Journalism of Courage
While retail inflation fell to an 11-month low of 5.88 per cent in November after remaining above the 6 per cent level for three consecutive quarters, Jayanth R Varma, a Member of Reserve Bank’s Monetary Policy Committee (MPC), has said the monetary policy can’t take much credit for the fall in inflation in recent months.
Varma, who voted against the proposal of other members of the six-member MPC to hike the repo rate (the rate at which the RBI lends to banks to meet their short-term fund needs) by 35 basis points to 6.25 per cent, said the monetary policy acts with a lag of 3-5 quarters, and the effects of this monetary action will be visible only in early and mid-2023.
The RBI wrote to the government in November explaining the reasons for the failure of the MPC to bring down inflation below the upper tolerance band of 6 per cent for three quarters in a row.
When asked whether the MPC policy stance was instrumental in bringing down inflation below 6 per cent in November, Varma, who is Professor in the Finance and Accounting at IIM Ahmedabad, said, “No. It takes around a year for monetary policy to influence inflation. First the policy rates have to be transmitted to bank deposit and lending rates, and also to the bond markets. Then there is a further lag in the transmission from interest rates to the real economy.”
At this point of time, the first hikes of April and May are just seeping into the real economy, and the impact of the rest of the hikes is several months away, he said. “So, I do not think that monetary policy can take much credit for the fall in inflation in recent months,” Varma told The Indian Express.
On December 7, the MPC’s decision on repo rate was taken in a majority of 5:1 with Varma voting against the hike. In a majority 4:2 decision, the MPC also retained the stance on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Varma and Ashima Goyal voted against this proposal.
The US Federal Reserve and other central banks around the world have been on a rate hiking spree to check soaring inflation levels.
The last policy meeting clearly showed the division in the MPC about tackling inflation and growth issues. “Differences of opinion within the MPC are healthy, because they signify careful analysis and debate about complex issues in an environment of heightened uncertainty. Disagreement is also more natural when the policy rate is close to the terminal rate which is hard to estimate,” Varma said.
“Earlier in the tightening cycle, there was less room for disagreement because the direction of policy was quite clear,” Varma said. The RBI has increased the repo rate by a cumulative 225 basis points (bps) since May this year in a bid to rein in elevated inflation. The MPC hiked the repo rate by 40 bps in May and then by 50 bps in each of the three successive meetings. A basis point is one hundredth of one percentage point.
WITH the inflation downward trend visible, there is debate around not just the quantum of rate hike but the monetary stance itself. Growth concerns dominate conversation among economists and analysts, given that the impact of the hikes since May, will play out from now and into the next calendar year.
On why he is against withdrawal of the accommodative policy stance, Varma said, “During much of 2022, inflation was a much bigger worry than economic growth across the world. However, in the last couple of months, the balance of risks has shifted, and it appears that the worst inflationary fears are receding.”
At the same time, globally, the outlook for growth has become less favourable and more uncertain. “That is why I have been urging caution in tightening monetary policy. I think that we have done enough tightening during this year to bring inflation under control, but monetary policy acts with long lags of 3-5 quarters, and the effects of this monetary action will be visible only in early and mid-2023,” he said.
While credit offtake has already risen to 17.5 per cent, there’s concern that rising interest rates will impact new investments and expansion. “The negative impact of high interest rates on investment decisions is one of the reasons for being cautious while tightening monetary policy. Moreover, investment decisions are driven by expectations about economic growth, and less rosy expectations also act as a dampener,” Varma said.
Several experts have said the global slowdown will impact India’s economy. “Most of the shocks to the Indian economy over the last three years have been global in nature. Whether we look at the pandemic, the supply chain bottlenecks, the Ukraine war, and the commodity price shocks, what we observe is that India is a fairly open economy that is strongly impacted by global factors. The risk of a global slowdown is therefore cause for worry to us in India as well,” he said.
Exports were extremely helpful in propping up economic growth for a couple of years, but in recent quarters, this growth has come to a halt due to global demand conditions, he said. This means that growth has to come from domestic demand, and supporting this demand becomes critical in coming months. “At the same time, a global slowdown dampens demand and cools commodity and energy prices, and it reduces the inflationary pressures in India as well. This again points to the balance of risks shifting from inflation to growth, and the need for monetary policy to adapt to the new alignment of risks,” Varma said.
