Jayanth Varma: ‘Approaching a point where a cut is must to check high real interest rate’

“I think we are approaching the point where an interest rate cut is necessary to prevent an excessive real interest rate,” Varma told The Indian Express in an interview.

To bring inflation down to 4% target, he said, there is a need for a restrictive monetary policy in which the real rate is above the neutral rate. The neutral real rate is hard to estimate accurately, but it is probably around 1%.

“With the dissipation of the Ukraine (war) induced energy and commodity price shocks, I believe that a real rate slightly below 1.5% is appropriate. That is why I argue that the current real interest rate of 2% is excessive,” he said.

Varma, who is part of the six-member rate-setting panel of the RBI, has been expressing his reservation on the ‘withdrawal of accommodation’ stance adopted by the rest of the MPC members.

The US Fed, which kept the key interest rate unchanged, recently hinted at three rate cuts next year. Fed Chair Jerome Powell said he did not expect further tightening would be necessary.

In the minutes of the MPC meetings held on December 6-8, Varma wrote that a stance is not needed at all at this stage, and if at all there is a stance, it should be neutral. “I am waiting only for firmer evidence supporting the current projections of a sustainable fall in inflation. If a rate cut is a distinct possibility, the monetary stance has to be consistent with that. That is why I recommended a neutral stance,” he said.

According to Varma, the current stance carries the risk that at a future meeting, the MPC would be faced with a choice between either postponing a needed cut to conform to the stance, or cutting rates in the face of a stance that calls for further withdrawal of accommodation.

In the December monetary policy, the RBI left the policy repo rate unchanged at 6.5% for the fifth time in a row and continued to focus on ‘withdrawal of accommodation’ stance.

The RBI has projected consumer-price index based (CPI) inflation at 5.4% for FY24. For the first three quarters of FY25, CPI is expected to be at 4.6%.

On the possibility of a rate cut, State Bank Chairman Dinesh Khara said, “For the time being, we may not replicate what they (US Fed) have said because we are still more than 5 per cent inflation, and the RBI governor has repeatedly maintained that we would like to bring the inflation down to 4%.”

“So, I think till such time we are in the vicinity of 4%, I don’t expect the rate cuts to happen. But at the same time, you should be mindful of the fact that the US Fed continued to increase the interest rates, but we never increased the interest rates,” Khara told The Indian Express recently.

Varma said the target for inflation is 4%, and the goal of monetary policy is to drive inflation to that target. “Until that is achieved, monetary policy has to be kept restrictive, but it can become less restrictive as we approach the target. A good analogy would be of how we stop a car while driving at high speed. Initially, we would brake hard, but once the car slows down, we would apply only a gentle brake to bring the car to a halt smoothly,” he said.

The RBI revised upwards real GDP growth forecast for FY24 to 7% from 6.5% earlier.

When asked about his assessment on the Indian economy, Varma said he expects a benign outcome where inflation trends down and growth remains robust. However, there are risks to this assessment emanating primarily from the external environment.

To a question on what he saw as major threats to the 7% growth outlook, Varma said, “The risks of global slowdown and geopolitical volatility are the major risks to the growth outlook. At the current juncture, these risks appear to be manageable, but we must be alert to any sign of further deterioration in the global economy.

To a question on when one can expect rate cuts to begin in India following the US Fed’s recent signal of possible reduction in interest rates in 2024, he said he believed that with flexible exchange rates Indian monetary policy can be reasonably autonomous and does not have to be dictated by the trajectory of US interest rates.

Varma said that during the last few quarters, capacity utilisation has been around the level at which companies start considering capacity expansion. “We are seeing private investment picking up in some sectors, and I am hopeful of further pick up in coming quarters,” he said.