Will vote for rate cut in April policy too: MPC Varma

Informist, Friday, Feb 23, 2024

--MPC Varma: High real rate impedes pvt sector taking capex baton
--MPC Varma: World econ has adapted to rising geopolitical volatility
--MPC Varma: Optimistic about growth potential of the economy
--MPC Varma: Choking off growth not prudent when economy not overheating
--MPC Varma: Food price spikes transient, won't generalise in CPI
--MPC Varma: Do not see serious evidence of economy overheating
--MPC Varma: Policy should move forward with 25-bps rate cut at a time
--MPC Varma: Will vote for cut Apr unless something unforeseen happens
--MPC Varma: Shouldn't form policy by seeing rear view mirror
--CONTEXT: External MPC member Jayanth Varma's remarks in interview
--MPC Varma: Policy must be forward-looking as it acts with lags

By Pratiksha and Shubham Rana

NEW DELHI – After casting the first vote in favour of a rate cut since May 2020 this month, Jayanth Varma, external member of the Monetary Policy Committee, says he will vote for a rate cut in April as well, unless something unexpected happens in between to change his mind.

On Feb 8, the Reserve Bank of India's rate-setting panel kept the policy repo rate unchanged at 6.50% for the sixth consecutive time and decided to maintain its "withdrawal of accommodation" stance. Out of the six panel members, Varma was the only one to vote for lowering the policy repo rate by 25 basis points.

Explaining the rationale behind his vote, Varma said in the policy minutes, "I do not believe that such a high real rate is required at this stage to drive inflation down to the target of 4%. It is true that economic growth is holding up well, but there is no evidence at all that the economy is overheating."

Real interest rate is defined as the rate of return over and above the expected rate of inflation in an economy. The RBI has projected CPI inflation for 2024-25 (Apr-Mar) at 4.5%.

"If the potential growth rate of the economy is close to 8%, then the economy is not at risk of overheating in 2024-25. A real interest rate of 1.0-1.5% would then be sufficient to glide inflation to the target of 4%. A real interest rate of 2% creates the very real risk of turning growth pessimism into a self-fulfilling prophecy."

On being asked whether the real interest rate metric is a vague one, Varma told Informist in an email interview "monetary policy has to be forward-looking because it acts with long lags: a policy action today impacts growth and inflation 4-5 quarters ahead." Therefore, the MPC member said, it does not make sense to set monetary policy by looking at the rearview mirror. The RBI has projected inflation for Apr-Jun quarter of 2024-25 at 5.0%, Jul-Sep at 4.0%, Oct-Dec at 4.6%, and 4.7% for the last quarter.

Varma, a professor of finance at Indian Institute of Management, Ahmedabad, says that the MPC should traverse with a rate cut of 25 bps at a time, and see how the macroeconomic environment evolves in the next few quarters.

When asked if one should wait for clarity on the trajectory of food inflation before slashing rates, Varma says that though food inflation is extremely volatile, all the evidence suggests that these inflation spikes are transient and are not leading to a generalisation of inflationary pressures.

India's retail inflation rate based on the Consumer Price Index fell to a three-month low of 5.10% in January from 5.69% in December, due to a statistical effect of a high base and a fall in vegetable prices.

"Moreover, the dual mandate of the MPC (inflation and growth) means that prudence has to be evaluated in terms of growth as well as inflation. I do not think that choking off growth is prudent when the economy is not overheating," Varma says.

When asked if there is any risk to inflation from the external sector, Varma says he thinks the world economy has adapted to rising geopolitical volatility. "The reduced expectations of the medium term growth rate in China is also putting a lid on inflationary pressures," he adds.

Varma says he is optimistic about the growth potential of the economy and one of the tasks of the monetary policy is to ensure that growth potential is not thwarted by excessively high real interest rates.

When asked if a rapid fiscal consolidation roadmap poses risk to growth, Varma says, "the process of fiscal consolidation means that the private sector has to pick up the baton on capital expenditure. A high real interest rate impedes this process."

The Interim Budget has projected a fiscal deficit of 5.1% of GDP for 2024-25 (Apr-Mar), which means a consolidation of 70 bps from this year's revised estimate of 5.8%.

When asked if a rate cut is needed when the credit-deposit ratio is around 80%, Varma says that it is just one metric of the state of the economy. "On balance, I do not see serious evidence that the economy is overheating."

The credit-deposit ratio indicates how much percentage of a bank's total deposits are given as loans. Higher credit-deposit ratio hints to robust loan demand and economic activity in the country.

RBI Governor Shaktikanta Das said in his monetary policy statement that the transmission of the cumulative 250 bps of policy rate hikes between May 2022 and February 2023 is still incomplete. "Our stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation ruling above the target of 4 per cent and our efforts to bring it back to the target on a durable basis," Das had said.

On being asked if he agrees with the RBI's statement of seeing policy stance in context of interest rate and not liquidity, Varma says "I have repeatedly bemoaned the lack of clarity on what the stance really means." Along with the dissenting vote on rate, Varma was also the only MPC member who voted for a change in stance to neutral. End

Edited by Ashish Shirke

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