RBI aim is to not have over-tightening or over-stimulus: MPC's Ashima Goyal

Central bank has to target inflation but with 'awareness of nuances',' she says in interview.

At a time when India is in the midst of a rising interest rate cycle, Ashima Goyal, member of the Monetary Policy Committee (MPC), tells Bhaskar Dutta that the aim is not to have over-tightening but to raise interest rates in line with inflation and growth outcomes. Edited excerpts:

You have pointed out in the latest MPC minutes that it is important to differentiate between inflation in the US and India. With domestic inflation running the risk of becoming broad-based, in your view, how targeted should the Indian policy response be?

We are focusing on inflation as the first priority. Even though it is supply-shock led, it has gone on for a long time because of multiple supply shocks. The kind of fuel and food price rise, which the Russia-Ukraine war has created, is worrying because India is particularly sensitive to shocks in these commodities. In the past, they have triggered broad-based inflation. In a number of ways, it is different from the past. For example, in 2011 when we had very high food inflation, we were coming out of a boom where there was very high credit growth. Now, we are coming out of a pandemic-led recession. In that time, you had rural real wages rising in double digits, which was unheard of in India. There was a particular set of factors — the MGNREGA, rise in minimum wages, high rise in MSP prices and large expenditure on construction, which were raising rural demand. These are not there this time. The US had a very large fiscal stimulus as well as huge quantitative easing. Our macro-stimulus was nowhere as large as the US. It has an overheated labour market. Wages are rising. Here in India, you are not seeing that. Average industry wages are flat. That is what really creates second rounds of inflation that makes it persistent — wage price spirals. We are not seeing signs of that as yet. We have to target inflation but with awareness of these nuances.

You also said that India is now coming out of a pandemic-induced slump, and as such, policy needs to focus on recovery. To what extent could the on-going tightening cycle threaten the growth recovery?

What matters for demand is the real interest rate. In the US, where they have super over-heating, currently the real interest rate is minus 6 per cent. In India it’s minus 1 per cent in terms of one-year ahead inflation. And we have much higher spreads. So, our loan rates are higher. If the real interest rate is neither too negative nor too positive – and it’s linked to the recovery – then the negative effect on growth is moderate. The aim is not to have over-tightening or over-stimulus but raising the rate in line with inflation and growth outcomes. For instance, if we see the recovery faltering — so far it seems quite robust — and we see inflation coming down, then the pace of rate hikes will be adjusted accordingly. That’s why we are not committing to a path of rates. It’s because it depends on inflation and growth outcomes. There is a lot of uncertainty. Already in the last two weeks, we have seen some softening of commodity prices and the monsoon seems normal, which may soften the vegetable prices. So, we have to look at outcomes and then decide.

The rupee has been charting new record lows. The finance ministry recently expressed concern about twin deficits. How much of a risk does the economy face from the external headwinds?

When you say it is touching record lows, it sounds fairly sensational. If we just compare with other emerging markets or even Europe, the depreciation is much less. Most countries are depreciating as the dollar strengthens because of large rate hikes in the US. Since India has large reserves and other caps on capital flows — we are not a fully-open capital account — that gives us a very valuable degree of freedom. The rupee’s rate is determined by markets but markets sometimes overshoot, as is happening currently. Fear that more foreign portfolio outflows will lead to more depreciation magnifies outflows. But since we have large reserves, we can intervene. As the domestic market grows in size, volatility in inflows does not affect domestic prices that much. We are seeing that in the stock markets. There are huge outflows, larger than the global financial crisis, but the stock markets have not crashed. There are other investors with diverse positions. The sequencing in our capital account convertibility was meant to welcome foreign flows. They contribute to developing the markets and help finance deficits. But, as long as they come in as a percentage of domestic markets, they do not create so much volatility. Then there is less mayhem in markets, less price fluctuation.

In the April policy minutes, you had spoken about outflows under Fed tightening providing more room for support of the borrowing programme. In the current scheme of things, however, does that still stand, given the RBI’s aim of withdrawing accommodation?

That is true. The RBI’s balance sheet is predominantly made up of its reserve accumulation. So, it holds US government securities much more than Indian government securities.

Earlier, much of the required expansion used to be all foreign inflows, so there was no room to hold government securities. But as we are seeing outflows and some reduction in reserves, that leaves more space for holding more Indian government securities.

It is in the phase of liquidity withdrawal, however. There is excess liquidity, but it has schemes such as the Standing Deposit Facility, the VRR etc to absorb this liquidity as required. And with recovery, we are seeing the excess liquidity going down quite rapidly. So, that gives it some room to support government borrowing.

How much of a concern is the fiscal situation, given the government’s recent decision to cut excise and sharply hike fertiliser subsidy?

Overall, the tax buoyancy is pretty good because GST seems to have settled down somewhat and the base on which tax is levied is improving.

Moreover, whenever nominal growth is high, tax revenues rise. So, because you had somewhat higher inflation, nominal growth is in double digits. That increases the tax-GDP ratio.

When it comes to excise taxes, we have some of the highest rates of taxation on fuel. When international crude oil prices fell they raised taxes. So, they have some room to reduce taxes without it having extremely negative effects.

Allowing oil prices to rise and fall as well is important to sustain inflation targeting. Countercyclical excise taxes help people to look through temporary price hikes. Earlier when we had administered pricing, Indian fuel prices did not rise as much as international prices. But they did not fall when international prices fell, and the overall price rise was higher. Taxes that only rose and never fell would create a similar ratchet effect raising inflation.

Moreover, the government’s Budget estimates were quite conservative. So, they have some room. I don’t think the fiscal situation will deteriorate that much despite the adjustment in taxes and subsidies.