This paper presents background information to the assessment of competitiveness and exchange rate policy in India, as well as challenges to monetary policy from financial globalization. This paper discusses the role of communication in enhancing the effectiveness of monetary policy and strengthening the financial system in India. Currency derivatives can provide important benefits for financial systems. This paper aims to document the extent to which Indian growth has benefited the bottom of the income distribution and how India can achieve significantly better social outcomes.


This paper presents background information to the assessment of competitiveness and exchange rate policy in India, as well as challenges to monetary policy from financial globalization. This paper discusses the role of communication in enhancing the effectiveness of monetary policy and strengthening the financial system in India. Currency derivatives can provide important benefits for financial systems. This paper aims to document the extent to which Indian growth has benefited the bottom of the income distribution and how India can achieve significantly better social outcomes.

III. Monetary Policy Communication And Transparency1

A. Introduction

1. This paper discusses the role of communication in enhancing the effectiveness of monetary policy in India. Monetary policy worldwide has evolved toward increased transparency in the past 15 years (Figure III.1). This trend partly reflects the adoption by many advanced and emerging countries of inflation targeting frameworks, which put a premium on clear and frequent communications. As India is increasingly scrutinized by external investors, implementing best practice policy in the area of communications would ensure that market expectations are formed efficiently. This in turn would help the central bank address the challenges that India’s increased financial globalization poses to the conduct of monetary policy (see Chapter II).

Figure III.1.
Figure III.1.

Transparency, by Region

Citation: IMF Staff Country Reports 2008, 052; 10.5089/9781451947502.002.A003

Source: Dincer and Eichengreen (2007).

2. In 2004, the RBI took measures to enhance its effectiveness and provide clearer policy signals. At its mid-year policy review, the RBI announced that, while retaining a variety of instruments, it would conduct monetary policy mainly through secondary market operations with government securities.2 It also simplified its operating framework, casting policy in terms of two key policy rates (the repo and the reverse repo rates) and clarifying the role of each instrument. This move increased transparency and reinforced the policy signal of each instrument, possibly eliciting a stronger response from firms and individuals. Timely increases in policy rates since October 2004 have signaled the RBI’s commitment to price stability, moved monetary policy to a less accommodative footing, and avoided the need for a more aggressive move later.3 The RBI has also since 2005 increased the frequency of its formal policy communications by shifting to a quarterly schedule of policy reviews, announcing the date of the next review in the policy statement and accompanying press statement issued at the end of each review.

3. More recently, some in the market have questioned the RBI’s credibility as the need to cope with rising capital inflows has led to policy moves and a change in operating procedures that were not well anticipated by market participants. Since October 2006, capital inflows have averaged $4.6 billion a month, double their level during the past 12 months (Figure III.2). In response, the RBI altered the conduct of monetary policy in several instances, each time surprising the markets. Since October, it de-linked the two policy rates, which had earlier moved in tandem. Since December, it has raised bank reserve requirements five times by a cumulative 250 bps (as against the stated medium-term objective of reducing the cash reserve ratio—thereafter CRR—to 3 percent), and changed twice its procedures for liquidity absorption. Unlike in 2004, the recent moves seem to have reduced transparency and weakened the policy signals, introducing confusion among market participants. Policy measures taken in March-April in the absence of sufficient guidance by the RBI have also led to a perception of weakened independence of the central bank.4

Figure III.2.
Figure III.2.

Capital Flows and International Reserves

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2008, 052; 10.5089/9781451947502.002.A003

Source: CEIC.

4. A clarification of the RBI’s objectives and operating framework and instruments, including the role that the cash reserve ratio (CRR) plays in the new framework, would be useful at this juncture. CRR hikes in late 2006 and early 2007, in conjunction with hikes in the repo rate, were perceived as tightening signals; however, more recent CRR hikes (with interest rates left unchanged) appeared aimed primarily at liquidity management. Clarifying the respective roles of the CRR and policy rates would enable the public to better understand the new policy regime, predict policy decisions, and anticipate how the RBI might react to likely contingencies. Section B argues that more frequent policy meetings together with enhancements in the key policy documents and arrangements surrounding their release would also help clarify policy signals. Section C discusses other communication activities, including building an ongoing dialogue with markets and information sharing.

