When money market rates breach the Reserve Bank of India’s interest rate corridor, as they intermittently have over the past six months, the process of transmitting the central bank’s policy rate changes faces serious impediments, Jayanth Varma, external member of the Monetary Policy Committee, said to ET in an interview.
Edited excerpts:
Is there a case for liquidity management to be included within the MPC’s ambit? Actual market rates have been driven more by liquidity conditions for six months even as the MPC votes on a certain benchmark policy rate.
Liquidity management is an operational matter about how the central bank implements the monetary policy formulated by the MPC and keeps the money market rates within a narrow corridor around the policy rate. When the call rate breaches either end of the corridor, that represents serious frictions (if not failure) in the process of monetary policy transmission from the policy rate to the overnight rate. Like other transmission frictions, this also increases the difficulty of monetary policy making. In my view, it calls for better tools and faster reaction times in monetary policy operations and not in policy making.
You mention that a real rate of 2% creates the risk of growth pessimism turning into a self-fulfilling prophecy. Do you expect a sharp growth slowdown if tight financial conditions were to persist?
There are two issues here. First, that we should be trying for a growth acceleration given the fact that the average growth rate since the pandemic is only 4.25%. India has the potential to grow even faster than we have done in the last couple of years.
Second, 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. If this persists for several years, we could descend into a vicious cycle of diminishing expectations that depresses growth.
In the latest MPC minutes, you have said that based on the FY25 inflation projection of 4.5%, current real rates are too high. Are you confident that inflation is now durably on a path towards target?
I am not saying that the war against inflation has been completely won. In fact, I think that a high real interest rate has to be maintained for a protracted period to glide inflation towards the target. However, I believe that this requires a real interest rate of only 1-1.5% and not 2%. Also, a lot of the inflation volatility that grabs the headlines consists of transient spikes and should not distract us from the broader goals.In the latest minutes you have stressed on the need for the MPC to send out clear signals of commitment to its dual mandate. In your view, are policy signals blurred?
A year ago, the MPC was rightly focused exclusively on inflation because we had breached the upper tolerance band for several quarters in succession. The inflation situation today is much less alarming, and the risks are now evenly balanced to both inflation and growth. In the changed circumstances, the MPC must now take its dual mandate seriously and consider the balance of risks and rewards more carefully while taking decisions.On the growth front, you have pointed out that the economy is quite resilient. Amidst the global slowdown in growth, what is buttressing India’s economy?
In the last few years, there have been significant economic reforms as well as significant infrastructure investments. These coupled with the digitalization of the economy have in my view boosted its potential growth rate. This makes me believe that the economy is capable of growing even faster than it is doing now.
