Jayanth Varma is the only member in the Monetary Policy committee (MPC) who voted against the continuation of accommodative stance in the August round of monetary policy review. Except Varma, all other five members voted in favour to continue with the accommodative stance "as long as necessary" to revive and sustain growth and continue to mitigate the impact of COVID-19 on the economy while ensuring that inflation remains within the target going forward.
According to the minutes of the monetary policy published on August 20, Varma said at a time when the economic recovery is still nascent, it is extremely important that monetary policy serves as an anchor of macroeconomic stability. By creating the erroneous perception that the MPC is no longer concerned about inflation and is focused exclusively on growth, the MPC may be inadvertently aggravating the risk that inflationary expectations will be disanchored. In that scenario, rising risk premia could cause long term rates to rise, Varma said.
In an interview with Moneycontrol, Varma spoke about views on MPC stance, on inflation and the disagreement within MPC on inflation forecasts. Edited Excerpts:
You have questioned the accommodative stance and the nature of forward guidance at MPC meets. Do you think your arguments have been received with desired seriousness at the panel?
In my experience, the MPC treats the views of all members with full seriousness and respect. I think some degree of difference of opinion is healthy and leads to better decision making in the long run.
Do you think there is a fundamental problem in the way the MPC mechanism works?
You have repeatedly pointed out that the monetary policy’s ability to counter Covid is limited compared with fiscal policy. Do you think that fiscal response has been inadequate?
As an MPC member, I do not want to comment on the fiscal stance. My limited point is that many of the fiscal measures that have been adopted (for example, Direct Benefit Transfer) are highly focused and selective. Monetary policy cannot achieve this kind of targeting to specific groups.
Your notes in MPC minutes highlight the risks of ignoring inflation problem in search of growth. Also, you have pointed out the influence of easy money regime on the asset price inflation. Has MPC moved away from its primary mandate?
I believe that the entire MPC is committed to fulfilling its inflation mandate. The disagreement in the MPC is about (a) whether the inflation that is observed now is persistent or transient, and (b) whether the survey based inflation expectations are showing signs of entrenchment or are transitory. I judge the risks of persistent inflation and entrenched expectations to be somewhat higher than what the majority believes.
What should be the stance of monetary policy at this point, according to you?
My view is that (a) the effective interest rate in the money market should rise towards the current repo rate of 4%, and (b) the future outlook for the repo rate should be neutral.
Is the current inflation targeting framework (2%-6% with a focus on 4%) being followed in letter and spirit?
On this issue, the major source of disagreement is that I see a lot of uncertainty around the point estimates of future inflation. I believe that the range of uncertainty is close to 2% so that inflation can be kept within the band only by targeting 4%. The contrary view is that a proactive monetary policy can contain the forecast errors well below 2% so that even if inflation forecasts are centred at 5%, the realized outcome is likely to be within the band. The difference of opinion is really about the degree of confidence that one has in various economic forecasts and models, and therefore the margin of safety that the MPC should endeavour to maintain.
What is your biggest learning after joining the MPC?
I am still learning! My professional training in finance teaches me to think of most decisions as a tradeoff between risk and reward. Applying this risk-reward analysis to macroeconomic decision making is even more challenging than it is for decision making at the level of individuals and enterprises. And the stakes are much higher than they are in the classroom!
Is there a need for review of the way the MPC operates now?
The MPC is still a relatively young institution and its success must be evaluated over a longer time horizon.
What is your outlook on Covid impact on Indian economy ?
My view is that just as the virus has mutated, the societal response to Covid has also mutated across the world. There is, in my view, an enhanced understanding of the limitations of non pharmacological interventions, and a greater willingness to accept carefully calibrated risks in the pursuit of economic and social goals. I believe that this tends to alleviate the economic consequences of the disease.
What are your views on inflation trajectory for the next one year? Are the RBI surveys capturing the true essence of inflation expectations?
My MPC statement relies on the RBI forecasts which are themselves based on a wide range of inputs including internal models and surveys of professional forecasters, enterprises and households. I am not trying to challenge or second-guess these forecasts, but I am focusing a lot more on the band of uncertainty around these forecasts.