5. This paper focuses on communications policy but recent communication challenges faced by the RBI also reflect characteristics of the recent conduct of monetary policy and the absence of a clear measure of the cost of living. The RBI’s approach has led to a perception among market participants that RBI intervention in foreign exchange markets to stem rupee volatility (only partly sterilized) has loosened liquidity conditions, undermining the stated goal of a tight stance of monetary policy. The risk is that this strategy will become unsustainable if inflows become large enough, overwhelming the RBI and forcing it to tolerate more exchange rate volatility.5 The public understanding of inflation performance and the outlook is also hampered by conflicting signals sent by indicators other than the WPI, such as the recent divergence between CPI and WPI inflation. Until a resolution of these basic policy and data issues has been achieved, the RBI may expect persistent difficulties in its external communication efforts.

B. Communication of Policy Signals

Strengthening the RBI’s Policy Signaling

6. Two specific issues arise in the signaling of adjustments in the stance of monetary policy: the timing of such signals and their clarity.

  • With regard to the timing of policy signals, the RBI’s approach over the past year has been discretionary. Rather than using the quarterly reviews to announce policy changes—as has been the practice since the 2005 shift to more frequent reviews—the RBI chose to adjust the CRR post-review in December 2006, surprising market participants. Increasing the frequency of policy meetings would reduce the need for such inter-meeting measures, allowing the public to anticipate and prepare for a possible change in policy stance. In other countries, policy decision-making meetings are held 8–12 times a year. The policy stance can still be changed between meetings, but only in the case of an emergency such as risk of financial instability.

  • Expanding on its current practice of announcing the date of the next review following the conclusion of each review, the RBI could also consider pre-announcing the schedule of policy meetings for the year ahead.6 When announcing the schedule, the RBI should make clear that adjustments in the policy stance will only occur on the pre-announced dates except in exceptional circumstances.

  • This also implies that the RBI’s intervention in the foreign exchange market should be fully consistent with the announced policy stance (Heenan and others, 2006). In particular, if the policy stance is tight, the intervention should be fully sterilized to avoid being perceived as a loosening measure.

7. There is also a need for the RBI to improve the clarity of its policy signaling. The current situation is complicated by the fact that the RBI has been using several instruments, not just the key ones identified in the 2004 Review (namely, hiking the two policy rates in tandem to maintain a stable policy corridor, LAF, and MSBs), to achieve its objectives. As a result, some market confusion over the RBI’s signaling appears to be undermining the effectiveness and credibility of monetary policy. Several examples of unclear policy signals are outlined below:

  • The decoupling of the two policy rates in October 2006 created market confusion, sending mixed signals as to the RBI’s underlying adjustment in its policy stance. Market participants expected the rates to be hiked in tandem, as they had been in the past year. Some observers interpreted the decoupling as an implicit decision by the RBI to use the repo rate as its key operational policy rate, reflecting the tight money market conditions prevailing at the time. Others perceived it as a more modest tightening than if both rates had been increased. Still others interpreted the move as a decision not to tighten firmly policy, despite inflation risks (see below). An important first step to clarifying policy signaling is to reestablish a policy corridor, keeping the difference between the two policy rates constant.

  • Another example of the lack of clarity in current arrangements is that the policy assessments on October 31 and January 31 highlighted the need for a firmer policy response7 but the reverse repo rate was left unchanged. Observers unfamiliar with money market conditions would conclude that the RBI decided not to tighten despite inflation risks. In the event, the RBI tightened liquidity via two post-review CRR hikes. The moves affirmed the RBI’s firmer policy stance but, unlike a hike in the reverse repo rate, gave the market no clear indication as to how much of a rate increase was consistent with the tighter liquidity conditions. In the event, lending rates remained unchanged in October, but increased in January by 50 bps (following the December CRR hike) and in March by another 60 bps (following the February hike).

