'Closer to where rates have to be cut to avoid excessive real interest'

Varma says that since monetary policy acts with lags of three to five quarters, rate actions must be based on projected inflation rather than past inflation prints. In an interview with Manojit Saha

JAYANTH R VARMA, an external member of the Reserve Bank of India’s monetary policy committee, says that since monetary policy acts with lags of three to five quarters, rate actions must be based on projected inflation rather than past inflation prints. In an interview with Manojit Saha, Varma elaborates on his views. Edited excerpts:

For the first time in this tightening cycle, you have said, “If at all there is a stance, it should be neutral”. Why do you think, in case the stance is changed, it should be neutral?
 

As I mentioned in my statement, I think we are close to the point where interest rates have to be cut to prevent an excessive real interest rate. I am waiting only for firmer evidence that projected inflation is coming down on a sustainable basis.

If a rate cut is a distinct possibility, the monetary stance has to be consistent with that. That is why I recommended a neutral stance.

You also flagged about 2 per cent real rates and said there is a compelling case to calibrate the nominal policy rate so that the real rate falls slightly below 1.5 per cent. When do you see the first reduction in the repo rate?
 

I would not like to specify a time frame, but as I said earlier, all that is needed is firmer evidence supporting the current projections of a sustainable fall in inflation.

Do you think the repo rate can be lowered even if headline inflation does not fall exactly to 4 per cent, but a 2 per cent real rate is a sufficient condition — if headline inflation is below 6 per cent — to start cutting rates?
 

Monetary policy acts with lags of three to five quarters, and therefore rate actions must be based on projected inflation rather than past inflation prints. Waiting for the actual print to fall before cutting rates would imply that the cut would be three to five quarters late.

While growth is strong so far, is there a concern that high real rates could impact growth going ahead?
 

That is exactly my worry. Real rates must be kept restrictive long enough to drive inflation to 4 per cent, but the real rate should not be allowed to rise to the level where it chokes growth. That is why I wrote about continuous calibration of the nominal rate to keep it consistent with the desired real rate.

Do you think the spike in food inflation is transient and should be looked through? Or is there a concern that such consistent shocks could lead to higher inflation expectations?
 

Food price shocks have so far been transient spikes that have been quickly corrected. As long as monetary policy is consistent with keeping inflationary expectations well anchored, I do not expect significant second-round effects that could lead to the generalisation of food price inflation spikes.