This is right time to normalise key policy rates: Prof Jayanth R Varma

There are significant risks related to inflation. These risks to inflation are coming from the global side as commodity prices are very much elevated globally and do not show any sign of coming down. Jayanth R Varma, Member of Reserve Bank of India's Monetary Policy Committee (MPC), and Professor at IIM Ahemdabad, in an exclusive interview with Bizz Buzz, says:"This is the right time for MPC to normalise key interest as the as the pandemic is abating, at least in the terms of economic impact,and the economy is recovering.I agree that there are major risks to the recovery, but I havebeen emphasising that there are substantial risks on inflation aswell. If inflation gets entrenched, it will be harder to eradicate it."

You have been opposing the accommodative stance of RBI for past two bimonthly reviews in a row. Still, the rate hike doesn't seem to be imminent?

There is disagreement about the timing of the exit from the post-pandemic monetary accommodation. See, the first thing is that everybody was agreed that such an easing was required in the aftermath of the pandemic. There was no disagreement on that. The only point of disagreement which has arisen is about the pace of withdrawing the emergency measures that were applied in the pandemic. My view is that as the pandemic is abating, at least in the terms of economic impact, and the economy is recovering, withdrawal should begin soon.

On the other hand, other members of the committee are more worried about the economic recovery which they perceive to be tentative and less worried about inflation which they perceive to be transient. Therefore, they think that normalisation can be delayed for some more time. I agree that there are major risks to the recovery, but I have been emphasising that there are substantial risks on inflation as well. If inflation gets entrenched, it will be harder to eradicate. That is why, I have been arguing that the timing for normalisation of key policy rates has arrived.

When should we go for hike in key policy rates?

I have not been talking about increasing the Repo rate, which is the main policy rate that I think, needs to remain at its present level. The reason is the economy even prior to the pandemic, was not doing particularly well and it needed monetary support. So, we are not yet talking about any kind of rise in the headline interest rate. What we are talking about is two things.

First, normalising the accommodation, which was done over and above the repo rate. The lower band was stretched to 60 basis points and the liquidity was injected to push interest rate to that level which was far below the repo rate. I am saying that repo rate at 4 per cent is correct. It is appropriate. But the money market interest has been pushed well below 4 to 3.35 per cent. My position is that needs to be withdrawn. We need to come back to a narrow band at around 3.75-4 per cent quite quickly. Although, the rest of the committee members also, I believe, agree that the gap between Repo and Reverse Repo should be normalised, they want it to be done more slowly. That is the only point of disagreement.

The second point of disagreement is that I now see the risk has become balanced on both sides - there is risk not only on growth and recovery, but also on inflation. I agree that the recovery has still not firmly established. There are pockets of the economy which are still doing badly. The entire MSME sector is still struggling. A large number of individuals are struggling, particularly those who are working in the unorganised sector and so on. This means that there are risks involved in the ongoing process of recovery process. Other Committee members also strongly feel about it.

However, I also think that there are significant risks related to inflation. These risks to inflation are coming from the global side as commodity prices are very much elevated globally and do not show any sign of coming down. That is impacting us and creating the risk that inflation gets deeply entrenched and we will be having difficulty in getting rid of it. That is what worries me. I think that the risks to economic recovery and inflation are balanced. Other members of the committee are more worried about the tentative nature of the recovery and less worried about inflation risk which they think is transient.

Do you think if there was a need to change the structure of MPC?

I don't think so. There is no question of a conflict between internal and external members in the committee. That is not what is going on. I think what is going on is that the economic environment is highly uncertain, and therefore, if you put six people in the same room, they are going to think and react in different ways because the uncertainties are so high. This is healthy because the entire purpose of an MPC is to allow multiple points of view instead of one individual, the head of the central bank, deciding unilaterally. There is merit in bringing multiple perspectives and that is what the MPC does. Out of the six members of the MPC, three are external members who come from diverse backgrounds with different kinds of expertise about various sectors of the economy. They bring various perspectives. The internal members are distinguished economists in their own right, and they also bring with them the huge reservoir of institutional expertise of the RBI. I am quite happy with how the MPC decides after calculated deliberation and after hearing different views.

What is your view on inflation and GDP?

On GDP growth, the projected 9.5 per cent growth for this year looks very good. But all that it does is to wipe out the negative growth of the previous year. We will have a sort of comeback to pre-pandemic levels. I mean FY21 and FY22 will cancel out and we will be back at roughly FY 20 levels. Basically, we have lost two years.

Normally, we should have an average GDP growth of 6-7 per cent each year, but over two years, the growth has been effectively zero, and this means that we have lost well over 10 per cent of GDP growth in this couple of years. Moreover, there are risks even to the projected 9.5 per cent GDP growth rate for FY 2021-22. And the more important question is really about what kind of growth we will be having in 2022-23.

I am hopeful that we will achieve high growth in 2022-23. Having said that, you can't assume that 9.5 per cent of growth will be achieved in 2022-23 as the growth rate in 2021-22 was from the low base of 2020-21. I expect a reasonable growth in 2022-23, because there are lots of things which are going right. Exports are booming, and the services sector is also coming back. Aviation is improving, and even the hospitality sector is also improving. We are already highly vaccinated, and by March-end we are likely to achieve much more. I think that the economy should be doing well. But there are risks to this scenario and that is what we worry about in the MPC.

Turning to inflation, the whole question is how soon will the inflation come down. We have gone through a once in a century pandemic and there was a significant disruption to the supply chain. Domestically and globally too, due to shortage of many items, inflation is running high. That again is understandable. The hope is as the situation eases, the inflation should start coming down.

The inflation target for the MPC is 4 per cent, and the critical question is how quickly does inflation come down to the 4 per cent target. The danger which I see is that it is not showing sign of coming down to 4 per cent so quickly. Even when you look at mid-2022, the projections are suggesting that inflation would be around 5 per cent instead of 4 per cent. That is cause for worry. The worry is also about expectations. When people have seen high inflation for two years, they start thinking that high inflation is a fact of life, and start planning accordingly. Then it becomes a self-sustaining expectation as businesses starts increasing prices and consumers don't resist. Inflation of 5 per cent then just gets ingrained in the system. The challenge is to bring inflation down to around 4 per cent before expectations of 5 per cent inflation get entrenched.