  • A third example of lack of clarity in policy implementation was the February 26 decision to start remunerating excess reserve requirements. The impact of this measure ran counter to that of the CRR hike announced on February 13, adding to confusion among market participants and analysts on the underlying policy stance.

  • A fourth example was the decision on March 2 to limit the absorption under the LAF, which some analysts interpreted as an effective easing of monetary policy.8 Other observers considered it a confirmation of the role of the repo rate as the new RBI’s key operational rate, given that the move effectively made the reverse repo rate irrelevant.

  • Finally, at its July policy review, the RBI raised the CRR but left interest rates unchanged. The market was left guessing what interest rate was consistent with the new liquidity situation.

8. Overall, the emphasis should be on clarifying the operational tool(s) of monetary policy. Currently, it is unclear whether it is the repo rate, the reverse repo rate, the bank rate, the CRR, or other mechanisms that are the main operational tools of monetary policy. Reverting to the earlier system of maintaining a consistent corridor for the repo and reverse repo rates, ensuring that the market rate remains within that corridor by using market based mechanisms such as the stabilization bonds to absorb liquidity, and reducing reliance on the CRR would enhance the clarity of the RBI’s policy actions.9 However, the RBI may consider the use of all monetary policy instruments (including the CRR) warranted under current circumstances. If this is the case, to avoid confusing markets, the RBI should explain and clarify the new operational framework, including the role that each instrument plays in this framework.

9. It would also be helpful to clarify the RBI’s approach to foreign exchange market intervention. Given the market perception that the RBI faces a difficult balancing act between its focus on addressing inflationary pressures and resisting fast rupee appreciation (the “impossible trinity”), it is important to ensure that any intervention does not send conflicting signals. This can be done by establishing a set of criteria for internal RBI use to decide when intervention is likely to be effective and also consistent with the RBI’s stated objectives. In this regard, the RBI could draw on the analysis in De Gregorio and Tokman (2005) and Holub (2004), and also the intervention criteria proposed by the Reserve Bank of New Zealand (Box III.1). Such criteria are tailored to countries’ individual circumstances, but all require the central bank to take a view on equilibrium exchange rate levels (and associated risks), similar to the inflation and growth outlook and uncertainties guiding interest rate decisions. The practice, suggested earlier, of preannouncing a schedule of policy meetings would also minimize the risk that RBI actions in the foreign exchange market (even fully sterilized) are misinterpreted as policy signals.

10. The RBI could also use existing fora such as the FIMMDA (Fixed Income Money Market and Derivatives Association of India) to clarify its approach to market operations. By using these fora more actively, the RBI could help minimize market confusion regarding the implementation of monetary policy (Section C).

Moving the RBI’s Communication Strategy Closer to Best Practice

11. The RBI’s communication strategy already follows best practice in many areas. This section discusses further enhancements that would support greater transparency and effectiveness of monetary policy, including increasing the forward-looking and analytical content of RBI policy documents and modifying arrangements surrounding their release.

The Quarterly Review

12. In general, written policy documents are the primary vehicle for both policymaking and communication of policy decisions. They serve two purposes. First, their preparation should provide a comprehensive and forward-looking framework for discussion among the Governor(s) and advisory committee members as an aid to their decision making. Second, their publication allows the Governor(s) (or monetary policy committee in countries that have such an arrangement in place) to share their thinking and explain the reasons for their decisions to those whom they affect.

13. The RBI Annual Statement and Quarterly Reviews (with the accompanying report on Macroeconomic and Monetary Developments—thereafter, MMD) satisfy these requirements in large measure, and the overall quality of the documents has improved.10 Two changes deserve special mention: the noticeable shift from a simple description to more explanation of developments and the shift to more forward-looking analysis. The suggestions, which follow, are intended to further increase the effectiveness of these reports as communication devices.

