Informist, Friday, Aug 23, 2024

--MPC Varma: Voted for only 25 bps cut to move cautiously to 50 bps cut

--CONTEXT: MPC External Member Jayanth Varma's remarks in interview

--MPC Varma: No rate cuts for more qtrs to hurt FY26, FY27 growth

--MPC Varma: Food price shocks, geopolitical events major risk to CPI

--MPC Varma: Won't worry excessively about geopolitical events

--MPC Varma: If rate cut delayed till FY26, growth in FY27 at risk

--MPC Varma: Likely to lose 1% of GDP growth in FY25, FY26

--MPC Varma: Hoping pvt investment revives, cut in real rates helps

--MPC Varma: See medium-term potential growth rate at least 8%

By Pratiksha

NEW DELHI - If the Monetary Policy Committee delays cutting interest rates for a few more quarters, there is a 'serious' risk that the growth sacrifice will be prolonged beyond 2025-26 (Apr-Mar) and into 2026-27 as well, Jayanth R. Varma, outgoing external member of the Reserve Bank of India's rate-setting panel said.

"Monetary policy acts with lags of 3-5 quarters. If monetary easing is delayed till 2025-26, then it would put growth in 2026-27 at risk," Varma said in an email interview to Informist today. "We are already likely to lose 1% of GDP growth in 2024-25 and again in 2025-26. Stretching the losses for one more year would be unfortunate." He believes that since monetary policy acts with lags, deeper rate cuts will not really make up for the lost time.

Among the six members of the Monetary Policy Committee, Varma has been an outlier. He has earlier clearly expressed reservations on the current monetary policy stance of 'withdrawal of accommodation' and has been voting for a change in stance to 'neutral' and a rate cut of 25 basis points in the last four monetary policy meetings. The policy meeting this month was the last one as a panel member for the three external members, including Varma.

The professor of finance at the Indian Institute of Management, Ahmedabad, thinks that the medium-term potential growth rate of the economy is at least 8%. "Stepping up the growth even higher (closer to double digit) would probably require more extensive factor market reforms," he said.

The RBI has projected GDP growth for the current financial year at 7.2%. In its report released in April, the central bank estimated real GDP growth in 2025-26 at 7%.

Varma sees food price shocks as a major risk to inflation. However, his argument of a rate cut is based on the fact that over the last year or so, food inflation has consisted largely of transient spikes that do not spill over into core inflation, he said.

CPI inflation fell to a 59-month low of 3.54% in July, mainly on account of the statistical effect of a high base. This is the first time CPI inflation fell below the RBI's target of 4% since September 2019. Food inflation fell to a 13-month low of 5.42% in July, also mainly because of a base effect. On a sequential basis, the food price index rose 2.8% in July.

In his minutes, Varma had said, "The RBI's projections show inflation bouncing up and down from quarter to quarter, but the trend line is clearly downward, and the projected inflation for the first quarter of 2025-26 is 4.4%."

In its policy outcome this month, the RBI raised its CPI inflation forecast for Jul-Sep by 60 bps to 4.4% while retaining the inflation projection for the current financial year at 4.5%.

Varma also sees geopolitical events as another risk to inflation but feels that the world has learned to live with this risk, and it should not be a point of worry.

Following are edited excerpts from Varma's interview:

Q. You've said that real interest rate of 1.5% is sufficiently restrictive and a reduction of over 50 bps in the repo rate is needed within a short span of time. If you were a member of the MPC in October as well, would you have voted for a 50 bps rate cut?

A. I have written in my statement that a reduction of over 50 basis points in the repo rate is needed within a short span of time. My vote to cut by only 25 basis points is driven by the desire to move cautiously in this direction. So if inflation continues to behave as expected over the next couple of months, it would be time for the second cut. Further cuts would be driven by projected inflation dropping more towards 4%.

Q. Will we need a deeper rate cut cycle if its start is delayed for another six months? How much more will rates be required to cut then?

A. Since monetary policy acts with lags, deeper cuts will not really make up for the lost time. If we keep delaying easing for a few more quarters, there is a serious risk that the growth sacrifice will be prolonged beyond 2025-26 into 2026-27 as well. That is the reason for urgency in cutting rates quickly.

Q. You've not mentioned any risk to inflation. Do you currently not see any risk to the target of 4% inflation?

A. Food price shocks are the major risks to inflation. My argument for a rate cut is that over the last year or so, food inflation has consisted largely of transient spikes that do not spill over into core inflation. Theory also suggests that in the presence of a credible inflation targeting regime and reasonably restrictive monetary policy, food shocks will only lead to a change in relative prices, and would not spill over to core inflation.

The other major risk is geopolitical, but my assessment is that the world has learned to live with this risk, and at this stage, I would not worry excessively about this.

Q. How much will the current level of repo rate hurt growth, if kept unchanged till the end of FY25?

A. Monetary policy acts with lags of 3-5 quarters. If monetary easing is delayed till 2025-26, then it would put growth in 2026-27 at risk. We are already likely to lose 1% of GDP growth in 2024-25 and again in 2025-26. Stretching the losses for one more year would be unfortunate.

Q. You have said that expectations of robust growth depend heavily on an expectation that private capital investment will pick up soon, and that has not transpired as of now. What do you think needs to be done to make this happen?

A. I think the two major reasons are demand uncertainty and cost of capital. Restrictive monetary policy controls inflation by suppressing demand, and until companies see robust demand growth, they may be reluctant to invest despite reasonably high capacity utilisation. High real interest rates make capital more expensive and make capital investment harder to justify in terms of the return on investment. I remain hopeful that private capital investment will revive, but a reduction in the current excessive real interest rate would definitely help.

Q. What can be India's real GDP growth rate over the next five years?

A. I think the medium-term potential growth rate of the economy is at least 8%. Stepping up the growth even higher (closer to double digit) would probably require more extensive factor market reforms.

Q. Do you agree with the view that neutral rate is a theoretical concept on which real world policy decisions cannot be based?

A. It is true that there are numerous difficulties in estimating the neutral rate empirically, but some estimate (whether econometric or judgemental) is unavoidable while setting monetary policy.

Q. You were the first MPC member to vote for a rate cut in this cycle. Do you feel you're missing an opportunity to participate in a policy pivot, with your term ending before October?

A. What is important is that interest rates are lowered to more reasonable levels quickly. Whether I am part of the MPC that takes this step or not is totally immaterial. The issue is not about individuals and personalities, it about the national interest as we can best perceive them.

Q. Was it frustrating to repeatedly dissent and not have the committee turn in the direction you wanted?

A. I do not experience any frustration or not because I can see the scope for honest difference of opinion on these matters. As long as one views dissent as an intellectual disagreement rather than a personal disagreement, one never experiences a sense of frustration.

Q. Do you have any guidance to your successors on this panel?

A. I am not presumptuous enough to offer any guidance to the next MPC. I am sure that they will be bright minds bringing their own independent perspective to the challenging task of running monetary policy.

Q. How do you reflect on your term in the MPC? Do you regret any decisions or any particular decision you would want to go back in time and change?

A. It has been a great privilege to have served on the MPC during these challenging times. I have become more convinced than before that flexible inflation targeting is an effective tool to deal with unexpected shocks of various kinds. All in all, I am quite happy with my experience. End

Edited by Ashish Shirke

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