Interview | Must lower inflation to 4% as quickly as possible: MPC’s Jayanth Varma

Consumer Price Index (CPI) inflation eased to a five-month low of 6.71 percent in July. Even so, it has been above 4 percent for 34 months in a row. Headline retail inflation may not be anywhere near 4 percent by the middle of 2023, with the RBI's most forward-looking projection pegging average CPI inflation at 5 percent for April-June 2023.

Also read: Interview | Indian markets too focussed on US Fed actions: MPC’s Ashima Goyal

Path to 4 percent

For Varma, the inflation mandate is clear—4 percent, with the tolerance range of 2 percentage points on either side only a "cushion to deal with shocks". But the effects of a crisis have to be dealt with quickly and inflation returned to 4 percent otherwise the economy would be "utterly defenceless against the next crisis," he said.

"The moment the pandemic abated, we should have focused on bringing inflation down to 4 percent because that is what prepares us for the next crisis. And what we have seen is that we got too little time for that," Varma said.

"Before we had even fully normalised policy post-pandemic, Russia had invaded Ukraine. Who knows what's lurking around the corner now? So we cannot draw comfort from inflation being within the band."

While Varma's comments suggest the MPC is yet to discuss how quickly it wants to bring inflation down to 4 percent, RBI Governor Shaktikanta Das said on August 23 that a period of two years would give the RBI the time to move to the target "in a steady manner without too much growth sacrifice."

Varma, too, seems to be working with a similar timeline in mind. He expects the repo rate hikes announced in May and June to start showing results in early 2023, with any further rate increases the MPC may effect later this year expected to have an impact only by the end of next year.

"If we wanted to reduce inflation to 4 percent more quickly than that, then the pain we would have to inflict on the economy would be very severe. I am not sure we can inflict that pain if inflation is within the 2-6 percent band. The economy is still very weak."

Much of the economic weakness is down to two factors: a distinctively hostile global environment and the possibility of the coronavirus pandemic leaving behind permanent scars. However, Varma is "cautiously optimistic" given early signs of a revival in capital expenditure and post-pandemic recovery in consumption.

Also read: Lowering inflation expectations closer to 4% key policy goal: MPC’s Shashanka Bhide

Braking early

India's growth outlook would have been worse, Varma said, had the MPC not increased the repo rate by 140 basis points since the beginning of May to 5.4 percent in three steps.

Rate hikes of 25 basis points would have allowed inflationary pressures to build up even more and forced the committee to keep increasing the repo rate beyond 6.5 percent, which would have taken a far greater toll on growth.

"If you hit the brake early, you don't need to slam them hard. If you wait until the truck in front is almost in your face, then you have to slam the brakes really hard."

"I have always been a fan of what Milton Friedman used to say, that easy money leads to high interest rates. If you do easy money today, then 6-12 months down the line, you will be imposing very high interest rates on the economy," Varma said.

While the MPC's recent rate hikes may not have been responsible for the fall in inflation from 7.79 percent in April to 6.71 percent in July, Varma said the actions have shown the committee is serious about lowering inflation and will do "whatever it takes to bring it down to target".

"That credibility is very important and without it almost everything else is wasted."

"No frustration"

Varma has been the lone dissenting voice on the MPC for some time now, having wanted a shift in the stance to neutral as well as larger rate hikes.

When asked if being in the clear minority and not receiving any support for his proposals had left him frustrated, Varma asserted that a diversity of views was essential and it would only be a problem when the six members agree on everything at every meeting.

According to Varma, India's experience with a committee-led monetary policy has been a positive one so far as the MPC has "never degenerated into group think".

"I don’t see being in the minority as frustrating at all. We often joke that if two academics agree, then one of them is redundant. All I would ask for is that whatever I have to say receives a patient hearing. And on that I can’t have any complaints at all," he said.

Despite his reservations about the extent of rate hikes announced over the last three-and-a-half months, Varma voted with the majority. Where he has chosen to dissent is the MPC's language on its guidance–that it remains focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. For Varma, this guidance should be dropped altogether.

"Each person has a different interpretation of what 'withdrawal of accommodation' means. I think we should either have a dictionary (laughs) to clarify what we mean by these words—calibrated, withdrawal, focus, and so on. Or we use words that are clear," Varma said, expanding on his views from the minutes of the August 3-5 meeting.

While Varma favours a more quantitative guidance, not dissimilar to the US Federal Reserve's "dot-plot" for the future interest rate path, Das has publically voiced his opposition to such projections.

"The concern has been that if the MPC is too clear about its guidance, it ties down its hands. But if it really believes that, the answer is to drop the guidance and say we will take each meeting as it comes based on incoming data," Varma said.