14. Some specific areas in which the Reviews and the MMD have improved since 2004 include:

  • The discussion of Inflation Conditions in the MMR is more thorough: in addition to descriptive sections, it now provides an analytical understanding of the driving forces behind developments; it also provides a review of past policy measures, including an explanation of the way in which risks and uncertainties have been taken into account in policymaking.

  • The Real Economy chapter (also in the MMR) now includes a forward-looking discussion of business expectations (based on survey data) and a review of GDP growth projections by different agencies.

  • The Review provides an overview of recent economic and financial developments, as well as a forward-looking assessment of how they are expected to affect the outlook for inflation and inflation pressures.

  • Recent Reviews provide a clear explanation of how RBI’s approach to setting policy in the quarter ahead will differ from that in the previous quarter. For example, the 2006/07 Third Quarter Review clearly stated a shift in emphasis toward managing liquidity.

  • The Review has become quite candid in describing various risks and uncertainties, such as lags in transmission, exogenous factors influencing prices, and how these uncertainties are weighed in reaching policy decisions.

15. At the same time, there are a number of areas and elements where further improvements can be made. The suggestions that follow pertain to the Review. Substantive changes could be introduced over a few quarters (changes involving the development of new statistics and data—highlighted in italics—could be implemented over 1–2 years).

  • The overlap between the Review and the MMD could be eliminated, by shortening the descriptive parts in the former (already discussed at length in the MMD). Even the more analytical parts of the Review, such as the discussion of financial markets’ responses to past policy measures, could be shortened if, as suggested below, the MMD itself took a less descriptive, more analytical, approach.

  • The Review could be much shorter (best practice is to keep the statement under two pages—compared to 52 pages in the October Review). It could emphasize only new information since the last Review, perhaps in the form of bullet points. Should the RBI implement the suggestion of adding an additional policy meeting in between reviews, only an interim Review would be published at these meetings (the MMR would continue to be issued quarterly). A way to keep the statement short in the absence of the MMR would be to simply supplement it with a package of charts used in the policy meeting for background (as is done for example by Norges Bank).

  • Given the flexible monetary policy framework in India (monetary policy has a dual objective—price stability and adequate credit growth—and uses a multiple indicators approach), it is critical that the Review explain clearly and credibly how considerations other than inflation are factored into decision-making, in a manner consistent with the RBI’s medium-term objective (a 4 percent ceiling on inflation).

  • To this effect, it is suggested that the Review state the Policy Actions upfront (rather than at the end) followed by a discussion of the outlook and risks factors and a succinct discussion of macro and monetary developments.

  • It is also suggested that each Review link back to discussion in the previous Review or quarterly MMD in a more specific manner (the link is already present in a general form). For instance, the policy statement could refer to the realization or non-realization of risks included in the previous review. This could help better convey the continuity and inter-temporal coherence in the RBI’s policy approach.

  • Devolving a full section to the outlook and risk factors would present an even more accurate picture of the uncertainties and responses to these uncertainties.

  • The discussion of alternative scenario(s) in the outlook and risks section would enhance transparency and credibility. For instance, the RBI could discuss the inflation and growth outlook under a “no-measures” scenario (e.g., unchanged interest rates). Scenarios exploring the impact of shocks to oil or other international commodities prices could also be considered, as warranted.

  • Finally, the Review could publish an inflation expectations survey and market forecasts of interest rates, in addition to the growth forecasts already published.11

16. Improvements can also be made in the MMD. Some of the suggested changes are substantive, while others (such as the introduction of summaries) could be implemented immediately:

  • The discussion of economic and financial developments still tends to be descriptive rather than analytical, and the big picture tends to be buried in an excess of detail. The value of this chapter could be enhanced by deepening the ongoing efforts to shift the emphasis from detailed description to the driving forces behind developments and how they have been transmitted through the key financial, real, and nominal economic developments. This shift in emphasis would allow the MMD to be shortened and therefore more accessible to interested readers.

