The Economic Survey 2018-19 introduced a unique idea of Economic Policy Uncertainty (EPU) index, which indicates that a stable policy regime promotes investment activity and economic growth. The Survey says surges in economic policy uncertainty increase the systematic risk, and thereby the cost of capital in the economy.
An increase in economic policy uncertainty dampens investment growth in India for about five quarters. “Unlike generic economic uncertainty, which cannot be controlled, policymakers can reduce economic policy uncertainty to foster a salutary investment climate in the country…policymakers’ must make their actions predictable, provide forward guidance on the stance of policy, and reduce ambiguity/arbitrariness in policy implementation,” it said. EPU index must be tracked at the highest level on a quarterly basis.
The survey pointed out that EPU index for India shows peaks in few months of 2011 and 2012, reflecting the policy paralysis during that period, which witnessed the problems of the high twin deficits and high inflation, thereby exacerbating macroeconomic vulnerability. The index is also high in the second half of 2013 when the economy faced the episode of “taper tantrum” leading to volatile capital flows, depreciation of rupee vis-à-vis US dollar. EPU index is created by quantifying newspaper coverage of policy-related economic uncertainty and it has found to be effective and useful in measuring uncertainty. The EPU index correlates very strongly to macroeconomic stability, the survey said. It strongly correlated to volatility in exchange rate, stock market & inflation and various other macroeconomic variables.
“India has secularly decreased domestic economic policy uncertainty since 2012 and has been exceptional in reducing this uncertainty since 2015 amidst a global environment of increases in the same. However, policymakers need to double down on reducing domestic economic policy uncertainty,” the Survey concludes. It suggests that the government must encourage construction of economic policy uncertainty sub-indices to capture economic policy uncertainty stemming from fiscal policy, tax policy, monetary policy, trade policy, and banking policy. Tracking these sub-indices would enable monitoring and control over economic policy uncertainty.
To ensure predictability, the horizon over which policies will not be changed must be mandatorily specified so that investor can be provided the assurance about future policy certainty, the survey said. While this will generate some constraints in policy making, such voluntary tying of policymakers’ hands is undertaken in several cases including the Fiscal Responsibility and Budget Management Act, the Monetary Policy Framework of the Reserve Bank of India. A similar constraint placed on ensuring no changes in policy for a specified horizon would go a long way to ensuring policy certainty.
Baker et al. (2016) developed the Economic Policy Uncertainty (EPU) index for various countries including India, looking at certain key words appearing in newspapers. The survey adopted the model to arrive at the economic policy uncertainty for India based on articles published in newspaper including Economic Times, Times of India, Times, The Hindu, Financial Express, Indian Express and the Statesman.