No stance is best stance for monetary policy: Jayanth Varma

My worry is about the risks to the growth forecast, says MPC member Jayanth Varma

Jayanth Varma was the lone voice of dissent in the rate-setting panel against the continuation of the RBI policy stance since he felt it was increasingly making a disconnect with reality. The minutes of the June 6-8 monetary policy committee (MPC) meeting, released on June 22, showed that he termed the stance vestigial at this juncture.

This wasn't the first time that Varma went against the majority opinion on the MPC with respect to the policy stance. The external member in the panel had also argued against the majority view on rate hikes several times.

In an exclusive interview with Moneycontrol a day after the minutes were released by the Reserve Bank of India, Varma in plainspeak said that the policy stance was discordant with the MPC’s course of action.

"Also, the MPC has a responsibility to communicate with the public in a transparent language," he said. Excerpts from the exclusive interaction:

You said monetary policy is now dangerously close to levels at which it can inflict significant damage to the economy. 

The objective of monetary policy is to control inflation with as little growth sacrifice as possible. The current real repo rate is close to 1.5 percent based on a projected inflation 3-4 quarters ahead. At this level, there are worries about the extent of demand destruction that it will cause and the consequent damage to economic growth. Therefore, there is need for fine-tuning the monetary policy in the light of how inflation and growth unfold in the ensuing quarters to keep the real rate calibrated to the optimal level.

You called the stance vestigial. Do you think that the current policy stance/ guidance will pave way for uncertainty, if not confusion, in the markets?

I used the word 'vestigial' because it appeared to me that the wording has been simply carried over from previous meetings without change because it was thought desirable to avoid making any change. Increasingly, the plain language of the stance is discordant with the MPC’s actual actions and its likely future actions. I am told that financial firms and professional forecasters understand the stance well enough and so there is no harm in retaining it. However, I disagree strongly with the idea that the MPC should be communicating mainly to an 'inside' audience of regulated entities in a coded language that does not confuse them. The MPC has a responsibility to communicate with the general public in as transparent a language as possible.

What do you think should be the appropriate policy stance at this stage?

My first preference as I mentioned in my statement a long time ago is not to have a stance at all and, instead, provide projections by individual MPC members about the future trajectory of the policy rate. If that is not acceptable, the next best thing would be a neutral stance since risks are balanced on both sides.

You said the current repo rate is high enough to keep inflation under check… 

Yes, the current real repo rate will, in my opinion, keep inflation within the tolerance band and gradually align it to the 4 percent target. But this process will take time and, as I wrote in my statement, we should not declare victory too early. I think the real repo rate should be kept between 1 percent and 1.5 percent until projected inflation drops close to 4 percent. Monetary policy should focus on the real repo rate and not the nominal repo rate which would have to be set mechanically at the level consistent with the desired real rate.

There are opinions that your views on interest rates have been changing over the last three years…

I argued for upfront, sharp rate hikes to control inflation during 2021 precisely to avoid the high interest rates that we are grappling with today. Milton Friedman used to say that easy money leads to high interest rates, and this is precisely what has happened in India. My desire back in 2021 was to keep the terminal repo rate as low as possible - perhaps 5.5 percent instead of the 6.5 percent today. In my view, the MPC overcompensated for the easy money of 2021 with excessive tightening in 2023, and I disagree with both phases of this cycle. Going forward, we need a real interest rate of 1 percent to 1.5 percent - my preference is towards the lower end of this - until inflation is vanquished. It makes no sense to inflict a growth sacrifice by raising rates and then give up before the tightening achieves its desired goal of bringing inflation down.

The MPC’s key focus now is to bring inflation aligned with the 4 percent band. Is this achievable in near future?

I agree with this statement if rate cut means a cut in the real repo rate, but not if it refers to the nominal repo rate. I do think alignment with the target is eminently feasible since inflation risk has moderated considerably due to lower crude oil and commodity prices as well as the abating of supply chain disruptions. Inflationary expectations have come down and are now well anchored. I expect inflation to be controlled by (a) the lagged effect of the rate hikes that were undertaken during the last year or so, (b) supply side measures by the government, and (c) the lagged effect of declining wholesale prices.

How do you see growth? Do you think the current recovery is sustainable?

My worry is about the risks to the growth forecast. If all goes well, we may well hit or even surpass the forecast growth rate. But there are a lot of things that can go wrong, and the MPC should, in my view, watch out for this. The biggest concern is of course the unfavourable global economic and geopolitical environment. We are an open economy and these global factors constitute a major headwind for economic growth. The second issue is that the government has quite rightly embarked on a programme of fiscal consolidation which withdraws fiscal stimulus to the tune of about 0.5 percent of the GDP. Third, the rate hikes over the last year or so are working their way through the economy, and this is suppressing the domestic demand.

You expressed discomfort with the 'self-congratulatory tone' in the MPC statement. Do you believe that the RBI is under pressure to call victory on inflation fight?

My statement was not really about the future trajectory of inflation. My point was that monthly inflation data is very noisy and is driven by transient factors, and the MPC should not read too much into it. Also, if the MPC did not describe an inflation print of above 7 percent as being the consequence of its monetary policy, it should not make that attribution for a favourable reading. I am confident that the MPC is not under any pressure to call victory on its inflation fight. I see the statement as simply an instance of the self-serving bias which is almost universal, and I think it is necessary to constantly guard against it.

Do you have a feeling that MPC’s inflation forecast of 5.1 percent for FY24 is realistic?

I think it is within the normal band of forecast errors for such forecast horizons.

Finally, should India follow the global central banks on rate approach?

No. I believe that there is a great deal of monetary autonomy for India at this point of time. The inflation situation in India is far more benign than in the US. In the US, inflation is far above their target, their economy is extremely robust and inflationary pressures are more deeply entrenched. We are in a much better position on all these metrics. Let me also add that the exchange rate is not within the remit of the MPC. The whole purpose of an inflation targeting regime with an independent MPC is to insulate monetary policy from exchange rate considerations.