What the MPC tells us about RBI’s communication strategy

In one of his speeches, recently, Reserve Bank of India (RBI) Governor Shaktikanta Das quoted former United States central banker Alan Greenspan, who once famously quipped: “Since I’ve become a central banker, I’ve learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.” Das was probably trying to explain the evolution of monetary communication, emphasising how far central bankers have come in the age of Reserve Bank of New Zealand-style inflation targeting regime, and accompanied transparency.

While Das and his team have been everything but the stereotype represented by Greenspan, there are certain observations that need further clarity as monetary policies are normalised, and central bank communications tweaked. These observations pertain to the very ingredients of the RBI’s communication along with its ‘credibility building’ strategy among stakeholders.

Regarding the first observation, speaking to this author, IIM Ranchi’s Professor of business communication Rajiv Aricat said, “when communicating policy changes to the public, an institution of national importance must frame the implications in tangible statements, maintain transparency, and, finally, offer choices to the stakeholders.” These can be defined as the three critical components of an effective institutional communication strategy.

Referring to the RBI’s forward guidance communication, clearly, the central bank has successfully followed these principals, and nudged market sentiments in real time. However, given the fact that over the past two years, almost all central banks around the world have acted this way to calm nervous markets, perhaps, the RBI’s feat becomes less impressive.

Where the bankers at South Mumbai’s Fort Area shine though is in their ability to hold the line, when all monetary tools were rendered useless amidst the record domestic liquidity, underwhelming credit offtake, taper-tantrums, and a galloping inflation problem. Facing similar challenges, when most Asian central banks started to modulate their communication strategy to warn their stakeholders of the dangers lurking in the background, most notably the reversal of quantitative easing, the RBI has refused to budge from its targets.

This is where the second observation pertaining to credibility building becomes important. Aricat’s says, “Credibility is linked to public’s trust in the communication. And it is mutually reinforcing – only institutions with credibility can influence public sentiment in a positive way.”

In trying to solve the forward guidance puzzle through her research, macroeconomist Carola Binder reiterates that there are two types of inflation forecasters in the market, recognised by their expectation formation, basis central bank communications.

The first category comprises of ‘credibility believers’, who ardently believe in the central bank’s targets, and consequently use the Phillips Curve to assess inflation. The second category represents ‘adaptive expectation users’, who merely use past inflation data to model future trends. It is so believed, empirically of course, that the former category turns out to be more accurate, with their inflation forecasts matching those of their central bank in the long term.

The interesting bit here is that despite the RBI’s relentless market calming commentary, the Indian forecasting market is largely comprised of the latter, the ‘adaptive expectation users’. This is because an official unemployment variable in India does not exist and, therefore, an inflation assessment using the Phillips Curve is not possible. To overcome this problem, forecasters in India must build independently, complex multivariate models to compensate for standardisation, and risk being too far away from the long-term averages. Something that is not in line with the RBI’s intention of ‘anchoring expectations’ realistically.

The topic of anchoring expectations brings us to the third observation, referring to the monetary policy committee’s (MPC) communication orientation. An MPC can be either individualistic, collegial, or intermediate in how it communicates its decision to the public.

The collegial committee is preferable because it offers the most centralised monetary communication, as all members speak in one voice. According to monetary academics such as Alan Blinder and Charles Goodhart, an individualistic orientation, on the other hand, often “confuses market because of the conflicting signals” that are emanated.

In RBI’s MPC, even though the policy document and the minutes of meeting are published on different dates, there appears to be a deliberate attempt to inform the market, the individual views of the committee members, beforehand. This is done by giving a brief on each member’s vote and explaining their hunch, within the policy document itself.

While the very composition of the MPC, with both internal and external members, contributes to a somewhat collegial output, dissent within the group causes some confusion, nevertheless. The recent difference among committee members concerning the normalisation of the policy corridor, made the MPC’s communication strategy cacophonous and confused forecasters at a time when Das’ statement seemed collegial and devoid of any conflict.

Finally, now that the RBI has allowed ‘growth’ and ‘inflation’ to trade places in its hierarchy of importance, the market is expecting normalisation to start by the next meeting. With the addition of the geopolitical variable, while the tone of the central bank’s communication strategy has slightly changed, it remains to be seen until how long it manages to temper market insecurities without materially changing its policy stance. Perhaps the more important question now pertains to how the RBI’s communication will manage its credibility, if it is already behind the curve.

Karan Mehrishi is economist, specialising in monetary economics and fixed income. 

Views are personal and do not represent the stand of this publication.