Issues ranging from differences in the nature and availability of data in India and an uncertain global and domestic economic outlook loom as hurdles in the Reserve Bank of India (RBI) adopting a Federal Reserve-style “dot plot,” economists say.
The dot plot is a chart that records each Fed official’s projection for the US central bank’s key short-term interest rate. The dots reflect what each thinks will be the appropriate midpoint of the Fed Funds Rate at the end of each calendar year three years into the future should the economy behave as they expect.
"The dot plot is a good policy guidance to the market on what lies ahead and hence helps in minimising volatility,” Upasna Bhardwaj, Chief Economist at Kotak Mahindra Bank, said. “However, in this highly uncertain environment when sources of inflation are mostly idiosyncratic and supply-led, a Fed-like guidance of three-to-four years does not seem feasible.”
The debate on whether India should adopt a dot plot-like instrument was triggered when an external member of the Monetary Policy Committee (MPC), Jayanth Varma, said that the time was “ripe” for panel to provide projections for the future path of the policy rate.
“This would help stabilise long-term bond markets and also anchor inflation expectations,” Varma said, according to the minutes of the MPC’s June 6-8 meeting that were released on June 22.
According to Varma, the MPC has enough experience to provide a forward-looking view for interest rates, with the RBI having evolved into a “mature” inflation-targeting central bank.
Varma did not elaborate, but he seemed to be suggesting that the six-member MPC provide a forecast for the repo rate similar to that of the US Federal Open Market Committee’s (FOMC) famous dot plot for the midpoint of the federal funds rate target range.
What is a dot plot?
The dot plan represents expectations of FOMC policymakers - both voting and non-voting members – on the extent of rate increases, or decreases, from one meeting to the next. It constantly adjusts its expectations and rates based on economic trends and global events.
Although the dot plot may change with each of the Fed’s meetings, markets seem to prefer having something to predict rather than nothing. This helps provide some financial stability and is aimed at preventing market shocks.
Earlier this month, the Fed hiked the Federal Funds Rate by 75 basis points, the largest increase since 1994, after inflation in the world’s largest economy unexpectedly rose despite expectations that it had peaked.
The dot plot of individual members’ expectations signalled that the Fed’s benchmark rate will end the year at 3.4 percent, an upward revision of 1.5 percentage points from a March estimate.
Not as rosy as it sounds
To be fair, a dot plot could bring out the best of monetary policy in India. It could possibly represent the inflation expectations of the MPC, balanced with the growth outlook, and provide a view on concepts like “neutral rate” and “terminal rate” in a particular cycle. It could also replace the monetary policy stance to an extent.
This could also help provide the markets an additional cue to future rate movements and anchor inflation expectations. It could enhance the RBI’s communication with the markets and prevent volatility in equity and bond prices.
Yet, in the current scenario, and given the nature of available data sets in India, this may not be feasible, economists said.
“India can adopt a dot plot and Summary of Economic projections as the Fed but there will be a few differences due to data availability,” said Gaura Sen Gupta, India Economist at IDFC FIRST Bank. “Regarding the Summary of Economic Projections, India does not have timely unemployment rate data so projections on that will not be possible.”
That apart, forward guidance provided in extremely uncertain scenarios may not be appropriate given emerging markets like India are quite volatile and that could lead to foreign fund outflows from equities and debt, said experts.
Take for example, the constant developments around the Russia-Ukraine war and the rapidly changing around COVID-19 globally.
“More than the dot plot, I am worried about the forward guidance in a highly uncertain environment that can put the central bank in a bind and can delay an action that might be construed as a shock,” said Kunal Kundu, India economist at Societe Generale. “For the central bank, clear communication is very important and clarity should involve accepting the fact that even the central bank may not be certain.”
“Like the Fed, even the RBI has not exactly covered itself with glory especially with regard to its headline inflation forecast,” added Kundu.
He was referring to the RBI raising the FY23 inflation forecast from 4.5 percent in February to 5.7 percent in April and then to 6.7 percent in June, indicating that the central bank “has been behind the curve.”
Independent India economics commentator Karan Mehrishi said dot plots were highly uncertain and "rendered useless" in times of rapid change.
“Fundamentally, India is largely an unorganized economy and a working Phillip Curve does not exist here,” said Mehrishi.
The Phillip Curve is an economic model that says inflation and unemployment have an inverse relationship.
“I therefore, think that a forward guidance tool of this nature will merely be guesswork of committee members and can often be a figment of their imagination,” added Mehrishi.
Some economists said that while volatility in the macroeconomic environment should not be a deterrent to providing guidance, there could be a need for change in some data sets that are gathered and assessed.
“In order to implement a dot-plot like structure the in case of India, the members of the MPC would need to come up with their individual forecasts on gross domestic product growth and CPI (Consumer Price Index) inflation rather than relying upon the common set of forecasts provided by the RBI team,” said Vivek Kumar, economist at QuantEco Research.Even if a long-run policy rate is not projected, MPC members’ projections on where they see the repo rate over the next two-years would be instructive to financial markets, said IDFC FIRST Bank's Sen Gupta.