India's flexible inflation targeting has been a useful tool to deal with unexpected shocks of various kinds, said Jayanth Varma, the Monetary Policy Committee's (MPC) consistent dissenter who attended his last meeting as an external member in August.
Since his first meeting at the Reserve Bank of India's rate-setting panel four years ago, Varma's view on interest rates and monetary policy stance has diverged from the consensus opinion. At a time of accommodative monetary policy after the pandemic outbreak, Varma had argued for normalizing the policy stance. Since February this year, he has been voting for a cut in repo rate, citing high real interest rates. He has often argued that tight monetary policy would hurt growth, especially since inflation has largely eased.
Varma, a professor of finance at the Indian Institute of Management - Ahmedabad, had joined the Reserve Bank of India’s (RBI's) MPC in October 2020. A day after the MPC released the minutes of its latest meeting, which kept the repo rate and policy stance unchanged, Varma spoke to Mint in an email interview.
“Each member of the MPC brings a different intellectual perspective to the decision-making, and a certain amount of disagreement is inevitable and indeed healthy. It is critically important to see these as intellectual disagreements and not as something about individuals and personalities. Everybody in the MPC is trying their best to do what they think is right for the country at each point of time. Therefore, as long as my viewpoint is accorded serious consideration, I am not at all upset about this viewpoint not being accepted by the majority,” Varma said.
In the MPC's minutes, Varma was quoted as saying said that an excessively restrictive policy will result in sacrificing growth, at a time when growth should be accelerating. Given that the downward trend in inflation is clearer and more robust, Varma pressed for a 50 basis reduction in repo rate.
“I voted for a cut of 25 basis points in the August meeting itself. The subsequent cut would be based on the inflation and growth outcomes over the next couple of months,” Varma said in the interview.
While Varma noted in the minutes that there are multiple early warning signals of growth slowing down, he was also cautious about a revision in growth projection. “At the moment, these are just early warning signals that remind us of the downside risks to growth. It is premature at this point to translate this into a precise revision to the growth forecast. The more important point is that even the projected growth rate without any revision is well below the potential growth rate,” said Varma.
India’s gross domestic product (GDP) growth is expected to slow down to 7.2% this year from 8.2% in FY24. According to Varma, this is lower than India's potential growth rate of 8%.
On the issue of whether the MPC should retain headline inflation as the target for inflation, Varma sounded cautious. The minutes had shown that all three internal members of the six-member panel noted the need to retain food prices within the central bank’s broader inflation target.
“The MPC has a statutory mandate set by the government, and our task is to conform to that target, which happens to be headline CPI inflation. As an MPC member, I do not wish to comment on changing the benchmark. It is up to the government to modify the target if it considers it desirable to do so,” he said.
Varma also observed that the current divergence in the credit and deposit growth is owing to a pricing problem.
“If deposits are not growing fast enough, it must be the case (almost by definition) that deposits are not priced attractively enough in relation to the alternative investment opportunities. For example, mutual funds have steadily expanded their footprint, and it is natural that banks have to offer better interest rates to attract more deposits. The problem for the banks is that this would impact their net interest margin. I am sure that over a period of time, business models would evolve and the problem would go away,” he said.
