Tower of Babel

Too many government gurus confuse the market

Economists are known to be a fairly harmless lot with a penchant for disagreeing with each other. This can be mildly annoying or simply amusing, depending on one’s perspective, and has given rise to a rather tame brand of “economist” jokes. But when the economists happen to belong to different agencies of the government and differ on their forecasts or their opinion on policy, the discord could have deeper consequences. Take the case of GDP growth forecasts for 2009-10. The Reserve Bank of India has a forecast of 6 per cent for the year. The Prime Minister’s Council of Economic Advisers (CEA) has an official forecast of 6.5 per cent, but recent statements by its chairman suggest that it could revise its forecast up to a range of 7-7.5 per cent. The deputy chairman of the Planning Commission believes that growth could be somewhat higher than 7 per cent. The mid-year review of the economy released by the finance ministry earlier this month forecasts growth at 7.75 per cent or more and the finance minister seems to believe that the economy will grow by 8 per cent.

One could argue that this difference is actually good for policy-making. Dissent rather than consensus creates awareness of the risks associated with policy choices and could make policy-making robust. The problem, however, is the fact that financial markets tend to take these forecasts quite seriously and base investment and trading decisions on them. They also, perhaps somewhat naively, expect the different agencies of the government to speak in a common voice. When the government appears to speak in a “babel” of voices instead, it confuses market participants, often leading to a rise in market volatility. The problem becomes even more acute when there are conflicting opinions on specific policy measures. The recent confusion in the government bond markets over the likely monetary response to food inflation is an example. Officials from both the finance ministry and the Reserve Bank of India have repeatedly emphasised that they view the current inflationary episode as essentially “supply-driven” and hurried monetary action would not have much impact. The chairman of the CEA on the other hand suggested a few days back that if food prices did not abate soon, an “early reversal” in monetary policy is warranted. This led to a sharp spike in bond yields. The 10-year bond yield (a commonly-used benchmark for the bond market), fearing an imminent rate hike, went up by almost a quarter of a percentage point in response to the CEA chairman’s statements. It settled down later as the monetary move did not come through and the fear abated. The global financial and economic environment remains fuzzy and financial markets have more than their fair share of risks and uncertainty to deal with. Government economic agencies might want to desist from adding to this with their cacophony of discordant views. This does not, of course, mean that there should be no difference of opinion between them. But it is perhaps best to keep these behind closed doors and present a more consistent view to the public.