Have expressed clear preference for front-loaded rate action: Jayanth Varma

I expect the rate-setting exercise to become increasingly data-driven in the months ahead, said Varma

Jayanth Varma, member of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC), says the rate-setting exercise will become increasingly data-driven in the months to come in conversation with Manojit Saha. Edited excerpts:

You haven’t agreed with the phrase ‘withdrawal of accommodation’. What is the alternative?
 

As I have indicated in my statement, I am quite comfortable with indicating that further tightening is needed, but I am uncomfortable with the implicit suggestion that the policy rate will go up to 6.5 per cent.

I offered two alternatives in my statement. One, to provide quantitative projections (by each member) of the future path of the policy rate. That would have given a clear sense of the likely magnitude and pace of future tightening, while also highlighting the diversity of views within the MPC on this issue. Two, was to drop the guidance in favour of a data-dependent decision-making by the MPC.

One of the members said a small positive rate is good enough. What is your perspective on the real rate of interest? What should be the appropriate real interest rate? When do you think we will attain that real rate?
 

Most estimates of the neutral or natural real rate are between 0.5 per cent and 1.5 per cent. If inflation is within target and growth is satisfactory, we should aim for a small positive real rate somewhere in this range.

The challenges for the MPC are twofold. One, as we approach the neutral rate, it becomes necessary to choose our best estimate of the neutral rate within this range of 0.5-1.5 per cent, and this is a challenging task.

Two, the policy rate needs to be higher than the neutral rate when inflation is above target (as it is now), but the policy rate needs to be lower than the neutral rate when growth is unsatisfactory (as is likely to be the case currently).

After determining the neutral rate, the MPC has to decide whether to adjust it upward or downward, based on projections about future growth and the inflation trajectory.

Given these complexities, I expect the rate-setting exercise to become increasingly data-driven in the months ahead.

As far as pace goes, I have expressed a clear preference for front-loaded action which I believe will help reduce the terminal repo rate that is needed to accomplish the mandate of the MPC.

Do you think there is a downward bias to the RBI’s inflation projection since projection is made with the assumption of $105 per barrel?
 

The assumption of $105 per barrel took into account the spot and futures market prices of crude oil in the beginning of August. Since then, both spot and futures prices have fallen considerably. This is good news from an inflation point of view. However, crude is notoriously volatile, and it is important to avoid becoming complacent on the basis of a few weeks of price action in this market. The underlying geopolitical risks have not abated, and a fall in prices is driven more by fears of recessionary trends in the global economy.

There was a view among market participants that the 50-basis point repo rate hike in the August policy was also taken from the perspective of exchange rate. Do you think interest rate should be used to manage exchange rate?

We need to remember that the previous episodes of interest rate defence of the rupee (in 2013, and earlier in 1998) took place before India shifted to an inflation-targeting regime. The inflation-targeting regime enshrined in the statute requires the MPC to take account of inflation and growth.

As such, the MPC does not consider exchange rate management issues while setting the policy rate. There are other tools available to the government and to the RBI (as distinct from the MPC) to deal with exchange-rate volatility, and these tools have been deployed in recent months to stabilise the exchange rate. 

The MPC has enough on its plate managing the trade-off between inflation and growth; and it is a great relief that we do not have to worry about the currency, too.

Do you think inflation in India has peaked?
 

There is good reason to believe that inflation has peaked. However, the global environment remains extremely fluid, and it is necessary to remain watchful and data-driven.

When do you see inflation coming down closer to 4 per cent? Do you think it can happen in the first quarter of next fiscal year, given there would be base effects?
 

Monetary policy acts with a lag, and it would be several quarters before we see the full effect of all the tightening we have done in the past few months. The MPC is firmly committed to bringing inflation back to the target of 4 per cent as quickly as possible without imposing an intolerable growth sacrifice.