We should accept 4-5% inflation for several quarters, says MPC's Jayanth Varma

Jayanth Varma is one of the three external members on the Reserve Bank of India’s Monetary Policy Committee.

The Indian economy may have to face above-target inflation for a few more quarters so that growth is not adversely affected, Jayanth Varma, one of the three external members on the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC), has said.

"I have been saying for quite some time now that while there is great urgency for bringing inflation well below the upper tolerance band, we can be more patient when it comes to gliding inflation to the target. A more rapid pace of reduction could impose an intolerable growth sacrifice," Varma told Moneycontrol following the release of the minutes of the October 4-6 meeting of the MPC on October 20.

"We should be willing to accept inflation between 4 percent and 5 percent for several quarters as the price of avoiding a growth shock," he added.

Varma's comments come after Consumer Price Index (CPI) inflation returned to the RBI's tolerance range of 2-6 percent in September after a two-month gap, falling to a three-month low of 5.02 percent. However, inflation has now completed four full years above the medium-term target of 4 percent and the central bank's forecasts seem to suggest it may continue to be there for the next 18 months or so, apart from a temporary sub-4 percent print in July-September 2024, before ending the last quarter of 2024-25 at 4.3 percent.

The last few months have also seen the RBI return its focus to the 4 percent target, with Governor Shaktikanta Das saying on October 6 that he wanted to "emphatically reiterate" that the inflation target is 4 percent and not 2-6 percent.

While Varma does not put much stock in a sharp fall—or rise—in inflation in one or two months, Das and he are on the same page. "What we are striving for is a durable fall to the target. I am confident that we will achieve this goal, but I think it will take a few more quarters," he said.

Also Read: Four years of 4%-plus inflation – how RBI lost and is regaining control

Changing expectations

Monetary policy's emphasis on achieving the 4 percent inflation target has left central bank watchers concerned that rate cuts may be further away than they expect. As such, the MPC's long pause – after it hiked the policy repo rate by 250 basis points in 2022-23 – could be more prolonged than previously thought, leaving interest rates higher for longer.

Also Read: RBI doubles down to ward off complacency as long rate pause gets longer

According to Varma, the numerous uncertainties about inflation as well as growth make it difficult to forecast the timing and pace of repo rate cuts.

"The real repo rate has to be maintained around 1 percent till projected inflation 3-4 quarters ahead comes close to the target. But as projected inflation keeps coming down, the 1 percent real rate would translate into a lower nominal repo rate," Varma, a professor of finance at the Indian Institute of Management, Ahmedabad, said.

While economists have now pushed forward their rate cut forecasts close to the middle of 2024, the RBI's latest State of the Economy article said the MPC's October 6 resolution Rate cuts not on the agenda at the moment, says RBI Governor Das. When asked for his thoughts on the same, Varma said he didn't want to comment on it as it was not the MPC's language.

"All that I can say is that neither the policy rate nor the stance has been changed for several meetings now, and in this sense, the operative part of the October resolution is no different from the past," he said.

Also Read: Rate cuts not on the agenda at the moment, says RBI Governor Das

Continuing growth momentum

Unlike the RBI, Varma has previously expressed his concerns about domestic economic growth, having told Moneycontrol in June that one quarter of good growth data did not mean the growth struggle was over. But his statement in the minutes released on October 20 conceded that the growth outlook had improved, albeit "modestly".

India has clocked a GDP growth rate of 6.1 percent and 7.8 percent in the first two quarters of 2023, with the government and the RBI confident that their forecast of 6.5 percent for 2023-24 will be met.

Varma, however, continues to see "significant risks" to growth, although he said data points to "continuation of the growth momentum".

As for India's long-term growth prospects and the government's aim to become a developed country by 2047, Varma said such targets were outside the scope of monetary policy.

"But, yes, I agree that something like 8 percent is the rate that India should aspire for, and in this sense, a world-beating 6.5 percent growth is still below the aspiration level."