  • The following specific suggestions could help shorten and sharpen the focus of several sections of the MMD. The sections on international developments in the Price Situation and Financial Markets could focus only on the global developments that have affected domestic variables and the mechanisms through which this has happened. Another suggestion would be to expand the real economy chapter into two sub-chapters, the first covering Demand Developments (Domestic Demand as well as External Demand and Net Trade) and the second covering Output and Supply Developments. This would help structure the discussion in a more analytical way, conveying to the reader a clear sense of the extent of overheating in the economy and whether the overheating is likely to be temporary (e.g., due to short-term supply bottlenecks) or more permanent. It would also allow some shortening, as the External Economy chapter would be replaced with a shorter discussion under External Demand and Net Trade.

    • The demand developments section would include a discussion of government spending, private investment, and consumption, and other leading indicators such as retail sales, car sales, etc.

    • The supply developments section would include a discussion of labor costs and other indicators of tightness in labor markets such as the unemployment rate, capacity utilization rates, and producer prices. Currently, these indicators, except for capacity utilization rates, are not mentioned at all. There are well-known data limitations in India in this regard: addressing those should be a priority of future data improvement efforts given their importance in policy decision-making.

    • The chapter on the fiscal situation could, like the External Economy chapter, be shortened and subsumed under the Real Economy chapter (Domestic Demand section, under the discussion of government contribution to domestic demand).

    • The chapter on financial markets could be subsumed under a more general chapter on Money and Financial Markets (replacing the current Monetary and Liquidity Conditions chapter). The descriptive parts could be shortened and more emphasis placed instead on reviewing and assessing how the market has responded to past RBI monetary measures and the linkages with global markets.

    • The Financial Markets discussion of asset price developments should be expanded to the housing market, given the growing importance of this asset segment. This would require nation-wide data on housing prices and housing market developments, such as home sales and new construction.

    • In addition, the discussion of interest rate developments in that section could be made more reader-friendly by casting it broadly in terms of short-term versus long-term interest rates.

  • It is also suggested that the RBI discuss developments in core inflation and seasonally adjusted q/q inflation, which would uncover turning points in inflation more rapidly than y/y data. When introducing such measures, the RBI should provide analysts with a short note describing how they are constructed (ideally, together with a spreadsheet to eliminate all ambiguity). These could also be posted on the RBI website. Eventually, the CSO could be responsible for the production of core inflation measures. Research suggests that the credibility of core inflation measures calculated and published independently by statistical offices is less likely to be questioned, than if the measures are produced by the central bank (Heenan and others, 2006).

  • Parts of the discussion of recent economic and financial developments still tend to be backward-looking. To advance the ongoing shift toward a forward-looking emphasis, the MMD could more systematically relate the developments to inflation forecasts. For instance, the RBI could consider concluding the Price Situation chapter with a section on Short-Term Inflation Prospects. The latter would discuss factors likely to influence price developments in the near-term, such as recent supply developments (food, energy, and international prices) and the extent to which they may have a more permanent impact on inflation. In addition, the section could discuss how it expects the effect of administrative measures (such as export and futures trading bans and hikes in administered prices, e.g., for energy) to play out.

  • Such changes and shortening would make room to add a new chapter on the economic outlook, covering the whole economy and transmission mechanism. It would discuss the RBI’s inflation and growth projections and attendant risks; determinants of future inflation (including prospects for energy and import prices, labor costs, inflation expectations); and the outlook for demand (consumer spending, government spending, and private sector investment); and GDP. This would require that the RBI develop surveys of wages and inflation expectations, and other such metrics of expectations and labor costs.

17. The table below illustrates a possible new structures for a streamlined Review, supported by a more analytical, forward-looking, MMD:12

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Or an alternative scenario deemed appropriate by the RBI.

The Release of the Annual Statement and Policy Reviews

18. A review of the arrangements surrounding the release of the Annual Statement and Reviews suggests that they already follow best practice in many areas.

