Amid All The Uncertainty, India Gets An ‘Uncertainty Index’

Your sentiment and those of many others like you will now be captured in a new ‘India Uncertainty Index’ crafted by staffers at the Reserve Bank of India. The index picks up the sentiment from newspapers, words you use and even what you search for online.

Researchers at the central bank have created three sub-indices, which when combined together, bring us the India Uncertainty Index, according to a working paper released by the Reserve Bank of India on Tuesday.

The Three Sub-Indices...

The three sub-indices for uncertainty developed by researchers at the RBI, are based on an analysis of Google Trends, newspapers and words used in articles to judge whether sentiment is negative or positive.

The Newspaper Index

The first of these indices is based on analytics of newspaper articles from three Indian business news dailies—The Economic Times, Hindu Businessline and The Financial Express.

An article was classified as indicating uncertainty, if they contained at least one keyword from any of these three sets: E containing economy-related keywords; P containing policy-related keywords; and, U containing words related to uncertainty.

An article fulfilling these conditions is classified as an EPU article and is assumed to convey uncertainty, the paper said. The daily count of such articles is computed and measured against the total number of articles published in a month.

The resultant index gives us the ‘Newspaper Index’.

Lexicon-Based Index

Then comes the lexicon-based index, which provides analytics of the kinds of words used in articles.

Depending on whether a word conveys a positive or negative connotation, it is assigned a sentiment score. The list of such words used in this index were borrowed from a 2011 paper authored by Tim Loughran and Bill McDonald. So, for instance, the frequent use of the word ‘able’ is associated with positive sentiment but the use of the ‘abandon’ is associated with negative sentiment. Other such words are assigned sentiment scores as well and finally computed into an index.

“The use of sentiment score as a proxy for uncertainty is supported by the fact that when an economy goes through periods of stress, especially recessions, the public mood turns gloomy in general, along with a rise in uncertainty about the future,” said the RBI paper. “This ultimately gets reflected in newspaper coverage which can be quantified in the form of a net sentiment score.”

The Internet Search Intensity Index

This sub-index captures the internet search intensity of 70 keywords representing fiscal, monetary and trade policies. The number of searches for keywords in these categories are measured against total search volume.

While the search words themselves may not carry any negative connotation, increased ‘uncertainty’ in the economy may prompt people to search for information related to the concerned topic, explained the paper.

And Finally, The Uncertainty Index...

The three sub-indices are used to compute an India Uncertainty Index.

The index, so far computed for a period from 2014-2019, correlates well with major periods of stress in the global or local economy, said the working paper.

“Both domestic and global politico-economic events are captured by the index. It can also be seen that uncertainty in the Indian economy generally increases and remains high during the recession,” the paper said.

But ... How Does It Help?

Ok, so we have India Uncertainty Index. But does it really help us understand or predict trends in the broader economy?

Yes and no.

The RBI paper suggests that the Uncertainty Index may not prove to be the first sign of trouble. The “causality” runs from financial markets to uncertainty, said the paper. “This may suggest that financial markets are ahead of newspapers and economic agents in picking up early signs of any impending risk and/or uncertainty in the economy.”

However, a spike in the uncertainty index will point to weaker macro economic fundamentals ahead. The RBI study showed that uncertainty has a negative impact on three key variables — investment, real GDP growth and inflation expectations.

The results of the study, the RBI paper said, “suggest that financial markets, private investment, inflation and overall economic activity are negatively impacted by heightened uncertainty.”