MPC resolution to remain focused on withdrawal of accommodation confusing: Jayanth Varma

Jayanth Varma, Member, MPC, RBI

The resolution of the monetary policy committee (MPC) in the August 3-5 meeting to remain focused on the withdrawal of accommodation confuses than clarifying the panel's position, according to member Jayanth Varma.

"I now turn to the second resolution to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. This statement confuses more than it clarifies," said Varma.

Explaining his point, Varma said, since the rate hike in the August meeting took the policy rate above the pre-pandemic level, “withdrawal of accommodation” cannot refer to the withdrawal of the pandemic era accommodation.

"It can only mean withdrawal of the pre-pandemic accommodation that began with the rate cut from 6.50% to 6.25% in February 2019. A plain reading of this resolution would then be that the MPC is focused on taking the repo rate back to 6.50%," Varma said.

The MPC hiked the repo rate, or key lending rate, by 50 basis points to 5.4 percent thereby effecting a total of 140 bps hike within a span of four months citing high inflation.

Varma argued that a terminal repo rate of 6.50% is totally unwarranted in the current situation saying the Ukraine war and monetary tightening in the advanced economies have led to a very serious risk of recession in the world economy, resulting in a collapse in commodity prices from April peaks.

"Crude oil remained elevated for longer, but it too is softening even as the MPC meeting is in progress. If this trend continues, we could see significant downward adjustments to the projected inflation trajectory," Varma said.

Also, though the Indian economy has been highly resilient to geopolitical and commodity price shocks so far, the weakening of exports in July indicates that India would not be immune to growth shocks emanating from the rest of the world, the MPC member added.

Varma added a few months from now, the economic data could point to a terminal repo rate that is well below 6.50%. "To focus on one thing implies paying less attention to other things, and I do not think it would be wise to say that the MPC will remain “focused” on withdrawal of accommodation ignoring other considerations," the MPC member said.

Though expressed his reservation on the MPC resolution, Varma refused to mark an official dissent saying clearly that further withdrawal of accommodation is warranted.

"The resolution should in my view be interpreted only as stating that there is a high likelihood of further front-loaded tightening without restricting the freedom of the MPC to respond to the changing environment in a data-driven manner," Varma said.

In the past too, on several occasions, Varma had expressed his dissent on the forward guidance language used by the MPC saying the panel risks its credibility if the guidance is not followed in letter and spirit.

Also, Varma has consistently argued that the MPC's ability to fight the perils of the pandemic is limited considering the limited ability of monetary policy to fight an economic slowdown that is primarily caused by external factors.

The MPC is facing its biggest test in six years as inflation is set to breach the 6% upper band for three consecutive quarters. This means by September, the MPC will have to write to the Government explaining the reasons for failure and suggesting a future road map. Inflation averaged 6.34 percent in the January-March quarter, 7.28 percent in the April-June quarter and is projected to average at 7.1 percent in the July-September quarter.