Subbarao Boosts RBI Transparency as India Bond Buying Climbs

By Kartik Goyal - Mar 19, 2012

The Reserve Bank of India’s tomes on interest-rate policy made Subir Gokarn despair when he was a Standard & Poor’s economist. Now a deputy governor, he’s part of the biggest communication overhaul in the bank’s 77-year history.

“That really wasn’t the best way to do it,” Gokarn, 52, who joined the RBI in 2009, said in an interview in Mumbai last month. “Keep it short, keep it straightforward, so it takes five, 10 minutes to read and most people read it.”

Snappier, more frequent reviews of rate decisions and the introduction of guidance on future direction are part of an effort by Governor Duvvuri Subbarao to make monetary policy more predictable and credible in Asia’s third-largest economy. The campaign hasn’t been flawless: Gokarn wrong-footed analysts Jan. 5 by signaling that a reduction in lenders’ cash-reserve ratios would be “premature,” only to cut them 19 days later.

At stake is reducing the RBI’s gap with practices abroad as foreign investors have an increasing role in India’s government- debt market, with their holdings soaring more than sixfold since Subbarao, 62, took over in September 2008.

“The RBI has improved significantly in terms of clarity and frequency of market communication,” said Jahangir Aziz, chief India economist for JPMorgan Chase & Co., who previously worked at the International Monetary Fund. “There have been rather glaring flip flops by the RBI at times while the market for a long time -- and in some cases even now -- hasn’t fully got used to the new rhetoric.”
Briefings Started

On Subbarao’s watch the Reserve Bank has doubled the number of scheduled monetary policy meetings each year, to eight. It now releases minutes of a key advisory committee, and started regular media and analyst briefings.

“The changes that the RBI has enacted have helped improve the perception of external investors,” said Dhawal Dalal, Mumbai-based head of fixed income at DSP Blackrock Investment Managers Pvt., a joint venture with the world’s largest money manager. “They are trying to make the system safer.”

A relaxation of limits on purchasing Indian debt saw international investment in government and corporate debt surge to a record $31.5 billion in February, from $5.1 billion in the month Subbarao succeeded Yaga Venugopal Reddy, according to data compiled by Bloomberg. In November, authorities boosted the ceiling on foreign buying to $60 billion.

Investors also have been lured by yields on benchmark 10- year government securities that are more than twice that of China and South Korea and about four times the rate on similar- maturity U.S. Treasuries.
Bond Lure

Indian government bonds are Asia’s second-best performers this year after Indonesia, among 10 Asian local-currency debt markets monitored by HSBC Holdings Plc.

Subbarao, who pledged greater clarity after taking office, increased the number of scheduled monetary policy reviews in July 2010. Two months later, the central bank gave its first guidance on future action, saying tightening to damp inflation had “taken the monetary situation close to normal.”

In February 2011, the bank began releasing the minutes of the 12-person technical advisory committee on monetary policy, which includes seven outside advisers, along with Subbarao, Gokarn, and other RBI officials. The records revealed that the governor sometimes went against external guidance, such as on Jan. 24, when he left borrowing costs unchanged for a second month even after most outside advisers called for a cut.
ICICI Sees Clarity

“There is more clarity in the language of the policy statements and forward guidance on policy actions,” said N.S. Kannan, chief financial officer of ICICI Bank Ltd., India’s second-largest lender. Subbarao “has made the RBI more transparent through an effective communication policy,” he said.

As India’s economy increased sixfold from 1993, central bank practices struggled to keep up, retaining a preference for the 100-page policy documents full of repetitions and ambiguities that disheartened Gokarn. India’s gross domestic product has risen to 10th in the world, from 15th in 1993, reaching $1.84 trillion last year, according to IMF data.

Pressure for overhauling the RBI’s policy making escalated when the global financial crisis deepened in 2008, requiring faster action than afforded by the bank’s four scheduled rate- setting meetings. The Reserve Bank embarked upon a string of changes to rates or lenders’ reserve requirements at 11 unscheduled meetings in a period of about three years.