  • The press release states upfront the decisions regarding the setting of the policy instruments, thanks to the introduction of a useful “Highlights” section.

  • The release of the policy decision is accompanied by a press conference at which the basis of the policy decision is explained, followed by a Q&A session.

  • A webcast of the conference and Q&A session is also available on the RBI website for the benefit of market participants and members of the press.

19. A number of changes might be made that could further improve the efficiency and impact of these events. Changes would aim at streamlining and standardizing communications activities on the days that policy decisions and the MMD are released.

  • The effort to shorten and focus the press release (from 22 pages in May 2004 to 5–6 pages at present) is a welcome step. Further efforts could be made—best practice is for press release to remain under two pages in length.13

  • It is recommended that the RBI also make presentations of the MMD when the report is released.

    • The first presentation in the morning of the release should be restricted to the press, but a webcast could be made available on the RBI website for the benefit of market participants.

    • A second presentation would be made in the afternoon, to a restricted audience of market analysts, academics, and government officials. This would provide the opportunity for more in-depth discussion with the more sophisticated audience. Such an opportunity would improve market understanding of the basis of policy decisions. Officials in the ministry of finance, CSO, and other government agencies that may be interested in better understanding monetary policy should be invited to attend.

  • It is suggested that the RBI Governor consider following the common practice of discussing the main quarterly Reviews or just the Annual Policy Review (and supplementary background documents) with a relevant parliamentary committee. Even if such appearances are not required, they would help build broad political support for the policy framework (Heenan and others, 2006). The practice is also recommended in the IMF Code of Good Practices on Transparency.

  • Finally, the RBI could at a later stage consider the publication of minutes of the policy-making committee (also a practice recommended in the Code of Good Practices), although followed by only a few central banks worldwide.

C. Other Communication Activities

20. In the current more open financial environment, it is particularly important for the RBI to establish and maintain strong channels of communications (see Chapter II). In particular, reaching out to financial sector participants is key, since they have a crucial role to play in explaining RBI policy to others (investors, etc.) and in influencing wider perceptions of the role of the RBI.

21. The RBI may be able to improve its communications with the financial community by building on and intensifying the ongoing dialogue on policy issues. Senior RBI officials already participate in many existing forums for members of the financial market and business community, and their speeches and interventions in such forums are a key instrument in shaping the policy debate and conveying the RBI’s objectives and policy approach. The Governor also presents the policy statement to chief executives of commercial banks. Establishing a separate briefing for analysts would be an important next step to make such interaction regular and systematic. Along these lines, the RBI could also establish a regular (perhaps semi-annual) round table to discuss policy and forecasting issues with analysts. It could participate in (or establish) a program of workshops or seminars for presenting papers on various research and policy topics. It is important that such contacts take place not just at the most senior levels of the institutions involved, but also at the level of regular economists. Here it would be important to ensure RBI staff familiarity with communication rules, which senior officials of the RBI already observe fully (Box III.2).

22. The RBI could consider sharing information on its approach to forecasting. Transparency in the central bank’s research will help bolster confidence in its capability and commitment and help educate markets about the functioning of India’s economy. Without sharing precise functional forms or parameters of its forecasting models, it could share information on the forecasting framework, the types of short-term forecasting models used, the basic structure of the medium-term model, and general form of the equations, and the approach taken to parameterization. At some point, the RBI could prepare and present a paper explaining more in detail the full model(s).

23. External communications can also be enhanced by providing much more basic information on monetary policy through the RBI website. While the site already provides a wealth of information and data, including publication of all speeches given by the Governor and Deputy Governors, it lacks a basic description of the monetary and policy framework. The best practice would be to post under the “Policy Documents” subdirectory—which already includes links to previous policy documents—a schedule of future policy releases, as well as documents describing the basic building blocks of monetary policy:

  • The framework for the RBI’s monetary and exchange rate operations, including the details of the various instruments, facilities, and regulations and links to relevant documentation, research, and data.14

  • The policy framework, including the RBI’s legal framework (already featured under another section) and the broad lines of the policy decision making process.

