Prospect of a growth sacrifice in 2024-25 is the price for bringing inflation down: Jayanth R Varma

In an interview to HITESH VYAS and GEORGE MATHEW, Varma, Professor of Finance and Accounting, IIM Ahmedabad, says that the 25-basis point cut in the repo rate proposed by him in the June monetary policy would still have left monetary policy highly restrictive. “There is a lot of catch up still to be done to return the economy to the pre-pandemic trend line,” he says.

There’s big concern over high food inflation as vegetable prices have gone through the roof. Monsoon has not picked up in many regions. There are severe heatwaves in several places and reservoir levels are alarmingly low. Do you foresee inflation exceeding MPC projections in the next two quarters?

The good news about food prices during the last year has been two-fold. First, food price spikes have been transient and have reversed quite quickly. Second, food price shocks have not had second round effects. Moreover, the monsoon is expected to be normal this year. So, I expect food price uncertainty to contribute more to the volatility of inflation than to its level.

You have mentioned growth sacrifice in FY25 and FY26 due to restrictive monetary policy. Can you elaborate on this further? Don’t you think inflation would have risen further if monetary policy is eased? What is your expectation of growth in the current and next financial year?

We were already reconciled to the prospect of a growth sacrifice in 2024-25 as the price for bringing inflation down. What is alarming is that the forecasts from the RBI survey of professional forecasters and elsewhere is that growth in 2025-26 will be roughly similar to the forecast for 2024-25. In other words, the growth sacrifice of 0.75 per cent or 1 per cent will last not for one year, but for two. This makes the growth-inflation trade-off a lot worse than we expected. With the inflation scenario looking a lot more benign than last year, we should ask ourselves whether such a large sacrifice is necessary.

It is also important to keep a sharp focus on the real policy rate and not on the nominal repo rate. As inflation has fallen over the last few quarters, a cut in the nominal repo rate only serves to prevent a rise in the real repo rate. The 25-basis point cut that I proposed this meeting would still have left monetary policy highly restrictive. At a time when inflation expectations are well anchored, there is no need to raise the real repo rate at all.

Do you think the RBI is behind the curve in bringing down the interest rates in the system? Despite high interest rates, credit growth is now 16.1 per cent.

One has to look at the totality of evidence. The cumulative economic growth rate from the pre-pandemic period is quite low (around 5 per cent or so). There is a lot of catch up still to be done to return the economy to the pre-pandemic trend line. The projected growth rates for 2024-25 and 2025-26 are below potential growth.

Do you see GDP growth for FY25 to be lower than the projected 7.2 per cent, if repo rate continues to be at 6.5 per cent? You mentioned about the possibility of lower 7 per cent growth. What are the major risks to growth?

There is a lot of forecast uncertainty, and I am not too concerned about a variation of 10 or 20 basis points in the growth rate. My worry is that almost all forecasters are projecting a growth rate that is below potential and below what is needed at the current stage in our demographic transition.

There’s a perception in the RBI that domestic demand should continue to drive the economy, with private consumption receiving a fillip from the revival in rural spending. Do you agree with this?

The point is that after taking all this into account, the RBI is projecting a growth rate that is unacceptably low given our potential growth rate.

Do you think monetary policies of other major central banks will influence the decisions of India’s monetary policy panel?

First, I think India has sufficient monetary autonomy to formulate its monetary policy based on domestic macroeconomic considerations. Second, we are beginning to see some degree of divergence between major global central banks.

Do you expect a big jump in government spending/ capex in the wake of higher GST mobilisation and RBI surplus?

I would like to wait and see what happens in the budget which is not so far away.