India is nearing a phase where an interest rate cut is essential to prevent an excessive real interest rate, Jayanth Varma, an external member of the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC), told The Indian Express (IE) during an interview. This statement came after the US Federal Reserve indicated potential interest rate reductions.
In order to bring the inflation rate down to four per cent, Varma emphasised the need for a restrictive monetary policy, keeping the real interest rate above the neutral rate. He explained that while it may be challenging to estimate the neutral real rate accurately, it is likely around 1.5 per cent, making the current two per cent real interest rate excessive. This is based on the energy and commodity price shocks induced by the ongoing Russia-Ukraine conflict.
'Withdrawal of accommodation' stance
In the recent December monetary policy review, the RBI maintained the policy repo rate at 6.5 per cent for the fifth consecutive time, focusing on a "withdrawal of accommodation" stance. This means the RBI will be focussing on curbing the money supply in the economy to control inflationary pressure.
Varma, a member of the six-person rate-setting panel of the RBI, also expressed reservations about the "withdrawal of accommodation" stance adopted by other MPC members.
Varma argued that a neutral stance was more suitable at this stage, awaiting stronger evidence supporting the projections of a sustainable decline in inflation.
With the US Fed hinting at potential rate cuts, Varma pointed out that the MPC might face a choice between delaying a necessary cut to adhere to the stance or cutting rates against a stance calling for further withdrawal of accommodation.
More From This Section
RBI's projections and chairman's perspective
The RBI projects consumer price index (CPI) inflation at 5.4 per cent for the financial year 2023-24 (FY24), with an expected decline to 4.6 per cent in the first three-quarters of FY25. The RBI also revised the real GDP growth forecast for FY24 to seven per cent from the previous 6.5 per cent.
On this, Varma reiterated that until the four per cent inflation target was achieved, monetary policy should remain restrictive, suggesting a gradual shift as the economy slows down.
When questioned about the timing of rate cuts in India following the US Fed's signals, he emphasised that flexible exchange rates grant autonomy to Indian monetary policy, not necessarily dictated by US interest rate trajectories.
Varma also shared his hope for further private investment to pick up in the coming quarters while stating that capacity utilisation in recent quarters had reached a level where companies contemplate capacity expansion.
