Exclusive Interview | Inflation firmly inside the corridor, MPC should be more sensitive to growth now, says Jayanth Varma

The Monetary Policy Committee (MPC) has to be much more sensitive to growth concerns to a much greater extent than a year ago in the backdrop of falling inflation, according to MPC member Jayanth Varma.

In an exclusive interview with Moneycontrol on February 26, Varma said that with inflation firmly inside the corridor, the dual mandate of the MPC requires it to be sensitive to growth to a much greater extent than a year ago. Also, the most pressing concern for the MPC has been that inflation should not spread over through the second round effects. Easing core inflation provides great comfort in this context, he said.

“I agree completely with the proposition that the real rate of interest has to be kept high - 1-1.5 percent in my view - until inflation is projected to remain close to the target of 4 percent on a sustainable basis. But that is very different from saying that the nominal rate should not be cut till then. Falling inflation means that keeping the repo rate at 6.5 percent is the same as steadily raising real rates which is unwarranted. Also, with inflation firmly inside the corridor, the dual mandate of the MPC requires it to be sensitive to growth to a much greater extent than a year ago.”

Varma was the lone voice when the six-member rate-setting panel decided on keeping the key policy rate unchanged in its last review earlier this month. One of the issues where Varma has registered his difference of opinion is on the monetary policy stance. For long, he has argued that the MPC has to clearly communicate its stance to the public or rather have no stance at all. In the February round of the monetary policy, a majority of the MPC members voted to continue with the current stance of withdrawal from the accommodation, while Varma voted against this stance. In fact, he said he might keep up the view in the April meeting as well.

In the free-wheeling chat, Varma spoke on a range of issues, including the present risks to inflation and, more importantly, his thoughts about core inflation. Excerpts from the interview:

The Fed has recently indicated a cautious approach on easing rates with no clear commitment ahead. How much of the Fed stance do you think would influence the monetary policy in India?

I think that India has sufficient monetary autonomy to base its monetary actions on the needs of the domestic economy. Moreover, the statutory mandate of the MPC covers only inflation and growth. External sector considerations are completely outside the mandate of the MPC.

The MPC has clearly indicated that rate cuts can happen only when the CPI (consumer price index based inflation) aligns with the 4 percent target. Is it wise to delay rate cuts till then considering the growth recovery is still in early stages?

I agree completely with the proposition that the real rate of interest has to be kept high - 1-1.5 percent in my view - until inflation is projected to remain close to the target of 4 percent on a sustainable basis. But that is very different from saying that the nominal rate should not be cut till then. Falling inflation means that keeping the repo rate at 6.5 percent is the same as steadily raising real rates which is unwarranted. Also, with inflation firmly inside the corridor, the dual mandate of the MPC requires it to be sensitive to growth to a much greater extent than a year ago.

How much comfort will you draw from the easing core inflation numbers? Should core at 3.5-3.6 percent be seen as a desired level?

Food inflation is extremely volatile and has been elevated for the last several quarters. The most pressing concern for the MPC has been that this should not lead to generalisation of inflationary pressure through second round effects. Easing core inflation provides great comfort in this context.

The optimal level of core inflation is a more difficult question. It is not quite clear whether food inflation will remain permanently elevated or whether we have just been through a series of adverse shocks which may not be repeated. If we are really in an environment of persistent high food inflation, non food inflation has to run below the 4 percent target to keep overall inflation close to the target.

What are the big upside risks to inflation this year? By when inflation is likely fall to a level this year for the MPC to have the comfort to cut rates?

At this point, there is no single risk that dominates. There are multiple sources of risks: domestic and global, economic and geopolitical that are imparting uncertainty to both growth and inflation. I also agree with the MPC statement that the risks are evenly balanced. I do not know when the rest of the MPC would come around to the view that the time has come to cut rates.

At a broader level, quality of inflation data has been a matter of discussion in the past with the likes of Pranab Sen highlighting the importance of this aspect. Do you think the current system of data collection gives a correct picture about price trends?

There is uncertainty about all macroeconomic estimates and policymakers have to simply live with this. More importantly, the MPC has to work with projected inflation and growth for 3-5 quarters ahead because that is how long it takes for monetary action to impact the economy. I think the uncertainty in these projections swamps the uncertainty about the realised numbers.

Do you think the MPC has a case to change the policy stance to neutral in April?

I voted for changing the stance this meeting itself, and unless something unexpected happens in the interim, that would be my view in the April meeting as well. How the rest of the MPC would think about this, I do not know.

Do you think the central bank could have handled the Paytm episode in a better way?

I would not like to comment on these matters as an MPC member.

Do you think the RBI’s mandate needs to be confined to a monetary policy authority while debt management and the banking regulation part be spun off to a separate regulatory body as it is in some developed countries?Again, I would not like to comment on this as an MPC member. There is a great deal of diversity in the regulatory architecture of the central bank around the world. The Financial Sector Legislative Reforms Commission (of which I was a member) did analyse these questions at length.