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Informist, Wednesday, Jun. 18, 2025

 

Please click here to read all liners published on this story

--Jayanth Varma: RBI rate cuts to support econ, but with lag of few quarters
--Jayanth Varma: Fincl system, real econ frictions to slow rate transmission
--Jayanth Varma: 'Neutral' stance to allow RBI to cut rates more when needed
--Jayanth Varma: Real rate near neutral limits space for RBI to cut rates
--CONTEXT:Former external member of MPC Jayanth Varma's comments in interview
--Jayanth Varma: 8% GDP growth achievable, necessary for Indian economy
--Jayanth Varma:Sanguine about inflation, should fluctuate around MPC target
--Jayanth Varma: Recent spike in crude prices too small to be called a shock
--Jayanth Varma: See merit in surplus liquidity amid global uncertainty
--Jayanth Varma: Surplus liquidity allows RBI to act quickly on uncertainty
--Jayanth Varma: RBI's responsibility is to keep LAF corridor symmetric
--Jayanth Varma: Makes sense to let rupee absorb global macro-econ shocks
 

By Pratiksha

 

NEW DELHI - The Reserve Bank of India's Monetary Policy Committee can lower interest rates further even after the cumulative easing of 100 basis points so far this calendar year, according to Jayanth Varma, former member of the rate-setting panel. However, the space for monetary policy easing has reduced a lot with the real interest rate now close to the neutral rate, he added.

 

Varma's remarks, in an email interview to Informist, are in the context of RBI Governor Sanjay Malhotra's comments that monetary policy now has "very limited space" to support growth. The RBI's MPC unexpectedly cut the repo rate by 50 bps to 5.50% on Jun. 6, and also changed the stance to neutral from accommodative. It also cut banks' cash reserve ratio requirement by 100 bps to 3% of banks' net demand and time liabilities in four tranches starting September.

 

"Limited does not mean non-existent," Varma told Informist. "There is still space for monetary easing though this space is now much reduced as the real rate is now closer to the neutral rate." Neutral rate of interest is the rate which is compatible with keeping inflation at target and output at potential. Real interest rate is the nominal interest rate adjusted for inflation.

 

With India's CPI inflation at an over six-year low of 2.82% in May, and policy repo rate at 5.50%, the current real interest rate is 2.7%. Going by the RBI's forecast of 3.7% for CPI inflation for 2025-26 (Apr-Mar), the real interest rate in FY26 will be 1.8%.

 

Varma--who was several times the only MPC member voting for rate cuts during his term that ended in August--said the recent rate cut will definitely support the economy, but with a lag. The benefits of lower interest rates would be visible only after a couple of quarters, he said. "The long lag was the principal argument for front loading the cuts," he said. "As far as the magnitude of the cuts is concerned, I think the neutral stance would allow the RBI to cut rates further as and when required given the high degree of uncertainty in the global economy."

 

During his time in the rate-setting panel, Varma had expressed reservations on MPC's then stance of 'withdrawal of accommodation'. Instead, Varma had voted for a change in stance to 'neutral' in his last four monetary policy meetings. 

 

On the change in policy stance, he said, "I think this time the actions matched the words: the accommodative stance was followed by a rate cut. Back in the days when I expressed my criticism, the stance talked about "withdrawal of accommodation", while the MPC remained on pause for several meetings at a stretch." 

 

TRANSMISSION AND REAL ECONOMY

Varma said that while monetary transmission of the rate cuts would be relatively quicker, it does not mean it would be very quick in absolute terms. "There are a large number of frictions both in the financial system and in the real economy that slow down the transmission," the professor of finance at the Indian Institute of Management, Ahmedabad, said.

 

The central bank has infused large amounts of liquidity into the banking system for quicker transmission of rate cuts. Apart from infusing INR 5.2 trillion of liquidity through bond purchases at auctions under its open market operations so far, the CRR cut announced at the Jun. 6 policy is expected to infuse another INR 2.5 trillion into the banking system by December.

 

Varma sees merit in a surplus liquidity regime at a time of global uncertainty and persistent dollar weakness. "It (surplus liquidity) provides flexibility to the central bank to act quickly in the face of any unanticipated pressures," he said.

 

The former MPC member, however, highlighted that while rate cuts and higher liquidity certainly improve the availability of credit, the demand for credit depends on consumer demand and corporate investment. "...we will have to wait and see how these forces play out in the ensuing quarters," he said.

 

Varma continues to believe that a GDP growth of 8% is achievable as well as necessary for the Indian economy at this stage of the demographic transition. During the last few MPC meetings of his tenure, which began in October 2020, Varma had argued the medium-term potential growth rate of the Indian economy is at least 8%.

 

The RBI forecasts GDP will grow 6.5% in FY26. The central bank wants the economy to grow as fast as possible, and aspires for a level close to 7-8%, Malhotra said at the post-policy conference on Jun. 6.

 

Varma shares the central bank's optimism that inflation will remain under control. "I am also sanguine about inflation. Absent unforeseen shocks, inflation should fluctuate around the target," he said. 

 

He added that the recent spike in crude oil prices is too small to be called a shock. "Oil going to triple digits would be a different matter, but as of now the futures market does not seem to be worried about that happening," he said. On Friday, Brent crude oil prices jumped over 13% to $78.50 per barrel, the highest level since Jan. 27, after Israel struck Iranian nuclear bases to stop it from developing nuclear weapons.

 

When asked about what the central bank's course of action should be in case of a spike in food inflation, Varma said historically food price shocks have been transitory and in the presence of a credible inflation targeting regime, food price shocks will only lead to a change in relative prices and would not spill over to core inflation.

 

"This implies that when framing monetary policy based on projections several quarters ahead, food prices do not look as frightening as they look when seen in the rear view mirror. But for this to be true, maintaining the credibility of inflation targeting is absolutely critical," he said. 

 

Food inflation remained very high for most part of Varma's tenure in the MPC, averaging over 6% between FY22 and FY25. Food inflation was particularly high in FY24, when it was at three-year high of 7.5%. During this four year period, CPI inflation stayed above RBI's 4% target, averaging 5.5?tween FY22 and FY25.

 

When asked about his views on what should be the operating target for the central bank right now-–the repo rate or the standing deposit facility rate--Varma said the RBI's responsibility is to keep the liquidity adjustment facility or LAF corridor symmetric. 

"In a corridor system, the responsibility of the central bank is to ensure that short term rates remain inside the corridor intervening on either side as necessary to prevent any breach of the corridor," he said.

 

Tuesday, Malhotra had said in an interview with financial daily Business Standard that the RBI will continue to weigh the trade-off between keeping the weighted average call rate closer to the SDF rate for better transmission or closely aligned to the policy repo rate as part of the framework.

 

Varma also said it made sense for the central bank to let the Indian rupee absorb global macroeconomic shocks. Since Malhotra took charge as the RBI governor in December, the rupee has been highly volatile, not only cumulatively but on a day-to-day basis as well, as the global landscape turned uncertain with US President Donald Trump's unpredictable tariff policies.

 

"Globally, there has been a lot of volatility in the exchange rates between key currency pairs," he said. "In such a situation, it makes sense to let the currency absorb some of the global macroeconomic shocks while insulating the domestic economy from these shocks to the extent possible."  End

 

US$1 = INR 86.31

 

Edited by Vandana Hingorani

 

 

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