RBI’s Monetary Policy Committee (MPC) member Jayanth R Varma, who voted for a 25 basis point rate cut in the last panel meeting, on Tuesday explained why he wanted the rate cut. He was the only one in the six-member panel to favor a rate cut.
Varma said the inflation is projected to average 4.5 per cent in 2024-25, and therefore, the current policy rate of 6.5 per cent translates into a real rate of 2 per cent. “I do not believe that such a high real rate is required at this stage to drive inflation down to the target of 4 per cent. It is true that economic growth is holding up well, but there is no evidence that the economy is overheating,” he said while speaking to Business Today TV’s Managing Editor Siddharth Zarabi.
He said we need a high-interest rate, either when inflation is running very high and not coming down or when the economy is growing too fast beyond its potential. That’s really not the case, he said, because inflation is projected to come down and the economy is growing at the projected rate.
“If an economy is capable of growing at only eight and you try to make the economy grow at 9 or 10…so instead of growing at nine or 10, it will possibly end up in inflation. We’re projecting an economic growth of around 7 per cent. In 2024-25, it might be 6-6.5 per cent or 7 per cent – something in that range, which is within the potential of the economy. Indian economy is probably capable of growing at more than 7 per cent. It’s capable of growing more and even 8 per cent without producing big inflation. So the economy is growing only within its potential. Inflation is coming down then we don’t need 2 per cent (more real interest rate),” he said.
The MPC member said that if inflation keeps coming down the way it is being projected, then the panel will need to keep cutting rates because the target for the interest rate is always a real rate, not the nominal rate.
When asked whether a rate cut at this stage could undo the gains that have been made in the fight against inflation, the professor said: “I don’t think that cutting rate will undo this.” He said the panel is not cutting the real rate at all. In fact, he said, the real rate was very low when the central bank began the rate hike process.
“When inflation was running at 6 per cent, then 6.5 per cent repo rate was only half per cent real. And what has happened, over a period of time, is that half percent real (rate) has climbed to 2 per cent. As inflation kept coming down, the real rate kept going up, and it went beyond what it should be going. So I want to emphasise that even after we cut 25 basis points that I proposed, monetary policy would still be very restricted. We will be talking about 1.75 per cent real, which is a restrictive policy that would still keep pushing inflation down.”
Verma said that a real interest rate of 1-1.5 per cent would be sufficient to glide inflation to the target of 4 per cent. He said that a real interest rate of 2 per cent creates a real risk of turning growth pessimism into a self-fulfilling prophecy.
“It must also be borne in mind that the process of fiscal consolidation is projected to continue in 2024-25. This opens up space for monetary easing without risking an inflationary spiral. In my view, the time has come for the MPC to send a clear signal that it takes its dual mandate of inflation and growth seriously, and that it would not maintain a real interest rate that is significantly more than what is needed to achieve its target,” he said.
In its latest monetary policy meeting, the MPC retained the key interest rate at 6.5 per cent signalling that the central bank’s battle against persistently high inflation was not over yet. The panel decided by a 5:1 majority to remain focused on “withdrawal of accommodation”, RBI Governor Shaktikanta Das said.
The Governor said that the RBI needs to be vigilant on new supply shocks. “Headline inflation remains high with considerable volatility this year. The CPI inflation target of 4 per cent is yet to be reached,” he said.