India’s economy has the potential to safely grow around 8% but the nominal repo rate has to fall along with a projected decline in inflation, Ashima Goyal, an external member of the Monetary Policy Committee said to Bhaskar Dutta. The Reserve Bank of India has projected India’s GDP growth at 7.2% in the current fiscal year. Edited excerpts:
In the latest MPC minutes, you have flagged weak consumption and below-potential growth. What is India’s potential growth according to you?
If inflation continues to fall and expected inflation is approaching the target with growth at 8%, it means we can safely grow at such rates. There is a literature inferring potential growth from inflation. As long as it does not raise inflation, growth can be allowed to rise in Indian conditions.
You have spoken about the mistake of keeping rates high in 2015. How much of a hit to GDP growth are you seeing this year if rates are kept where they are?
My estimate of Indian real interest rate elasticity of aggregate demand is -0.21. This suggests a 1% rise in the real interest rate will, other things remaining constant, reduce growth by 21 bps. But when supply shocks lead to downward shifts in demand the economy can be tipped to a lower growth path. My estimate of the growth sacrifice over 2011-17 when this happened was 6.7%.
Given the risks to growth that you have highlighted, what determines your preference that there should be “no softening path”?
There is no need to sacrifice growth more than necessary to establish the inflation target but the convergence to the target also has to continue. A positive repo rate around unity is currently adequate to establish the MPC’s inflation-fighting credentials and keep inflation near the target. This implies the nominal repo rate has to fall with expected inflation.
The RBI is wary of food inflation. Is there any risk to the anchoring of inflation expectations if rates were to be lowered now?
The repo rate cannot affect food prices. So keeping it above equilibrium will not reduce food inflation. A positive real repo rate is adequate for credibility of monetary policy and anchoring of inflation expectations. A real repo rate of 2% can have adverse effects on demand as well as worsen the supply side.
You have spoken about how a rate cut would cut costs for borrowers and pointed out stress in loans to self-employed. Are you seeing signs of indebtedness trap building up?
No, since lending is risk-based, loans are small in size, capital cover is adequate and prudential or preventive regulation has tightened, there is unlikely to be pressure on asset quality. But demand will fall for highly leveraged borrowers.
