Likely to lose 1% of GDP growth in FY25, FY26 due to rate-cut delay: Varma

Jayanth Varma, an external member of the Reserve Bank of India’s Monetary Policy Committee (MPC), has been voting for an interest rate cut since the February 2024 review meeting. Varma, in an e-mail interview with Manojit Saha, says a delay in the rate cut has resulted in growth sacrifice, and such losses for one more year would be unfortunate. The August meeting was the last one for external members who have a fixed four-year tenure.

In the minutes, you said that multiple policy measures during the last few years boosted the potential growth rate of the Indian economy to at least 8 per cent. But there is also a view that there is a positive output gap, indicating demand pressure. How do you see the impact of demand-side pressure on inflation?

I do not see any evidence of excess demand or overheating of the economy. On the contrary, there are many indicators of demand deficiency - the extremely low level of core inflation, the delay in the revival of private capital expenditure, and the low level of consumer confidence. The slow pace of disinflation is being driven by food supply shocks and not by demand pressures.

You have also said the positive real interest rate is 2.1, and there is room to cut the repo rate by 50 basis points (bps). There is a view that the neutral rate or real rate is a theoretical concept and could be misleading for policy-making purposes. How do you respond?

It is true that there are numerous difficulties in estimating the neutral rate empirically, but some estimates (whether econometric or judgemental) are unavoidable while setting monetary policy. The only available yardstick for evaluating the tightness of monetary policy is the real interest rate. The nominal repo rate is useless for this purpose.

What is the estimate on growth sacrifice in case the repo rate stays at 6.5 per cent till the end of FY25?

Monetary policy acts with lags of 3-5 quarters. If monetary easing is delayed till FY26, then it would put growth in FY27 at risk. We are already likely to lose 1% of GDP growth in FY25 and again in FY26. Stretching the losses for one more year would be unfortunate.

Do you think RBI’s mandate should be to address core inflation and not headline inflation?

The MPC has a statutory mandate set by the government, and our task is to conform to that target which happens to be headline CPI inflation. It is up to the government to modify the target if it considers it desirable to do so. As an MPC member, I do not wish to comment on changing the benchmark. It would be particularly inappropriate for an MPC member to suggest changing the goal post when high food inflation makes it difficult to reach the target.

The current flexible inflation framework is in force till March 31, 2026. What will be your suggestion to improve the framework?

I have become more convinced than before that flexible inflation targeting is an effective tool for dealing with unexpected shocks of various kinds. All in all, I have been quite happy with my experience, and have no suggestions for improvement.