Failing to contain inflation biggest embarrassment

RBI's Monetary Policy Committee (MPC) is upbeat on the outcome in next two quarters on inflation front and price stability. Since mid 2022, the MPC's priority has (quite correctly) been to tame inflation and this effort is likely to bear fruit in another couple of quarters. After that, we will have to decide how far to go in reducing demand in an economy, which is growing less fast than we would like, Prof Jayanth R Varma, RBI MPC member, tells Kumud Das in an exclusive interview with Bizz Buzz

Excerpts:

What are the challenges being faced by the RBI at the moment?

Inflation has been unacceptably high during the last year or so. Cumulative economic growth over the last three years has also been unsatisfactory. This requires the MPC to make difficult choices between these conflicting priorities. Since mid 2022, the MPC's priority has (quite correctly) been to tame inflation and this effort is likely to bear fruit in another couple of quarters. After that, we will have to decide how far to go in reducing demand in an economy, which is growing at kisser rate than we would like it to. RBI has raised rates several times in the recent past. Still, price stability continues to be a big challenge.

Monetary policy acts with a lag of 3-5 quarters. This means that the rate hikes of early 2022 are just beginning to have an effect, and the increases later this year will start having an effect only in mid 2023. All available data suggests that inflationary expectations have come down, and the price stability objective is likely to be achieved in the next few quarters.

High price levels present a double whammy to economies – it can stifle demand and act as a drag on nascent growth recover. Your view?

There is no question that inflation has pernicious effects on the economy. The problem is that the interest rate increases that we use to tame inflation also have strong adverse effects. Rising rates

depress demand and deter capital investment which could be disastrous when the economic recovery is very fragile.

The central bank and the rate-setting MPC faced their biggest embarrassment in history after failing to contain inflation within the 2-6 per cent band for three consecutive quarters.

Is it true that the central bank acted too late on inflation?

It is useful to look at this in terms of three time periods. In the first period from mid-2020 to mid- 2021, the economy confronted the worst waves of the pandemic that shut down large parts of the economy while also causing inflation due to supply chain bottlenecks. In this period, the economy was in dire need of monetary support, and the MPC quite rightly prioritized economic recovery over inflation. In the second phase, from mid-2021 to early-2022, the MPC should, in my view, have begun normalizing monetary policy as the economic effects of the pandemic faded away, and inflationary pressures manifested themselves.

But we delayed this normalization in the face of the uncertainties about the future course of the pandemic. In the third phase, from early 2022, we have been confronting the unexpected inflationary shock arising from the Ukraine war. The MPC responded to this quite rapidly with front loaded rate hikes that have raised the policy rate to what I believe is at or above the rate required for price stability.