No justification for $95 oil price assumed in RBI's CPI forecast, says MPC's Jayanth Varma

Varma is one of the three external members on the Monetary Policy Committee.

The Reserve Bank of India's (RBI) assumption on the price of crude oil in its latest inflation forecast cannot be justified, Jayanth Varma, one of the three external members on the Monetary Policy Committee (MPC), told Moneycontrol in an interview.

"In the December meeting, the forecast assumed $100 per barrel (as the price of India's crude oil basket) when futures were at $85 per barrel," Varma told Moneycontrol in an interview following the release of the minutes of the February 6-8 meeting of the MPC on February 22.

"Since then, it has remained at around $80-85, although it goes up and down. The RBI's response has been only to cut the assumption from $100 to $95. Further, more and more of India's crude purchases are from Russia, which is at $60 a barrel," he said.

"Even if we assume that we are buying crude, on average, at $70 or so, to assume that the crude price is $95 — there is no justification whatsoever for that; there was none in December and there is none now," Varma added.

The Indian central bank's Consumer Price Index (CPI) inflation forecast for 2023-24 has assumed $95 per barrel as the price of India's crude oil basket. This resulted in an inflation forecast of 5.3 percent for the next financial year, which economists pointed out was too high and could be undershot by as much as 50 basis points.

One basis point is one-hundredth of a percentage point.

The price of India's crude oil basket so far in February has been $82.3 per barrel, according to data from the government's Petroleum Planning & Analysis Cell.

Some have argued that while global crude oil prices have eased, the retail price of fuel in India has remained unchanged for several months. However, according to Varma, the change in pump prices lags global prices and it is reasonable to assume that retail prices will fall if global crude oil prices are low for a sufficiently long period of time.

January inflation shocker

Days after the MPC decided to increase the repo rate by 25 basis points to 6.5 percent on February 8 — a decision Varma voted against — data released by the statistics ministry showed CPI inflation rose far more than expected to 6.52 percent in January.

The latest inflation number caused some confusion among economists, who pointed out that there seemed to be a discrepancy in the cereals index of the CPI, which was perhaps pushing up the headline inflation rate by as much as 35 basis points.

Varma, though, isn't too worried by the unexpected spike in inflation last month and thinks the issue with the cereals index will get resolved over a period of time.

"The way I look at it is that one month's inflation number doesn't really matter too much because we are looking at inflation over at least one quarter. If there is a blip in one month's number, that should not really matter," said the professor of finance at Indian Institute of Management-Ahmedabad.

Varma has a similar assessment when it comes to the RBI's inflation forecast for 2023-24.

"For two quarters I have been uncomfortable with the inflation projection. But these point estimates don't really matter: 5.3 percent or 5.4 percent. The issue, to my mind, is: where are the balance of risks?"

And, according to Varma, the risks to growth are more serious than risks to inflation.

Hidden demand destruction

Varma's no-nonsense reputation was on full display in the minutes of the February 6-8 meeting of the MPC. His statement was just 165 words long, as he decided against repeating his arguments from December, when he had said India's growth was "extremely fragile and definitely not robust enough to withstand excessive monetary tightening".

Varma, who has opposed the last two interest rate hikes, said it takes time for monetary policy to destroy demand. However, he thinks the demand destroyed by the tightening of monetary policy so far — 250 basis points worth of repo rate hikes since the start of 2022-23 — has been camouflaged by India's K-shaped recovery; growth is not as robust as it looks and too many pain points are accumulating.

"The moment one looks out of what the top 10 percent consume, I think demand destruction is clearly evident. And I think there is a lot more coming. The relentless rise in EMIs (equated monthly installments) is going to destroy demand. It takes time for that to flow through," he explained.

In his short statement in the minutes, the IIM professor said monetary policy had become complacent about growth. In his interview with Moneycontrol, he added that this was the case all over the world, and not just India.

"Globally, monetary policy is being guilt driven — we were guilty in the past of being complacent about inflation and therefore we must now be extra vigilant. To my mind, the response to being wrong once is not to be wrong in the opposite direction. The response is to accept that we are fallible and that we will make mistakes and at each point of time to make the best judgment that's possible and be prepared to correct one's mistakes."

Withdrawal of accommodation

Varma's opposition to the MPC's 'stance' predates his votes against the recent repo rate hikes. And the committee's decision to "remain focused on withdrawal of accommodation" continues to baffle him.

"I thought withdrawal of accommodation meant that we are going back to the February 2019 level (of the repo rate). But we've now reached that point and we are still saying withdrawal of accommodation. What accommodation are we now withdrawing?"

"Does it mean going back to the real repo rate at that point of time? So, I just don't understand that at all. It's not only you who doesn't understand it," Varma said, laughing.

While Varma struggles to understand what accommodation continues to be withdrawn by the MPC, most of his fellow members on the committee do not appear to share his concern, with only Ashima Goyal joining him in voting against this part of the resolution.