and continuity, qualities which any institution should aspire to.
Another important expectation was increased transparency in the monetary policy decision-making process. It was clear that inflation forecasts and the accompanying commentary of the MPC would influence India’s public discourse and improve general understanding of how the economy works. The minutes would provide an insight into how the different committee members think.
How has the MPC fared against these expectations? So far, the signs have been encouraging. The RBI has been consistent in its inflation-targeting narrative and is expected to adhere to the inflation “glide path” which was formulated under the previous governor, signifying continuity.
Questions were raised on the independence of the RBI in the context of demonetization, a government decision which technically does not need the central bank’s approval. But, the display of independence from the MPC has been remarkable. It has not buckled under pressure, despite repeated calls for rate cuts from the finance ministry. Add to that, the MPC members refused to attend a meeting called by the finance ministry just before the MPC meeting in June.
When it comes to pluralism and dissent, the MPC seems to have been a slow starter. The first four meetings saw consensus voting, and concerns were expressed regarding “group think”. However, the concerns were quickly allayed as dissent votes were cast in all subsequent meetings, twice by an internal RBI member. A detailed reading of the minutes shows that MPC members have been quite vocal about their individual judgement and position on various issues, including food prices, the Seventh Pay Commission and asset price inflation.
Finally, the MPC’s track record on transparency has been impressive. For every meeting, it identifies individual votes cast by each member on the rate decision. Let’s put this in a global context. In 2009, the Bank for International Settlements surveyed 47 central banks around the world to understand how monetary policy decisions are made. The report showed that 80% of the central banks favour collective decisions, either by voting or consensus. However, only 20% go a step further and identify individual votes cast by MPC members. It is a matter of pride for India that the RBI is among the most transparent central banks of the world on this front.
That being said, there is room for improvement when it comes to forecasting. The current practice is to release a single inflation forecast (fan chart) based on RBI’s model. At times, MPC members have revealed their individual forecasts, especially when they were materially different from the RBI forecast. In the August meeting, Dholakia was the only member to vote for a 50 basis points (bps) rate cut. An important factor influencing his vote was his independent inflation forecast for March 2018, which was 50 bps lower than the RBI forecast.
It might be a good idea for MPC members to reveal their individual forecasts to give a clear picture of the dispersion in inflation forecasts within the MPC. Rajan seems to be in agreement with this view. In response to a question I asked him at his recent book launch, he said, “If you want more transparency (about how MPC members think), maybe the members of the committee, over time, might want to put out their forecasts.”
There is also a lack of transparency about forecasts of the key policy variable: interest rates. Currently, the RBI’s monetary policy stance is expressed in subjective terms as accommodative or neutral. A useful tool to quantify the stance is a “dot plot”, a plot which shows where each member thinks the policy rate would be at the end of the year for the next few years and in the longer run. The dots need not be identified with individual members, as is the case for the US Federal Reserve dot plot.
Since the dot plot is not an official policy tool, it does not bind the MPC and maintains its freedom to revise projections based on new data and events. At the same time, since a dot plot gives a sense of future rate movements, it would be valued by markets, firms and households.
It is amply clear that the MPC’s journey so far has been exemplary. A dot plot seems to be the natural next step in the evolving MPC culture, one that will boost efforts to increase the transparency and accountability of India’s public institutions.
Rohan Chinchwadkar is an assistant professor at IIM Trichy.
Comments are welcome at firstname.lastname@example.org