Interview | MPC in agreement about bringing inflation quickly down to 5%: Jayanth Varma

Jayanth Varma, Member, MPC, RBI

Members of the Reserve Bank of India's Monetary Policy Committee agree inflation should be quickly brought down to 5 percent, Jayanth Varma, one of the three external members on the rate-setting panel, said.

"I think there is no disagreement within the MPC that we need to come down to around 5 percent very quickly. That I think everybody agrees," Varma told Moneycontrol in an interview.

"If the (upper bound of) tolerance band is 6 percent, you can't take comfort at 5.6-5.7 percent; any small disturbance could take inflation above 6 percent. So you need to bring it down to the neighbourhood of 5 percent very quickly to give you some cushion to deal with shocks," he added.

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Varma's comments come days after the minutes of the December 5-7 meeting of the MPC suggested the committee may announce another rate hike when it meets next February 6-8, although Varma himself voted against the decision earlier this month to raise the policy rate by 35 basis points to 6.25 percent.

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

Enough already?

The RBI's latest forecasts see inflation averaging 6.6 percent in the last quarter of 2022 and 5.9 percent in the first quarter of 2023. In the first two quarters of 2023-24, inflation is seen at 5 percent and 5.4 percent, respectively.

According to Varma, a professor of finance at Indian Institute of Management Ahmedabad, the MPC has done enough to bring inflation down to well below 6 percent.

Data released days after the committee's interest rate decision showed Consumer Price Index (CPI) inflation fell more than expected to an 11-month low of 5.88 percent in November.

"We have done a lot – 225 basis points to 290 basis points (of rate hikes), depending on how you count it. That's a lot of tightening. The real question is: is that enough? The answer is we don't know because monetary policy acts with 3-5 quarter lags. It is only when 2023 numbers come will we know whether we have destroyed enough demand to bring inflation sustainably below 6 percent," Varma said.

Path to 4 percent

If there is agreement within the MPC on quickly lowering inflation to 5 percent, consensus on the path to the 4 percent target is unclear.

While Governor Shaktikanta Das has publicly said the RBI is committed to lowering inflation to 4 percent over a two-year timeframe, Varma thinks the transition from 5 percent to 4 percent should depend on the growth situation.

"If growth is robust, then the glide path from 5 percent to 4 percent should be very quick. But if growth is fragile, then the question is: do we still want a fast glide path from 5 percent to 4 percent? I would argue that we can be more relaxed on that glide path if growth is really in trouble," he said.

"I really don't know what the rest of the MPC thinks about that. That would become clearer a couple of months or so down the line. But there cannot be tolerance about not bringing inflation down to 5 percent. We can't say growth is really bad, so let's tolerate 6 percent (inflation). We can't do that."

Fear of overtightening

While he had voted for a 50-basis-point increase in the repo rate on September 30, Varma had said in the minutes of that meeting that the MPC should now pause its rate hikes. He backed up his words with action in December, voting against the 35-basis-point rate hike, due to fears of overtightening.

In the minutes of the latest meeting, Varma said the December 7 rate hike was not warranted.

According to Varma, if the growth or inflation forecasts are undershot, then monetary tightening has been overdone. And there is a significant risk of undershooting both, he warned.

The fear of overtightening is not limited to India, with central banks around the world having been quick to tighten monetary policy. According to Varma, central banks will be "equally proactive" in cutting interest rates if required. This, he said, should ensure that the global growth downturn will be short-lived.

"So there is a risk global central banks will overshoot the monetary tightening; I fear that we will overshoot in India as well. But I think in both cases the correction will be very fast."

While Varma was alone in voting against the rate hike this month, he had company in the opposition camp when it came to the 'stance' of withdrawal of accommodation - which the MPC decided to retain - after fellow external member Ashima Goyal joined him in the minority.

For Varma, the most important role the MPC's external members play is to break the group-think in monetary policy-making.

"We are not bound by the house view of the central bank. That hopefully provides room for other analysts to break from that group-think. When we see that monetary policy is often slow to change course, that is a function of the group-think," Varma said.

"If the MPC is split 4-2, it is much easier for that 4-2 to become 2-4."

Asked to comment on the committee's decision to continue with the language of withdrawal of accommodation, Varma reiterated that he did not know what the stance meant.

"I have been saying we need to explain what that really means. I have proposed having a dot plot. But this belief in constructive ambiguity remains. And my view is that ambiguity is always destructive and not constructive."

Fragile outlook

Varma's statement in the minutes of the December 5-7 meeting stood out for its warning on the outlook growth, which he said is "fragile".

"When I say our growth looks fragile, I am talking not of the quite respectable growth rate that we observe now but of the drivers of growth dissipating. Exports, which contributed to growth over the last year or so, have ground to a halt. And the fiscal stimulus can be expected to contract," Varma told Moneycontrol.

Comparing the Indian economy to an aircraft, Varma said it could not fly for long at the desired speed and altitude on just one engine – private consumption.

"One engine has shut down, and another is probably going to shut down. A third engine – capex – has not revved up in the last five years," Varma explained, referring to exports and the fiscal stimulus as the first two engines.

As such, the IIM-A professor is worried about how growth performs in 2023-24, which will see the economy encountering numerous headwinds simultaneously. But when it comes to India's long-term prospects, Varma is more optimistic given the multiple pillars of strength: a young workforce and the resultant demographic dividend, a high savings rate, and economic policies that are conducive for higher growth. Even 2024-25, according to Varma, could look very good as the major worries may be resolved by then.

"But it will look good provided we survive 2023-24 without doing too much damage to the economy. And the fear is that every incremental rate hike is doing damage to the economy."

Fiscal matters

When asked to comment on the upcoming Budget for 2023-24, Varma refused to do so.

"Running monetary policy is hard enough. I don't want to run fiscal policy too," he said, laughing.

Finance Minister Nirmala Sitharaman will present the Budget in Parliament on February 1.

While Varma admitted that monetary policy has to make certain assumptions about what fiscal policy will be to arrive at a decision, the independence of the MPC meant it should also respect the fiscal and not stray into that territory. As such, members of the committee should not be asked what the finance minister should do.

"I think the MPC should not even think about it, forget talking about it. That's my view. Maybe I am too much of a purist."

With the MPC set to announce its next decision a week after the Budget, one will not have to wait for long to find out what Varma and his colleagues think of fiscal policy.