Excessively high real interest rate can dampen growth prospects: MPC member Jayanth Varma

Why have you voted for reducing the repo rate by 25 basis points (bps)?

I have mentioned two reasons in my statement. First, with inflation projected to average 4.5 per cent in 2024-25, the current policy rate of 6.5 per cent translates into a real rate of 2 per cent which is well above the 1-1.5 per cent needed to bring inflation down to the target. I do not believe that such a high real rate is required at this stage to drive inflation down to the target of 4 per cent.

Second, though economic growth is holding up well, there is no evidence at all that the economy is overheating, and therefore there is need for pre-emptive monetary action to choke off growth.

When do you expect CPI inflation to touch the 4 per cent target and remain there on a durable basis?

I expect this to happen in 2025-26, and therefore, monetary policy would have to be restrictive (real interest rate of 1-1.5 per cent) for several more quarters.

Other MPC members have raised concerns over elevated food inflation. What is your view on it?

Food inflation is extremely volatile, but all the evidence suggests that these inflation spikes are transient and are not leading to generalisation of inflationary pressures.

You have said the MPC should send a clear signal that it takes its dual mandate of inflation and growth seriously. Can you please elaborate on this?

The process of fiscal consolidation means that the private sector has to pick up the baton on capital expenditure. My main worry is that a high real interest rate could impede this process and dampen the growth prospects of the economy.

Why do you think it is the right time for the MPC to change its policy stance to neutral?

I believe that the risks are evenly balanced to both inflation and growth. Unlike last year, the current situation does not warrant focusing exclusively on inflation without paying attention to the growth dynamics of the economy.

What’s your overall assessment of the economy? There’s a view that GDP growth is likely to slow down in FY25. What’s your take on this?

I am optimistic about the growth potential of the economy. It is one of the tasks of monetary policy to ensure that this potential is not thwarted by excessively high real interest rates.

I also believe that, while India’s growth is robust when compared to the rest of the world, it is below our potential or to our aspirations. The average growth rate since the pandemic is only 4.25 per cent.

You said the real interest rate of 2 per cent creates the very real risk of turning growth pessimism into a self-fulfilling prophecy. Can you elaborate?

An excessively high real interest rate could dampen private sector capital expenditure, and when combined with fiscal consolidation, this could lead to a lower growth rate. If this persists for several years, we could descend into a vicious cycle of diminishing expectations that depresses growth.

Do you see any major risk, external or internal, to growth?

At this point, there is no single risk that dominates. There are multiple sources of risks: domestic and global, economic and geopolitical that are imparting uncertainty to both growth and inflation.

Do you think the potential growth rate of the economy can be 8 per cent? Can it be achieved without bringing down interest rates?

Yes, I think the reforms and infrastructure investment in recent years have pushed the potential growth rate of the economy to at least 8 per cent. Also, there is some growth required to close the post pandemic output gap. However, as I have mentioned above, I see an excessively high real interest rate as a risk to growth.

Are you seeing a pick-up in private capex? You have said sectors battered by the pandemic are bouncing back

While there are some signs of revival, these are still too weak and tentative, I worry that unnecessarily restrictive monetary policy could nip this revival in the bud.