‘Economy is Recovering Well’
‘Even if there is a third wave or a fourth wave, it is hard to see the economy will suffer like that (during the first wave).’
Jayanth R Varma was the lone one in the Reserve Bank of India’s six-member Monetary Policy Committee who dissented with maintaining an accommodative stance in the August review of monetary policy.
Varma, a professor at the Indian Institute of Management-Ahmedabad, tells Manojit Saha, “Monetary policy by its very operation is like the tide that lifts all boats. If the tide comes into an ocean, all boats are going to rise, you cannot say I will lift only those boats which are in trouble.”
Do you believe that RBI has started the process of normalising the monetary policy as many market participants think? That is, a beginning has been made to end the easy money policy.
I don’t think so because to my mind normalisation starts with moving the reverse repo rate. Right now, the money market is at the reverse repo rate. Until that move, I do not think normalisation has begun.
Do you think RBI can start normalisation even if the stance is accommodative?
I think you can probably do that; you can start some normalisation without changing the stance.
What should be the ideal sequence for liquidity normalisation and rate normalisation? Can rates be normalised only after the gap between repo and reverse repo is restored to 25 bps?
I am coming at it from a slightly different point, that, though the repo rate is 4 per cent what has happened is that 3.35 per cent [reverse repo rate] has become the effective interest rate in the economy. This 4 per cent has, sort of, become irrelevant.
The effective interest rate in the economy is not 4 per cent, but 3.35 per cent. The way I see it is that 3.35 per cent is lower than what is desirable. Interest rate closer to 4 per cent and sustaining that for a reasonable period is what I think is important.
If inflationary expectations become entrenched, and then they have to get into a serious inflation-fighting mode, then the risk comes that the repo rate has to be raised above 4 per cent and raised prematurely.
What I have been arguing is that we should try to push back that as much as possible and avoid inflationary expectations becoming entrenched and raising the rate towards 4 per cent would help in doing that.
From a long-run point of view, 4 per cent is a much more sustainable interest rate than 3.35 per cent.
Therefore, we should abandon 3.35 per cent and try to prevent rates having to be pushed above 4 per cent as long as possible.
There are some signs of economic recovery, but aggregate demand is yet to pick up, as was stated by some of the members of the MPC. What a change of stance at this juncture should aim to achieve?
If we go back to the first MPC after the pandemic, which is March 2020, when the repo, reverse repo rates was [were] slashed, which reflected some degree of the impact of the pandemic and also the pre-existing recessionary forces in the economy.
If we compare the rates of the end of March 2020 with today, the rates are significantly lower than then.
With the pandemic abating in terms of impact on the economy — yes, as a human tragedy the pandemic is not less worst than last year, but in terms of the economic impact, the pandemic is much milder than what it was, right?
The second wave had much less impact than the first wave did in terms of economic impact. So, from an economic and a monetary policy point of view, we are coming out of the pandemic.
If we are coming out of the pandemic, then the rate, we had set at the worst point, how is that is still appropriate?
Even if there is a third wave or a fourth wave, it is hard to see the economy will suffer like that (during the first wave).
If the worst is over for the economy, then how can we remain in an accommodative stance?
I am distinguishing between the pandemic as a human tragedy and the pandemic disaster. Purely in economic terms, we are well recovering from the pandemic.
If that has happened, the extreme accommodative stance that we had at the worst point of the pandemic, then the justification for continuing that becomes weaker, and coupled with increasing persistence of inflation.
Do you think the MPC risks losing its credibility if inflation stays persistently high?
That is what my whole dissent is all about. That, it is extremely critical for the MPC to maintain that credibility.
So long as the MPC is credible as an inflation fighter, the severity of the actions is less. When credibility is weakened then you will need harsher action to achieve the same effect.
What may be achieved by a phased normalisation today when the monetary policy is credible, may require a rate hike if the credibility is weakened.
So, the way I am looking at it is by removing some of the accommodation which is no longer needed, we reducing the risk of loss of credibility, and inflation becoming more entrenched and ultimately the need for higher rates in the future.
When do you see the repo rate moving up?
Given that the economy is still weak and the recovery is still tentative, the way I look at it is we would like to postpone a hike in the repo rate as much as possible.
The risk is that by keeping rates even more accommodative than the official repo rate, we may be risking that objective. I have a line in the statement, ‘Easy money today could lead to higher interest rates tomorrow.’ By abandoning excessive accommodation, we may be able to sustain a reasonable interest rate policy for long.
I also think that once one takes a longer-term perspective because the downturn in the Indian economy predates the pandemic, and the easing cycle also predates that.
The problem is that the easing cycle has lasted for so long and we are still not got the economy on to a robust growth path, and part of the problem has been that the investment is not picking up.
And, the argument that I have been making is that, investment is much more a function of long-term interest rates than short-term interest rates.
If I can borrow money at 3.35 per cent for one month, that’s not going to persuade me to set up a new factory. If I am thinking about setting up a new factory, what is relevant is the rate at which I can borrow 5-year/ 10-year money. Also, I want a high degree of macroeconomic certainty because I am making a long-lived decision.
An investor will be looking at macroeconomic stability for 5-10 years… the life of the asset they are building. It is very important to provide that assurance that everything is under control, inflation will be under control, the economy will not be subjected to a disruptive rate hike.
It is very important to provide the assurance of a stable interest rate, stable inflation over a much longer horizon.
How big a worry is an inflation, going ahead?
The biggest threat to that [macroeconomic stability] is the entrenchment of inflation expectations. Then that becomes a self-fulfilling kind of prophecy.
Inflation goes up because people think it will go up. One has to prevent that cycle from starting. It is very difficult to break it once the cycle has started.
We don’t want that vicious cycle to happen. The thing that prevents that is there is an independent monetary policy which is very strongly focuses on ensuring inflation remains under control.
We want everybody to believe that this current inflation is temporary. And, the main thing which keeps people believing that it is temporary is the credibility of the monetary policy which is clearly directed toward eradicating inflation.
What is your take on the bond market?
As MPC member, I would not want to comment. A lot of it has to do with the central bank’s role as a debt manager of the economy. That is not a part of the MPC’s mandate.
How the government borrowing programme is managed is totally a different function. MPC has no role in that. Monetary policy is completely different from managing government debt.
RBI is playing both roles, but the MPC is not. The RBI has multiple functions and multiple objectives. I would not like to comment on how performs its other functions.
You seem to suggest a K-shaped recovery in the MPC minutes. Are you suggesting that whatever it takes to revive the growth kind of approach will only increase inequality as inflation hurts the poor most?
I don’t want to go that far. What I am saying is in April and May of 2020 everybody was hurt. Every industry is hurt; every segment was hurt. Now the situation is that it is only some segments that are suffering.
On the other hand, monetary policy by its very operation is like the tide that lifts all boats. If the tide comes into an ocean, all boats are going to rise, you cannot say I will lift only those boats which are in trouble.
You cannot target monetary policy and say I want to benefit only target certain segments X, Y, Z, in the economy.
When the distress in the economy is no longer generalised, then the monetary policy’s ability to redress that is very much weaker.
The distinction that I am making between last year and this year is that, apart from the magnitude of the distress following the second wave is lower, the impact is now restricted to only some segments. Monetary policy is ill-designed for that.
You have touched upon an important issue regarding the remit of the MPC, by raising the issue of the reverse repo rate. Do you think setting a reverse repo rate should also be a part of the MPC mandate?
That is part of the legislative framework and the rules and regulations under which MPC operates. I think the MPC’s job is to operate within what is there. And, I think the current regulatory regime clearly says the remit is the policy rate which is defined to be the repo rate.
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