A total cut of 400 basis points off the cash reserve ratio and 425 basis points off the repurchase rate after Lehman Brothers Holdings Inc. collapsed in September 2008 “didn’t go down well with the market because of the surprise element,” Subbarao said in a speech in New Delhi in January 2011.
‘Unclear and Guarded’

“Earlier the RBI was quite secretive, even the language was very unclear and guarded,” said Tushar Pradhan, who manages about $1 billion as chief investment officer at HSBC Asset Management (India) Pvt. “The RBI has found that more information helps.”

As recently as 2005, monetary-policy reviews were held on a semiannual basis. Central banks worldwide have overhauled their communication strategies since that time, with the U.S. Federal Reserve accelerating publication of minutes of policy meetings and introducing press briefings, and the Reserve Bank of Australia and Banco de Mexico starting releases of minutes.

“The changes are part of the opening up of India’s economy and markets to the world -- a necessary process if India is to meet its aspirations of becoming a global power,” said Bimal Jalan, who led the RBI for almost six years, until September 2003.
Economic Test

The effectiveness of the increased transparency is being tested as Subbarao contends with slowing expansion amid elevated inflation. Prime Minister Manmohan Singh’s government last month lowered its forecast for gross domestic product growth to 6.9 percent for the fiscal year through March, the weakest since 2009, when the world was pulling out of recession.

India’s benchmark wholesale-price index increased 6.95 percent in February from a year before, quickening from 6.55 percent in January. While retaining a bias toward easing policy in future, the central bank said in a March 15 statement that “notwithstanding the deceleration in growth, inflation risks remain, which will influence both the timing and magnitude of future rate actions.’

Finance Minister Pranab Mukherjee said March 18 that he expects “policy rates to be reversed by the central bank in coming months.” Subbarao said in 2011 it’s an established practice for the central bank governor to meet the prime minister and the finance minister informally close to the policy decision.
Gokarn’s Signal

Among the bank’s challenges is managing periodic liquidity shortages in India’s banking system, which have prompted two reductions in the cash-reserve ratio so far this year.

Gokarn told journalists on Jan. 5 that cutting the ratio -- the proportion of deposits lenders must hold in reserve -- would send a “premature” signal of a change in monetary policy. The RBI then lowered it by half a percentage point on Jan. 24, surprising 16 of 21 economists surveyed by Bloomberg who predicted no change.

While “more frequent communication is positive,” the central bank is “talking too much, too often across many different channels, which causes confusion,” said Rajeev Malik, a senior economist at CLSA Asia-Pacific Markets in Singapore.

Interest-rate swaps, a gauge of investors’ expectations for borrowing costs, also show the market isn’t always buying the bank’s rhetoric, according to Aziz at JPMorgan.
Swaps Market

The swaps rose as much as 18 basis points from Jan. 24, to 8.23 percent, even after the Reserve Bank signaled it’s more likely to cut interest rates. In September last year, the swaps fell to 7.6 percent while the central bank was raising rates.

“There have been long periods when the overnight swap spreads have diverged substantially from the RBI’s policy guidance and subsequent policy action,” said Aziz, a former adviser at the Ministry of Finance in New Delhi. “One doesn’t see that happening very often for example in the U.S. or Australia.”

The new openness doesn’t stop at the doors of the central bank’s headquarters in Mumbai. Subbarao and his four deputies visit villages across India to promote financial literacy in a nation where more than two thirds of the 1.2 billion population live on less than $2 a day. The officials also hold town-hall events where investors can question their decisions.

For investor Mahendra Jajoo, the move toward transparency is a reflection of the rapid changes the country has experienced in the past few decades, since Singh as finance minister in the early 1990s helped lead an effort to reduce regulation and barriers to trade and investment.

“My grandfather used to wear dhoti-kurta, my father shifted to wearing trousers and I wear jeans,” said Jajoo, chief investment officer for fixed income at Pramerica Asset Managers Ltd. which oversees $600 million. “I can’t say that my grandfather’s sense of dressing was bad. He was a person of his time. This is what the RBI has done. The current governor has responded very fast to the changing needs of the time.”

To contact the reporter on this story: Kartik Goyal in Mumbai at kgoyal@bloomberg.net.

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net.
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