  • The RBI’s understanding of the monetary policy transmission mechanism.

24. Additional actions the RBI could take to improve the broader dissemination of information on the MIA framework and its approach to policy issues include.

  • Publishing a series of pamphlets containing basic explanations of various aspects of the MIA framework. These could be posted in a new “Education” section on the website.

  • Expanding on the Frequently Asked Questions (FAQ) section on the website: the existing chronological list of postings is a good start, but the presentation of Q&A could be standardized to make it more user-friendly, and the coverage of topics expanded. The Federal Reserve Bank’s FAQ section provides an excellent example.15

Criteria for Intervention

Central banks in several countries have adopted internal criteria to ensure that intervention is effective and does not undermine policy credibility by providing signals about the future course of monetary policy that are inconsistent with the stated policy objective(s). For example, under an inflation targeting (IT) regime, any intervention in the foreign exchange markets needs to be consistent with the medium-term inflation target objective. When countries are classified as free-floaters, they may still reserve the right to intervene, but intervention should be sporadic enough to not warrant a change in classification.

Intervention criteria vary according to the individual country circumstances:

  • Countries with freely floating exchange rates and where risks associated with financial and price instability are low limit intervention to exceptional circumstances in the exchange rate market. For example, following the shift to a free float in the late 1990s, the central bank of Chile retained the right to intervene when it believes that the exchange rate is becoming misaligned. Interventions—including dates and maximum amounts—are pre-announced, in order to work through the information channel (empirical studies find this channel to be more effective, the larger the uncertainty in the market, as measured by exchange rate volatility). Lack of effectiveness indicates that exchange rate movements could result from a need for real currency depreciation. Therefore, intervention is limited in time; it does not target a particular level, but rather aims to avoid an excessive weakening of the currency that could raise inflation. In practice, such interventions have been rare and not automatic, involving actual $ sales well below the announced maximum.1/

  • The Bank of New Zealand follows similar criteria for intervention, with an additional requirement of consistency with the IT regime. Specifically, before intervening the Bank of New Zealand needs to be satisfied that the following criteria are met: (i) the exchange rate must be exceptionally high or low; (ii) the exchange rate must be unjustified by economic fundamentals; (iii) intervention must be consistent with the Policy Targets Agreement; and (iv) conditions in markets must be opportune and allow intervention a reasonable chance of success.2/

  • Countries with managed floats and inflation targeting (IT), like the Czech Republic, retain the possibility to intervene “in the event of excessive volatility or unjustified exchange rate trends.” In this context, Holub (2004) proposes criteria to ensure regime consistency, based on the idea that interest rates should remain the primary tool of monetary policy and interventions (if any) should work in the same direction as interest rate changes. In practice, this would mean that interventions against appreciation are admissible only when: (i) the inflation forecast undershoots the target and/or the output gap is negative; (ii) the interest rates are relaxed and/or declining; and (iii) exchange rate developments are viewed as a direct cause of target undershooting, i.e. the currency is judged to be misaligned in relation to fundamentals or moving in that direction quickly. In practice, the criteria need not be adhered to rigidly, but can serve as useful guidance to avoid a possible credibility loss from sending mixed signals.3/

1/De Gregorio, J. and Andrea Tokman R., 2005, “Flexible Exchange Rate Regime and Forex Intervention,” in BIS Papers No. 24 (Basel: Bank for International Settlements).2/Eckhold, Kelly and Chris Hunt, 2005, “The Reserve Bank of New Zealand’s New Foreign Exchange Policy,” in BIS Papers No. 24 (Basel: Bank for International Settlements).3/Holub, T., 2004, “Foreign exchange Interventions Under Inflation Targeting: the Czech Experience,” CNB Internal Research and Policy Note (Prague: Czech National Bank).

