Informist, Monday, Aug 26, 2024

--MPC Goyal: Will need steep rate cuts if policy easing delayed

--MPC Goyal: Have space to cut policy rates by 100 bps over one year

--CONTEXT: MPC external member Ashima Goyal's remarks in an interview

--MPC Goyal: No second-round effects of food price shocks

--MPC Goyal: No broad-based pressures on core inflation

--MPC Goyal: Even at 7.2% GDP growth FY25, still below potential output

By Shubham Rana

NEW DELHI - If the Monetary Policy Committee continues to delay easing interest rates, the eventual rate cuts would have to be steep, rather than gradual, to reach the required real policy rate, according to Ashima Goyal, external member of the Reserve Bank of India's rate-setting panel.

Goyal, who has voted in favour of a 25-basis-point rate cut in the last two policy meetings, said there is space for the MPC to lower the repo rate by 100 bps over the next one year based on the inflation forecast of 4.5% for 2024-25 (Apr-Mar).

"But it is important for the MPC to ensure the expected real policy rate does not become too large or too small since this is the variable affecting the primary aggregate demand channel of monetary policy," Goyal told Informist in an email interview after the RBI on Thursday released minutes of the Monetary Policy Committee's Aug 6-8 meeting.

A real rate of interest is defined as the nominal rate minus inflation. A rate that is derived by using an expected rate of inflation is defined as an expected real rate. With the repo rate at 6.50% and the RBI projecting CPI inflation at 4.5% in 2024-25, the real expected interest rate would be 2%.

While Goyal and another external member of the committee Jayanth Varma voted to lower interest rates, the six-member MPC voted with a 4-2 majority to keep the policy repo rate unchanged. The majority of the committee members cited high food inflation, and headline inflation staying above the 4% target, as reasons to keep the repo rate at 6.50%, a level where it has been since February 2023.

Goyal, however, does not share the broader concern over inflation. The Indira Gandhi Institute of Development Research professor said that there have been no second round effects of high food inflation, and there are no broad-based pressures on core inflation as well.

"My vote was also for a pause for long in order to see if there were second round effects of food shocks. But they have not occurred," she said. "So, it is time to learn from this experience."

This was Goyal's last meeting in the MPC. She, along with fellow external members Jayanth Varma and Shashanka Bhide, were appointed to the committee for four years in October 2020. While the term of the three members will officially end on Oct 4, the rate-setting panel is scheduled to next meet on Oct 7-9, meaning the next meeting will see a new set of external members.

When asked if it was frustrating to repeatedly dissent and not have the committee turn in the direction she wanted, Goyal said that this only happened in three out of 24 meetings. "Some disagreement is healthy and is to be expected in complex decisions," she said. "But having been associated with monetary policy since I joined the Technical Advisory Committee in 2011, I have seen the staff fear old problems will recur."

Even if inflation is low, the central bank staff worries it may rise again. This fear, Goyal said, has prevented the RBI staff from "recognising that the future can be different from the past, or allowing it to be so."

"As a result, the growth sacrifice becomes higher than it needs to be," she said.

Following are edited excerpts from the interview:

Q. You have voted for a 25 basis-point rate cut for two consecutive meetings now. Is a repo rate of 6.25% the appropriate level for the current macroeconomic situation? In your view, by how much should the MPC cut the repo rate in the current cycle?

A. The current forecast of inflation is 4.5% for this year. So, there is space for a 1% cut in policy rates over the year.

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. Steep cuts will be required rather than gradual cuts to get to the required real policy rate. It will depend on the path of inflation and growth.

Q. RBI officials have repeatedly flagged high food inflation concerns, and the possible second round effects. Do you think this level of concern on food inflation is valid?

A. My vote was also for a pause for long in order to see if there were second round effects of food shocks. But they have not occurred. There are no broad-based pressures on core inflation. The current rise is just because of telecom tariffs. Even recurrent food shocks have not led to persistence--headline inflation continues to fall. The government is also acting on the supply side. So, it is time to learn from this experience.

Q. An RBI study has said that potential output was 7%. Do you think this estimate is credible or is India's potential output higher?

A. If core inflation is below target and trend headline inflation is falling, then we are below potential. If there is excess demand or output exceeds the supply-side potential, but then core inflation should be rising and cannot be below target.

Q. You listed out several negative signals for India's growth. Do you think the 7.2% GDP growth estimate for 2024-25 is achievable?

A. Yes, if the slowdown in Apr-Jun is reversed. The good monsoon should help and the pickup in government spending. But even at 7.2%, we would still be below our potential output.

Q. How much will the current level of repo rate hurt growth, if kept unchanged till the end of 2024-25?

A. Firms and households will take their decisions today based on higher expected real interest rates reducing consumption and investment next year. Recent Neilson and Kantar surveys show urban consumption is slowing. Growth this year is expected to be 1% below last year.

Q. Do you think the way RBI officials are looking at natural interest rate and real rates is incorrect, with RBI Governor Shaktikanta Das saying that the natural interest rate is an abstract and theoretical model and can't dictate policy in real world?

A. There are controversies in measuring the natural rate, so it is right not to be tied to a precise value or particular estimate. But it is important for the MPC to ensure the expected real policy rate does not become too large or too small since this is the variable affecting the primary aggregate demand channel of monetary policy. To meet India’s employment needs, the repo rate should be at the minimum consistent with keeping inflation at target.

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

A. It depends on policy support and can vary from 6% to 8% per annum.

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

A. This only happened in three out of 24 meetings. Some disagreement is healthy and is to be expected in complex decisions. RBI is one of the pillars of the economy and we have to thank it for our relative macroeconomic stability.

But having been associated with monetary policy since I joined the Technical Advisory Committee in 2011, I have seen the staff fear old problems will recur. Even if inflation is low, they worry it may rise again. But trend inflation is lower in India and commodity price shocks are less persistent. Fear prevents them from recognising that the future can be different from the past, or allowing it to be so. As a result, the growth sacrifice becomes higher than it needs to be.

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

A. That policy should be countercyclical, and smoothens shocks, is particularly important.

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 was good to see policy helping the economy overcome major supply shocks. I would have liked the pause to start when the repo rate was 6.25% and cuts to begin in June this year--I had voted for this.

End

Edited by Vandana Hingorani

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