We shouldn't restrict our ability to respond: External member of RBI's MPC

The Ukraine situation is a shock both to growth and to inflation, and it is too early to say which of these two shocks will be bigger, says Jayanth R Varma

Jayanth R Varma, the external member of the Reserve Bank of India’s Monetary Policy Committee (MPC), says he doesn’t think monetary policy is ineffective when inflation is driven by supply-side forces. Varma, the only dissenting member of the MPC, tells Manojit Saha why he has not voted for maintaining the RBI’s accommodative stance in the last four policies. Edited excerpts:

With growth yet to revive on a durable basis and inflation expected to come down sharply from the current level, what is the main reason for your voting against the accommodative stance?

There is a very high degree of uncertainty on both inflation and growth and I see the risks as being balanced on both sides. In such a situation, it is imperative that the policy stance should be neutral. I am not objecting to keeping rates low today, but I do think it is imprudent to commit to keeping rates low in future as well. We should not tie our hands behind our back and restrict our ability to respond to the growth and inflation shocks that may arise.

Can you throw some light on why you said ‘the continued harping on combating the ill effect of the pandemic has become counterproductive’?

With the pandemic behind us, monetary policy has to go back to dealing with the slowdown of the business cycle that began in 2019 (if not earlier). The critical issue is understanding where we are on this cycle. Are we on the cusp of a cyclical growth recovery or are we going to remain in the trough for an extended period? Similarly, is inflation a transient phenomenon or is it longer lasting? This requires deep analytical thinking, but the continued focus on the pandemic deflects attention away from these difficult questions, and encourages a status quo bias.

In the minutes, you said ‘fan charts also reveal a very large range of uncertainty on both inflation and growth’.  What is your view on the fact that all the MPC members unanimously accept RBI’s inflation projection?

For me (and I speak only for myself here), the main takeaway from the fan chart is not the point forecast of 4.2 per cent or 4.5 per cent, but the huge width of the fan chart. The uncertainty is so large that point forecasts are not very meaningful. The difference between the RBI forecasts and the more hawkish forecasts that I have seen from analysts is much less significant than one may think, because the confidence bands of these apparently divergent forecasts overlap quite a lot. In particular, the risk of inflation going beyond even the upper tolerance band is non-trivial even under the RBI forecasts.

Do you think monetary policy is completely ineffective if the sources of inflation are from the supply side?

Not at all. Supply shocks should lead to shifts in relative prices, and the job of monetary policy is to prevent these from affecting the general price level. Currently, supply shocks are affecting goods more than services. Changes in relative prices that make services cheaper help shift demand away from scarce goods to abundant services, and thereby rebalance the economy. There is no reason at all why this should cause a change in inflation.

What is the range of positive real interest rates you will be comfortable with?

That depends on the growth and inflation outcomes, and I am unwilling to quantify that more precisely at this stage.

Geopolitical tensions have deepened with Russia invading Ukraine. Does it change your views?

My statement began by noting that geopolitical tensions are now more important than the pandemic, and so these developments do not necessitate any change in my views. The Ukraine situation is a shock both to growth and to inflation, and it is too early to say which of these two shocks will be bigger.