Economists, journalists and financial market participants have to go through the quarterly ritual of reading the Reserve Bank of India’s (RBI’s) voluminous and dense monetary policy statements. It is at such times that we look with hope to the shorter and pithy announcements of the US Federal Reserve. The press release on the Fed’s 22 January interest rate cut, for example, was all of six brief paragraphs.
Short and clear communication with the world outside the citadel is just one part of a larger change in central banking in recent times. “Transparency is the most dramatic difference between central banking today and central banking in earlier historical periods,” said economists Nergiz Dincer and Barry Eichengreen in a research paper published last year.
There is little doubt that RBI has become more open and transparent over the past few years. But has it become transparent enough? Dincer and Eichengreen have developed an index that measures how transparent various central banks are. RBI does not fare too well here. The average transparency score for the 100 central banks that are part of the index rose from 3.4 in 1998 to 5.2 in 2005. RBI’s score in 2005 was way below average, at 2. This was lower than even the South Asian average of 3.9. New Zealand tops the league with a score of 13.5.
Surprisingly, the Dincer and Eichengreen index suggests that RBI is one of the very few central banks in the world that have not become more transparent between 1998 and 2005. That’s hard to believe. But there is little doubt that we need a policy debate on how central banking in India can be made more open and transparent.
The International Monetary Fund (IMF) has recently come up with a bagful of suggestions on how RBI can improve its functioning. Earlier this month, IMF released what it calls a Selected Issues paper on India, which serves as background material for the fund’s new staff report on the Indian economy. Of the seven selected issues considered this year, one is monetary policy communication and transparency.
The eight economists who wrote the paper say, quite correctly, that RBI has tried to provide clearer policy signals since 2004. (That’s later than most other central banks and, hence, one possible reason why it scores poorly in the transparency index.) But after this preliminary recognition, the IMF staffers have come out with a sharp critique of RBI.
The Reserve Bank needs to improve the way it signals policy changes on two fronts—the timing of these changes and the clarity with which they are communicated to the outside world. RBI, for example, has been far from clear about its policy over the past few years, especially as it tries to cope with huge capital inflows. There is a long list of suggestions of how these two problems can be tackled more effectively. Here, I’ll just mention a few that I personally found interesting:
1. Increase the frequency of policy meetings, from four times a year to 8-12 times a year.
2. Clarify which are its main tools of monetary policy—the repo rate, the reverse repo rate, the bank rate or the cash reserve ratio.
3. Just as it takes a view on growth and inflation, RBI should also take a public view on equilibrium exchange rates.
4. Have better and shorter policy statements. The quarterly review of monetary policy should be kept down to two pages against the current 50-plus pages.
5. Publish the inflation expectations survey and market forecasts of interest rates.
6. A bigger discussion on the housing market, given its importance. That would require data on housing prices, home sales and construction.
7. At a later stage, RBI should consider publishing the minutes of its monetary policy committee.
8. While not providing the full details of its forecasting models, RBI should publish information on the basic econometrics that underlies its forecasts on money, output and prices.
The best central banks in the world now have very clear policy targets, use a limited number of tools to meet these targets and give us a lot of information about the data and discussions that went into an interest rate decision. RBI will have to move closer to global best practices, sooner rather than later.
It cannot do the job all by itself. The government needs to publish better and more reliable statistics on stuff like housing starts, inventories and inflation. More developed domestic bond and derivative markets will also help it pick up market expectations on inflation and interest rates. And a less interfering finance ministry would undoubtedly help.
Together with more transparency at RBI, these reforms will help reduce market confusion about what the central bank is really up to—and make monetary policy more effective.
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