Don't think today's situation calls for negative real rates: Jayanth Varma

Either inflation has to come down on its own or we will have to raise the rate, or it will be a combination of the two, says MPC member Varma

Jayanth R Varma, member of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC), says a discussion should start on whether to send out quantitative guidance in order to give a greater clarity to the market about central bank actions. In an interview with Manojit Saha, Varma says modest growth sacrifice is inevitable to bring down inflation. Edited excerpts: 

You said the RBI still needs to do a lot of catching up, the MPC minutes showed. Repo rate has been hiked by 90 bps since May. How much more repo rate hike will you see by the end of 2022?

What I was highlighting was that the inflation has been rising faster than the repo rate. Ninety bps look large and a decisive action, until you see that the realised inflation has shot up by more than 100 bps and even the projection for the entire financial year — which is forward looking — even that has risen by 100 bps. Either inflation has to come down on its own or we will have to raise the rate, or it will be a combination of the two. Right now, the real policy rate is strongly negative, not just based on April, May numbers, but based on FY23 projected numbers. I do not think the situation today calls for negative real rates.

When do you see the real rate becoming positive?

I don’t know… because part of the inflation surge which has happened is due to the Ukraine situation, which is global in nature. If that global environment stabilises, if crude oil prices come down, good monsoon leads to a drop in food prices and so on — all of these could bring inflation down. But if inflation remains elevated, then the response has to be by raising the nominal rate. And how fast we can do that and how long it will take, I really do not know.  

How much growth sacrifice is tolerable in the current circumstances?

I think the situation is a lot different from 2020 or early 2021. At that time the pandemic was wreaking havoc on the economy and at that point in time it was unacceptable to worry about anything other than recovery. The MPC was quite explicitly prioritising the recovery over inflation. But today the situation is different. The economic recovery is quite robust. We are also at a point where inflation itself poses a threat to the recovery. Because real income has eroded, people are not buying products. Inflation itself has choking demand. When I look at these factors, the MPC has rightly changed its priorities. Inflation is in the intolerable zone, some modest growth sacrifice is inevitable because we have to bring inflation down. MPC cannot ignore growth, but it cannot impose unacceptable growth sacrifices.

Does that mean your views are more aligned now with the rest of the MPC members as compared earlier?

Yes, that is true. I see the big difference as how the pandemic was shaping up. Around the middle of 2021, I started feeling the pandemic was over in economic terms. The damage it was doing to the economy was abating, by the middle of 2021. So I became a lot more optimistic about the economy. I think that is where the divergence was. For several months, the rest of the MPC was still worried about the pandemic, when I had stopped worrying from an economic point of view. I was arguing a year ago that it was a health issue and not a monetary policy issue. That was the biggest source of disagreement. Now I think everybody agrees that the pandemic is no longer an economic issue.

Some of the members indicated that if the MPC fails to meet the inflation mandate, it is mainly due to external factors. Seventy-five per cent of the rise in inflation since February is due to the war in Europe. Do you agree?

Well, I agree with that. But I also think that when all of us joined the MPC, we joined very knowing clearly what was the mandate given to us. The mandate was very clear, 4 per cent, +/-2 per cent and three quarters. There were two kinds of leeway given, one you can deviate from the target — the target was 4 per cent, and you can go to 6 per cent. Second is that since monetary policy acts with lag, if you start doing something today it will not bring inflation down tomorrow so you need some time to deal with any event that happens and the time that was given to us is three quarters. This is what all of us signed up for…anybody joined MPC accepted this.

When we accepted this, I think that however valid the excuse is, you know, the MPC should not be trotting out that excuse.

It is perfectly open to the government to say that, yes, we recognise the situation that has happened and, you know, the government can condone that (by) saying that because the inflation target is set by the government. I do not believe that the MPC should be chasing excuses. MPC should accept and has the humility to say that this is what has happened.

In the minutes, you have said, “as the MPC navigates this process of withdrawal, there is merit in signalling the likely pace of this tightening in more quantitative terms.” Do you think MPC members should put in a dot plot in the lines of the US Fed, giving their projections on inflation and interest rates?

That statement in the minute is based upon my readings that for the past several meetings analysts have not been able to understand how the MPC is positioning itself. The analysts had great difficulty in figuring out how fast we will raise rates, for how long…There is a stance of withdrawal and things like that which I think is too qualitative and they are not able to communicate the MPC’s intentions. More quantitative things would help.

The dot plot is one to do that. But I am not saying we should blindly follow what other countries do. We can think and adapt it to Indian conditions. We can have a better way to present it.

What I like to see is a greater deal of discussion about this. First of all, does quantitative guidance help? Second is, if the MPC is in a position to give quantitative guidance. Third would be in what form it would be provided. Fourth, how quickly can we provide it? Because this would need some preparation.