Giving forward guidance is questionable, says Y V Reddy

Reserve Bank of India Governor Y V Reddy has defended the central bank's practice of not providing forward guidance on inflation and interest rates.

"The appropriateness of doing the thinking on the course of markets for participants rather than allowing them to do it is a questionable practice," Reddy said, speaking at a symposium on the 'sources of central banker's influence over the economy' organised by the Bank of England in London.

"We, in India, prefer to provide detailed information and share relevant analysis fully to influence expectations but are hesitant to give firm inferences from analysis or forward guidance," he said.

Reddy pointed out that almost all central bankers prefer to inform and fall short of guiding. The only notable exception to this practice was former US Federal Reserve Chairman Alan Greenspan, though his successor Ben Bernanke is clearly revisiting the approach, he said.

It is a delicate task to make a distinction between inflation monitoring and influencing inflation expectations and giving forward indication. But it is crucial to keep in mind such distinction in policy-making and communication, Reddy said.

Guidance on future course becomes far more difficult when the policy rates of monetary authorities get closer to what appears to be the relevant range of neutral interest rates. The challenge of communication gets more daunting if the inflation expectations are also under stress, he said.

Further, Reddy said financial stability requires the use of interest rate tool, in conjunction with other prudential measures. Sometimes, there could be a trade-off between raising the short-term interest rate and tightening of prudential norms if risks are perceived to originate from certain segments of the market.

In India, noticing the unusual movements in several asset prices (like real estate) in the recent years, the RBI raised risk weights and provisioning requirements by banks for certain classes of assets, he added.