Liquidity overhang should not pose a risk to inflation: Ashima Goyal

For food price shocks supply-side measures are more effective. The government has long experience with intervention in the food economy, Goyal opines

Ashima Goyal, a member of the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC), told Manojit Saha in an email interview that the committee should ensure that the real policy rates are positive in terms of inflation forecast. 

In the MPC minutes you have said: “Headline inflation forecasts have risen in the short term but remain slightly above 5 per cent for the next year, so a repo rate of 6.5 per cent still gives a positive real rate of around unity. This is the apt real rate given uncertainties in both growth and inflation.” Does that mean the repo rate is likely to stay at the current level for at least one year? 

Not necessarily. The forecast can change as more data comes in over the next few months. 

Do you think liquidity overhang poses a risk to inflation? 

It should not, because in an inflation-targeting regime, higher short rates should make it worthwhile for banks to deposit excess liquidity back with the RBI. To the extent there is more leakage to the informal issue, it may be an issue, but these leakages tend to become worse when there is a large deficit, since many parts of the Indian financial sector do not have lender-of-last-resort facilities and are willing to pay more. 

Headline inflation for the next few months could be on the higher side. Should MPC sit through such spikes or are some measures required to prevent second-round effects? 

For food price shocks, supply-side measures are more effective. The government has a long experience of intervening in the food economy. Vegetable price shocks reverse because of short crop cycles. In my view, the MPC should ensure that real policy rates are positive in terms of inflation forecasts, which are less contaminated by transient shocks or measurement issues. 

Liquidity has been in a deficit in the last few days. Do you think this is temporary and the situation could reverse by the beginning of next month? 

In an inflation-targeting regime, short-term liquidity is adjusted to maintain short rates around the repo rate mandated by the MPC. Therefore, any deficit that is raising short rates above the repo should reverse. 
 

Will it be prudent to maintain liquidity in deficit from here on since festival-related spending will start soon? 

Only to the extent that short rates do not rise above the repo rate set.