Indian economy still growing below its potential, says Jayanth R Varma

Varma says if the economy is not overheating, there is no need of a high real interest rate, which can choke growth

The average growth rate of the Indian economy, which is 4.25 per cent from the pre-pandemic period, is inadequate, given the potential, says Jayanth R Varma, member of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC). In an email interview with Manojit Saha, he says if the economy is not overheating, there is no need of a high real interest rate, which can choke growth. Edited excerpts:

You voted for a 25 basis points (bps) rate cut along with a change of stance to neutral. Why do you think it is not premature to start cutting the policy repo rate when inflation is yet to reach the 4 per cent target?

The real rate of interest has to be kept high (1-1.5 per cent in my view) until inflation is projected to remain close to the target of 4 per cent on a sustainable basis. But that does not mean that the nominal rate should not be cut. Falling inflation means that keeping the repo rate at 6.5 per cent is the same as steadily raising rates. Such a policy of ever rising rates is uncalled for.

Are you not worried about the last mile disinflation, which others are concerned about while advocating status quo on both rate and stance? Are you not concerned that markets will turn euphoric if RBI takes a neutral stance?

I agree that it is absolutely important not to declare victory prematurely in the war against inflation. It is essential to ensure that the last mile of disinflation is successfully accomplished. This does require a high real interest rate to be maintained for a protracted period. My only point is that the required high real interest rate is only 1-1.5 per cent and not 2 per cent.

Why do you think the 2 per cent real interest rate is high in the Indian context? 

I think while growth is robust in comparison to the rest of the world, the Indian economy is still growing below its potential. The 4.25 per cent average growth rates from the pre-pandemic period are inadequate, given our aspirations. If the economy is not overheating, there is no need for a punitive real interest rate to choke economic growth.

What gives you confidence that 8 per cent is the potential growth rate of the country?

In the last few years, there have been significant economic reforms as well as infrastructure investments. These coupled with digitalisation of the economy have in my view boosted its potential growth rate.

You were the one who advocated rate hikes from August 2021 much before the rates were actually hiked. RBI failed in its inflation mandate and faced criticism then for falling behind the curve. Are you worried that the MPC will fall behind the curve again by postponing rate cuts?

I sincerely hope that this does not happen.