Rules of Communication: Examples1/

  • It should be assumed that all “off-the-record” discussions with the press will be leaked until a set of rules has been established that the press will abide by;

  • Policy discussions should not take place outside the context of regular Reviews;

  • Policy implications of data releases should not be discussed outside the context of Reviews;

  • Changes in forecasts should not be discussed outside the context of Reviews. In the week prior to any policy meeting, “radio silence” (no speeches, briefings, etc.) should be maintained.

1/Such “rules” are simple guidelines evolved from common sense, which are already followed at the RBI.


  • Chandavarkar, A., 2005, “Towards an Independent Reserve Bank of India: A Political Economy for Reconstitution,” Economic and Political Weekly, Vol. XL, No. 35, pp. 383745.

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  • De Gregorio, J., and Andrea Tokman R., 2005, “Flexible Exchange Rate Regime and Forex Intervention,” in BIS Papers No. 24 (Basel: Bank for International Settlements).

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  • Dincer, N. N. and B. Eichengreen, 2007, “Central Bank Transparency: Where, Why, and With What Effects? NBER Working Paper No. 13303, (Cambridge, Massachusetts: National Bureau of Economic Research).

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  • Heenan, G., M. Peter, and S. Roger, 2006, “Implementing Inflation Targeting: Institutional Arrangements, Target Design, and Communications,” IMF Working Paper 06/278 (Washington: International Monetary Fund).

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  • Malik, R., 2007, “India: Making Sense of RBI’s Hands-Off Approach,” mimeo, JP Morgan.


Prepared by Hélène K. Poirson.


The Market Stabilization Scheme (MSS) was introduced in April 2004 with an initial ceiling of Rs. 600 billion for 2004/05. Issuance of market stabilization bonds (MSBs) has been used since in conjunction with other instruments, such as daily repo operations under the liquidity adjustment facility (LAF), to manage liquidity.


The third policy rate (the bank rate) was left unchanged.


With high inflation seen as a major political liability, the RBI was perceived as being under pressure to tighten policy. The moves in March (hike in the repo rate and CRR) and April (faster currency appreciation) surprised markets as they were not accompanied by sufficient guidance (Malik, 2007). Moreover, the Ministry of Finance’s concurrent statements on inflation may also have contributed to a perceived lack of RBI independence (see Chandavarkar, 2005, for a broader discussion of this topic).


One analyst characterized the main risk to the macro outlook as “RBI finds it too difficult to manage the balance between holding the exchange rate and keeping liquidity conditions tight.”


Pre-announcing a schedule of policy meetings is a relatively recent innovation internationally, but has quickly become standard practice. For financial market participants, analysts, and the media it is helpful to know that adjustments in the central bank’s policy stance will only take place (except in extraordinary circumstances) on the pre-announced dates, minimizing confusion over the interpretation of actions and comments by the central bank.


Analysts perceived the statement as relatively more skewed toward containing inflation than previous statements, which indicated a balance between inflation and growth.


Shortly following the move, call rates dropped below the floor of the RBI’s policy corridor.


The use of CRR can be problematic and puts a premium on clear communication by the RBI, as future cuts in the CRR may be perceived by markets as monetary policy measures, even though they are structural measures (aimed at producing a more level playing field for financial institutions). Such an example of misunderstanding of CRR cuts occurred during the late 1990s when the market interpreted them as a policy loosening.


The frequency of published policy reviews was also increased from annual to quarterly starting in April 2005.


The RBI is conducting an inflation expectations survey, but the results are not publicly available.


The recommended structure for the MMD (resp. Review) is loosely based on the Bank of England’s Inflation Report (resp. Norges Bank policy statements), and is only indicative. Both could be tailored in a way that suits the RBI’s communication objectives.


If the Review is shortened to under two pages as suggested in section B, there would be no need for a separate press release.


Almost all inflation targeting central banks and central banks of advanced countries provide such documents on their websites. Some would provide excellent models for RBI documents. See, for example,,, or

India: Selected Issues
Author: International Monetary Fund