There is a new style of central banking in town.
Like its peers elsewhere, the Reserve Bank of India (RBI) has started listening intently to what voices outside the citadel are saying about the current state of the economy and its future direction. The Indian central bank is now regularly quizzing various groups of outsiders on the economy—be it economists fiddling with forecasting models, businessmen poring over sales and inventory data or housewives coming home from the bazaar.
And it is now also sharing this stuff with others. RBI last week released, for the first time ever, the results of its survey of professional forecasters. This release was ignored by much of the financial press, even though it is an important step in the evolution of central banking communication in India.
The public release of the survey data tells us how RBI’s style of operation is gradually changing. The central bank is now increasingly trying to gauge what people expect in the future, rather than being content with official data on what happened in the previous week, month and quarter. So, it is now more keen to state inflation expectations than the actual inflation number released by the government’s statistics office every Friday. It’s looking ahead rather than just in the rear-view mirror.
RBI has been asking 29 select forecasters about their expectations on everything from economic growth and inflation to interest rates and corporate profits. The first such survey was done for the quarter that ended in September 2007. RBI has been using this survey (in tandem with its own internal assessments) as an input in its monetary policy decisions since then. This is the first time it is sharing its results with the outside world. Private businesses and investors would also do well to take a close look at these results to help in their own decisions.
The professional forecasters’ survey has the great advantage of showing that peering into the future is fraught with uncertainties. While there is headline news there—annual economic growth for 2008-09 is expected to be 8.1%, which is less than what was expected by these forecasters three months ago—RBI has also slipped in a lot of probabilistic stuff that highlights the ifs and buts in economic trends.
In other words, the forecasters have been asked what they think is the probability that economic growth will be within a certain range in a given year. For example, there is a 40% probability that economic growth in 2008-09 will be between 7% and 7.9%. This is in welcome contrast to the almost arrogant certainty with which economists divine the future, down to the second decimal point.
Besides the survey of professional forecasters, RBI has also been conducting surveys of business expectations and inflation expectations. In its report on the Indian economy that was released a day before its April monetary policy statement, RBI published the results of its latest survey on business expectations. The results of the survey on inflation expectations— perhaps the most important one right now—are still under wraps.
“The use of statistics has increased manifold and the demand is for real- time or near-real-time data on almost all aspects of life and economy. The system of national accounts and the related accounting system on balance of payments, fiscal and financial statistics provide the basic framework for collection of statistics. As the monetary policy responds quickly to emerging developments in the economy, and its effectiveness depends on market expectations, the set of data required for the same, (such as) business expectations and inflation expectations, need to be collected through quick surveys,” RBI governor Y.V. Reddy explained in a June 2007 speech.
Surveys are just one way that popular expectations about growth, inflation and business conditions can be measured. A more effective way to do this is by keeping a close track on how various prices in the forward markets behave—and that’s because the beliefs of thousands of traders are aggregated in these markets.
In the US, movements in the Fed funds futures tell us a lot about what probability the markets are assigning to interest rate cuts or increases from the Federal Reserve. The traded prices of inflation-indexed bonds are a great gauge of inflation expectations.
India cannot use these prices as trustworthy indications because there is very little trading in the bond markets and prices are dominated by the actions of the central bank. Neither bond prices nor the shape of the yield curve could predict the sudden spike in inflation that we have seen this year. That’s unfortunate.
The use of surveys by RBI is a welcome first step in trying to understand what other participants in the economy expect in the days ahead. The next step will be to create deeper and more liquid bond markets—and a yield curve that is far more than the mere curiosity it currently is. RBI needs to tap into the wisdom of the crowds.
Your comments are welcome at cafeeconomics@livemint.com
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